This article has been written by Oishika Banerji of Amity Law School, Kolkata. This article discusses the Heckscher-Ohlin theory of international trade, which is one of the prime theories of economics according to which countries export goods and services that are the easiest and most plentiful to produce.

It has been published by Rachit Garg.

Introduction 

The post-World War II global economy is better characterised by the Heckscher-Ohlin (HO) model. It is predicated on the idea that trading nations will use similar production technology. Eli Heckscher and Bertil Ohlin, two Swedish economists, had the original idea in 1919. According to the Heckscher-Ohlin model of economics, nations should export the goods and services they can create most effectively and in large quantities. It is also known as the H-O model or the 2x2x2 model, and it is used to assess trade, particularly, the equilibrium of trade between two nations with different skills and natural resources. According to the theory, which is a comparative advantage theory in economics, nations with relatively abundant capital and relatively insufficient labour will tend to export capital-intensive goods and import labour-intensive ones, whereas nations with relatively abundant labour and relatively insufficient capital will tend to export labour-intensive goods and import capital-intensive ones. The export of commodities requiring abundantly available production inputs is emphasised by the model. This article discusses the Heckscher-Ohlin theory of international trade in detail. 

What is the Heckscher-Ohlin theory of international trade

According to the Heckscher-Ohlin theory, what matters is the amount of capital per worker rather than the total amount of capital. A small nation like Luxembourg has more capital per worker than India, but has far less capital overall. Therefore, according to the Heckscher-Ohlin theory, Luxembourg will export capital-intensive goods to India and purchase labour-intensive goods in exchange.

In 1919, Eli Heckscher of the Stockholm School of Economics published a study in Sweden that served as the foundation for the Heckscher-Ohlin model. Further, in 1933, Bertil Ohlin, one of his students, contributed to it. Practical implementation of this theory can be seen, for instance, in the fact that some nations have significant oil deposits but very little iron ore. Other nations, however, have little in the way of agricultural production despite having easy access to and storage for precious metals. For instance, the Netherlands exported over $577 million in U.S. dollars in 2019 compared to imports of roughly $515 million in that same year. Germany was its principal import-export partner. It was able to manufacture and supply its products more successfully and economically by importing on a nearly comparable scale.

Paul Samuelson, an economist, developed the initial framework in essays published in 1949 and 1953. For this reason, some call it the Heckscher-Ohlin-Samuelson model. The Heckscher-Ohlin model provides a mathematical explanation of how a nation should manage its resources and conduct international trade. It identifies the desired equilibrium between two nations, each with their own resources. 

The factor endowment hypothesis was created and expanded upon by Heckscher’s pupil, Bertil Ohlin. In addition to teaching economics at Stockholm University, he was also a prominent politician in Sweden. He served in the Swedish parliament, the Riksdag, and led the liberal party for nearly 25 years. He served as the trade minister during World War II. Ohlin and James Meade shared the 1979 Nobel Prize for economics for their contributions to the theory of international commerce.

The model is not constrained to trade goods. It also takes into account additional production factors, such as labour. According to the model, as labour prices differ from country to country, those with inexpensive labour forces should concentrate primarily on creating items that require a lot of labour. Even though the Heckscher-Ohlin model seems plausible, most economists have had trouble locating supporting data. Other models have been proposed to explain why industrialised and developed nations have historically tended to trade more with one another and less with developing nations.

