Comparative advantage is affected by the interaction between a country’s resources, namely the endowments of the factors of production and the production technology which determines how intensively these factors are used in the production process. What we understand from the Heckscher-Ohlin model is that trade is by and large directed by the differences in resources or to state it differently, the existence of differences in economies’ resources is the cornerstone of international trade.
It is important to highlight that Heckscher-Ohlin theory does not contradict the Ricardian one which is built on the assumption that international trade is based on differences in comparative costs. Actually, Heckscher-Ohlin theory tries to explain what causes the differences in comparative costs of goods between different countries. Different countries have different factor endowments. Some countries use relatively more capital, some others more labour and some others more land. Let’s assume that Home is capital abundant whereas Foreign is land abundant. Consequently, in Home, land is relatively scarce whereas in Foreign capital is relatively scarce. Thus it holds that K/L>(K*)/(L*). The relative price of the factor which is found in abundance will tend to be lower than the relative price of the factor which is found in scarcity. Thus, it also holds that PK/PL<(PK*)/(PL*). Let’s also assume that the two countries produce two goods, X and Y and that good X is capital intensive whereas good Y is land intensive i.e. Kx/Lx>Ky/Ly for any given values of rental rate (r) paid when renting capital and rental rate when using land (l). It follows that the Home country which has a relative abundance of capital will have a comparative advantage in the production of the good that utilizes the factor whose available quantity is larger. Therefore, Home country tends to specialize and will be relatively efficient at producing the capital-intensive good. This result is driven by the fact that the relative price of that good is lower in Home i.e. Px/Py<(Px*)/(Py*). On the contrary, Foreign tends to specialize in the production of the land-intensive commodity. Under the aforementioned, the autarky relative price of the good X (Px/Py) will be lower in Home and higher in Foreign. Likewise, the autarky relative price of the good Y (Py/Pz) will be lower in Foreign and higher in Home. When free trade occurs, relative prices of the goods converge. Relative price of good X will be increased in Home and decreased in Foreign until both countries have the same relative price in that good. In Home, the increase in the relative price of good X leads to the increase of good’s X production. However, the consumption of good X is going to fall as good X is now more expensive for the country’s consumers. …show more content…
Thus he concludes, a part of trade is actually “missing” and identical technologies among countries may account for this “gap”. Under this scope, Heckscher-Ohlin theory may explain the direction of trade well. US imports from Bangladesh include more low-skill-intensity commodities, while US imports from Germany include more high- skill-intensity goods. However, it explains poorly the volume of trade. In fact, the actual trade volume is much lower than the predicted volume of …show more content…
They use the case of Japan as although the country was isolated for over 200 years, managed to move from complete autarky to free trade within seven years. The authors found that trade and thus exports were indeed driven by the mechanism of comparative advantage as the opening-up may have had a significant substantial impact on relative returns to factors. They provided evidence that the comparative advantage gains from trade in real income do not exceed 9 percent of Japan's GDP. A key feature of this transition is that trade liberalization in Japan led relative prices to be changed dramatically. Consequently, their results are in favor of the Heckscher-Ohlin theorem described above. In their most recent paper, Bernhofen and Brown (2016) tested the overall validity of the Heckscher-Ohlin theorem. In particular, they proved that each country’s factor price vector in autarky determines what the country will trade in terms of factors with the rest of the word. In other words, this result confirms the prediction of Heckscher-Ohlin theorem that countries will export the factors they have in abundance whereas they import the factors in scarcity.
The basic idea of the Heckscher-Ohlin theory i.e. that factors’ endowments are substantial for trade
It is important to highlight that Heckscher-Ohlin theory does not contradict the Ricardian one which is built on the assumption that international trade is based on differences in comparative costs. Actually, Heckscher-Ohlin theory tries to explain what causes the differences in comparative costs of goods between different countries. Different countries have different factor endowments. Some countries use relatively more capital, some others more labour and some others more land. Let’s assume that Home is capital abundant whereas Foreign is land abundant. Consequently, in Home, land is relatively scarce whereas in Foreign capital is relatively scarce. Thus it holds that K/L>(K*)/(L*). The relative price of the factor which is found in abundance will tend to be lower than the relative price of the factor which is found in scarcity. Thus, it also holds that PK/PL<(PK*)/(PL*). Let’s also assume that the two countries produce two goods, X and Y and that good X is capital intensive whereas good Y is land intensive i.e. Kx/Lx>Ky/Ly for any given values of rental rate (r) paid when renting capital and rental rate when using land (l). It follows that the Home country which has a relative abundance of capital will have a comparative advantage in the production of the good that utilizes the factor whose available quantity is larger. Therefore, Home country tends to specialize and will be relatively efficient at producing the capital-intensive good. This result is driven by the fact that the relative price of that good is lower in Home i.e. Px/Py<(Px*)/(Py*). On the contrary, Foreign tends to specialize in the production of the land-intensive commodity. Under the aforementioned, the autarky relative price of the good X (Px/Py) will be lower in Home and higher in Foreign. Likewise, the autarky relative price of the good Y (Py/Pz) will be lower in Foreign and higher in Home. When free trade occurs, relative prices of the goods converge. Relative price of good X will be increased in Home and decreased in Foreign until both countries have the same relative price in that good. In Home, the increase in the relative price of good X leads to the increase of good’s X production. However, the consumption of good X is going to fall as good X is now more expensive for the country’s consumers. …show more content…
Thus he concludes, a part of trade is actually “missing” and identical technologies among countries may account for this “gap”. Under this scope, Heckscher-Ohlin theory may explain the direction of trade well. US imports from Bangladesh include more low-skill-intensity commodities, while US imports from Germany include more high- skill-intensity goods. However, it explains poorly the volume of trade. In fact, the actual trade volume is much lower than the predicted volume of …show more content…
They use the case of Japan as although the country was isolated for over 200 years, managed to move from complete autarky to free trade within seven years. The authors found that trade and thus exports were indeed driven by the mechanism of comparative advantage as the opening-up may have had a significant substantial impact on relative returns to factors. They provided evidence that the comparative advantage gains from trade in real income do not exceed 9 percent of Japan's GDP. A key feature of this transition is that trade liberalization in Japan led relative prices to be changed dramatically. Consequently, their results are in favor of the Heckscher-Ohlin theorem described above. In their most recent paper, Bernhofen and Brown (2016) tested the overall validity of the Heckscher-Ohlin theorem. In particular, they proved that each country’s factor price vector in autarky determines what the country will trade in terms of factors with the rest of the word. In other words, this result confirms the prediction of Heckscher-Ohlin theorem that countries will export the factors they have in abundance whereas they import the factors in scarcity.
The basic idea of the Heckscher-Ohlin theory i.e. that factors’ endowments are substantial for trade