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 that they produce efficiently and in abundance. 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.

• The Hecksher-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 plenty and produce skillfully.
• It was developed by Swedish economist Eli Heckscher and his student Berlin Ohlin. Later, economist Paul Samuelson made a few additions. Hence, Heckscher-Ohlin-Samuelson model.
• It is called the 2x2x2 model because it comprises two countries. In addition, the two countries are involved in the two goods trading.
• The four components of the theory are the factor price equalization theory, Stolper-Samuelson Theory(SST), Rybczynski Theorem, and Heckscher-Ohlin Trade Theorem.

The Heckscher-Ohlin 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 or in reserves. A country will have a comparative advantage in the good that intensively uses its relatively abundant factor. Though this model proves to be better than the traditional model, it adopts assumptions that are tough to accept and expect.

It is also known as the 2X2X2 model given the involvement of two countries in the process of trading two goods. As there are two homogeneous production factors required for the same, the model is called so.

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 intensive goods in the country. Hence, the government would have a competitive advantage that opens up mutually beneficial trade.

The Heckscher-Ohlin model assumptions that one must be aware of include the following:

• There are two countries in the picture, which makes the model plain and simple.
• There are two factors: capital and labor. There is a constraint in certain aspects, like the limitation in 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, which signifies the elimination of differences in preferences as in the case of technology.
  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 competition.
  • 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 profit.
  • 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.

The four major components of the theory are as follows:

• 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 trade.
• Stolper-Samuelson Theorem - The Stolper-Samuelson theorem (SST) proposed that, in any particular country, an increase in the relative prices of the labor-intensive goodwill 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.”

Let us consider a real-life Heckscher-Ohlin model example to understand how it works:

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.

Though the Heckscher-Ohlin model of international trade is beneficial for the countries as they know what they produce and abundance and hence can choose to export the same for the nations looking for the same product. However, there are issues that exist in this theory. Some of the problem areas of the model are:

• 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 unemployment.
• 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.

The Heckscher-Ohlin model is a better explanation of the world economy 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. It ignored capital and assumed labor was the only factor of production. Hence, this 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.

This article has been a guide to what is the Heckscher-Ohlin model. Here we explain its assumptions along with an example, vs Ricardian model, and components. You can learn more about accounting from the following articles: -

• Calculate Current Account
• Formula of Balance of Payments
• Currency Devaluation
• Examples of Capitalism