History behind the Heckscher Ohlin theory of international trade

1. Since 1933, the Heckscher-Ohlin model has been a particularly popular hypothesis of global trade. Since then, a large number of economists have examined the theory’s applicability to statistics on global commerce. Wassily Leontief conducted the most well-known test. To assess whether the United States was exporting capital-intensive items and importing labour-intensive goods as the theory would suggest, Leontief examined trade statistics from 1947. He made use of input/output tables for replacing American exports and imports. Leontief divided the 200 industries into 50 sectors.
2. He came to the conclusion that America was actually exporting labour-intensive items rather than capital-intensive ones in 1947 because he discovered that exports were 30% more labour-intensive than import alternatives. It was completely at odds with how people had perceived America’s capital endowments. He was the first to empirically examine the Heckscher-Ohlin model and his findings contradicted the model itself. 
3. Despite Leontief’s findings, the Heckscher-Ohlin model continued to be a significant contribution to the discipline for the following three decades. Still, economists held that the endowments of various nations had to affect commerce. People eventually began referring to his discoveries as the Leontief Paradox. This new conundrum sparked a number of additional testing of the H-O model by other economists as well as explanations for why the theorem failed.
4. According to Leontief, the United States actually has an abundance of workers because its labour productivity is three times higher than that of the rest of the world. Tests in subsequent years revealed that the paradox had diminished. Here are a few justifications for the Leontief Paradox:

• Leontief actually made an attempt to resolve the dilemma by claiming that American workers were more productive than those from other countries. Due to this, the United States exported items that required labour as opposed to goods that required capital.
• The topic of tariffs and transportation expenses was brought up as an additional justification. W.P. Travis suggested that the Leontief Paradox may have been brought on by tariffs. Then it was determined that only the volume of trade is truly impacted by tariffs rather than the flow. The fact that Leontief neglected to account for human capital is another factor that has been cited as a source of the conundrum. Resources, time, and investment are all required for human capital. The outcomes of his studies would have been significantly altered had he included human capital in the model.
• Using trade statistics from 1962, Robert Baldwin discovered that American imports required 27% more capital than an American export. Tatemoto and Ichimura conducted a test in the 1950s, when Japan was a labour-rich nation, and discovered that the country’s overall trade did not follow the H-O model. 
• Japan purchased labour-intensive items while exporting capital-intensive ones. They discovered that it was consistent with the H-O model when they tested solely the Japanese and American commerce. Baldwin investigated India’s global trading patterns. He discovered that India’s exports required a lot of labour, which was in line with the Heckscher-Ohlin theory. He discovered that India was exporting capital-intensive commodities and buying labour-intensive goods when he used his criteria on merely trade between the two countries. This contradicts the H-O model.

Components of the Heckscher Ohlin model

The Heckscher-Ohlin-Vanek Theorem, which forecasts the factor content of commerce, has garnered attention recently. This is because it is challenging to predict the patterns of trade in a world with many different items. There are four major components of the Heckscher-Ohlin model:

Stolper-Samuelson Theorem

1. The Stolper-Samuelson Theorem, which was created by these two authors, is based on the following key presumptions:

• One of the two trade nations under consideration for the analysis solely manufactures steel and fabric and uses labour and capital as its only two inputs.
• The first-degree homogeneity of the production functions for the two commodities is present. It suggests that consistent returns to scale control production.
• Capital and labour are both fully used.
• The availability of the two production factors is fixed.
• Both the product and factor markets meet the requirements for perfect competition.
• The given nation has a surplus of labour but a shortage of capital.
• Steel is a capital-intensive good, whereas cloth is a labour-intensive good.
• The rules governing international trade are set.
• Neither good serves as an input in the manufacture of the other good.
• Although both criteria are transferable across two businesses or sectors, they are not transferable between two nations.
• There are no transportation expenses.

2. According to the Stolper-Samuelson theory, a country with two commodities and two factors will see a greater than proportionate increase in the price of the associated “intense” factor. On the other hand, Rybczynski establishes the hypothesis that, in a country with two commodities and two productive factors, an increase in the labour force combined with a constant aggregate endowment of the other productive factor leads to an actual decline in the total output of the other commodity and a greater than proportionate increase in the output of the labour-intensive commodity when the terms of trade are held constant.
3. The Stolper-Samuelson Theorem leads to some important implications that has been laid down hereunder:

Increase in welfare

Trade results in an improvement in the welfare of the production component that is heavily utilised in the growing industry at the expense of the scarce factor. Overall, there has been a net improvement in the community’s welfare.

