Trade and Resources: The Heckscher-Ohlin Model

4
1 Heckscher-Ohlin
Chapter 4: Trade and Resources: The Heckscher-Ohlin Model

Model
2 Testing the
Heckscher-Ohlin
Model
3 Effects of Trade on
Factor Prices

4 APPE N D IX TO
CHAPTER 4
The Sign Test in the
Heckscher-Ohlin
Model

Prepared by:
Fernando Quijano
Dickinson State University
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 Introduction

In this chapter, we outline the Heckscher-Ohlin

model, a model that assumes that trade occurs
because countries have different resources.’
Our first goal is to describe the Heckscher-Ohlin (HO)
model of trade.
Chapter 4: Trade and Resources: The Heckscher-Ohlin Model

• The specific-factors model (Chapter 3) was a

short-run model because capital and land could
not move between the industries.
• In contrast, the HO model is a long-run model
because all factors of production can move
between the industries.

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 Introduction

Our second goal is to examine the empirical evidence

on the Heckscher-Ohlin model.
• By allowing for more than two factors of
production and also allowing countries to differ in
their technologies, as in the Ricardian model, the
Chapter 4: Trade and Resources: The Heckscher-Ohlin Model

predictions from the Heckscher-Ohlin model

match more closely the trade patterns in the
world economy today.
The third goal of the chapter is to investigate how the
opening of trade between the two countries affects the
payments to labor and to capital in each of them.

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 1 Heckscher-Ohlin Model

Assumptions of the Heckscher-Ohlin Model

Assumption 1: Two factors of production, labor and

capital, can move freely between the industries.
Chapter 4: Trade and Resources: The Heckscher-Ohlin Model

Assumption 2:
• Two products: shoes vs computers;
• Shoes production is labor-intensive; that is, it requires
more labor per unit of capital to produce shoes than
computers, so that LS /KS > LC /KC.
• Computers are capital-intensive: KS / LS > KC / LC
• Factor intensity reversal can resolve L-paradox.

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 1 Heckscher-Ohlin Model

Labor Intensity of Each Industry The demand for labor relative to

capital is assumed to be higher in shoes than in computers,
LS/KS > LC/KC.
These two curves slope down just like regular demand curves,
but in this case, they are relative demand curves for labor (i.e.,
demand for labor divided by demand for capital).
Chapter 4: Trade and Resources: The Heckscher-Ohlin Model

FIGURE 4-1

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 1 Heckscher-Ohlin Model

Assumptions of the Heckscher-Ohlin Model

Assumption 3: Foreign is labor-abundant, by which we
mean that the labor–capital ratio in Foreign exceeds that
in Home, L*/K*> L/K. Equivalently, Home is capital-
abundant, so that K/L >K*/L*.
Chapter 4: Trade and Resources: The Heckscher-Ohlin Model

Assumption 4: The final outputs, shoes and computers,

can be traded freely (i.e., without any restrictions)
between nations, but labor and capital do not move
between countries.
Assumption 5: The technologies used to produce the
two goods are identical across the countries.
Assumption 6: Consumer tastes are the same across
countries, and preferences for computers and shoes do
not vary with a country’s level of income.
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 1 Heckscher-Ohlin Model
No-Trade Equilibrium
Production Possibilities Frontiers, Indifference Curves, and
No-Trade Equilibrium Price
FIGURE 4-2 (1 of 3) No-Trade Equilibria in Home and Foreign
Chapter 4: Trade and Resources: The Heckscher-Ohlin Model

The Home production possibilities Because Home is capital

frontier (PPF) is shown in panel (a), abundant and computers are
and the Foreign PPF is shown in capital intensive, the Home
panel (b). PPF is skewed toward
computers.
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 Why are Production Possibilities Frontiers
skewed?
Home is capital-abundant and computer producing is capital-
intensive .
 Home is capable to produce more computers than shoes.
 Production possibility frontier is skewed in the direction of
Chapter 4: Trade and Resources: The Heckscher-Ohlin Model

computers.

Foreign is labor-abundant and shoes producing is labor-intensive.

 Production possibility frontier is skewed in the direction of shoes.

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 1 Heckscher-Ohlin Model
No-Trade Equilibrium
Production Possibilities Frontiers, Indifference Curves, and
No-Trade Equilibrium Price
FIGURE 4-2 (2 of 3) No-Trade Equilibria in Home and Foreign (continued)
Chapter 4: Trade and Resources: The Heckscher-Ohlin Model

Home preferences are summarized The Home no-trade (or autarky)

by the indifference curve, U. equilibrium is at point A.
The flat slope indicates a low
relative price of computers, (PC
/PS)A.
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 Heckscher-Ohlin Model

• Indifference curves are the same shape in both countries as

required by assumption 6.
• The slope of an indifference curve equals the amount that
consumers are willing to pay for computers in terms of shoes
Chapter 4: Trade and Resources: The Heckscher-Ohlin Model

given up.
• In the equilibrium, the slope of an indifference curve equals the
slope of a production possibility frontier.
• A steeply sloped price line implies a high relative price of
computers whereas a flat price line implies low relative price of
computers.

