The Heckscher-Ohlin Model PDF (2024)

INTERNATIONAL ECONOMICS AND TRADE The Heckscher – Ohlin model 2024.11.20 Asist. Dr. Julija Gavėnaitė-Sirvydienė [email protected] 866204092 1 Internation economics and trade Topic...

INTERNATIONAL ECONOMICS AND TRADE The Heckscher – Ohlin model 2024.11.20 Asist. Dr. Julija Gavėnaitė-Sirvydienė [email protected] 866204092 1 Internation economics and trade Topics of the course 1. International economics and trade- introduction 2024.11.07 2. The theory of comparative advantage 2024.11.07 3. The Heckscher – Ohlin model 2024.11.20 4. Alternative theories of trade 2024.11.20 BUSINESS CHALLENGE 5. Tariffs 2024.11.28 PRESENTATION 6. Balance of payments 2024.11.28 2025.01.09 7. The foreign exchange determination 2024.11.28 8. International lending and financial crises 2024.12.05 9. TEST 2024.12.05 11/19/2024 2 Setting ground rules for IET lectures Attendance matters (compulsory attendance of lectures and seminars - 50%) Ask questions, there are no stupid ones All material will be available in Moodle course “Sustainable Economy” 11/19/2024 3  The Heckscher–Ohlin (H–O) theory The leading theory of what determines nations’ trade patterns emerged in Sweden. Eli Heckscher, the noted Swedish economic historian, developed the core idea in a brief article in 1919. A clear overall explanation was developed and published in the 1930s by Heckscher’s student Bertil Ohlin. 11/19/2024 4  The Heckscher–Ohlin (H–O) theory In 1817 David Ricardo presented — in Principles — a theory that was meant to explain why countries trade and based on the concept of opportunity cost, how the pattern of export and import is ruled by countries exporting goods in which they have comparative advantage and importing goods in which they have a comparative disadvantage. Ricardo’s theory of comparative advantage, however, didn’t explain why the comparative advantage was the way it was. In the beginning of the 20th century, two Swedish economists — Eli Heckscher and Bertil Ohlin — presented a theory/model/theorem according to which the comparative advantages comes from differences between countries. 11/19/2024 5 The Heckscher–Ohlin (H–O) theory Heckscher–Ohlin theory predicts that a country exports the product (or products) that uses its relatively abundant factor(s) intensively and imports the product (or products) that uses its relatively insufficient factor(s) intensively. 11/19/2024 6 The Heckscher–Ohlin (H–O) theory Key Assumptions of the Heckscher–Ohlin Theory: 1. Two-Factor Production: The theory assumes that two main factors of production, usually capital and labour, determine the production capabilities of each country. 2. Factor Endowments Differ by Country: Countries have varying amounts of factors; for example, some may have more capital (machinery, infrastructure) while others have more labour (workforce). 3. Constant Technology: It assumes that technology is similar or constant between trading countries, meaning productivity differences arise from resource availability rather than technological disparity. 4. Perfect Competition: It assumes that markets are competitive, with no monopolies or oligopolies, so prices reflect the costs of production. 11/19/2024 7 The Heckscher–Ohlin (H–O) theory Key Predictions of the Theory Factor Proportions: Factor Price Equalization: Each country will export goods that use International trade should lead to an its relatively abundant factor intensively. equalization of factor prices. As trade For instance: increases, the wage gap between A country rich in labour (like China) countries with abundant labour and will export labour-intensive goods, those with abundant capital should such as textiles or electronics. shrink. A country rich in capital (like the U.S.) will export capital-intensive goods, like heavy machinery or advanced technology products. 11/19/2024 8 Example of Heckscher–Ohlin Theory in Action Imagine two countries: Farmville and Techland. Farmville has lots of open fields and fertile land, but few highly skilled workers. Techland has many skilled workers but limited farmland. Farmville is great at growing food, while Techland is amazing at making electronics. If each country focuses on what it's best at (Farmville on food, Techland on electronics), they can trade, and both have plenty of food and electronics. 11/19/2024 9 Core Idea: Factor Abundance and Specialization Farmville has land in abundance (its strength). Techland has skilled labour in abundance. Countries use these abundant resources to produce goods that need them. This means Farmville will specialize in goods that need lots of land (like crops), while Techland will specialize in goods that need skilled labour (like electronics). 11/19/2024 10 Core Idea: Factor Abundance and Specialization Country Abundant Specialization Trade Exports Factor (good) Techland Skilled Labor Electronics Electronics Farmville Land Crops/Food Crops/Food 11/19/2024 11 Real-world examples of resource-abundant countries : Saudi Arabia: Has abundant oil resources, so it specializes in oil exports. Bangladesh: Has an abundance of low-cost labour, so it specializes in textile manufacturing. United States: With high capital availability and skilled workers, it produces technology and advanced machinery. 11/19/2024 12 Real-world examples of resource-abundant countries : UNITED STATES CANADA SAUDI ARABIA BRAZIL Technology Timber Oil Coffee Innovation Minerals Agricultural Machinery products UNITED STATES JAPAN NORWAY ARGENTINA Manufactured Advanced Oil Beef goods technology Fish Soybeans Electronics Automobiles 11/19/2024 13 How Trade Makes Both Countries Better Off If Farmville only made food, they’d have all they need but no electronics. If Techland only made electronics, they’d have electronics but not enough food. By trading, each country specializes in what it does best and gets both food and electronics, improving life for people in both countries! 