“Tell me and I forget. Teach me and I remember. Involve me and I learn.

”
Benjamin Franklin

ECON 4321

Module 3: The Factor-Proportions

Theory or Heckscher-Ohlin Model

Corresponding Chapter in the Book: 4

FA 2025
 INTRODUCTION
So far, we have learned that two countries can benefit from
trade if each specializes in producing the good it can produce
at a lower comparative cost and imports the good that would
require a higher relative cost to produce.

However, the Ricardian model leaves us with some

unanswered questions:
What determines a country’s comparative advantage?
How does international trade influence the size of different
industries within an economy?
How does international trade influence the payments or
returns to factors of production, such as labor and capital?
How does international trade affect the distribution of
income within a country?

Econ 4321: International Trade 2

 INTRODUCTION 2
In this lecture, our goal is to introduce the basic theory that
explains the causes of comparative advantage.

We will achieve this by using the so-called Heckscher-Ohlin

(H-O) or Factor Proportions Theory.
According to this theory, the sources of comparative
advantage are the differences in factor endowments used
to produce goods and services.

The theory is then extended to explain how international

trade affects the returns of the production factors and income
distribution within a country.

Econ 4321: International Trade 3

 INTRODUCTION 3
We will study four theorems of the Factors Proportion or H-O
Theory.
The first one, Heckscher-Ohlin (H-O) hypothesis, states that a
nation exports goods and services that use intensively its
relatively abundant factors of production or resources.
According to this theorem, trade is driven by differences in
factor endowments.
We will also study the Stolper-Samuelson, Rybczynski, and
factor equalization theorems.
We will demonstrate that as the factors of production are
shifted from contracting sectors to expanding ones, the
changes in the capital-to-labor ratio (K/L) influence the returns
to capital (rent) and labor (wages), and consequently, the
comparative advantage.
The abundant factors (e.g., capital or skilled labor in the U.S.)
benefit, while the relatively scarce factors (e.g., unskilled
workers in the U.S.) lose. Econ 4321: International Trade 4
 INTRODUCTION 4
Although there is strong evidence that open trade makes
nations richer, some argue that it also leads to income
inequality both within (e.g., abundant factors versus scarce
factors as highlighted above) and between countries (i.e.,
developed versus developing countries).
Inequality between nations has declined during the last several
decades.
Just in China and India, millions of people moved out of
poverty
However, inequality within countries (especially in developed
countries) primarily results from technological changes that
complement capital and skills, but substitute for unskilled
tasks.
It increases the demand for skilled workers not only in
advanced countries but also in developing ones, and thus it
contributes to within-country income inequality.
Econ 4321: International Trade 5
 INTRODUCTION 5
Firms from advanced nations have incentives to outsource
the activities that are not their core ones (e.g., iPod’s
assembly, which is a low-skill labor activity, and Apple lowers
the costs by locating this part of the supply chain in a country
that is abundant in unskilled labor)
This, however, reduces the demand for unskilled labor in the
U.S. However, the outsourcing of these activities increases the
demand for some skilled workers in advanced nations (e.g.,
the U.S.), as Apple now needs to hire more skilled workers
who can organize and manage these activities.
Thus, the technological change and outsourcing of low-
skilled labor-intensive activities to developing countries lead
to higher productivity, demand, and wages for skilled labor in
advanced nations.
But it hurts the lower-skilled workers in advanced nations.

Econ 4321: International Trade 6

 INTRODUCTION 6
We will discuss how the Trade Adjustment Assistance is used
as a policy during this process.
Improvements in educational attainment and skill upgrading
are highly important.
Some countries, such as Finland, have done a much better job
managing this process than others.

Econ 4321: International Trade 7

 INTRODUCTION 7
In this module, we also explain what happens if factors of
production cannot easily move from one sector to another.
We show that the capital that is sector-specific in the
comparative disadvantage industry (import-competing
industry) is worse off even in a capital-abundant country.
That's why import computing firms and industries often
lobby for protection or assistance from governments.
Moving to the comparative advantage industry would be a
better option for them.
Software engineers or computer programmers can move
smoothly from one sector to another.
We also discuss the empirical evidence for the H-O model. We
explain the puzzle advocated by the Leontief Paradox and
discuss the trade that the H-O model does not define.

