Post Heckscher Ohlin Theories

POST HECKSCHER-OHLIN THEORIES
EMPIRICAL EVALUATION OF HECKSCHER-OHLIN THEORIES
Prasad S
Assistant Professor
Department of Economics
Sree Sankara College Kalad
Ernakulam – Kerala

THE FACTOR ENDOWMENT THEORY
 The classical comparative cost theory maintained that the comparative cost advantage
of trading nations was based on differences in labor productivity, but they failed to
provide satisfactory explanation for such differences.
 The theory for analyzing the pattern of international trade developed by Swedish
economists Eli Heckscher (1919) and Bertil Ohlin (1933) attempted to deal with this
question.
 This theory did not supplant the comparative cost theory but supported it by providing
explanation for the relative commodity price differences between the countries and
their respective comparative advantages.

HECKSCHER-OHLIN THEORY – THE FACTOR ENDOWMENTTHEORY
 Heckscher-Ohlin Theory addressed two questions left largely unexplained by Ricardo:
 What determines comparative advantage?
 What effect does international trade have on the earnings of various factors of production in
trading nations?
 Because Heckcher Ohlin maintained that factor (resource) endowments underlie a
nation’s comparative advantage, their theory become known as the Factor
Endowment Theory. It is also known as Heckscher-Ohlin Theory.

HECKSCHER-OHLIN THEORY
 The Heckscher-Ohlin theory focuses on the differences in the relative
abundance of factors of production in various nations as the most important
determinant of the difference in relative commodity prices and comparative
advantage.
 Heckscher –Ohlin Theory is based on factor intensity and factor abundance.
 the H-O theorem postulates that the differences in relative factor abundance
and relative factor prices is the cause of the pre trade commodity prices
between two nations.

H-O THEOREM
 If country I is 𝐾-abundant and good 𝑋 is 𝐾-intensive, then HO theorem predicts that
country I will export good 𝑋 (𝐾-intensive) and import good 𝑌 (𝐿-intensive) while
country II will import good 𝑋 and export good 𝑌.
 Capital-Labour Ratio
𝐾
𝐿
of the exported goods must be greater than the Capital-
Labour Ratio
𝐾
𝐿
the imported goods
𝐾
𝐿
𝑒𝑥𝑝𝑜𝑟𝑡𝑠
>
𝐾
𝐿
𝑖𝑚𝑝𝑜𝑟𝑡𝑠
→
𝐾
𝐿
𝐾
𝐿
𝑒𝑥𝑝𝑜𝑟𝑡𝑠 < 1

EMPIRICAL EVALUATION OF H-OTHEORY
 The first empirical test of the Heckscher-Ohlin model was conducted by W.W. Leontief in
1953 using U.S. data for the year 1947.
 It has been widely recognised that in the United States capital was relatively abundant and
labour was relatively scarce.
 According to the Heckscher –Ohlin theory, the United State should export capital-intensive
goods and its import-competing goods should be labour intensive.
 In a 1953 article by Leontief showed, using input-output analysis, that U.S. exports were
relatively labor-intensive compared to U.S. imports.
 This was the opposite of what the H-O model predicted, given the high level of U.S. wages
and the relatively high amount of capital per worker in the United States. Leontief’s
discovery was termed the Leontief Paradox.

LEONTIEF’S FIRSTTEST -1947 DATA
Capital Requirement Labor Requirement
Exports Kx = 2550780 Lx=182.313 man-years
Imports Km = 3091339 Lm=170.114 man-years
𝐾
𝐿
= $14300
𝐾
𝐿
= $18200
𝐾
𝐿
𝐾
𝐿
𝑒𝑥𝑝𝑜𝑟𝑡𝑠 = 𝟏. 𝟑𝟎 (𝐊/𝐋) 𝒆𝒙𝒑𝒐𝒓𝒕𝒔
The results obtained was contrary to the prediction of the H-O theorem The US is believed to be
endowed with more capital per worker than any other country in the world in 1947. Thus, the H-O
theory predicts that the US exports would have required more capital per worker than US imports.
However, Leontief was surprised to discover that US imports were 30% more capital-intensive than US
exports

