International Economics

Heckscher-Ohlin Model

Giuseppe Berlingieri
giuseppe.berlingieri@essec.edu
@g berlingieri

ESSEC Business School

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Outline of the Course
I Introduction to International Trade

I Classical Trade Theory: Trade Patterns & Winners/Losers

I The Ricardian Model
I The Specific-Factors Model
I The Heckscher-Ohlin Model

I Trade and Inequality

I New Trade Theory: Trade Patterns & Policy

I External Economies of Scale
I Industrial (and Trade) Policy
I Market Power and Imperfect Competition

I Firms in the Global Economy

I Heterogeneous Firms
I Multinationals, FDI and Offshoring

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Outline

Introduction

Model

Empirical Evidence

Conclusion

Appendix

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Introduction

I Also referred to as the Heckscher-Ohlin-Samuelson model or Factor

Proportions model.

I Started with Heckscher (1919) and Ohlin (1933). Major additions by

Samuelson in the 1940s.

I As in the Specific-Factors model comparative advantage is due to

differences in endowments.

I Trade will again influence the distribution of income.

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Factor Proportions: Short-run

I Specific factors model: with same technologies countries face lower

opportunity costs (comparative advantage) in the good whose
specific factor is relatively abundant in the local market.

I E.g. if land is relatively abundant, the country (partially) specializes

in and thus exports food.

I The notion of specific factors is useful to understand the role of

relative factor abundance but has a short-run flavour.

I In the long run all factors can be reallocated between sectors.

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Factor Proportions: Long-run

I The HO model looks at the long run focusing on an economy in

which there are two factors and these are both mobile between two
sectors.

I Comparative advantage is influenced by the interaction between

countries’ factor endowments (‘relative factor abundance’) and
sectors’ technologies (‘relative factor intensity’).

I Factor-proportions theory: interplay between the proportions in

which factors are available in countries and the proportions in which
they are used in producing goods.

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Outline of the Lecture

I The Basic 2 x 2 x 2 Model

I The Four Trade Theorems:

I The Rybczynski Theorem: Specialization
I The Stolper-Samuelson Theorem: Income redistribution
I The Heckscher-Ohlin Theorem: Patterns of trade
I Factor Price Equalization: Income redistribution

I Application and Empirical Tests

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Outline

Introduction

Model

Empirical Evidence

Conclusion

Appendix

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The Basic Model
I Two goods: Cloth and Food.
I Two factors: Labor (L) employed in both sectors, land capital (T)
employed in both sectors
I Perfect competition: labor and capital are paid the value of their
marginal productivity and work in the production of the good that
pays them more.
I Production functions: How much cloth can be produced for any
given inputs of capital and labor?

Qc = F (Tc , Lc ) Qf = H(Tf , Lf )

I Assumptions about F (.) and H(.): Constant returns to scale,

Positive marginal product, Diminishing marginal returns.
I Different factor intensities: Cloth is labor intensive, if for any w /r it is
the case that Lc /Tc > Lf /Tf .

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Production Possibilities
I Land capital and labor endowment constrain maximal production
(they are fully employed): Lc + Lf = L and Tc + Tf = T .
I Producing more cloth increases its opportunity cost as capital would
be increasingly more productive if used instead in food.

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Production

I As in the Ricardian and Specific Factors models, production is

determined by the relative price Pc /Pf
I In equilibrium production is such that the opportunity cost of cloth
(i.e. the slope of the PPF) equals its relative price
I When that happens, the economy produces produces at the point
that maximizes the value of production: V = Pc Qc + Pf Qf or
Qf = V /Pf − (Pc /Pf )Qc , given prices.
I This defines an isovalue line for any given value of production V
I The value of production is maximized at the tangency between the
PPF and the highest possible isovalue line.
I At this tangency the opportunity cost of cloth equals its relative
price.

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Production

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Rybczynski Theorem

I An increase in the relative endowment of a factor leads to a more

than proportionate increase in the output of the good that uses that
factor relatively intensively, ceteris paribus (= everything else
constant, e.g. constant prices).

I This happens because that good benefits from an increased supply of

the factor and expands production by drawing resources from the
other good, whose production shrinks.

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Rybczynski Theorem
I More labor favors cloth to the detriment of food.

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Factors Prices and Goods Prices

I The relative price of cloth Pc /Pf determines the relative output of

cloth Qc /Qf

I As factors are paid the values of the marginal products in both

sectors, Pc /Pf also determines the relative remuneration of labor
w /r

I The higher Pc /Pf , the higher Qc /Qf

I As cloth is labor intensive, the higher Qc /Qf , the higher w /r

I The reason is that higher relative output of cloth requires

disproportionately more labor than land, so the relative demand of
labor increases

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Factors Prices and Goods Prices

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Stolper-Samuelson Theorem

I If the relative price of a good rises, then the real remuneration of the
factor used intensively in its production also rises, while the real
remuneration of the other factor falls.

I This happens because higher relative price of that good expands its
sector but this expansion disproportionately relies on the factor in
which the sector is relatively intensive.

