3

Comparative advantage in the

Heckscher-Ohlin trade model
In Chapter l we studied the theory of comparative advantage in terms of a one-
factor model. In this setting differences in the productivity of labor were the
cause of trade. It is now time to take a closer look at
the Heckscher-Ohlin
theory ofcountries
different trade. (According
have different this
to theory, trade results
factor endowments.
from the fact that

The Heckscher-Ohlin theory is usually formulated in terms of a two-factor

model, with labor and capital as the two factors of productionjWe will use this
model, and in the following we will be concerned only with this
case. It would
be possible in some instances to generalize the result to the case in which there
are many factors of production. Attempts at such generalizations, however,
Would require the use of fairly advanced mathematics and therefore fall outside the
scope of this book. The two-factor case will give us an understanding of all the
essentials of the Heckscher-Ohlin theory.
As we have said, according to the Heckscher-Ohlin theory, what determines
trade is differences in factor endowments.((Some countries have much capital,
others have much labor. The theory now says that countries that are rich in
Heapital will export capital-intensive goods, and countries that have much labor
Awill export labor-intensive goods)
The terms 'rich in capital' and 'rich in labor' are not very precise at. the
moment. Before we can get much further, we have to define our terms and give
we will comment upon and
them a more precise meaning. First, however,
for this type of analysis. Since the
explain some of the more general assumptions
exposition in Chapter 2 has paved the way for us, we can do this briefly.
essential to the analysis: (1)there are nob
(The following five assumptions areto
trade; (2there is perfect competition in
transport costs or other impediments
production functions are homo
both commodity and factor markets; (all
production functions are such that the two
geneous of the first degree; (4) the
factor intensities; and (5) the production functions
commodities show different
but are the same in bóth countries, i.e. good A is
differ between commodities,
in both countries and good B is produced
produced with the same technique
with the same technique in both countries)
should not be too difficult to understand. The first
The meaning of these that commodity
abstraction to facilitate the analysis. It implies
assumption is an
be the same in both countries. The meaning of
the second
prices under trade will factors of
clear from Chapter 2. It implies that the
assumption should be
an optimal way.
production will be allocated in
refer to characteristics of the production
The last three assumptions all
function being linearly homogeneous
functions. The meaning of a production means that different
was explained in Chapter, 2. The fourth assumption
 42 The Pure Theory of International Trade

techniques of production are used in the two industries. Furthermore, we assume

that there is a one-to-one correspondence between factor intensities and factor
prices, another way of stating this fact is by saying that there are no factor
reversals.
The fifth assumption, that production functions are the same in both
countries, is quite a strong one. What it amounts to is assuming that knowledge
travels freely. In other words, the best techniques of production in the world are
known to everyone.
These are the assumptions used in connection with the Heckscher-Ohlin
theory of trade. They are necessary to state the meaning of comparative advan
tage in the two-by-two-by-two' model, and to prove the factor-price
theorem. They are quite strong assumptions, and one might think thatequaliZation
they are
rarely fulfilled in the real world. Sometimes, however, strong assumptions are
needed to prove interesting theorems. The conclusions of the theorems can still
be empirically valid, even though some of the
assumptions are only approxi
mations of conditions existing in the real world. Simplifying assurnptions have to
be made in theoretical studies. The theorems built on such assumptions can still
be important. The theorems we are about to derive will give us a most useful in-
sight into the general-equilibrium character of economics. In this way we will be
able to see that a change in one variable in our trading system necessarily implies i
changes in all the other variables.

FACTOR ABUNDANCE DEFINED BY FACTOR PRICES

We will now try to demonstrate the proposition that capital-rich countries export
capital-intensive goods and that labor-rich countries export labor-intensive goods.
It is, however, not yet clear what is meant by a country being rich in capital. At
least two alternative defînitions can be given.
One of these definitipns runs in terms of factor prices. This definition says
that country I is capital-rich compared with country II if capital is relatively
cheaper in country I than in country II.,The second definition compares over
all physical amounts of labor and capitál. It says that country I is rich in capital
ifthe ratio of capital to labor is larger in country I than in country II.
T h e s e two alternative definitions are not equivalent. We will now show that
the Heckscher-Ohlin proposition follows if we use the first definition but that
it does not necessarily follow using the second definition.Dhlin himself defined
richness in factor endowments with the help of factor prices.(According to his
definition country I is abundant in capital if PicPiL KPolPzL, where Pic is the"
price of capital in country I, Pu, is the price of labor in country I, and P2c and
other words,
PL are the prices in country II of capital and labor, respectivelyjln and
if capital is relatively cheap in country I, the country is abundant in capital,
if labour is relatively cheap in country II, country II is rich in labor.,
It now remains for us to show that/country I will export the capital-intensive
This is easily done,
good and that country II will export the labor-intensive good.
as is demonstrated with the help of Figure 3.1.{We
start with two isoquants, ad
the same in both
and bb) which characterize the production functions and are
labor-intensive good and A is
countries. According to these isoquants,jB is the
 Heckscher-Ohlin Trade Modet 43
Advantage in the
Comparative

