What is the Heckscher-Ohlin Model?

The Heckscher-Ohlin model, also known as the H-O model or 2X2X2 model, is a theory in international trade that suggests that nations export goods in abundance and produce efficiently. It was developed by Swedish economist Eli Heckscher and his student Bertin Ohlin, hence the name. Later, economist Paul Samuelson contributed a few additions. Therefore, a few references to this model as a Heckscher-Ohlin-Samuelson model.

Countries export great products or products for which they have the material/labor in abundance. These countries have a competitive advantage for such goods, including land, labor, and capital, which is the basis for this model. Not just abundance, the cost of production or procurement has to be cheaper in such countries.

Why is it Called the 2X2X2 Model?

The reason is simple – there are two countries. Moreover, the two countries engage in the trading of two goods. Therefore, there are two homogeneous production factors required for the same.

Assumptions of the Heckscher-Ohlin Model

  • There are two countries in the picture. It is used to make the model plainer and simpler.There are two factors: capital and labor. There is a constraint in aspects, i.e., the factors are limited to the funding (endowment) of the country.Countries have similar production technology. Therefore, governments will share the same technologies. Although unrealistic, this assumption eliminates trade differences because of technological differences.Prices are the same everywhere.The tastes in the two countries are identical. Similar to technology, this is assumed to eliminate the difference in preferences.The two countries have different relative factor endowments: capital, land, and labor. Based on the relative factor endowments, countries are classified as capital-abundant, labor-abundant, or land-abundant.Factor intensities may vary. Similar to the above, goods are classified as capital-intensive, labor-intensive, or land-intensive based on relative factor intensities.Perfect competitionPerfect CompetitionPerfect competition is a market in which there are a large number of buyers and sellers, all of whom initiate the buying and selling mechanism. Furthermore, no restrictions apply in such markets, and there is no direct competition. It is assumed that all of the sellers sell identical or homogenous products.read more. Firms in the market choose the output level at which price equals marginal costs.There is free entry and free exit of firms in the market in response to profitProfitProfit refers to the earnings that an individual or business takes home after all the costs are paid. In economics, the term is associated with monetary gains. read more.Necessary information is available and is perfect. There are no transport costs and no hindrances in trade.There are no trade restrictions between the two countries.

Intuitions of Heckscher-Ohlin Model

There is a large relative supply of a factor, say capital. Therefore, it results in a low relative price of capital in the country. That, in turn, results in cheaper capital intensiveCapital IntensiveCapital intensive refers to those industries or companies that require significant upfront capital investments in machinery, plant & equipment to produce goods or services in high volumes and maintain higher levels of profit margins and return on investments. Examples include oil & gas, automobiles, real estate, metals & mining.read more goods in the country. Hence, the government would have a competitive advantageCompetitive AdvantageCompetitive advantage refers to an advantage availed by a company that has remained successful in outdoing its competitors belonging to the same industry by designing and implementing effective strategies that allow the same in offering quality goods or services, quoting reasonable prices to its customers, maximizing the wealth of its stakeholders and so on and as a result of which the company can make more profits, build a positive brand reputation, make more sales, maximize return on assets, etc.read more that opens up mutually beneficial trade.

  • Firms in the market choose the output level at which price equals marginal costs.There is free entry and free exit of firms in the market in response to profitProfitProfit refers to the earnings that an individual or business takes home after all the costs are paid. In economics, the term is associated with monetary gains. read more.Necessary information is available and is perfect.

Components of the Heckscher-Ohlin Model

The four major components of the theory are as follows:

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  • Factor Price Equalization Theorem – The most fragile of all, the FPE states that it will equalize the prices of factors of production among countries because of international tradeInternational TradeInternational Trade refers to the trading or exchange of goods and or services across international borders. read more.Stolper-Samuelson Theorem – The Stolper-Samuelson theorem (SST) proposed that, in any particular country, an increase in the relative prices of the labor-intensive goodwillGoodwillIn accounting, goodwill is an intangible asset that is generated when one company purchases another company for a price that is greater than the sum of the company’s net identifiable assets at the time of acquisition. It is determined by subtracting the fair value of the company’s net identifiable assets from the total purchase price.read more makes labor better off and capital worse off. The converse also applies.Rybczynski Theorem – It makes labor better off and capital worse off. The converse also applies.At constant prices, an increase in the endowment of one factor will lead to an expansion in the sector’s output that uses that factor and will lead to a complete decline in the production of the other goods.Heckscher-Ohlin Trade Theorem – This is a critical theorem of this model, which boils down to this statement “a country having capital in abundance will produce goods that are capital-intensive, and a country having abundant labor will produce labor-intensive goods.”

How is the Heckscher-Ohlin Model Superior to Classical Theory?

  • It is a better explanation of the world economyEconomyAn economy comprises individuals, commercial entities, and the government involved in the production, distribution, exchange, and consumption of products and services in a society.read more after World War II.The traditional Ricardian theory overlooked the demand factors and completely focused on the supply factors. The H-O model is relatively better and considers both supply and demand.The classical theory ignored capital and assumed labor was the only factor of production.Hence, the classical theory accredits any cost difference to the differences in labor.The H-O model is more specific and realistic when compared to the classical approach.This model also brings about integration between trade theories and value theories.

Real-Life Example and Study

Saudi Arabia holds around 18% of the world’s petroleum reserves and ranks as the largest exporter of petroleum and second-largest producer. Oil in Saudi is available plenty and closer to the earth’s surface. Hence, extracting oil in Saudi Arabia is cheaper and more profitable than in many other places. It can be taken as an example of the H-O model.

Criticism

  • Poor prediction and performance.The unfair assumption is that all labor is employed. This model assumes that all work in the country is engaged, thus ignoring the concept of unemploymentUnemploymentUnemployment refers to a situation where individuals capable of working seek active opportunities for work but cannot find any for various reasons.read more.The unrealistic assumption is that similar production exists. Furthermore, this model assumes that nations have the same technology for production, undermining the effects and ignoring the technological gaps.The unrealistic assumption is that similar production exists. Furthermore, this model assumes that nations have the same technology for production, undermining the effects and ignoring the technological gaps.

To sum up, this model postulates that countries export what they can produce. This model proposes that countries export what they can create abundantly or what they are already in abundance of (reserves). A country will have a comparative advantageComparative AdvantageIn order to determine comparative advantage, the opportunity cost of each item from each country needs to be calculated. Then, on a comparative table, these costs are plotted to get the comparative advantage.read more in the good that intensively uses its relatively abundant factor. Though this model has been proven to be better than the traditional model, this model adopts assumptions that can hardly be expected to be fulfilled.

This article has been a guide to the Heckscher-Ohlin model and its definition. We discuss components, assumptions, and examples of the Heckscher-Ohlin model. You can learn more about accounting from the following articles: –

  • Calculate Current AccountFormula of Balance of PaymentsCurrency DevaluationExamples of Capitalism