Econ 4321: International Trade 8

 H-O/ FACTOR PROPORTION THEORY

Two Swedish economists, Eli Heckscher and Bertil Ohlin,

explained the causes of comparative advantage.
Paul Samuelson improved his theorem, which is known as the
factor-proportions theory.
The factor proportion theory is also known as the factor-
endowment model, the Heckscher-Ohlin model (H-O)
There are four main theorems in the H-O Model
Heckscher-Ohlin Theorem/Factor Proportion Theorem
Stolper-Samuelson Theorem
Rybczynski Theorem
Factor-price equalization Theorem

Econ 4321: International Trade 9

 HO/ FACTOR PROPORTION THEORY 2
Heckscher-Ohlin Theorem/Factor Proportion Theorem
articulates that a country’s comparative advantage is
determined by its factor resource endowments.
With two goods and two factors, each country will export the
good that uses intensively the factor of production it has in
abundance and will import the other good.
The U.S. exports computers—the good that uses her
abundant factor of production intensively—capital and
knowledge
The U.S. imports shirts—the good that uses her scarce factor
of production intensively— lower-skilled labor

Econ 4321: International Trade 10

 H-O/ FACTOR PROPORTION THEORY 3
Recall that in the Ricardian Model
Only one factor of production, labor (L), is assumed
The productivity of labor is assumed to vary across countries
This suggests that there are technological differences
between nations
Trade is caused by differences in technology, which leads
to relative productivity or cost differences
It does not explain what causes a country to have a
comparative advantage or lower opportunity cost in
certain goods and services

Econ 4321: International Trade 11

 H-O/ FACTOR PROPORTION THEORY 4

H&O Model
Capital (K) and labor (L) are used in the production of two
final goods
K generates income for the owner, which is called rent
L earns wages
The ratio of the quantity of capital to the amount of labor is
called the capital-labor ratio (K/L)
Different industries producing different goods have different
K/L
The factor proportions model is based on this ratio

Econ 4321: International Trade 12

THE FACTOR-PROPORTIONS THEORY/H-O
THEOREM 5
Assumptions of the Factor Proportions Theory
Two countries – US and India, produce two goods –
machines (M) and cloth ©
Production and consumption are governed under
perfect competition
Firms are price takers
Prices of inputs or factors (K and L) are determined by
supply and demand in each market.
In the long run, goods' prices equal their production
costs.
No barriers to trade (e.g., no tariffs or non-tariff
barriers)
International trade does not lead to full specialization

Econ 4321: International Trade 13

THE FACTOR-PROPORTIONS THEORY/H-O
THEOREM 6
Assumptions of the Factor Proportions Theory
Consumers in both countries have similar tastes and
preferences
Both countries are endowed with Capital (K) and Labor
(L), and they are both used
Technology for production is similar in both countries and
produced under constant returns to scale
Capital and Labor can flow freely from one industry to
the other within the country
Labor and Capital cannot move freely between countries

Econ 4321: International Trade 14

THE FACTOR-PROPORTIONS THEORY/H-O
THEOREM 7
Assumptions of the Factor Proportions Theory
Given the available production techniques, the cloth is a
labor-intensive good, and the machine is a capital-
intensive good in both countries.
Machines use a lot more capital relative to labor – a high
K/L ratio
Cloth uses a lot of labor relative to capital – low K/L ratio
The US is relatively capital-abundant, and India is
relatively labor abundant.
The K/L ratio is higher in the US than in India.
Important: The relative quantity of capital to labor is the
key.

