The Heckscher–Ohlin model

Eli Heckscher published the idea in 1919, and his student Bertil Ohlin developed it in Interregional and International Trade (1933). They assumed that every country has the same technology. If so, costs can differ for only one reason: countries own different amounts of the factors of production, and goods use those factors in different proportions. India has a lot of labour relative to capital, the United States a lot of capital relative to labour. Labour is cheap in India, so goods that need a lot of labour are cheap there too.

So in the Heckscher–Ohlin model, trade comes from differences in factor endowments (CUET 2019, 2021, 2026; Hyderabad 2013, 2021). In the two-good, two-factor version, the countries differ only in the relative availability of factors (DSE 2019; Hyderabad 2014): not in tastes, not in technology.

Factor intensity is a property of goods. Good Y is capital-intensive relative to X if it uses more capital per worker: a higher K/L ratio, or a lower L/K ratio (CUET 2018). The amount of capital doesn’t matter. A huge textile industry may use more machines in total than a small chemicals industry, and still be the labour-intensive one.

The comparison has to hold at every factor price. A labour-intensive good is the one with the lower capital–labour ratio at all relative factor prices (UGC NET 2024). If wages rose, both industries would use more capital per worker, but X would still use less than Y. When that fails, and the ranking flips at some factor prices, there is a factor-intensity reversal, and the theory breaks down.

Factor abundance is a property of countries, and it is always relative. India may have more capital than Switzerland in total. It is still labour-abundant, because it has much more labour per unit of capital. There are two ways to define it:

Usually the two agree: a country with lots of capital has cheap capital. They can disagree if a capital-rich country’s people also love capital-intensive goods. Then demand bids the price of capital up, and by prices the country may not be capital-abundant at all. With the price definition the Heckscher–Ohlin theorem always holds; with the physical one it needs tastes to be the same in both countries.

An Edgeworth box shows how a country can split its labour and capital between the two goods. Its width is all the labour and its height all the capital. X is measured from the bottom-left corner and Y from the top-right. The efficient splits, where neither good can grow without the other shrinking, form the contract curve. Each point on it is one point on the production frontier.

Both countries use the same technology and have the same tastes. Only their capital differs. Watch the labour-rich country’s frontier bulge toward X, the labour-intensive good.

The lab shows the argument in three steps:

1. The labour-rich country can make relatively more of the labour-intensive good, so its frontier is skewed toward X.
2. With the same tastes, it therefore has a lower autarky price of X. That is a comparative advantage in X.
3. Open trade, and it exports X. The capital-rich country exports Y.

So a capital-rich country exports capital-intensive goods (Hyderabad 2010), and trade follows relative factor endowment advantages (Hyderabad 2012). The theory fits trade between countries with very different endowments: between developing and developed countries (CUET 2018). It has much less to say about trade between similar rich countries, which Lesson 8 takes up.

In effect, countries trade factors indirectly. India can’t ship its spare workers to Germany, but it can ship the labour they put into shirts. That idea drives the theorems in Lesson 5.

One more point UGC NET has asked: with Cobb–Douglas or other technologies where both industries have the same elasticity of substitution between labour and capital, the capital–labour ratios move together and can never cross, so there is no factor-intensity reversal (UGC NET 2026). Reversals happen when one industry can substitute capital for labour much more easily than the other.