Positive trade theory identifies the determinants of patterns of trade. The HeckscherOhlin model, which relates trade flows to differences in countries' endowments of factors of production, assumes that some things are tradable and others usually factors of production non-tradable, thus making assumptions about what is traded rather than subjecting this to economic analysis. In Discussion Paper No. 766, Research Fellows Victor Norman and Anthony Venables investigate both the direction of trade and which goods and factors are traded. They assume that all are potentially tradable, but trade entails the costs of transactions and transport and certain taxes. Goods trade alone does not equalize factor prices, which creates incentives for international factor mobility, but whether this occurs in practice will depend on the cost of trading factors. The direction of trade, and the question of what is traded, are determined simultaneously.

In this generalization of the HeckscherOhlin model, the form of trade depends on factor endowments and trade costs; equilibrium may involve no trade or trade in goods, factors or both. This approach indicates that changes in relative transactions costs can have dramatic and surprising effects on the pattern of trade. For example, even a small reduction in the cost of migration may induce sufficient inflows of workers into a labour-scarce economy to make it an exporter of labour-intensive products. Economic liberalization that reduces transactions costs for trade in both goods and factors may thus increase or reduce international trade; its effects on production and trade can be predicted only by taking account of the interaction between goods trade and factor trade. This will be particularly relevant to the current liberalization in Eastern Europe.

International Trade, Factor Mobility and Trade Costs
Victor D Norman and Anthony J Venables

Discussion Paper No. 766, January 1993 (IT)