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1 of 55Copyright 2011 Worth Publishers International Economics Feenstra/Taylor, 2/e.

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Trade and Resources:

The Heckscher-Ohlin Model

41 Heckscher-OhlinModel

2 Testing the

Heckscher-OhlinModel

3 Effects of Trade onFactor Prices

4 A P P E N D I X T O

C H A P T E R 4The Sign Test in theHeckscher-OhlinModel

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In this chapter, we outline the Heckscher-Ohlin

model, a model that assumes that trade occurs

because countries have different resources.

Introduction

Our first goal is to describe the Heckscher-Ohlin (HO)model of trade.

The specific-factors model that we studied in the

previous chapter was a short-run model becausecapital and land could not move between theindustries.

In contrast, the HO model is a long-run modelbecause all factors of production can movebetween the industries.

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Our second goal is to examine the empirical evidenceon the Heckscher-Ohlin model.

By allowing for more than two factors of

production and also allowing countries to differ intheir technologies, as in the Ricardian model, thepredictions from the Heckscher-Ohlin modelmatch more closely the trade patterns in the

world economy today.

The third goal of the chapter is to investigate how theopening of trade between the two countries affects the

payments to labor and to capital in each of them.

Introduction

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1 Heckscher-Ohlin Model

Assumptions of the Heckscher-Ohlin Model

Assumption 1: Two factors of production, labor andcapital, can move freely between the industries.

Assumption 2: Shoe production is labor-intensive; thatis, it requires more labor per unit of capital to produce

shoes than computers, so that LS /KS > LC /KC.

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FIGURE 4-1

Labor Intensity of Each Industry The demand for labor relative tocapital is assumed to be higher in shoes than in computers,LS/KS > LC/KC.

These two curves slope down just like regular demand curves,but in this case, they are relative demand curves for labor (i.e.,demand for labor divided by demand for capital).

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Assumptions of the Heckscher-Ohlin Model

Assumption 3: Foreign is labor-abundant, by which wemean that the laborcapital ratio in Foreign exceeds that

in Home, L*/K*> L/K. Equivalently, Home is capital-abundant, so that K/L >K*/L*.

Assumption 4: The final outputs, shoes and computers,

can be traded freely (i.e., without any restrictions)between nations, but labor and capital do not movebetween countries.

Assumption 5: The technologies used to produce thetwo goods are identical across the countries.

Assumption 6: Consumer tastes are the same acrosscountries, and preferences for computers and shoes do

not vary with a countrys level of income.


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Are Factor Intensities the Same across

Countries?While much of the footwear in the world isproduced in developing nations, the UnitedStates retains a small number of shoe

factories.

In India, the sewing machine used to producefootwear is cheaper than the computer used in a call center. footwear

production in India is labor-intensive as compared with the call center,which is the opposite of what holds in the United States.

This example illustrates a reversal of factor intensities between the

two countries.

In the United States, agriculture is capital-intensive. In many developingcountries, it is labor-intensive.

Despite its nineteenth-centuryexterior, this New Balance factoryin Maine houses advanced shoe-

manufacturing technology.

APPLICATION

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No-Trade EquilibriumProduction Possibil ities Frontiers, Indifference Curves, andNo-Trade Equilibrium Price

FIGURE 4-2 (1 of 3)

The Home production possibilitiesfrontier (PPF) is shown in panel (a),

and the Foreign PPF is shown inpanel (b).

Because Home is capitalabundant and computers arecapital intensive, the HomePPF is skewed toward

computers.


No-Trade Equilibria in Home and Foreign

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FIGURE 4-2 (2 of 3)

Home preferences are summarizedby the indifference curve, U.

The Home no-trade (or autarky)equilibrium is at pointA.

The flat slope indicates a lowrelative price of computers, (PC/PS)A.


No-Trade Equilibria in Home and Foreign (continued)

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r-OhlinModel


FIGURE 4-2 (3 of 3)

Foreign is labor-abundant and shoes arelabor- intensive, so the Foreign PPF isskewed toward shoes.

