Question

Consider the simple Heckscher-Ohlin model discussed in class, with two countries, two goods, and two factors, and incomplete specialization. The two countries are Turkey and Vietnam, the two factors are capital and labor, and the two goods are chemicals and apparel. You are given the following data on the factor endowments for Turkey and Vietnam. Turkey has a labor force of 75 million workers and a capital stock of 375 thousand machines. Vietnam has a labor force of 80 million workers, and a capital stock of 240 thousand machines. Assume that machines and workers are comparable units.

a) Which country is relatively capital abundant? Which country is relatively labor abundant? Explain.

b) Suppose that the production of chemicals is capital intensive relative to apparel. Which country will have comparative advantage in the production of chemicals? Explain.

c) Explain which factor gains the most in Vietnam from free trade.

d) Which group in Turkey would resist signing a free trade agreement with Vietnam: workers or capital owners?

e) Use a figure to show whether free international trade improves the standard of living in Turkey and Vietnam as a whole, or not.

Answer 1

Let us first do some preparatory work:

"Turkey has a labor force of 75 million workers and a capital stock of 375 thousand machines"
From the above we can calculate:
Turkey's Capital investment per million workers = 375000/75 = 5000

"Vietnam has a labor force of 80 million workers, and a capital stock of 240 thousand machines"
From the above we can calculate:
Vietnam's Capital investment per million workers = 240000/80 = 3000

Now, let us come to the questions:

a)
Turkey is capital abundant (because capital stock investment i.e. 5000 machines per million workers is more than that of Vietnam)
Vietnam is labour abundant (because capital stock investment i.e. 3000 machines per million workers is less than that of Turkey)

b)
Since production of chemicals is a capital intensive industry, definitely, Turkey will have a comparative advantage here. Why? Because Turkey has more capacity to invest in machines, plants etc. for chemical manufacturing. Also, by using more capital, Turkey can automate the production process and raise the efficiency in terms of quality and output quantity. In long run, Turkey will have cost advantage as well because of low labour costs.

c)
From free trade, the factor of labour will gain the most in Vietnam. Vietnam is a labour-intensive economy which is having a comparative advantage in producing and exporting apparels. This advantage comes in form of production efficiency and ends with low cost and selling price. Being highly competitive in apparel market across the globe, Vietnam's products will be more in demand, requiring the country to produce more, further requiring the country to hire more labour to serve the increasing demand. From free trade, the factor labour is supposed to get benefited the most in Vietnam.

d)
Mind it. Turkey has 75 million workers (labour force). When Free Trade Agreement is signed, since Vietnam has a comparative advantage over Turkey in case of apparels, Turkey would like to import form Vietnam. Why? It's because Vietnam must be exporting apparels to Turkey at lower prices than Turkey's own domestic prices. If this goes on so, Turkey's domestic apparel market will be trouble and so will be the labour workforce employed in it. Turkey's apparel producing firms may run in losses and several of those may have to wound up too; risking the labour workforce to become unemployed. Hence the workforce group in Turkey is expected to oppose free trade agreement.

e)
This is a contentious issue. Free trade agreements, actually, have a mid to long term design to being well-being to all party-countries involved; well, as long as the dominating ones amongst them do not go malicious. In the presented case, let Turkey specialize in Chemicals and Vietnam in apparels. In short run, however, Turkey will see labour unrest and Vietnam will see redundancy of capital, but gradually both the countries will have to adjust their economic factors to suit their specialization areas more. Standard of living also is supposed to improved in both the countries over a period of time.