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A Test of the Heckscher-Ohlin Theorem on India Exports

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A Test of the Heckscher-Ohlin Theorem on India Exports A TEST OF THE HECKSCHER-OHLIN THEOREM ON INDIA EXPORTS A Thesis Presented to the Faculty of California State Polytechnic University, Pomona In Partial Fulfillment Of the Requirements for the Degree Master of Science In Economics By Amith Jay Shetty 2014 SIGNATURE PAGE THESIS: A TEST OF THE HECKSCHER-OHLIN THEOREM ON INDIA EXPORTS AUTHOR: Amith Jay Shetty DATE SUBMITTED: Spring 2014 Economics Department Dr. Carsten Lange _________________________________________ Project Committee Chair Professor of Economics Dr. Bruce Brown _________________________________________ Professor of Economics Dr. Craig Kerr _________________________________________ Professor of Economics ii ABSTRACT The Heckscher-Ohlin model is a general equilibrium mathematical model of international trade. The model states that countries will export products that will utilize their abundant and cheap factors of productions and import products that utilize the countries’ scarce factors. This paper will test that theory against the international trade data between India and the United States. India is known to be a labor abundant country, which should result in India exporting labor-intensive goods to the United States. Using 126 commodities and labor statistics taken from both countries, this paper will find if the 2009 trade data between India and the United States are consistent with the Heckscher- Ohlin model. iii TABLE OF CONTENTS Signature Page .............................................................................................................. ii Abstract ......................................................................................................................... iii List of Tables ............................................................................................................... v List of Figures .............................................................................................................. vi Introduction ................................................................................................................... 1 Growth of India ............................................................................................................. 2 India and United States Trade Relations ....................................................................... 4 Heckscher-Ohlin Model ................................................................................................ 6 Theory………………………………………………………………………... 6 Model………………………………………………………………………... 8 Literature Review.......................................................................................................... 10 Methodology................................................................................................................. 13 Data…………............................................................................................................... 14 Empirical Testing and Results ...................................................................................... 15 Conclusion……. ........................................................................................................... 21 References ..................................................................................................................... 23 Appendix A: Export Import Data 2009 ........................................................................ 26 Appendix B: Export Import Data 2005 ......................................................................... 27 iv LIST OF TABLES Table 1 Sectoral Breakdown of India’s GDP ........................................................... 3 Table 2 United States and India Country Comparison ............................................ 5 Table 3 Eviews Statistics on 2009 Data ................................................................... 15 Table 4 Eviews Statistics on 2005 Data ................................................................... 17 Table 5 Eviews Statistics on Manufacturing Sector using 2009 Data ..................... 19 v LIST OF FIGURES Figure 1 India’s Nominal Gross Domestic Product, 2002-2007 ............................... 2 Figure 2 Growth in India’s Merchandise and Service Trade 1990-2005 .................. 4 Figure 3 U.S. Merchandise Trade with India, 1958-2006 (U.S. $Billions) ............. 6 Figure 4 Export/Import Ratios vs Capital/Labor Ratios using 2009 Data ............... 17 Figure 5 Export/Import Ratios vs Capital/Labor Ratios using 2009 Manu Only .... 20 vi Introduction India has been on the rise for emerging markets. A lot of that is due to trade among global leaders like the United States and other European countries. India’s diverse economy includes traditional village farming, modern agriculture, wide range of modern industries and a large amount of services (Martin & Kronstadt, 2007). Today, India and the U.S. share an extensive cultural, strategic, military, and economic relationship (Martin & Kronstadt, 2007). To get an in depth look at the economic relationship between the two countries, this paper will look at the international trade between India and the U.S. One theory that studies the international trade between two countries is the Heckscher-Ohlin theorem. The model states that countries will export products that utilize their abundant and cheap factors of production and import products that utilize the countries’ scarce factors (Kurtishi-Kastrati, 2013). The H-O theorem expands more on David Ricardo’s theory of comparative advantage by predicting patterns of commerce and production based on factor endowments. This paper will explore on the Heckscher-Ohlin theorem. It will apply the Heckscher-Ohlin model and see if it applies to India exports 2009 trade data. The economies of the United States and India have had different characteristics, but the United States is known as a capital abundant country while India has been labor abundant. One would expect that testing the Heckscher-Ohlin model using the trade data between India and the United States would provide evidence that India exports labor intensive goods. This paper will test the hypothesis that labor abundant India will export labor intensive goods to the United States. The paper will talk about the growth of India through the years and give a history of the trade relationships between the United States and India. It will include a literature review of some of the notable tests done in the past and the author’s conclusions. After the literature review, empirical testing will be done on 1 import/export data. It will be reviewed for several different sectors between the two countries. The data set will contain a list of 125 commodities and will be divided up by either capital intensive or labor intensive. Labor intensive exports will be analyzed as a proportion of capital intensive exports to determine how the export/import ratio compares to the capital/labor ratio for each commodity for each country. Depending on the results, conclusions will be made on whether the Heckscher-Ohlin model applies to the 2009 trade between India and the United States. Growth of India India’s economy is the 10th largest in the world by nominal GDP (Bank, 2013). In the 1990’s, the country began to experience very fast growth as markets opened for international competition and investment. India is emerging as an economic power with huge amounts of human and natural resources. Economic reforms and better economic policy in the 2000’s accelerated India’s economic growth rate. Figure 1 . India’s nominal gross domestic product, 2002-2007 2 In Figure 1 on the facing page (Martin & Kronstadt, 2007) shows India’s nominal GDP for the years 2002 through 2007. India’s GDP grew 24.5 trillion rupees in 2002 to 40.3 trillion rupees in 2006, which is an increase of 64% (Martin & Kronstadt, 2007) . In 2008, India became the world’s second fastest growing major economy(Pasricha, 2008). The reason why India has been growing so fast is because of the expansion of its manufacturing and service sectors. Table 1 (Martin & Kronstadt, 2007) shows the breakdown of India’s real GDP for fiscal years of 1996, 2001, and 2006. Table 1 Sectoral Breakdown of India’s GDP This shows the shift from the agriculture sector to the services sector. Even though there is a decrease in the agricultural sector, it is still a very important part of India’s economy. The shift of India’s economy is driven by the rapid growth in the nation’s trade in goods and services. Figure 2 on the following page (Martin & Kronstadt, 2007) shows the increase in both merchandise and services trade from 1990 to 2005. It shows a drastic growth in trade at the beginning of 2000 till 2005. One of the causes of this increase can be attributed to the internet tech boom and the outsourcing of computer services by other countries, one of them largely being the United States. 3 Figure 2 . Growth in India’s merchandise and service trade 1990-2005 India’s economy is largely an internal market with external trade accounting for 20% of the country’s GDP. India’s major trading partners are China, the United States, the United Arab Emirates, the United Kingdom, Japan, and the European Union (Tharoor, 2009). This paper will only concentrate on the trade between the United States and India. India and United States Trade Relations In the past, the United States and India have not always had the best relationship. India developed a relationship with the Soviet Union during the Cold War. This caused a huge impact on its relationship with the United States. After the collapse of the Soviet Union, India began to
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