CHAPTER FOU

An Introduction to
International Economics
Second Edition

The Heckscher-Ohlin
and Other Trade
Theories

Dominick Salvatore
John Wiley & Sons, Inc.
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Theories of international
trade
 The previous chapter provided a
framework within which international
trade occurs.
 This chapter extends this analysis in
three ways:
 The cause of comparative advantage is
considered.
 The implications for factors returns are
considered.
 Models beyond the standard model of
international trade are considered.
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Theories of international
trade
 The theories that will be considered are:
 The Heckscher-Ohlin model of trade
 An economy of scale model of trade
 A product differentiation model of trade
 A product cycle model of trade
 A transportation cost model of trade
 An environmental standards model of
trade
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The Heckscher-Ohlin theory
 The Heckscher-Ohlin (H-O) theory is
based on two subsidiary theorems:
 The H-O theorem

A nation will export the commodity whose
production requires the intensive use of the
nation’s relatively abundant (and therefore,
cheap) factor and import the commodity whose
production requires the intensive use of the
nation’s relatively scarce (and therefore,
expensive) factor.

In other words, relative factor abundance drives
comparative advantage and the pattern of
trade.
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The Heckscher-Ohlin theory
 The Heckscher-Ohlin (H-O) theory is
based on two subsidiary theorems:
 The H-O theorem
 The factor price equalization theorem

International trade will bring about equalization
in the relative and absolute returns to
homogenous factors across nations.

In other words, wages and other factor returns
will be the same after specialization and trade
has occurred.

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Demonstrating the H-O
theorem
 Suppose there are two countries with
identical technology and societal
preferences.
 The nations differ in that one is
relatively labor abundant while the
other is relatively capital abundant.
 Factor abundance is determined by the
ratio of capital (K) to labor (L) available in
the countries.
 The country with the greater K/L ratio is
defined as being capital abundant.
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H.O. THEORY: FACTOR
ENDOWMENT

U.S.: capital/labor ratio = 0.5 (100/200)

Since the U.S. is capital abundants, the U.S.

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Demonstrating the H-O
theorem
 Under these assumptions, the PPFs
indicated on the next slide will show
the relative productive potential of
the trading nations if Nation 1 is
labor abundant and Nation 2 is
capital abundant while commodity Y
is labor intensive while commodity
X is capital intensive.

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Demonstrating the H-O
theorem
Y Nation 1 Y Nation 2

X X

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Demonstrating the H-O
theorem
 For ease of Y
presentation, the
two PPFs may be
overlaid in one
diagram.
 Under the
assumption of
identical societal
preferences, this
yeilds a possible
community X
indifference with the
indicated shape.
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Demonstrating the H-O
theorem
 This combination of Y
PPFs and community
indifference curves
establishes a higher
opportunity cost for
Nation 1 in the
production of X.
 Using the logic of
the standard model
of trade this shows
that Nation1 will
specialize in the X
production of and
export Y.
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Factor price equalization
 In the H-O model of trade, the
pattern of trade is driven by relative
factor abundance.
 Labor abundant countries export goods
that are labor intensive in their
production.
 Capital abundant countries export
goods that are capital intensive in their
production.

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Factor price equalization
 Exported commodities experience
an increase in their price relative to
the autarky situation.

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Factor price equalization
 Exported commodities experience an
increase in their price relative to the
autarky situation.
 The Stolper-Samuelson theorem
demonstrates that an increase in
the relative price of a commodity
raises the return of the factor used
intensively in its production.
 At the same time, the return of the
relatively scarce factor will fall.
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Factor price equalization
 Exported commodities experience an increase
in their price relative to the autarky situation.
 The Stolper-Samuelson theorem demonstrates
that an increase in the relative price of a
commodity raises the return of the factor used
intensively in its production.
 Thus, the labor abundant country will see
an increase in wages, but a fall in the
return to capital while the capital
abundant country will experience the
opposite pattern of change.
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FACTOR PRICE EQUALISATION
CONCLUSION:
 By redirecting demand away from the
scarce resource to the abundant
resource in each nation trade leads
to
FACTOR PRICE EQUALISATION
In each Nation the cheap
relatively abundant resource
becomes more expensive and the
relatively scarce and expensive
resource becomes cheaper.

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Implications of FPE
 Developed nations are expected to
be capital abundant.
 Therefore, following the opening of
trade the return to capital in the
developed countries is expected to
increase and wages are expected to fall.
 This pattern of change should worsen
inequality in the developed countries.

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Implications of FPE
 Developed nations are expected to be
capital abundant.
 The change in inequality should be
the opposite for the developing (and
labor abundant) countries.