LEONTIEF’S SECONDTEST -1951 DATA
Capital Requirement Labor Requirement
Exports Kx = 2256800 Lx=174 man-years
Imports Km = 2303400 Lm=168 man-years
𝐾
𝐿
= $12970
𝐾
𝐿
= $13711
𝐾
𝐿
𝐾
𝐿
𝑒𝑥𝑝𝑜𝑟𝑡𝑠 = 𝟏. 𝟎𝟓𝟕 (𝐊/𝐋) 𝒆𝒙𝒑𝒐𝒓𝒕𝒔
In 1956 Leontief repeated the test for US imports and exports which prevailed in 1951.
In his second study, Leontief aggregated industries into 192 industries. He found that
US imports were still more capital-intensive than US exports. US imports were 5.7%
more capital-intensive. The degree had been reduced but the paradoxical conclusion
remained.

EXPLANATIONS FOR THE LEONTIEF PARADOX
Demand Reversal
 There is a possibility that the countries demand more of their abundant-factor-
intensive goods than they produce.This is called demand reversal. In the presence of
demand reversal, trade does not follow the H-O pattern
Factor Intensity Reversal
 FIR occurs when a good is produced in one country by relatively K-intensive
methods but is produced in another country by relatively labour intensive methods.
Therefore, there is a possibility that the trading partner (L-abundant country) would
conform to HO by exporting L-intensive good (which is produced with K-intensive
method in the US).

USTariff Structure
 H-O and Stolper Samuelson theorem suggest that the opening of a country to trade
increases the real return of the abundant factor and reduces the real return of the
scarce factor. Being a labour scarce country, the US may experience decline in the
wage rate Labourers will argue for restricting imports of labour intensive
products imports of relatively capital intensive goods.
Different Skill Level (Human Capital)
 Leontief considered only physical capital and ignored human capital. Skill level of the
workers are different. US is not only K- abundant but also skilled labor abundant.This
fact is completely ignored by Leontief.

Natural Resources
 Two factor test is too restrictive. In the context of Leontief Paradox, many
goods labeled as K-intensive might actually be natural resource intensive. For
example, petroleum uses a great deal of natural resources in addition of
capital.
Ignores the Possibliity of Intra IndustryTrade (IIT)
 Intra-industry trade occurs when a country exports and imports goods within
the same industry or product group such as exporting automobile and
importing automobile.

TECHNOLOGY GAP
In an economy firms have several alternatives for obtaining technology, which yield a
higher level of TFP (total factor productivity) for any given of capital-labour ratio
These alternative include
 purchase of new equipments
 foreign direct investment (FDI)
 purchase of technology licenses for domestic production
 use of non-proprietary including that obtained from purchasers of export
 acquisition of knowledge from returning nationals who have been educated or have
worded in industrial countries and from national who remain in industrial countries
 domestic research and development (R&D) and efforts in reverse engineering.

TECHNOLOGY GAP
 There is a wide gap between those who have access to technology and use it effectively and those who do
not.
 The technology gap exists between those who can create and innovate to produce new technologies and
those who cannot.
 It also exists between those who can access, adapt, master and use existing technologies and those who
cannot.
 Exploiting the potential of technology for development goes beyond creating new technologies but also
finding ways to access, adapt and use technology that already exists for the benefit of all the population is
important
 Now technology gap is considered as serious development problem of less developed countries.
 The ability of countries to acquire, master, adapt and improve upon scientific and technical knowledge is a
major determinant of their capacity to achieve sustainable economic growth.
 A key area where the technology gap exists is in research and development (R&D).
 R&D capability is essential to develop access, absorb and master new technologies.
 Low levels of R&D reinforce the existing technology gap making it harder for countries or companies to
compete.