Econ 4321: International Trade 15

THE FACTOR-PROPORTIONS THEORY/HO THEOREM 8
Input Requirements to Produce
Country Production conditions in the 10
1 Machine USYards
and of
India
Cloth
10 units of capital 4 units of capital
U.S.
+4 days of labor +8 days of labor
10 units of capital 4 units of capital
India
+4 days of labor +8 days of labor

Production of machines in both countries demands more

capital than labor
Capital-to-labor, K/L, ratio for the machine industry is 2.5
(=10/4)
In both countries, the production of cloth demands more L
than K, and the cloth industry’s K/L ratio is 0.5 (=4/8)
Thus, the production of machines in both countries is
relatively capital-intensive

Econ 4321: International Trade 16

THE FACTOR-PROPORTIONS THEORY/H-O
THEOREM 9
The U.S. is relatively capital-abundant
India is relatively labor-abundant
This means that K/L in the U.S. is greater than the K/L in
India
The important point here is not whether the US has more
units of capital (K) than India, but whether the US has
greater K/L than India

Econ 4321: International Trade 17

THE FACTOR-PROPORTIONS THEORY/H-O
THEOREM 10
Factor Intensity: Assume that we have two commodities
(cloth and machine) and two factors (labor and capital)
Then, we state that a machine is capital-intensive if the capital-
labor ratio (K/L) used in the production of a machine is greater
than the K/L used in the production of cloth.

Factor Abundance: Assume that there are two countries

(the U.S. and India) and two factors (labor and capital)
Then, we say that the U.S. is capital-abundant compared to
India (and India is labor-abundant compared to the U.S.) if the
ratio of the total amount of capital to the total amount of labor
(K/L) available in the US is greater than that in India.

Econ 4321: International Trade 18

THE FACTOR-PROPORTIONS THEORY 11
Table 4.2: Capital stock per worker of selected countries in 2011 (in $2005
PPP dollars)

Econ 4321: International Trade

19
THE FACTOR-PROPORTIONS THEOREM 12
The Factor-Proportions Theorem
Assume that the U.S. and India have similar tastes or
demand conditions
Given the same relative price of the two goods, the U.S. and India
have similar relative demands for machines and cloth
Assume that both countries have the same technology:
A given amount of capital and labor supply the same output of
either cloth or machines in the two countries
Supply of the factors will be the primary determinant of
factor prices (rent and wages)
The only difference between the countries is in their
production factors: the US has a higher ratio of capital to
labor than India does

Econ 4321: International Trade 20

THE FACTOR-PROPORTIONS THEOREM 13

Before trade
Capital is less expensive in the capital-abundant country –
the U.S.
Labor is less expensive in the labor-abundant country –
India.

The ratio of payment made to labor (wages) and payment

made to capital (rent) is higher in the US than in India.
 Wages in US   Wages in India 
 Rent in US    Rent in India 
   

Econ 4321: International Trade 21

OPPORTUNITY COST OF PRODUCTION
A country will have a lower opportunity cost of production in
goods where the production process requires more abundant
factors.
The U.S. has a lower opportunity cost in producing goods
using more capital and less labor.
The U.S. has a comparative advantage in the production of
machines, as that is capital-intensive, and the US has an
abundance of capital.
India has a lower opportunity cost in producing goods using
more labor and less capital.
India has a comparative advantage in the production of
cloth, as that is labor-intensive, and India has an
abundance of labor.

Econ 4321: International Trade 22

SOURCE OF COMPARATIVE ADVANTAGE
Factor-proportions theorem
A country will have a comparative advantage in goods
whose production intensively uses its relatively
abundant factor of production.
A country will have a comparative disadvantage in
goods whose production intensively uses its relatively
scarce factor of production.

Econ 4321: International Trade 23

THE FACTOR-PROPORTIONS THEOREM
The U.S. imports goods from countries where labor is the
abundant factor
US exports goods that are capital intensive
Gains from trade are realized when a country exports
goods based on its comparative advantage and imports
goods based according to the comparative disadvantage

Econ 4321: International Trade 24

THE FACTOR-PROPORTIONS THEOREM 2
Table 4.3: The factor-proportions theory and US–China trade

Econ 4321: International Trade 25

FACTOR-PRICE EQUALIZATION AND THE
DISTRIBUTION OF INCOME

Moving from autarky to free trade

What happens to the relative size of industries?
What happens to the payments or returns to
factors of production?
What happens to the distribution of income
within the country?