A better income distribution

Trade increases the proportion of plentiful factors in the GNP (Gross National Product), which improves the equity of income distribution.

Promotional export strategy

The theory has a significant policy application in that it suggests that export promotion, as opposed to import substitution, is a better strategy for achieving development and equal income distribution in less developed nations.

Impact of tariffs and other protective measures

According to the theorem, imposing tariffs and other punitive or protective measures will result in a decrease in imports. That will also reduce the chances of increasing exports. It will continue to keep the abundant factor’s real income at a lower level than the scarcity factor’s. The growth process will be halted as a result, and the income distribution will become unfair.

4. By authors like Kelvin Lancaster, Lloyd Metzler, and Jagdish Bhagwati, the Stolper-Samuelson Theorem was eventually questioned, altered, and expanded. Metzler abandoned the idea of fixed terms of trade and proposed that, given an inelastic offer curve from a foreign country, the imposition of a tariff would result in an improvement in the terms of trade of the country imposing the tariff through an increase in the internal price of the country’s export and a decrease in the internal price of the country’s import. As a result, fewer import alternatives will be produced, and money will be allocated so that it benefits the factor that is utilised more frequently in the manufacturing of exportable goods. The idea that protection would lead to an unfair income distribution was rejected by Kelvin Lancaster. Jagdish Bhagwati disagreed with the theorem’s general applicability. He talked about potential alternate consequences of protection on the wages of more heavily employed workers. The author wrote that “protection (prohibitive or otherwise) will raise, reduce, or leave unchanged the real wage of the factor intensity employed in the production of goods according to protection raises, lowers, or leaves unchanged the relative price of that good”.

Rybczynski Theorem

1. Tadeusz Rybczynski (1923–1998), an economist who was born in Poland, created the Rybczynski theorem in 1955. According to this, at stable relative goods prices, an increase in the endowment of one component will result in an absolute decrease in the output of the other good and a more than proportional expansion of the output in the sector that employs that factor heavily. 
2. According to the Rybczynski theorem, there is a direct correlation between changes in a factor’s endowment and changes in the output of a product that heavily depends on that factor. According to the Rybczynski theorem, changes in a factor’s endowment have a negative impact on the output of a product that does not heavily utilise that factor.
3. When full employment is maintained, the Rybczynski theorem illustrates how changes in an endowment impact the outputs of products. In the context of a Heckscher-Ohlin model, the theorem is helpful in examining the consequences of capital investment, immigration, and emigration.
4. Open commerce between two regions frequently results in changes in the relative factor supply between the regions, according to the Heckscher-Ohlin model of international trade. The amounts and types of outputs between the two regions may change as a result. The Rybczynski theorem explains both the results of an increase in the supply of one of these factors and the impact on the output of an item whose production is dependent on the opposite element.
5. The Heckscher-Ohlin model’s most basic iteration, the Rybczynski theorem implies that two items, like automobiles and textiles, are produced utilising the same two-factor inputs, such as labour and capital, but in different proportions depending on the industry. The auto business is said to be a capital-intensive industry if it employs a larger capital-to-labour ratio than the textile industry, which is referred to as a labour-intensive industry. The production possibility frontier moves outward when either factor’s supply rises while keeping the other’s supply constant, according to the model’s normal assumptions. As a result, the economy can now produce more of both goods. Prior to Rybczynski’s contribution, the majority of economists assumed that this type of biassed growth would lead to higher equilibrium outputs of each good, though with relatively greater growth of the industry that uses more of the growth factor.

