Chapter 8
The Basis for
Trade: Factor
Endowments
and the
HeckscherOhlin Model
McGraw-Hill/Irwin
Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.
Heckscher-Ohlin In
General
 Heckscher, and his student Ohlin,
worked in the early part of the 20th
century.
 Paul Samuelson refined their work
after WWII.
 Closer attention is paid in this
model to each country’s resource
endowment.
8-2
H-O-S Assumptions
2 countries
2 commodities
2 factors (labor and capital)
Perfect competition exists in all
markets.
 Each country’s endowment of
factors is fixed.
 Factors are mobile internally, but
immobile internationally.




8-3
H-O-S Assumptions
(cont’d)
 Each producer has a wide range of options
as to how to produce X or Y
• if K is cheap relative to labor, a
relatively capital-intensive method will
be adopted.
• if K is expensive relative to labor, a
relatively labor-intensive method will be
adopted.
 Each country has the same CRTS
technology.
 Tastes and preferences are the same for
both countries.
8-4
Concepts and
Terminology
 The capital-labor ratio for good X is simply
KX/LX, and for Y is KY/LY.
• If KX/LX > KY/LY, production of good X is
capital intensive relative to production of
good Y.
• For example, the amount of capital per
worker in the U.S. petroleum and coal
industry is $468,000.
• The similar figure for apparel products is
$8,274.
• Therefore, petroleum and coal is produced
in a relatively capital-intensive manner.
8-5
Concepts and
Terminology
 Also, production of Y must be
relatively labor intensive (If KX/LX >
KY/LY, then LY/KY > LX/KX).
• That is, clothing is produced in a
labor-intensive manner (as
compared to petroleum and coal).
8-6
Relative Factor Intensities,
Selected Canadian Industries
(2006), in C$
Commodity
Petroleum and coal
Chemicals
Paper
Transportation equipment
Truck Transportation
Leather and products
Clothing
Capital per employee
$617,066
$144,029
$118,777
$92,315
$30,180
$12,573
$8,954
8-7
Relative Factor
Intensities,
 According to a research in 2009, globally
Machinery and Transport Equipment is the
most capital intensive industry followed
by Chemicals industry whereas animal and
vegetable oils and fats is the lowest capital
intensive industry followed by the
Beverage and Tobacco industry.
8-8
Concepts and
Terminology
 Country A is said to be capital
abundant relative to Country B if
(K/L)A > (K/L)B.
• For example, if the U.S. has a
capital stock of $4.8 trillion and a
labor force of 153 million, then K/L
is about $32,000.
• K/L for Mexico works out to $328
billion/45 million = $7,282.
• Therefore, the U.S. is K- abundant
relative to Mexico; Mexico is
relatively L-abundant.
8-9
Relative Factor
Endowments, Selected
Countries (2007), in U.S. $
Country
Japan
France
U.S.
Australia
Canada
Mexico
Capital per worker
$49,081
$31,810
$31,657
$30,792
$24,700
$7,282
8-10
Concepts and
Terminology
To summarize:
• goods are produced relatively K
or L intensively.
• countries are relatively K or L
abundant.
8-11
Concepts and
Terminology
 The factor price of labor (the wage)
is denoted w.
 The factor price of capital is
denoted r.
 If labor is relatively expensive, w/r
will be a relatively big number.
 If labor is relatively cheap, w/r will
be a relatively small number.
8-12
More on Factor Prices
 What makes labor relatively
expensive?
• If it is relatively scarce.
 What makes labor relatively cheap?
• If it is relatively abundant.
 So: If (K/L)A is a relatively big
number (that is, capital is relatively
abundant), w/r will be a relatively big
number, reflecting the relative
scarcity of L and abundance of K.
8-13
A Review of Trade in the
Neoclassical Model
 Suppose the U.S. is capital
abundant relative to Mexico.
 This, of course, means that Mexico
is relatively labor abundant.
 These differences affect the shape
of each country’s PPF.
 Suppose that cars are produced rel.
K-intensively, and textiles labor
intensively.
8-14
Autarky in Mexico and the
U.S.
 The relative price of textiles in
autarky is greater in the U.S. than
in Mexico.
 That is, the U.S.’s autarky price line
is steeper than Mexico’s.
 In symbols, (PT/PC)U.S. > (PT/PC)Mex.
 This means that Mexico has the
comparative advantage in textiles.
8-15
Autarky in Mexico and the
U.S.
 This also means that the relative
price of cars in autarky is lower in
the U.S. than in Mexico.
 That is, (PC/PT)U.S. < (PC/PT)Mex.
 This means that the U.S. has the
comparative advantage in cars.
8-16
Trade in the H-O Model
Cars
Y3
Y1
Mexico
Y5
C'
E
Y4
E'
Y2
X3X1
U.S.
Cars
e'
e
c'
Y6
X2 Textiles
X5 X4 X6
Textiles
8-17
The Result
 The relatively capital abundant
country (U.S.) exports the relatively
capital intensive good (cars).
 The relatively labor abundant
country (Mexico) exports the
relatively labor intensive good
(textiles).
8-18
The Heckscher-Ohlin
Theorem
 A country will export the
commodity that uses relatively
intensively the factor that country
has in relative abundance.
 A country will import the
commodity that uses relatively
intensively the factor that is
relatively scarce in that country.
8-19
The Source of
Comparative Advantage
 So it is a country’s relative factor
endowment that determines its
comparative advantage.
 This is why the H-O-S model is also
called the factor proportions
theory.