FIGURE 3.1 factor prices

defined in terms of
Factor abundance

P
D1

Pa
b H
LABOR

where capital is
the capital-intensive good. Relatiye factor prices in country I, 1
assume that the isoquants represent
cheap, are given by the line PoPo)Let us be produced with Oaj of
unit of the respective good. Then 1 unit offgood A will
for each other
capital and Oa1 of labor. But capital and labor can be exchanged
in a ratio shown by the factor-price line PoPo. Therefore, Oa of labor is worth
aG of capital, and Oa, of capital is worth a'H of labor:])
We said that 1 unit of good A would be produced with Oaj of capital and
Oa of labor. But now we can view the line GH as a budget line, or a cost line,
and we can express the cost of producing 1 unit of A in terms of capital alone,
or of labor alone. Doing so, we find that the cost of producing 1 unit of A is OG
measured in capital or OH measured in labof
By applying exactly the same kind of reasoning we also find that the cost of
producing 1 unit of good B in country I is the _ame as that for producing I unit
of A, i.e. it is OG measured in capital and OH measured in labor
The next step is to find out the cost of producing 1-unit of each good in
country II. The only information we have about [country II is that capital is
relatively more expensive there than in country I. This means that the slope of
the line representing the ratio of factor prices in country II will be less
than the slope of PoPo.
steep
A possible factor-price line in
country is P1P1. It is tangential toto the
isoquant at E, A parallel factor-price line is P2P2, which is tangential
the aa
bb
isoquant F.)It is obvious that PzP2 must lie below PP. From this it follows
at
that (the cost of producing 1 unit of
good A in II is OC measured in
capital, whereas it is OD measured in capital forcountry
1 unit of good
country II it is more expensive to produce a B Thus in
produce the same amount of good B. given amount of good A than it is to
 International Trade
44 The Pure Theory of
FIGURE 3.2
Factor abundance defined

in physical terms

Country l's production

possibility curve

Country Il's production

possibility curve

GOOD B

Itwe now compare production costs in the two countries, we find that itis
relatively cheap to produce good A in country I and rélatively cheap to produce
good B in country I1. From this it follows that country I will export good A and
country II will export good B. This establishes the Heckscher-Ohlin theorem
that the country abundant in capital will export the capital-intensive good and
the country abundant in labor will export the labor-intensive
good.
Thus, starting from the definition of factor abundance in terms of factor
prices, it is easy to establish the Heckscher-Ohlin theorem. We might mention
in passing that the reverse of the theorem also holds, i.e. if a country exports the
capital-intensive good, capital is its relatively cheap factor of production.
One could argue, however, that stating the theorem in terms of factor
prices
is not very interesting, because factor prices are themselves results of a compli.
cated interplay of economic forces. They are, for instance, not only determined
by supply factors but are also influenced by demand factors. It is not possible to
say anything about factor prices from the knowledge of factor endowments
alone. To state the Heckscher-Ohlin theorem in terms of factor prices gives
perhaps not the most interesting version of the theorem.
A more natural definition, it seems, would run in terms of physical amounts.
Let us now use this definition and see what the result will be.

DEFINED IN PHYSICAL TERMS

FACTOR ABUNDANCE

terms, we say that country I is rich in

Defining factor abundance in physical if
rich in labor CG/L > CG/la, where C, is the total
capital and country II is of labor in country I, and
capital in country I, L1 1s total amountrespectively, in country II
the
amount of
amounts of capital and labor,
C and L2 are the total in capital according to this
We will now showcountry I is abundant
that/if
that country I has a bias in favor of producing the capital.
definition, it implies
 Comparative Advantage in the Heckscher-Ohlin Trade Model 45

