Economic Theory: Past and Future

Murray C. Kemp

For twenty years I have enjoyed a close and harmonious relationship with Kobe
University and, in particular, with the Research Institute for Economics andBusiness Administration.
It therefore gives me great pleasure to receive from the University its highest
award and to receive it in the presence of many close friends, including
several former students.
This is an occasion for reflection – on the path traveled and on the path to be taken– and this evening I offer you some quite personal thoughts on the presentstate of economic theory. They are, for the most part, grey thoughts but you
will detect in them a strong undercurrent of hope for the future.
During the last half-century, that is, during my own professional lifetime, we haveworked in an intellectual environment dominated by two bodies of thought.
The first is based on the pioneering work of Léon Walras, Kenneth Arrow,Gérard Debreu and Lionel McKenzie.
The second has grown out of the work of Eli Heckscher, Bertil Ohlin, Abba
Lerner and Paul Samuelson.
For brevity (but unhistorically, unfairly, and ungrammatically) I will refer tothese two bodies of thought as “Walrasian”and “ Heckscher-Ohlin.”
Within this environment, our work has for the most part been of the comparative
static kind, with our normative calculations rooted in the Walrasian paradigm
and our descriptive calculations rooted in the Heckscher-Ohlin paradigm.
This neat division of labor is, at first sight, puzzling. For after all, the HeckscherOhlin model is merely a special case of the Walrasian. Why then do we
persist with Heckscher-Ohlin? The answer is painfully obvious: theWalrasian model yields no descriptive comparative statics; more precisely, it2

yields no descriptive comparative statics that are easy to interpret and also
profound, that is, answer questions that are interesting and non-trivial.
To obtain descriptive results of that kind we have taken on board the family of
special Heckscher-Ohlin assumptions, and we have been rewarded with theStolper-Samuelson, Rybczynski, Heckscher-Ohlin, Factor Price Equalizationand Hicks-Ikema propositions.
Most of those assumptions are well known; one easily remembers constant returns
to scale, non-joint production and small numbers of just about everything.
But there are other assumptions, assumptions that are rarely mentioned, even informal expositions of Heckscher-Ohlin theory. Here I think specially of zero
costs of factor re-allocation, representative agents and existence of autarchic
equilibria for all trading countries.
We have long known that each of the five Heckscher-Ohlin propositions must be
qualified if the assumptions of constant returns, non-jointness and small
dimensions are relaxed. What we are now beginning to understand is thatthose propositions crumble and entirely disappear if the hitherto hidden
assumptions are relaxed.
Let me briefly explain, beginning with the assumption that all trading countries
have autarchic equilibria. Casual observation suggests that even wealthy
trading nations may lack autarchic equilibria. In particular, they may lack theclimate and fertile land needed for subsistence food production; one thinks ofHolland, Belgium, Ireland, Singapore and even the United Kingdom andJapan.
Such countries were once able to survive in autarchy; indeed there may once
have been no alternative to autarchy. Over the years, however, trade based
wealth may have induced a substantial increase in population, to the point
where it cannot be supported in autarchy.
If a country has no autarchic equilibrium, and if there are just two traded
goods, the offer curve of that country consists of two disjoint segments; andthis in turn suggests that, if there are just two countries, the offer curves of
those countries may fail to intersect.

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Thus the absence of an autarchic equilibrium, even for one country may
ensure the absence of a world trading equilibrium.
Clearly the Heckscher-Ohlin depiction of world equilibrium in terms of anintersection of continuous offer curves must be revised.
Similarly the common belief that any distortion free Walrasian economy must
benefit from the opening of its frontiers, whatever the characteristics of othereconomies, must be reconsidered.
Let me now change tack and briefly consider another of the hidden HeckscherOhlin assumptions, that the reallocation of factors is costless. If thatassumption is dropped, so that a factor of production may earn different
rewards in different industries, even in stationary equilibrium, then, quite
simply, all five Heckscher-Ohlin propositions should be abandoned.
Finally, changing direction again, let us consider, even more briefly, the hidden
Heckscher-Ohlin assumption of the representative agent. We now know that
if that assumption is seriously relaxed, so that the Sonnenschein-DebreuMantel proposition comes into play, then even normative Heckscher-Ohlin
results must be foregone.
That completes the act of demolition. Where do we go from here? Some of you willrecall that, thirty years ago, Ivor Pearce suggested that we should abandon theHeckscher-Ohlin model. He thought that any tailoring of theory to achieve
easily interpreted comparative statics is indefensible. According to Pearce,
the task of the theorist is to ask comparative static questions on the basis ofvery general theory and then leave it to the econometrician to findapproximate answers.
I could not agree with Ivor Pearce when he issued his manifesto; and I still cannot
join him. We cannot get along without restricted theoretical models. At thevery least, they help us to sharpen the questions asked of econometricians –including Ivor Pearce’s own questions.
But we should not place our faith in a single body of theory. By all means, let us
keep Heckscher-Ohlin. It has much to teach us about the role of factor
endowments in determining the shape of the world equilibrium. But we need4competing theories, each highlighting a particular subset of processes andcollectively providing a set of hypotheses from which econometricians canchoose. Perhaps some of them will do without the three hidden assumptionsof Heckscher-Ohlin. I hope so.