Foreign preferences are summarized bythe indifference curve, U*

The Foreign no-trade equilibrium is atpointA*, with a higher relative price ofcomputers, as indicated by the steeperslope of (P*C/P*S)

A*.


No-Trade Equilibria in Home and Foreign (continued)

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Free-Trade EquilibriumHome Equilibrium with Free Trade

FIGURE 4-3 (1 of 2)

At the free-trade world relative price ofcomputers, (PC/PS)

W,

Home produces at point B in panel (a) andconsumes at point C,

exporting computers and importing shoes.

PointA is the no-trade equilibrium.

The trade triangle has a base equal tothe Home exports of computers (thedifference between the amount producedand the amount consumed with trade,

(QC2QC3).


International Free-Trade Equilibrium at Home

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Free-Trade EquilibriumHome Equilibrium with Free Trade

FIGURE 4-3 (2 of 2)

The height of this triangle is the Homeimports of shoes (the difference betweenthe amount consumed of shoes and theamount produced with trade, QS3QS2).

In panel (b), we show Homeexports of computers equal to zeroat the no-trade relative price, (PC

/PS)A,

and equal to (QC2QC3) at the

free-trade relative price, (PC/PS)W.


International Free-Trade Equilibrium at Home (continued)

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Free-Trade EquilibriumForeign Equilibrium with Free Trade

FIGURE 4-4 (1 of 2)

At the free-trade world relative price ofcomputers, (PC/PS)

W,

Foreign produces at point B* in panel (a) andconsumes at point C*,

importing computers and exporting shoes.

PointA* is the no-trade equilibrium.)

The trade triangle has a base equal toForeign imports of computers (thedifference between the consumption ofcomputers and the amount produced with

trade, (Q*C3Q*C2).


International Free-Trade Equilibrium in Foreign

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Free-Trade EquilibriumForeign Equilibrium with Free Trade

FIGURE 4-4 (2 of 2)

The height of this triangle is Foreignexports of shoes (the differencebetween the production of shoes andthe amount consumed with trade, Q*S2

Q*S3).

In panel (b), we show Foreign importsof computers equal to zero at the no-trade relative price, (P*C/P*S)

A*, andequal to (Q*C3Q*C2) at the free-trade relative price, (PC/PS)

W.


International Free-Trade Equilibrium in Foreign (continued)

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Free-Trade EquilibriumEquilibrium Price with Free Trade Because exports equal imports,there is no reason for the relative price to change and so this is a free-trade equilibrium.

FIGURE 4-5

The world relative price ofcomputers in the free-tradeequilibrium is determined at the

intersection of the Home exportsupply and Foreign importdemand, at point D.

At this relative price, thequantity of computers that

Home wants to export, (QC2QC3),just equals the quantity ofcomputers that Foreign wants toimport, (Q*C3Q*C2).


Determination of the Free-Trade World Equil ibr ium Price

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Free-Trade EquilibriumPattern of Trade

Home exports computers, the good that uses

intensively the factor of production (capital) foundin abundance at Home.

Foreign exports shoes, the good that usesintensively the factor of production (labor) found in

abundance there.

This important result is called the Heckscher-Ohlin theorem.


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Heckscher-Ohlin Theorem:

Assumption 1: Labor and capital flow freely between theindustries.

Assumption 2: The production of shoes is labor-intensiveas compared with computer production, which is capital-intensive.

Assumption 3: The amounts of labor and capital found inthe two countries differ, with Foreign abundant in labor andHome abundant in capital.

Assumption 4: There is free international trade in goods.

Assumption 5: The technologies for producing shoes andcomputers are the same across countries.

Assumption 6: Tastes are the same across countries.


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The first test of the Heckscher-Ohlin theorem wasperformed by economist Wassily Leontief in 1953.

