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Chapter 5

The document discusses the Heckscher-Ohlin theory of international trade. It explains the theory's assumptions and key concepts including factor intensity, factor abundance, and the shape of production frontiers. It also discusses how factor endowments relate to patterns of trade and the equalization of factor prices between countries.

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Hoa Nguyễn
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22 views

Chapter 5

The document discusses the Heckscher-Ohlin theory of international trade. It explains the theory's assumptions and key concepts including factor intensity, factor abundance, and the shape of production frontiers. It also discusses how factor endowments relate to patterns of trade and the equalization of factor prices between countries.

Uploaded by

Hoa Nguyễn
Copyright
© © All Rights Reserved
Available Formats
Download as PDF, TXT or read online on Scribd
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International Economics

Assoc. Prof. Dr. Ngo Thi Tuyet Mai


Senior Lecturer, Department of International Economics
Email: [email protected]
CHAPTER FIVE

5 Factor Endowments
and the H-O Theory

Dominick Salvatore (2016), International Economics, 12th edition, John Wiley & Sons, Inc.
H-O theory
Learning goals: After reading this chapter, you
should be able to:
 Explain how comparative advantage is based on
differences in factor endowments across nations
 Explain how trade affects relative factor prices
within and across nations
 Explain why trade is likely to be only a small
reason for higher skilled-unskilled wage
inequalities
Content
 Introduction
 Assumptions of the H-O theory
 Factor Intensity, Factor Abundance, and the
Shape of the Production Frontier
 Factor Endowments and the H-O Theory
 Factor-Price Equalization and Income
Distribution
 Empirical Tests of the H-O Model
The H-O (Factor Endowments or
Factor Proportions) Theory

Developed by Eli Heckscher

Expanded by Bertil Ohlin


Assumptions of the Theory

 Heckscher-Ohlin theory based on following


assumptions:
1. Two nations, two commodities (X and Y),
two factors of production (L and K)
2. Technology in production same in both
nations
3. Commodity X is labor intensive, commodity
Y is capital intensive in both nations
Assumptions of the Theory

 Heckscher-Ohlin theory based on following


assumptions:

4. Constant returns to scale for X and Y in both


nations
5. Incomplete specialization in production in
both nations
6. Tastes are equal in both nations
Assumptions of the Theory

 Heckscher-Ohlin theory based on following


assumptions:
7. Both commodities and factors are traded
in perfectly competitive markets
8. Perfect factor mobility within each nation,
but not between nations
9. No transportation costs, tariffs or other
barriers to free trade.

=> What does making assumptions mean?


Assumptions of the Theory

 Heckscher-Ohlin theory based on following


assumptions:
10. All resources are fully employed in both
nations
11. International trade between the nations is
balanced.

> What does making assumptions mean?


Factor Intensity, Factor Abundance, and the
Shape of the Production Frontier

 Factor Intensity
 In a two-commodity, two factor world:
 Y is capital intensive commodity if the capital-labor
ratio (K/L) used in the production of Y is greater than
K/L used in the production of X.
 X is labor intensive commodity if the capital-labor ratio
(K/L) used in the production of X is less than K/L used in
the production of Y.
 It is not the absolute amount of capital and labor
used in production of X and Y, but the amount of
capital per unit of labor that determines capital
intensity.
FIGURE 5-1 Factor Intensities for Commodities X and Y
in Nations 1 and 2.
Factor Intensity, Factor Abundance, and the
Shape of the Production Frontier

 Factor Abundance
 In terms of physical units:
 Nation 2 is capital abundant if the ratio of the
total amount of capital to the total amount of
labor (TK/TL) available in Nation 2 is greater
than that in Nation 1.

 It is not the absolute amount of capital and


labor available in each nation, but the ratio of
the total amount of capital to the total amount
of labor.
Factor Intensity, Factor Abundance, and the
Shape of the Production Frontier

 Factor Abundance
 In terms of relative factor prices:
 Nation 2 is capital abundant if the ratio of the
rental price of capital to the price of labor time
(PK/PL) is lower in Nation 2 than in Nation 1.

 Rental price of capital is usually considered to


be the interest rate (r), while the price of labor
time is the wage rate (w), so PK/PL = r/w.
 It is not the absolute level of r that determines
whether a nation is K-abundant, but r/w.
Nation 2 is K-abundant, and
commodity Y is K-intensive

Nation 1 is L-abundant, and


commodity X is L-intensive

FIGURE 5-2 The Shape of the Production Frontiers of


Nation 1 and Nation 2.
Factor Endowments and the Heckscher-Ohlin
Theory

 The H-O theorem


A nation will export the commodity whose production
requires the intensive use of the nation’s relatively
abundant and cheap factor and import the commodity
whose production requires the intensive use of the
nation’s relatively scarce and expensive factor.
Factor Endowments and the Heckscher-Ohlin
Theory

 The H-O theorem


 In short, the relatively labor-rich nation exports

the relatively labor-intensive commodity and


imports the relatively capital – intensive
commodity.
 Explains comparative advantage rather than
assuming it (as was the case for classical
economists).
FIGURE 5-3 General Equilibrium Framework of the
H-O Theory.
FIGURE 5-4 The Heckscher-Ohlin Model.
Factor-Price Equalization and Income
Distribution

 The factor price equalization theorem


 International trade will bring about equalization in

the relative and absolute returns to homogenous


factors across nations.
 In short, wages and other factor returns will be

the same after specialization and trade has


occurred.
 Holds only if H-O theorem holds.
Factor-Price Equalization and Income
Distribution

 The factor price equalization theorem


 International trade causes w to rise in Nation 1

(the low-wage nation) and fall in Nation 2 (the


high-wage nation), reducing the pre-trade
difference in w between nations.
 Similarly, trade causes r to fall in Nation 1 (the

K-expensive nation) and rise in Nation 2. (the K-


cheap nation), reducing the pre-trade difference
in r between nations.
Factor-Price Equalization and Income
Distribution

 The factor price equalization theorem


 Thus, international trade causes a

redistribution of income from the relatively


expensive (scarce) factor to the relatively cheap
(abundant) factor.
FIGURE 5-5 Relative Factor–Price Equalization.
Factor-Price Equalization and Income
Distribution

 Specific Factors Model


 Trade will:
 have an ambiguous effect on a nation’s mobile
factors,
 benefit the immobile factors specific to a
nation’s export commodities or sectors, and
 harm the immobile factors specific to a nation’s
import-competing commodities or sectors.
Empirical Tests of the Heckscher-Ohlin Model

 The Leontief Paradox


 A 1951 test of the H-O theory
 Leontief calculated amount of L and K in U.S
exports and import substitutes for year 1947
 Showed that the pattern of trade did not fit the
conclusions of the H-O theorem.
 Exports in the U.S. seemed to be labor intensive
when they should have been capital intensive.
Empirical Tests of the Heckscher-Ohlin Model

 Source of the Leontief Paradox Bias


 Assumed a two factor world which required
assumptions about what is capital and what is
labor.
 Most heavily protected industries in U.S. were
L- intensive, reduced imports and increased
domestic production of L-intensive goods.
 Only physical capital included as capital,
ignoring human capital (education, job training,
skills).
Empirical Tests of the Heckscher-Ohlin Model

 Implications of the conflicting empirical


results:
 The H-O model is useful in explaining
international trade in raw materials and
agricultural products which represents a large
components of trade between developed and
developing countries
 There should be other basis for international
trade
H-O Theory

 Basic questions:
 What is the basis for trade?
 What are the gains from trade?
 What is the pattern of trade?

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