Theories of World Economy
Agenda
• The Heckscher–Ohlin theory
• Leontief’s paradox
• Theorem Ribchinsky
1. The Heckscher–Ohlin theory
• The Heckscher–Ohlin model (H–O model) is a
general equilibrium mathematical model of
international trade, developed by Eli
Heckscher and Bertil Ohlin at the Stockholm
School of Economics.
• It states that a country will export goods that
use its abundant factors intensively, and
import goods that use its scarce factors
intensively.
• In the two-factor case, it states: "A capitalabundant country will export the capitalintensive good, while the labor-abundant
country will export the labor-intensive good."
Assumptions of Heckscher-Ohlin's
(H-O) Theory
• There are two countries involved.
• Each country has two factors (labour and
capital).
• Each country produce two commodities or
goods (labour intensive and capital intensive).
• There is perfect competition in both
commodity and factor markets.
• Factors are freely mobile within a country but
immobile between countries.
Assumptions of Heckscher-Ohlin's
(H-O) Theory
• Two countries differ in factor supply.
• Each commodity differs in factor intensity.
• The production function remains the same in different
countries for the same commodity. For e.g. If
commodity A requires more capital in one country then
same is the case in other country.
• There is full employment of resources in both countries
and demand are identical in both countries.
• Trade is free i.e. there are no trade restrictions in the
form of tariffs or non-tariff barriers.
• There are no transportation costs.
Understanding The Concept of Factor
Abundance
• In the two countries, two commodities & two
factor model, implies that the capital rich
country will export capital intensive
commodity and the labour rich country will
export labour intensive commodity.
Initially, when the countries are not
trading:
• the price of capital-intensive good in capitalabundant country will be bid down relative to
the price of the good in the other country,
• the price of labor-intensive good in laborabundant country will be bid down relative to
the price of the good in the other country.
Once trade is allowed, profit-seeking firms will
move their products to the markets that have
(temporary) higher price. As a result:
• the capital-abundant country will export the
capital-intensive good,
• the labor-abundant country will export the
labor-intensive good.
Heckscher Ohlin's Theory has been criticised on basis
of following grounds:
• Unrealistic Assumptions : Besides the usual
assumptions of two countries, two
commodities, no transport cost, etc. Ohlin's
theory also assumes no qualitative difference
in factors of production, identical production
function, etc. All these assumptions makes the
theory unrealistic one.
• Restrictive : Ohlin's theory is not free from
constrains. His theory includes only two
commodities, two countries and two factors. Thus
it is a restrictive one.
• One-Sided Theory: According to Ohlin's theory,
supply plays a significant role than demand in
determining factor prices. But if demand forces are
more significant, a capital abundant country will
export labour intensive good as the price of capital
will be high due to high demand for capital.
• Static in Nature: Like Ricardian Theory the HO Model is also static in nature. The theory is
based on a given state of economy and with a
given production function and does not
accept any change.
• Consumers' Demand ignored: Ohlin forgot an
important fact that commodity prices are also
influenced by the consumers' demand.
• Other Factors Neglected: Factor endowment
is not the sole factor influencing commodity
price and international trade. The H-O Theory
neglects other factors like technology,
technique of production, natural factors,
different qualities of labour, etc., which can
also influence the international trade.
2. Leontief's paradox
• Leontief's paradox in economics is that the country
with the world's highest capital-per worker has a lower
capital/labor ratio in exports than in imports.
• This econometric find was the result of Professor
Wassily W. Leontief's attempt to test the HeckscherOhlin theory empirically. In 1954, Leontief found that
the U.S. (the most capital-abundant country in the
world) exported labor-intensive commodities and
imported capital-intensive commodities, in
contradiction with Heckscher-Ohlin theory ("H-O
theory").
Reasons of Leontief’s paradox
• The availability of natural resources was
ignored
• Usually governments use trade barriers
• The differences of consumer preferences
• U.S. has an advantage in highly skilled labor
3. Theorem Ribchinsky
• The theorem is the assertion that, if the value
of one of the two factors of production
increases, then to maintain the constancy of
prices of goods and factors necessary to
increase the production of the product, which
is intensively used, this factor is increased, and
reduce the production of the rest of the
production, intensively using a fixed factor.
• To the prices of goods remained constant, the same
should be the price of factors of production. Prices of
factors of production can remain constant only in the
case when the ratio of the factors used in the two
sectors remains constant.
• If growth is one factor can only take place with
increasing production in the industry, which relies
heavily on this factor, and reducing production in other
industries, leading to the release of a fixed factor,
which will be available for use together with a growing
factor in the growing industry.