The Heckscher-Ohlin model explains trade patterns based on countries' factor endowments. It predicts nations will export goods that use their abundant factors intensively, while importing products relying on scarce factors.

This model builds on comparative advantage, showing how differences in labor, capital, and resources shape trade. It also explores how trade affects factor prices and income distribution, linking international economics to domestic markets.

Assumptions of the Heckscher-Ohlin Model

Core Model Structure

• Utilizes a 2x2x2 framework involving two countries, two goods, and two factors of production (typically labor and capital)
• Assumes identical production technologies and consumer preferences across countries
• Posits perfect competition in all markets
• Incorporates constant returns to scale in production
• Allows perfect factor mobility within countries but prevents factor movement between countries

Key Predictions

• Countries export goods that intensively use their relatively abundant factor
• International trade leads to factor price equalization between trading partners
• Stolper-Samuelson theorem states an increase in a good's relative price increases the real return to the factor used intensively in its production
  • Example: If the price of textiles (labor-intensive) rises, wages will increase more than proportionally
• Rybczynski theorem predicts an increase in one factor's endowment leads to a more than proportional increase in the output of the good using that factor intensively
  • Example: A surge in a country's labor force may disproportionately boost production in labor-intensive industries (garment manufacturing)

Factor Endowments and Trade Patterns

Understanding Factor Endowments

• Represent the relative abundance of production factors (labor, capital, land) in a country
• Countries considered factor-abundant when they possess a higher ratio of that factor compared to trading partners
• Factor intensity describes the relative use of different factors in producing a good
  • Example: Automobile manufacturing (capital-intensive) vs. textile production (labor-intensive)
• Comparative advantage tends to arise in goods using abundant factors intensively

Trade Pattern Dynamics

• Countries specialize in and export goods utilizing their abundant factors intensively
• Nations import goods that intensively use their scarce factors
• Shifts in factor endowments over time can alter comparative advantage and trade patterns
  • Example: A developing country's increasing capital stock may shift its exports from agricultural goods to manufactured products
• Changes in one factor's endowment can disproportionately impact output in related industries
  • Example: Discovery of oil reserves (increase in natural resources) may boost petrochemical production more than other sectors

Factor Prices and Goods Prices

Price Relationships and Effects

• Stolper-Samuelson theorem links changes in goods prices to factor prices in international trade
• Increase in a good's relative price boosts the real return to its intensively used factor while decreasing returns to other factors
  • Example: Rising computer prices may increase returns to skilled labor but decrease returns to unskilled labor
• Magnification effect causes factor price changes to be proportionally larger than goods price changes
• Factor price equalization suggests free trade can substitute for factor mobility, leading to cross-country convergence in factor prices

Short-Term Considerations

• Specific factors model examines how factor immobility in the short run affects trade gains distribution
• Changes in relative factor endowments can shift the production possibility frontier, impacting goods' relative prices and factor prices
  • Example: Rapid increase in a country's skilled workforce may lower skilled wages relative to unskilled wages

Limitations of the Heckscher-Ohlin Model

Empirical Challenges

• Leontief Paradox found U.S. exports were relatively labor-intensive despite being capital-abundant, challenging the model's validity
• Model struggles to explain significant intra-industry trade, especially among developed economies
  • Example: Simultaneous import and export of automobiles between countries

Simplifying Assumptions

• Identical production technologies across countries often unrealistic
  • Example: Technological disparities between developed and developing nations can significantly impact trade patterns
• Factor immobility between countries increasingly challenged by globalization of labor and capital markets
• Two-factor simplification may not capture complexity of modern production processes
  • Example: High-tech industries often require specialized labor, advanced technology, and significant R&D investment

Dynamic Considerations

• Static nature fails to account for changes in factor endowments, technology, and consumer preferences over time
• Overlooks demand-side factors like consumer preferences and income levels in determining trade patterns
  • Example: Changing consumer tastes for organic products can influence agricultural trade patterns regardless of factor endowments