Handbooks of Research Methods and Applications series
Edited by Charlie Karlsson, Martin Andersson and Therese Norman
A key result in neoclassical trade theory, or the Heckscher–Ohlin model, is the so-called factor price equalization theorem (FPE; see Leamer, 2012 for a survey). It states that countries engaged in free trade that produce the same set of commodities, using similar techniques, have identical factor prices. This is a surprising result if one considers that in this stylized neoclassical world, countries that differ with respect to factor supplies still have the same factor prices. This result implies that, for example, (il)legal immigrants do not affect local wages. The differences in factor supplies are absorbed by differences in the commodity bundle that a country produces. In equilibrium, a labor-abundant country produces more of the labor-intensive commodity, and the capital-abundant country more of the capital-intensive commodity. So an inflow of migrants does not lower wages because this inflow increases production of the labor-intensive commodity and thereby raises demand for labor. Consumers are not affected either because international trade corrects for the differences in local supply and demand (the excess supply of the labor-intensive commodity is traded in order to restore equilibrium). In a closed economy this outcome is not possible because an increase in labor supply and the resulting increase of the production of the labor-intensive commodity would lower its price and also wages. If this seems too good to be true, this opinion is correct.
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