Eli Filip Heckscher

(Stockholm November 24, 1879 - Stockholm December 23, 1952)

was a Swedish political economist and economic historian.

Heckscher was born in Stockholm into a prominent Jewish family, son of the Danish-born businessman Isidor Heckscher and his spouse Rosa Meyer, and completed his secondary education there in 1897. He studied at university in Uppsala and Gothenburg, completing his PhD in Uppsala in 1907. He was professor of Political economy and Statistics at the Stockholm School of Economics from 1909 until 1929, when he exchanged that chair for a research professorship in economic history, finally retiring as emeritus professor in 1945.

According to a bibliography published in 1950, Heckscher had as of the previous year published 1148 books and articles, among which may be mentioned his study of Mercantilism, translated into several languages, and a monumental Economic history of Sweden in several volumes. Heckscher is best known for a model explaining patterns in international trade that he developed with Bertil Ohlin.

Eli Heckscher's son was Gunnar Heckscher (1909-1987), political scientist and leader of what later became Moderate Party 1961-1965. His grandson, however, is Social Democratic politician Sten Heckscher.

Bertil Ohlin (pronounced "ber´til O´lin") (April 23, 1899 – August 3, 1979), was a Swedish economist and winner of the 1977 Bank of Sweden Prize in Economic Sciences in Memory of Alfred Nobel. His name lives on in one of the standard mathematical model of international free trade, the Hecksher-Ohlin model.

Having received his B.A. from Lund University 1917, and his M.A. from Harvard University in 1923, Ohlin received his doctorate from Stockholm University in 1924. In 1925 he became a professor at the University of Copenhagen. In 1929 he debated with John Maynard Keynes, contradicting the latter's view on the consequences of the heavy war reparations payments imposed on Germany. (Keynes predicted a war caused by the burden of debt, Ohlin thought that Germany could afford the reparations.) Although Keynes was probably right, the debate was important in the modern theory of unilateral international payments.

In 1930 Ohlin succeeded Eli Heckscher, his teacher, as a professor of economics, at the Stockholm School of Economics. In 1933 Olin published a work that made him world renowned, Interregional and International Trade. In this Ohlin built an economic theory of international trade from earlier work by Heckscher and his own doctoral thesis. It is now known as the Heckscher-Ohlin model, one of the standard model economists use to debate trade theory.

The model was a break-though because it showed how comparative advantage might relate to general features of a country's capital and labour, and how these features might change through time. The model provided a basis for later work on the effects of protection on real wages, and has been fruitful in producing predictions and analysis; Ohlin himself used the model to derive the Heckscher-Ohlin theorem, that nations would specialize in industries most able to utilize their mix of national resources efficiently. Today, the theory has been largely disproved, yet it is still a useful framework by which to understand international trade.

Later, Ohlin and other members of the "Stockholm school" extended Knut Wicksell's economic analysis to produce a theory of the macroeconomy anticipating Keynesianism.

Ohlin was party leader of the liberal Folkpartiet from 1944 to 1967, the main opposition party to the Social Democrat Governments of the era, and from '44 to '45 was minister of commerce in the wartime government. His daughter Anne Wibble, representing the same party, served as Minister of Finance in 1991-1994.

The theory is that trade between countries is in proportion to their relative amounts of capital and labor. In countries with an abundance of capital, wage rates tend to be high; therefore, labor-intensive products, e.g. textiles, simple electronics, etc., are more costly to produce internally. In contrast, capital-intensive products, e.g. automobiles, chemicals, etc., are relatively less costly to produce internally. Countries with large amounts of capital will export capital-intensive products and import labor-intensive products with the proceeds. Countries with high amounts of labor will do the reverse. (1)

The following conditions must be true. (2)

• The major factors of production, namely labor and capital, are not available in the same proportion in both countries.

• The two goods produced either require relatively more capital or relatively more labor.

• Labor and capital do not move between the two countries.

