Heckscher-Ohlin Model Essay ⋆ Business Essay Examples ⋆ EssayEmpire

The Heckscher-Ohlin model (H-O model) was constructed to understand the role of productive resources in international trade, analyzing an economy in which two goods are produced using two factors of production. It is a general equilibrium model that extends some important results of the comparative advantage theory developed by David Ricardo. One of the principal results of the model is that the countries export the products that employ their abundant factors of production intensively, and import commodities that utilize scarce factors of production. That result is known as the Heckscher-Ohlin theorem. The model was developed in the 1920s by Swedish economists Eli Heckscher and his student Bertil Ohlin (winner of the Nobel Prize in Economics in 1977), and has been extended since by other economists like Paul Samuelson, Wolfgang Stolper, Jaroslav Vanek, and Ronald Jones.

The original formulation of the H-O model refers to the case of two countries, two factors of productions—capital and labor—that have unlimited supplies, and two final goods (for that reason, sometimes the model is called the 2x2x2 model). In the model, the economies use the same technology of constant returns of scale, and the production of the goods differs between countries in the intensity of utilization of inputs. The intensity is about the proportions in which the two factors of production (capital and labor) are used. There is private ownership of the productive capital (that is, the physical machines and equipment that are used in production) and perfect mobility of factors within a country, but controls in the mobility of labor and capital between nations. Additionally, each commodity has the same price everywhere and its production takes place under perfect competition in both countries.

These assumptions widen the conception of the basic Ricardian model of international trade, because this model only supposes the existence of one factor of production—labor—that is required to produce all the goods and services in the economy. The productivity of labor is assumed to vary across countries, which implies a difference in technology between nations. It was the difference in technology that motivated advantageous international trade in the model.

In the H-O model the specialization of the production is incomplete, because of differences in factor endowments. A capital-abundant country is one that is well endowed with capital relative to another country. This gives that country the possibility to produce the good which uses relatively more capital in the production process (the capital-intensive good). As a result, if these two countries were not trading initially, i.e., they were in autarky, the price of the capital-intensive good in the capital-abundant country would be offered in a minor quantity (due to its extra supply) relative to the price of the good in the other country. Similarly, in the labor-abundant country the price of the labor-intensive good would be bid down relative to the price of that good in the capital-abundant country.

Once trade is allowed, profit-seeking firms will move their products to the markets that temporarily have the higher price. Thus, the capital-abundant country will export the capital-intensive good since the price will be temporarily higher in the other country. In the same way, the labor-abundant country will export the labor-intensive good. Commercial flows will rise until the prices of both goods are equalized in the two markets.

The Heckscher-Ohlin theorem is the main result of the model. It states that a capital-abundant country will export the capital-intensive good while the labor-abundant country will export the labor-intensive good. Thus, the H-O theorem shows that differences in resource endowments, as defined by national abundance, are one reason for international trade to take place. Another important conclusion is about the prices of the final goods and the distribution variables: a rise in the relative price of a good will lead to a rise in the return to that factor which is used most intensively in the production of the good, and conversely, to a fall in the return to the other factor.

At the time of the appearance of the original model, the empirical evidence for the 19th century and the first 20 years of the 20th century coincided with the results of the model. In 1953, economist Wassily Leontief developed an empirical test of the H-O model to analyze the case of the United States economy in the 25 years after World War II. Leontief found that the United States, despite having a relative abundance of capital, tended to export labor-intensive goods and import capital-intensive goods; this result is known as the Leontief paradox. There is not a unique explanation for the paradox, and alternative trade models and several alternative explanations have emerged as a result of the Leontief ’s conclusion. Recent estimates have shown some difficulties with the empirical verification of the model, associated with the key assumption that technology is the same everywhere. However, to change this assumption would mean abandoning the pure H-O model altogether.

Bibliography:

Heckscher, “The Effect of Foreign Trade on the Distribution of Income,” Ekonomisk Tidskrift (1919);
R. Krugman and M. Obsfeldt, International Economics: Theory and Policy, 7th ed. (Addison-Wesley, 2007);
Leamer, The Heckscher-Ohlin Model in Theory and Practice (Princeton Studies in International Economics, 1995);
Ohlin, International and Interregional Trade (Harvard University Press, 1933);
Serdar Sayan, “Heckscher-Ohlin Revisited: Implications of Differential Population Dynamics for Trade Within Overlapping Generations Framework,” Journal of Economic Dynamics & Control (v.29/9, 2005);
F. Stolper and P. A. Samuelson, “Protection and Real Wages,” Review of Economic Studies (v.9, 1941);
Xiaokai Yang and Wenli Cheng, An Inframarginal Analysis of the Heckscher-Olin Model (Monash University, Department of Economics, 1997).

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