Evidence on the Heckscher-Ohlin Theorem - YouTube

Now let's take a look at what the evidence says about

the Heckscher-Ohlin theorem.

But, of course, you should be watching this in conjunction with

our video on the Heckscher-Ohlin theorem itself.

We're going back to the key question of what explains trade,

and here we're talking about the quantity, the direction,

and also the composition of that trade.

One possible nomination for an explanatory factor about trade

is factor intensities,

namely, whether your country has a lot of capital or a lot of labor

relative to other countries in the world.

So just to recap the Heckscher-Ohlin theorem,

or HOT for short,

it's saying that capital-intensive countries, by global standards, that is,

should be exporting capital-intensive products.

Similarly, labor-intensive countries, again, by global standards,

should be exporting labor-intensive products.

You can think of these propositions as a way of making

the theory of comparative advantage just a little more concrete.

So for instance, if your country has a lot of capital

relative to global standards

you might expect that, all other things being equal,

that country will be very good at exporting capital-intensive products.

In any case, that's the hypothesis

which the Heckscher-Ohlin theorem is directing our attention to.

But of course, we run up against that very tough question,

"Is this actually true?"

Now enter Wassily Leontief, who later won a Nobel Prize in economics.

He published a very famous paper in 1953,

and in that paper he calculated the labor-output and capital-output ratios

for a variety of sectors in the American economy.

He also calculated how much capital and how much labor are embodied in exports.

And here's the problem.

By global standards, as you might expect,

the United States measured as capital-intensive.

Yet, if you look at the content of American exports in Leontief's paper,

he found that the US exports, on net, labor-intensive goods

and it imports, on net, capital-intensive goods.

And of course, that is the exact opposite

of what the Heckscher-Ohlin theorem would lead you to believe.

Actually, ever since Leontief's paper in the 1950s,

the empirical status of Heckscher-Ohlin has been somewhat in a state of crisis.

And so, this is a puzzle which researchers have been trying to solve

for the last 60 years.

Another important test, again, with largely negative results,

came in a famous paper by Bowen, Leamer, and Sveikauskas published in 1987.

They developed what is called the "sign test".

To do the sign test,

you start by looking at a country's factor endowment.

For instance, you might decide that a particular country is capital-intensive.

You then want to ask about the exports of that country.

Will the exports of that country also be capital-intensive?

In essence, you're testing to see if you can find the same sign.

Yet, for that simple test, using global data,

actually, the Heckscher-Ohlin theorem fails at least 1/3 of the time.

The authors also developed what is called the rank test.

So let's say we look at a country which ranks, say, at number 3,

when it comes to labor intensity of its factors.

We would expect that same country,

when you're looking at the factor content of its exports,

to rank very high when it comes to labor intensity of exports.

Yet, in general, that is not the case.

The rank order of factor intensity in a country

does not very well predict the rank order of factor content

in that country's exports.

Instead, a country which ranks really high in having a lot of labor

will be exporting more capital in its goods than you otherwise tended to expect.

Further empirical problems for the Heckscher-Ohlin theorem

came out of a 1995 paper by Trefler called,

"The Case of the Missing Trade and Other Mysteries".

The missing trade puzzle is this:

given that there are big differences in factor endowments across countries,

we should, in fact, expect to see much trade than what we actually observe.

Furthermore, the trade we do see on net doesn't actually

send much-embodied capital to the labor-intensive countries,

or much-embodied labor to the capital-intensive countries.

So there is hardly any trade in net factor content.

I find this a very useful perspective.

The observed deviations from Heckscher-Ohlin;

you can read them as really asking,

"Why isn't there, in the global economy, much more trade than what we observe?"

It's really a Coasian question about,

"Why are transaction costs so high

and limiting, what are potentially, mutually beneficial exchanges?"

Another observed puzzle from the "Missing Trade" paper is this:

namely that poor countries export less than is predicted by theory,

and they import more than is predicted by theory.

There's some difficulty in getting those countries

to be viable sellers on a large scale,

which our theory isn't quite picking up.

So given all these problems,

can we, in fact, save the Heckscher-Ohlin theorem when it comes to empirics?

And it turns out, there actually is a way forward

which makes the theory more defensible.