• There are no costs associated with transporting the goods between countries.

• The citizens of the two trading countries have the same needs.

The theory does not depend total amounts of capital or labor, but on the amounts per worker. This allows small countries to trade with large countries by specializing in production of products that use the factors which are more available than its trading partner. The key assumption is that capital and labor are not available in the same proportions in the two countries. That leads to specialization, which in turn benefits the country’s economic welfare. The greater the difference between the two countries, the greater the gain from specialization. (2)

Leontief made a study of the theory that seemed to invalidate it. He noted that the United States had a lot of capital; therefore, it should export capital-intensive products and import labor-intensive products. Instead, he found that it exported products that used more labor than the products it imported. This is counter to the H-O Theory, and it is named The Leontief Paradox. (1) "However, Leontief's explanation was that the workers in the U.S. have a lot of knowledge. In other words, the U.S. exports the goods that require a production factor that the U.S. is particularly well-endowed with, namely knowledge. Thus, Leontief's explanation was consistent with the Heckscher-Ohlin theory." (2)

Correct Source: Appleyard, Field, & Cobb. (2006). International Economics (5th ed.). McGraw-Hill Irwin. ISBN 0-07-287737-5.

Retrieved from "http://en.wikipedia.org/wiki/Heckscher-Ohlin_theorem"

Relative endowments of the factors of production (land, labor, and capital) determine a country's comparative advantage. Countries have comparative advantage in those goods for which the required factors of production are relatively abundant. This is because the prices of goods are ultimately determined by the prices of their inputs. Goods that require inputs that are locally abundant will be cheaper to produce than those goods that require inputs that are locally scarce.

For example, a country where capital and land are abundant but labor is scarce will have comparative advantage in goods that require lots of capital and land, but little labor - grains, for example. Since capital and land are abundant, their prices will be low. Those low prices will ensure that the price of the grain that they are used to produce will also be low - and thus attractive for both local consumption and export. Labor intensive goods on the other hand will be very expensive to produce since labor is scarce and its price is high. Therefore, the country is better off importing those goods.

The Ricardian model of comparative advantage has trade ultimately motivated by differences in labour productivity using different technologies. Heckscher and Ohlin didn't require production technology to vary between countries, so (in the interests of simplicity) the H-O model has identical production technology everywhere. Ricardo considered a single factor of production (labour) and would not have been able to produce comparative advantage without technological differences between countries (all nations would become autarkies at various stages of development, with no reason to trade with each other). The H-O model removed technology variations but introduced variable capital endowments, recreating endogenously the inter-country variation of labour productivity that Ricardo had imposed exogenously. With international variations in the capital endowment (i.e. infrastructure) and goods requiring different factor proportions, Ricardo's comparative advantage emerges as a profit-maximizing solution of capitalist's choices from within the model's equations. (The decision capital owners are faced with is between investments in differing production technologies: The H-O model assumes capital is privately held.)

Interregional and International Trade itself was verbose, rather than being pared down to the mathematical, and appealed because of its new insights.

The original H-O model assumed that the only difference between countries was the relative abundances of labour and capital. The original Heckscher-Ohlin model contained two countries, and had two commodities that could be produced. Since there are two (homogeneous) factors of production this model is sometimes called the "2×2×2 model".

The model has variable factor proportions between countries: Highly developed countries have a comparatively high ratio of capital to labour in relation to developing countries. This makes the developed country capital-abundant relative to the developing nation, and the developing nation labour-abundant in relation to the developed country.

With this single difference, Ohlin was able to discuss the new mechanism of comparative advantage, using just two goods and two technologies to produce them. (One technology would be a capital intensive industry, the other a labour intensive business - see "assumptions" below).

The model has been extended since the 1930s by many economists. These developments did not change the fundamental role of variable factor proportions in driving international trade, but added to the model various real-world considerations (such as tariffs) in the hopes of increasing the model's predictive power, or as a mathematical way of discussing macroeconomic policy options.