FIGURE 3.3
Demand factors offsetting production bias

Country 1's production

possibility curve

Country IW's production

possibility curve

GOOD B

intensive good! The nature of this bias is

best illustrated by Figure 3.2.
good A is the capital-intensive good and good B isItthe
assumed in the figure that is
labor-intensive good. If both countries were to
proportion, say along the ray OR, country I would. prqduce the goods in the same
be producing at point
its
production-possibility curve and country II would S' on
be producing
on its
production-possibilitycurve. The slope of
at point S
urve at S' is country I's production-possibility
steeper than the slop of country II's curye at S.This implies that
igood Awoud be cheaper in country I than in country II, and that good B would
be cheaper in country II than in country I, were the two
the respective points. This is also illustrated by the factcountries
that the
producing at
prico line P1Pi is steeper than the line P2P2. The commodity
production good A is therefore lower in
of opportunity cost of
expanding
versa for good B. This shows that country I than in
country II, and vice
in favor of the
country I, the capital-rich country, has a bias
capital-intensive good from the production side, _and that the
country abundant in labor, country II, has a bias
in favor of producing the labor
intensive good
I t does not follow from this, however, that the
the labor-intensive good. It might be the case that
labor-rich country will expoort
demand factors more than
offset the bias from the production side. Such a case is
which contains the same production-possibility curves asillustrated in Figure 3.3
is still the capital-intensive "good and Figure 3.2, and goog A4
good B the
difference is that now we have taken demand into labor-intensive goodThe
countries is characterized by two sets of indifferenceaccount.Demand in the two
, I , etc., represent demand in country I and thecurves, where the curves
curves I'ol0,
represent demand in Country II. Demand in country I'1/', etc.,
I is obviously biased toward
the capital-intensive good and demand in
intensive good. Thus in isolation good A iscountry II is biased
relatively more
toward the labor.
than in country II. This is shown by the fact that the expensive in country
P.P in country II is steeper than the line PiP} commodity price line
prices in country I. representing relative commodity
46
The Pure
Theory of International Trade
From this it follows that
when trade is
country will export good B and opened up between the two countries
the country abundant in country II will export good A. In other
country abundant in labor capital will export the
will export the labor-intensive words
goad, the
and
In conclusion we can say that capital-intensive
factor abundance can begood.v
in the Heckscher-Ohlin defined in two ways
trade model. The two
equivalent. Only according to one of them doesalternative definitions are not
abundant in capital will export the it, follow that the country
capital-intensive good and that the country
riçh in labor will export the labor-intensive
Chapter, compare and contrast the goodLet us, before we conclude this
Ricardian and in the Heckscher-Ohlinmeaning of comparative advantage
trade models.
in the

A COMPARISON OF COMPARATTVE ADVANTAGE IN THE RICARDIAN

AND IN THE HECKSCHER-OHLIN TRADE MODELS
In Chapter 1, where we treated comparative advantage in the Ricardian model,
the only factor of production was labor. In the Ricardian model,
comparative
advantage was determined by production conditions alone. We also learned that
if a country had a comparative advantage in the production of a good, it would
export that good.
In the neoclassical, two-factor model these two conditions are no longer met.
Speaking in terms of the first definition of factor abundance, i.e. in terms of
factor prices, we can see that the second condition is fulfilled and that if a
country is abundant in capital, it will also export the capital-intensive good,But,
the first condition is not met, because we cannot infer from production
conditions alone anything about factor prices.
Then, going to the second definition of factor abundance the definitionin
terms of physical amounts of factors of production we find that it is the other
way around. This definition
takes into account only production conditions; here'
the first condition of the Ricardian model is fulfilled, but the second is not,
because we cannot infer anything about comparative advantage. We cannot, for
instance, use this definition to say that the country abundant in capital
export the capital-intensive good.
the country that is
One thing which does hold, however, is that even though
abundant in capital according to the secónd definition might export the labor
intensive good, it will still produce relatively more of the çapital-intensive good
than the other country. If A is the capital-intensive good and B is the labor
intensive good, and if country I is abundant in capital and country II in laboi,
we know that country I will always produce A/B in a higher ratio than country
in the
II. In this sense we can say that country I has a comparative advantage
II has a comparative
production of the capital-intensive good and that country
advantage in the production of the labor-intensive good.
 ITsCRITICISMS following grounds:
two-by-two-by-tw.
o mode
on the presenting
been criticised for
out, it c a n be
extend
Ohlin's theory has
Model. Ohlin has been
criticised
Ohlin
himself points
it in thhe mathema
tended to
1.
Two-by-two-by-two

