CHAPTER F I V E

5 International
Economics
Tenth Edition

Factor Endowments and the

Heckscher-Ohlin Theory
Dominick Salvatore
John Wiley & Sons, Inc.

Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.
 In this chapter:
 Introduction
 Assumptions of the Theory
 Factor Intensity, Factor Abundance, and the
Shape of the Production Frontier
 Factor Endowments and the Heckscher-Ohlin
Theory
 Factor-Price Equalization and Income
Distribution
 Empirical Tests of the Heckscher-Ohlin Model

Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.
 Introduction

 Extending trade model to include:

 Basis of comparative advantage
 Effect of international trade on return to labor

Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.
 Assumptions of the Theory

 Heckscher-Ohlin theory based on following

assumptions:
1. Two nations, two goods, two factors of
production
2. Technology same in both nations
3. Commodity X is labor intensive, commodity Y is
capital intensive in both nations
4. Constant returns to scale for X and Y in both
nations
5. Incomplete specialization in production in both
nations
Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.
 Assumptions of the Theory

 Heckscher-Ohlin theory based on following

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

Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.
 Factor Intensity, Factor Abundance, and the
Shape of the Production Frontier

 Factor Intensity
 In a two-commodity, two factor world,
commodity Y is capital intensive if the capital-
labor ratio (K/L) used in the production of Y is
greater than K/L used in the production of X.

 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.

Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.
 FIGURE 5-1 Factor Intensities for Commodities X and Y
in Nations 1 and 2.

Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.
 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.

Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.
 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.
Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.
 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.
Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.
 Factor Endowments and the Heckscher-Ohlin
Theory

 Heckscher-Ohlin (H-O) theory is based on

two theorems:
1. 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.

Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.
 Factor Endowments and the Heckscher-Ohlin
Theory

 Heckscher-Ohlin (H-O) theory is based on

two theorems:
1. The H-O theorem
 In short, the relatively labor-rich nation exports
the relatively labor-intensive commodity and
imports the relatively
 Explains comparative advantage rather than
assuming it.

Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.
 FIGURE 5-3 General Equilibrium Framework of the
Heckscher-Ohlin Theory.
Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.
 FIGURE 5-4 The Heckscher-Ohlin Model.

Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.
 Factor-Price Equalization and Income
Distribution

 Heckscher-Ohlin (H-O) theory is based on

two theorems:
2. 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.

Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.
 Factor-Price Equalization and Income
Distribution

 Heckscher-Ohlin (H-O) theory is based on

two theorems:
2. 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 pretrade
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 pretrade difference
in r between nations.
Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.
 Factor-Price Equalization and Income
Distribution

 Heckscher-Ohlin (H-O) theory is based on

two theorems:
2. 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.

Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.
 FIGURE 5-5 Relative Factor–Price Equalization.
Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.
 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.

Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.
5.6 Empirical Tests of the H-O Model

5.6A. The Leontief Paradox

(1) Empirical test by Wassily Leontief (1951)
- Data: U.S. data for the year 1946.
- Hypothesis: Since the U.S. was the most K-abundant nation in the world,
it was expected that the U.S. exported K-intensive commodities and
imported L-intensive commodities.
- Test method: Calculated the amount of labor and capital in a
‘representative bundle’ of $1 million worth of U.S. exports and import
substitutes for the year 1947.
- Result: U.S. import substitutes were more K-intensive than U.S. exports.
 This is called the Leontief paradox.
5.6 Empirical Tests of the H-O Model

- Table 5.6. Capital and Labor Requirements per Million Dollars of U.S. exports
and import substitutes
Imports
Exports Imports Substitutes
Exports
Leotief
(1947 input requirements, 1947 trade):
Capital $2,550,780 $3,091,339
Labor (worker-years) 182 170
Capital/worker-year $14,010 $18,180 1.30
Leotief
(1947 input requirements, 1951 trade):
Capital $2,256,800 $2,303,400
Labor (worker-years) 174 168
Capital/worker-year $12,977 $13,726 1.06
Capital/worker-year, excluding natural
0.88
resources
Baldwin
(1958 input requirements, 1962 trade):
Capital $1,876,000 $2,132,000
Labor (worker-years) 131 119
Capital/worker-year $14,200 $18,000 1.27
Capital/worker-year, excluding natural
1.04
resources
Capital/worker-year, excluding natural
0.92
resources and human capital
 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).

Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.
5.6 Empirical Tests of the H-O Model

 Implications of the conflicting empirical results

 The H-O model is useful in explaining international

trade in raw materials, agricultural products which is
large component of trade between developing and
developing countries.

 There should be other basis for trade.  Chapter 6.

 Appendix to Chapter 5

 The Edgeworth Box Diagram for Nation 1

and Nation 2–Once Again
 Formal Proof of the Factor–Price Equalization
Theorem
 Specific-Factors Model
 Factor-Intensity Reversal

Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.
 FIGURE 5-7 The Edgeworth Box Diagram for Nation 1 and
Nation 2–Once Again.
Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.
 FIGURE 5-8 Formal Proof of the Factor–Price
Equalization Theorem.
Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.
 FIGURE 5-9 Specific-Factors Model.
Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.
 FIGURE 5-10 Factor-Intensity Reversal.
Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.