The heckscher-ohlin

Case Analysis : Can Heckscher-Ohlin explain China's Trade?

Summary

The Heckscher-Ohlin (H-O) Theorem states that countries export those commodities which require, for their production, relatively intensive use of those productive factors found locally in relative abundance.

The trade relation between China and U.S. seems to follow the logic of H-O theorem. China is full of cheap labor while on the other hand U.S. is full of cheap capital availability. So those firms for which having cheap labor is the only basis of competition shifted their bases from U.S. to china. And majority of the banking business has shifted to U.S. gains from exchanges are enormous.

The available trade data seems to support this argument quite handsomely. We find that majority of the export (around 78%) from U.S. to china consists of aircrafts, engines, turbines, fats, oils, and industrial inorganic chemicals. While China's export to U.S. contains footwear, watches, toys, weaving and finishing tools (around 73%).

Case analysis

For the U.S. and Australia, the database tariff rates are already very low. A 10 per cent tariff cut alters relative prices only modestly for these countries. In the H-O model, small shocks to prices can trigger large resource reallocation and output changes. To restore equilibrium, all prices have to change which results in slightly larger terms of trade effects, but these effects are outweighed by strong output expansion effects and result in the smaller welfare losses mentioned earlier.

The terms of trade effects in the H-O model for China are much smaller and are also smaller for many of its trading partner countries and regions. This result can be explained by China's high initial tariff rate and the type of goods it exports. A 10 per cent cut in Chinese tariffs causes a relatively large increase in the domestic demand for imports. China therefore exports more to balance its trade, i.e. trade surplus. According to H-O model China does not suffer from heavy terms of trade losses, and also other countries do not gain as much in their terms of trade. These smaller terms of trade losses combined with the large output expansion captured in the H-O model lead to the welfare gains for China predicted as a result of China's trade liberalization.

The critical assumption of the Heckscher-Ohlin (H-O) model is that the two countries are identical, except for the difference in resource endowments.

Specializations of each country

This relationship is much more apparent in Figure shown below (drawn with the help of table 4). As the skill intensity of the industry increases, the share of China's export to U.S. in these industries declines. Though a slope of -4.89 may not seem significant, keep in mind that this graph is China's share relative to total U.S. imports from the rest of the world in each industry. Also, the scale of the graph makes the line to appear much flatter than it actually is because the range of the x-axis is bounded by the maximum value of the industries represented by Chinese exports. This is done to spread out the data so that the distribution in industries that are actually represented in import goods from China can be seen clearly.

It is clear from the concentration of the data points toward the left of the graph that the majority of industries that are represented by Chinese exports to the U.S. are in the low skill intensity range. This result makes sense given our assumptions about the Chinese unskilled to skilled labor ratio relative to the U.S. Furthermore, it appears from this data that countries capture larger shares of world production in commodities that intensively use their abundant, relatively inexpensive factors of production. China's high unskilled to skilled labor force relative to the U.S. causes it to specialize in goods that require unskilled labor more intensively.

This is reflected in the U.S. import pattern with imports from China being highly represented in low skill intensity industries.

As China has grown over this period, it has accumulated significant amounts of skilled-labor and capital. So the basis for comparative advantages is cheap labor. If we assume that the level of unskilled labor is constant, this would increase their relative skilled to unskilled labor ratio; if capital accumulates quicker than skilled labor, the capital labor ratio will also increase. These accumulations should cause China to shift production to higher skill and capital-intensive goods, which should be revealed by an increase of China's share of U.S. imports in skilled and capital-intensive industries.

Learning

The data shows that China is not shifting production into capital-intensive industries and specializing in exporting those goods. This conclusion seem to be counterintuitive when thinking about China's growth, one would think that China is producing more capital intensive goods for export as they continue to grow. What could account for this counterintuitive, if not contradictory result in the capital-intensity coefficient?

Continued growth of the labor force as millions of Chinese leave the agricultural sector for the urban sector puts pressure on both capital and workers to leave the capital-intensive sector as labor-intensive production expands.

Because of this mass migration from the agricultural sector to the urban sector, "capital-intensive production has to contract unless additional capital is made available to combine with an increased flow of labor from the agricultural sector. Protectionism and its policies have become less potent with the time and increased trade.

The flow of labor from China's massive agricultural sector is hugeon the order of hundreds of millions of workers." Holding labor constant as capital accumulates causes the capital-labor ratio to increase and production is shifted into capital-intensive industries. However, this mass migration from the agricultural sector is increasing the labor supply even as capital is being accumulated. If labor accumulation outpaces capital accumulation, the capital-labor ratio will actually decline. Thus, labor becomes cheaper relative to capital and manufacturers will start substituting capital for labor. This will either cause capital-intensive industries to change their production process to one that utilizes the cheap labor, or contract production as capital as an input to production becomes relatively more expensive. If this is indeed what is going on in China then, holding the U.S.'s capital-labor ratio constant, China's capital-labor ratio will decrease and become relatively in 2000s; as a result of this, China will shift production to labor-intensive goods and export less capital-intensive goods. Opportunity of costs for wanting to export

References

  1. Andrew J. DuBrin , Essentials of Management, Electronics Source, Retrieved on 8th April 2010 from http://books.google.co.in/books?id=dNThzoekGQcC&pg=PA48&lpg=PA48&dq=Armstrong,+David.+U.S.+Racks+Up+Record&source=bl&ots=-uwX0Evh_e&sig=S0dwkJ3rqAvzzgLiMhTO8F0i-hU&hl=en&ei=Jc2-S4PENom2rAeIx_jUCQ&sa=X&oi=book_result&ct=result&resnum=2&ved=0CAkQ6AEwAQ#v=onepage&q=Armstrong%2C%20David.%20U.S.%20Racks%20Up%20Record&f=false
  2. US Trade Imbalance, Electronics Source, Retrieved on 8th April 2010 from http://articles.sfgate.com/2006-02-11/business/17279935_1_trade-deficit-trade-policy-billion
  3. HECKSCHER-OHLIN TRADE THEORY, Electronics Source, Retrieved on 8th April 2010 from http://www.econ.rochester.edu/Faculty/jones/Palgrave_Jones_on_Heckscher_Ohlin.pdf
  4. Krugman, Paul R. "Scale Economies, Product Differentiation, and the Pattern of Trade," American Economic Review 70, no. 5 (December 1980): 950-59.
  5. Whalley, J. 1985. Trade liberalization among major world trading areas. Cambridge, The MIT Press.

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