TECHNOLOGY GAP
Important themes to bridge the technology gap
 Human capital and skills
 Infrastructure
 Private sector development and clusters
 International partnerships

TECHNOLOGY GAP THEORY – IMITATION LAG HYPOTHESIS
 The technology gap theory describes an advantage enjoyed by the
country that introduces new goods in a market.
 As a consequence of research and development activity and
entrepreneurship, new goods are produced and the innovating country
enjoys a monopoly until the other countries learn to produce these
goods: in the meantime they have to import them.
 international trade is created for the time necessary to imitate the new
goods (imitation lag).

THE IMITATION LAG HYPOTHESIS
 The theory was introduced by Michael V. Posner in 1961
 It relaxes the assumption of H-O model that the same technology
is used everywhere.
 It assumes that the same technology is not always available in all
countries
 But there is a possibility to have a delay in the diffusion of
technology from one country to another

The imitation lag has several components, that Posner (1961) classifies (from the point
of view of the importing country) in the following categories:
 foreign reaction lag.This is the time between the successful utilisation of the
innovation by entrepreneurs in the innovating country and the new goods becoming
regarded, by some firms in the importing country, as a likely competitor for their
products.
 domestic reaction lag, which is the time required for all firms in the importing country
to become aware of the competition from the new good.
 learning period, which is the time required for the importing country's firms to learn
to produce the new good, and actually produce and begin selling it on the domestic
market.

 Suppose that country I develops a new product due to the successful effort of R&D
 The new product will not be produced immediately by firms in country II because of
imitation lag
 The imitation lag is defined as the length of time (say, 15 months) that elapses
between the product’s introduction in country I and the appearance of its version
produced by firms in country II
 The imitation lag includes a learning period, time to purchase inputs, install
equipment, process the inputs, bring the finished product to market and so on.
 The country II must acquire technology and know-how in order to produce the
product

 Subsequently, a second adjustment lag will also be there, known as demand lag
 Demand lag is the length of time between the product’s appearance in country I and its
acceptance by consumers in country II as a good substitute for the product they are already
consuming.
 This lag may be due to loyalty to existing consumption bundle, inertia, and delays in
information flows.
 Posner compares the length of imitation lag and the length of the demand lag.
 The net lag is 11 month (15 months of imitation lag and 4 months of demand lag
 During this 11-month period, country I will export the product to country II.
 Before this period, country II has no real demand for this good
 After this period, firms in country II are also producing and supplying that product, implying
that demand for country I’s product diminishes
 The theory explains about the possibility of Technology Gap between countries

THE PRODUCT CYCLE THEORY
 This theory was developed in 1966 by RaymondVernon
 One of the purposes of this theory is to explain Leontief’s paradox.
 It builds on the imitation lag hypothesis in its treatment of delay in the diffusion of
technology.
 This theory is concerned about the life-cycle of a typical ‘new product’ and its impact on the
international trade.
 Vernon argues that reasons for foreign trade are technological advantages, which are
embodied in innovations
 The access to the core technologies is limited, innovations are spreading gradually and
differently across countries from country, that is from the innovator country to country
imitator (receiving country).

 One of the reasons for this is that countries differ in the levels of economic development
and technology.
 Vernon’s theory assume time as a factor of gradual evolution
 of product (from innovation, growth, maturity to decline);
 markets (from country innovator to country imitator) and
 production process (from complexity to standardisation).
 Dynamics of technology transfer depend also on the strategy of a particular firm innovator.
 Some firms prefer expansion by technology licensing others through foreign direct
investment as the most appropriate and safest solution for securing the technology and to
prolong the rent from the exclusivity of ownership.