Leontief supposed correctly that in 1947 the United States

was abundant in capital relative to the rest of the world.Thus, from the Heckscher-Ohlin theorem, Leontiefexpected that the United States would export capital-intensive goods and import labor-intensive goods.

What Leontief actually found, however, was just theopposite: the capitallabor ratio for U.S. imports washigher than the capitallabor ratio found for U.S. exports!

This finding contradicted the Heckscher-Ohlin theorem andcame to be called Leontiefs paradox.

2 Testing the Heckscher-Ohlin Model

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TABLE 4-1

Leontief used the numbers in this table to test the Heckscher-Ohlin

theorem. Each column shows the amount of capital or labor needed toproduce $1 million worth of exports from, or imports into, the United Statesin 1947. As shown in the last row, the capitallabor ratio for exports wasless than the capitallabor ratio for imports, which is a paradoxical finding.

Leontiefs Paradox

Leontiefs Test

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Leontiefs ParadoxExplanations

U.S. and foreign technologies are not the same, incontrast to what the HO theorem and Leontief assumed.

By focusing only on labor and capital, Leontief ignoredland abundance in the United States.

Leontief should have distinguished between skilled and

unskilled labor (because it would not be surprising tofind that U.S. exports are intensive in skilled labor).

The data for 1947 may be unusual because World War II

had ended just two years earlier. The United States was not engaged in completely free

trade, as the Heckscher-Ohlin theorem assumes.


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Factor Endowments in the New Millennium

To determine whether a country is abundant in a certainfactor, we compare the countrys share of that factor withits share of world GDP.

If its share of a factor exceeds its share of world GDP, then

we conclude that the country is abundant in that factor,and if its share in a certain factor is less than its share ofworld GDP, then we conclude that the country is scarce inthat factor.


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For years, many of Chinas best and brightest left for theUnited States, where high-tech industry was more cutting-

edge.

But Mark R. Pinto is moving in the opposite direction.

Mr. Pinto is the first chief technology officer of a major

American tech company to move to China. Applied Materials,is one of Silicon Valleys most prominent firms. It suppliedequipment used to perfect the first computer chips.

Not just drawn by Chinas markets, Western companies arealso attracted to Chinas huge reservoirs of cheap, highlyskilled engineers.

HEADLINES

China Drawing High-Tech Research from U.S.

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Capital, Labor and Land AbundanceFactor Endowments in the New Millennium

FIGURE 4-6

Country Factor

Endowments, 2000Shown here arecountry shares of sixfactors of productionin the year 2000, for

eight selectedcountries and the restof the world.

In the first bar graph, we see that 24% of the worlds physical capital in 2000was located in the United States, with 9% located in China, 13% located inJapan, and so on. In the final bar graph, we see that in 2000 the United States

had 22% of world GDP, China had 11%, Japan had 8%, and so on.


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Differing Productivit ies across Countries

Remember that in the original formulation of the paradox,Leontief had found that the United States was exporting

labor-intensive products even though it was capital-abundant at that time.

One explanation for this outcome would be that labor ishighly productive in the United States and less productive

in the rest of the world.

If that is the case, then the effective labor force in theUnited States, the labor force times its productivity (which

measures how much output the labor force can produce),is much larger than it appears to be when we just countpeople.


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Measuring Factor Abundance Once Again To allowfactors of production to differ in their productivities across

countries, we define the effective factor endowment asthe actual amount of a factor found in a country times itsproductivity:

Effective factor endowment = Actual factor endowment

Factor productivity


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Measuring Factor Abundance Once Again

To determine whether a country is abundant in a certain

factor, we compare the countrys share of that effectivefactor with its share of world GDP.

If its share of an effective factor exceeds its share of worldGDP, then we conclude that the country is abundant in

that effective factor; if its share of an effective factor isless than its share of world GDP, then we conclude thatthe country is scarce in that effective factor.


