The Heckscher-Ohlin Theorem - YouTube

Let's now consider the Heckscher-Ohlin theorem.

This is basically a theorem about factor endowments.

So, how much capital or labor does a country have?

And how do those factor endowments shape the content of trade?

The simplest way to put the theorem is that countries

which are relatively capital-intensive will export captial-intensive goods.

Similarly, countries which are relatively labor-intensive

will export labor-intensive goods.

The intuition here really is pretty simple

and it's that factor endowments should matter.

So, imagine you had a country which quite easily grew lots of corn.

What you might you expect that country to export?

Well, possibly corn.

Now lets look at some of the underlying assumptions behind the theory.

So, in the core model, we have two countries,

a home country and a foreign country.

We assume two goods, computers and shoes.

There are two factors of production, labor and capital,

and we're going to assume here that it's the foreign country,

and shoe production, which are labor-abundant.

We're also going to assume that factors can move across industries

within a single country, but not across countries.

That means, if a country is rich in one factor,

that factors is available for potential use in either sector.

The theorem also will assume that final outputs are traded freely.

A very important assumption is that of identical technologies

in the two countries.

That is, the available means of production are the same, no matter where we are.

The point here is not that this is descriptively realistic,

but it's a way of focusing our attention on

the differences in factor endowments alone.

Please note this assumption because it will play a critical role

in our video on empirical tests of the Heckscher-Ohlin theorem.

Also, as simplifying assumptions, the theorem assumes that

consumer tastes are identical across countries

and those tastes do not vary with the level of income.

Again, those two assumptions both serve to help make factor endowments

the key operating force at the margin.

It's easiest to see a proof of the theorem in graphical terms,

and here, we're outlining the two production possibilities frontiers

for the two countries.

Here is the PPF for the home country,

here is the PPF for the foreign country,

and you'll find that, according to our assumptions,

the PPF for the home country, it skews toward output of computers,

because the home country has more capital,

and the PPF of the foreign country, it skews toward the output of shoes,

and thus it has this different slope,

and that is related to the assumption that the foreign country has a lot of labor

and can make shoes more readily.

Let's now consider each country in the absence of international trade.

So, going again to the home country,

pictured here,

what we see is we still have our PPF.

We're now adding in a price vector, which expresses the relative price

of computers to shoes,

and the way the slope of this price vector is drawn,

it's suggesting that the home country has to give up a fair number of computers

to get more shoes, because it's harder for the home country

to produce shoes.

There are then also indifference curves, expressing preferences for

computers versus shoes,

and we have a point of tangency, given here by A,

and that's where the home country ends up, without trade.

The situation of the foreign country is pictured here in this graph

and that's similar in principle, but you'll notice an important difference,

in addition to having a different PPF,

is that the price vector for the foreign country is different

and this, again, reflects the difference in factor of endowments.

What's the case in the foreign country is that they have to give up

a relatively high number of shoes to get more computers,

because it's basically hard for them to produce more computers.

Now let's consider the picture for the home country

after trade is possible.

The key difference here is that, now, we have a new price line,

and this new price line is given by the ability to trade for some shoes

from the labor-intensive country.

So, we want to now ask, what is the point along the PPF

that the home country will pick, knowing that it can then

trade up along this price vector to get a different allocation

of shoes and computers.

Well, the way this is pictured, the home country

gets on the highest indifference curve by producing at point B.

Previously, without trade, they had been producing at point A,

but now they will produce at B, which means

producing more computers than before.

They produce more computers,

and they then trade up along this price line,

and they achieve levels of consumption, where, for computers, it's given down here

and, for shoes, it's given up here on the vertical axis.

So here, if the home country is producing at point B,

but consuming at point C, then we find the net exports

of computers are given by this amount, that is, the difference between B and C

on the horizontal axis, representing computers,

and the import of shoes is given by the difference between

this point here, and that point there,

and here is the quantity of shoe imports,

and we see exactly what the theorem had predicted.

Namely, that the home country, the capital-intensive country,

is exporting the capital-intensive good,

namely computers.

If we look at the foreign country, the labor-intensive country,

it's the same logic, but basically in reverse.

The foreign country also faces a new price vector,

and this will change how much they produce.

They're looking to choose a place on their PPF

where, after trading along the new price line,

they can achieve a higher indifference curve,

or a higher level of customer satisfaction.

So, without trade,

they had been producing here, at point A.

Once trade is possible,

they will produce here, at point B.

That means they will produce more shoes.

They then move along this price vector,

which represents trading those shoes for computers,

and we find that shoe exports are given by this difference here,

the difference between point B and point C drawn across to the horizontal axis,

and computer imports are given by this difference here.

Again, the difference between point B and point C

drawn down to the horizontal axis,

and, again, as the Heckscher-Ohlin theorem suggests,

here we have the labor-intensive country

and it is exporting the labor-intensive good,

namely shoes.

Admittedly, this is all under very simple assumptions,

but the point is simply to isolate the effect of one mechanism,

not to argue that it's the only thing going on in the real world,

but, what we have demonstrated is that, under these simple assumptions,

first, the capital-intensive country exports the capital-intensive product.

Second, the labor-intensive country exports the labor-intensive product.

That's the Heckscher-Ohlin theorem.

For sources, we very much recommend the treatment

in the Feenstra and Taylor text, "International Trade"

and, indeed, we have borrowed very directly from their Powerpoints.

Also, if you don't have access to that book,

you can just Google "Heckscher-Ohlin theorem"

to some similar treatments.