A Story of Trade-Induced Industrialization
by
Alan V. Deardorff and Jee-Hyeong Park
Preliminary Draft
June, 2009
Abstract
We offer a simple variant of the standard Heckscher-Ohlin Model that
explains how a developing country, by opening to trade with a large capitalabundant economy, can be induced to shift resources into more capital-intensive
production than what it was producing in autarky. As a result it experiences arise in its return to capital and, if capital is internationally mobile, both anincrease in its capital stock and an increase in trade. These results arise in amodel in which both a traditional and a modern sector can produce final goods
that are perfect substitutes. The modern sector uses intermediate inputs thatdiffer in their relative capital intensities, while being both more capital intensive
than the traditional sector. The results of this model accord well with theexperience of the Asian Tiger economies during the early decades of theirexport-oriented industrialization.

A Story of Trade-Induced Industrialization*
by
Alan V. Deardorff, University of Michigan
andJee-Hyeong Park, Seoul National University

1. Introduction
We develop a simple model of trade between a developing country and adeveloped

one

where

their

trade

can

inducethedeveloping

country’s“industrialization” of creating or expanding a manufacturing sector.

We modify

theastandard

Heckscher-Ohlin

model

in

two

ways.

First,

modern(manufactured) good requires two intermediate inputs for its production with one
intermediate input being more capital intensive than the other and bothintermediate inputs being more capital intensive than a traditional good.

Second,we assume that consumers perceive the modern good as a perfect substitute forthe traditional one.1
This

modifiedHeckscher-Ohlin

unconventional results.

model

then

generatesanumberofFirst, the developing country will trade with thedeveloped country only when its endowment of capital per labor is higher thana critical level.

It then imports the capital-intensive intermediate input inexchange for exporting the labor-intensive intermediate input. 2*

The importation

We have benefited from discussions of this paper with Gene Grossman and Andrei Levchenko.
We assume that one unit of the modern good is a perfect substitute for one unit of the
traditional good, but it could just as easily be a perfect substitute for more than one unit of thelatter, to reflect difference in quality. The assumption of perfect substitution, however, is needed
to keep the exposition of the model simple.
2
Alternatively, the developing country may also, or instead, import the modern final good in
exchange for exporting the labor-intensive intermediate input. Regardless of these different formsof trade that may arise between the countries, in terms of the factor content of trade, thedeveloping country ends up importing the services of capital from the developed country in11

of the capital intensive-intermediate input allows the developing country to
produce the modern good at a cost lower than its autarky cost, facilitating its
creation or expansion of a modern sector, which we denote as trade-induced
industrialization.

Second, such trade will raise the return to the capital in thedeveloping country when it produces both the traditional good and the labor
intensive-intermediate input, despite the fact that it is indirectly importing capitaland exporting labor through its trade with the developed country.

Finally, an

increase in the relative capital endowment of the developing country, which may
arise either through its own capital accumulation or through inflow of foreign
capital, will accompany an expansion of trade as long as its relative price ofcapital is still higher than that of the developed country.
Our model is useful in explaining the experiences of developing countries
that have pursued an export-oriented industrialization strategy, such as Hong
Kong, Singapore, South Korea, and Taiwan in the 1960s and 1970s, and more
recently China in the 1980s and 1990s.

These countries have attained a rapid

expansion of their manufacturing sector with a large portion of its output being
exported to developed countries.

In addition to sharing this experience of

creating a heavily export-oriented manufacturing sector, these developing countries
also share the following economic profiles in their industrialization process: a
rapid expansion of imports of intermediate inputs from developed countries; ahigh return to capital sustained for an extended period of time; an expansion ofinternational trade, both in its absolute value and in its ratio to the size of theeconomy, accompanying a rise in the capital-labor ratio. 3

These profiles of

exchange for exporting the services of labor embodied in the labor-intensive intermediate input.
Section 4 provides a detailed discussion of these characteristics of trade-induced industrialization32

industrialization correspond well with our model’s implication for a developing
country’s trade-induced industrialization.
There exist other works that are related to ours.

Davis (1996) has

demonstrated that a developing country’s trade liberalization may induce a rise in
the return to capital even when it is a labor abundant country relative to therest of the world.

