HECKSCHER-OHLIN

2 THEORY
2.1 Introduction
2.2 General Equilibrium Approach
2.3 Heckscher-Ohlin Theory/Modern Theory
(a) Factor Intensity
(b) Factor Abundance

(i) In Physical Termns

(ii) In Terms of Factor Prices
2.4 Limitations of Heckscher-Ohlin Theory
2.5 Comparison Between Ricardian and Heckscher-Ohlin
Theory

2.1 INTRODUCTION
The drawbacks of the classical theory of international trade induced
the Swedish economist Prof. E. Heckscher (1919) to develop an
alternate explanation of comparative advantage theory. His theory

improved by his pupil Bertil

further Ohlin (1933). Hence it is
was
known as Heckscher-Ohlin (H-O) theory.
is need for
(H-O) theory argues that there
no a
fHeckscher-Ohlin
to it,
theory to explain international trade. According
Separate trade. Factor
International trade is but a special case of interregional
 2.3 HECKSCHER -OHLIN THEORY/MODERN
THEORY
The Modern or Heckscher -

(H-O) Theory explains the new

Ohlin
advantage on the basis of general value
approach to comparative
work together in general equilibrium,
theory. From all the forces that
H-O theory isolates the differences in the physical availability
or

of factors of production among the nations to explain the

supply trade between the
difference in relative commodity prices and
countries. According to the theory "a nation
will export the
whose production requires the intensive use of the
commodity and import the
nation's relatively abundant and cheap factor
whose production requires the intensive use of the
commodity
mation's relatively scarce and expensive factor".
HO theory explains the modern approach to international theory
on following assumptions:
the basis of the

1There are two countries, each having two factors (Labour and
capital) and producing two commodities.
and factor
2 There is perfect competition in both commodity
markets.
All production functions are homogeneous of the first degree
1.e. production is subject to constant returns to scale.
Factors are mobile within the country and immobile between
COuntries. In international trade commodities move between
the countries instead of factors.
5. The two countries differ in factor
supply
 BustncEconomics-VI(T.YBCom SEM

Each commodity differs ir

tactor intensity.
6.
commodities but are
differs be t w e e n the
Factor intensity
countries for each commodity 1.e. good
t X is labo
in both However goods X
countries. and
intensive, it will be so in both
in the same country.
Y ditter in factor intensity
exists in both eronomiess
tactors
S. Full emplovment of
no trade restrictions in the torm of
Trade is free i.e. there are
taritts or non-taritt barriers

cost.
10. No transport
it can be stated ihat (i each
On the basis of the above assumptions differs in
each country tactor
commodity differs in factor intensity (1)
endowments leading to differences in
tactor prices. It is therefore
understand the above terms factor intensity and factor
necessary to
abundance in order to explain H-O theory.

(A) FACTOR INTENSITY:

model, commodity Y is capia

In our two country two commodity ot Y s
intensive if the capital-labour ratio (K/L) in the production
with
greater than K/L used in the production of X. To explain an

example, if commodity Y requires 2 units of capital (28) andunis

of labour (2L), the capital-labour ratio (K/L) tor producing

commodity Y is 2/2=1. For commoditv X, it the required inpus an

iK and 4L, the capital-labour (K/L) ratio is 1/4.

The ratios can be stated as

ForCommodity Y, the K/L =

2K/21 =1
For Commodity X, the K/L = 1K/4L = 1/4

Here commodity Y is capitalintensive and N is labour intensive

shown in table 2.1.

Table 2.1

Commodity Capital Labour K/L Ratio

2
1/4
Heckscher-(Hlin Theory 17
Capit or labour intensity is not measured in absolute terms but by
the ratio i.e. units otcapitalper labour or units of labour per capital.
In our example, K/lL ratio tor Y is 1 and for X is 1/4.

Instead, if units ot capital and labour used in the production of Y

are 2K and 2L where as tor A, K and 12 L, commodity Y still remains
capital intensive though X requires more capital in absolute terms
ie. 3K. Capital used per labour in the production of X is 3K/12L i.e.
3/12 1/4. Where as for Y it is 2K/21L =1 as shown in table 2.2.
Table 2.2

Commodity Capital Labour K/L Ratio

2 2
12 1/4
Factor intensity, therefore is measured by the factor ratios and not
by absolute units.

In our example of two commodities, two factors and two countries,

we say commodity Y is capital intensive if capital-labour ratio
(K/L) of Y is greater than the K/L ratio of X. To illustrate the point
let us say that production of one unit of Y requires two units of

capital (2K) and 2 unit labour (2L). The capital-labour ratio (K/L) of
Yi 2/2 = 1. Similarly, if the production of X requires 3K and 12L,
the capital-labour ratio of X is 1/4. Here we say Y is capital intensive

and X is labour intensive.

It 15 to be noted that goods are not categorised based on absolute

ot a
guantity units of capital and labour used in the production
or
unit of a good Y or X but the ratio of capital-labour of each

Commodity. For example if Y requires 5K and 51L and X requires 6K

l , here good X requires more capital in absolute number than
Y. Yet in terms of ratio, it is Y which is capital intensive (5/5= 1)
where as X is l a b o u r i n t e n s i v e ( 6 / 2 4 = 1/4).