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Implications of FPE
 Developed nations are expected to be
capital abundant.
 The change in inequality should be the
opposite for the developing (and labor
abundant) countries.
 The conclusion of worsened inequality
in the developed world holds only if:
 The assumptions of the H-O theory holds.
 As will be seen, this may not be the case.
 The Stolper-Samuelson theorem is the only
force driving changes in inequality.
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Empirical tests of the
H-O theory
 The Leontief Paradox
 A 1951 test of the H-O theory
 Showed that the pattern of trade did
not fit the conclusions of the H-O
theorem.
 Imports in the U.S. were capital intensive
when they should have been labor
intensive.

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Empirical tests of the
H-O theory
 The Leontief Paradox
 Is the paradox real?
 The test assumed a two factor world
which required assumptions about
what is capital and what is labor.
 The test assumed consistent
technology between nations.
 However, technology varies so this
assumption may have biased the test.

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Empirical tests of the
H-O theory
 The Leontief Paradox
 Is the paradox real?
 The test assumed a two factor world which
required assumptions about what is capital
and what is labor.
 The test assumed consistent technology
between nations.
 The test assumes perfect mobility
between factors of production.
 In practice, some factors of production are specific to
sectors of the economy.
 Sector specific factors alter the predictions of the H-
O theory and require a different testing procedure.
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Empirical tests of the
H-O theory
 The Leontief Paradox
 Is the paradox real?
 More current tests of the H-O
theory are built on multiple factor
(including sector specific factors)
models that extend the basic H-O
framework. These show good
predictive ability.

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An economy of scale model of
trade
 Some productive relationships are
characterized by increasing returns
to scale.
 A production situation where output
grows proportionally more than the
increase in inputs to the productive
process.
 A doubling of inputs more than doubles
outputs.

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An economy of scale model of
trade
 Some productive relationships are
characterized by increasing returns to
scale.
 In this situation, production on a
larger scale lowers per unit costs of
production and provides a new
source of cost advantage on which
to base exports.

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Product differentiation based
trade
 Differentiated products
 Similar products produced by different
manufacturers in the same industry or
general trade group.
 Toyota and Ford automobiles are
differentiated products

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Product differentiation based
trade
 Differentiated products
 Intra-industry trade may arise from
product differentiation.
 Intra-industry trade is international
trade in differentiated products.

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Product differentiation based
trade
 Differentiated products
 Intra-industry trade may arise from
product differentiation.
 Reasons for intra-industry trade
 Allows producers to exploit product
specific economies of scale.
 Allows consumers to benefit from
product variety that would not exist
without international trade.

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The product cycle model of
trade
 Advanced industrialized countries
develop and introduce new products
 While only one country possess the
product, it possesses international
monopoly power and will be the sole
exporter of the product.

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The product cycle model of
trade
 Advanced industrialized countries
develop and introduce new products
 As the technology producing the
product becomes more widespread,
production will spread to other
nations.
 This moves international trade to a
standard comparative advantage
framework.

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The product cycle model of
trade
 Advanced industrialized countries develop
and introduce new products
 As the technology producing the product
becomes more widespread, production will
spread to other nations.
 As production becomes standardized,
the original introducer of the product
loses its technologically based
comparative advantage in the
production of the product and becomes
an importer of the product.
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Examples of product cycles
 Television
 The Television History WWW site
provides a nice discussion of the
history of television. A look at the
manufacturers of televisions
provides a good example of the
product cycle model.

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Transportation cost models of
trade
 Transportation costs
 Transportation costs are the freight
charges, warehousing costs, costs of
loading and unloading, insurance
premiums, and interest charges
incurred while goods are in transit
between nations.

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Transportation cost models of
trade
 Transportation costs
 The introduction of transportation
costs into the standard model of
trade may eliminate a country’s
comparative advantage in the
production of an item.
 High enough costs may result in an item
not being able to be traded.
 Highly perishable food products may suffer
this fate.
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Transportation cost models of
trade
 Transportation costs may provide
an advantage for trade between
geographically close countries.
 This serves as partial explanation for
why Canada and Mexico are the two
largest trading partners of the US.

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Environmental standards and
trade
 A nation’s environmental standards
determine the level of acceptable
pollution that may be generated
from production.

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Environmental standards and
trade
 A nation’s environmental standards
determine the level of acceptable
pollution that may be generated from
production.
 Strict environmental standards are
expected to raise the costs of
production.
 These increased costs may reduce (or
remove) a country’s comparative
advantage in production and alter the
pattern of trade.
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Environmental standards and
trade
 A nation’s environmental standards
determine the level of acceptable
pollution that may be generated from
production.
 Strict environmental standards are
expected to raise the costs of production.
 In order to maintain comparative
advantage, a nation may reduce its
environmental protections.
 This may spur a “race to the bottom.”
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Environmental standards and
trade
 This concern has spurred calls for
inclusion of environmental
legislation along with agreements
to lower barriers to trade.
 For instance, the environmental rider
attached to the NAFTA.

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