Notable contributions came from Paul Samuelson, Ronald Jones, and Jaroslav Vanek, so that variations of the model are sometimes called the Heckscher-Ohlin-Samuelson model or the Heckscher-Ohlin-Vanek model in the modern synthesis.

The original, 2x2x2 model was derived with restrictive assumptions, partly for the sake of mathematical simplicity. Some of these have been relaxed for the sake development. These assumptions and developments are listed here.

As mentioned above, the HO model differs from Ricardo's most drastically by assuming that the production functions available in each country are identical. The production functions simply convert labour and capital input to output.

This assumption means that producing the same output of either commodity could be done with the same level of capital and labour in either country. Actually, it would be inefficient to actually use the same balance in either country (because of the relative availability of either input factor) but, in principle this would be possible. Another way of saying this is that the per-capita productivity is the same in both countries in the same technology with identical amounts of capital.

Countries have natural advantages in the production of various commodities in relation to one another, so this is an 'unrealistic' simplification designed to highlight the effect of variable factors. (This meant that the original HO-model produced an alternative explanation for free trade to Ricardo's, rather than a complementary one). In reality, both effects may occur (differences in technology and factor abundances).

In addition to natural advantages in the production of one sort of output over another (wine vs. rice, say) the infrastructure, education, culture, and 'know-how' of countries differ so dramatically that the idea of identical technologies is a theoretical notion. Ohlin said that the HO-model was a long run model, and that the conditions of industrial production are "everywhere the same" in the long run. ([1]).

Both of the countries in the simple HO model produced both commodities, and both technologies have constant returns to scale (CRS). (CRS production has twice the output if both capital and labour inputs are doubled, so the two production functions must be 'homogeneous of degree 1').

These conditions are required to produce a mathematical equilibrium. With increasing returns to scale it would likely be more efficient for countries to specialize, but specialization is not possible with the Heckscher-Ohlin assumptions.

Where A is the output in arable production,

F is the output in fish production, and K, L are capital and labour in both cases.

In this example, the marginal return to an extra unit of capital is higher in the fishing industry, assuming units of F(ish) and A(rable) output have equal value. The more capital-abundant country may gain by developing its fishing fleet at the expense of it arable farms. Conversely, the workers available in the relatively labour-abundant country can be employed relatively more efficiently in arable farming.

Within countries, capital and labour can be reinvested and re-employed to produce different outputs. Like the comparative advantage argument of Ricardo, this is assumed to happen costlessly.

If the two production technologies are the arable industry and the fishing industry it is assumed that farmers can shift to work as fishermen with no cost, and vice versa.

It is further assumed that capital can shift easily into either technology, so that the industrial mix can change without adjustment costs between the two types of production.

For instance, if the two industries are farming and fishing it is assumed that farms can be sold to pay for the construction of fishing boats with no transaction costs.

The basic Heckscher-Ohlin model depends upon the relative availability of capital and labour differing internationally, but if capital can be freely invested anywhere competition (for investment) will make relative abundances identical throughout the world. (Essentially, Free Trade in capital would provide a single worldwide investment pool.)

Differences in labour abundance would not produce a difference in relative factor abundance (in relation to mobile capital) because the labour/capital ratio would be identical everywhere. (A large country would receive twice as much investment as a small one, for instance, maximizing capitalist's return on investment).

As capital controls are reduced, the modern world has begun to look a lot less like the world modelled by Heckscher and Ohlin. It has been argued that capital mobility undermines the case for Free Trade itself, see: Capital mobility and comparative advantage Free trade critique. Capital is mobile when:

Like capital, labour movements are not permitted in the HO world, since this would drive an equalization of relative abundances of the two production factors, just as in the case of capital immobility above. This condition is more defensible as a description of the modern world than the assumption that capital is confined to a single country.

