Chapter 4 Outline

Heckscher-Ohlin Theory

Ricardo's theory stresses that comparative advantage arises from differences in productivity. Thus, whether Ghana is more efficient than South Korea in the production of cocoa depends on how productively it uses its resources. Ricardo particularly stressed labor productivity and argued that differences in labor productivity between nations underlie the notion of comparative advantage. Swedish economists Eli Heckscher (in 1919) and Bertil Ohlin (in 1933) put forward a different explanation of comparative advantage. They argued that comparative advantage arises from differences in national factor endowments.¹¹ By factor endowments, they meant the extent to which a country is endowed with such resources as land, labor, and capital. Different nations have different factor endowments, and different factor endowments explain differences in factor costs. The more abundant a factor, the lower its cost. The Heckscher-Ohlin theory predicts that countries will export those goods that make intensive use of those factors that are locally abundant, while importing goods that make intensive use of factors that are locally scarce. Thus, the Heckscher-Ohlin theory attempts to explain the pattern of international trade that we observe in the world economy. Like Ricardo's theory, the Heckscher-Ohlin theory argues that free trade is beneficial. Unlike Ricardo's theory, however, the Heckscher-Ohlin theory argues that the pattern of international trade is determined by differences in factor endowments, rather than differences in productivity.

The Heckscher-Ohlin theory also has commonsense appeal. For example, the United States has long been a substantial exporter of agricultural goods, reflecting in part its unusual abundance of large tracts of arable land. In contrast, South Korea has excelled in the export of goods produced in labor-intensive manufacturing industries, such as textiles and footwear. This reflects South Korea's relative abundance of low-cost labor. The United States, which lacks abundant low-cost labor, has been a primary importer of these goods. It is relative, not absolute, endowments that are important; a country may have larger absolute amounts of land and labor than another country, but be relatively abundant in one of them.

The Leontief Paradox

The Heckscher-Ohlin theory has been one of the most influential theoretical ideas in international economics. Most economists prefer the Heckscher-Ohlin theory to Ricardo's theory because it makes fewer simplifying assumptions. It has been subjected to many empirical tests. Beginning with a famous study published in 1953 by Wassily Leontief (winner of the Nobel prize in economics in 1973), many of these tests have raised questions about the validity of the Heckscher-Ohlin theory.¹² Using the Heckscher-Ohlin theory, Leontief postulated that since the United States was relatively abundant in capital compared to other nations, the United States would be an exporter of capital-intensive goods and an importer of labor-intensive goods. To his surprise, however, he found that US exports were less capital intensive than US imports. Since this result was at variance with the predictions of the theory, it has become known as the Leontief paradox.

Why do we observe the Leontief paradox? No one is quite sure. One possible explanation is that the United States has a special advantage in producing new products or goods made with innovative technologies. Such products may be less capital intensive than products whose technology has had time to mature and become suitable for mass production. Thus, the United States may be exporting goods that use skilled labor and innovative entrepreneurship, while importing manufactures that use large amounts of capital. More recent empirical studies tend to confirm this.¹³ Recent tests of the Heckscher-Ohlin theory using data for a large number of countries tend to confirm the existence of the Leontief paradox.¹⁴

This leaves economists with a difficult dilemma. They prefer Heckscher-Ohlin on theoretical grounds, but it is a relatively poor predictor of real-world international trade patterns. The theory they regard as being too limited, Ricardo's theory of comparative advantage, actually predicts trade patterns with greater accuracy. The best solution to this dilemma may be to return to the Ricardian idea that trade patterns are largely driven by international differences in productivity. Thus, one might argue that the United States exports commercial aircraft and imports automobiles not because its factor endowments are especially suited to aircraft manufacture and not suited to automobile manufacture, but because the United States is more efficient at producing aircraft than automobiles.