Skip to main content
SpringerLink
Log in

Heckscher-Ohlin Theory or the Modern Trade Theory: How the Overall Trade Characterizes at the Global Level?

  • Original Article
  • Published:
Journal of Quantitative Economics Aims and scope Submit manuscript

Abstract

This paper has two objectives: to locate the global trade pattern and to compute the export potential of world economies. Considering the maximum number of countries and maintaining a good representative sample of the overall international trade, an empirical examination is conducted by utilizing the trade complementary index and the per-capita income variable in the standard gravity model. The main aim is to determine which of the two theoretical frameworks―either the Heckscher-Ohlin theory, which is based on factor endowments or the Modern Trade theory of Krugman-Helpman and Linder, based on the intra-industry trade―is explaining the overall global trade flows. The estimated results support the factor endowments trade theory. In other words, the observed trade patterns conform to the Heckscher-Ohlin theory of trade over intra-industry Modern trade theories. The inference drawn is based on the significantly positive coefficient of the trade complementarity index and the absolute differenced PCI variable. Furthermore, as far as export potential is concerned, there exists a vast scope for the export potential across economies. These countries can exploit the existing export potential through trade cooperation and integration at the regional and the bilateral level.

This is a preview of subscription content, log in via an institution to check access.

Access this article

Log in via an institution

Price excludes VAT (USA)
Tax calculation will be finalised during checkout.

Instant access to the full article PDF.

Institutional subscriptions

Fig. 1

Similar content being viewed by others

Notes

  1. Drysdale (1967) has examined the nature of trade patterns and concluded that two components explain two-country trades under complementarity nature: (1) factor endowment differences; and (2) biasness, which comprises geographical, social, linguistic, or any other policy. Therefore, his proposed complementarity index value can be incorporated under the gravity model to measure factor endowment.

  2. Lineman’s (1966) model, although based on the quasi-Walrasian general equilibrium model, failed to incorporate prices in the final reduced form gravity model. Leamer and Stern (1970) doubted that this theoretical model even fails to explain the multiplicative functional form of the gravity model.

  3. On the demand side, every individual is willing to have some of each commodity produced across the geographic regions which explain consumers’ homothetic preferences. On the supply side, every country produces varieties of commodities with different characteristics because of their place of origin. Hence, based on these two important assumptions the gravity model of trade is theoretically derived.

  4. The term friction is defined as factors that cause resistance in the flow of goods between partners, sourced from human-made interventionist policies (tariff and non-tariff barriers) and natural barriers (Language, Culture, Religion, Border, Landlocked, etc.), including physical geographical distance.

  5. Dixit-Stiglitz monopolistic competition assumes that a large number of competitors – touching infinity- exist in the market. This, in turn, leaves equilibrium pricing independent of the type of market structure. As the number of competitors increases, so the number of varied commodities available for consumption increases. Furthermore, the consumers ‘love of variety’ helps them raise their utility through the consumption of differentiated varieties of goods. This is technically known as Dixit-Stiglitz preference.

  6. Linder Hypothesis states that countries with similar per-capita income consume similar quality products that push them to trade more.

  7. The homoscedasticity assumption of the OLS technique means that the variances of error terms (equation) are constant. However, this is unlikely to occur in trade data. Therefore, a nonlinear technique of Poisson Pseudo Maximum Likelihood (PPML) estimator is employed for gravity estimations. It works well in the presence of heteroscedasticity and naturally takes care of zero value of export or import flows. It does not require fulfilling stringent OLS assumptions.

  8. One should incorporate as many countries as possible so that the sample size becomes large enough. This can help in measuring the actual cross-country effects in the final results. Time should be taken periodically (i.e., at three years or five years interval) so that adjustment of change can be allowed for. Values should be in nominal terms. Fixed effect (paired fixed effect, exporter-importer time fixed effect) should be used for controlling multilateral trade resistance (MTR). Instead of cross-sectional data, panel data should be used as it increases degrees of freedom. Estimation techniques should be Nonlinear (PPML is recommended). In the case of panel data, covariates should be as less in number as possible (utilize the features of panel data techniques). Take care of the issue of zero trade values scientifically (deleting/truncating zero trade observations or adding a small value (censoring) at the places of zero trade flows or even averaging surrounding trade observations must be avoided).

References

  • Anderson, J.E. 1979. A theoretical foundation for the gravity equation. The American Economic Review 69 (1): 106–116.