Based on "International Economics" by Dominic Salvatore, let us

the term factor intensity with the help of tollowing

nderstand
diagrams.
 Business Economics- VI (T. Y.B.Com.: SEM.t
18 1-VI
Country A

inY1

IY 2x
inx-
X
2 3 4 5 6 7 8 9 10 11 12
Labour
Fig. 2.1 (a)

K Country B

9
in Y=4
8 2Y

inX 1
IY

2 3 4 56
Labour
Fig. 2.1 (b)
In Fig.2.1 (a) and (b), countries A and B are
one unit of Y is shown. In
country A
with
produced with the help of 2K and
is
capital-labour ratio of 1. X in A is 21. (1/1 1) that =

capital-labour ratio of 1/4.produced by using IK a

4L (1/4) that is

Similarly in country B, Y is
with the K/L ratio
of 4. produced by using 4K and 1L thnat
The ratios are
given by the slope of the ray from the
commodity shown in
the diagrams. origin tor each
e
From the
K/L ratio, it ca n be
 19
Heckscher-Ohlin Theory
intensive and commodity
that commodity Y is capital
understood in both the countries. Country B uses more

intensive
Xis labour commodities than country A, which
of both
the proxduction
capital in production of both
Y and1X.
more
labour in the
uses

(B) FACTOR ABUNDANCE:

Terms
Abundance in Physical
Factor
more natural
endowments. Some have
ditter in tactor more of capital. A
Nations and others
more ot labour
have
resources,
some
be defined either
in physical
abundance can
country's factor two country model,
given
of relative factor prices. In o u r total
terms or in terms terms the ratio of
abundant, if in physical that is
country I is capital amount of labour (TL)
to the total
of capital (TK)
amount
TK1 K2
TL, I t
1 is greater than nation 2 1.e. TL.
(TK/TL) in nation and
the absolute amount of capital
that it is not
should be noted to the total
amount
total a m o u n t of capital
labour but the ratio
of the
of capital than
1 have a lesser quantity
of labour. Country
may a b u n d a n t if TK to
TL in
1 will be capital
country 2, yet country in
than country 2.
country 1 is greater the
terms can also
be explained with
Factor abundance in physical frontier, as
c u r v e OR production
possibility
help of production
shown in Fig. 2.2.

(Capital) Y Country
P

Country I1

B Labour)
Commodity X

Fig. 2.2
 (T. Y.B.Com
usiness
Economies
- VI

the
SEM-V
20 countryI
is capital
abundant,
ards Y-axis. Cou
refore, its
above diagram, skewed towar
is
In the
possibility
curve

production
possibility r
production
its
accordingly
abundant,
is
labour
s k e w e d t o w a r d s X-axis.

In ourexample:
intensive.

Y is capital
Commodity

intensive.
labour
Commodity
X is
countr more than
CA quantity
OA of Y i.e.
Country I can produce c a n produce OD of X, i.e. BD quantity more
II which is labour
II. Similarly country m o r e ot X
II can produce
than country I. Country abundant country and country I can
intensive because
it is a labour
intensive due to its abundant
more of Y
which is capital
produce
capital.
and PP, in countries I and II. The
The domestic price lines are PP,
of production
points E and Qare the respective equilibrium points
and P, indicate that commodity
and consumption. The price lines P, the basis tor
Yis cheaper in country I and X in country II,
providing
trade
Factor Abundance in Terms of Factor Price

The cause of international trade is the difference in commodity pre

Price of commodity differs because of cost of production whicn
turn depends on factor prices.It is therefore necessary to expla
factor abundance theory in terms of factor prices.

A nation is capital abundant if the ratio of the capital price to tn

labour price (PK/PL) is lower in it than in the
other.
It can be stated as:

PL P2
The two definitions give us the same hysic
abundance explains the
supply side. The
meaning. The
price ratios are o
 21
Heckscher-Ohlin Theory
of demand for and supply of
determined by the
the prices tactors derived from
demand for factors is derived demand i.e.
factors. The of the factors.
the demand
for commodities produced with the help
to be the same in
our two
nations model, demand is assumed
In units of
both the nations. In a country where the supply of physical
to be lower in comparison to the
capital (K) is more, its price has
(r) is
in nation 1, the price of capital i.e. interest
other factor (L). If nation 2, r is more
ot labour i.e. wage (w) and in
less than the price
1< Here nation 1 is a capital
then we have
than w,
W1 W2
abundant country.
can be explained with the help of Fig. 2.3.
Above aspect

Ihten
c a pa
TCR E. ecom
mad4-

L-i

R ****. 3 m nb
s
d1o h k

1a

Apr
"
----*-----.*
M
L
M,0, LQ B
X

Labour
Fig. 2.3
In Fig. 2.3 there are two commodities a and b shown by the two
IS0quants aa and bb. There are two countries i.e. I and II. Commodity
d 1s capital intensive and b is labour intensive. The relative tactor

the factor line PL. Assuming that

price in
country I is given by price
the isoquants represent 1 unit of commodity a and b, country I

Tequires ON of capital and OM of labour to produce 1 unit ot a at

pOint E, the point of tangency between isoquant aa and tactor price
 RusnessFoms VT(T VBCom. SEM VD
line P'1 Similarly. commmality b is produced with ON, f capital
and OM, ot Lalaur. It oould b* observed that in country I capital is
cheaper than labur as morecapital ( ) is available than labou
) . Theretore country I special1ses in the production of commodity

whuh i18 apital intensive.

a

untry IIs pruv linc i8

gIVen by B. For cOuntry Il to produce
mmaiitv bit ruires OR of capital ant OQ ot Labour.

