Heckscher Ohlin Theory of International Trade

Swedish economists Eli Heckscher and Bertil Ohlin developed the theory of relative factor endowments to answer the question – “How do the countries acquire comparative advantage?” Heckscher Ohlin Theory of International Trade considers Factor endowments of  trading region to predict patterns of commerce and production. The key factor endowments which vary among countries are Land, Capital, Natural resources, labor, climate etc. Heckscher Ohlin model is based on the theory of Comparative advantage given by David Ricardo.

The model essentially says that countries will export products that use their abundant and cheap factor(s) of production and import products that use the countries’ scarce factor(s)

These two economist observed some important points which are given below –

Endowment factor are important for countries

CountryRich in
USACapital resources
Saudi ArabiaOil resources
IndiaLabour
South Africa and Papua New GuineaGold mines

Chart: relative factor endowments of selected countries.

CountryCapital/Labour  (S Per worker)  Capital/Land (S Per hectare) Land/Labour (Worker per hectare)
USA 10,260.91,058.6 0.103
 UK  4359.65169.81.186
Canada 10.583.1198.0 0.019
France 6,868.53,136.9 0.456
Japan 3358.55,286.51.5’4
South Korea 320.4337.3 1.053
Mexico 1684.8122.91.852

Source: Harry P.Bowen et.al., “Multi-country. Multifactor tests of the Factor Abundance Theory”. American Economic Review, pp.806-807.

2. In relation to land and capital, if labour is available in abundance in a country, the price of labour would be low and the price of land and capital would be high in that country. The vice-versa is true in those countries where land and capital are available in abundance in relation to labour.

3. These relative factor costs would lead countries to produce the products at low costs.

4. Countries have comparative advantage based on the factors endowed and in turn the price of the factors. Countries acquire comparative advantage in those products for which the factors endowed by the country concerned are used as inputs.

For example, India and China have comparative advantage in labor intensive industry like textile and tobacco, Saudi Arabia has comparative advantage in oil. Therefore, countries export those goods in which they have comparative advantage due to factors endowed

Chart: principal exports of selected countries.

Country Principal exports % of Principal Exports to Total Exports 
USACapital Goods48.7
UKFinished Manufactured goods57.2
JapanAutomobiles18.3
CanadaAutomobiles and Parts22.4
FranceCapital Equipment31.4
GermanyMotor vehicles22.4
MalaysiaElectric and Electronic Machinery55.6
SingaporeMachinery and Equipment62.4
IndiaManufacturer & Engineering72.1
China Manufacturers30.1

Source : Adapted from The WTO

5. Countries participate in international trade by exporting those products which they can produce at low cost consequent upon abundance of factors and import the other products which they can produce comparatively at high cost.

Assumptions of Theory

Both countries have identical production technology

Production output must have constant Return to Scale

The technologies used to produce the two commodities differ

Labor mobility within countrie: Within countries, capital and labor can be reinvested and re-employed to produce different outputs

Capital mobility within countries

Capital immobility between countries

Labor immobility between countries

Commodities have the same price everywhere

Perfect internal competition

Land Labour Relationship

Condition (Country)Go forProducesExample
area of land available is less in relation to the peoplemultistorey factorieslight-weight productsclothing production in Hongkong
large area of land in relation to population-sheep, wheat and other agricultural related products Canada, Australia, India

Labour Capital Relationship:

CountryConditionGo forProducesExample
Labour Abundantlabour is abundant in relation to capitalexport labour—intensive productsIndia has export competitiveness in textile garments
Capital AbundantCapital is abundant in relation to labourexport capital—intensive productsIran has export competitiveness in handmade carpets, Japan in computers, televisions, refrigerators, cars etc

Leontief Paradox:

There are certain surprising aspects to the Labor Capital relationship in international trade.

Wassily Leontief observed that US exports are labour—intensive compared with US imports.

But, it is assumed that the USA has abundant capital relative to labour. Therefore, this surprise finding is known as the Leontief Paradox. This is because of variation in labour skills.

Advanced countries have higher labour skills compared to developing countries. Therefore, advanced countries have competitive advantage in exporting products requiring higher labour skills while the developing countries have advantage in exporting products requiring less skilled labour.

Technological Complexities:

Different methods for production can be used due to technological advancements..

Canada:wheat production with machines

India: Wheat production with labour

Industries locate different production processes in different countries in order to reduce cost of production.

This theory explains relative advantage of the countries based on the factor endowments.

Thus, the theories discussed so far, are country-based theories rather than firm– based theories. Now, we shall discuss firm-based theories.

Firm based theories include:

1. Country similarity theory

2. product life cycle theory and

3. global strategic rivalry theory

References

International Business, P. Subba Rao, Himalaya Publication

Wikipedia HeckScher Ohlin Model

One Comment

  1. Anupama Senanayake
    Nov 29, 2013 @ 10:18:41

    Thank you very much. got a great support to my studies.

    Reply

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