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Introduction:

The Heckscher-Ohlin model is an economic theory also known as the H-O model or 2×2×2 model. The theory is used to evaluate trade between two countries or states. This theory contains four critical theorems. Those are:

  1. Endowment theorem
  2. Factor Price Equalization
  3. Stolper- Samuelson theorem
  4. Rybczynski theorem

Heckscher-Ohlin Endowment Theory

The theory proposes that the country exports those goods which they can produce most efficiently and effectively. This model is used to evaluate the equilibrium theory or trade between those countries having variable specialities and natural resources.

It focuses on the nature of export, that the factors of production which the country has abundantly exported those goods. At the same time, the nature of import is that the goods that a country cannot produce efficiently. It emphasizes that if the country, any good in excess or in abundance shall export it to other countries and the goods which they need most but cannot produce efficiently shall be imported from another country. This model is not limited up to goods only but it extends up to labours as well.

Historical Development

The Heckscher-Ohlin theory is mainly based upon a 1919 Swedish paper written by Eli Heckscher at the Stockholm School of Economics. Her student Bertil Ohlin added more contents in it in 1933. Whereas Economist Paul Samuelson expanded the original model in his articles written in 1949 and 1953. Therefore this theory is also known as the Heckscher-Ohlin-Samuelson Model. For his work, Ohlin was awarded the Nobel Prize in Economic Sciences in 1977.

Nature of the Model

This model mathematically explains how a country should function when the resources available are imbalanced. It is a general phenomenon that no country has all-natural resources available because of its geographical location. It is not limited to commodities only but also includes labour. It is a well-known fact that the cost of labour is varying from one country to another country. This model says that a country having less cost of labour shall emphasise more on producing labour-intensive goods. If the country has an abundance of capital and the worker has plenty of machinery to handle in such countries the labour cost is relatively higher which raises the cost of production and thus the price of the commodity. But such production cost is less in those countries where labour cost less.

Features of the Heckscher- Ohlin – Samuelson Theory

The endowment of the factors of production i.e labour, capital and land determines a comparative advantage. The profitability of goods is ensured by its input cost if the input cost is less, the product is profitable. The products which require those raw materials which are locally available at the cheap price are likely to be produced than the raw materials which are scarce.  

The Heckscher- Ohlin model assumes that there is only one difference between two countries which is the abundance of capital and labour. This model has two countries, two commodities and two factors of production. Therefore it is known as the 2×2×2 model.

The H-O model further explains comparative advantage in terms of the factor intensity and factor abundance of the commodities and nations respectively. For example, Canada has more labour and capital than the USA but the quantity of capital advantage in Canada is greater than the USA but the USA has a labour advantage than Canada. Therefore, Canada is capital abundant and the USA is labour abundant.

Assumptions of the Theory

These assumptions were taken for proving it mathematically. But these assumptions can be twisted as a part of the development of nations. Following are the assumptions of the O-H Model:

1. Countries having similar production technology

This model assumes that the infrastructure, education, know-how, knowledge, cultures etc of both countries shall be similar or identical. The technology used by them shall be identical. This assumption aims that production of the same output of any commodity can be done with the same amount of labour and capital in either country.

2. Output is constant returns to scale

Both nations shall produce two commodities. These two commodities shall be produced with the help of two factors capital (K) and labour (L). The technologies of each commodity are assumed to exhibit constant returns scale (CRS). CRS implies that when inputs of both the labour and capital are multiplied by a factor of K, the output shall also be multiplied by a factor of K. For example if the input of capital and labour is doubled up then the output of the goods shall be doubled.

3. Factor mobility within a country

The factors such as capital and labour can be reemployed and reinvested within the country to produce different outputs. For example, the two production technologies are the fishing industry and agriculture industry, the fisherman can shift to work as a farmer and farmer can shift to work as fisherman without any further cost.

4. Factors immobility between two countries

The basis of this model is the different relative availability of factors like labour and capital internationally. If capital is expended worldwide freely, it will make relative abundance identical throughout the world. This theory does not support free labour mobility as it will create equalisation of two factors of production.

5. Commodity prices are same

This model assumed that there are no tariffs, no transportation cost, no barriers to trade. It assumed that the prices of goods shall be the same in each country.

6. Perfect competition

It assumed to have the perfect competition market where neither capital nor labour affects the prices and supply of goods.

Formulation of the Conclusion of Theories

1. Heckscher-Ohlin Theorem

This theorem concludes that a country with capital abundance exports capital intensive industries whereas labour abundant countries imports them. The labour abundant countries shall export labour-intensive commodities in return.

2. Rybczynski Theorem

This theorem concludes that when the amount of either factor of production rises the price of goods also increases.  As this theory suggests perfect competition, the price and factor of production are assumed to be equal.

3. Stolper-Samuelson Theorem

It concludes that when there is a relative change in the output of goods prices this will attract the relative price of the factors of production.

4. Factor-Price Equalization (FPE) Theorem

This is said to be the most significant conclusion of the H-O model. This theorem emphasizes that competitive and free trade makes the prices of factors converge along with the prices of traded goods. But this has no practical evidence in economics. Neither wage rate nor rent to capital seems to be consistent converge between trading prices.

Criticisms

This model received criticism around the world for its impractical assumptions like identical countries, commodities price are the same, similar production technology etc. Following are drawbacks of the Heckscher- Ohlin model:

1. Poor predictive power

Daniel Trecker and Susan Chun Zhu in their paper claimed that “it is hard to believe that factor endowment theory could give an adequate explanation of international trade patterns”. It was observed that the H-O model was well fitted to the national level as it fits well to the regional data of Japan. But the factor endowment theory has many errors at the same time.

2. No unemployment

This theory has completely ignored the fact of unemployment. This theory has assumed that there will be no unemployment and all the labour factors are employed in production.

3. Leontief Paradox

In 1953, Wassily Leontief presented the Leontief paradox on the US being the most capital abundant country in the world. In this year, the US being a capital abundant country exported labour-intensive commodities and imported capital intensive commodities which are contrary to the H-O model theory. However, if we separate the kinds of labour in skilled and unskilled labour where the US exported skilled labour-intensive commodities and imported unskilled labour-intensive commodities which is appropriate as per the theory.

4. Homogeneous Capital

Heckscher- Ohlin model assumes to have homogenous capital and can be transferable to any form. The assumption conflicts due to its diversity because it is difficult to measure the amount of capital.

5. Capital as Endowment

Machines, apparatuses and tools are considered as capital. Capital is not considered as an endowment given by nature.

Conclusion

The Heckscher-Ohlin theory further gave birth to many other theories viz. New trade theory, Gravity model of trade, Ricardo- Staffs trade theory, Stolper – Samuelson theorem. There is wide agreement among modern economists about the explanation of international trade offered by Heckscher and Ohlin. This theory is called by the New Modern Theory of International Trade.


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