According to product life cycle theory, production
is being moved from the country innovator to
country imitator at the product’s maturity stage.
 The New-Product Stage
 The Maturing-Product Stage
 The Standardized-Product Stage

THE NEW PRODUCT STAGE
In the first stage of product development the production process is being conducted in the country of
innovator (because of specifics of supply of production factors and the character of local market demand).
 A new product is developed in the developed country (DC) – The US
 Firms produce in the US because that is where the demand is located (high income people).
 Nature of production process and the product itself change its nature because the firms
seek to familiarize with the product and the market – no standardization of product.
 Production is other DCs is nearly zero.
 There may be a few demand in the other DCs, but insignificant.
 No international trade.

THE MATURING-PRODUCT STAGE
In the second stage, together with diffusion of products, some export activities are established
to middle developed countries.
 Some standardisation and mass production start taking place.
 Possibility of economies of scale (as opposed to CRS in earlier trade theories)
 Increase in the demand form other DCs (high income countries) → export from US to
other DCs.
 Firms may begin to explore the possibility of producing in other DCs (cost reduction).They
would do so if the cost of producing at home plus the transportation cost exceeds the
production cost abroad → technology transfer through FDI.
 Export displacement of US produced output occurs. (If an US firm sets up a plant in France,
that facility may be used to export the good not only in France but also neighboring
countries).

THE MATURING-PRODUCT STAGE
 Thus, initial increase in US export is followed by its decline and a likely decline in US
production of that good as well.This relocation of production recognizes the
movement of factors (K and management) internationally (as opposed to earlier
trade theories where factors of production were immobile internationally).
 K being more mobile than L → equalization of price of capital across countries →
difference of product prices comes from the difference in its labor cost → with
lower labor cost in Europe (not true anymore), Europe might undersell US → US
may start importing this good.
 Relative factor endowment and relative factor prices, which played a significant part
in H-O model, have been completely ignored in the PCT.

THE STANDARDIZED-PRODUCT STAGE
In the third stage full technology diffusion takes place. Production process simplifies when the
innovator fails to resist its oligopolistic position.
This often leads to move production to foreign countries in order to find relative cheaper production
factors, to ensure better service of foreign markets and to internalise possessed technology.
 Product is highly standardised.
 Many producers in the world.
 Widespread technology and mass production.
 Increase in the importance of the cost of labor in deciding the competitiveness of the
product.
 Production may shift to developing countries.
 US and the other DCs might import the product from developing countries.

THE PRODUCT CYCLE HYPOTHESIS
This theory was developed partly to explain
the Leontief paradox: the US exports the new
product (may be labor intensive) and imports
standardized products (may be capital-
intensive).
Technical progress is the key factor in
economic development and decreasing the
technology gap between countries.
The intensity of technology transfer depends
mainly on innovation potential of a receiving
country.
The more advanced it is the more
complicated the transfer will be.
The level of economic development is one of
the main factors determining the intensity of
technology transfer.

EMPIRICAL EVALUATION OF PCT
 There is no single all-encompassing test for the PCT. However, new product development (which is critical
to PCT) is often the result of R&D expenditure.
 Therefore, there should be positive correlation between R&D expenditure and the successful export
performance.
 Kravis and Lipsey (1992), found that high R&D intensity was positively associated with large share of
exports by US MNCs. Furthermore, greater shares of exports from US MNCs have come from overseas
production, which is consistent with the direct investment and export displacement feature of the PCT.
 Hufbauer (1966) found that the US and other DCs tended to export new products while the developing
countries tended to export older products
 Gruber, Mehta andVernon (1967) discovered that research-intensive US industries have high propensity to
invest abroad (conformation with maturing-stage of PCT).
 In 1979,Vernon suggested to modify his PCT theory to include the possibility of a new product being
developed by other countries because of the presence of subsidiaries of large MNCs in other countries.

