Understanding Stolper-Samuelson, Rybczynski, and Factor Price Equalization Theorems
The Stolper-Samuelson Theorem
Under the assumptions that the underlying production technology exhibits constant returns to scale and that both goods are produced, an increase in the price of one good leads to an increase in the real income of the factor that is used intensively in producing that good, and lowers the real income of the other factor. Trade results in the rising of the price of the good which uses intensively the abundant factor that earned relatively low in autarky. Since demand for the abundant factor increased with trade, the price of the factor would be raised thereafter. Hence, trade is beneficial to owners of abundant factors or resources at the cost of hurting the owners of scarce factors or resources. The income redistribution effects require government to launch compensating measures to those who would have been hurt before opening up for trade.
The Rybczynski Theorem
If the relative price remains constant and both goods are produced, an increase in the supply of one factor leads to an increase in the production of the good which uses the factor intensively in the production, and reduces the production of the other good. A country that has a comparative advantage in producing labor-intensive goods may choose to maintain this advantage by immigrating foreign labor. Is this really a good policy?
The Factor Price Equalization Theorem
Under constant returns to scale technology, free trade would equalize the relative price of factors employed in both trading countries through the equalization of commodities’ relative price, as long as two goods are both produced.
To most policymakers, international trade is just a means to promote economic growth. The Factor Price Equalization Theorem, introduced in the late 1950s by several economists, has played an important role in changing policymakers’ minds toward international trade. Leaders in many developing countries have taken it for granted that they have incorporated international trade into their economic development strategy. However, leaders in the advanced economies were not taking international trade seriously in forming their national policy until the publication of this theorem.
However, by examining the theorem carefully, it is not difficult to realize that the perfect competition market condition requirement is too restrictive for practical purposes if one’s purpose is aiming at pursuing the same standard of living through factor price equalization. In other words, it is almost impossible to be realized given the present situation in which an imperfect market structure dominates. In order to achieve the goal of equality in incomes between countries, it is not sufficient to rely solely on trade. Allowing free movements of factors between countries is required as a complementary strategy and is inevitable. The Rome Treaty, in which free movements of factors among member countries to form a Common Market by 1979, signed by the European Custom Union countries in 1958, was initiated as a response to the Factor Price Equalization Theorem mentioned above. Even the more recent Maastricht Treaty of 1992, also known as the Treaty leading to Economic Union in Europe, is aiming at enhancing the mechanism for factor mobility among member nations by eliminating existing regulations and technical obstacles that have prevented professional jobs from opening to foreigners.