GLOBAL FACTOR TRADE: Introduction 2
The salient feature of the recent research is to ask if parsimonious amendments allow the model to match the data. The research focuses on two classes of amendments: technology and absorption. The technological assumptions considered include cross-country differences, either Hicks-neutral or factor-augmenting, and industry-level economies of scale [Trefler 1993, 1995; Gabaix 1997; Antweiler and Trefler 1997]. The assumptions about absorption introduce non-homotheticities, most prominently a home-bias in demand [BLS, Trefler 1995].
The search for parsimonious amendments that allow the model to work is precisely the right research strategy. However, the existing literature has one major drawback. The hypothesized amendments concern technology and absorption. Yet the empirical tests draw on only a single direct observation on technology (typically that of the United States) and no observations whatsoever concerning absorption. Hence even if these hypotheses improve the model’s performance by selected statistical measures, it remains uncertain if the estimated parameters have a structural interpretation in terms of the economic fundamentals.
In the present study, we likewise search for parsimonious amendments that allow the HOV model to work. However, in contrast to all prior work, we have sufficient data on technology and absorption to estimate the structural parameters directly. Having estimated these directly from the data of interest, we then impose the resulting restrictions in our tests of the HOV model. By starting with the basic model and relaxing one assumption at a time, we see precisely how improvements in our structural model translate into improvements in the fit of the HOV predictions.
The results are striking. The step by step introduction of our key hypotheses yields corresponding improvement in measures of model fit. Countries export their abundant factors and in approximately the right magnitude. The results are remarkably consistent across variations in weighting schemes and sample. In sum, the Heckscher-Ohlin-Vanek theory, suitably amended, receives powerful support in our study.
The Heckscher-Ohlin-Vanek model of net factor trade is exquisite. Unfortunately, in its standard form, it does not describe the world that actually exists. Various hypotheses have been advanced to account for the divergence of theory and data, such as technical differences and divergences in demand structure. These have so far proved wholly insufficient to bridge the gap between theory and data. Nonetheless, they are likely to be part of a complete account. We advance several new hypotheses with the hope of providing a first successful match.