Heckscher-Ohlin Model

ECON 171 · Spring 2026 · Week 4

Sasha Petrov

Today’s Agenda

  1. Factor intensity in production
  2. The Heckscher-Ohlin theorem
  3. Equilibrium allocation and factor prices
  4. Factor price equalization
  5. The Stolper-Samuelson theorem
  6. The Rybczynski theorem
  7. Case study: Globalization and inequality in developing countries

What We Aim to Learn

Motivation for Heckscher-Ohlin Model

  • Specific factors model predicts

    • Negative shocks to the terms of trade are mitigated through re-allocation of mobile workers
  • What is insufficient about the specific factors model?

  • Specific factors model cannot explain:

    • Disproportional income losses among workers hit by trade shocks

Setup and Assumptions

  • Two countries: Home and Foreign

  • Two goods: cloth (\(C\)) and wine (\(W\))

  • Two factors of production: capital (\(K\)) and labor (\(L\))

    • Both factors are mobile across sectors (long run) but immobile across countries
  • Both countries have identical Cobb-Douglas technology: \[Q_C = K_C^{\alpha_C} L_C^{1-\alpha_C}, \quad Q_W = K_W^{\alpha_W} L_W^{1-\alpha_W}\]

  • Countries differ only in their factor endowments (\(K/L\) vs. \(K^*/L^*\))

  • Identical homothetic preferences (Cobb-Douglas utility)

Key difference from specific factors: both factors are mobile across sectors, so the model describes the long run.

How does the economy work in autarky?

#import "@preview/fletcher:0.5.8" as fletcher: diagram, node, edge

#let uchicago-maroon = rgb("#800000")
#let uchicago-dark-gray = rgb("#3e3e3e")
#let accent-gold = rgb("#ffa319")
#let blue-sector =

Opening to trade

#import "@preview/fletcher:0.5.8" as fletcher: diagram, node, edge

#let uchicago-maroon = rgb("#800000")
#let uchicago-dark-gray = rgb("#3e3e3e")
#let accent-gold = rgb("#ffa319")
#let blue-sector =

Factor Intensity in Production

Factor intensity

Factor Intensity: Good \(i\) is capital-intensive relative to good \(j\) if the capital-labor ratio used in producing \(i\) exceeds that in \(j\) at every common factor price ratio: \[(K/L)_i > (K/L)_j \quad \text{for all } w/r\]

  • With \(\alpha_W > \alpha_C\): wine is capital-intensive, cloth is labor-intensive

  • Cost minimization \(\Rightarrow\) each sector’s \(K/L\) ratio depends on \(w/r\): \[\frac{K_i}{L_i} = \frac{\alpha_i}{1 - \alpha_i} \cdot \frac{w}{r}\]

  • Since \(\alpha_W > \alpha_C\): \((K/L)_W > (K/L)_C\) at every factor price ratio

Which good uses capital more intensively?

Factor Abundance: Home is capital-abundant relative to Foreign if \(K/L > K^*/L^*\).

  • In our example: Home has \(K/L = 1\), Foreign has \(K^*/L^* = 0.5\)
    • Home is capital-abundant, Foreign is labor-abundant
  • Factor abundance is a relative concept — it is the ratio that matters, not the absolute amount

Factor intensity describes technologies; factor abundance describes countries. The H-O theorem connects the two.

Why must factor-intensity rankings be unambiguous? (No FIR)

  • A factor intensity reversal occurs when good \(i\) is capital-intensive at one \(w/r\) but labor-intensive at another
  • With Cobb-Douglas technology, reversals cannot happen:
    • \((K/L)_i = [\alpha_i / (1-\alpha_i)] \cdot (w/r)\) is always proportional to \(w/r\)
    • Since \(\alpha_W > \alpha_C\): wine always uses a higher \(K/L\) ratio

No factor intensity reversals is a critical assumption. It guarantees that the ranking of goods by capital intensity is the same in both countries. Without it, the H-O theorem fails.

How are factors split between sectors? (Edgeworth box)

What do countries trade? (Heckscher-Ohlin theorem)

What do countries trade? (H-O theorem)

Heckscher-Ohlin Theorem

A country will export the good that uses its abundant factor intensively, and import the good that uses its scarce factor intensively.

  • Home is capital-abundant (\(K/L > K^*/L^*\)), wine is capital-intensive (\(\alpha_W > \alpha_C\))
    • \(\Rightarrow\) Home exports wine, Foreign exports cloth
  • Trade pattern is determined entirely by relative factor endowments and factor intensities
    • No role for absolute productivity differences (contrast with Ricardo)

Why does the H-O theorem hold?

  • Home’s relative abundance of capital makes capital relatively cheap in autarky

  • Cheap capital \(\Rightarrow\) cheap production of capital-intensive goods \(\Rightarrow\) low autarky price of wine relative to cloth

  • \(p_C/p_W\) is higher at Home than at Foreign in autarky

  • When trade opens, Home has a comparative advantage in wine (the capital-intensive good)

From specific factors to H-O: in the specific factors model, trade patterns depend on which sectors have which factors. In H-O, trade patterns follow from economy-wide factor abundance — a deeper, more structural explanation.

How do endowments shape the PPF?