Econ 4321: International Trade 26

FACTOR-PRICE EQUALIZATION AND THE
DISTRIBUTION OF INCOME 2
Factor-Price Equalization
When trade occurs between countries with different
factor proportions, free trade will equalize the price of
the goods and cause the relative factor prices to
converge.
Convergence of factor prices takes place in the long run
In countries that had high wages before trade openness,
the wages are likely to fall after trade
In countries that had low wages before trade openness,
the wages are likely to increase after trade
This will continue until wage equalization is attained
This will also be the case for the rental rates on capital
input
Econ 4321: International Trade 27
 FACTOR-PRICE EQUALIZATION AND THE
DISTRIBUTION OF INCOME 3
Example: US and India
This theorem predicts that some payments to the
factors of production will increase, and others will
decrease with openness to trade.
Example: US and India
Openness to trade causes prices of machines and cloth
to equalize between countries
The size of the machine and cloth industries will
change in each country, changing their industrial
structure (e.g., the percentage of sales by each
industry within a country)
Stolper and Samuelson’s theorem makes this more
evident.
Econ 4321: International Trade 28
 FACTOR-PRICE EQUALIZATION AND THE
DISTRIBUTION OF INCOME 4

The U.S. has a comparative advantage in machines

This causes an increased demand for machines
The price of machines rises relative to the price of cloth
Machine production expands
Cloth production contracts
Increased demand for inputs to make machines

Econ 4321: International Trade 29

 FACTOR-PRICE EQUALIZATION AND THE
DISTRIBUTION OF INCOME 5
The U.S. has a comparative advantage in machines.
An increase in capital is greater than the increase in
labor, as machines are capital-intensive.
Resources shift from cloth to machines
Cloth industry declines
Imports replace much domestic production of cloth
More labor than capital is released on the market
Shortage of capital increases rents
A surplus of labor decreases the wages of lower-skilled
workers
The ratio of wages to rent declines

Econ 4321: International Trade 30

 FACTOR-PRICE EQUALIZATION AND THE
DISTRIBUTION OF INCOME 6
India has a comparative advantage in cloth
Increased demand for cloth
The price of cloth rises relative to the price of machines
Machine production contracts
Cloth production expands
Increased demand for inputs to make cloth

Econ 4321: International Trade 31

 FACTOR-PRICE EQUALIZATION AND THE
DISTRIBUTION OF INCOME 7
India has a comparative advantage in cloth.
An increase in labor is greater than the increase in
capital as the cloth is labor intensive.
Resources shift from machines to cloth
Machine industry declines
Imports replace much domestic production
More capital than labor is released on the market
Shortage of labor increases wages
Surplus of capital decreases rents
The ratio of wages to rent increases

Econ 4321: International Trade 32

 FACTOR-PRICE EQUALIZATION AND THE
DISTRIBUTION OF INCOME 8
Wages
The decline in the U.S.
Increase in India
Overall – Prices get closer to equalization
Rents
Increase in the U.S.
Decrease in India
Overall - Prices get closer to equalization.

Econ 4321: International Trade 33

 FACTOR-PRICE EQUALIZATION AND THE
DISTRIBUTION OF INCOME 9
Trade and the Distribution of Income
Trade produces a convergence of relative prices
Changes in relative prices have substantial effects on the
relative earnings of labor and capital in both countries:
In the U.S., where the relative price of machines rises:
Capital owners are made better off, and workers are
made worse off
In India, where the relative price of machines falls, the
opposite happens:
Capital owners are made worse off, and workers are
made better off

Econ 4321: International Trade 34

 FACTOR-PRICE EQUALIZATION AND THE
DISTRIBUTION OF INCOME 10
Trade and the Distribution of Income
Owners of a country’s abundant factors gain from trade,
but owners of a country’s scarce factors lose.

International trade will reduce the income of the scarce

factor of production and increase the income of the
abundant factor of production within a country.

