This assumption implies that the textile product is labour intensive and the soybeans are more capital intensive than textile. This assumes:
LT LS
_____ > ____
KT KS
This is the labour to capital ratio of both textile and soybeans. As this ratio changes so does the intensity of the factor. If the labour, capital ratio of soybeans increases this means that the intensity also increases. Constant returns to scale will occur when proportionate changes in the labour to capital ratio give equally proportionate changes in output. For example, if the ratio doubles, then the output will double.
The next assumption we are to add is also taken from Husted and Melvin (2004). “Countries differ in their endowments of factors of production, L and K. In our presentation we will assume that A is relatively capital abundant, while B is relatively labour abundant”.
Country A will in this case export their capital abundant good and this will pay for the import of country B’s labour abundant good. They will each import the ratio they need to fulfil the county’s demand for the good that they do not have a comparative advantage in. From this assumption we can show when a country is abundant in a good.
KA KB
______ > ______
LA LB
The final assumption we need to add is that, “tastes in the two countries are identical”. It simply states that where two countries have the same/similar income, they will also have the same/similar tastes. This means that the two countries will have the same indifference curves. The only difference is that when trade opens the labour intensive good will move down the curve, increasing prices and attracting more factors. Whereas the capital intensive good will move up the curve when trade opens, production will be stimulated, leading to an increased price of capital and a decreased price of labour. These can be seen below:
The Hecksher-Ohlin model can be called the 2x2x2 model, which comes from, 2 factors, 2 products and 2 countries. To construct this model, we need to use the assumptions I have just distinguished. We then need to look at the 2 countries, factors and products. To form the model we can use isocost and isoquant lines. For this model we have made the 2 goods, wine and cloth. Portugal is capital rich and UK is labour rich. This means that Portugal will export wine and import cloth, as wine is their intensive good. The UK will export cloth to Portugal and also import wine from Portugal. The graph assumes that technology is the same in both countries. Portugal has a comparative advantage of wine and the UK has a comparative advantage in cloth production. This is what the graph looks like:
This model shows the trade relationship between the UK and Portugal. At the top of the diagram, towards the left, we can see the capital, labour ratios of wine between the UK and Portugal, whereas on the right you can see the capital, labour ratios for cloth.
I will now go on to talk about Hecksher-Ohlin in terms of advanced industrialised countries. Wee can discuss this by looking at the Factor Price Equalisation, this will help us as we need to look at the country before trade begins as well as after trade begins.
Before trade begins, the w/r ratio is lower in the labour abundant country denoting that when trade opens this will cause expansion within the labour abundant country.
When trade begins there will be a convergence in prices, first leading to equalisation in w/r then in PL/PW. This equalisation will occur until the price equals the marginal costs for both countries. When equalisation occurs neither can hold a comparative advantage over the other, meaning no more expansion because product prices and factor prices are equal between countries. This then means that neither country will specialise in a particular product. If they do the good will become too expensive. We can also say that factor price equalisation will not occur in a country if complete specialisation does.
Now I will look at some of the many criticisms that are involved with the Hecksher-Ohlin trade theory. Many economists have tried to change so as it is able to explain trade flows better. The first economist that I will look is W. Leontief (1906-1999) one of the most followed and trusted economists. Leontief tested the Hecksher-Ohlin model by using his input-output analysis. He calculated the labour and capital content of US exports and used a proxy variable to find out the content of imports which would have occurred. He found that he wasn’t just simply testing for one hypothesis, but for a joint hypothesis, therefore requiring him to test for two hypotheses together. These were:
- Was Hecksher-Ohlin correct?
- Was the US more capital abundant than the countries with which it traded?
To find out this he used the following ratio; this allowed him to see if the hypotheses were correct.
Kx / Lx
_______ > 1
KM / LM
This ratio simply means the ratio of US exports divided by the amount of US imports. If the result is greater than 1 then the test has worked. But the results Leontief received first in 1953 for 1947 were wrong as they showed that the ratio equalled 0.77. This is the Leontief Paradox. He could not understand how this would not work. A criticism arose that the data used was too close to World War 2 and was not a typical year, so therefore was invalid. Leontief then conducted another test in 1956 from data in 1951, this time the results showed 0.945, which is still contradicting the Hecksher-Ohlin model.
He was still unsure as to why this test did not work. He suggested he needed to question whether or not, the US was more capital abundant than the countries with which it traded, was correct due to the assumption that the US was capital rich. He then found that US labour was 3 times more efficient than abroad. He then made them labour rich by increasing the labour force by three times, giving an increase in the US labour force.
Other critics also tried to test the Hecksher-Ohlin theorem. Peter Kennan (1965) thought that the best way to do this was to distinguish between skilled and unskilled labour, meaning the US had skilled labour which has been generated by the US education system and also Research and Development. He also said it would be better to treat skilled labour as a type of capital than a type of labour. This therefore makes the US capital rich again. By putting skilled labour as capital, it removes the Leontief Paradox.
To conclude I feel that the Hecksher-Ohlin model does not completely explain trade flows between advanced industrialised industries. I think I have fully covered the Hecksher-Ohlin model and feel it gives an insight to how effectively the model explains trade flows.
References
Husted, S. & Melvin, M. (2004), International Economics, 6th Edition, New York & London: Pearson, Addison-Wesley.
Lindet, P.H. & Pugel, T.A. (1996), International Economics, 10th Edition, Chicago & London: Irwin
www.econs.ecel.uwa.edu.au/235/IIT/Hecksher.html, Dr MoonJoong Tcha, 1997-2003, place not specified.