In a two-factor three-final-good version of a Heckscher-Ohlinmodel with many countries, a globally labor abundant country (producing only
the two most labor-intensive goods) can be locally capital abundant in the sensethat it imports the most labor intensive good from a more labor abundant
country.

Trade liberalization by such a developing country raises the return tocapital because its import expansion of the most labor-intensive good induces its
resources to move away from the production of this most labor-intensive good,thus generating a higher demand for capital.

This contrasts with our model

where a rise in the return to capital in association with trade liberalization of adeveloping country will only accompany an import expansion of the mostcapital-intensive intermediate input from the developed country.
Likewise, Feenstra and Hanson (1996) present a model of outsourcing inwhich wages rise in both countries for reasons similar to what happens here.
Deardorff (1986) is also related to our model in the sense that he shows how
preferences can interact with factor intensities to create a situation in which
factor prices move further apart with trade, the return to capital in a capitalscarce country rising instead of falling.
recently

AntrasandCaballero

While Markusen (1983) and more

(forthcoming)

developmodelsof developing countries that have pursued the export-oriented industrialization strategy.
3

of

trade

demonstrating complementarity between trade and capital mobility, their models
are different from ours in the sense that the difference in relative factor
endowments across countries is not the primary cause for trade in their models.
The rest of the paper proceeds as follows.
setup

of

our

model,

characterizing

its

Section 2 explains the basic

autarkyequilibrium.

Section3

demonstrates how trade can induce industrialization of a developing country inthepresence

of

a

large

unconventional results.

developed

country,

focusingonthemodel’s

In connection with these results, Section 4 discusses theexperiences of developing countries that have pursued the export-oriented
industrialization strategy.

Section 5 then concludes with a brief discussion of

possible future work based on our model of trade-induced industrialization.

2. Basic Setup and Autarky Equilibrium
Consider a world in which there are two types of industries, a traditional
industry and a modern industry.

The traditional industry produces good X andthe modern one produces good Y.

They are perfect substitutes in demand, butthey are produced using capital and labor subject to different technologies. 4
Good X is the more labor intensive.

Good Y is assembled costlessly from twointermediate inputs, M and N, which differ in capital intensity and are bothmore capital intensive than X.
In autarky, none of these goods are traded, and the technologies of M andN can be combined to imply a single technology for good Y.
4Since X and Y

One may model good Y of the modern sector to be a superior substitute for the traditional
good X, consumers having the utility function, u(x, y) = x + λy with λ > 1 and lower caseletters representing the amounts of consumption of the corresponding goods. Assuming λ > 1(or even λ < 1) instead of λ = 1, however, does not affect the qualitative results of thefollowing analysis. For simplicity of exposition, we assume that λ = 1.
4

are perfect substitutes, their prices must be the same if both are produced andconsumed.

The autarky equilibria are fully described by Figure 1, in which thesolid curves show unit (and hence unit-value) isoquants for X and Y.

As shown

in Figure 1, there is a unique common tangent line to the unit-value isoquants
for X and Y, creating two tangency points.

Denote the capital-labor ratios

defined by these tangency points on the X and Y isoquants by kx and ky
respectively.
As is usual in the familiar Lerner Diagram, a country with factor
endowment such as point E2, which lies between the rays kX and kY of thecommon tangencies to the two isoquants, will produce both goods.

It will havefactor prices w2 and r2 given by the (reciprocals of) the intercepts of the tangentline.

It will produce more of good Y, and less of good X, the closer is theendowment point to ray kY.
Production of good Y actually requires production of the intermediate goods,
M and N, whose unit value isoquants at the prices pM2 and pN2 corresponding tofactor prices w2 and r2, are shown as dashed curves in Figure 1.

The isoquant

for good Y is a weighted average of these two isoquants, which must therefore
lie on opposite sides of it.

Nothing in the construction so far requires that

good M be more capital-intensive than good X, although that will become
important later in the story.
A country that is less well endowed with capital than ray kX, such as atpoint E3, will produce only the more labor-intensive good X.

