2 management - School of International Business and ...

155 The Puzzle of Globalization
The extension of Heckscher-Ohlin’s Factor Endowment Theorem by Paul Samuelson – usually
named HOS Theorem - [Samuelson, 1948] allows, in addition to the description of the pattern
of trade, the prediction of its impact on the equilibrium on the markets for the production factors.
If factor price equalization has been achieved (Annex, figure 4), free trade is fully substituting
cross-border capital flows and/or migration. The world equilibrium is Pareto-optimal.
Another important result of free trade within the framework of the Heckscher-Ohlin model refers
to the income distribution. If in the free trade situation the production of the relatively labour-in-
tensive good expands in the labour-rich country and its relatively capital-intensive production
shrinks, the aggregate demand for labour will rise relative to capital, thus increasing the wage
and decreasing the rent. This result – established as Stolper-Samuelson Theroem [Stolper/
Samuelson, 1941] has initiated a still ongoing debate on »trade and wages«.
The first empirical test of the Heckscher-Ohlin model based on input-output tables of the U.S.A.
delivered a surprising result. Contradictory to the expectation that its exports are capital-inten-
sive, Leontief calculated the opposite factor intensity: The exports are labour-intensive and the
imports capital-intensive [Leontief Paradoxon, Leontief, 1953]. His suggestion for this paradox-
ical conclusion referred to the higher effectiveness of workers in the U.S.A. If the same work-
ers produce in other countries, their effectiveness will be three times lower. He argued that the
economic organization and the economic incentives in the U.S.A. explain his result. Among the
theoretical and empirical explanations of a huge number of economists, the demand bias hy-
pothesis fits best into the neo-classical trade model (Annex, figure 5) , but its empirical relevance
is controversial. This holds also for other explanations, such as factor intensity reversal (e.g.
capital-intensive agricultural products in the U.S.A. and labour-intensive agricultural products in
developing countries) or trade imbalance (depending on surplus or deficit in the current account
balance the factor intensity of export/imports can change).
3.2.3 NEW TRADE THEORY: INTRA-INDUSTRY TRADE
The New Trade Theory emerged from the observation that after World War II the transatlantic and
European trade showed a pattern that more and more contradicted the neo-classical prediction
of inter-industry trade. Analysing two-way trade in the same industry needs new tools that basi-
cally rely on the theory of monopolistic competition but specify both consumer preferences and
cost. The former were based on the assumption that utility depends on the consumption level of
a large but variable number of distinct goods implying consumers’ preference for diversity. The
cost function includes fixed and constant variable cost. The former decreases with higher outputs,
thus implying increasing returns to scale. Producers in the same industry can achieve a monop-
olistic market position. The standard equilibrium model of monopolistic market is implemented
into the Heckscher-Ohlin model. In the autarky situation each firm produces the quantity of its
differentiated good according to the monopoly market theory and realizes the price that clears the