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 1 Heckscher-Ohlin Model
No-Trade Equilibrium
Production Possibilities Frontiers, Indifference Curves, and
No-Trade Equilibrium Price
FIGURE 4-2 (3 of 3) No-Trade Equilibria in Home and Foreign (continued)
Chapter 4: Trade and Resources: The Heckscher-Ohlin Model

Foreign is labor-abundant and shoes are Foreign preferences are summarized by

labor- intensive, so the Foreign PPF is the indifference curve, U*
skewed toward shoes. The Foreign no-trade equilibrium is at
point A*, with a higher relative price of
computers, as indicated by the steeper
slope of (P*C /P*S)A*.
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 Heckscher-Ohlin Model

• We expect the equilibrium relative price of computers to lie

between the no-trade relative prices in each country
• This implies, hence, that Home will be exporting computers and
Foreign will be exporting shoes
Chapter 4: Trade and Resources: The Heckscher-Ohlin Model

• Importantly, in contrast to Ricardian model Home and Foreign

are not completely specialized to produce only a single product.

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 1 Heckscher-Ohlin Model
Free-Trade Equilibrium
Home Equilibrium with Free Trade
FIGURE 4-3 (1 of 2) International Free-Trade Equilibrium at Home
Chapter 4: Trade and Resources: The Heckscher-Ohlin Model

At the free-trade world relative price of Point A is the no-trade equilibrium.

computers, (PC /PS)W, The “trade triangle” has a base equal to
Home produces at point B in panel (a) and the Home exports of computers (the
consumes at point C, difference between the amount produced
exporting computers and importing shoes. and the amount consumed with trade,
(QC2 − QC3).
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 1 Heckscher-Ohlin Model
Free-Trade Equilibrium
Home Equilibrium with Free Trade
FIGURE 4-3 (2 of 2) International Free-Trade Equilibrium at Home (continued)
Chapter 4: Trade and Resources: The Heckscher-Ohlin Model

The height of this triangle is the Home In panel (b), we show Home
imports of shoes (the difference between exports of computers equal to zero
the amount consumed of shoes and the at the no-trade relative price, (PC
amount produced with trade, QS3 − QS2). /PS)A,
and equal to (QC2 − QC3) at the
free-trade relative price, (PC/PS)W.
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 1 Heckscher-Ohlin Model
Free-Trade Equilibrium
Foreign Equilibrium with Free Trade
FIGURE 4-4 (1 of 2) International Free-Trade Equilibrium in Foreign
Chapter 4: Trade and Resources: The Heckscher-Ohlin Model

At the free-trade world relative price of Point A* is the no-trade equilibrium.)

computers, (PC /PS)W, The “trade triangle” has a base equal to
Foreign produces at point B* in panel (a) and Foreign imports of computers (the
consumes at point C*, difference between the consumption of
importing computers and exporting shoes. computers and the amount produced with
trade, (Q*C3 − Q*C2).
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 1 Heckscher-Ohlin Model
Free-Trade Equilibrium
Foreign Equilibrium with Free Trade
FIGURE 4-4 (2 of 2) International Free-Trade Equilibrium in Foreign (continued)
Chapter 4: Trade and Resources: The Heckscher-Ohlin Model

The height of this triangle is Foreign In panel (b), we show Foreign imports
exports of shoes (the difference of computers equal to zero at the no-
between the production of shoes and trade relative price, (P*C /P*S)A*, and
the amount consumed with trade, Q*S2 equal to (Q*C3 − Q*C2) at the free-
– Q*S3). trade relative price, (PC /PS)W.

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 1 Heckscher-Ohlin Model
Free-Trade Equilibrium
Equilibrium Price with Free Trade Because exports equal imports,
there is no reason for the relative price to change and so this is a free-
trade equilibrium.
FIGURE 4-5 Determination of the Free-Trade World Equilibrium Price

The world relative price of

Chapter 4: Trade and Resources: The Heckscher-Ohlin Model

computers in the free-trade

equilibrium is determined at the
intersection of the Home export
supply and Foreign import
demand, at point D.
At this relative price, the
quantity of computers that
Home wants to export, (QC2 −
QC3), just equals the quantity of
computers that Foreign wants to
import, (Q*C3 − Q*C2).

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 1 Heckscher-Ohlin Model
Free-Trade Equilibrium
Pattern of Trade
• Home exports computers, the good that uses
intensively the factor of production (capital) found
in abundance at Home.
Chapter 4: Trade and Resources: The Heckscher-Ohlin Model

• Foreign exports shoes, the good that uses

intensively the factor of production (labor) found in
abundance there.
• This important result is called the Heckscher-
Ohlin theorem.

