A New Theory of International Trade: Capital Deepening and Market Segment Determines the Pattern of International Trade

Through growth and investment, two countries will have the same capital-labor ratio and productivity which leads to the same factor prices in the long run if two countries have the same production function with constant return to scale. Consequently, H-O model predicts no trade in the long run as Stolper and Samuelson (1941) recognized a contradiction in the H-O model that the full equalization of factor prices, which eliminates the cost difference between two countries, will lead to no trade. Since a theory is false if we derive contradictory conclusions (e.g., trade and no trade) from assumptions (i.e., premises in the sense of logic), we should completely get rid of the H-O model even H-O model explains some trade patterns (e.g., a natural resources abundant country exports natural resource) because we can derive true conclusions from a false model. Capital deepening suggests that productivity rises when the capital-labor ratio increases. Thus, productivity determines the trade pattern. For example, capital-abundant countries can export labor-intensive goods if the capital-labor ratio (productivity) of a labor-intensive industry in a capital-abundant country is higher than its counterpart in labor-abundant countries and vice versa, e.g., British exported cotton textiles to India even British was a relatively capital-abundant country to India and cotton textiles were a labor-intensive good in the nineteenth century British. Besides, oligopoly explains intra-industry trade in the global market because the strategy of competition between firms would segment the market by quality and price hierarchies rather than monopolistic competition. Finally, Ting (2020) implied that wage rates in capital-intensive industries and capital-abundant countries (e.g., manufacturing) are higher than labor-intensive industries and labor-abundant countries (e.g., agriculture) so factor prices differentiate.