International Trade Theory p2

International Trade Theory
Heckscher-Ohlin
Heckscher-Ohlin model is one of the most important models of international trade.
It expands upon the Ricardian model largely by introducing a second factor of
production. In its two-by-two-by-two variant, meaning two goods, two factors, and
two countries, it represents one of the simplest general equilibrium models that
allows for interactions across factor markets, goods markets, and national markets
simultaneously.
With the H-O model, we learn how changes in supply or demand in one market
can feed their way through the factor markets and, with trade, the national markets
and influence both goods and factor markets at home and abroad. In other words,
all markets are everywhere interconnected.
The H-O model incorporates a number of realistic characteristics of production that
are left out of the simple Ricardian model. Recall that in the simple Ricardian
model only one factor of production, labor, is needed to produce goods and
services. The productivity of labor is assumed to vary across countries, which
implies a difference in technology between nations. It was the difference in
technology that motivated advantageous international trade in the model.
The Heckscher-Ohlin theory
Heckscher and Ohlin - comparative advantage arises from differences in national
factor endowments (the extent to which a country is endowed with resources such
as land, labor, and capital)the more abundant a factor, the lower its cost countries
will export goods that make intensive use of those factors that are locally abundant,
and import goods that make intensive use of factors that are locally scarce Now,
let’s move on to look at another theory of trade. Eli Heckscher and Bertil Ohlin
extended Ricardo’s work by suggesting that a country’s comparative advantage is a
result of differences in national factor endowments.
Heckscher and Ohlin argued that countries will export goods that make intensive
use of factors of production like land, labor, and capital that are locally abundant.
At the same time, countries will import goods that make intensive use of factors
that are locally scarce. So, a country like China with abundant low-cost labor
will produce and export products that are labor intensive like textiles, while the
U.S., which lacks abundant low cost labor, imports textiles from China.
Note that this theory explains trade patterns using differences in factor
endowments, while Ricardo explains trade patterns using differences in
productivity.
The assumption of two productive factors, capital and labor, allows for the
introduction of another realistic feature in production: differing factor proportions
both across and within industries. When one considers a range of industries in a
country, it is easy to convince oneself that the proportion of capital to labor applied
in production varies considerably. For example,
steel production generally involves large amounts of expensive machines and
equipment spread over perhaps hundreds of acres of land, but it also uses relatively
few workers. (Note that relative here means relative to other industries.) In the
tomato industry, in contrast, harvesting requires hundreds of migrant workers to
hand-pick and collects each fruit from the vine. The amount of machinery used in
this process is relatively small.
The quantity of capital to the quantity of labor according to
the H-O model.
In the H-O model, we define the ratio of the quantity of capital to the quantity of
labor used in a production process as the capital-labor ratio. We imagine, and
therefore assume, that different industries producing different goods have different
capital-labor ratios. It is this ratio (or proportion) of one factor to another that gives
the model its generic name: the factor proportions model.
In a model in which each country produces two goods, an assumption must be
made as to which industry has the larger capital-labor ratio.
Thus if the two goods that a country can produce are steel and clothing and if steel
production uses more capital per unit of labor than is used in clothing production,
we would say the steel production is capital intensive relative to clothing
production. Also, if steel production is capital intensive, then it implies that
clothing production must be labor intensive relative to steel.
Another realistic characteristic of the world is that countries have different
quantities—that is, endowments—of capital and labor available for use in the
production process. Thus some countries like the United States are well
endowed with physical capital relative to their labor force. In contrast, many less-
developed countries have much less physical capital but are well endowed with
large labor forces. We use the ratio of the aggregate endowment of capital to the
aggregate endowment of labor to define relative factor abundance between
countries.
Thus if, for example, the United States has a larger ratio of aggregate capital per
unit of labor than France’s ratio, we would say that the United States is capital
abundant relative to France. By implication, France would have a larger ratio of
aggregate labor per unit of capital and thus France would be labor abundant
relative to the United States.

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International Trade Theory

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