Trade Theories:
#4 … Heckscher-Olin
Introduction: The Determinants of Comparative
Advantage
• There are many factors that determine
comparative advantage between countries
• The reasons why one country might be more
productive than another in a particular line of
production should be analyzed
Modern Trade Theory
• Adam Smith and David Ricardo assumed that each
country would have its own technology, climate, and
resources, and that these differences would give rise to
productivity differences (and thus differences in
comparative advantage)
• In the 20th century, several economists developed more
detailed explanations of trade in which comparative
advantage of a country depends on it’s endowments of
inputs (factors of production) to produce goods
Heckscher-Ohlin (HO) Model
•
Eli Heckscher and Bertil Ohlin, Swedish
economists
•
Model based on two concepts:
1. Factor endowments—the quantities of
productive resources possessed by a country
2. Factor intensity—the amount of labor per unit
of capital used in production of a product
Heckscher-Ohlin (HO)
Trade Model
• A country’s factors of production (a country’s endowments of
inputs) are used to make each good give rise to productivity
differences between countries
• Factor endowments:
– Factor abundance versus factor scarcity: When a
country enjoys a relative abundance of a factor, the
factor’s relative cost is less than in countries where the
factor is relatively scarce
– A country’s comparative advantage lies in the production
of goods that use relatively abundant factors
Heckscher-Ohlin (HO)
Trade Model
Factors?
• Labor
• Capital
Heckscher-Ohlin (HO)
Trade Model
• Export goods that intensively use factor
endowments which are locally abundant
• So … A country that is relatively labor abundant
(capital abundant) should specialize in the
production and export of that product which is
relatively labor intensive (capital intensive)
• Corollary: import goods made from locally scarce factors
• Patterns of trade are determined by differences in
factor endowments - not productivity
Country Factor Abundance
• Country A is relatively capital-abundant if:
KA / LA > KB / LB
Obviously, County B would be labor-abundant :
LB / KB > LA / KA
Example
• Two countries (EU and India) and two
factors (labor and capital)
• EU is capital-abundant compared to India
(and India is labor-abundant compared to
EU) if and only if the ratio of the total
amount of capital to the total amount of
labor (K/L) available in EU is greater than
that in India
An Example of Factor Abundance
EU
India
Capital
50 machines
2 machines
Labor
150 workers
10 workers
• Indian capital-labor ratio: KInd / L Ind is 2/10 or 1/5
• EU capital-labor ratio: Kus / L us is 50/150 or 1/3
• Since the EU’s capital-labor ratio is higher, it is the
relatively capital abundant country:
(KEU / L EU > KInd. / LInd. or 1/3 > 1/5 )
Factor Intensity
• Labor (capital)-intensive GOOD
– a good is labor (capital)-intensive relative to
another, if its production requires more (less)
labor per machine than the other good requires
in its production.
– So if production of good x is more labor intensive
than production of good z
Lx / K x > Lz / Kz
Factor Intensity
• So assume that the production of…
Cloth requires 3 units of labor per 1 units of
capital
Machines require 2 units of capital per 1 unit
labor
Obvious … Cloth is Labor intensive and Machines are Capital
Intensive
Factor Intensity
• What about this…
Cloth requires 3 units of labor per 1 units of
capital
Machines require 2 units of labor per 1 unit
capital
Since we are looking at “relative” values … Still the same …
Cloth is Labor intensive and Machines are Capital Intensive
Heckscher-Ohlin (HO)
Trade Model
• Assumptions of the Heckscher-Ohlin Model
– There are two countries and two goods … (2x2)
model
– Production and consumption conducted under
perfect competition
• Firms are price takers
• Prices of factors are determined by supply and demand
in each market
• In long run, prices of goods are equal to their respective
costs of production
Heckscher-Ohlin (HO)
Assumptions, continued
• No transportation costs, taxes, or other
obstructions to trade
• International trade does not cause complete
specialization
• Consumers in both countries have equal tastes
and preferences
• Both countries are endowed with
homogeneous factors of production, capital (K)
and labor (L), and both are used in production
Heckscher-Ohlin (HO)
Trade Model
Assumptions, continued
• Technology for production is the same in both
countries and produced under constant returns
to scale
• Capital and labor are mobile domestically
• Labor and capital cannot move between
countries
Heckscher-Ohlin (HO) Trade Model
• The EU is richly endowed with a wide variety of
factors: natural resources, skilled labor, and physical
capital
– Expectation: The EU will export agricultural products
(particularly those requiring skilled labor and physical
capital) and machinery and industrial goods (requiring
physical capital and scientific and engineering skills)
– Result: Major EU exports include grain products made with
small labor and large capital inputs; and commercial aircraft
made with physical capital and skilled labor
Gains from Trade in the HO Model
• Ricardian (Comparative Advantage) model assumed
that each country faced a constant set of tradeoffs
because of only one homogeneous input: labor
• The HO model assumes: (1) multiple inputs—labor
capital, land, etc.—and (2) variations in the quality of
inputs
• Thus, the PPC cannot be assumed to have constant
costs. Under the HO model, each country has a rising
opportunity cost for each type of production
Production Possibility Frontier
• Because EU is capital-abundant and Machines
are capital-intensive, IEU’s PPF will lie
primarily along (or biased toward) the
Machine axis
• Because India is labor-abundant and Cloth is
labor-intensive, India’s PPF will lie primarily
along (or biased toward) the Cloth axis
Production Possibility Frontiers
Machines
..
EU
Slope still equals opp. cost …. But since
the PPC is curved, the tradeoff between
machines and cloth is different at each
point of production
A
India
..
Cloth
Production Possibility Frontiers
Machines
..
A – can be the “no-trade”
Autarky position for the countries
Aeu
Aind
..
Cloth
• Domestics of India will see that relative price of
machines in EU is lower than at home
• Domestics of EU will see that relative price of cloth in
India is cheaper than at home
• Producers see the change in consumer patterns and
will increase production of abundant factor.
• Results in an equalization of price ratios in both
countries
Production Possibility Frontiers
Machines
..
Qeu
EU will exploit their comparative
advantage and increase
production of Machines
Aeu
p
Aind
Qind
p
..
Cloth
H-O Model
FACTOR-PROPORTIONS THEORY
Capital Stock per Worker of Selected Countries in 1992 (in 1985 international dollar
prices)
High-Income
Country
Switzerland
Capital-to-Labor
Ratio
Middle & Low
Income Country
Capital-to-Labor
Ratio
$76,733
Mexico
$11,697
Canada
44,970
Poland
11,811
Japan
41,286
Chile
11,306
Australia
38,729
Turkey
7,626
France
37,560
Thailand
5,853
United States
35,993
Philippines
3,598
Netherlands
34,084
India
1,997
Italy
33,775
Kenya
822
Spain
30,888
Nigeria
735
United Kingdom
22,509
Trade and Income Distribution
• The HO model provides a more sophisticated way to analyze
gains and losses from trade because it drops unrealistic
assumptions
– Labor can be divided into categories of different skill levels
– Other types of inputs can be included
– Industries can require different mixes of various inputs
• There is a systematic relationship between the factor
endowments of a country and the winners and losers from
trade
• Let’s analyze this claim further…