based on
oversimplified
assumptions.
But, as
and many
He
demonstrated

factors matical
many regions, many
commodities
in nature. "Itonly giveseSome
book. model is static
appendix to his
theory, the Ohlin ation ah
give intormation abo
2. Static Theory. Like the classical
in time. For
instance, it can about how
at a given point any
indication
the
characteristics of an
economy
m o m e n t s , but
it cannot give
at given
conditions w e r e to change.
how to rank goods any
homogeneous factors
would develop if production
the existence of the in
economy The theory assumes
endowment
ratios. But, in rosl
3. Factors not Homogeneous. calculating factor
which can be measured for and even one factor is t
the two countries between countries,
qualitatively various types. Similarl
factors are homogenous unskilled, is of
ity, no two both skilled and are labour sa
For instance, labour labour when they
various types. the tasks of
capital goods take many forms and also perform
model assumes homogeneous
ing. Homogeneous. Again,
the Ohlin
4. Production Techniques not countries. But production techniques
are
commodity in the two
production techniques for each countries. For instance,
textiles may be produced
different for the s a m e commodity in the two
or with highly sophisticated
labour and less capital
with handlooms which require m o r e not follow the
small number of workers. In such a situation, trade may
powerlooms requiring a

Ohlin pattern. The H.O. theory is based on

the assumption of
5astes and Demand Patterns not Identical.
in both countries. This assumption implies
Videntical tastes and demand patterns of consumption income groups. This
are the same for different
that the tastes and demand patterns of c o n s u m e r s
in consumers' goods, changes in tastes
is unrealistic. Moreover, with inventions taking place
countries. Commodities
and demand patterns of consumers also occur even among developed
demand in the United States are different from what
consumers demand in
which consumers

Germany. Consequently, tastes are not identical in trading countries.

6. No Constant Returns. The assumption that there are constant returns to scale is also not real
istic because a country having rich factor endowments often obtains the advantages of econo-
mies of scale through lesser production and exports. Thus there are increasing returns to scale
rather than constant.
VTransport Costs influence Trade. This theory does not consider transport costs in trade be-
tween two countries. Ths is an unrealistic assumption. Alongwith transport costs, loading and
unloading of goods and other port charges affect the prices of produced commodities in the two
countries. When transport costs are included, they lead to price differentials for the same com-
modity in the two countries which affect their trade relations.
Unrealistic Assumptions of Full Employment and Perfect Competition. The H.O. theory is
G. Haberler, A Survey of
International Trade Theory, 1961, p.
 THE MODERN THEORY OF FACTOR ENDOWMENTS : THE HECKSCHER-OHLIN THEOKkT *0
63

based
on the unrealistic assumptions of full emplovment and perfect competition because ue
1sneither full employment nor perfect competition in anv country of the world. Katnet, un-
tries do not have free trade
but impose trade restrictions on a large
9. Leontiet Paradox
has Falsified the Theorv. Ohlin scale.
assumes that relative factor prices Tee
exactly relative factor endowments. It implies that in the determination of factor prices, Suppiy
r e mportant than demand. If, however. the demand factors are given more importance in
determinung factor prices, a capital-rich country will export a labour-intensive
commoaty
cause the high demand for capital will raise the price of capital relative of labour. Prof. Leonier s
empirical study of the Ohlin theorem. known as the Leontief Paradox, has led to paradoxical
reslts that the United States
exports labour-intensive goods and imports capital-intensive Bo
even though it is a
capital-richcountry.
10-Fartial Equilibrium Analysis, Prof, Haberler criticises Ohlinfor his failure to.develop.a.com
prenensiye generalequilibrium.concept. He regards Ohlin's theory as, by and large, a parlal
equilibrium analysis.4
. Factor Prices do not determine Commodity Prices. Wijanholds has criticised Ohlin for his
View that commodity
prices are determinedby the factor prices which in turn, determine costs
e holds that the prices of commodities are determined by their utility to the consumers, ana
that the prices of raw
materials and labour ultimately dependent on the prices of the nnal
are
commodities. He maintains that the right approach is to start with commodity prices rather than
factor prices.
12.
Vague and Conditional Theory. Ohlin's theory has been characterised as "somewhat vague
and conditional.' Aspointed out by Haberler, "With many factors of production, some of which
are
qualitatively incommensurable as between different countries, and with dissimilar produc-
tion functions in different
countries, no sweeping a priori generalisation concerning the compo
sition of trade are possible."
Conclusion. Despite these criticisms, the Ohlin theory of international trade is
definitely an imn
provement over the classical theory as it attempts to explain the basis of international trade in
the general equilibrium setting. According to Lancaster, the H.O. model
tre of international trade theory for reasons unconnected with its
"occupies the very cen-
realism, and indeed strength-
ened by the very properties which have been
subject to so much criticism."6

