Economics 340: International Economics
Andrew T. Hill
Heckscher-Ohlin Theory
& Textbook Readings: Pugel & Lindert, International Economics, 11th Edition, pp. 54-57, 61-76.
10th Edition, pp. 50-52, 57-69.
In the previous sections, we have looked at comparative advantage as it was explained by
Ricardo and further developed by the neo-classical economists. Ricardo’s explanation for comparative advantage centered on differences in labor productivity (technology) coupled with the
idea of opportunity cost. But, he didn’t explain why there were differences in productivity in
different countries.
◆ Weaknesses in Ricardo’s model:
1.
2.
In 1919, Eli Heckscher (1879-1952) wrote a short article entitled “The Effects of Foreign Trade
on the Distribution of Income.” (Economisk Tidskrift 21 [1919] pp. 497-512). In that article, he
argued that international trade alters factor prices and that those changes in factor prices lead
to the redistribution of income within a country. It was Heckscher’s landmark article that laid
the groundwork for factor endowment theory which is more often referred to by international
economists as Heckscher-Ohlin Theory.
■ Eli Heckscher (1879-1952):
Born in Stockholm in 1879, Eli Heckscher studied history and economics at Uppsala
University. In 1909 he became professor of economics and statistics at Stockholm
University College of Commerce. He held that post until 1929 when he was made
research professor and director of the Institute of Economic History. He retired from
academia in 1945. He was considered a leader in a diverse array of economic topics from
economic history to international trade theory. His most significant contribution to economic theory was the factor proportions theory of international trade first outlined in his
1919 article “The Effects of Foreign Trade on the Distribution of Income” and developed
further by Ohlin in 1933.
Heckscher’s student Bertil Ohlin (1899-1979) developed further Heckscher’s work. Ohlin
argued in his work Interregional and International Trade (1924) that countries were endowed disproportionately with different factors of production which make them better at producing
goods which use the more abundant factor more intensively.
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■ Bertil Ohlin (1899-1979):
Bertil Ohlin was born on 23 April 1899 in Klippan, Sweden. He received a degree in
mathematics, statistics, and economics at the University of Lund in 1917. He continued
his studies with Eli Heckscher at the Stockholm School of Business Administration
where he was awarded a degree in economics in 1919. He received an AM at Harvard in
1923 and completed his Ph.D. at the University of Stockholm in 1924. Ohlin taught at the
University of Copenhagen from 1925 to 1930 before taking the position vacated by Eli
Heckscher at the Stockholm School of Business Administration in 1930. He remained in
his post at Stockholm until 1965. He was visiting professor at the University of California
at Berkeley in 1937 and at Columbia and Oxford in 1947. Ohlin was one of the few economists who have been successfully able to contribute widely to economic theory and
also hold political office. He served as a member of the Swedish Riksdag (parliament)
from 1935 to 1970, was Swedish Trade Minister from 1944 to 1945, and leader of the
Swedish Liberial Party from 1944 to 1967. He was awarded the Nobel Prize in Economics
jointly with James Meade in 1977 for his work on international trade theory. He died on
3 August 1979 in Stockholm.
◆ The factor endowment theory (a.k.a. Heckscher-Ohlin Theory) relies on several simplifying
assumptions:
1.
2.
3.
◆ According to the factor-endowment theory, relative price levels differ among nations
because:
1.
2.
● Heckscher-Ohlin Theory (Factor Endowment Theory) states that given these circumstances
listed immediately above, a nation will export that commodity for which a large amount of
the relatively abundant (cheap) input is used in production. The country will import that
commodity for which a large amount of the relatively scarce (expensive) input is used in
production.
◆ Example of Resource Abundance and Input Intensity:
A country is relatively labor-abundant if it has a higher ratio of labor to other factors of
production than does the rest of the world.
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A product is labor-intensive if labor costs are a greater share of its value than they are of
the value of other products.
To determine whether the United States is a land-abundant country, we could use a
formula like this one:
To determine whether a certain good X is land-intensive, we could use a formula like this
one:
◆ Example: Simple Case using Heckscher-Ohlin Theory:
Assume that auto production is capital-intensive, requiring much capital and little land;
wheat production is assumed to be land-intensive, requiring much land and little labor.
Suppose that capital is relatively abundant in Germany and that land is relatively
abundant in France.
What country will have the comparative advantage in autos? __________
What country will have the comparative advantage in wheat? __________
● Factor-Price Equalization Theory says that a nation that is trading will find output expanding in its comparative-advantage industry, which uses a lot of the cheap, abundant factor. As
a result of the rise in demand for the abundant factor, its price increases. At the same time,
the expensive, relatively scarce factor is being released from the comparative-disadvantage
industry. As a result of the decrease in demand for the scarce factor, its price decreases. This
process occurs simultaneously in both countries in the two-good, two-country model.
Therefore, each country experiences a rise in the price of the abundant factor and a fall in the
price of the scarce factor. So, trade will lead to an equalization in the price of each factor in
the two countries.
