The Heckscher-Ohlin Model: Trade, Growth and Convergence

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Table of Contents

Introduction
The context in the existing literature
Context in reality
Evidence
Conclusion
Summary
Works Cited

Introduction

Numerous scholarly materials explain the impacts of international trade on developed and developing countries. The existing literature combines various models with the neoclassical growth theory to determine the effects of trade on closed economies. However, in this essay, the dynamic Heckscher-Ohlin model will be considered in determining the consequences of the introduction of international trade in both closed and open economies.

Market incompleteness is also addressed in the paper, which makes the approach different from the existing models. The third world countries’ per capita income diverges every time there is some engagement in the international community as far as trade is concerned. The benefits gained for both the trading countries will be analyzed thoroughly to determine the significance of such dealings under uncertainties, as a majority of the existing literatures have overlooked this area. The model under analysis will determine the benefits accrued when two countries do business, especially trade, between the third world countries and developed states. In this paper, a comparison of the data and assumptions used by different models will be considered in a bid to determine the reliability of this model as compared to the other models.

The context in the existing literature

Most traditional models emphasize closed economies to determine the convergence of income levels. However, the dynamic Heckscher-Ohlin model seeks to analyze the results emanating from opening up the closed countries to international trade. The effect of this opening is twofold, as it may lead to either convergence or divergence. However, opening up these countries to trade can also hinder convergence in some cases, especially if it is caused by a productive factor in the country. This model will thus examine these effects deeply to determine the consequences of opening this form of an economy to international trade. The model will study the effects of trading between countries with high and low income per capita.

In closed economies, international trade results in divergence of income per capita of poor countries in the economy due to the favorable terms of trade offered by the international markets that reduce the incentive to build up capital. In poor countries, the convergence of per capita income is caused by productive factors, which may be either labor or physical capital. In this model, a country is said to be rich if it possesses any of the factors of production in abundance.

Convergence can also be dictated by the substitution elasticity of the products in the market. However, this scenario is not the case where each trading country specializes in production of a single line of product. However, the Heckscher-Ohlin model has its limitations (Cunat and Maffezzoli 707). It is based on the assumption that countries export goods that they have in abundance. A country, which is labor abundant, is expected to utilize this factor of production more than the rest, and thus it should export these products in exchange for those items it lacks the factors necessary for their manufacture. In addition, the theory assumes the existence of identical technologies in the various countries and thus the uniformity of the products produced. These assumptions may lead to poor performance of the model especially in the selection of the data to be used in determining the desired results.

Context in reality

Unlike the existing literatures, the dynamic Heckscher-Ohlin model provides room for incorporation of open economies when examining the effects of international trade on it (Sayan 1471). It also includes the assumptions that the state of uncertainty exists and that there is balance of trade. The two highlighted assumptions that the model incorporates on top of the rest existing models and its consideration of open economies lead to a difference in the obtainable results in regard to introduction of international trade. In a closed economy, the implementation of international trade has the divergence effect on the income per capita.

However, the case is different when an open economy is considered. In an open economy, the introduction of international trade results in convergence of per capita income. The case is also different with the assumption of uncertainty and balance of trade. In cases where there is no uncertainty, trade leads to divergence of per capita income in economy. However, with the assumption of uncertainty, the obtained results will be a divergence in per capita income. These differences call for a more reliable model that can produce results that can be trusted. The dynamic Heckscher-Ohlin model endeavors to explain these differences.

Convergence

There exists the unique invariant probability measure μ on (X, B) so that limt → ∞ Pt(k0,B) = μ(B) for all k0 > 0. The full support of μ is the unique non-degenerate compact interval on R++ given by [kmaxz , kminz ] (Sayan 1471).

Evidence

The extract above suggests that the short and long term per capita income of different small open economies will remain constant regardless of where they start. Based on the assumption that trade conditions remain constant, the per capita capital of stock will converge in the end, thus leading to the convergence of per capita income of the various countries involved. In this case, a certain amount of uncertainty drives the small economies to rely on loans and grants from the world’s economy. Alternatively, the small economies can increase their savings at times when their income exceeds their consumption as well as reduce the overall savings at times when their income is lower than their consumption is.

This assertion is true as the marginal propensity to save raises with the increase in the income and goes down with reduction in the overall income. In this uncertainty state, “there is no equalization of factor prices despite the view that the future factor prices are assumed to be equal” (Cunat and Maffezzoli 716). The participants in the economy are thus faced with the risk of losing some income gained or its reduction. So that they will thus have to make decisions regarding accumulating or de-accumulating capital.

Conclusion

In the diversification cone, trade will induce favorable trading terms, which will negatively affect the saving preference as many will prefer to invest under the favorable terms in place in order to increase their savings, thus leading to convergence of per capita income. So far, this analysis shows that under uncertainty and balance of trade, the result will be convergence in the per capita income. The speed and the route of the convergence can be determined in this case as well. It is possible to incorporate the Cobb Douglas and the log utility models to conduct a simulation hence to obtain the reliable results (Bajona and Kehoe 149). The results of the aforementioned models are perfectly made in agreement with the results obtained from Heckscher-Ohlin model, and they only serve as guidance on the convergence speed and accuracy of the data used and the model itself.

Summary

The results of this analysis differ greatly with the existing literatures. Variance is probably caused by the approaches in these different models. In this paper, the approach involves the assumptions of uncertainty and balanced trade that the earlier works do not consider. Therefore, there exist notable differences in this new approach as compared to the subsisting literatures. The first and the most crucial difference is noted in the results of introducing international trade. In an open economy, trade will lead to divergence of per capita income in the economy. On the other hand, trade will contribute to the convergence of per capita income in a closed economy where conditions of uncertainty exist. Therefore, there is a “great danger of using a closed economy to illustrate the effects of international trade” (Cunat and Maffezzoli 707).

The results might not reflect the reality, and thus they may be completely unreliable. The dynamic Heckscher-Ohlin model gives reliable results, and thus it can be used to predict the status of economy over a given period. For example, one may use the model to determine the per capita income of economy in future. The model proves that the assumption of factor price equalization, which has been applied in most models, can be misleading, and it suggests that factor prices at a given time cannot be equal to those in the future.

Works Cited

Bajona, Claustre, and Timothy Kehoe. “Trade, growth, and convergence in a dynamic Heckscher–Ohlin model.” Review of Economic Dynamics 13.3 (2010): 487-513. Print.

Cunat, Alejandro, and Marco Maffezzoli. “Neoclassical growth and commodity trade.” Review of Economic Dynamics 7.3 (2004): 707-736. Print.

Sayan, Serdar. “Heckscher–Ohlin revisited: implications of differential population dynamics for trade within an overlapping generations framework”. Journal of Economic Dynamics and Control 29.9 (2005): 1471-1493. Print.

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