Hecksher-Ohlin trade modeljhuato.sfc@gmail.com

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

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

Theorems derived from the Hecksher-Ohlin model

1. Hecksher-Ohlin theorem2. Stolper-Samuelson theorem3. Factor-price equalization theorem4. Rybczynski theorem

Hecksher-Ohlin theorem

With trade, the country with the higher K/L ratio (e.g. H, which is K-abundant) will export the good that is intensive in the use of K (e.g. Steel) and import the good that is intensive in the use of L (e.g. corn). The pattern of trade of the other country will be the converse.

Hecksher-Ohlin theorem

Stolper-Samuelson theorem

In each country, trade will increase the real return of the abundant factor of production and decrease the real return of the scarce factor of production.

E.g. for H, where K is abundant and L is scarce, trade will increase r/P and decrease w/P, where r is the return on K (or “profit rate”), w is the return on L (or wage rate), and P is the price level.

Stolper-Samuelson theoremAt H, let MCS = a r + b w and MCC = c r + d w, where a, b, c, and d are 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. Since steel uses K intensively compared to L and its output will expand, 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 output shrinks, then w will go down. If w decreases and PS increases, then by (1) r must increase more than proportionally.

In other words, a shift in the output mix towards more steel and less corn will have a magnified effect on r and w compared to PS and PC. Therefore, r/P will go up and w/P will go down, where P is a weighted average of PS and PC.

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

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.

Rybczynski theorem If the 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