Home > Uncategorized > The end of Ricardo-Heckscher-Ohlin-Samuelson trade theory

The end of Ricardo-Heckscher-Ohlin-Samuelson trade theory

from Lars Syll

In 1817 David Ricardo presented — in Principles — a theory that was meant to explain why countries trade and, based on the concept of opportunity cost, how the pattern of export and import is ruled by countries exporting goods in which they have comparative advantage and importing goods in which they have a comparative disadvantage.

Heckscher-Ohlin-HO-Modern-Theory-of-International-TradeRicardo’s theory of comparative advantage, however, didn’t explain why the comparative advantage was the way it was. In the beginning of the 20th century, two Swedish economists — Eli Heckscher and Bertil Ohlin — presented a theory/model/theorem according to which the comparative advantages arose from differences in factor endowments between countries. Countries have a comparative advantages in producing goods that use up production factors that are most abundant in the different countries. Countries would mostly export goods that used the abundant factors of production and import goods that mostly used factors of productions that were scarce.

The Heckscher-Ohlin theorem –as do the elaborations on in it by e.g. Vanek, Stolper and Samuelson — builds on a series of restrictive and unrealistic assumptions. The most critically important — beside the standard market clearing equilibrium assumptions — are

(1) Countries use identical production technologies.

(2) Production takes place with a constant returns to scale technology.

(3) Within countries the factor substitutability is more or less infinite.

(4) Factor-prices are equalised (the Stolper-Samuelson extension of the theorem).

These assumptions are, as almost all empirical testing of the theorem has shown, totally unrealistic. That is, they are empirically false. 

That said, one could indeed wonder why on earth anyone should be interested in applying this theorem to real world situations. As so many other mainstream mathematical models taught to economics students today, this theorem has very little to do  with the real world.

Using false assumptions, mainstream modelers can derive whatever conclusions they want. Wanting to show that ‘free trade is great’ just e.g. assume ‘all economists from Chicago are right’ and ‘all economists from Chicago consider free trade to be great’  The conclusions follows by deduction — but is of course factually totally wrong. Models and theories building on that kind of reasoning is nothing but a pointless waste of time.

david-ricardoThe logic behind classical free trade is that all can benefit when countries specialize in producing those things in which they have comparative advantage. The necessary requirement is that the means of production (capital and technology) are internationally immobile and stuck in each country. That is what globalization has undone.

Several years ago Jack Welch, former CEO of General Electric, captured the new reality when he talked of ideally having every plant you own on a barge. The economic logic was that factories should float between countries to take advantage of lowest costs …

Previously, when corporations were nationally based, profit maximization by business contributed to national economic success by ensuring efficient resource use. Today, corporations still maximize profits, but they do so from the standpoint of their global operations. Consequently, what is good for corporations may not be good for country …

Thomas Palley

  1. December 19, 2016 at 10:00 pm

    i first heard of stolper-samuelson theorem in a basically popular paper by krugman. krugman’s point was this theorem showed that ‘free trade’ was a small, if any part of the source of income inequality. he did suggest a bigger source—‘social conventions’ (and there are many ways to phrase that concept–h simon may have one of the first modern formulations. Krugman also mentioned technolagical change and ‘skills’.) .

    i looked up the theorem—that kind of reasoning was not my style or field but its pretty basic.
    its just a basic balance / accounting equilibrium problem very similar to ones in chemistry.

    the first thing i noticed was it assumed ‘full employment’. its a nice theorem, but full employment is a myth (unless one takes the ‘no involuntary unemployment’ view).

    the other 3 assumptions i noticed later. (to an extent, my view is all these assumptions are equivalent. if you assume any of them , you have all the rest. the one i like which is not listed is ‘perfect substitutibility’. i view that as a variant of the ‘ergodic theorem’. this implies one hour of traditional work is perfectly substituible for an hour of sleep, or an hour of moving rocks around or playing video games. its correct analytically (georgescu-rogescu had a version of this tho i disagreed with some math details in his ‘entropy law’ book–the point is the economy is always at equilibrium if you assume that, and also that humans and products are basically like infinitesimal points .

    Modern condensed matter physics suggests that while that may be fundamentally true –‘in the long term everyone is dead’—boltzmann, keynes) —its not true in any relevant time scale. (the first 2 or 3 proofs of the ergodic theorem by von neumann, birkhoff, and weiner all used CLT or variants (central limit theorem—they assumed what they proved. Boltzmann also had that assumption in his papers—‘molecular chaos assumption’ –ie statistical independence).

    one of last papers p samuelson wrote said was basically the theorem was not applicable to this world.

