Dynamic Effects and Economic Growth

Our simple comparative advantage model assumed that trade does not change a country's stock of resources or the efficiency with which it utilizes those resources. This static assumption makes no allowances for the dynamic changes that might result from  Figure 4.4

The Influence of Free Trade on the PPF

trade. If we relax this assumption, it becomes apparent that opening an economy to trade is likely to generate dynamic gains.⁹ These dynamic gains are of two sorts. First, free trade might increase a country's stock of resources as increased supplies of labor and capital from abroad become available for use within the country. This is occurring right now in Eastern Europe, where many Western businesses are investing large amounts of capital in the former Communist bloc countries.

Second, free trade might also increase the efficiency with which a country uses its resources. For example, economies of large-scale production might become available as trade expands the size of the total market available to domestic firms. Trade might make better technology from abroad available to domestic firms. In turn, better technology can increase labor productivity or the productivity of land. (The so-called green revolution had this effect on agricultural outputs in developing countries.) Also, opening an economy to foreign competition might stimulate domestic producers to look for ways to increase the efficiency of their operations. Again, this phenomenon is occurring currently in the once-protected markets of Eastern Europe, where many former state monopolies must increase the efficiency of their operations to survive in the competitive world market.

Dynamic gains in both the stock of a country's resources and the efficiency with which resources are utilized will cause a country's PPF to shift outward. This is illustrated in Figure 4.4, where the shift from PPF₁ to PPF₂ results from the dynamic gains that arise from free trade. Because of this outward shift, the country in Figure 4.4 can produce more of both goods than it did before free trade. The theory suggests that opening an economy to free trade not only results in static gains of the type discussed earlier, but also results in dynamic gains that stimulate economic growth. If this is so, the case for free trade becomes stronger, and the World Bank has assembled evidence that suggests a free trade stance does have these kind of beneficial effects on economic growth.¹⁰

Heckscher-Ohlin Theory

Ricardo's theory stresses that comparative advantage arises from differences in productivity. Thus, whether Ghana is more efficient than South Korea in the production of cocoa depends on how productively it uses its resources. Ricardo particularly stressed labor productivity and argued that differences in labor productivity between nations underlie the notion of comparative advantage. Swedish economists Eli Heckscher (in 1919) and Bertil Ohlin (in 1933) put forward a different explanation of comparative advantage. They argued that comparative advantage arises from differences in national factor endowments.¹¹ By factor endowments, they meant the extent to which a country is endowed with such resources as land, labor, and capital. Different nations have different factor endowments, and different factor endowments explain differences in factor costs. The more abundant a factor, the lower its cost. The Heckscher-Ohlin theory predicts that countries will export those goods that make intensive use of those factors that are locally abundant, while importing goods that make intensive use of factors that are locally scarce. Thus, the Heckscher-Ohlin theory attempts to explain the pattern of international trade that we observe in the world economy. Like Ricardo's theory, the Heckscher-Ohlin theory argues that free trade is beneficial. Unlike Ricardo's theory, however, the Heckscher-Ohlin theory argues that the pattern of international trade is determined by differences in factor endowments, rather than differences in productivity.

The Heckscher-Ohlin theory also has commonsense appeal. For example, the United States has long been a substantial exporter of agricultural goods, reflecting in part its unusual abundance of large tracts of arable land. In contrast, South Korea has excelled in the export of goods produced in labor-intensive manufacturing industries, such as textiles and footwear. This reflects South Korea's relative abundance of low-cost labor. The United States, which lacks abundant low-cost labor, has been a primary importer of these goods. It is relative, not absolute, endowments that are important; a country may have larger absolute amounts of land and labor than another country, but be relatively abundant in one of them.