Effective R&D Scientists

Effective R&D scientists

Actual R&D scientists R&D spending per scientist

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Differing Productivities across CountriesFIGURE 4-7 (1 of 2)

Shown here are countryshares of R&D scientists

and land in 2000, usingfirst the information fromFigure 4.6, and thenmaking an adjustmentfor the productivity of

each factor acrosscountries to obtain theeffective shares.

China was abundant in R&D scientists in 2000 (since it had 14% of the worldsR&D scientists as compared with 11% of the worlds GDP) but scarce ineffective R&D scientists (because it had 7% of the worlds effective R&D

scientists as compared with 11% of the worlds GDP).


Effective Factor Endowments, 2000

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Differing Productivities across CountriesFIGURE 4-7 (2 of 2)

Shown here are countryshares of R&D scientists

and land in 2000, usingfirst the information fromFigure 4.6, and thenmaking an adjustmentfor the productivity of

each factor acrosscountries to obtain theeffective shares.

The United States was scarce in arable land when using the number of acres(since it had 13% of the worlds land as compared with 22% of the worlds GDP)but neither scarce nor abundant in effective land (since it had 21% of the

worlds effective land, which nearly equaled its share of the worlds GDP).


Effective Factor Endowments, 2000

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Differing Productivities across CountriesEffective Arable Land

TABLE 4-2

This table shows that U.S. food trade has fluctuated between positive andnegative net exports since 2000, which is consistent with our finding that theUnited States is neither abundant nor scarce in land. Total agriculture trade(including nonfood items like cotton) has positive net exports, however.


U.S. Food Trade and Total Agr icultural Trade, 20002009

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Leontiefs Paradox Once Again

FIGURE 4-8

Shown here are the share oflabor, effective labor, and GDPof the US and the rest of theworld in 1947. The US had only8% of the worlds population, ascompared to 37% of the worldsGDP, so it was very scarce inlabor. But when we measureeffective labor by the totalwages paid in each country,then the United States had 43%of the worlds effective labor ascompared to 37% of GDP, so itwas abundant in effective labor.

Labor Abundance


Labor Endowment and GDP for the United States and Rest of World, 1947

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Leontiefs Paradox Once AgainLabor Productivity

FIGURE 4-9

Shown here are estimated

labor productivities acrosscountries, and theirwages, relative to theUnited States in 1990.

Notice that the labor andwages were highlycorrelated acrosscountries: the pointsroughly line up along the45-degree line.


Labor Productivity and Wages

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Leontiefs Paradox Once AgainLabor Productivity

FIGURE 4-9 (revisited)

As suggested by Figure 4-9, wages across countriesare strongly correlatedwith the productivity oflabor. We use the wages

earned by labor tomeasure the productivityof labor in each country.Then the effective amountof labor found in each

country equals the actualamount of labor times thewage.


Effective Labor Abundance

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Effect of Trade on the Wage and Rental of HomeEconomy-Wide Relative Demand for Labor

3 Effects of Trade on Factor Prices

FIGURE 4-10

The economy-wide relativedemand for labor, RD, is anaverage of the LC/KCand LS/KScurves and lies between thesecurves.

The relative supply, L/K, isshown by a vertical line becausethe total amount of resources inHome is fixed.

The equilibrium pointA, at which

relative demand RD intersectsrelative supply L/K, determinesthe wage relative to the rental,W/R.

Relativesupply

Relativedemand

Determination of Home Wage/Rental

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Effect of Trade on the Wage and Rental of HomeIncrease in the Relative Price of Computers

FIGURE 4-11

Initially, Home is at a no-tradeequilibrium at pointA pwith arelative price of computers of(PC/PS)

A.

An increase in the relative

price of computers to theworld price, as illustrated bythe steeper world price line,(PC/PS)

W, shifts production

from pointA to B.At point B, there is a higheroutput of computers and alower output of shoes, QC2 >Q

C1and Q

S2< Q

S1.