I Hence, the relative remuneration of the factor increases more than

the relative price of the good.

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Factor Prices and Factor Demands

I Vice versa higher w /r reduces the relative demand of labor L/T , and
thus increases the relative demand of land T /L, in both sectors

I But dis-proportionally so in food as this sector is relatively intensive

in land

I Hence, for any given w /r the relative demand of labor in cloth is

larger; and it falls less when w /r rises.

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Factor Prices and Factor Demands

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Goods Prices, Factor Prices and Factor
Demands

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Change in Goods Prices: Distribution of
Income

I An increase in the relative price of cloth Pc /Pf is predicted to:

I raise the income of workers relative to capital owners w /r
I raise the ratio of capital to labor services T /L in both sectors
I raise the real income of workers and lower the real income of land
owners (Stolper-Samuelson Theorem).

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Factor Endowments and PPF

I Assume the home country is relatively labor abundant:

L/T > L∗ /T ∗ .

I Then, Rybczynski Theorem implies that its relative supply of cloth

RS = Qc /Qf is higher than the foreign relative supply of cloth RS ∗
for any relative price Pc /Pf .

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Trade Liberalization

I Remember: the countries are assumed to have the same technology

and the same tastes:
I With the same technology, each economy has a comparative
advantage in producing the good that relatively intensively uses the
factors of production in which the country is relatively well endowed.
I With the same tastes, the two countries will consume cloth to food in
the same ratio when faced with the same relative price of cloth under
free trade.

I Since cloth is relatively labor intensive, at each relative price of cloth

to food, Home will produce a higher ratio of cloth to food than
Foreign:
I Home will have a larger relative supply of cloth to food than Foreign.
I Home’s relative supply curve lies to the right of Foreign’s.

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Trade Liberalization
I When trade is liberalized: the home country (partially) specializes in
and therefore exports cloth.
I The foreign country (partially) specializes in and exports food.

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Trade Liberalization

I Like the Ricardian model, the Heckscher-Ohlin model predicts a

convergence of relative prices with trade.

I With trade, the relative price of cloth rises in the relatively labor
abundant (home) country and falls in the relatively labor scarce
(foreign) country.
I Pattern of trade: at Home, the rise in the relative price of cloth leads
to a rise in the relative production of cloth and a fall in relative
consumption of cloth.
I Home becomes an exporter of cloth and an importer of food.

I The decline in the relative price of cloth in Foreign leads it to

become an importer of cloth and an exporter of food.

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Heckscher-Ohlin Theorem and Gains from
Trade
I H-O Theorem: With trade, a country specializes in the sector that
intensively uses its relatively abundant factor. The country exports
the good that intensively uses its relatively abundant factor and
imports the other good.

I The theorem follows directly from the difference between the home
and foreign PPFs and the assumption of identical and homothetic
preferences across countries.
I Gains from trade:
I As in previous models, gains from trade arise from the possibility of
trading at a relative price that is different from the autarkic one.
I The country (partially) specializes in the sector whose opportunity
cost with autarky is lower than its relative price with trade.

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Factor Price Equalization Theorem

I Recall each goods price ratio corresponds to a factor price ratio.

I What does this imply about factor prices across countries?

I Goods price equalization (due to trade) implies factor price

equalization if specialization is partial.

I Trade increases the demand of goods produced by relatively

abundant factors, indirectly increasing the demand of these factors,
raising the prices of the relatively abundant factors.

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Factor Price Equalization Theorem
Does it hold in the real world?

I In the real world, factor prices are not equal across countries.

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Factor Price Equalization Theorem
Does it hold in the real world?

I It is clear that factor prices are not equal across countries. Why does
the model fail?
I The model assumes that trading countries produce the same goods,
but countries may produce different goods if their factor ratios
radically differ (full specialization).
I Same technology across countries, but different technologies could
affect the productivities of factors and therefore w /r .
I No trade barriers and transportation costs, which may prevent output
prices and thus factor prices from equalizing.
I The model focuses on the long run, but after trade liberalization,
factors of production may not quickly move to the industries that
intensively use abundant factors: in the short run, the productivity of
factors is determined by their use in their current industry, so w /r
may vary across countries.

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Outline

Introduction

Model

Empirical Evidence

Conclusion

Appendix

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Empirical Evidence on the H-O Model
Leontief Paradox

I The oldest and still very famous test of the Heckscher-Ohlin model is
Leontief (1953).
I Leontief argued that the US must be a capital abundant country
relative to its trading partners.
I Are US exports capital intensive relative to its imports?
I Computed the capital/labour ratio embodied in the output of import
competing and exporting US industries.
I Surprisingly he finds that US export industries are less capital
intensive than import competing industries.
I Bowen, Leamer, and Sveikauskas (AER 1987) tested the
Heckscher-Ohlin model on data from 27 countries and confirmed the
Leontief paradox on an international level.

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Empirical Evidence on the H-O Model
Leontief Paradox

I Factor Content of U.S. Exports and Imports for 1962.