Econ 4321: International Trade 35

 STOLPER-SAMUELSON THEOREM
Stolper-Samuelson Theorem
International trade will reduce the income of the scarce factor
of production and increase the income of the abundant factor
of production within a country.
So, international trade benefits the abundant factor and hurts
the limited/scarce factor.
The Trade Adjustment Assistance program can be used as a
policy during this process.
Improvements in educational attainment and skill upgrading
are highly important.
Lower-skilled workers in capital/skilled-abundant countries
and capitalists in capital-scarce countries are likely to lobby
their policymakers for policies to limit international trade.
Capitalists/skilled workers in capital/skilled abundant
countries are likely to lobby in favor of freer trade.
Econ 4321: International Trade 36
 THE RYBCZYNSKI THEOREM
The Rybczynski Theorem
If a country encounters an increase in the supply of one factor (e.g.,
capital input, K), it is likely to produce more of the goods/services
whose production process uses that factor of production (e.g., K)
intensively (relative to the other factor of production, such as lower-
skilled labor)
Countries with high investments in physical (new plants, machinery,
equipment, etc.) and human capital (educational attainment and skill
upgrading) are likely to produce and export capital/skill-intensive
goods and services.
Countries with low investments in physical (new plants, machinery,
equipment, etc.) and human capital (educational attainment and skill
upgrading) are likely to produce and export lower-skilled labor-
intensive goods and services.

Econ 4321: International Trade 37

Table Data for South Korea and India

Econ 4321: International Trade 38

 THE SPECIFIC-FACTORS MODEL- FACTORS
MOVEMENT BETWEEN INDUSTRIES

Factor proportions theory assumes that factors can move

between industries
However, adjustments in capital and labor take time
Labor will take time to retrain or gain new skills
Capital will take time to adapt, or may not be adaptable
at all to another industry

With imperfect factor mobility, the gains and losses resulting

from trade to the factors of production need to be modified.

Econ 4321: International Trade 39

 THE SPECIFIC-FACTORS MODEL

Specific Factor
A factor of production that is specific to an
industry or is immobile between industries

Mobile Factor
A factor of production that can move between
industries or is mobile between industries.

Econ 4321: International Trade 40

 THE SPECIFIC-FACTORS MODEL 2
The existence of specific factors helps explain why some
groups are against free trade
Owners of abundant factors are likely to favor free trade
Owners of scarce factors are likely to favor trade
restrictions

Econ 4321: International Trade 41

 EMPIRICAL EVIDENCE ON THE FACTOR-
PROPORTIONS THEORY
Testing the Heckscher-Ohlin Theorem: Leontief’s Paradox
Wassily Leontief implemented the first test of the HO
theorem in 1953 using data for the US from 1947
He constructed the levels of labor and capital used in all
industries
This data is in Table 4.1, which also shows the
capital/labor ratio in dollars per person (Feenstra and
Taylor, 2008)
Leontief found that U.S. exports were less capital-
intensive than US imports, even though the U.S. is the
most capital-abundant country in the world

Econ 4321: International Trade 42

 EMPIRICAL EVIDENCE ON THE FACTOR-
PROPORTIONS THEORY 2
Leontief’s Test

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.

The capital-labor ratio for exports was less than the capital-labor ratio
for imports, which is a paradoxical finding.
Source: Feenstra and Taylor, 2008.

Econ 4321: International Trade 43

 EMPIRICAL EVIDENCE ON THE FACTOR-
PROPORTIONS THEORY 3
Leontief used labor and capital used directly in producing
final goods exports in each industry.
He also measured the labor and capital used indirectly in
the industries that produced the intermediate inputs used
in making exports.
The capital is high because we are measuring the whole
capital stock—not the part actually used to produce exports.
The capital/labor ratio was $14,000; each worker was
working with $14,000 worth of capital.