Increase in the Price of Computers

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Effect of Trade on the Wage and Rental of HomeIncrease in the Relative Price of ComputersFIGURE 4-12 (1 of 2)

An increase in therelative price ofcomputers shifts theeconomy-wide relativedemand for labor, RD1,toward the relativedemand for labor in thecomputer industry, LC

/KC.

The new relative demandcurve, RD2, intersects

the relative supply curvefor labor at a lowerrelative wage, (W/R)2.


Effect of a Higher Relative Price of Computers on Wage/Rental

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Effect of Trade on the Wage and Rental of HomeIncrease in the Relative Price of ComputersFIGURE 4-12 (2 of 2)

As a result, the wage

relative to the rental fallsfrom (W/R)1 to (W/R)2.

The lower relative wagecauses both industries toincrease their labor

capital ratios, asillustrated by theincrease in both LC/KCand LS/KS at the newrelative wage.

Relative supply

No change

Relative demand

No change in total


Effect of a Higher Relative Price of Computers on Wage/Rental(continued)

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Determination of the Real Wage and Real RentalChange in the Real Rental

R PC MPKCand R PS MPKS

MPKC= R/PCand MPKS = R/PS Change in the Real Wage

W = PC MPLCand W = PS MPLS

MPLC= W/PCand MPLS = W/PS


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Determination of the Real Wage and Real RentalStolper-Samuelson Theorem: In the long run, when allfactors are mobile, an increase in the relative price of a

good will increase the real earnings of the factor usedintensively in the production of that good and decreasethe real earnings of the other factor.

For our example, the Stolper-Samuelson theorem

predicts that when Home opens to trade and faces ahigher relative price of computers, the real rental oncapital in Home rises and the real wage in Home falls. InForeign, the changes in real factor prices are just the

reverse.


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Changes in the Real Wage and Rental: A Numerical Example


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Changes in the Real Wage and Rental: A Numerical ExampleGeneral Equation for the Long-Run Change in Factor Prices Thelong-run results of a change in factor prices can be summarized inthe following equation:

Realwagefalls

Real rentalincreases

Realrentalfalls

Realwageincreases

Realrentalfalls

Realwageincreases

The equations relating the changes in product prices to changes infactor prices are sometimes called the magnification effect becausethey show how changes in the prices of goods have magnified effectson the earnings of factors:


APPLICATION

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According to the specific-factors model, in the short run wedo not know whether labor will gain or lose from free trade,

but we do know that the specific factor in the export sectorgains, and the specific factor in the import sector loses.

Opinions toward Free Trade

APPLICATION

APPLICATION

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We would expect that workers in export industries willsupport free trade (since the specific factor in that industrygains), but workers in import-competing industries will beagainst free trade (since the specific factor in that industryloses).

In the short run, then, the industry of employment ofworkers will affect their attitudes toward free trade.

In the long-run Heckscher-Ohlin model, however, theindustry of employment should not matter.


APPLICATION

APPLICATION

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According to the Stolper-Samuelson theorem, an increase

in the relative price of exports will benefit the factor ofproduction used intensively in exports and harm the otherfactor, regardless of the industry in which these factors ofproduction actually work.

APPLICATION

APPLICATION

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An increase in the relative price of exports will benefit skilledlabor in the long run, regardless of whether these workersare employed in export-oriented industries or import-

competing industries.In the long run, then, the skill level of workers shoulddetermine their attitudes toward free trade.

In a survey conducted in the United States by the NationalElections Studies (NES) in 1992, workers with lower wagesor fewer years of education are more likely to favor import

restrictions, whereas those with higher wages and moreyears of education favor free trade.

APPLICATION

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1. In the Heckscher-Ohlin model, we assume that thetechnologies are the same across countries and that

countries trade because the available resources (labor,capital, and land) differ across countries.

K e y T e r mKEY POINTS

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2. The Heckscher-Ohlin model is a long-run framework,so labor, capital, and other resources can move freely

between the industries.