Let's go back to the original Leontief critique.

Leontief classified the United States as capital-intensive.

But, you might ask, "Well, who says

the United States is in fact capital-intensive?"

You can add up the labor in the United States

and you can add up the capital,

but what's the natural unit of measurement?

You might argue that

if the United States has different technologies than other countries,

which indeed it does,

well, we need to sum up labor in the United States

to take account of the quality of labor in the United States,

because the quality of labor is augmented by how much capital we have invested.

So once we allow for different technologies,

and once we allow for the fact that labor may be more effective

in some countries than others,

well, there exist measures that make the US labor-intensive

rather than capital intensive,

and then the Leontief paradox would go away,

because we would be measuring the US as labor-intensive

and finding that US exports are also labor-intensive.

To go back to our video on the theory of Heckscher and Ohlin,

keep in mind we really did assume a common technology across all countries.

And when you have a common technology, it's relatively easy to add up

which countries are labor-intensive or capital-intensive.

But when that technology is varying, we then have to worry,

not just about the quantity of labor in a country,

but how effective that labor is.

There's even a way to make

the Heckscher-Ohlin theorem a kind of tautology.

If you observe that the United States is exporting labor-intensive goods,

simply postulate that we have technologies,

so that, when you combine them with labor,

the degree of "effective" labor in this country is so high,

that we're actually labor-intensive after all.

And, indeed, there's an interesting test of the Heckscher-Ohlin theorem

within a single country, looking only at regions of Japan.

And, of course, within Japan, a relatively homogeneous country,

you would expect technology across the different regions

to be more or less constant.

And what is it we find?

Well, when technology is more or less uniform,

the predictions of the Heckscher-Ohlin theorem do pretty well.

And, in fact, it's the capital-intensive regions of Japan

which are exporting capital-intensive goods to other parts of Japan.

Well, what to do?

So there's now a whole new research program.

What you can do is take observed Heckscher-Ohlin theorem violations,

then see, given those violations,

what is the implied difference in technologies across borders.

And then, you can do independent tests to see

if these differences are in fact true.

The original postulated version of the Heckscher-Ohlin theorem

still is turning out to be false,

but the theorem remains nonetheless useful.

If you take the theorem and you modify the assumption of identical technologies,

the combination of the theorem and an account of technological differences

still will give you a kind of useful hammer

for explaining some patterns of global trade.

In this sense, the Heckscher-Ohlin research paradigm is alive and well.

This point about technology differences directs our attention to a fundamental link

between the Heckscher-Ohlin theorem and the lack of what is called

factor price equalization across borders.

That is, returns to capital and returns to labor

do not equalize borders,

do not equalize across rich and poor countries.

This too, in part, is because countries have different technologies

or maybe even different cultures.

In this regard, you can think of a culture as a technology.

So there's this fundamental factor, some kind of differences across countries,

which prevent perfect factor price equalization

and they prevent the Heckscher-Ohlin theorem from holding

and we're back to this basic fundamental philosophical question

that we have two literatures on international trade,

Heckscher-Ohlin theorem and factor price equalization,

and they're both getting at what is basically the same question:

how and why is it that countries are different

and how is it that those differences inhibit the amount of trade?

The literature on the Heckscher-Ohlin theorem and related issues,

of course, continues to grow.

So some of the questions that people are working on now

is trying to disaggregate the data better.

So you're not just dealing with

economy-wide or sector-wide measures of factor intensity

and also studying firm-level export decisions,

again a move in the direction of greater disaggregation.

The Heckscher- Ohlin theorem continues to generate

fruitful puzzles for people to work on.

This video already has listed plenty of sources and papers to read.

But for overviews, I found the following especially helpful.

There's a paper by Helpman online called "The Structure of Foreign Trade"

and it provides an overview of some of these debates.

A book by Robert Feenstra, "Advanced International Trade,"

and the underground graduate text by Feenstra and Taylor

give very good surveys on the Heckscher-Ohlin theorem.

There's also a paper online by Davis and Weinstein called

"What Role for Empirics in International Trade?"

For closely related issues to Heckscher-Ohlin,

see also our videos covering the topics of

increasing returns and international trade,

the gravity equation and also factor price equalization.