Heckscher-Ohlin Theory of International Trade

The Heckscher-Ohlin model, also known as the H-O model or 2 x 2 x 2 model, is a

theory in international trade that suggests that nations export goods in abundance
and produce efficiently. The primary work behind the Heckscher-Ohlin model was a
1919 Swedish paper written by Eli Heckscher at the Stockholm School of Economics.
His student, Bertil Ohlin, added to it in 1933.

Countries export great products or products for which they have the material/labour
in abundance. These countries have a competitive advantage for such goods,
including land, labour, and capital, which is the basis for this model. Not just
abundance, the cost of production or procurement has to be cheaper in such
countries.

In the Heckscher-Ohlin model, factors of production are regarded as scarce or

abundant in relative terms and not in absolute terms. That is, one factor is regarded
as scarce or abundant in relation to the quantum of other factors. Hence, it is quite
possible that even if a country has more capital, in absolute terms, than other
countries, it could be poor in capital. A country can be regarded as richly endowed
with capital only if the ratio of capital to other factors is higher when compared to
other countries.

(i) In Country A: Supply of labour = 25 units and Supply of capital = 20 units

Capital-labour ratio = 0.8
(ii) In Country B: Supply of labour = 12 units and Supply of capital = 15 units
Capital-labour ratio = 1.25

In the above example, even though Country A has more capital in absolute terms,
Country B is more richly endowed with capital because the ratio of capital to labour
in Country A (0.8) is less than in Country B (1.25).
Heckscher and Ohlin Model is based on a number of explicit and implicit
assumptions. The important assumptions of the model are:

• Both product and factor markets in both countries are characterised by perfect
competition.
• Factors of production are perfectly mobile within each country but immobile
between countries.
• Factors of production are of identical quality in both countries.
• Factor supplies in each country are fixed.
• Factors of production are fully employed in both the countries.
• Factor endowments of one country vary from that of the other.
• There is free trade between the countries, i.e., there are no artificial barriers to
trade.
• International trade is costless, i.e., there is no transport cost.
• Techniques of producing identical goods are the same in both countries. Due
to this, the same input mix will give the same quantity and quality of output in
both the countries.
• Factor intensity varies between goods. For instance, some goods are capital
intensive (i.e., they require relatively more capital for their production) and
some others are labour intensive (i.e., they require relatively more labour for
their production).
• Production is subject to the law of constant returns, i.e., the input-output ratio
will remain constant irrespective of the scale of operation.

How is the Heckscher Ohlin Model Superior to Classical Theory?

• It is a better explanation of the world economy after World War II.

• The traditional Ricardian theory overlooked the demand factors and
completely focused on the supply factors. The H-O model is relatively better
and considers both supply and demand.
• The classical theory ignored capital and assumed labour as the only factor of
production.
 • Hence, the classical theory accredits any difference in costs to the differences
in labour.
• The H-O model is more specific and realistic when compared to the classical
approach.
• This model also brings about integration between trade theories and value
theories.

Real-Life Example and Study:

Saudi Arabia holds around 18% of the world’s petroleum reserves and ranks as the
largest exporter of petroleum and second-largest producer. Oil in Saudi is available
plenty and closer to the earth’s surface. Hence, it is cheaper and more profitable to
extract oil in Saudi Arabia than in many other places. It can be taken as an example
of the H-O model.

Criticisms:

• Poor prediction and performance.

• The unfair assumption is that all labor is employed. This model assumes that
all work in the country is engaged, thus ignoring the concept
of unemployment.
• The unrealistic assumption is that similar production exists. Furthermore, this
model assumes that nations have the same technology used for production,
undermining the effects and ignoring the technological gaps.
• The unrealistic assumption is that similar production exists. Furthermore, this
model assumes that nations have the same technology used for production,
undermining the effects and ignoring the technological gaps.

To sum up, this model postulates that countries export what they can produce. This
model proposes that countries export what they can create abundantly or what they
are already in the abundance of (reserves). A country will have a comparative
advantage in the good that intensively uses its relatively abundant factor.
Source:

• Francis Cherunilam, 2008. International Economics (5th Edition). Tata

McGraw-Hill Publishing Company Limited, NEW DELHI.
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