To tind out the requirements to proctuce comnodity a, in country

wedraw a tactor prie l i e CDparallei

to AB, which is
tangent to aa
at point
S It tells us that to proluce conmodity a, country requines
OR, ot capital and OQ, ot labour. Country ll's capitalavailabilityis

less (OA) than capital required {OR,)

to
produce commodity a. As

labur intensiVe, country 1l which is labour abundant

mmadity b is
Country ll being capital
will sperialise in commodity b. a scarce

in the production of commodity a which

country it can not specialise
Factor prices are low tor capital in country
nquires nmore capital. ot
Il as it can be understood by their
I and tor labour in country
tactor price lines PL and
AB CD. It is therefore, natura
=

respective
tor country I to specialise in commodity a which requires mor
it is available in plenty in country I making it cheap
capital and labour which it
Country Il specialises in b which requires more has
in abundance making it cheaper than capital.

From our above discussion we can derive the following

conclusions:

some have
in factor endowments,
1)Each country differs and others have
abundant labour, some possess plenty of land

huge amount of capital and so on.

11) Each country production of that commodity

specialises in the
which requires more of its abundant factor.
1) Abundance of a factor makes it cheaper in terms of its price

L o w tactor prices result in low cost of production and in u

low commodity prices.

L o w ommodity price is the basis of international trade.

Heckscher-Ohlin Theory

2.4 LIMITATIONS OF HECKSCHER -OHLIN

THEORY

Unrealistic Assumptions : The Heckscher Ohlin theory

intended to provide a better explanation of international trade
by analysing its cause. However, this theory too, like Ricardian
theory, is based on
many unrealistic assumptions. Besides the
usual assumptions of two countries, two commodities, perfect
competition, no transport cost etc. the theory also assumes no
qualitative difference in factors of production, identical
scale and All these
production function, constant return to s o on.

assumptions make the theory unrealistic.

Static in Nature: Like the Ricardian Theory the H-O model is

2 of
also static in nature. The theory is based on a given state
and does not
economy and with a given production function
accept any change.
Demand Condition Neglected: Like the classical theory, Ho

theory also emphasises on supply conditions. The supply of

the factor determines its price and also specialisation in the

production by a Demand is assumed to be the same. If

country.
changes in demand is accepted then the position of abundance,
If the
Scarcity and factor prices would undergo change.
a

implications of changes in demand are incorporated

specialisation would experience a change.

4 Leontief Paradox American economist W.W. Leontief

:
empirically tested H.O. theory under U.S.A. conditions.
According to H.O. theory, U.S.A being a capital abundant
cOuntry must export capital intensive goods and import labour
them at home (labour is scarce
intensive goods than produce
hence costly in U.S.A) Leontiel, however, through his empirical
study found out that U.S.A exports labour intensive goods and
imports capital intensive ones, this situation is called Leontief
paradox! which negates H.O. theory.
5. Other Factors Neglected: Only two factors are considered in
the production function of 14-O theory. There are many other
 SEM-VD
Rusiness Economics -VI(1.Y.B.Com.
4
qualities of
diterent
factors like technology, natural tactors,
ot production and hence
intluence the cost
labour etc. which
commodity prices.

Commodity
Prices Neglected : According to
H.O. theorv
o. depend on tactor prces therefore, the cause
ommodity prices
trade is the difference in tactor prices. Critics,
of international
out that the
demand tor a tactor is a derived
however, point commodities that
it is the demand tor
demand. Theretore,
intluence the price ot factors and not the other way round.

BETWEEN RICARDIAN
2.5 COMPARISON
-OHLIN THEORIES
AND HECKSCHER

Ricardian Theory H.O. Theory

Two Countries
(1) Two Countries
Two Commodities
Two Commodities
Two Factors
One Factor (Labour)
2-2-1 Model 2-2-2 Model
the
Factor abundance is
2) Labour is the responsible
responsible factor.
factor for comparative

advantage. terms of (money)|

in
in ternm of labour Expressed
3) Expressed
theory of value. price theory.
International trade
is a special
(4) International trade requires inter-
extension ot
a separate theory tor case or

regional trade.
explanation. It is
Neglects space element it Space aspect is considered.
(5)
-

a multi-market theory.
is one market theory.
is
Ditterence in labour efficiency| Difference in factor suppiy
(6)
Is taken into account. taken into account.

(7) Adopted a normative Adopted a positive approach

approach concentrating on and explained the causes of
welfare aspect. trade.