Its factor prices(not shown in Figure 1) will be given by a line tangent to the X isoquant at
the capital-labor ratio of its endowment, thus a lower wage than w2 and a5higher rental than r2.
A country that is endowed with more capital per worker than kY will
similarly specialize, this time in good Y.

This is shown in Figure 2, where thecountry’s wage, w1 is higher, and its rental on capital r1 is lower, than would
have been needed to produce both goods.

Instead, the country produces none ofgood X, since at these factor prices good X would cost more than it would be
worth to consumers.
Production of good Y in autarky requires production of both intermediates,
M and N, whose prices must therefore also adjust to accommodate the different
factor prices.

The unit-value isoquants for these goods that achieve this areshown in Figure 2.

Comparing to the gray image of the isocost line from

Figure 1, which was tangent to the two unit-value isoquants in Figure 1, it canbe seen that the price of M is higher and the price of N is lower than was thecase in Figure 1.
Thus, depending on the capital-labor ratio of its endowment, denoted by k,a country under autarky belongs to one of three distinct development stages interms of its industry composition:

Proposition 1. Under autarkyi) if k < kx, a country will produce and consume only good X, with the returnto capital (labor) falling (rising) in response to an increase in k;ii) if kx ≤ k ≤ ky, a country will produce and consume both goods X and Y,
with the return to capital (labor) being fixed in response to an increase ink; and6iii) if k > ky, a country will produce and consume only good Y, with the returnto capital (labor) falling (rising) in response to an increase in k.

Creation or an expansion of a modern sector producing good Y, namely“industrialization,” will not occur unless a country is endowed with enoughcapital.

Once a country starts to produce good Y as well as good X with k ≥kx, then the prices of both factors and intermediate goods at first remain fixed
as the country becomes more well-endowed with capital.

But once a country

completes its industrialization, specializing completely in the more capitalintensive suite of technologies, additional capital abundance raises the wage,
pushes

down

the

price

of

capital,andcausesmore

capital-intensive

intermediates to fall in price while more labor-intensive intermediates rise in
price.

3. Trade-induced Industrialization: the Case of Small Developing Countries
Consider now a free-trade world in which a very large capital abundant
country with its k > ky (Country 1), like the one in Figure 2, trades with othercountries that are, collectively, too small to influence world prices.

With theexception of good X, which is not produced in the large country, the prices
prevailing under free trade are the ones underlying the black unit-value isoquantsin Figure 2.

The price of good X, if it is to be consumed anywhere under free

trade, must be the same as good Y, since X and Y are perfect substitutes.
Thus the relevant unit-value isoquants for the small countries are those shown in
Figure 3, the convex hull of which therefore provides the full menu of options

7

for countries of various capital-labor endowments to produce a unit of value.
Figure 3 emphasizes the unit-value isoquants of the two most laborintensive options for such a country, since these will be relevant for the poorest
countries.

Thus it shows, in black, the isoquants for X and M and the common

tangent between them. We denote the capital-labor ratios defined by the tangency
points on the M and X isoquants by

andrespectively.

The return tocapital if both are produced is the inverse of the vertical intercept of thecommon tangent line, denoted by.

From these we can describe what a

relatively labor-abundant country will do as a result of free trade.
Countries whose capital-labor endowment ratios are below that of the newray, such as E5 in Figure 3, will do nothing.

In autarky they were

producing only the traditional good X, and they continue to do so with free
trade, since their factor prices, given by a tangent to the X-isoquant at theirfactor ratio, make even good M too costly to produce.
trade.

They therefore do not

It is true that they could, in principle, export good X in exchange forgood Y, since the two are perfect substitutes and have the same price in bothcountries, but nobody gains from such a trade and we exclude it.5
Countries that have factor endowments like E4 in Figure 3, which placethem between
only good X.

andare more interesting.

Prior to trade they produced

But with trade their factor prices make them competitive in

producing the intermediate good M, and they therefore reallocate some of theirlabor and more of their capital to producing it.
“industrialize” as a result of trade.

Thus they begin to

Good M is of no direct use to them by

5This could be justified by the introduction of an infinitesimally small iceberg transportationcost.
8

itself, however, so they must export it, in exchange either for good Y or for theother intermediate good with which they can produce good Y.