THE LINDER THEORY
 This theory was proposed by S. B. Linder in 1961.
 This theory drastically departs from the H-O model because it is almost exclusively
demand oriented.
 The H-O approach was primarily supply oriented.
 Linder theory focuses on the manufactured goods
 The tastes of consumers are determined by their income levels.
 The pattern of tastes will determine the demand for the manufactured products.
 The demand will generate a production response of that country
 So the production pattern of country would reflect the income levels

THE LINDER THEORY
 The kind of goods produced in a country reflect the per capita income level of that country.
 International trade in manufactured good will be more intense between countries with similar income levels than
between countries with dissimilar income levels
 Which goods will be traded?
 What will be trade pattern?
 3 countries (I, II and III: I being the poorest and III being the richest).
 9 goods (A-I) ranked in terms of quality or sophistication (A is of the lowest quality).
 Country I demands for A-E, country II for C-G, and country III for E-I.
 Each country will produce only those goods for which demand exists within the country.
Trade will occur in goods that have overlapping demand.

THE LINDER THEORY
 3 countries (I, II and III: I being the poorest and III being the richest).
 9 goods (A-I) ranked in terms of quality or sophistication (A is of the lowest quality).
 Country I demands for A-E, country II for C-G, and country III for E-I.
 Each country will produce only those goods for which demand exists within the country.

THE LINDER THEORY
 x: goods for which there are demand in that country and only these will be
produced under autarky.
 Good C, D and E will be traded between country I and II; good E, F and G will
be traded between country II and III; and good E will be traded between I and
III.

THE LINDER THEORY – IMPLICATIONS
 Implication: international trade in manufactured goods will be more intense between
countries with similar per capita income levels than between countries with
dissimilar per capital income levels.
 Though Linder’s theory identifies which good will be traded and which one will not,
it does not identify the direction of the trade flows.
 Linder, however, said that a good might be sent in both directions – exported and
imported by the same country.This kind of trade can happen if the products are
differentiated. For example, in the car market, US exports Ford to Japan and imports
Honda from there.This type of trade is called ‘Intra-IndustryTrade (IIT).

 The availability approach to the theory of international trade seeks to
explain the pattern of trade in terms of domestic availability and non
availability of goods.
 Availability influences trade through both demand and supply forces.
 Availability approach states that a nation would tend to import those
commodities which are not readily available domestically and export
those whose domestic supply can be easily expanded beyond the
quantity needed to satisfy the domestic demand.
AVAILABILITY APPROACH AND NON AVAILABILITY APPROACH

 According to Irving B Kravis, Leontief’s paradox can be very well explained with the
help of availability factor.
 Goods that happen to have high capital content are being bought abroad because
they are not available at home.
 This unavailability may be due to lack of natural resources (oil, gold, etc.: this is
absolute unavailability) or to the fact that the goods cannot be produced domestically
 Sometimes, certain products could only be produced at prohibitive costs (for
technological or other reasons)
 The country exports the goods that are available at home
 This is relative availability and relative unavailability

 According to Kravis, there are four bases of the availability factor, namely
natural resources, technological progress, product differentiation and
government policy.
 The presence or absence of natural resources could easily be fitted into
the Heckscher-Ohlin model that stresses the differences in relative
endowments.
 A generalised version of the model can be used by adding an additional
factor termed as natural resources.

In the case of relative availability there are two reasons
 Technical Progress
 Kravis observes that the stimulus to exports provided by technological change is not just confined to the reduction costs but
also includes the advantages deriving form the possession of completely new products and of the most recent
improvements of existing types of goods.
 In such cases the operation of the demonstration effect of Duesenberry (1949) creates an almost instantaneous demand
abroad for the products of the innovating country and thus generates international trade.
 Product Differentiation
 The idea of Kravis is to extend to international trade as a result of monopolistic competition.
 Product differentiation creates demand for specific commodities from the foreign countries.
 This creates monopolistic power for the certain products and also it may create consumers' demand for foreign
commodities from a different dimension that they believe foreign commodities are different from similar domestic
commodities, the result being to create international trade.

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