Trade Equilibrium Overview

Home (\(K\)-abundant)

World market

Foreign (\(L\)-abundant)

How does trade affect the income distribution? (Stolper-Samuelson theorem)

How does trade affect the income distribution? (Stolper-Samuelson theorem)

Stolper-Samuelson Theorem

An increase in the relative price of a good raises the real return to the factor used intensively in producing that good, and lowers the real return to the other factor.

  • If \(p_C/p_W\) rises: \(w\) rises and \(r\) falls — in terms of both goods (labor gains, capital loses)
  • Magnification effect: factor prices move proportionally more than goods prices

In equilibrium, each factor’s payment equals its marginal revenue product:

Cloth sector \[w = p_C \cdot \mathrm{MPL}_C \qquad r = p_C \cdot \mathrm{MPK}_C\]

Wine sector \[w = p_W \cdot \mathrm{MPL}_W \qquad r = p_W \cdot \mathrm{MPK}_W\]

How do factor markets adjust to a price shock? (Cobweb mechanism)

Trigger. \(p_C/p_W\) rises — cloth becomes relatively more profitable, so cloth expands and wine contracts.

  • Workers move from wine to cloth
    • \(MPL\) falls in cloth, rises in wine → wage equalizes
    • But \(MPK\) now higher in cloth, lower in wine → rental gap opens
  • Capital chases that gap, moving from wine to cloth
    • \(MPK\) falls in cloth, rises in wine → rental rate equalizes
    • But \(MPL\) now higher in cloth, lower in wine → smaller wage gap reopens
  • The chain repeats — each move closes its own factor’s gap and reopens the other’s — but every round’s gap is smaller → the system converges.

How does the cobweb play out, round by round?

Why do factor prices move in the opposite directions?

  • All reallocation forces push the rental price up
    • Directly due to the price increase of cloth
    • Indirectly as workers also move to cloth from wine, increasing capital’s marginal product
  • Two reallocation forces push the wage in different directions
    • The price increase of cloth pushes the wage up
    • The exit of capital from wine pushes the wage down
  • But the downward pressure on the wage dominates
    • As workers move to cloth from wine, the wage is equalized between the sectors
    • The exit of capital from wine drives the lower bound of the equalized value down

Who wins and who loses from trade?

  • Trade raises the relative price of the exported good

  • In Home (capital-abundant, exports wine): trade raises \(r\) and lowers \(w\)

    • Capital owners gain, workers lose
  • In Foreign (labor-abundant, exports cloth): trade raises \(w^*\) and lowers \(r^*\)

    • Workers gain, capital owners lose
  • Winners and losers are determined by which factor you own, not which sector you work in

Contrast with specific factors: there, the mobile factor’s real wage was ambiguous. Stolper-Samuelson gives a sharp prediction: winners and losers are determined by factor type, not sector of employment.

How does endowment growth reshape output? (Rybczynski theorem)

How does endowment growth reshape output? (Rybczynski theorem)

Rybczynski Theorem

At constant goods prices, an increase in the endowment of a factor raises output of the good that uses that factor intensively, and lowers output of the other good.

  • If Home’s capital \(K\) rises (at fixed \(p_C/p_W\)):
    • Wine output rises (wine is capital-intensive)
    • Cloth output falls (labor is pulled into wine)
  • This is another magnification effect: output changes are proportionally larger than the endowment change

What does Rybczynski tell us about growth and trade?

  • Capital accumulation in a capital-abundant country reinforces comparative advantage

    • More wine production \(\Rightarrow\) more wine exports
  • Immigration (increase in \(L\)) shifts comparative advantage toward labor-intensive goods

  • Rybczynski explains biased growth: factor accumulation changes the pattern of production and trade

Rybczynski links economic growth to trade patterns. A country that accumulates the factor it is already abundant in will see its exports grow; accumulating the scarce factor erodes the trade pattern.

Case Study: Globalization and Inequality

What does H-O predict for developing countries?

  • Developing countries are labor-abundant relative to developed countries

  • H-O predicts they export labor-intensive goods (textiles, assembly manufacturing)

  • Stolper-Samuelson predicts: trade should raise wages for unskilled labor in developing countries

    • Trade opening should reduce inequality in the developing world

Standard H-O prediction: globalization should compress wage inequality in developing countries by raising the returns to their abundant factor (unskilled labor).

What do the wage data show?

  • Contrary to Stolper-Samuelson, wage inequality rose in many developing countries after trade liberalization (Mexico, Colombia, India in the 1990s)
  • The skill premium (wages of college vs. non-college workers) increased, not decreased
  • This is the H-O paradox for developing countries

“The 1990s dealt a blow to Heckscher–Ohlin.” — Harrison, McLaren & McMillan (2011)

Further reading: Goldberg & Pavcnik, Distributional Effects of Globalization in Developing Countries (JEL 2007) · Goldberg & Pavcnik on VoxDev (2018, accessible summary).

Where does H-O fall short?

1. Skill-biased technological change

  • Trade opening (1980s–90s) overlapped the IT revolution (PCs, automation, robots)
  • These technologies complement college-educated workers and automate routine manual tasks
  • Developing countries imported the new goods and the technology — raising skill demand everywhere

2. Offshoring of tasks

  • A U.S. firm keeps design, R&D, marketing at home and offshores assembly to Mexico or Vietnam
  • Those tasks are unskilled in the U.S. but require literacy, numeracy, discipline — above average locally
  • So demand for skilled workers rises in both regions — a channel H-O misses

Both mechanisms lift the skill premium in both rich and developing countries — something pure H-O cannot explain.