8-20
Changes in Relative
Commodity Prices : Review
 As we learned before,
• (PT/PC)US falls as the U.S. moves
to trade. That is, the
international relative textile price
is lower than the U.S.’s autarky
price.
• (PT/PC)Mex rises as Mexico moves
to trade. That is, the international
relative textile price is higher
than Mexico’s autarky price.
8-21
Changes in Factor Prices
 In autarky, the K-intensive product
(cars) is less expensive to produce
in the U.S. as compared to Mexico.
• This is because K is relatively
abundant in the U.S., which
makes the price of capital
relatively low.
 As trade commences, r will rise
since demand for capital will rise.
8-22
Changes in Factor Prices
 In autarky, the L-intensive product
(textiles) is more expensive to
produce in the U.S. as compared to
Mexico.
• This is because L is relatively
scarce in the U.S., which makes
the price of labor relatively high.
 As trade commences, w will fall
since demand for labor will fall.
8-23
Commodity and Factor
Prices In Trade: A Summary
 In our example, (PT/PC)US falls as
trade commences.
 (w/r)US also falls.
 In Mexico, the opposite is
happening:
• (PT/PC)Mex rises.
• (w/r)Mex also rises.
 Therefore relative commodity and
factor prices move together as trade
commences.
8-24
The Relative Cost Curve
PT/PC
(PT/PC)US
(PT/PC)Int
(PT/PC)Mex
Both relative commodity and
factor prices equalize in trade.
(w/r)Mex (w/r)Int (w/r)US
w/r
8-25
The Factor Price
Equalization Theorem
In equilibrium, with both countries
facing the same relative product
prices, relative costs will be
equalized. This can only happen if
relative factor prices are equalized
between countries.
8-26
H-O and the Distribution
of Income
 The H-O theorem, together with the
FPE theorem, also tell us about how
the incomes of different groups
within a country change as trade
starts.
 This provides insight into the
politics of free trade.
8-27
The Stolper-Samuelson
Theorem
As trade commences, the owners of
the relatively abundant factor will
find their real incomes rising; the
owners of the relatively scarce
factor will find their real incomes
falling.
8-28
H-O and the Distribution
of Income
 According to the S-S theorem, if the
U.S. is a relatively K-abundant
country, who in America should
favor free trade?
 Who in America should favor
protectionism?
8-29
Theoretical Qualifications
to H-O
 Suppose we relax some of the
many assumptions. Will the
implications of the H-O-S
model still be the same?
8-30
Qualification #1: Demand
Reversal
 Suppose we let demand conditions
differ.
 Suppose domestic demand for the
good that uses relatively
intensively the relatively abundant
factor is very strong in each
country.
 That is, suppose demand for cars is
very strong in the U.S., and that
demand for textiles is very strong
in Mexico.
8-31
Qualification #1: Demand
Reversal
 Such strong demand makes the
autarky car price in the U.S. higher,
and the textile price in Mexico
higher.
 In the extreme, demand reversal
could occur: (PC/PT)US > (PC/PT)Mex,
and
 (PT/PC)US < (PT/PC)Mex
8-32
Bottom Line on Demand
Reversals
 If demand reversals occur, the H-O
theorem no longer holds: the Kabundant country is exporting the
L-intensive good, and the Labundant country is exporting the
K-intensive good.
8-33
Qualification #2: Factor
Intensity Reversal
 Implicitly, we’ve assumed that if
good X is K-intensive relative to
good Y at one factor price ratio, it
will be K-intensive at all factor
prices.
 A FIR is when a good is relatively Kintensive at one set of factor
prices, but relatively labor intensive
at another.
8-34
Qualification #2: Factor
Intensity Reversal
 FIRs occur when capital and labor
can be substituted more easily in
the production of one good than
another.
8-35
Factor Intensity Reversal:
Implications for Trade
 Suppose France is K-abundant
relative to Germany (that is (K/L)F >
(K/L)G).
 This means that (w/r)F > (w/r)G.
 Suppose further that there is a FIR:
in France, at (w/r)F apples are
produced relatively K-intensively
but in Germany at (w/r)G apples are
produced in a relatively L-intensive
way.
8-36
Factor Intensity Reversal:
Implications for Trade
 If trade begins, according to the HO theorem the relatively Kabundant country (France) will
export the rel. K-intensive good
(apples) and the rel. L-abundant
country will export the rel. Lintensive good (also apples).
 H-O theorem breaks down.
8-37
Qualification #3:
Transportation Costs
 In the real world, it is costly to
transport goods internationally.
 How do the implications of our
model change if we allow for
transportation costs?
 Consider the supply and demand
curves for textiles in Mexico and
the U.S.
8-38
Adding Transportation
Costs
 Unless Mexico is the only seller in
the world, transportation costs will
be borne by both the consumer (the
U.S.) and the seller (Mexico).
 How does this look on the graph?
8-39
Adding Transportation Costs
PT
U.S.
SText
PT
Mexico
SText
PIntl
t-costs
Exp.
PIntl
Imp.
DText
q1 q2
QT
DText
q1 q2
QT
8-40
Adding Transportation
Costs: the Bottom Line
 In general, the H-O theorem will
still hold.
 The FPE theorem breaks down,
since factor prices only equalize if
the commodity prices do.
 Therefore, in the presence of
transportation costs, factor prices
have a tendency to move towards
each other, but we should not
expect equalization.
8-41
Relaxing Other
Assumptions
 One can relax many other
assumptions and examine how the
implications of the model change:
• perfect competition
• CRTS
• identical production technologies
• lack of policy obstacles
• factors being perfectly
transferable
8-42