Heckscher-Ohlin Trade Theorem 

1. The traditional comparative cost theory was unable to adequately explain why the comparative costs of producing different goods varied between nations. The novel hypothesis put out by Heckscher and Ohlin probed the fundamental factors that influence variations in comparative costs. They clarified that the disparities in comparative costs are due to variances in the factor endowments of various countries and the various factor ratios required to produce various commodities. Therefore, the Heckscher-Ohlin theory of international trade is the name given to this novel theory. 
2. Heckscher and Ohlin’s explanation of international commerce is widely accepted among contemporary economists, hence the theory is also known as the modern theory of international trade. Additionally, this theory is often referred to as the General Equilibrium Theory of International Trade because it is based on a general equilibrium analysis of price setting. It is important to note that Ohlin claims there is no fundamental distinction between domestic (inter-regional) and international trade, in contrast to the perspective of classical economics. He is correct in saying that inter-regional trade is only a specific case of international trade.
3. Ohlin argues that while transportation costs are included in domestic inter-regional trade, they do not serve as a defining factor in separating domestic trade from international trade. Trade is possible because the value or purchasing power of different currencies is determined by their relationship to one another through foreign exchange rates.

Factor Price Equalisation Theorem

1. The factor-price equalisation theorem is the fourth significant theorem that results from the Heckscher-Ohlin model. The theorem simply states that as countries transition to free trade and the prices of the output goods are equalised between them, the prices of the factors (labour and capital) will also be equalised. 
2. The implication is that free trade will globally equalise both worker salaries and capital rents. The model’s most crucial premise that the two nations have the same manufacturing technology and that markets are perfectly competitive is where the theorem stems from.
3. The value of a factor of production’s marginal productivity determines the return on investment in a market with perfect competition. The amount of labour being employed and the amount of capital both affect a factor’s marginal productivity, such as labour. The marginal productivity of labour decreases as the amount of labour in a certain industry increases. The marginal productivity of labour increases as capital increases. 
4. Finally, the output price that the good in the market commands determines the value of productivity. In autarky, the pricing for the output goods is different in the two nations. Because it influences marginal productivity, a difference in pricing alone can lead to variations in wages and rents between nations. The variance in wages and rents, however, also has an impact on the capital-labour ratios in each industry, which in turn has an impact on the marginal products, in a variable proportions model. 
5. All of this indicates that the wage and rental rates will vary between nations in autarky for a variety of reasons.
6. The two nations’ production prices will be equal once unrestricted trade in goods is permitted. Since the marginal productivity relationships between the two countries are the same, only one set of wage and rental rates can fulfil these relationships for a certain set of output prices. As a result, free trade will equalise the cost of commodities as well as wage and rent rates.
7. Both nations will use the same capital-labour ratio to create each good because they have the same salary and rental costs. However, the countries will generate different amounts of the two things since they continue to have differing amounts of factor endowments. 
8. In contrast to the Ricardian model, this outcome states that the two nations’ production technologies are thought to differ. Real wages continue to differ between nations even after they adopt free trade as a result; the nation with the highest productivity will have higher real wages.
9. It might be challenging to determine whether production technologies are unique, comparable, or distinct in the actual world. One could contend that cutting-edge capital can be sent anywhere in the world if equivalent industrial technology is used. On the other hand, one may argue that just because two pieces of equipment are comparable, it doesn’t necessarily follow that the workforce will use it in the same way. Differences in organisational skills, work habits, and incentives will probably always exist.
10. One way to translate these model results into reality is to claim that, to the degree that nations have comparable production capacities, factor prices will tend to converge as freer trade is achieved.

Purposes of the Heckscher Ohlin theory of international trade

The approach emphasises how when each nation makes the greatest effort to export commodities that are domestically naturally abundant, everyone benefits globally and through international trade. When nations import the resources they lack natively, everyone wins. A country can benefit from elastic demand since it need not rely entirely on domestic markets. As additional nations and new markets grow, labour costs rise and marginal productivity falls. Trading globally enables nations to adapt to capital-intensive manufacturing, which would be impossible if each nation exclusively sold goods domestically. 

Additionally, it highlights the importation of items that a country cannot produce as effectively. It advocates for nations to export commodities and resources they have an excess of while proportionately importing those resources they require. Some nations have a relatively high level of capital, which means that the average worker has access to a wide range of tools and machines to help with the job. These nations typically have high pay rates, which makes it more expensive to produce labour-intensive commodities like textiles, sporting goods, and basic consumer electronics than it would be in nations where there is a surplus of labour and low wage rates. 