They can also

export good Y in exchange for good N because they can combine imported
good N with domestically made good M to produce and export good Y. 6

The

exact pattern of production and trade is here indeterminate, as is often the casewhen more goods than factors have the same cost.
This

trade-induced

industrializationarisesbecausetrade

enablescountries to obtain good Y at a cost lower than their autarky cost.

such

Under free

trade, they can obtain a unit value of good Y using any combination of laborand capital on the isoquant for M instead of the ones on the isoquant for Y in
Figure 3.

This implies that they can obtain the same unit of Y using lesscapital and less labor, thus at a lower cost under free trade than under autarky.
Whichever pattern of production and trade that they end up taking, in essence,theyobtainthecapital-intensive

intermediate

input

N

necessary

for

the

production of good Y at the lower cost by producing extra units of good M andexchanging it for good N (or indirectly conducting such an exchange ofintermediate inputs in terms of factor content of trade) in the world market.7
Note, too, that this move to free trade by the poor country has caused its
6

Again, however, an infinitesimal transport cost for all goods would preclude this unnecessary
trade.
7
There is one more way of obtaining good N for the production of good Y at the same lower
cost: they can produce extra units of good X beyond what is necessary for their domestic
consumption and exchange it for good N (first by exporting good X in exchange with good Y,then exchanging good Y for good N). Producing one unit of good Y using the imported good
N obtained by exporting good X will require a combination of labor and capital that is in the
middle of the X and M isoquants in Figure 3 and on the tangent line common to these two
isoquants. Denote such a combination of labor and capital by (LXN, KXN). Note that it is amore labor-intensive way to produce one unit of good Y than exporting good M in exchange forgood N. While exporting good X in exchange for good N may replace exporting good M inexchange for good N, the latter form of trade should occur (at least be a part of trade) if k >KXN/LXN in order to satisfy the full employment condition.
We thank Gene Grossman for
mentioning this alternative way to obtain good N for the developing countries.
9wage of labor to fall and its rental on capital to rise, contrary to what one
would normally expect from the Stolper-Samuelson Theorem when a laborabundant country opens to trade.
Similar results obtain for a country that has somewhat more capital, so thatin autarky it did produce at least a little of goods M, N, and Y.

Such acountry, with endowment E3 in Figure 3, will cease production of the mostcapital-intensive intermediate input N when it opens to trade, reallocate factors
from both goods N and X to good M, and export good M in exchange either
for good N or good Y.

Thus such a country was already somewhat

industrialized in autarky, since it produced both goods M and N, but it now
specializes more in the single intermediate good that it can produce more
efficiently.

And again, the factor prices change against labor and in favor of

capital with the move to free trade.
These factor-price changes contradict the Stolper-Samuelson Theorem onlyin what the Theorem says about scarce and abundant factors.

In its essential

version, 8 the theorem merely says that relative price changes favor the factor
used intensively in the sector whose price rises and hurt the other factor.
of these are very much the case here.

Both

The reason that the labor-abundant

country shifts into producing good M in this case is that good M has a higher
price relative to good Y, and therefore good X, in the large country than what
prevailed in autarky in a small country.

This, in turn, was because of therelatively high wage in the large country, which made the labor-intensive
intermediate input more costly there.

8

Thus the factor price changes in the small

See Deardorff (1994).
10

country here are exactly what one would expect from the Stolper-Samuelson
theorem for a rise in the price of the (within the poor country) capital-intensive
good M.
This and other effects on factor prices, as well as specialization, for small
countries of a variety of factor abundances, are shown in Figure 4.

This islargely the same as Figure 3, except that different curves are emphasized andtheir proportions have been changed somewhat for ease of viewing.

The graycurve and gray lines show the Y isoquant and the associated autarky factor
prices and proportions.

The black curves and lines show the unit-value

isoquants for goods X, M, and N as determined in the large (therefore autarkic)
country.

A small country of any factor endowment can be placed into thisfigure and it will operate on the convex hull of these three isoquants, producing
either a single good if it is on an isoquant itself, or producing a mix of two
goods if it is on the straight line tangent to two of them.

