An Introduction to

International Economics
Chapter 4: The Heckscher-Ohlin and
Other Trade Theories
Dominick Salvatore
John Wiley & Sons, Inc.
Dale R. DeBoer
University of Colorado, Colorado Springs

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Theories of international trade

The previous chapter provided a framework
within which international trade occurs.
This chapter extends this analysis in three
ways:
The cause of comparative advantage is
considered.
The implications for factors returns are
considered.
Models beyond the standard model of
international trade are considered.
Dale R. DeBoer
University of Colorado, Colorado
Springs

4-2

Theories of international trade

The theories that will be considered are:

The Heckscher-Ohlin model of trade

An economy of scale model of trade
A product differentiation model of trade
A product cycle model of trade
A transportation cost model of trade
A environmental standards model of trade

Dale R. DeBoer
University of Colorado, Colorado
Springs

4-3

The Heckscher-Ohlin theory

The Heckscher-Ohlin (H-O) theory is based on
two subsidiary theorems:
The H-O theorem
A nation will export the commodity whose production
requires the intensive use of the nations relatively
abundant (and therefore, cheap) factor and import the
commodity whose production requires the intensive
use of the nations relatively scarce (and therefore,
expensive) factor.
In other words, relative factor abundance drives
comparative advantage and the pattern of trade.

Dale R. DeBoer
University of Colorado, Colorado
Springs

4-4

The Heckscher-Ohlin theory

The Heckscher-Ohlin (H-O) theory is based on
two subsidiary theorems:
The H-O theorem
The factor price equalization theorem
International trade will bring about equalization in the
relative and absolute returns to homogenous factors
across nations.
In other words, wages and other factor returns will be
the same after specialization and trade has occurred.

Dale R. DeBoer
University of Colorado, Colorado
Springs

4-5

Demonstrating the H-O theorem

Suppose there are two countries with identical
technology and societal preferences.
The nations differ in that one is relatively
labor abundant while the other is relatively
capital abundant.
Factor abundance is determined by the ratio of
capital (K) to labor (L) available in the countries.
The country with the greater K/L ratio is defined as
being capital abundant.

Dale R. DeBoer
University of Colorado, Colorado
Springs

4-6

Demonstrating the H-O theorem

The nations differ in that one is relatively labor
abundant while the other is relatively capital
abundant.
Further, the commodities produced differ in
factor intensity.
Factor intensity is determined by the ratio of
capital (K) to labor (L) required for the production
of the commodity.
The commodity requiring the greater K/L ratio per
unit of production is defined as being capital
intensive.
Dale R. DeBoer
University of Colorado, Colorado
Springs

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Demonstrating the H-O theorem

Further, the commodities produced differ in factor
intensity.
Under these assumptions, the PPFs indicated
on the next slide will show the relative
productive potential of the trading nations if
Nation 1 is labor abundant and Nation 2 is
capital abundant while commodity Y is labor
intensive while commodity X is capital
intensive.
Dale R. DeBoer
University of Colorado, Colorado
Springs

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Demonstrating the H-O theorem

Y

Nation 1

Dale R. DeBoer
University of Colorado, Colorado
Springs

Nation 2

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Demonstrating the H-O theorem

For ease of
presentation, the two
PPFs may be overlaid in
one diagram.
Under the assumption
of identical societal
preferences, this yeilds
a possible community
indifference with the
indicated shape.

Dale R. DeBoer
University of Colorado, Colorado
Springs

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Demonstrating the H-O theorem

This combination of
PPFs and community
indifference curves
establishes a higher
opportunity cost for
Nation 1 in the
production of X.
Using the logic of the
standard model of trade
this shows that Nation1
will specialize in the
production of and
export Y.
Dale R. DeBoer
University of Colorado, Colorado
Springs

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Factor price equalization

In the H-O model of trade, the pattern of trade
is driven by relative factor abundance.
Labor abundant countries export goods that are
labor intensive in their production.
Capital abundant countries export goods that are
capital intensive in their production.