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Empirical Evidence on the H-O Model
Trefler’s Missing Trade

I Because the Heckscher-Ohlin model predicts that factor prices will

be equalized across trading countries, it also predicts that factors of
production will produce and export a certain quantity goods until
factor prices are equalized.
I In other words, a predicted value of services from factors of production
will be embodied in a predicted volume of trade between countries.

I But because factor prices are not equalized across countries, the
predicted volume of trade is much larger than actually occurs.
I A result of “missing trade” discovered by Daniel Trefler (AER 1995).

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Empirical Evidence on the H-O Model
Trefler’s Missing Trade

I The Case of the Missing Trade and Other Mysteries

I Daniel Trefler, The American Economic Review, Vol. 85, No. 5,
(Dec., 1995), pp. 1029-1046.

I Relate factor endowments to the factor content of net trade:

fc = Vc − sc · Vworld

where f is the factor content of net exports of country c (the

amount of factor f needed to produce the net exports); s is its share
of world consumption, and V denotes factor endowments.
I If country c is abundant in a certain factor f (Vc > sc · Vworld ), then it
should export the services of that factor (fc > 0).

I Trefler (1995) shows that the factor content of net trade differs from
the HO predictions systematically.

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Empirical Evidence on the H-O Model
Trefler’s Missing Trade

I Prediction error = c = fc − (Vc − sc · Vworld ) = Actual f - HO

Predicted f .

I Plots the error against the predicted factor content of trade

Vc − sc · Vworld .

I Should be clustered around the x-axis (c = 0).

I But, observations are clustered around the line

c = −(Vc − sc · Vworld ).

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Empirical Evidence on the H-O Model
Trefler’s Missing Trade
I The measured factor content of net trade is close to zero.
I What could explain that?

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Empirical Evidence on the H-O Model
Trefler’s Missing Trade

I The reason appears to be the assumption of identical technology

among countries.
I Technology affects the productivity of workers and therefore the value
of labor services.
I A country with high technology and high value of labor services does
not necessarily import a lot from a country with low technology and a
low value of labor services.

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Empirical Evidence on the H-O Model
Skill Intensity

I Looking at changes in patterns of exports between developed (high

income) and developing (low/middle income) countries supports the
theory.
I US imports from Bangladesh are highest in low-skill-intensity
industries, while US imports from Germany are highest in high-
skill-intensity industries.

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Empirical Evidence on the H-O Model
Skill Intensity

Source: John Romalis, “Factor Proportions and the Structure of Commodity Trade,”
American Economic Review 94 (March 2004), pp. 67-97.

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Outline

Introduction

Model

Empirical Evidence

Conclusion

Appendix

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Conclusion

I The Heckscher-Ohlin Model is the last part of the classical trade

theory that we encounter.
I There are two key similarities with the Specific-Factors model:
I Differences in comparative advantage are due to differences in
endowments
I There are aggregate gains from trade but these gains are not
distributed equally

I In contrast to the Specific-Factors model there are only two factors

of production which are mobile between both sectors.

I More refined test of the Heckscher-Ohlin model tend to find more

support for the model.

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Outline

Introduction

Model

Empirical Evidence

Conclusion

Appendix

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Goods Prices, Factor Prices, Factor Demand

I For given goods prices we can draw unit value isoquants where:

Pc F (Tc , Lc ) = 1 Pf H(Tf , Lf ) = 1

I The unit cost line is defined as: rT + wL = 1 which can be rewritten

as: T = 1r − wr L

I In equilibrium, we have profit maximization and zero profits if both

sectors produce.

I This implies that factor prices have to be such that the unit cost line
is tangent to both unit value isoquants.

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Factor Prices and Factor Demand
I Think of choosing labor and land to produce 1 unit of Food.
I If w /r goes up, you choose less labor relative to land.

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Lerner Diagram
I Suppose you are given $1 to spend on buying land and labor to
produce $1 worth of Food.
I Isocost line: x-intercept of line = 1/w , y-intercept = 1/r .
I Production Functions: (FF) Pf H(Tf , Lf ) = 1 and (CC)
Pc F (Tc , Lc ) = 1.

I For the same w /r , need less T /L to produce $1 of Cloth.

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Change in Goods Prices: Distribution of
Income

I An increase in the relative price of cloth Pc /Pf is predicted to:

I raise the income of workers relative to capital owners w /r
I raise the ratio of capital to labor services T /L in both sectors
I raise the real income of workers and lower the real income of land
owners. Why?

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Distribution of Incomes
I Rise in Pc/Pf =⇒ Need to produce less Cloth to get same profit as
Food sector =⇒ CC shifts inwards.

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Distribution of Incomes
I Rise in Pc/Pf =⇒ CC shifts inwards =⇒ w /r rises.

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Distribution of Incomes

I The real return to labor rises in terms of both goods.

I Implies that the proportional increase in w is bigger than that in Pc .

I Application: Trade and wage inequality - Rise in price of

skill-intensive products after trade would increase real wages of
skilled workers, and lower real wages of unskilled workers.

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