Conversely, in nations with cheap and abundant capital, items like automobiles and chemicals that require a lot of capital but little labour tend to be relatively inexpensive. Therefore, nations with a lot of capital should be able to create capital-intensive commodities fairly cheaply and export them to cover the cost of importing goods that require a lot of labour.

Assumptions made by the Heckscher Ohlin theory of international trade about the world economy 

The seven assumptions that were put forth by the Heckscher Ohlin theory of international trade about world economy have been listed hereunder: 

1. Consumers deal with the same preferences and consumption functions;
2. All nations use the same production technology;
3. While the marginal returns to any one factor are declining, the output yields constant returns to scale;
4. The technical costs of capital and labour per unit differ between the items;
5. Perfect competition is the foundation of the markets;
6. There are no restrictions on foreign trade; and
7. The availability of resources is fixed to a certain degree and is the same across all nations.

Heckscher Ohlin’s theory of international trade in India

Indian emergent markets have grown recently. Trade between major industrialised nations like the United States and other European nations is largely to blame for this. Traditional village farming, modern agriculture, a wide range of contemporary businesses, and a significant quantity of services are all part of India’s varied economy. America and India currently have close cultural, strategic, military, and economic ties. The Heckscher-Ohlin theorem is one hypothesis that analyses the trade between two nations.

The 1990s saw the country start to grow very quickly as markets opened up to foreign competition and investment. India is growing economically and has abundant natural and human resources. India’s economic growth rate was accelerated in the 2000s by economic reforms and stronger economic policy. India’s economy is primarily a domestic market, with 20% of its GDP coming from exports. China, the United States, the United Arab Emirates, the United Kingdom, Japan, and the European Union are India’s top trading partners. India’s economy is primarily a domestic market, with 20% of its GDP coming from exports. China, the United States, the United Arab Emirates, the United Kingdom, Japan, and the European Union are India’s top trading partners.

The capital/labour ratio is the portion of capital to labour employed in a production that is described in the Heckscher-Ohlin model. Thus, the capital/labour ratios of various industries producing various items will vary. Each nation produces two items in the model, hence it must be assumed which industry has a higher capital-to-labour ratio. For instance, if a nation can produce both steel and clothing, and the production of steel requires more capital per worker than the manufacturing of clothing does, then we would say that the production of steel is more capital-intensive than the production of clothing.

Comparison between India and the United States with regards to the application of the Heckscher Ohlin theory 

As India and the United States are two different economies, with the former being developing and the latter exceeding the developed one, a comparison between the two can help the reader distinguish between the theory’s application in economies belonging to different spectrums. 

When compared to its workforce, the US possesses a large amount of physical capital. Developing nations have a sizable labour force despite having little physical wealth. Then, to determine the relative factor abundance between nations, we would use the capital-to-labour ratio. For instance, the United States has a higher ratio of total capital to labour than India. Accordingly, we may claim that the United States has more capital than India. India would be more labour-abundant than the United States because of its higher ratio of total labour to capital. The model presupposes that the only distinctions between the two nations are their varying relative endowments of production components.

Based on the characteristics of the countries, the Heckscher-Ohlin theorem predicts the pattern of commerce between them. A country with an abundance of capital is said to export goods that require a lot of capital, whereas a country with an abundance of labour will export goods that require a lot of work. The reason for this is that a country with an abundance of capital generates goods that require significantly more capital during manufacture. As a result, if the two countries stopped trading, the cost of goods in the country with ample capital would decrease due to the increased availability of goods.

This will be contrasted with the cost of identical goods in the other nation. The cost of labour-intensive goods will be the same everywhere there is an abundance of workers. Businesses will relocate their products to markets with higher prices once commerce between the two nations is open. Because the capital-intensive goods will temporarily cost more in the other country, the capital-abundant nation will export them. The labour-intensive goods will be exported from the country with an abundance of workers since the price will temporarily be higher in the other country.

