Unequal factor prices and incomplete specialization in a Heckscher-Ohlin model of endogenous growth

Abstract

It is a central result of the pure theory of international trade based on two-factors, two-goods Heckscher-Ohlin models that — under certain conditions — trade leads to factor-price equalization (FPE) if countries are incompletely specialized. Factor rewards will usually not equalize if at least one country is completely specialized. Necessary assumptions for FPE in the case of incomplete specialization are free trade, absence of transportation costs, both countries producing with the same technology and the absence of factor-intensity reversals, but, as is well-known, no international mobility of factors is required. This dichotomy of free trade can be found, additionally to text book treatments of the simple two-country, two-homogeneous-goods case (e.g. Gandolfo, 1986, p. I 77) in static models of inter-and intra-industrial trade (Helpman and Krugman, 1985, ch. 7) as well as in dynamic models of innovation and growth (Grossman and Helpman, 1991a, ch. 7.1). Unequal factor rewards, however, are not automatically linked to complete specialization. A situation of incomplete specialization of both countries and no equalization of factor prices can occur, too, with all the conditions mentioned above being satisfied. In order to demonstrate this effect we will build on the model of Grossman and Helpman (1991a, ch. 7.1) who derived the properties of the balanced growth path1 under the assumption of identical interest rates in both countries, due to either free international mobility of financial capital or identical discount factors of the representative consumer in both countries.