    • December 20, 2016 at 2:03 am

      “but full employment is a myth”

      Worse than that. Full employment is a reification. They are probably in reality assuming that the country lies on the production possibilities frontier, which is a much rarer situation than the unemployment rate being below 4%

  2. patrick newman
    December 22, 2016 at 10:35 am

    Comparative advantage beyond the accident of natural resources means to global corporations low corporate tax, weak or non-existent trade unions, a population acustomed to long hours and a basic standard of living, a stable political climate that ‘manages’ the work force. The economic picture is distorted by the ability of the global to transfer price and to transfer tax liabilities. The theory of comparative advantage grew up in the UK but its true ‘comparative advantage’ was surely horticulture and agriculture according to its climate but the industrial revolution ‘messed’ it up!

  3. May 4, 2017 at 5:27 am

    There are several dimensions that we have to argue on Mart Malakoff’s short article. I can count three major topics:
    (1) Is it plausible to use the name Ricardo-Heckscher-Ohlin-Samuelson trade theory?
    (2) Admitting that HOS model (or HOV model) is completely false, what is the alternative to HOS model or more widely neoclassical trade theories?
    (3) How should we assess the free trade policy? Are there any alternatives on policies to be adopted in relation to international trade?

    Let me briefly argue each of them.

    (1) HOS theory is not an authentic descendant of Ricardo.
    It is necessary to know that there lies a deep valley between classical and neoclassical economics. If I cite the term that J. R. Hicks used, classical economics is an economics of production (Plutology) and neoclassical economics is an economics of exchange (Catallactics). Now Ricardo with his cost of production theory of value, Ricardo is the main person who clarified (even though of course insufficiently) the logical structure of the classical economics. He did not argue in terms of input substitutions. He clearly admitted that different country may have different production technologies. A conspicuous example is his four magic numbers.

    HOS models are conceived totally in the framework of neoclassical economics. Factor proportions (resource scarcity) and input substitution (infinite factor substitutability) are two of conspicuous characteristics of neoclassical economics.

    Many authors who think they are not in the neoclassical tradition confuse the great difference between Ricardo and HOS theory. We should not use the term “Ricardo-Heckscher-Ohlin-Samuelson trade theory.”

    (2) Alternatives to HOS model
    After HOS model, there are many “new” theories of international trade: HOV models (V indicates Vanek who thought that trade is only an exchange of factors), Krugman’s new trade theory (which explain the possibility of intra-industry trade), Melitz’ new new trade theory (which was born in the 21 century and explains why large number of firms do not engage in international trade while some of the same industry actively trade across national borders.) and Eaton and Kortum’s “Ricardian” model (which is thought to have explained gravity equations).

    I do not argue the reality of those theories. Let me only point that first three theories (HOV, the New, and the New New) deal only with trade of finished goods. They exclude input trade. Eaton and Kortum’s “Ricardian” model admits intermediate goods (input goods) but assumes that labor share in the total cost is the same for all industries. We cannot say that it is a theory which really admits input trade.

    As everyone knows we are in the age of global economy where global value chains are changing the picture of the world production. The mainstream economics has no general theory by which to analyze the global values chains and globalization. They are far back from the actual economy.

    However, to criticize the mainstream alone is not productive. The most important point is what we have. Fortunately, we have now a new theory of international trade. For the details, please see my paper:
    The New Theory of International Values: An Overview
    (This is already published as chapter 1 of a book by Springer-Science, but you can get a rough image by the draft paper.)

    The new theory of international trade is an extension of the Ricardo’s domestic value theory to international trade situation. It is based on a Ricardo-Sraffa trade economy composed of many countries and many commodities. Each nation has its own set of production techniques and choice of production techniques is explicitly analyzed. The international value (comprising wage rates of all nations and prices of commodities) is stable when all firms are producing with global optimal procurement policy. There is no need to assume any special patterns of specializations as they are assumed in the most of mainstream analysis of input trade, fragmentation or outsourcing, and others.

    Another merit of the new theory is that it has an explicit theory on how the wage disparity between nations necessarily appears. It is totally different from HOS theory which admits Factor Price Equalization Theorem as a standard situation. It is useless to say that we can know what to do if we know the real mechanism of the origin of wage disparity.

    Thus the theory of international trade is one of rare fields of economics where an heterogeneous theory supersedes the mainstream theories.

    (3) Trade policy
    The new theory of international trade has no uniquely determined policy implications. It can be used to know the origin of gains from trade (e.g. Sraffa bonus that Samuelson named). As it admits involuntary unemployment, it can be used to know what kind of protection strategy and transitive measures.

    • May 4, 2017 at 7:16 am

      The name “Mart Malakoff” in the first line should be replace by “Lars Syll.” I apologize for my confusion.

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