EXERCISES
 THEMODERN THEORY OF FACTOR ENDOWMENTS: THE HECKSCHER-OHLIN THEORY :61
ITS SUPERIORITY oVER THE CLAsSICAL THEORY
The H.O. theorem is an
improvement over the classical theory of international trade in many
aspects.
1. Înternational Trade a Special Case. The H.O. theory is superior to the classical theory in that
it regards international trade as a special case of inter-regional or inter local trade as distinct
from the classical theory which considers international trade totally different from domestic
trade.
2eneral Equilibrium Theory. The H.O. analysis is cast within the framework of the realistic
general equilibrium theory of value. It frees the classical theory from the defunct and unrealistic
labour theory of value.
3wo Factors of Production: The H.O. model takes two factors-labour and capital-as against
the one factor (labour) of the classicalmodel,and is thus superior to the latter.
4.Differences in Factor Supplies. The H.O. theory issuperiorthe
tothe Ricardian theoryinthatit
regards differences in factor supplies basic for determining
as pattern of international trade
while the Ricardian theory takes no notice of it.
because it is based on the relative prices
5 Relative Prices of Factors. The H.O. model is realistic
of while the Ricardian theory con
offactors which, in turn, influence the relative prices goods,
siders the relative prices of goods only.
The H.O. theory considers differences in
relative
6. Relative Productivities of Factors. while the classical theory
as the basis of
international trade,
productivities of labour and capital than the latter.
alone. Hence the former is more realistic
takes the productivity of labour based differences in factor endow-
Endowments. The H.O. model is
on
7. Differences in Factor
countries as against the quality
of one factor labour in the classical theory.
ments in different on the quality but also on the
because it lays emphasis not only
Thus the former is superior
international values.
quantity of factors in determining Samuelson, the Ricardian theory
inComparative Costs. Accordingto
8. Causes of Differences
differences in.comparave ad vanage Themteritofti.O. theory
causes.of
could not explain thesame-satisfactorily.
from trade between the two
es inexxplaming theThe classical theory demonstrates the gains the H.O. model is scientific
9. Positive Theory. On the other hand,
related to the welfare theory.
This is of the positive theory.
countries.
trade. It, thus, partakes
the basis of which high-
and concentrates on
Haberler, the
H.O. theory is a location theory
According to while the classical theory regards
10. Location Theory. in international trade
of the space factor former theory is superior to the
latter.
lights the importance as markets. Thus the
spaceless based o n the as-
H.O. theorem is explicitly
countries
the different Two Countries.
The
Functions of theory S
classical is
11, Production functions of the
On
the other hand, the
two countries.countries.
sumption of production
production of the trading realistic than the classical theory in that
based on differences in the The H.O. model is more
12.Complete Specialisation. in the prcauction
of one commodity by one country
theformer leads to complete specialisation
the second country when they enter into trade with each other.
and of the other commodity by or may not lead to complete specialisation in
trade between two
countries may
By contrast, the
the classical theory. H.O. theory is superior to the classical theory
13. Future of Trade. According to Lancaster, the
differences in comparative costs
the future of trade. In the classical theory,
because it refers to in future, labour
are due to differences in the efficiency of labour. If,
between two countries
in both the countries, there will be no trade between them. But in the
becomes equally efficient
even if labour becomes equally efficient in the two countries
H.O. theory trade will not cease

1. The above two paras with Figures 3 and 4 are meant for M.A. students. Others may leave them.
ERNATIONAL EcONOMICS
es
because the basis of trade is differences in factor endowments ana prt to the classi.
from the above discuSsion that the
It is clear H.O. theorem is superior
sion. Costs and Mill's Concept
The H.O. theorv absorbs Ricardo's theorv of Comparative
tneory. of Comparative Costs. Rather, it
eprocal Demand. But it does not invalidate the Theory
comparative advantage as
the cause of international trade.
PCnents because it also accepts
it
of trade With the economic
when the pattern
cSame time, it improves upon it it links
the effects of a change
i n trade on the
of trading countries. In this way, it analyses
ucre
Onesuc econömic structures and on the domestic income distribution.
 Second Edit on
INTERNATIONAL
ECONOMICS
Bo
 6th Editioon

International
Economiçs

M.L. Jhingan
VAINDA