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Heckscher Ohlin

The Heckscher Ohlin (HO) model of international trade proposes that trade occurs due to differences in factor endowments between countries. Specifically, the model states that a capital abundant country will export capital intensive goods, while a labor abundant country will export labor intensive goods. The model assumes two countries, two goods, and two factors of production (capital and labor). Factor prices determine whether a country is relatively capital or labor abundant.

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762 views

Heckscher Ohlin

The Heckscher Ohlin (HO) model of international trade proposes that trade occurs due to differences in factor endowments between countries. Specifically, the model states that a capital abundant country will export capital intensive goods, while a labor abundant country will export labor intensive goods. The model assumes two countries, two goods, and two factors of production (capital and labor). Factor prices determine whether a country is relatively capital or labor abundant.

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Heckscher Ohlin's (HO) Modern Theory of

International Trade

The Modern Theory of international trade has been advocated by Bertil Ohlin. Ohlin has drawn
his ideas from Heckscher's General Equilibrium Analysis. Hence it is also known as Heckscher
Ohlin (HO) Model / Theorem / Theory.

According to Bertil Ohlin, trade arises due to the differences in the relative prices of different
goods in different countries. The difference in commodity price is due to the difference in factor
prices (i.e. costs). Factor prices differ because endowments (i.e. capital and labour) differ in
countries. Hence, trade occurs because different countries have different factor endowments.

The Heckscher Ohlin theorem states that countries which are rich in labour will export labour
intensive goods and countries which are rich in capital will export capital intensive goods.

Assumptions of Heckscher Ohlin's H-O Theory ↓

Heckscher-Ohlin's theory explains the modern approach to international trade on the basis of
following assumptions :-

1. There are two countries involved.


2. Each country has two factors (labour and capital).
3. Each country produce two commodities or goods (labour intensive and capital intensive).
4. Factors are freely mobile within a country but immobile between countries.
5. There is full employment of resources in both countries and demand are identical in both
countries.
6. Trade is free i.e. there are no trade restrictions in the form of tariffs or non-tariff barriers.
7. There are no transportation costs.

Given these assumption, Ohlin's thesis contends that a country export goods which use relatively
a greater proportion of its abundant and cheap factor. While same country import goods whose
production requires the intensive use of the nation's relatively scarce and expensive factor.

Understanding The Concept of Factor Abundance ↓


In the two countries, two commodities & two factor model, implies that the capital rich country
will export capital intensive commodity and the labour rich country will export labour intensive
commodity. But the concept of country being rich in one factor or other is not very clear.
Economists quite often define factor abundance in terms of factor prices. Ohlin himself has
followed this approach. Alternatively factor abundance can be defined in physical terms. In this
case, physical amounts of capital & Labour are to be compared.

• Price Criterion for defining Factor Abundance ↓

A country where capital is relatively cheaper and labour is relatively costly is said to be capital
rich country. Whereas a country where labour is relatively cheaper and capital is relatively costly
is said to be labour rich country.

Price of the factor can be symbolically measured as follows :-

In above relation,

1. P refers to price of the factor,


2. K refers to Capital,
3. L refers to Labour,
4. E stands for England, and
5. I stands for India.

Note:- In reality, England is not a country else a part of United Kingdom (U.K). England is
called a country in this article just for the sake of learning example.

The above analysis highlights a fact that in England capital is cheap, and hence it is a capital
abundant country. Whereas in India, Labour is cheaper, and thus it is a labour rich country.
Now lets understand how such a pattern of trade will necessarily emerge.

• Diagram Explaining Heckscher Ohlin's H-O Theory ↓

Let us take an example of same two countries viz; England and India where England is a capital
rich country while India is a labour abundant nation.

In the above diagram XX is the isoquant (equal product curve) for the commodity X produced in
England. YY is the isoquant representing commodity Y produced in India. It is very clear that
XX is relatively capital intensive while YY is relatively labour incentive. The factor capital is
represented on Y-axis while the factor labour is represented on the horizontal X-axis.

PA is the price line or budget line of the country England. The price line PA is tangent to XX at
E. The price line PA is also tangent to YY isoquant at K. The point K will help us to find out
how much of capital and labour is required to produce one unit of Y in England.

P1B is the price line of the country India, The price line P1B is tangent to YY at I. The price line
RS which is drawn parallel to P1B is tangent to XX at M. This will help us to find out how much
of capital and labour is required to produce one unit of commodity X in India.

Under the given situations, the country England will choose the combination E. Which means
more specialisation on capital goods. It will not choose the combination K because it is more
labour intensive and less capital intensive.
Thus according to Ohlin, England will specialise on production of goods X by using the cheap
factor capital extensively while India specialises on commodity Y by using the cheap factor
labour available in the country.

The Ohlin's theory concludes that :-

1. The basis of internal trade is the difference in commodity prices in the two countries.
2. Differences in the commodity prices are due to cost differences which are the results of
differences in factor endowments in two countries.
3. A capital rich country specialises in capital intensive goods & exports them. While a
Labour abundant country specialises in labour intensive goods & exports them.

Limitations of Heckscher Ohlin's H-O Theory ↓

Heckscher Ohlin's Theory has been criticised on basis of following grounds :-

1. Unrealistic Assumptions : Besides the usual assumptions of two countries, two


commodities, no transport cost, etc. Ohlin's theory also assumes no qualitative difference
in factors of production, identical production function, constant return to scale, etc. All
these assumptions makes the theory unrealistic one.
2. Restrictive : Ohlin's theory is not free from constrains. His theory includes only two
commodities, two countries and two factors. Thus it is a restrictive one.
3. Static in Nature : Like Ricardian Theory the H-O Model is also static in nature. The
theory is based on a given state of economy and with a given production function and
does not accept any change.
4. Wijnholds's Criticism : According to Wijnholds, it is not the factor prices that determine
the costs and commodity prices but it is commodity prices that determine the factor
prices.
5. Consumers' Demand ignored : Ohlin forgot an important fact that commodity prices are
also influenced by the consumers' demand.
6. Other Factors Neglected : Factor endowment is not the sole factor influencing
commodity price and international trade. The H-O Theory neglects other factors like
technology, technique of production, natural factors, different qualities of labour, etc.,
which can also influence the international trade.

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