    Google Scholar 

  • Anderson, J. E., and Van Wincoop, E. (2001). Borders, trade and welfare (No. w8515). National Bureau of Economic Research. Accessed at Borders, Trade and Welfare | NBER

  • Anderson, J.E., and E. Van Wincoop. 2003. Gravity with gravitas: A solution to the border puzzle. The American Economic Review 93 (1): 170–192.

    Article  Google Scholar 

  • Anderson, J.E., and E. Van Wincoop. 2004. Trade costs. Journal of Economic Literature 42 (3): 691–751.

    Article  Google Scholar 

  • Anderson, J.E., and Y.V. Yotov. 2010. The changing incidence of geography. The American Economic Review 100 (5): 2157–2186.

    Article  Google Scholar 

  • Armington, P.S. 1969. A theory of demand for products distinguished by place of production. Staff Papers (international Monetary Fund) 16 (1): 159–178.

    Article  Google Scholar 

  • Armstrong, S. P., Drysdale, P., and Kalirajan, K. (2008). Asian trade structures and trade potential: an initial analysis of South and East Asian trade. Available at SSRN: https://ssrn.com/abstract=1767686. https://doi.org/10.2139/ssrn.1767686

  • Baldwin, R., and Taglioni, D. (2006). Gravity for dummies and dummies for gravity equations (No. w12516). National bureau of economic research. Accessed at Gravity for Dummies and Dummies for Gravity Equations | NBER

  • Bergstrand, J.H. 1985. The gravity equation in international trade: Some microeconomic foundations and empirical evidence. The Review of Economics and Statistics 67 (3): 474–481.

    Article  Google Scholar 

  • Bergstrand, J.H. 1989. The generalized gravity equation, monopolistic competition, and the factor-proportions theory in international trade. The Review of Economics and Statistics 71 (1): 143–153.

    Article  Google Scholar 

  • Bergstrand, J.H. 1990. The Heckscher-Ohlin-Samuelson model, the Linder hypothesis and the determinants of bilateral intra-industry trade. The Economic Journal 100 (403): 1216–1229.

    Article  Google Scholar 

  • Beverelli, C., Keck, A., Larch, M., and Yotov, Y. (2018). Institutions, trade and development: a quantitative analysis. CESifo Working Paper No. 6920, CESifo, Munich, 2018. Available at Institutions, Trade and Development: A Quantitative Analysis | Publication | CESifo

  • Brülhart, M. 2009. An account of global intra-industry trade, 1962–2006. The World Economy 32 (3): 401–459.

    Article  Google Scholar 

  • Bryan, I.A. 1974. The effect of ocean transport costs on the demand for some Canadian exports. Weltwirtschaftliches Archiv 110 (4): 642–662.

    Article  Google Scholar 

  • Burger, M., F. Van Oort, and G.J. Linders. 2009. On the specification of the gravity model of trade: Zeros, excess zeros and zero-inflated estimation. Spatial Economic Analysis 4 (2): 167–190.

    Article  Google Scholar 

  • Deardorff, A. 1998. Determinants of Bilateral Trade: Does Gravity Work in a Neoclassical World? In The Regionalization of the World Economy, ed. J.A. Frankel, 7–32. University of Chicago Press.

    Google Scholar 

  • Drysdale, P. (1967). Japanese Australian trade: an approach to the study of bilateral trade flows. Ph.D. Dissertation. Australian National University, Canberra.

  • Drysdale, P., and R. Garnaut. 1982. Trade intensities and the analysis of bilateral trade flows in a many-country world: A survey. Hitotsubashi Journal of Economics 22 (2): 62–84.

    Google Scholar 

  • Eaton, J., and A. Tamura. 1994. Bilateralism and regionalism in Japanese and US trade and direct foreign investment patterns. Journal of the Japanese and International Economies 8 (4): 478–510.

    Article  Google Scholar 

  • Eaton, J., and S. Kortum. 2001. Technology, trade, and growth: A unified framework. European Economic Review 45 (4–6): 742–755.

    Article  Google Scholar 

  • Egger, P.H., and M. Larch. 2008. Interdependent preferential trade agreement memberships: An empirical analysis. Journal of International Economics 76 (2): 384–399.

    Article  Google Scholar 

  • Elliott, R.J., and K. Ikemoto. 2004. Afta and the Asian crisis: Help or hindrance to ASEAN intra-regional trade? Asian Economic Journal 18 (1): 1–23.

    Article  Google Scholar 

  • Evenett, S.J., and W. Keller. 2002. On theories explaining the success of the gravity equation. Journal of Political Economy 110 (2): 281–316.