Econ 4321: International Trade 44

 EMPIRICAL EVIDENCE ON THE FACTOR-
PROPORTIONS THEORY 4
Leontief couldn’t get information on the labor and capital
required to produce imports.
He used data on US technology to calculate estimated
amounts of labor and capital used in imports from abroad.
Remember the H-O model assumes technologies are the
same across countries
This gave a capital/labor ratio of $18,200 per worker
This exceeds the ratio for exports

Econ 4321: International Trade 45

 EMPIRICAL EVIDENCE ON THE FACTOR-
PROPORTIONS THEORY 5
Why would this paradox exist?
The U.S. and foreign technologies are not the same
By focusing only on labor and capital, land abundance in
the U.S. was ignored
Labor differs by levels of human capital
The US exports are not labor-intensive but human
capital-intensive products
The data for 1947 could be unusual due to the recent
end of WWII
The U.S. was not engaged in completely free trade as is
assumed by the HO model

Econ 4321: International Trade 46

EMPIRICAL EVIDENCE ON THE FACTOR-
PROPORTIONS THEORY 6

The US is land abundant, and lots of what it was

exporting might have been agricultural products
that are land intensive.
Much of the export was likely skilled labor intensive.
Some follow-up papers replicated the Leontief test
The results appear to be consistent with the “extended”
H-O model for the same data

Econ 4321: International Trade 47

EMPIRICAL EVIDENCE ON THE FACTOR-
PROPORTIONS THEORY 7
International Trade Not Explained by the Factor-
Proportions Theory
Natural Resources
Diamonds, Oil, Gold, Climate
Intra-Industry Trade
Importing and Exporting similar but differentiated
goods
Computers, Automobiles, Steel

Econ 4321: International Trade 48

EFFECTS OF TRADE ON FACTOR PRICES
The association between the changes in prices of products
and the changes in factor prices is called the “magnification
effect.”
How changes in the prices of goods magnify the changes
in the earnings of factors
The fluctuations in the relative prices of goods on world
markets can lead to exaggerated changes in the long-
run earnings of both factors, as discussed earlier.

This explains why some oppose trade and others support

it.

Econ 4321: International Trade 49

 OPINIONS TOWARD FREE TRADE
A survey was organized in the U.S. by the National Election
Studies (NES) in 1992 to see how different groups of people
viewed trade (Feenstra and Taylor, 2008)
The answer could be:
I do not support free trade,
Or I support free trade
The education level, Wages, or the industries the
individuals work in
Workers in exporting industries support free trade, and
those in import-competing industries are against free
trade

Econ 4321: International Trade 50

 OPINIONS TOWARD FREE TRADE 2

In the short run, the industry of employment of workers will

affect their attitudes toward free trade.

Econ 4321: International Trade 51

 OPINIONS TOWARD FREE TRADE 3
In the short run, the industry in which workers are
employed will influence their perspective on free trade.
In the long run, the HO model suggests that the industry of
employment should not be as important.
The skill level of the workforce likely determines their
view about free trade in the long run.
In the NES survey, the industry in which workers work was
relevant to their view towards free trade, but the skill level
was a lot more important.
Workers in exporting industries supported free trade,
and those in import-competing industries were against
free trade.

Econ 4321: International Trade 52

 OPINIONS TOWARD FREE TRADE 4
The skill level of workers, which is proxied by wages or
years of education
Workers with lower wages or less education are more
likely to favor import restrictions.
Those with higher wages and more schooling favor free
trade
This hints that workers consider the long-run earnings as
predicted by H-O and Stolper-Samuelson theory

Econ 4321: International Trade 53

 OPINIONS TOWARD FREE TRADE 5
Those who owned homes in regions where the
domestic industries faced severe import
competition were much more likely to be against
free trade.
People who owned homes in a place where the
industries gained from exports were more likely to
support free trade

Econ 4321: International Trade 54

 SOURCES
Sources
Robert C. Feenstra and Alan M. Taylor, International Trade,
1st edition, 2008.
W. Charles Sawyer and Richard L. Sprinkle, International
Economics, 2nd edition, 2006.
R. Glenn Hubbard and Anthony P. O'Brien,
Microeconomics,1st edition, 2006.
C. W. L. Hill, Global Business Today, 3rd edition, 2004.
P. R. Krugman and M. Obstfeld, International Economics:
Theory &Policy, 7th edition, 2006.
ECON 5321 Lecture Notes, 2009, UTA.

Econ 4321: International Trade 55