The Heckscher-Ohlin model is named after Swedish economists Bertil Ohlin and Eli Filip Heckscher. Ohlin, who developed the model while a student of Heckscher, won the Nobel Prize for Economics in 1977. The Heckscher-Ohlin model is an economic theory suggesting countries only export what they can produce efficiently and in sufficient quantity.
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Understanding the Heckscher-Ohlin model
In general terms, the Heckscher-Ohlin model is a theory of international trade suggesting nations with relatively plentiful capital and relatively scarce labor will tend to export capital-intensive products and import labor-intensive products.
Conversely, a nation where labor is relatively plentiful and capital relatively scarce will tend to export labor-intensive products and import capital-intensive products.
Wealthy nations have access to more capital, which means workers are assisted by equipment and technology.
As a result, the cost of producing labor-intensive goods tends to be higher than in poorer, less advanced countries with plentiful labor and lower wages.
By the same token, goods requiring more capital and less labor tend to be cheaper in wealthy countries because the cost of paying employees is reduced.
This leads to a situation where a wealthy nation can produce capital-intensive goods more cheaply than a poorer country.
These goods are then exported to the poorer nation to pay for the import of labor-intensive goods in return. In theory, this should be a mutually beneficial arrangement for both parties.
The two assumptions of the Heckscher-Ohlin model
The model makes two major assumptions that are worth mentioning.
Firstly, it assumes each country in a trade arrangement will differ according to the factors of production it has available.
For example, one country may have a large and uneducated population with an abundance of labor and land but relatively less access to capital.
The other country may have access to capital and be technologically advanced, but have less access to land and a smaller workforce.
Secondly, Heckscher and Ohlin assumed that different countries have the same preferences for one good over another.
With preferences being equal, it is the relative cost of production (and not the relative demand) that drives how much of a good is produced and consumed before being traded.
Using these assumptions, model posits that countries with an abundance of land, labor, or capital will have a comparative market advantage for the goods produced over other countries.
The country is the largest exporter in the world because petroleum is a capital-intensive resource that is easy to extract – which reduces labor costs.
In other words, Saudi Arabia has an advantage over competing nations because it can export petroleum more efficiently and in greater quantities.
Criticisms of the Heckscher-Ohlin model
Despite the model appearing plausible on paper, it frequently differs from actual patterns of dynamic international trade.
This occurs when a government is lobbied by a group or body to protect its interests through tax breaks, extra duties, or bans on imported products.
This may result in a wealthy nation exporting labor-intensive products and importing capital-intensive products, instead of the more economically viable reverse.
Assumes all workers are employed
In other words, the model does not account for the prevalence of unpaid work in poorer countries which reduces labor costs.
Assumes that production is equal
Rather unrealistically, Heckscher and Ohlin suggest every nation has the same level of production technology.
This ignores the major discrepancies in technological innovation and design between some countries.
Ignores trade between two wealthy countries
The model implies that trade will not occur between two capital-intensive nations, despite obvious evidence to the contrary.
Indeed, a significant proportion of world trade occurs between the United States and the countries of Western Europe.
In this case, comparative advantage is driven by transport costs, economies of scale, and cost or price differences.
Ignores factor mobility
Both capital and labor can move between countries, which the model does not consider.
Capital moves from advanced countries to those with petroleum, mineral, or plantation resources, among other things.
Similarly, the large-scale movement of labor from third-world countries to much richer countries is well documented.
In the resource-rich nation of the United Arab Emirates, there are thought to be 8 million foreign temporary contract workers from poor nations such as India, Bangladesh, Nepal, Sri Lanka, and Pakistan.
Key takeaways
The Heckscher-Ohlin model is an economic theory suggesting countries only export what they can produce efficiently and in sufficient quantity. It was developed by Swedish economists Bertil Ohlin and Eli Filip Heckscher
The Heckscher-Ohlin model assumes international trade is mutually beneficial to both parties. It also assumes that the relative cost of production is the key driver of how much of a good is produced and consumed.
The Heckscher-Ohlin model has several limitations. It does not account for workers in poor nations who are not employed, which reduces total labor costs. Nor does it account for trade between two wealthy nations or the high mobility of capital and labor across international borders.
Key Highlights
Heckscher-Ohlin Model:
Named after economists Bertil Ohlin and Eli Filip Heckscher.
Suggests countries export goods they can produce efficiently and in abundance.
Highlights the importance of factor endowments (capital and labor) in determining trade patterns.
Factor Abundance and Trade:
Nations with abundant capital and scarce labor export capital-intensive products.
Nations with abundant labor and scarce capital export labor-intensive products.
Effect of Capital and Technology:
Wealthy countries have more capital and advanced technology.
Labor-intensive goods are costlier to produce in advanced countries due to higher wages.
Mutually Beneficial Trade:
Wealthy nations export capital-intensive goods and import labor-intensive goods.
Poorer nations export labor-intensive goods and import capital-intensive goods.
Should result in mutual benefits due to efficiency gains.
Two Major Assumptions:
Differences in factor endowments among countries.
Equal preferences for goods, focusing on relative production costs.
Rent-Seeking and Trade Distortion:
Model doesn’t account for lobbying efforts causing trade distortions.
Governments may protect specific interests through policies affecting trade.
Unemployment and Labor Costs:
Model doesn’t consider unemployment or unpaid labor in poorer nations.
Neglects the effect of unpaid work on labor costs.
Production Technology Assumption:
Assumes all countries have the same production technology.
Ignores technological disparities among nations.
Trade Between Wealthy Countries:
Model implies no trade between two capital-intensive nations.
Reality shows trade occurs due to transport costs, economies of scale, and price differences.
Factor Mobility Ignored:
Model overlooks mobility of capital and labor between countries.
Capital moves from advanced to resource-rich nations; labor migrates from poor to rich countries.
Real-World Example: UAE Labor Migration:
United Arab Emirates hosts millions of foreign temporary contract workers from poorer nations.
Capital and labor mobility contradicts the model’s assumption.
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