2.2 Heckscher-Ohlin model and factor endowments

The Heckscher-Ohlin model explains trade patterns based on countries' factor endowments. It predicts that nations will export goods that use their abundant factors intensively. For example, capital-rich countries export capital-intensive products, while labor-abundant nations export labor-intensive goods.

This model has implications for factor prices and income distribution. Trade increases returns to abundant factors and decreases returns to scarce ones. While empirical evidence is mixed, the model offers insights into how differences in resources shape international trade patterns.

Heckscher-Ohlin Model and Factor Endowments

Key assumptions of Heckscher-Ohlin model

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• Assumes two countries (United States and China), two goods (automobiles and textiles), and two factors of production (capital and labor)
• Countries have identical technologies (same production methods) and preferences (similar consumer tastes)
• Goods differ in their factor intensities
  • One good is capital-intensive (automobiles require more capital per unit of labor)
  • The other is labor-intensive (textiles require more labor per unit of capital)
• Countries differ in their factor endowments
  • One country is capital-abundant (United States has a higher ratio of capital to labor)
  • The other is labor-abundant (China has a higher ratio of labor to capital)
• Predicts that countries will export goods that intensively use their relatively abundant factor
  • Capital-abundant country (United States) exports capital-intensive good (automobiles)
  • Labor-abundant country (China) exports labor-intensive good (textiles)
• Trade leads to factor price equalization across countries
  • Prices of capital (interest rates) and labor (wages) converge between trading partners

Factor endowments in comparative advantage

• Factor endowments refer to a country's relative supplies of factors of production
  • Factors include land (arable land for agriculture), labor (skilled and unskilled workers), capital (machinery and infrastructure), and natural resources (oil, minerals)
• Relative factor abundance determines comparative advantage
  • Country with higher capital-to-labor ratio (Germany) has comparative advantage in capital-intensive goods (machinery)
  • Country with higher labor-to-capital ratio (Bangladesh) has comparative advantage in labor-intensive goods (garments)
• Differences in factor endowments drive trade patterns
  • Countries specialize in and export goods that intensively use their abundant factor (Saudi Arabia exports oil, while Japan exports high-tech electronics)

Trade effects on factor prices

• Trade affects relative factor prices within countries
  • Increases demand for abundant factor (skilled labor in developed countries), raising its price (higher wages for skilled workers)
  • Decreases demand for scarce factor (unskilled labor in developed countries), lowering its price (lower wages for unskilled workers)
• Stolper-Samuelson theorem: trade benefits owners of abundant factor and harms owners of scarce factor
  • In capital-abundant country (South Korea), trade increases returns to capital (higher profits for business owners) and decreases wages (lower income for workers)
  • In labor-abundant country (Vietnam), trade increases wages (higher income for workers) and decreases returns to capital (lower profits for business owners)
• Trade can lead to changes in income distribution within countries
  • Owners of abundant factor (skilled workers in developed countries) gain, owners of scarce factor (unskilled workers in developed countries) lose

Empirical evidence of Heckscher-Ohlin model

• Leontief paradox: U.S. exports were found to be labor-intensive, contradicting H-O predictions
  • Possible explanations include human capital differences (U.S. workers are more educated and skilled) and technological advantages (U.S. has more advanced technology)
• Tests of the H-O model have yielded mixed results
  • Some support for factor endowments driving trade patterns (resource-rich countries export primary commodities)
  • Other factors, such as economies of scale (larger firms have lower costs) and product differentiation (brands and unique features), also play a role
• Limitations of the H-O model:
  • Assumes identical technologies and preferences across countries (not always realistic)
  • Ignores transportation costs (shipping expenses), trade barriers (tariffs and quotas), and other real-world factors
  • Does not account for intra-industry trade (countries export and import similar products) or trade in services (consulting, tourism)
• Despite limitations, the H-O model provides valuable insights into the role of factor endowments in trade (helps explain why countries specialize in certain goods)