Dale R. DeBoer
University of Colorado, Colorado
Springs

4 - 12

Factor price equalization

In the H-O model of trade, the pattern of trade is
driven by relative factor abundance.
Exported commodities experience an increase
in their price relative to the autarky situation.

Dale R. DeBoer
University of Colorado, Colorado
Springs

4 - 13

Factor price equalization

In the H-O model of trade, the pattern of trade is
driven by relative factor abundance.
Exported commodities experience an increase in
their price relative to the autarky situation.
The Stolper-Samuelson theorem
demonstrates that an increase in the relative
price of a commodity raises the return of the
factor used intensively in its production.
At the same time, the return of the relative scarce
factor will fall.
Dale R. DeBoer
University of Colorado, Colorado
Springs

4 - 14

Factor price equalization

Exported commodities experience an increase in
their price relative to the autarky situation.
The Stolper-Samuelson theorem demonstrates
that an increase in the relative price of a
commodity raises the return of the factor used
intensively in its production.
Thus, the labor abundant country will see an
increase in wages, but a fall in the return to
capital while the capital abundant country will
experience the opposite pattern of change.
Dale R. DeBoer
University of Colorado, Colorado
Springs

4 - 15

Implications of FPE
Developed nations are expected to be capital
abundant.
Therefore, following the opening of trade the
return to capital in the developed countries is
expected to increase and wages are expected to
fall.
This pattern of change should worsen inequality
in the developed countries.

Dale R. DeBoer
University of Colorado, Colorado
Springs

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Implications of FPE
Developed nations are expected to be capital
abundant.
The change in inequality should be the
opposite for the developing (and labor
abundant) countries.

Dale R. DeBoer
University of Colorado, Colorado
Springs

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Implications of FPE
Developed nations are expected to be capital
abundant.
The change in inequality should be the opposite
for the developing (and labor abundant) countries.
The conclusion of worsened inequality in the
developed world holds only if:
The assumptions of the H-O theory holds.
As will be seen, this may not be the case.

The Stolper-Samuelson theorem is the only force

driving changes in inequality.
Dale R. DeBoer
University of Colorado, Colorado
Springs

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Empirical tests of the H-O theory

The Leontief Paradox
A 1951 test of the H-O theory
Showed that that pattern of trade did not fit the
conclusions of the H-O theorem.
Imports in the U.S. were capital intensive when they
should have been labor intensive.

Dale R. DeBoer
University of Colorado, Colorado
Springs

4 - 19

Empirical tests of the H-O theory

The Leontief Paradox
Is the paradox real?
The test assumed a two factor world which
required assumptions about what is capital and
what is labor.
The test assumed consistent technology between
nations.
However, technology varies so this assumption may
have biased the test.

Dale R. DeBoer
University of Colorado, Colorado
Springs

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Empirical tests of the H-O theory

The Leontief Paradox
Is the paradox real?
The test assumed a two factor world which required
assumptions about what is capital and what is labor.
The test assumed consistent technology between
nations.
The test assumes perfect mobility between factors
of production.
In practice, some factors of production are specific to
sectors of the economy.
Sector specific factors alter the predictions of the H-O
theory and require a different testing procedure.
Dale R. DeBoer
University of Colorado, Colorado
Springs

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Empirical tests of the H-O theory

The Leontief Paradox
Is the paradox real?
More current test of the H-O theory are built
on multiple factor (including sector specific
factors) models that extend the basic H-O
framework. These show good predictive
ability.

Dale R. DeBoer
University of Colorado, Colorado
Springs

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An economy of scale model of trade

Some productive relationships are
characterized by increasing returns to scale.
A production situation where output grows
proportionally more than the increase in inputs to
the productive process.
A doubling of inputs more than doubles outputs.

Dale R. DeBoer
University of Colorado, Colorado
Springs

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An economy of scale model of trade

Some productive relationships are characterized
by increasing returns to scale.
In this situation, production on a larger scale
lowers per unit costs of production and
provides a new source of cost advantage on
which to base exports.

