Transcript
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The speaker introduces factor price equalization as an extension of the Stolper-Samuelson theorem. They explain that the argument will rely on simple supply and demand reasoning rather than heavy math.
Welcome back.Here in this video, we are stepping into the last part of the theoretical analysis in this chapter.Okay?We're going to talk about something called the factor price equalization.Believe it or not, you should already uh understand this.Okay?Uh if you have a pretty good understanding of the um Stolper-Samuelson theorem.Okay?This is a a very easy extension we're going to make on the basis of that theorem.Okay?So, simply speaking, uh we are trying to say that um the factor price tends to be equalized across countries because of international trade.Okay?Now, let's take a look at this.What we're going to do here is just a logical reasoning on the change in relative price of factors.Okay?Uh of course, this is because of the trade.Okay?So, we're not going to, you know, use more math or even graphs.
Okay?And uh a very simple supply and demand analysis should be uh sufficient.All right.
The transcript walks through pre-trade and post-trade conditions in home and foreign, showing how trade raises wages in labor-abundant home and lowers them in labor-scarce foreign. It also explains the opposite movement in capital rental rates and argues that both factor prices should converge over time.
So, uh first off all, let's take a look at the pre-trade situation in home and foreign.Okay?The two economies.Remember, pre-trade here means uh the two economies are isolated from each other.Okay?And we still have the assumptions we made before.So, home is abundant in abundant in labor, right?And um then labor is priced relatively low because of its abundance, right?And uh of course, relatively speaking, uh capital is priced high because of its scarcity.Okay?And um in foreign, it will be the opposite.So, labor is priced relatively high because of its scarcity and capital is priced uh relatively low because of its abundance.Okay?Now, um when these two economies start trading with each other, what we find is uh post-trading home, labor is priced higher.Now, here, remember, higher means higher than the the uh that in pre-trade situation in home.
Okay?It doesn't mean they're going to be higher than um that in foreign.Now, and it's going to be higher than um itself in the previous situation.Okay?Or before trade.Um this is because we said that, you know, uh when they start trade, then home would export um cloth, which is labor intensive, right?So, uh along with the expansion of the cloth sector, there's going to be a larger demand uh for uh cloth and of course, a larger demand for labor, right?That pushes up uh the labor price, and or the wage.And uh in home, capital is priced lower again than that um before trade in home.Because of the smaller demand for food produced domestically.Remember, um now uh home would import more food from foreign, right?Because it's cheaper.So, the smaller demand for food means the food industry shrinks.And of course, the capital would face a lower demand.
So, that creates um I'm sorry, that leads to a a lower price relatively.Okay?Now, post-trading foreign uh means the uh labor is priced lower because of the smaller demand for cloth uh produced domestically in foreign.Okay?So, they just simply import from home, right?So, the cloth industry in foreign shrinks.And its demand for labor goes down.Of course, the wage will go down as a result.And capital is priced higher because now they're exporting food, they need more capital.So, higher demand leads to higher uh capital uh price or rental price.Okay?Now, putting together, you would find that, you know, labor used to be uh dirt cheap in home.Now, because of trade, it's priced higher, right?Uh in home.And labor used to be priced high in foreign before trade.Now, because of the trade, it will be priced lower.Okay?
So, you can imagine that, you know, at the beginning, um the uh wage in home is quite low, okay?And the wage in foreign is quite high.Now, because of the trade, the low wage in home increases, and the high wage in foreign decreases.Right?If this continues, then eventually the wage should be equal between these two economies.Right?Similarly, for the rental price, uh before trade, it used to be high in home and low in foreign, right?Now, because of trade, uh capital is priced lower, so that the high rental price in home goes down, and the low rental price in foreign goes up.And eventually, they should meet with each other and be equal between the two economies.Right?
This section summarizes the idea that countries are effectively trading factors of production through goods trade. Home exports labor embodied in cloth, while foreign exports capital embodied in food, even though the factors themselves do not move across borders.
All right.So, here, um that's a summary of what we just discussed.Once again, uh the two economies, home and foreign, are in effect trading factors of production.Okay?This is super important.Uh the most important um point we want to get across with the Heckscher-Ohlin model.Okay?Now, home exports its labor in embedded um in its labor-intensive export of cloth.And um foreign exports its capital embedded uh embodied um in its capital-intensive export of food.So, when we look at the pattern of trade, it looks like, you know, home exports cloth and foreign exports food.However, the fundamental um reason for that pattern of trade is because home wants to export its labor.Foreign wants to export its capital.Okay?But, in the realistic world, these factors of production, labor and capital, are usually difficult to move across the border, right?So, the then, you know, what we see is uh workers in home would just stay in home, but they produce something for foreign, right?
In this case, it would be cloth.And the capital uh in foreign will stay there.Okay?They're not going to travel across the border, but they produce food and uh export it to home.Okay?
The speaker turns to empirical evidence on labor costs in major auto-producing countries and shows that wages remain far from equal. The section ends by questioning why theory and reality differ and setting up the next discussion.
All right.Um the factor price equalization, let's check out the empirical evidence.It might be a bit disappointing.Okay?Are factor prices really equal across countries?Right?Now, here is a very simple piece of uh empirical evidence about uh wage, okay?Which is a um uh price of labor, right?Now, we're looking at the average hourly labor cost for workers uh in the largest auto manufacturing countries.Okay?Uh the data is from 2015.Now, several things uh we want to see here.Number one, uh we're looking at hourly wage, okay?Or labor cost.So, um that um should include the wage and some other compensation, okay?Like benefit uh package.Um Hourly wage, um that's how we measure labor cost, okay?Because we have a full-time versus uh uh part-time workers, right?So, we cannot simply count the number of heads.We have to count their um number of uh hours, okay?
Working hours.And uh the second thing is here, uh we narrowly focused upon the auto manufacturing uh countries because uh again, uh we want to compare apples with apples.Okay?Um sometimes, you know, you two countries are producing uh totally different things, then um it's pointless to put them together and compare labor cost.Okay?Now, here we find that um Germany has the highest uh labor cost per hour, right?$26.25, okay?So, we already converted um everything into US dollars.And the comes as the second, $23.83.Okay?And it goes all the way down to um for example, Mexico, $3.29 per hour.India, $1.09 per hour.So, you see a huge gap here in terms of the uh auto manufacturing labor cost.Okay?They are not equal at all.Right?So, here again, we would like to challenge the theoretical conclusions we drew before.Why are the wages still not equal, right?
So, we, you know, already experienced this um wave of globalization, right?Uh we see that, you know, um the trade share in GDP uh rose substantially, okay, across countries, regardless of the income level.Uh but here, we still see a huge gap in the um wage.Okay?Where did we go wrong in theory?Okay?I leave these two uh questions for you guys to think about.Okay?And bring your thoughts to our uh class.Okay?And we can discuss these.Is that really because the theory is wrong or probably because there's, you know, a slightly different way to interpret this uh factor price equalization thing?Or is that because something we discussed before, especially at the beginning of the chapter, uh that might have some uh implication here, okay?Uh for us to interpret this wide gap of the wage across countries.All right?So, um that's what we are uh discussing here, okay, for this video.
In uh in the next video, we're going to continue uh discussing more empirical evidence about Heckscher-Ohlin model.