Factor prices are

determined by the slope and intercepts of a line tangent to the hull at the pointof operation.

We denote the capital-labor ratios defined by the tangency points

on the large country’s autarkic isoquants for M and N byandrespectively, and the level of the return to capital defined by the inverse of thevertical intercept of the common tangent line by.

Clearly, and as is common in a multi-good, multi-cone Heckscher-Ohlinmodel, countries of different factor endowments specialize differently as they
climb the ladder of relative capital abundance:

They produce first only good X,

then goods X and M, then only good M, then M and N (and/or perhaps Y),

11and finally only good N.
The path of factor prices is also evident, the wage-rental ratio either falling
along isoquants or remaining fixed along their tangents as capital abundance
increases.

More interesting, however, is how the factor prices compare to what

they would have been in autarky.
and lines in Figure 4.

This can also be read from the gray curves

Figure 5, however, shows the results for the rental priceof capital as it varies with the ratio of capital to labor in the small country,
both closed (shown in gray) and open (shown in black).
The four smooth downward sloping curves in Figure 5 show the rental
along each of the unit-value isoquants for goods X, M, Y, and N.

Portions ofthese curves also appear on the curves for autarky and free trade equilibria whenthese equilibria are specialized in just one of those goods.

For other endowment

ratios k, however, the small country produces two of the goods and occupies aposition along a horizontal segment that extends between two curves.
The lesson from Figure 5 – which could also be seen in Figure 4 but may
be more evident here – is that there exists a range of rather low (in terms ofcapital) endowment ratios for the small country at which the move from autarky
to free trade causes the rental to rise, as well another range for which the rental
falls.

Perhaps surprisingly, given the normal expectation that capital is dear inpoor countries, the former range appears at lower capital abundance than thelatter.
Thus it is quite plausible in this model that a poor country – poor because
it is poorly endowed with capital relative to the world – may actuallyexperience an increase in its return to capital if it opens up to trade.

12Furthermore, if this happens, it also accompanies a move by the economy into
more capital-intensive production than what it was producing before, what wehere are calling industrialization.

The capital-intensive goods that it produces areof no use for it by themselves, however, but rather are intermediate inputs thatneed to be combined with even more capital-intensive intermediate inputs fromthe more developed world, to which the poor country exports them.
The poor country has a comparative advantage in these goods for two
reasons.

First, they are more labor-intensive than anything else produced in therich world, so that the poor country’s comparative advantage stems naturally
from its labor abundance.

And second, the even more labor-intensive good thatthe poor country produced in autarky is of no interest to consumers in the richcountry, and thus does not provide an export opportunity.

Instead, the switch towhat are for it more capital-intensive goods bids up the return to capital, andpushes down the wage.
The following proposition summarizes the results from our model, focusing
on results that are unconventional in the context of the standard Heckscher-Ohlinmodel:

Proposition 2.

Assume that there exists a fully-industrialized (producing only

good Y) large country in the world.

The following are the effects of a small

country, initially in autarky, opening to free trade with that large country.
i) If a small country is too poor, with its k ≤, then it will remain as anautarky economy, producing and consuming only good X.
ii) If a small country is somewhat less poor, with

13

< k ≤

, then tradewill induce its industrialization, moving some of its resources into theindustry producing good Y.
possible

becauseitcanSuch trade-induced industrialization is

obtain(import)

the

more

capital-intensive

intermediate good N at a cost lower than its autarky cost, in exchange
for exporting the more labor-intensive intermediate good M.
iii) As a result of this trade, the rental on capital in the small country will riseto the level,, as long as its k <so that it does not complete its

industrialization, continuing to produce good X as well as good M.
iv) An increase in k in a small economy will accompany an expansion of trade,both in absolute value and in the ratio of trade to the size of its
economy, as long as it continues to rely on imports for its supply of
good N with its rental on capital being higher than the rental in the large
country,; that is, as long as k <.

The last result in Proposition 2 is unconventional because an expansion of
trade between a poor country and a rich one here occurs when their relative
factor endowments are becoming more similar with an increase in the capitalendowment of the poor country.

