Heckscher –Ohlin’s Factor Endowment Theory (H-O Theory)

 the theory was introduced by two Sweden economists namely Eil Filip Heckscher and Bertil Gotthard Ohlin in 1933. According to the theory, a country will have comparative advantage in, and therefore will export; that good whose production is relatively intensive in the factor with which that country is relatively well endowed. Thus, the country which is relatively capital abundant compared wish the other country will have a comparative advantage in producing capital intensive goods and a country which has abundant labor; it will have a comparative advantage in producing labor intensive products. Compared to absolute and comparative advantage models, HO model is a complete model of the workings of an economy as it engages in international trade . The theory can summarize as follows;

1) The model shows that comparative advantage is influenced by the relative abundance of factors of production and the technology of production (which influence the relative intensity with when different factors of production are used in the production of different goods).

2) Unlike the classical model, HO model predicts that in equilibrium each country will continue to produce some of both goods.

3) Unlike other models, the HO model requires that strict assumptions be made on the nature of taste of each country.

4) Since changes in relative prices of goods have very strong effects on the relative earnings of resources, and trade changes relative prices, international trade has strong income distribution effects. The owners of country’s abundant factors gain from trade, but the owners of scare factors lose. Nevertheless HO model is extremely useful in analyzing the effects of trade on income distribution . 

The HO theory includes three other important theorem such as Rybczynski theorem [29], the factor price equalization theorem  and Stolper – Samuellson theorem . These theorems refer to issues such as the effect and impact of economic growth on trade and distribution of income.

1) Rybczynski Theorem: The theorem states that if a country experiences an increase in its endowment of any one factor, say labor, then holding all other things constant, the output of the that good uses the factor intensively will rise, and the output of other good will fall.

2) The Factor price Equalization Theorem: The factor price equalization theorem refers to the most controversial effect of international trade on factor prices. Given all the assumption of the HO model, free international trade will lead to the international equalization of individual factor prices. This idea was presented by Heckscher in 1933.

3) The Stolper – Samuellson theorem: The theorem states that free international trade benefits the abundant factor and harms the scare factor. It presented by Wolfang Stolper and Paul Samuelson in 1944. The model provides insights into why government may impose barriers to trade, because factor endowment cause to income distribution of the country.

Empirical Evidence on HO model and Leontief Paradox  

Wassily Leontief (1950) tested HO model by using input output table for 200 different industries in US for 1947-50 period and found that US is not a capital intensive country, that would export capital intensive goods and import labor intensive goods as defined in HO model. Instead according to his input-output table he showed that to replace $1 million of US imports by domestic output expansion would require 170 additional years per worker of labor and $3.1 million of capital. Reducing US exports by $1 million would provide 182.3 years per worker of labor and 2.6 million in capital. Thus, according to the experiment, US exports tend to be labor intensive relative to US imports. Because this finding is so unexpected, it has become known as the Leontief paradox.

As a result of puzzling and troubling empirical findings, many economists try to resurrect the model by developing explanations for Leontief paradox. Leontief, himself attempted reconciliations of findings saying that findings were due to the fact that implicit assumption of the model that American workers were of equal productivity to their foreign counterparts was incorrect. Leontief argues that because American workers were so productive relative to workers in the rest of the world, US should more properly view as being relatively labor abundant. Many other studies were conducted to explain Leontief paradox in other countries and showed counter reasons for Leontief paradox. It includes Deficiency of natural resources, trade barriers, competition and monopoly, International transaction of MNCs and human capital.     

Robert Baldwin (1962) studied the U.S. data 1962 and reported finding the paradox . Robert Stern and Keith Maskus studied the US trade data for 1972 and reported that capital/labor ratio in U.S. export sector exceeded that found in the U.S. import sector. Since, 1980 the interest of testing HO model was increased due to reasons; (1) Economists were understood that the test conducted by leontief and others were necessarily incomplete because these tests looked at the factor intensity of trade without directly linking trade flows to the factor endowment of the countries involved in the tests. (2) Theoretical interest of testing HO model as a multi factor version of HO model. Thus, based on multi factor analysis of HO model Leamer had appeared to resolve the Leontief paradox.