Factor Content Functions and the Theory of International Trade

Two theorems traditionally dominate the theory of international trade. On the one hand, the Heckscher-Ohlin theorem suggests a supply-side basis for trade patterns: each country will tend to export those goods which use intensively its relatively abundant factors. On the other hand, the gains from trade theorem suggests that under very general conditions a country's potential welfare is higher if it engages in international trade than if it pursues a policy of autarky. In recent years considerable work has examined the robustness of these theorems: for example, whether or not they apply when many commodities are produced and when trade is restricted by tariffs.

The present paper carries this process further and argues, perhaps for the first time, that generalisations of the two theorems are intimately related. In particular, Neary and Schweinberger show that a necessary and sufficient condition for an economy to gain as a result of participating in trade is that the country's trade patterns satisfy the predictions of the Heckscher-Ohlin theorem. This result as well as others proved in the paper permit a synthesis and extension of much recent work on both the
positive and normative theories of international trade.

The paper also makes a number of technical contributions. In particular, it shows how a country which is engaged in international trade in final goods can be viewed 'as if' it were implicitly trading the factors of production embodied in those goods. This new perspective throws considerable light on the behaviour of an open economy. It also suggests a number of new approaches which are likely to prove fruitful in empirical studies of trade patterns.

Factor Content Functions and the Theory of International Trade
J Peter Neary and Albert G Schweinberger

Discussion Paper no. 3, January 1984 (IT)