Dale R. DeBoer
University of Colorado, Colorado
Springs

4 - 24

Product differentiation based trade

Differentiated products
Similar products produced by different
manufacturers in the same industry or general
trade group.
Toyota and Ford automobiles are differentiated
products

Dale R. DeBoer
University of Colorado, Colorado
Springs

4 - 25

Product differentiation based trade

Differentiated products
Intra-industry trade may arise from product
differentiation.
Intra-industry trade is international trade in
differentiated products.

Dale R. DeBoer
University of Colorado, Colorado
Springs

4 - 26

Product differentiation based trade

Differentiated products
Intra-industry trade may arise from product
differentiation.
Reasons for intra-industry trade
Allows producers to exploit product specific
economies of scale.
Allows consumers to benefit from product variety
that would not exist without international trade.

Dale R. DeBoer
University of Colorado, Colorado
Springs

4 - 27

The product cycle model of trade

Advanced industrialized countries develop
and introduce new products
While only one country possess the product, it
possesses international monopoly power and will
be the sole exporter of the product.

Dale R. DeBoer
University of Colorado, Colorado
Springs

4 - 28

The product cycle model of trade

Advanced industrialized countries develop and
introduce new products
As the technology producing the product
becomes more widespread, production will
spread to other nations.
This moves international trade to a standard
comparative advantage framework.

Dale R. DeBoer
University of Colorado, Colorado
Springs

4 - 29

The product cycle model of trade

Advanced industrialized countries develop and
introduce new products
As the technology producing the product
becomes more widespread, production will
spread to other nations.
As production becomes standardized, the
original introducer of the product loses its
technologically based comparative advantage
in the production of the product and becomes
an importer of the product.
Dale R. DeBoer
University of Colorado, Colorado
Springs

4 - 30

Examples of product cycles

Television
The Television History WWW site provides a nice
discussion of the history of television. A look at
the manufacturers of televisions provides a good
example of the product cycle model.
WWW link to the Television History Site
WWW link to the list of television manufacturers

Dale R. DeBoer
University of Colorado, Colorado
Springs

4 - 31

Transportation cost models of trade

Transportation costs
Transportation costs are the freight charges,
warehousing costs, costs of loading and
unloading, insurance premiums, and interest
charges incurred while goods are in transit
between nations.

Dale R. DeBoer
University of Colorado, Colorado
Springs

4 - 32

Transportation cost models of trade

Transportation costs
The introduction of transportation costs into
the standard model of trade may eliminate a
countrys comparative advantage in the
production of an item.
High enough costs may result in an item not being
able to be traded.
Highly perishable food products may suffer this fate.

Dale R. DeBoer
University of Colorado, Colorado
Springs

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Transportation cost models of trade

Transportation costs may provide an
advantage for trade between geographically
close countries.
This serves as partial explanation for why Canada
and Mexico are the two largest trading partners of
the US.
WWW link to International Trade Administration da
ta on major US trading partners

Dale R. DeBoer
University of Colorado, Colorado
Springs

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Environmental standards and trade

A nations environmental standards determine
the level of acceptable pollution that may be
generated from production.

Dale R. DeBoer
University of Colorado, Colorado
Springs

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Environmental standards and trade

A nations environmental standards determine
the level of acceptable pollution that may be
generated from production.
Strict environmental standards are expected
to raise the costs of production.
These increased costs may reduce (or remove) a
countrys comparative advantage in production
and alter the pattern of trade.

Dale R. DeBoer
University of Colorado, Colorado
Springs

4 - 36

Environmental standards and trade

A nations environmental standards determine the
level of acceptable pollution that may be
generated from production.
Strict environmental standards are expected to
raise the costs of production.
In order to maintain comparative advantage, a
nation may reduce its environmental
protections.
This may spur a race to the bottom.
Dale R. DeBoer
University of Colorado, Colorado
Springs

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Environmental standards and trade

In order to maintain comparative advantage, a
nation may reduce its environmental protections.
This concern has spurred calls for inclusion
of environmental legislation along with
agreements to lower barriers to trade.
For instance, the environmental rider attached to
the NAFTA.
The Foreign Trade Information System has a good
discussion of this policy by Hufbauer and Oreja.
WWW link
Dale R. DeBoer
University of Colorado, Colorado
Springs

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