The 2x2x2 model originally placed no barriers to trade, had no tariffs, and no exchange controls (capital was immobile, but repatriation of foreign sales was costless). It was also free of transportation costs between the countries, or any other savings that would favour procuring a local supply.

If the two countries have separate currencies, this does not affect the model in any way (Purchasing Power Parity applies). Since there are no transaction costs or currency issues the law of one price applies to both commodities, and consumers in either country pay exactly the same price for either good.

In Ohlin's day this assumption was a fairly neutral simplification, but economic changes and econometric research since the 1950s have shown that the local prices of goods tend to be correlated with incomes when both are converted at money prices (although this is less true with traded commodities). See: Penn effect.

Neither labour nor capital has the power to affect prices or factor rates by constraining supply; a state of perfect competition exists.

The results of this work has been the formulation of certain named conclusions arising from the assumptions inherent in the model. These are known as:

The exports of a capital-abundant country will be from Capital intensive industries, and labour-abundant countries will import such goods, exporting labour intensive goods in return. Competitive pressures within the H-O model produce this prediction fairly straightforwardly. Conveniently, this is an easily testable hypothesis.

Any change in relative factor endowment causes a corresponding change in the industrial mix between capital-intensive and labour-intensive production. (This is the dynamic equivalent to the Heckscher-Ohlin theorem.)

Relative changes in output goods prices will drive the relative prices of the factors used to produce them. If the world price of capital-intensive goods increases relative to the price of labour intensive goods the rental rate will increase relative to the wage rate (the return on capital as against the return to labour).

Free and competitive trade will make factor prices converge along with traded goods prices. The FPE theorem is the most significant conclusion of the HO-model, but it is also the theorem which has found the least agreement with the economic evidence. Neither the rental return to capital, nor the wage rates seem to consistently converge between trading partners at different levels of development.

The Stolper-Samuelson theorem concerns nominal rents and wages. The Magnification effect on prices considers the effect of output-goods price-changes on the real return to capital and labour. This is done by dividing the nominal rates with a price index, but took thirty years to develop completely because of the theoretical complexity involved.

• The Magnification effect shows that trade liberalization will actually make the locally-scarce factor of production worse off (because increased trade makes the price index fall by less than the drop in returns to the scarce-factor induced by the Stolper-Samuelson theorem).

• The Magnification effect on production quantity-shifts induced by endowment changes (via the Rybczynski theorem) predicts a larger proportionate shift in output-quantity than in the corresponding endowment factor shift which induced it. This has implications to both labour and capital:

• Assuming fixed capital, population growth will dilute the scarcity of labour in relation to capital. If the population growth outpaces the growth in capital by 10% this may translate into a 20% shift in the balance of employment to the labour-intensive industries.

• In the modern world, money tends to be much more mobile than labour, so import of capital to a country will almost certainly shift the relative factor-abundances in favour of capital. The magnification effect says that a 10% increase in national capital may lead to a redistribution of labour amounting to a fifth of the entire economy (towards capital-intensive, high-tech production). Notably, employment patterns in very poor countries can be dramatically affected by a small amount of FDI, in this model. (See also: Dutch disease.)

Heckscher and Ohlin considered the Factor-Price Equalization theorem an econometric success because the large volume of international trade in the late 19th and early 20th centuries coincided with the convergence of commodity and factor prices worldwide.

Modern econometric estimates have shown the model to perform poorly, however, and adjustments have been suggested, most importantly the assumption that technology is not the same everywhere. (This change would mean abandoning the pure H-O model.)

In 1954, an econometric test by Wassily W. Leontief of the H-O model found that the US, despite having a relative abundance of capital, tended to export labor intensive goods and import capital intensive goods. This problem became known as the Leontief paradox. Alternative trade models and various explanations for the paradox have emerged as a result of the paradox. One such trade model, the Linder hypothesis, suggests that goods are trade based on similar demand rather than differences in supply side factors (i.e. H-O's factor endowments).