    Article  Google Scholar 

  • Feenstra, R.C. 2004. Advanced international trade: Theory and evidence. Princeton University Press.

    Google Scholar 

  • Freund, C., and Weinhold, D. (1999). On the effect of the Internet on International Trade, International Finance Discussion Papers, 693.

  • Frankel, J. A. (1997). Regional trading blocs in the world economic system. Peterson Institute for International Economics. https://www.piie.com/bookstore/regional-trading-blocs-world-economic-system. Accessed 27 Mar 2022.

  • Garnaut, R. 1972. Australian Trade with South-East Asia: A Study of Resistance to Bilateral Trade Flows, Doctoral Thesis, Economics Department. Canberra: Australian National University.

    Google Scholar 

  • Head, K. (2003). Gravity for beginners. University of British Columbia, 2053. Available at gravity.pdf (unctad.org)

  • Helpman, E., and Krugman, P. (1985). Market Structure and Foreign Trade: Increasing Returns, Imperfect Competition, and the International Economy. MIT Press. Accessed at Market Structure and Foreign Trade | The MIT Press

  • Helpman, E., M. Melitz, and Y. Rubinstein. 2008. Estimating trade flows: Trading partners and trading volumes. The Quarterly Journal of Economics 123 (2): 441–487.

    Article  Google Scholar 

  • Hummels, D., J. Ishii, and K.M. Yi. 2001. The nature and growth of vertical specialization in world trade. Journal of International Economics 54 (1): 75–96.

    Article  Google Scholar 

  • Isard, W. 1954. Location theory and trade theory: Short-run analysis. The Quarterly Journal of Economics 68 (2): 305–320.

    Article  Google Scholar 

  • Kim, A.R., and J. Lu. 2016. A study on the effects of FTA and economic integration on throughput of Korea and China. Open Access Library Journal 3 (4): 1–11.

    Google Scholar 

  • Krugman, P.R. 1981. Intra-industry specialization and the gains from trade. Journal of Political Economy 89 (5): 959–973.

    Article  Google Scholar 

  • Kunroo, M.H., and N.A. Azad. 2015. Theory-based specification of the gravity equation: An analysis using European Union as an example. Journal of International Economics, Institute of Public Enterprises, Hyderabad 6 (2): 101–117.

    Google Scholar 

  • Kunroo, M.H., I.A. Sofi, and N.A. Azad. 2016. Trade implications of the Euro in EMU countries: a panel gravity analysis. Empirica 43 (2): 391–413 (Access at Trade implications of the Euro in EMU countries: a panel gravity analysis | SpringerLink).

    Article  Google Scholar 

  • Leamer, E. E., and Stern, R. M. (1970). Quantitative International Economics. Allyn and Bacon, Inc. Available at specification_searches (ucla.edu)

  • Linnemann, H. 1966. An econometric study of international trade flows. Amsterdam: North-Holland Pub. Co.

    Google Scholar 

  • Mario Larch’s Regional Trade Agreements Database from Egger and Larch (2008). https://www.ewf.uni-bayreuth.de/en/research/RTA-data/index.html

  • Martin, W., and C.S. Pham. 2020. Estimating the gravity model when zero trade flows are frequent and economically determined. Applied Economics 52 (26): 2766–2779.

    Article  Google Scholar 

  • McCallum, J. 1995. National borders matter: Canada-US regional trade patterns. The American Economic Review 85 (3): 615–623.

    Google Scholar 

  • Metulini, R., R. Patuelli, and D. Griffith. 2018. A spatial-filtering zero-inflated approach to the estimation of the gravity model of trade. Econometrics 6 (1): 9.

    Article  Google Scholar 

  • Olivero, M.P., and Y.V. Yotov. 2012. Dynamic gravity: Endogenous country size and asset accumulation. Canadian Journal of Economics 45 (1): 64–92.

    Article  Google Scholar 

  • Piermartini, R., and Y. Yotov. 2016. Estimating trade policy effects with structural gravity. CESifo working paper series no. 6009. Available at estimating trade policy effects with structural gravity by Roberta Piermartini, Yoto Yotov. SSRN. https://doi.org/10.2139/ssrn.2828613.

    Article  Google Scholar 

  • Pöyhönen, P. 1963. A tentative model for the volume of trade between countries. Weltwirtschaftliches Archiv 90 (1963): 93–100.

    Google Scholar 

  • Salvatore, D. 2014. International Economics: Trade and Finance. John Wiley and Sons.

