Chapter 5
Resources and Trade: The Heckscher-Ohlin Model
■ Chapter Organization
Model of a Two-Factor Economy.
Prices and Production.
Choosing the Mix of Inputs.
Factor Prices and Goods Prices.
Resources and Output.
Effects of International Trade between Two-Factor Economies.
Relative Prices and the Pattern of Trade.
Trade and the Distribution of Income.
Case Study: North–South Trade and Income Inequality.
Skill-Biased Technological Change and Income Inequality.
Box: The Declining Labor Share of Income and Capital-Skill Complementarity.
Factor-Price Equalization.
Empirical Evidence on the Heckscher-Ohlin Model.
Trade in Goods as a Substitute for Trade in Factors: Factor Content of Trade.
Patterns of Exports between Developed and Developing Countries.
Implications of the Tests.
Summary
APPENDIX TO CHAPTER 5: Factor Prices, Goods Prices, and Production Decisions.
22 Krugman/Obstfeld/Melitz • International Economics: Theory & Policy, Eleventh Edition
Choice of Technique.
Goods Prices and Factor Prices.
More on Resources and Output
■ Chapter Overview
In Chapter 3, trade between nations was motivated by differences internationally in the relative
productivity of workers when producing a range of products. In Chapter 4, the Specific Factors model
considered additional factors of production, but only labor was mobile between sectors. In Chapter 5, this
analysis goes a step further by introducing the Heckscher-Ohlin theory.
The Heckscher-Ohlin theory considers the pattern of production and trade that will arise when countries
have different endowments of such factors of production as labor, capital, and land and where these factors
are mobile between sectors in the long run. The basic point is that countries tend to export goods that are
intensive in the factors with which they are abundantly supplied. Trade has strong effects on the relative
earnings of resources and, according to theory, leads to equalization across countries of factor prices.
These theoretical results and related empirical findings are presented in this chapter.
The chapter begins by developing a general equilibrium model of an economy with two goods that are
each produced using two factors according to fixed coefficient production functions. The assumption of
fixed coefficient production functions provides an unambiguous ranking of goods in terms of factor
intensities. (A more realistic model allowing for substitution between factors of production is presented
later in the chapter with the same conclusions.) Two important results are derived using this model. The
first is known as the Rybczynski effect. Increasing the relative supply of one factor, holding relative goods
prices constant, leads to a biased expansion of production possibilities favoring the relative supply of the
good that uses that factor intensively.
The second key result is known as the Stolper-Samuelson effect. Increasing the relative price of a good,
holding factor supplies constant, increases the return to the factor used intensively in the production of that
good by more than the price increase, while lowering the return to the other factor. This result has
important income distribution implications.
It can be quite instructive to think of the effects of demographic/labor force changes on the supply of
different products. For example, how might the pattern of production during the productive years of the
“Baby Boom” generation differ from the pattern of production for post–Baby Boom generations? What
Chapter 5 Resources and Trade: The Heckscher-Ohlin Model 23
does this imply for returns to factors and relative price behavior? What effect would a more restrictive
immigration policy have on the pattern of production and trade for the United States?
The central message concerning trade patterns of the Heckscher-Ohlin theory is that countries tend to
export goods whose production is intensive in factors with which they are relatively abundantly endowed.
Comparing the United States and Mexico, for example, we observe a relative abundance of capital in the
United States and a relative abundance of labor in Mexico. Thus, goods that intensively use capital in
production should be cheaper to produce in the United States, and those that intensively use labor should
be cheaper to produce in Mexico. With trade, the United States should export capital-intensive goods like
computers, while Mexico should export labor-intensive goods like textiles. With integrated markets,
international trade should lead to a convergence of goods prices. Thus, the prices of capital-intensive
goods in the United States and labor-intensive goods in Mexico will rise. According to the Stolper-
Samuelson effect, owners of a country’s abundant factors (e.g., capital owners in the United States, labor in
Mexico) will gain from trade, while owners of the country’s scarce factors (labor in the United States,
capital in Mexico) will lose from trade. The extension of this result is the Factor Price Equalization
theorem, which states that trade in goods (and thus price equalization of goods) will lead to an equalization
of factor prices. These income distribution effects are more or less permanent, given that factor
abundances do not quickly change within a country. Theoretically, the gains from trade could be
redistributed such that everyone is better off; however, such a plan is difficult to implement in practice.
The political implications of factor price equalization should be interesting to students.
After presenting the basic theory behind the Heckscher-Ohlin theory, the rest of the chapter examines
empirical tests of the model, beginning with a pair of case studies looking at income inequality in the
United States. Wages paid to skilled workers in the United States have been rising at a much faster rate
than those paid to unskilled workers over the past few decades. At the same time, there has been a large
increase in international trade. Given that the United States is relatively abundant in skilled labor, the
Heckscher-Ohlin theory would predict that increased trade should lead to higher wages for skilled workers
and lower wages for unskilled workers. On the surface, this appears to be an empirical confirmation of the
theory. However, other studies argue that rising wage inequality can only partially be explained by
increased trade. According to the Heckscher-Ohlin model, the increase in skilled wages should be driven
by an increase in the price of skill-intensive goods following trade. However, skill-intensive goods prices
have not increased by nearly the same proportion as skilled wages. If rising wage inequality in a rich
country like the United States is driven by factor price equalization, then we should also observe a
narrowing gap in developing countries that are exporting low-skill intensive goods. However, income
24 Krugman/Obstfeld/Melitz • International Economics: Theory & Policy, Eleventh Edition
inequality in these nations is actually larger than in rich countries. Finally, trade between rich and poor
nations is simply not large enough to be entirely responsible for the size of the income gap. Rather, the
increasing skill premium is most likely due to skill-biased technical innovations like computers that have
increased the productivities of skilled workers more than that of unskilled workers. This empirical
observation can be modeled by introducing a three-factor production function using unskilled labor,
skilled labor, and capital as inputs. Capital acts as a substitute for unskilled labor, but it is a complement to
skilled labor. For example, a new machine can replace the work done by an unskilled laborer, but it needs
a skilled worker to maintain and design it. With technological change, capital has become more productive
and increasingly displaces unskilled workers in both labor abundant developing countries and capital
abundant developed countries. This theory can help to explain labor’s decreasing share of total income in
both types of countries despite increased trade that would suggest a rising labor share of income in
developing countries.