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 2. Testing the HO Model
The first test was performed by Leontief (1953).
• He supposed that USA was abundant in capital relative to the
rest of the world.
• Thus, from the H-O theorem, US was expected to export
capital-intensive goods and import labor-intensive ones.
• He found the opposite: the capital–labor ratio for U.S. imports
Chapter 4: Trade and Resources: The Heckscher-Ohlin Model

was higher than the one for U.S. exports!

• This contradiction of the H-O is the Leontief’s paradox.

<
Each column shows the amount of capital or labor needed to produce $1
million worth of exports from, or imports into, the United States in 1947.

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 2. Testing the HOV Model
Leontief’s Paradox
Explanations

• U.S. and foreign technologies are not the same, in

contrast to what the HO theorem and Leontief assumed.
• By focusing only on labor and capital, Leontief ignored
Chapter 4: Trade and Resources: The Heckscher-Ohlin Model

land abundance in the United States.

• Leontief should have distinguished between skilled and
unskilled labor (because it would not be surprising to
find that U.S. exports are intensive in skilled labor).
• The data for 1947 may be unusual because World War
II had ended just two years earlier.
• The United States was not engaged in completely free
trade, as the Heckscher-Ohlin theorem assumes.

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 2. Testing the Heckscher-Ohlin-Vanek (HOV)
• HOV: Many countries, i = 1,…,C; Industries, j=1,…,N; Factors, k =1,..,M.
• Technologies are identical across countries.
• Tastes are identical and homothetic across countries.
• Matrix A=[ajk]' , with dimensions (MxN), denotes the amounts of labor, capital,
land,…needed for one unit of production in each industry.
• Notice that this matrix applies in any country (same technology in all C).
• Rows measure factors (k=1,…,M);
Chapter 4: Trade and Resources: The Heckscher-Ohlin Model

• Columns measure industries (j=1,…,N).

• Yi denotes the (Nx1) vector of outputs in each industry for country i,

• Di denote the (Nx1) vector of demands of each good (equal for all countries)
• Thus, Ti =Yi– Di equals the vector of net exports for country i.
• The factor content of trade is: Fi ≡ ATi, which is an (Mx1) vector.
• We denote individual components of this vector as Fik where:
• A positive value indicates that the factor is exported,
• A negative value indicates that the factor is imported.

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 2. Testing the HOV Model
• HOV relates the factor content of trade ATi to the endowments of country i.
• To do so, we compute AYi and ADi.
• AYi = demand for factors in country i. It is also, the endowments of country i,
• AYi = Vi
• ADi is simplified by using our assumption of identical and homothetic tastes.
• Since product prices are equalized across countries by free trade, the
Chapter 4: Trade and Resources: The Heckscher-Ohlin Model

consumption vectors of all countries must be proportional to each other.

• Thus Di = si Dw,
• where Dw = the world consumption vector
• si = the share of country i in world consumption.
• Thus: ADi= siADw.
• If trade is balanced, si = country i’s share of world GDP.
• Since world consumption must equal world production, then:
ADi= si ADw = siAYw = siVw.
HOV Theorem: Fi ≡ ATi = Vi– si Vw
HOV Theorem (for individual factors): Fik = Vik– si Vwk

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 2. Testing the HOV Model
Factor Endowments in the New Millennium

• To determine whether a country is abundant in a certain

factor, we compare the country’s share of that factor
Chapter 4: Trade and Resources: The Heckscher-Ohlin Model

with its share of world GDP.

• If its share of a factor exceeds its share of world GDP, then we
conclude that the country is abundant in that factor, and

• if its share in a certain factor is less than its share of world GDP, then
we conclude that the country is scarce in that factor.

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 2. Testing the HOV Model
Country Factor Endowments, 2000. Feenstra and Taylor (2011)
Chapter 4: Trade and Resources: The Heckscher-Ohlin Model

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 2. Testing the HOV Model Feenstra and Taylor (2011)

Differing Productivities across Countries

• Leontief found that the US was exporting labor-intensive
products even though it was capital-abundant.

• Why?
Chapter 4: Trade and Resources: The Heckscher-Ohlin Model

• Labor is more productive in the US than in the rest of the world.

• Then, the effective labor force in the US, the labor force times its
productivity, is larger than it appears to be when we just count people.

