Factor price equalization theorem

The factor price equalization (as Lerner-Samuelson theorem , states known) that a free international trade in goods (in terms of trade with finished products ) under certain conditions for an international equalization of factor prices (particularly of labor and capital leads). The factor price equalization theorem thus clarifies the conditions under which an international equalization of factor price relations takes place in free foreign trade . The theorem goes back to the US economists Abba P. Lerner and Paul A. Samuelson ( Nobel Prize in Economics 1970). It is an essential part of classical foreign trade theory and is based on the findings of the Heckscher-Ohlin model .

history

The first vague formulation of the theorem was made in 1919 by Eli Filip Heckscher , who dealt with the influence of trade on factor prices in his work . In 1933 Bertil Ohlin linked Heckscher's theory with that of general equilibrium theory . He has thus created greater clarity with regard to the basic relationships. Because the reference to the general equilibrium theory brings the problem of factor pricing and above all the factor quantities or factor proportions as exogenous quantities to the fore. This results in a much clearer question at Ohlin than at Heckscher. Abba P. Lerner came up with the first precise formulation in 1933. Lerner bases his work on the requirements of the 2x2 Heckscher-Ohlin model (2 goods, 2 countries), as well as the factor price equalization. Ohlin denied such a full factor price equalization, although he emphasized its alignment. He was supported by Ellsworth, who also dismissed a complete equalization of those factor price relationships in the foreign trade equilibrium as "impossible". Therefore, the real story of the theorem began in the late 1940s and early 1950s with Paul A. Samuelson. Samuelson tackled this problem precisely and came to the conclusion that, given the model requirements of Heckscher and Ohlin, factor price equalization would be necessary. In Abba P. Lerner's seminar paper, which was conceived in 1933 and rediscovered by Samuelson in 1949, factor price equalization was analyzed and expanded to include certain production-related elements that, however, contradict the Heckscher-Ohlin theorem. The general formulation of the traditional approach was given by McKenzie in 1955, the welfare-theoretical approach comes from Uzawa from 1959. The theorem was rediscovered by Dixit & Norman in 1980.

Alternative definitions

The factor price equalization theorem has been taken up and further developed in its historical development by a large number of economists. There are therefore no alternative definitions for this theorem. However, one can understand its development very well: from arguments related to the case (2 goods and 2 factors) to explanations of the case (2 goods, 2 factors and 2 countries) to the case ( goods, factors and countries). ${\displaystyle 2\times 2}$ ${\displaystyle 2\times 2\times 2}$ ${\displaystyle n\times m\times l}$ ${\displaystyle n}$ ${\displaystyle m}$ ${\displaystyle l}$

Classification and meaning

A capital-rich country exports capital-intensive goods and imports labor-intensive goods. As a result, the production of capital-intensive goods increases and that of labor-intensive goods decreases. As the production of capital-intensive goods increases, the demand for capital increases to ensure continued production. The increased demand for capital leads to an increase in interest rates . The interest rate is the price of capital. According to the factor price equalization theorem, the following applies: If the demand for capital increases, so does its price. As the production of labor-intensive goods falls due to the possibility of imports , the demand for labor shrinks and, as a result, wages fall .

The reverse is true for a busy country. It exports labor-intensive goods and imports capital-intensive goods. The production of labor-intensive goods is increased, that of capital-intensive goods is reduced. With the increased production of labor-intensive goods, the demand for labor is growing. The result is rising wages. The falling production of capital-intensive goods due to the possibility of imports leads to a decline in the demand for capital. As a result, interest rates fall.

If certain conditions are met, with free foreign trade the price of any production factor at home must correspond to the price of the same factor abroad, even if the international mobility of the production factors is not guaranteed. The mobility of goods would then be a full substitute for the mobility of the factors of production.

In order for a factor price equalization to take place, both goods must be produced even after they have been taken up by foreign trade. The following requirements must also be met:

1. In both markets there is complete competition in the goods and factors markets
2. There are no transport or trade barriers
3. The set of factors of production is constant; international movements of land and labor are excluded, while full factor mobility is guaranteed within a single country
4. The production factors are identical in both countries
5. Gut 1 and Gut 2 are manufactured under the same technical conditions in both countries.
6. The goods can be clearly classified according to their factor intensities (labor> capital = labor-intensive)
7. The factors of production are linearly homogeneous; so the assumption of constant level limit products applies , while the partial limit products decrease.

Model example

In order to make the factor price equalization theorem easier to understand, a fictitious and model-theoretical example is given below.

The following assumptions apply:

1. There are exactly two countries. Country A and Country B.
2. Both countries produce exactly 2 goods. Cars and oranges.
3. Both countries are technologically on the same level.
4. Country A is a capital rich country while Country B is a labor rich country.
5. There is free trade with no transport costs or other restrictions.

The question now arises as to why the factor prices in both countries should even out.

Country A has a comparative advantage over country B in car production , while country B has a comparative advantage in growing oranges. Country A can be described as a high-wage country and country B as a low-wage country .

Country A produces the capital-intensive cars and exports them to Country B. Thus, the capital factor is also exported indirectly. In country A this leads to an increased demand for capital, which in turn leads to rising prices and thus rising interest rates. Since country A imports the labor-intensive oranges from country B and does not produce them itself, the demand for labor and thus wages fall. These now adjust to the lower wages in country B.

