Hecksher-Ohlin model

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Basic description of the Hecksher-Ohlin model, its assumptions and theorems.

Basic description of the Hecksher-Ohlin model, its assumptions and theorems.

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  • 1. Hecksher-Ohlintrade modeljhuato.sfc@gmail.com
  • 2. Goals Understand the setup of the Hecksher- Ohlin model of trade, in which trade is based on differences in productive factor (input) endowments Understand the main theorems that result from the Hecksher-Ohlin model of trade, and apply the insights in the analysis of real-world cases
  • 3. Hecksher-Ohlin model There are two countries (H and F), two factors of production (labor [L] and capital [K]), and two goods (corn [C] and steel [S]) The K/L ratio for H is higher than for F, i.e. H is capital- abundant or labor-scarce, F is capital-scarce or labor- abundant Same technology is available in H and F, there are constant returns to scale in production, and C technology is labor- intensive while S-technology is capital-intensive K and L move freely within each country, but not across countries There is perfect competition within each country and, with trade, the price of a good is the same in both countries Demand patterns (preferences) are identical in both countries
  • 4. Theorems derived from theHecksher-Ohlin model1. Hecksher-Ohlin theorem2. Stolper-Samuelson theorem3. Factor-price equalization theorem4. Rybczynski theorem
  • 5. Hecksher-Ohlin theoremWith trade, the country with the higher K/Lratio (e.g. H, which is K-abundant) willexport the good that is intensive in the useof K (e.g. Steel) and import the good that isintensive in the use of L (e.g. corn). Thepattern of trade of the other country will bethe converse.
  • 6. Hecksher-Ohlin theorem
  • 7. Stolper-Samuelson theoremIn each country, trade will increase the realreturn of the abundant factor of productionand decrease the real return of the scarcefactor of production.E.g. for H, where K is abundant and L isscarce, trade will increase r/P and decreasew/P, where r is the return on K (or “profitrate”), w is the return on L (or wage rate), and Pis the price level.
  • 8. Stolper-Samuelson theoremAt H, let MCS = a r + b w and MCC = c r + d w, where a, b, c, and dare given physical input/output ratios. Under competition, P=MC:PS = a r + b w (1) and PC = c r + d w (2).Suppose that, due to trade, PS goes up and PC goes down. Sincesteel uses K intensively compared to L and its output willexpand, then r will go up. If r increases and PC decreases, then by(2) w must fall more than proportionally.Also, since corn uses L intensively compared to K and its outputshrinks, then w will go down. If w decreases and PS increases, thenby (1) r must increase more than proportionally.In other words, a shift in the output mix towards more steel and lesscorn will have a magnified effect on r and w compared to PS andPC. Therefore, r/P will go up and w/P will go down, where P is aweighted average of PS and PC.
  • 9. FPE theorem Compared to autarky, at H, the price of steel increases and the price of corn drops, which makes r go up and w go down (S-S theorem) Compared to autarky, at F, the price of steel decreases and the price of corn increases, which makes r* go down and w* go up (S-S theorem) This process continues to operate until the prices of corn and steel are equalized in both countries, which leads to r=r* and w=w* Little empirical evidence supporting the notion of total equalization of factor prices
  • 10. Final points All is required for trade is CA. As long as the MRTs are not equal, the countries have a basis for trading. With equal MRTs, the basis for trade cannot be technology, i.e. resource requirement differences. (They may still trade on the basis of preference differences.) Without full employment, the model does not hold any longer as the MRTs are undefined. It highlights an important source of trade. Empirically: economists need to go and measure the effect of these difference in technology (MRTs) on observable trade. Results are mixed.
  • 11. Rybczynski theorem Ifthe relative endowment of productive factors changes in a country, the output of the good intensive in the (relatively) expanding factor will increase more than proportionally E.g. if there is an increase in the immigration of L to H (other things equal), then the production of corn will expand faster than L itself