Production Uncertainty and the Heckscher-Ohlin Theorem

Abstract

Despite several recent contributions which have introduced uncertainty into general equilibrium models,3 trade theorists continue to assume that the economic environment is nonstochastic.4 One of the most fundamental theorems in trade theory is the HeckscherOhlin (HO) theorem which asserts that a country exports the commodities which are relatively intensive in the use of its relatively abundant factor. The purpose of this paper is to explore the implications of uncertainty in the production function for the validity of the HO theorem and its offspring, the factor-price equalization theorem. As a byproduct of our analysis, the Rybczynski theorem is also analysed. The HO theorem has been traditionally proved in terms of two alternative definitions of inter-country relative factor abundance, namely the factor-price definition and the physical definition. We show that the HO theorem cannot be proved in terms of the factor-price definition, but that the theorem is valid in terms of the physical definition even in the presence of uncertainty in the production process. The Rybczynski theorem also continues to hold, but the factor-price equalization theorem does not, even if all the assumptions made customarily for the validity of the theorem are satisfied. The reason for this turns out to be the producers' aversion towards risk.