International Trade Essay

Hecksher-Ohlin Trade Theory

In the following essay I will look at how effectively the Hecksher-Ohlin trade theory explains trade flows between the economies of advanced industrialised countries and also what alternative theories may be considered.  To explain this I will look at the basic Hecksher-Ohlin model, the assumptions that it holds and also other theorists who have attempted to make this trade theory better.

The Hecksher-Ohlin model is an extension of the classical comparative advantage theory of free trade.

To begin analysing the model we need to first establish the assumptions which are related with it.  The assumptions we are going to make are additional to those previously created for the classical Ricardian model.  They simply cover the following factors:  skilled and unskilled workers, trade patterns, factor mobility and domestic factor prices.

The first assumption I will look at is taken from Husted and Melvin (2004), “There are two factors of production: labour (L) and capital (K).  Furthermore, owners of capital are paid a rental payment (r) for the services of their assets.  Labour receives a wage payment (w)”.

This assumption relaxes the assumption from the ones in the classical model, as they implied labour was the only factor of production, meaning that the amount of labour would be fixed at the same amount among countries.

The second additional assumption we are required to make is “the technology sets available to each country are identical” (Husted and Melvin, 2004).  

This assumption says that the way the good(s) are made will be the same.  Therefore they will have the same labour and capital ratio to produce the goods.  If in one country labour is cheaper than capital, they will produce the labour intensive good and export this in payment for the capital intensive good, which is usually produced by the partner country.

The third new assumption says,”in both countries, the production of textiles always requires more labour per machine than the production of soybeans.  The production of both goods in both countries is subject to constant returns to scale” (Husted and Melvin, 2004).

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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.

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