Challenges surrounding the Heckscher Ohlin theory of international trade

The Heckscher-Ohlin theory is frequently at odds with the actual patterns of international trade, despite its plausibility. Wassily Leontief, a Russian-born American economist, carried out one of the earliest studies on the Heckscher-Ohlin hypothesis. Leontief noted that the United States had a respectable amount of capital. Therefore, the reasoning goes, the United States should export commodities that need a lot of capital and import goods that require a lot of labour. He discovered that the contrary was true: American exports typically require more labour than the kinds of goods that the country imports. The Leontief Paradox refers to his results since they were the exact reverse of what the theory predicted.

The Heckscher-Ohlin theory has undoubtedly been shown to be more accurate, precise, scientific, and analytically superior than the prior approaches to the theory of international trade, but it still has several flaws that have led to criticism from numerous writers.

1. Although Ohlin’s theory was acknowledged by Haberler to be less abstract, a general equilibrium idea was never developed. It still mostly falls under the partial equilibrium analysis. This theory ignores a number of additional effects, including transport costs, economies of scale, external economies, etc., which also have an impact on the cost of production, in favour of attempting to explain the pattern of trade simply in terms of factor proportions and factor intensities. When multiple factors are simultaneously affecting costs, according to Ellsworth, “it becomes a matter of adding up the influence of all cost-reducing and rising forces to arrive at a net outcome.”
2. This theory is built on a set of very oversimplified premises, including perfect competition, resource utilisation at 100%, a production function that is identical, constant returns to scale, the absence of transit costs, and the lack of product differentiation. This collection of presumptions renders the entire model wildly unrealistic.
3. Given production functions, incomes, and expenses, the Heckscher-Ohlin model makes the assumption that fixed amounts of production elements exist. This indicates that the theory examines the course of global trade in a fixed environment. Simply put, the results reached from such a study do not apply to a dynamic economic system.
4. According to this idea, factors are identical on a qualitative level and may be precisely measured in order to determine factor endowment ratios. However, there are variations in qualitative factors in the real world. Furthermore, each element comes in more than one variation. This poses significant challenges for both determining the trade pattern and measuring and comparing expenses.
5. The hypothesis ignores the part that product differentiation plays in global trade. Due to product differentiation, international trade may still occur even though the manufacturing agents are the same in two nations. For instance, American machines are sold out in Japan, whereas Japanese machines are sold out in the United States. According to Wijanholds, factor prices do not impact costs in this situation. Instead, factor prices are determined by commodity prices. According to the HO hypothesis, the export specialisation of various nations is determined by the relative factor proportions (or factor endowments). Labour- and capital-intensive items are exported by countries with ample capital, but the former also export capital-intensive goods. It suggests that trade between nations or regions with comparable relative factor proportions will not occur. However, this is untrue.
6. Prices of variables like raw materials, labour, etc., are ultimately dependent on the demand and prices of finished items because the desire for them is the derived demand. Prices of goods are decided by their utility to the buyers (the force of demand). Thus, according to Wijanholds, “prices are the only facts we can accept. Everything else should follow from that. He believes that the Heckscher-Ohlin theory and the Ricardian theory are both flawed because they overlooked the impact of product differentiation on global commerce and linked cost to factor prices”.

Conclusion 

Even though the H-O model has undergone several tests over the years and has produced a wide range of outcomes, there is still much we may learn about the theory. Numerous economists have attempted to refute the model, yet the theory is still relevant in economics. Since there is no method for calculating a country’s capital, as many studies have noted, calculating the factor abundance ratio for a country is still exceedingly challenging. Before measurement of labour and capital levels within a particular good is especially challenging. The fundamental presumptions of Heckscher-Ohlin are contested by some. They contend that the model is oversimplified because it makes the assumption that there are no technological distinctions between nations, even though we all know that there are. The model is still helpful in international economics, despite the many criticisms.

References 

1. https://www2.econ.iastate.edu/classes/econ355/choi/ho.htm.
2. https://scholarworks.calstate.edu/downloads/r494vn21h.

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