With the relative price of good Y being fixed,

an increase in capital in the small country induces its resources to move fromthe labor-intensive traditional sector to the capital-intensive modern sector,
following Rybczynski theorem.

Because only the size of modern sector mattersin determining the size of the small country’s trade, this inter-sectoral movementof resources implies an expansion of its trade relative to the size of its economy

14

as well as in absolute value. 9

Even after the completion of its industrialization(no longer producing good X) with k ≥, an increase in k will raise theabsolute size of its trade because it continues to rely on imports for its supply
of good N with k <.

Also note that this last result of Proposition 2 implies complementarity
between capital mobility and trade.

If we allow free mobility of capital as well

as free trade, then capital will move from the large developed country to thesmall developing country until the rental on capital in the small country falls tothe large country’s level.

The resulting increase in k to the level ofin thesmall country will accompany an expansion of trade according to Proposition 2(iv).

4. The Experiences of Trade-induced Industrialization
As briefly discussed in the introduction, our model can be useful inunderstanding the experiences of developing countries that have pursued theexport-oriented industrialization strategy, such as Hong Kong, Korea, Singapore,
and Taiwan in the 1960s and 1970s, and more recently, China in the 1980s and1990s.

The rapid expansion of these countries’ exports, which enabled their

9

The size of the modern sector in the small country represents the amount of its resources
employed for the (eventual) production of good Y. With no domestic production of good N in
the small country, the size of its modern sector is equal to the amount of resources employed to
produce good M (for eventual production of good Y), having its capital and labor be employedat the ratio of k/M, in the absence of exporting good X in exchange for good N considered inFootnote 4. Even when the small country exports good X in exchange for good N, we cancontinue to apply the same definition in determining the size of the modern sector: It employs
its capital and labor at the ratio of KXN/LXN in its modern sector (for the eventual production ofgood Y) instead of employing its resources at the ratio of k/M. An increase in k in the small
country requires its resources to move from the traditional sector (for the domestic consumptionof good X), which hires resources at the ratio of k/X , to the modern sector (for the eventual
production of good Y), which hires resources either at the ratio of k/M or at the ratio of KXN/LXN.
Note that only the modern sector is involved in trade (importing good N in exchange for its
output).
15

speedy industrialization, largely involves producing labor-intensive manufactured
goods mostly destined toward rich countries such as the US and European
countries as well as Japan.
A relatively less emphasized fact about these countries’ industrialization
through exports is an equally rapid expansion of imports of manufactured goods,
especially capital-intensive intermediate inputs from rich countries.

In the year

1966, for example, which Krueger (1979) identifies as the first year of theperiod during which the Korean economy emerged as a major exporter ofmanufactured goods (1966 – 1975), the “net exports to gross” ratio of
manufactures (the difference between gross value of manufactured exports andthe value of imports for export production, divided gross value of manufactured
exports) discretely jumped down from above 90% in earlier years to less than
50%, and then stayed at such a low level throughout the period of 1966-1975.10
This drastic drop in the domestic content of the manufactured exports of Korea,
which has concurred with its rapid expansion of such exports, indicates thatimports of intermediate inputs played an important role in its export expansion.
In the same year 1966, the percentage of manufactures, machinery andtransport equipment imports in the total imports of Korea jumped from a low of
30% to well above 40% and then stayed at such a high level during the period
1966 to 1975, with its total export value rising from 248 to 5081 and its total
import value rising from 716 to 7274, in millions of US dollars. 11

These facts

conform well to our model’s emphasis on the positive role of importing capitalintensive
10
11intermediate

inputsinfacilitating

poor

These figures come from Table 36 of Krueger (1979).
These figures come from Table 28, 36, and 37 of Krueger (1979).
16

countries’

exportsofmanufactured goods to rich countries, which in turn enables their trade-induced
industrialization.
While obtaining reliable data on the return to capital is difficult, one may
regard the incremental capital-output ratio (the ratio of investment to growth ofan economy) as a measure that is negatively correlated with the return to capital
at a nation-wide level.

According to Balassa (1980), incremental capital-output

ratios in the 1960-73 period were 1.8 in Singapore, 2.1 in Korea, and 2.4 in
Taiwan.