11/19/2024 14 Idea of Factor Price Equalization As countries trade and specialize, the prices of factors like labor and capital tend to equalize. When Farmville and Techland specialize and trade, wages in Farmville rise as food exports increase demand for land and labor. Similarly, in Techland, wages adjust as they focus on electronics. Over time, factor prices like wages start to even out globally. 11/19/2024 15 The Factor-Price Equalization Theorem Heckscher–Ohlin trade model leads to an even more surprising prediction about the effects of trade on factor prices in different countries. Beginning with a proof by Paul Samuelson in the late 1940s, the factor-price equalization theorem was established about the effect of trade on international differences in factor prices. 11/19/2024 16 The Factor-Price Equalization Theorem Main Idea: The Factor-Price Background: Part of the Heckscher- Equalization (FPE) Theorem states Ohlin model, which explains how that free trade between countries countries trade based on their factor will equalize the prices of production endowments. factors (like wages for labor and returns for capital) across countries. 11/19/2024 17 Core Assumptions of Factor-Price Equalization Theorem 1. Identical Technology: Countries have access to the same production technologies 2. No Barriers to Trade: No tariffs or trade restrictions are present. 3. Perfect Competition: Goods and factor markets are perfectly competitive. 4. Mobile Factors Domestically, but Immobile Internationally: Labor and capital are freely mobile within countries but not across borders. 11/19/2024 18 How Factor-Price Equalization Works KEY CONCEPT: As countries specialize and trade, the demand for factors (labor, capital) changes, aligning factor prices. EXAMPLE: Country A: Abundant in labor → Produces labour-intensive goods → High demand for labor → Wages increase. Country B: Abundant in capital → Produces capital-intensive goods → Demand for capital rises → Returns on capital increase. 11/19/2024 19 Factor-Price Equalization Works. Real-Life Example Example: United States: Abundant in capital; specializes in high-tech goods. Bangladesh: Abundant in labor; specializes in textiles. Result: Trade between these countries raises wages in Bangladesh and capital returns in the U.S., gradually narrowing wage and capital return differences. BANGLADESH USA 11/19/2024 20 Implications of the Factor-Price Equalization Theorem 1. Income Distribution Effects: Wages and returns on capital start to converge globally, affecting income inequality within and across countries. 2. Globalization Influence: Supports the idea that globalization can reduce wage gaps between countries. 3. Economic Policy Relevance: Relevant for policymakers aiming to understand the impact of trade on income distribution. 11/19/2024 21 Limitations of Factor-Price Equalization 1. Unrealistic Assumptions: Assumes perfect competition, no trade barriers, and identical technology—rare in real-world scenarios. 2. Partial Equalization: FPE rarely occurs completely due to trade restrictions, technology differences, and capital mobility. 3. Leontief Paradox: Evidence that factor abundance does not always predict trade patterns accurately. 11/19/2024 22  How Free Trade Affects Income Distribution in the Long Run: The Whole Chain of Influence 11/19/2024 23 Limitations of the Heckscher–Ohlin Theory 1. Leontief Paradox: In the 1950s, economist Wassily Leontief found that the U.S., a capital-abundant country, exported labour-intensive goods and imported capital-intensive goods. This finding contradicted the H-O theory and suggested that other factors, such as technology and consumer preferences, play a significant role in trade patterns. 2. Assumption of Constant Technology: The theory assumes that countries have equal access to technology, which is rarely the case in practice. 3. Neglect of Scale Economies: The theory doesn’t account for industries where economies of scale play a significant role in production and cost. 11/19/2024 24 Closing Thoughts on the Heckscher–Ohlin Theory The Heckscher–Ohlin (H–O) Theory provides a powerful foundation for understanding global trade by highlighting how countries can benefit from their unique factor endowments. By focusing on the abundance of labor, capital, land, or other resources, the theory explains why countries specialize and how trade can improve global efficiency and welfare. The H–O model also opens up important discussions on the effects of trade on income distribution and the challenges of achieving factor- price equalization. 11/19/2024 25 Closing Thoughts on the Heckscher–Ohlin Theory However, the theory is an idealized model that assumes perfect conditions—no trade barriers, identical technology, and perfectly competitive markets. Real-world complexities, such as technological differences, trade policies, and labor mobility constraints, often prevent the complete equalization of factor prices that the theory predicts. Furthermore, empirical observations like the Leontief Paradox reveal that trade patterns do not always follow factor endowment predictions, suggesting that factors beyond resource abundance—such as innovation, institutional quality, and cultural differences—also shape trade. 11/19/2024 26 Closing Thoughts on the Heckscher–Ohlin Theory Overall, the Heckscher–Ohlin Theory is invaluable for its insights into the forces behind specialization and trade, helping to frame the study of international economics. While it may have limitations, it continues to influence modern trade theory, inspiring more comprehensive models that consider the complex realities of globalization. The H–O theory ultimately encourages us to think critically about how countries can leverage their strengths to achieve economic growth and mutual benefit in an increasingly interconnected world. 11/19/2024 27  Thank You, any questions? What’s next? 1. 10 min. break??? 2. Lecture on Alternative Theories of Trade 11/19/2024 28