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 2. Testing the HOV Model Feenstra and Taylor (2011)

Differing Productivities across Countries

To allow factors of production to differ in their productivities

across countries, we define the effective factor
endowment as the actual amount of a factor found in a
Chapter 4: Trade and Resources: The Heckscher-Ohlin Model

country times its productivity:

Effective factor endowment = Actual factor endowment *

Factor productivity

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 2. Testing the HOV Model Feenstra and Taylor (2011)

Differing Productivities across Countries

• To determine whether a country is abundant in a certain
factor, we compare the country’s share of that effective
factor with its share of world GDP.
• If its share of an effective factor exceeds its share of
Chapter 4: Trade and Resources: The Heckscher-Ohlin Model

world GDP, then we conclude that the country is

abundant in that effective factor;
• if its share of an effective factor is less than its share
of world GDP, then we conclude that the country is
scarce in that effective factor.

Effective R&D Scientists

Effective R&D scientists =
Actual R&D scientists • R&D spending per scientist

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 2. Testing the HOV Model Feenstra and Taylor (2011)

Differing Productivities across Countries. 2000

Chapter 4: Trade and Resources: The Heckscher-Ohlin Model

• China: abundant in R&D scientists (14% > 11% of the world’s GDP) but scarce in effective
R&D scientists (7% < 11% of the world’s GDP).
• US: scarce in arable land (13% < 22% of the world’s GDP) but neither scarce nor
abundant in effective land (21% = 22% ).
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 2. Testing the HOV Model Feenstra and Taylor (2011)

Leontief’s Paradox Once Again

Labor Abundance
FIGURE 4-8 Labor Endowment and GDP for the United States and Rest of World, 1947
Shown here are the share of
labor, “effective” labor, and GDP
of the US and the rest of the
Chapter 4: Trade and Resources: The Heckscher-Ohlin Model

world in 1947. The US had only

8% of the world’s population, as
compared to 37% of the world’s
GDP, so it was very scarce in
labor. But when we measure
effective labor by the total
wages paid in each country,
then the United States had 43%
of the world’s effective labor as
compared to 37% of GDP, so it
was abundant in effective labor.

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 2. Testing the HOV Model
Fi ≡ ATi = Vi– si Vw T i = A-1(V i – s i V w)
Chapter 4: Trade and Resources: The Heckscher-Ohlin Model

Partial
tests

Complete
test

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 3. Effects of Trade on Factor Prices

Determination of the Real Wage and Real Rental

• Stolper-Samuelson Theorem: In the long run, when
all factors are mobile, an increase in the relative price
of a good will increase the real earnings of the factor
used intensively in the production of that good and
Chapter 4: Trade and Resources: The Heckscher-Ohlin Model

decrease the real earnings of the other factor.

• For our example, the Stolper-Samuelson theorem
predicts that when Home opens to trade and faces a
higher relative price of computers, the real rental on
capital in Home rises and the real wage in Home falls.
In Foreign, the changes in real factor prices are just
the reverse.

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 3. Effects of Trade on Factor Prices
Changes in the Real Wage and Rental: A Numerical Example
Chapter 4: Trade and Resources: The Heckscher-Ohlin Model

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 3 Effects of Trade on Factor Prices
Changes in the Real Wage and Rental: A Numerical Example
General Equation for the Long-Run Change in Factor Prices The
long-run results of a change in factor prices can be summarized in
the following equation:
Chapter 4: Trade and Resources: The Heckscher-Ohlin Model

Real Real rental

wage increases
falls

The equations relating the changes in product prices to changes in

factor prices are sometimes called the “magnification effect” because
they show how changes in the prices of goods have magnified effects
on the earnings of factors:

Real Real Real Real

rental wage rental wage
falls increases falls increases

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 4. Conclusions Feenstra and Taylor (2011)

1. In the Heckscher-Ohlin model, we assume that the technologies

are the same across countries and that countries trade because
the available resources (labor, capital, and land) differ across
countries.
2. The Heckscher-Ohlin model is a long-run framework, so labor,
capital, and other resources can move freely between the
Chapter 4: Trade and Resources: The Heckscher-Ohlin Model

industries.
3. With two goods, two factors, and two countries, the Heckscher-
Ohlin model predicts that a country will export the good that uses
its abundant factor intensively and import the other good.
4. The first test of the Heckscher-Ohlin model was made by Leontief
using U.S. data for 1947. He found that U.S. exports were less
capital-intensive and more labor-intensive than U.S. imports. This
was a paradoxical finding because the United States was
abundant in capital.
5. In response to the explanations of the paradox: HOV theorem.

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 4. Conclusions Feenstra and Taylor (2011)

5. The assumption of identical technologies used in the

Heckscher-Ohlin model does not hold in practice.
6. Current research has extended the empirical tests of
the Heckscher-Ohlin model to allow for many factors
Chapter 4: Trade and Resources: The Heckscher-Ohlin Model

and countries, along with differing productivities of

factors across countries.
7. When we allow for different productivities of labor in
1947, we find that the United States is abundant in
effective—or skilled—labor, which explains the Leontief
paradox.

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