Page 47 - DECO503_INTERNATIONAL_TRADE_AND_FINANCE_ENGLISH

Unit 4 : Modern Theories of International Trade : Theorem of Factor Price Equalization, H-O Theory, Kravis and...

The exchange rate (the rapport between the export prices and the import prices) is determined by Notes
the crossing/intersection between the two curves, the relative global supply curve and the relative
global demand curve.
If the other elements remain constant, the exchange rate improvement for a country implies a
substantial rise in the welfare of that country.
4. The Competitive Advantage (Michael Porter's Model)
The chain value
Main Activities
(cost advantage) -Logistics--- production-marketing---services
Support activities
quality advantage) ---Firm infrastructure - HR management--stock supply-Technological
development
Competitive Advantage
Michael Porter identified four stages of development in the evolution of a country:
- Development based on factors
- Development based on investments
- Development based on innovation
- Development based on prosperity
The theory is based on a system of determinants, called by the author "diamond":
- The capacity of internal factors
- The specific of the domestic market
- The links between the industries
- Domestic competition environment
We will discuss each of the two theorems in detail.
4.1 The Factor-Price Equalization Theorem

The factor-price equalization theorem has enjoyed far less limelight than the Heckscher-Ohlin theorem.
Nevertheless, it has attracted considerable attention from well-known economists. Heckscher (1919)
stated that free trade equalizes factor rewards completely. Ohlin (1933), on the other hand argued
that full factor-price equalization cannot occur in practice. Ohlin asserted that free trade brings about
only a tendency towards factor-price equalization, and only a partial factor-price equalization is
possible. The later models by Stolper and Samuelson (1941) and Uzawa (1959) also support partial
equalization thesis. The later works of Samuelson (1948, 1949, 1953) and of Lerner (1953) make out a
case for complete factor-price equalization.
In order to demonstrate how the fector-price equalization takes place as a result of international
trade, we will use our model of two countries (country A and B), two commodities (goods X and Y)
and two factors of production (capital K, and Labour, L). Before trade (i.e. in a situation of autarky)
we have the following situations : (1) In country A, a labour surplus country, labour is abundant and
cheap and capital is scarce and expensive. Therefore, the K/L (or capital labour ratio) is rather low.
And once the trade is opened up, labour becomes relatively scarce and the price of labour will go up.
Similarly, capital becomes relatively abundant and hence the cost of capital will go down. This follows
directly from the Heckscher-Ohlin theorem that the labour surplus country will specialize in the
production and exports of labour-intensive goods. In other words, the abundant factor becomes scarce
and the scarce factor becomes abundant, relatively so that (after trade) the K/L will go up in country
A. (2) In the capital surplus country—country B—the pre-trade situation is such that capital is abundant
and cheap, and labour is scarce and therefore expensive. The K/L will be high before trade. But after
trade, this country will specialize in the production of capital-intensive goods, so that the demand for
capital will rise relative to that of labour. This will result in capital becoming scarce and the cost of

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