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3. With two goods, two factors, and two countries, theHeckscher-Ohlin model predicts that a country will

export the good that uses its abundant factorintensively and import the other good.


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4. The first test of the Heckscher-Ohlin model was madeby Leontief using U.S. data for 1947. He found that

U.S. exports were less capital-intensive and morelabor-intensive than U.S. imports. This was aparadoxical finding because the United States wasabundant in capital.


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5. The assumption of identical technologies used in theHeckscher-Ohlin model does not hold in practice.

Current research has extended the empirical tests ofthe Heckscher-Ohlin model to allow for many factorsand countries, along with differing productivities offactors across countries. When we allow for different

productivities of labor in 1947, we find that the UnitedStates is abundant in effectiveor skilledlabor, whichexplains the Leontief paradox.


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6. According to the Stolper-Samuelson theorem, anincrease in the relative price of a good will cause the

real earnings of labor and capital to move in oppositedirections: the factor used intensively in the industrywhose relative price goes up will find its earningsincreased, and the real earnings of the other factor will

fall.


K T

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7. Putting together the Heckscher-Ohlin theorem and theStolper-Samuelson theorem, we conclude that a

countrys abundant factor gains from the opening oftrade (because the relative price of exports goes up),and its scarce factor loses from the opening of trade.


K T

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K e y T e r mA P P E N D I X T O C H A P T E R 4

The Sign Test in the Heckscher-Ohlin ModelMeasuring the Factor Content of Trade

FIGURE 4A-1

Factor Content of Trade for the United States, 1947 This table extends Leontiefs

test of the Heckscher-Ohlin model to measure the factor content of net exports.The first column for exports and for imports shows the amount of capital or laborneeded per $1 mill ion worth of exports from or imports into the United States, for1947. The second column for each shows the amount of capital or labor neededfor the total exports from or imports into the United States. The final column isthe difference between the totals for exports and imports.

By taking the difference between the factor content of exports and thefactor content of imports, we obtain the factor content of net exports, shown

in the final column of Table 4A-1.

K TA P P E N D I X T O C H A P T E R 4

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K e y T e r m

The Sign Test in the Heckscher-Ohlin ModelThe Sign Test

Sign of (countrys % share of effective factor % share of world GDP)= Sign of countrys factor content of net exports

We make use of the factor content of trade in developing a

test for the Heckscher-Ohlin model, called the sign test.This test states that if a country is abundant in an effectivefactor, then that factors content in net exports should bepositive, but if a country is scarce in an effective factor,

then that factors content in net exports should be negative.

A P P E N D I X T O C H A P T E R 4

K e y T e r mA P P E N D I X T O C H A P T E R 4

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Chapter4:TradeandResources:TheHecksc

her-OhlinModel

K e y T e r m

The Sign Test in the Heckscher-Ohlin ModelThe Sign Test in a Recent Year

FIGURE 4A-2

The Sign Test for 33 Countries with Differing Technologies, 1990 This table

shows the sign test for the Heckscher-Ohlin model for 1990, allowing fordifferent technologies across countries. There are 33 countries included inthe study and 9 factors of production. All countries have more factorspassing the sign test than failing it, especially the low- and medium-incomecountries. These results show that the sign test holds true when we allowproductivities to differ across countries.

Note: The countr ies with low GDP per capita are Bangladesh, Pakistan, Indonesia, Sri Lanka, Thailand,Colombia, Panama, Yugoslavia, Portugal, and Uruguay. The countr ies wi th middle GDP per capita areGreece, Ireland, Spain, Israel, Hong Kong, New Zealand, and Austr ia. The countr ies wi th high GDP percapita are Singapore, Italy, the United Kingdom, Japan, Belgium, Trinidad, the Netherlands, Finland,Denmark, former West Germany, France, Sweden, Norway, Switzerland, Canada, and the United States.

A P P E N D I X T O C H A P T E R 4

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