Gerald R. Ford School of Public Policy The University of Michigan Ann Arbor, Michigan 48109-3091
Discussion Paper No. 575
East is East and West is West: A Ricardian-Heckscher-Ohlin Model of Comparative Advantage
Peter M. Morrow
University of Toronto
January 8, 2008
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East is East and West is West: A Ricardian-Heckscher-Ohlin Model of Comparative Advantage Peter M. Morrow The University of Toronto January 8th, 2008 Abstract Models of comparative advantage are usually based either on diﬀerences in factor abundance or diﬀerences in total factor productivity within a country despite considerable empirical evidence that both matter. This paper articulates a uniﬁed and tractable model in which comparative advantage exists due to diﬀerences in factor abundance and relative productivity diﬀerences across a continuum of industries with monopolistic competition and increasing returns to scale. I provide evidence that both sources of comparative advantage shape international production patterns. In addition, I ﬁnd that relative productivity diﬀerences across industries are uncorrelated with the factor intensities of these industries. Therefore, each of the two forces for comparative advantage oﬀers valid partial descriptions of the data. Consequently, simply aggregating the predictions of the factor abundance-based and relative productivity-based models can be used to obtain a full description of industry-by-industry production patterns.
I thank Mary Amiti, Olivier Coibion, Alan Deardorﬀ, Ann Ferris, Yuriy Gorodnichenko, Juan Carlos Hallak, James Levinsohn, Jagadeesh Sivadasan, Gary Solon, and Daniel Treﬂer. I also thank seminar participants at Columbia University, The Federal Reserve Bank of New York, the University of Michigan, Syracuse University, and The University of Toronto. All errors are mine and mine alone. The title of this paper comes from the poem “The Ballad of East and West” by Rudyard Kipling which begins “Oh, East is East, and West is West, and never the twain shall meet....”
Production patterns around the world exhibit tremendous heterogeneity and specialization. For example, the United States supplies 16.2% of the world’s exports of aircraft while China provides only 0.1%. On the other hand, China supplies 14.9% of the world’s export supply of apparel and clothing while the United States only supplies 0.9%.1 The Ricardian and Heckscher-Ohlin (HO) theories are the two workhorse models used to explain this specialization. The Ricardian model of international trade predicts that countries specialize in goods in which they hold the greatest relative advantage in total factor productivity (TFP).2 The Heckscher-Ohlin model ignores diﬀerences in TFP across industries and assumes that all countries possess the same production function in a given industry. Heckscher-Ohlin asserts that diﬀerences in comparative advantage come from diﬀerences in factor abundance and in the factor intensity of goods. Neither model, in isolation, oﬀers a complete description of why production patterns diﬀer nor does either oﬀer a uniﬁed theory of international specialization. Consequently, empirical tests of each model can be subject to the omitted variable problems associated with ignoring the other. Finally, little work has been done in assessing the relative empirical importance of the two models. This paper presents a uniﬁed structural framework that nests each source of comparative advantage when there is a continuum of industries. The model’s tractability allows me to estimate the relative contributions of Ricardian and HO forces through traditional estimation techniques. I highlight three important ﬁndings. First, both the Ricardian and HO models possess robust explanatory power in determining international patterns of...