    Google Scholar 

  • Samuelson, P.A. 2004. Where Ricardo and Mill rebut and confirm arguments of mainstream economists supporting globalization. Journal of Economic Perspectives 18 (3): 135–146.

    Article  Google Scholar 

  • Silva, J.M.S., S. Tenreyro, and F. Windmeijer. 2015. Testing competing models for non-negative data with many zeros. Journal of Econometric Methods 4 (1): 29–46.

    Article  Google Scholar 

  • Silva, J.S., and S. Tenreyro. 2006. The log of gravity. The Review of Economics and Statistics 88 (4): 641–658.

    Article  Google Scholar 

  • Silva, J.S., and S. Tenreyro. 2010. On the existence of the maximum likelihood estimates in Poisson regression. Economics Letters 107 (2): 310–312.

    Article  Google Scholar 

  • Silva, J.S., and S. Tenreyro. 2011. Further simulation evidence on the performance of the Poisson pseudo-maximum likelihood estimator. Economics Letters 112 (2): 220–222.

    Article  Google Scholar 

  • Sohn, C. H. (2001). A gravity model analysis of Korea's trade patterns and the effects of a regional trading arrangement. Korea Institute for International Economic Policy Working Paper Series 2001–09, April 2001. Access link Microsoft Word - 2001–09.doc (agi.or.jp)

  • Terzi, N. 2011. The impact of e-commerce on international trade and employment. Procedia Social and Behavioral Sciences 24 (2011): 745–753.

    Article  Google Scholar 

  • Tinbergen, J. 1962. Shaping the World Economy; Suggestions for an International Economic Policy. New York: Twentieth Century Fund.

    Google Scholar 

  • Yilmazkuday, H. 2021. Drivers of global trade: A product-Level Investigation. International Economic Journal 35 (4): 469–485.

    Article  Google Scholar 

  • Yotov, Y. V., Piermartini, R., Monteiro, J. A., and Larch, M. (2016). An advanced guide to trade policy analysis: The structural gravity model. Geneva: World Trade Organization. Available at advancedwtounctad2016_e.pdf

  • Zhang, Y., and S. Wang. 2015. Trade potential of China’s export to ASEAN: The gravity model using new economic mass proxies. Journal of Systems Science and Information 3 (5): 411–420.

    Article  Google Scholar 

Download references

Acknowledgements

The authors are highly thankful to the two anonymous reviewers and the Journal of Quantitative Economics Editor for their valuable comments in improving this research work. The authors also express their gratitude towards the participants of the 7th International Conference on Empirical Issues in International Trade & Finance (EIITF) hosted by the Indian Institute of Foreign Trade, Kolkata, for their suggestions related to the earlier draft of this paper. Special thanks to Prof. Ranajoy Bhattacharya for his comments and suggestions on the methodology adopted in the article. The views expressed are those of the authors and not of the institution(s) they work for. The usual disclaimers apply.

Author information

Authors and Affiliations

  1. Indian Institute of Management (IIM) Sirmaur, Sirmaur, Himachal Pradesh, 173025, India

    Mohd Hussain Kunroo

  2. Office of the Economic Adviser, Ministry of Commerce and Industry, Government of India, New Delhi, India

    Imran Ahmad

Authors
  1. Mohd Hussain Kunroo
    View author publications

    You can also search for this author in PubMed Google Scholar

  2. Imran Ahmad
    View author publications

    You can also search for this author in PubMed Google Scholar

Corresponding author

Correspondence to Mohd Hussain Kunroo.

Additional information

Publisher's Note

Springer Nature remains neutral with regard to jurisdictional claims in published maps and institutional affiliations.

Rights and permissions

Springer Nature or its licensor (e.g. a society or other partner) holds exclusive rights to this article under a publishing agreement with the author(s) or other rightsholder(s); author self-archiving of the accepted manuscript version of this article is solely governed by the terms of such publishing agreement and applicable law.

Reprints and permissions

About this article

Check for updates. Verify currency and authenticity via CrossMark

Cite this article

Kunroo, M.H., Ahmad, I. Heckscher-Ohlin Theory or the Modern Trade Theory: How the Overall Trade Characterizes at the Global Level?. J. Quant. Econ. 21, 151–174 (2023). https://doi.org/10.1007/s40953-022-00330-x

Download citation

  • Accepted:

  • Published:

  • Issue Date:

  • DOI: https://doi.org/10.1007/s40953-022-00330-x

Keywords

JEL Classification

Search

Navigation