This contrasts with the fact that these ratios were much higher forcountries pursuing the import-substituting industrialization strategy – 5.5 in Chile,
5.7 in India, and 9.1 in Uruguay – showing that the returns to capital weremuch higher for countries pursuing export-oriented industrialization strategies.12
Instead of comparing these incremental capital-output ratios across countries
that had taken different industrialization strategies, one may want to check how
a change in a developing country’s trade policy from import-substitution toexport-orientation affects such a measure.

In the case of Korea, for example,

the incremental capital-output ratio significantly dropped, from 3.04 for theperiod of 1954-65 to 1.71 for the period of 1966-1975, indicating that the returnto capital rose after it had effectively switched its policy from import-substitution
to export oriented industrialization. 13

Possibly a more direct measure for therental on capital is the real interest rate.

The real interest rate in Korea stayed

at a very high level during the period of 1966-1975, mostly having its curbmarket rate above 30% and its rate on time deposits above 10%, except in those

12

These numbers come from the first Essay of Balassa (1980).
These numbers were calculated based on Korean GDP and investment data from the Penn
World Table Version 6.1.

13

17

later years affected by the first-oil shock.

Once again, these facts accord wellwith our model’s prediction of how a trade-induced industrialization may affectthe return to capital in poor countries.14
It is well known that both the ratio of trade to GDP and the absolutevalue of trade were rapidly expanding for the countries pursuing export-oriented
industrialization, especially in the early period of their industrialization during
which their capital per labor ratio was rising fast.

This again corresponds wellwith the prediction of our model of trade-induced industrialization:

According to

Proposition 2 (iv), there will be an expansion of trade between a poor country
and a rich one in response to an increase in the capital endowment of the poor
country, as long as their endowments are not similar enough to induce factor
price equalization between them.

Also recall that Proposition 2 (iv) implies

complementarity between capital mobility and trade.

In the case of Korea, it

was borrowing heavily from rich countries to fill the gap between its domestic
saving and investment during the period of 1960–85, at the same time that its
trade with rich countries was expanding rapidly.

5. Conclusion
The success of the Asian Tiger economies in fostering industrialization
through trade is well known, and it has provided the example that many otherdeveloping economies, which had attempted to industrialize through importsubstitution, have later followed.

Trade economists have applauded that success,but aside from pointing to the conventional gains from trade, trade theory has

14

See Table 1 of Kim (2007)18

not been particularly useful in explaining it.

The textbook Heckscher-Ohlin

Model would suggest that labor-abundant countries would specialize in evenmore labor-intensive goods if they pursued free trade, and this specialization
would hardly constitute industrialization.
The model here, while just a particular version of the Heckscher-Ohlin
Model expanded to include intermediate inputs in the industrial sector and madetractable

byassuming

perfect

substitution

between

final

goods,

remarkably well for explaining such export-led industrialization.

performs

Its predictions

conform well with the data that have been reported for the Tiger economies
during the early decades of their success.
More, of course, remains to be done.
particularandspecialexample,designedunderstanding rather than generality.

The model here has been a veryfor

expositional

simplicity

and

It remains to be seen what characteristics

of a more general model, with more industries and a more general formulationof preferences, would be needed to generate comparable results.

For example,

we might conjecture that similar results would obtain in a model with multiple
industries, each with both traditional and modern technologies. The modern
technologies would need to involve greater complexity than the traditional
technologies, in terms of intermediate inputs of varying but higher-than-traditional
capital intensities. If such a more general theoretical result could be established,
then it would then make sense to investigate actual technologies to see if they
conform to those assumptions.
The model here is static and only addresses the effects of trade and theeffects of capital accumulation.

It does not explain that capital accumulation,

19

except in our suggestion that if capital were internationally mobile, then it would
be attracted to the developing country when trade causes its return to capital torise.

It would be useful, however, to imbed this static model in a model ofendogenous growth, to see if that trade-induced rise in return to capital would
also stimulate capital accumulation.

If so, then we would have not just a modelof trade-induced industrialization, but also a model of trade-induced economic
growth.

20

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Davis, D., 1996, “Trade Liberalization and Income Distribution,” NBER Working
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