Country B will export the labor-intensive oranges grown in its own country to country A. The labor factor is thus indirectly exported to country A. In country B this leads to an increased demand for labor, which in turn leads to rising prices and thus rising wages. These wages are now adjusted to the higher wages in country A. Because country B imports the capital-intensive cars from country A and does not produce them itself, the demand for capital and thus also the interest rates fall.

As a result, according to model theory, there is a complete balance between interest and wages, i.e. the factor prices, in both countries.

Empirical Study

Graphical representation of the factor price adjustment; where K = production factor capital and L = production factor labor. EX and IM each stand for export and import. (Source: Morasch, Karl, Bartholomae, Florian (2017): Trade and competition on global markets, p. 94)

In the following it should be shown that the core statements of the Heckscher-Ohlin-Samuelson model, regarding the trading pattern and factor price adjustment, are also reflected in the data. For this purpose, an empirical study was carried out by Gary Hufbauer in 1965 and confirmed by William R. Cline in 1993. Essential for factor price equalization is the fact that capital-rich countries export capital-rich goods and labor-rich countries export labor-rich goods. The two countries Mexico and USA show an atypical behavior and this phenomenon was named after its discoverer Wassily Leontief, at least in the USA, the Leontief paradox . There are a number of attempts to explain the failure to comply with the theoretical prediction. The failure to consider other production factors such as the distinction between qualified and unskilled workers is particularly criticized . There are also some significant differences between the production technologies and their trading partners.

Critical appraisal

The factor price equalization theorem is based on the assumptions already mentioned, which are not ubiquitous and only exist in an ideal world. Reasons for the theorem to fail:

• Technological differences
• Not every country produces the same goods (oranges / cars)
• There are more than 2 countries, which means that a bilateral view is not possible, but a multilateral one -> Still possible through a country-world comparison instead of a country-country comparison
• Foreign trade does not always have an impact on factor prices
• Neighboring countries are mostly on the same level (technology, education, etc.)
• Customs duties and import restrictions can have a negative impact on the factor price adjustment (further: Stolper-Samuelson theorem )

On the one hand, a convergence of factor prices can be observed, on the other hand, the wages differ massively in some cases. In a comparison of Germany and South Korea, these wage differences are ten times greater in the production sector and eight times as much in the service sector. Even when comparing Germany and France, wages in the service sector are almost identical, but they are 20% higher in production. The main reason for this is to be found in the technology (training / qualification) in particular (as of 2011).

The labor costs in manufacturing are also subject to enormous fluctuations in a global comparison and do not correspond to the predictions of the factor price equalization theorem. While an hour of work in Poland costs 8.25 USD, it costs 45.79 USD in Germany (as of 2015). ( Labor costs in manufacturing. Retrieved on June 17, 2015 .  )

literature

• Max Albert: The factor price equalization theorem Mohr Verlag, Tübingen 1994 ISBN 3-16-146229-7 .
• Manfred Borchert: Foreign trade studies Springer Gabler, Wiesbaden 2001, ISBN 3-409-63907-1 .
• Manfred Borchert: The Lerner-Samuelson Theorem . In: Wirtschaftswwissenschaftliches Studium (WiSt), 4th year, issue 3 (March 1975), pp. 146–147.
• Karl Morasch, Florian Bartholomae: Trade and Competition on Global Markets, 2nd, updated and expanded edition, Springer Gabler Wiesbaden 2017, ISBN 978-3-658-16043-2 .
• Klaus Rose: Theory of Foreign Trade Verlag Vahlen, Munich 1999 ISBN 3-8006-2450-8 .
• Gabler Verlag: Gablers Wirtschaftslexikon 16th edition Gabler Verlag, Wiesbaden 2004, ISBN 3-409-10386-4 .
• Paul R. Krugman, Maurice Obstfeld: International economics, theory and politics of foreign trade, 7th edition Pearson Education, Munich 2009, ISBN 3-8273-7199-6 .

Web links

• Scheme of factor price equalization theorem
• Basic table of labor costs in an international comparison

Individual evidence

1. ↑ Borchert, Manfred (1975): Das Lerner-Samuelson-Theorem, WiSt (3), pp. 146–147.
2. ↑ Borchert, Manfred (2001): Außenwirtschaftslehre, 7th edition, p. 76.
3. ^ Albert Max (1994): The factor price equalization theorem p. 78.
4. ^ Albert Max (1994): The factor price equalization theorem p. 85.
5. ^ Albert Max (1994): The factor price equalization theorem p. 95.
6. ↑ Borchert Manfred (2001): Außenwirtschaftslehre, 7th edition, p. 76.
7. ^ Albert Max (1994): The factor price equalization theorem p. 125.
8. ^ Albert Max (1994): The factor price equalization theorem p. 155.
9. ^ Albert Max (1994): The factor price equalization theorem p. 177.
10. ↑ Klaus Rose (1999): Theory of Foreign Trade, p. 419.
11. ↑ Klaus Rose (1999): Theory of Foreign Trade, p. 419.
12. ^ Karl Morasch, Florian Bartholomae: Trade and competition on global markets. 2017, p. 94.
13. ^ Karl Morasch, Florian Bartholomae: Trade and competition on global markets. 2017, p. 95.
14. ^ Karl Morasch, Florian Bartholomae: Trade and competition on global markets. 2017, p. 95.