Another empirical observation testing the validity of the Heckscher-Ohlin theory is the Leontief paradox.
This is the observation that the capital intensity of U.S. exports is actually lower than that of U.S. imports,
exactly the opposite of what the theory would predict for a capital abundant country. Further evidence of
this paradox is found in global data, with a country’s factor abundance doing a relatively poor job of
predicting its trade patterns. Finally, the theory predicts a much larger volume of trade (given observed
differences in factor endowments) than we actually see in the data. A country like China, for example, has
a significant abundance in labor. However, China’s net exports of labor-intensive goods are lower than
what the theory would predict. Similarly, U.S. net imports of labor-intensive goods are lower than what
would be expected given its relative labor scarcity. An explanation for this “missing trade” is that the
assumption of identical technology across countries is flawed. Rather, there are significant differences in
productivity across countries. That said, when the sample is restricted to trade between developed and
developing countries (i.e., North–South trade), the Heckscher-Ohlin theory fits well. This is clearly seen in
Figure 5-12, with low-skill countries like Bangladesh, Cambodia, and Haiti exporting products that are
considerably less skill-intensive than the exports of more developed nations like France, Germany, and the
United Kingdom. We can also see this pattern of trade changing as countries develop, as evidenced by the
increasing skill intensity of Chinese exports following China’s increased growth and development. These
observations have motivated many economists to consider motives for trade between nations that are not
exclusively based on differences across countries. These concepts will be explored in later chapters.
Despite these shortcomings, important and relevant results concerning income distribution are obtained
from the Heckscher-Ohlin theory.
Chapter 5 Resources and Trade: The Heckscher-Ohlin Model 25
■ Answers to Textbook Problems
1. a. The first step is to compute the opportunity costs of both cloth and food. We are given the
following resource constraints:
aKC = 2, aLC = 2, aKF = 3, aLF = 1 L = 2000; K = 3,000
b. Note the input requirements for each good. One unit of cloth can be produced using 2 units of
capital and 2 units of labor. One unit of food is produced using 3 units of capital and 1 unit of
labor. In a competitive market, the unit cost of each good must be equal to the output price.
26 Krugman/Obstfeld/Melitz • International Economics: Theory & Policy, Eleventh Edition
© 2018 Pearson Education, Inc.
QC = 2 K + 2 L ➔ PC = 2r + 2w
QF = 3 K + L ➔ PF = 3r + w
This gives us two equations and two unknowns (r and w). Solve for the factor prices:
w = PF – 3r
PC = 2r + 2(PF − 3r) = 2r + 2PF − 6r = 2PF − 4r
*** r = (2PF − PC)/4
*** w = (3PC − 2PF)/4
c. Looking at the two expressions in part (b), we see that an increase in the price of cloth will cause
d. The capital stock increases to 4,000. The labor constraint will remain unchanged, keeping the
maximum price of cloth at 2 units of food. The new capital constraint is given by:
e. The actual production point for cloth and food will depend on the relative prices of cloth and
food. If we assume that the economy is producing at a point such that all resources are being
Chapter 5 Resources and Trade: The Heckscher-Ohlin Model 27
f. Prior to the expansion of the capital stock, the economy was producing 750 units of cloth and
2. The definition of cattle raising as land intensive depends on the ratio of land to labor used in
3. This question is similar to an issue discussed in Chapter 4. What matters is not the absolute
abundance of factors but their relative abundance. Poor countries have an abundance of labor relative
4. In the Ricardian model, labor gains from trade through an increase in its purchasing power. This
result does not support labor union demands for limits on imports from less affluent countries. The
5. Specific programmers may face wage cuts due to the competition from India, but this is not
inconsistent with skilled labor wages rising. By making programming more efficient in general, this
28 Krugman/Obstfeld/Melitz • International Economics: Theory & Policy, Eleventh Edition
© 2018 Pearson Education, Inc.
will face transition costs. There are many reasons to not block the imports of computer programming
services (or outsourcing of these jobs). First, by allowing programming to be done more cheaply, it
expands the production possibilities frontier of the United States, making the entire country better off
on average. Necessary redistribution can be done, but we should not stop trade that is making the
nation as a whole better off. In addition, no one trade policy action exists in a vacuum, and if the
United States blocked the programming imports, it could lead to broader trade restrictions in other
countries.
6. The factor proportions theory states that countries export those goods whose production is intensive
7. If the efficiency of the factors of production differs internationally, the lessons of the Heckscher-