The Hecksher Ohlin Theory Essay Example | Topics and Well Written Essays - 1500 words

The Hecksher Ohlin Theory - Essay Example The Hecksher - Ohlin model developed by Eli Hecksher and Bertil Ohlin in the 1920s, explores the possibility of two nations operating at the same level of efficiency, benefiting by trading with each other. The H-O model incorporates a number of realistic characteristics of production that are left out of the simple Ricardo's model. Recall that in the simple Ricardo's model only one factor of production, labor, is needed to produce goods and services (Krugman, 1997). The productivity of labor is assumed to vary across countries, which implies a difference in technology between nations. It was the difference in technology that motivated advantageous international trade in the model (Suranovic, 2003). According to the Hecksher-Ohlin Theory, capital refers to the physical machines and equipment that is used in production. Thus, machine tools, conveyers, trucks, forklifts, computers, office buildings, office supplies, and much more, is considered capital. All productive capital must be owned by someone. In a capitalist economy most of the physical capital is owned by individuals and businesses. In a socialist economy productive capital would be owned by the government. ... This model makes the following assumptions: 1. There are no obstructions to trade i.e. no trade controls, transport costs etc. 2. Both commodity and factor markets are perfectively competitive. 3. There are constant returns to scale. 4. Both the countries have the same technology and hence operate at the same level of efficiency. 5. There are two factors of production - labor and capital. Both are perfectly immobile in inter-country transfers, but perfectly mobile in inter-sector transfers. According to this theory, there are two types of products - labor intensive and capital intensive. Two countries operating at the same level of efficiency can, and do, benefit from trade due to the differences in their factor endowments. The labor-rich country is likely to produce labor-intensive goods, while the country rich in capital is likely to produce capital-intensive goods. The two countries will then trade I these goods and reap the benefits of international trade. The Hecksher-Ohlin model has also got some drawbacks. First and foremost, it assumes that factor endowments remain constant but they can be developed through innovation (Jain, 2000). Second, with many countries imposing minimum wage laws, factor prices may change to an extent, that a labor-rich country may find it cheaper to import labor-intensive goods than to produce them locally. An economist named Wassily Leontief has pointed out that, the exports of United States were more labor-intensive than capital-intensive despite that fact that the United States is a capital-rich country. It is worth emphasizing here a fundamental distinction between the Hecksher-Ohlin model and the Ricardian model. Whereas the Ricardian model assumes that production technologies differ