✑ THINK-PAIR-SHARE: If we have two countries, Mexico and the United States, and two
goods, textiles and corn, and we know that textiles are relatively labor-intensive in
production and corn is relatively land-intensive in production, does the factor-price
equalization theory say that the price of labor and the price of land in Mexico will equalize
while the price of labor and the price of land in the United States will equalize? Or, does
it say that the price of labor in Mexico and the United States will equalize while the price
of land in Mexico and the United States will equalize as a result of trade?
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● Trade and the Distribution of Income:
The factor endowment theory states that the export of commodities embodying large
amounts of the relatively cheap, abundant factors make those factors less abundant in
the domestic market. The increased demand for the abundant factor leads to an increase in
its return. At the same time, returns to the factor used intensively in the import-competing product (the scarce factor) decrease as its demand falls. The increase in the returns to
each country’s abundant factor thus comes at the expense of the scarce factor’s returns.
Using the example from the THINK-PAIR-SHARE immediately above,
◆ Group Problem:
Assume tastes and technology are identical in Hong Kong and Japan. Assume Hong
Kong is labor abundant and Japan is capital abundant. Assume production of textiles is
labor intensive and production of tractors is capital intensive.
a.
Sketch the production possibilities frontiers for Hong Kong and Japan in the
space below. Be prepared to explain why you drew them the way that you did.
b.
In autarky, which country has a comparative advantage in the production of
which good? Show how you know, or why you don’t know.
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c.
What does the Heckscher-Ohlin theory predict would happen if trade were
opened between Hong Kong and Japan?
d.
What do you predict will happen to the price of capital in Japan, the price of capital in Hong Kong, the price of labor in Hong Kong, and the price of labor in Japan
as a result of trade following the Heckscher-Ohlin model?
e.
What do you predict will happen to the incomes of capital owners and workers
in both Japan and Hong Kong?
● Leontief’s Paradox
There have been many attempts to test whether the factor endowment theory that
Heckscher and Ohlin developed actually holds empirically. The first such attempt came
from Wassily Leontief in 1953 in his paper “Domestic Production and Foreign Trade: The
American Capital Position Reexamined” in Proceedings of the American Philosophical
Society 97 (1953).
If you realize that the United States is a highly developed country with lots of capital
used in production, it follows from the factor endowment theory that the United States
is capital-abundant and should export capital-intensive goods while importing laborintensive goods. It is this prediction of the Heckscher-Ohlin theory that Leontief set out
to test. He examined data from 1947 for 200 export industries and import-competing
industries. Import-competing industries are those U.S. industries that compete heavily
against imports from foreign countries. He found the following data:
Table 11: Factor Content of U.S. Trade: Capital and Labor Requirements per Million
Dollars of U.S. Exports and Import Substitutes*
Empirical Study
Import Substitutes
Exports
LEONTIEF (1947 data)
Capital
$3,091,339
$2,550,780
Labor (person years)
70
182
Capital/person years
$18,184
$14,015
LEONTIEF (1951 data)
Capital
$2,303,400
$2,256,800
Labor (person years)
168
174
Capital/person years
$13,726
$12,970
* SOURCE: Carbaugh, International Economics, 7th Edition, 2000, p. 81.
Import/Export Ratio
1.30
1.06
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When Leontief looked at the 1947 data he found that the capital/labor ratio for our
exports were less than the capital/labor ratio in the import-competing industries. The
conclusion he drew was that the U.S. was exporting labor-intensive goods while
importing capital-intensive goods. This result is completely backwards from what
Heckscher-Ohlin theory would predict! Leontief was criticized for his work. Most
international economists at the time had some sort of argument as to why his findings
weren’t correct. The most widely accepted idea was that the 1947 data were not truly
reflective of normal trade patterns since the world was still recovering from World War
II. Leontief did the same study again using data from 1951. While he found that the
import/export ratio of the capital/labor ratio wasn’t nearly as big as when he used the
1947 data, he still found that the United States was exporting labor-intensive goods
while importing capital-intensive goods—a result that was completely contrary to the
results one would obtain from the factor endowment theory. Hence Leontief’s Paradox!
It has come to be generally accepted that the reason Leontief found his paradox is that
factors of production need to be much more narrowly defined when testing the factor
endowment theory. For example, there are many different kinds of land (urban, arable,
unusable for any production, etc.). Likewise, there are many forms of capital most
notably physical versus human capital. When one more narrowly defines the factors of
production into finer categories, one finds that the Heckscher-Ohlin theory holds much
better than when only considering land, labor, capital, and entrepreneurial ability.
✍ Predicated Essays
1.
“Korean workers earn only $2.50 an hour; if we allow Korea to export as much as it likes to
the United States, our workers will be forced down to the same level. You can’t import a $5.00
shirt without importing the $2.50 wage that goes with it.” Discuss.
2.
What does the factor-price equalization theorem postulate? What does it mean for wages and
the rental rate of land in Mexico and the United States if the United States is relatively landabundant and Mexico is relatively labor-abundant?
3.
How does the Leontief paradox challenge the overall applicability of the factor-endowment
model?
4.
“The factor-price equalization theorem indicates that with free trade, the real wage earned by
labor becomes equal to the real rental rate earned by landowners.” Is this correct or not?
Why?
5.
You read in a newspaper that the owners of capital in a particular country are urging their
government to restrict trade through import quotas. What might you infer about the relative
factor abundance in that country? Why?
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