The Heckscher-Ohlin model is an economic model that focuses on the dynamics of international trade. It was developed by Eli Heckscher and Bertil Ohlin at the Stockholm School of Economics. The model proposes that countries that are rich in certain factors of production will export products in which they have a comparative advantage and import goods produced using their more scarce factors. It clarifies the principle of gains from trade both between countries.
The concept of trade based on comparative advantage is that you produce the things you are especially good at, and buy from others, the goods you are less efficient in producing. Countries are better off when they each specialize in producing what they are good at, and trade with each other. Everyone has a comparative advantage in something, and everyone has a comparative disadvantage in something.
The model attributes a country's comparative advantage to differences in factor endowments. A factor of production is any resource that is used by companies to produce goods and services that are consumed by households. Countries with an abundant supply of certain factors of production have a comparative advantage in goods, which are produced primarily using that factor. Abundance in certain factors of production results in lower input costs and greater profitability in productions of those products.
Countries with certain scarce factor endowments generally have lower production and less profitability in such goods utilizing those factors. Consequently, international trade tends to address the uneven geographic distribution of productive resources. The ability to export and import factor endowments transforms a local market into a global market for factor endowments.
Traded commodities or products are essentially comprised of four kinds of factors, including the following:
- Natural resources: Land, oil, natural gas, minerals, forest products, animal products and agricultural products, such as sugar and coffee
- Labor: Workers in labor intensive production, such as textiles, footwear and handbags, furniture
- Physical capital: Machines, buildings, office & data processing, infrastructure, such as power generating and telecommunications
- Human capital: Education, other skills that enhance productivity
You might ask what does a factor actually look like? As we all know, many products are made in China these days, as the cost of labor or workers is cheaper than what you would find in the US or Europe. A business in China, which makes handbags or clothes, primarily uses factors such as labor and physical capital, such as machines.
Alternatively, countries, which are rich in minerals, such as Australia or oil and gas, such as the US or the Middle East, will export their abundance in such factor endowments, which are scarce in other countries such as those in Europe.
The US and Europe happen to be very rich in human capitalgiven the highly educated and trained workforce, including doctors, lawyers, engineers, etc. Goods and services are produced using skilled human capital and not simply unskilled labor.
The difference in the type of capital, physical versus human, is reflected in the fact that US exports are not so intensive in physical capital, i.e. machines and buildings, but rather, in human capital based, skill- intensive goods. Countries such as China, India, Bangladesh and Mexico have less educated workforces and tend to export goods whose production requires little skilled labor. As a result, poor countries, which have relatively large clothing industries, and require lower productivity, have a comparative advantage in producing and exporting those products, over other countries such as the US with an abundance of human capital that produce and export skill -
intensive product, (i.e. the capital-abundant country will export the capital-intensive good, the labor-abundant country will export the labor-intensive good). Both countries trade with each other and import the products in which they do not have a comparative advantage.
Within countries, capital and labor can be reinvested and reemployed in order to produce different outputs. Factors endowments are used to produce goods on an ongoing basis. Whereas, other inputs that go into producing goods, such as cloth, plastic, metal, or other components that are used up in the production process, are not available to use to produce subsequent goods for future income. Many economists believe that the factor of human capital is one of the most important utilized in today's economy.
The Heckscher- Ohlin model shows how factor endowments, which are unique to each country, are key drivers in international trade. Countries which have a greater supply of certain factors of production, have a comparative advantage in producing those goods as well as a comparative disadvantage in producing goods with scarce factors of production. Comparative advantages and disadvantages between countries are what determine the direction of a country's trade (i.e. imports versus exports). The model consequently clarifies the principle of gains from trade both between countries.
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