FACTOR REALLOCATION COSTS AND TESTS OF THE HECKSCHER-OHLIN TRADE THEORY

ISSN： 1521-0545

Source： The International Trade Journal, Vol.18, Iss.3, 2004-0, pp. : 147-176

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Abstract

The Heckscher-Ohlin-Samuelson (HOS) theory of international trade, a basic long-run microeconomic model in which adaptation occurs through the costless reallocation of factors between industries, performs poorly. Most attempts to improve the fit of the model have introduced productivity variations across countries. This article considers another source of error: the assumption of perfect factor mobility. Factors are neither perfectly mobile between industries, but neither are they perfectly industry-specific. Factors can be reallocated between industries, but at a cost. In previous work a measure of adjustment costs due to factor specificity were estimated in a two-period model of a firm's input allocation decision. These estimates are used in this article to test international trade models. Two contributions are made. First, factor reallocation costs explain 2-3% of the "missing trade" noted by Trefler. Second, the estimated country productivity differences vary considerably from the actual differences measured in this paper. In contrast to Trefler's finding that inclusion of estimated productivity differences improved the fit of HOS, when measured productivity differences are used in this paper, HOS performs almost as poorly as in its original specification. My findings highlight the inappropriateness of using HOS as a short-run explanation of trade.