Lecture notes
Lecture 1 The empirical tests of the Ricardian and HOS models
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- Loughborough University (LU)
The empirical tests of the Ricardian and HOS models full notes.
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Lecture 1: The Empirical Tests of the Ricardian and HOS ModelsRicardian Model
•2 products x 2 countries x 1 factor (labour)
•Technology difference between countries and industries
•Comparative advantage & absolute advantage
•Pattern of trade
•Specialization & Trade gains
Comparative advantage is technology (or productivity) differences across countries which drives
trade. A country has comparative advantage in the good it has a higher productivity in relative to
other countries.
Empirical Tests of Ricardian Model
• Very difficult! Why?
-The model is just too simple: 2 goods, 2 countries, 1 factor
• Different trade theories may have similar results (E.g. USA will export computers and China exports
shoes due to productivity differences).
-Suppose A and B both predict C. Now we observe C in the data, how can we tell it is due to A or due
to B? (Both RM and HOS model can predict a pattern of trade but we cannot differentiate which
causes the results and whether the outcome moving from autarky to free trade is due to RM/HOS)
• Autarky is not observable (Almost cannot observe a country without trade).
-Ricardian model predicts trade pattern from Autarky to trade, but it is rarely we can find data on
Autarky. (we will see a work making progress on this point- Some people have found data e.g. for
Japan in the past without trade)
• Complete specialization: If the model is right then there are some goods that a trading country
doesn’t make at all. (This rejects the RM prediction in this case)
-This doesn’t appear to be true in the data (A country produces most goods and exports them
instead of just one good showing there is not specialisation like RM predicts)
• Pattern of trade: if the model is right then high productive goods tend to have higher net exports.
-Early studies test the relationship between labour productivity and the net exports.
MacDougall (1951)
• The first such empirical test of the Ricardian model was provided by MacDougall in 1951.
• Data: labour productivity and export data for 25 industries in UK and US for the year 1937.
-Labour productivity is measured as output per worker. (Can be measured by wages -workers with
higher productivity have higher wages)
-Note that the wages should be considered as well.
• Wages were twice as high in US as in UK. Therefore costs of production would be lower in US in the
industries where the labour productivity in US was more than twice as large as productivity in UK.
- Greater productivity means comparative advantage.
• Instead of looking at the trade between US and UK, MacDougall looked at the exports to the
third market, i.e. the rest of the world
• Tariffs between US and UK varied widely across industries.
• Tariffs set by the world to US and UK were similar across industries.
•From the Ricardian model, we expect:
• In industries US (UK) had comparative advantage, US (UK) sold more than
, UK (US) into the world- higher exports. (True in 20/25 industries- 20 shown
in diagram)
• There tends to be a positive relationship between the relative productivity and
relative exports to the world. (True)
The results from
MacDougall's empirical test
indicated that those
industries where labour
productivity was relatively
higher in the United States
than in the United Kingdom
were the industries with the
higher ratios of US to UK
exports to third markets.
These results were confirmed
by Balassa using 1950 data,
Stern using 1950 and 1959
data and Golub using 1990
data.
In Ricardian Model, perfect competition is assumed. Under perfect competition, the price of
a product is equal to its marginal cost, i.e. the cost to produce one more unit of the product.
As labour is the only factor, the cost should be the wage paid to the labour used to produce
this unit. We should know that the unit labour requirement, i.e. the labour required to
produce one unit of X is:
-E.g. if output per worker was
0.5 units then 2 workers
would be needed to produce
one unit of X
-Labour is the only input so
P=MC (Due to perfect
competition)
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