Heckscher-Ohlin Theorem
Introduction
International trade is a key development tool that plays an integral role in global economic growth (Tarzi, 2016). It has facilitated great consumer satisfaction since countries are able to exchange different goods and services that are in high demand by various consumers. To ensure a suitable equilibrium of trade between countries is achieved, the knowledge of economists is very essential. Their strategic planning using various economic models and theorems is very vital in determining the demand and supply of commodities that would be enough to meet needs of consumers. As part of their endeavor in ensuring economic success, two Swedish economists, Bertil Ohlin and Eli Hecksher developed the Heckscher-Ohlin Theorem to try and explain the production of commodities using two factors of production that are capital and labor.
Briefly explain what the HO Theorem is about.
The HO Theorem is a model in economics which asserts that countries in global setting export the amount of products that they can plentifully and efficiently produce to other nations. This economic model is used in analysing the trade operations between two nations while giving more attention towards the determination of trade equilibrium between them. The two countries involved usually contain varying levels of natural resources and specialities. This theorem gives much emphasis on the exportation of commodities that need factors of production which are in abundance in certain country. Additionally, the model emphasises the importation of products that are not produced efficiently by a given country. This theorem exhibits economic standards of a given country by asserting that nations should preferably export resources and materials which they have in excess and at the same time import components that they require in a proportional manner.
The theorem works under various assumptions. Firstly, the model assumes two products are being traded between two nations under two factors of production which are capital and labour. Nevertheless, there is a possibility of extending this model to a multi-product and multi-factor case if the number of commodities and number of factors are equal. Secondly, the elements of production are assumed to be perfectly mobile within and around the respective nations but they remain immovable between them. Additionally, the theorem asserts that there exists a state of absolute competition across the factors and product markets. More so, the theorem maintains that there is total employment of the production factors in both nations. The production factors concerning the traded goods are also assumed to be linearly homogenous which means that the production is managed by stable returns to scale.
Limitations of the HO Theorem
With its exactness and preciseness due to its analytical and scientific approaches, the HO model is indeed a more superior theorem than the traditional theory of international trade. However, the theory has various limitations that remain challenging to most economists.
Partial equilibrium evaluation. The OH theory has not developed an ideal equilibrium concept. The theory only explains trade patterns by basing on factor intensities and factor proportions (Nápoles, 2020). The theory does not consider various factors such as economies of scale, transport costs, external economies among others that impact on the production costs.
Oversimplified assumptions. The model operates on over-simplified suppositions of perfect competition, similar production functions, absence of differentiation of products full resources of employment, lack of transportation costs and unvarying returns to scale which make the whole theorem unrealistic.
Negligence to product differentiation. The HO theorem overlooks the part played by the differentiation of products in international trade. This theory relates factor to cost prices and neglects the role of product differentiation in global trade. Under normal circumstances, international trade may still occur even if the production elements are identical between the two nations as long as product differentiation exists.
Static evaluation. This theory assumes fixed values of production factors given costs, incomes, and production functions. This implies the model looks into the trends of global trade in a stationary setting thereby resulting in questionable conclusions when it’s used in the evaluation of dynamic economic systems.
Specialisation and factor proportions. The HO model suggests that specialization in exports between different nations is mostly determined by the comparative factor proportions. The labour-abundant nations export labour-intensive commodities while capital-abundant nations export capital-intensive products. This therefore implies that trade can not occur between such regions or nations since they have similar comparative factor proportions which is an untrue statement. This is because specialization is controlled by many factors such as price and cost differences, external economies, and transport costs among many others.
Negligence of demand. This theorem assumes that comparative endowment factors of a given nation determine the factor prices. This implies that the wage rates should be slightly high while the interest rates relatively low in a labour-deficient but a capital-abundant nation. The relative factor prices are usually influenced by both demand and supply.
Negligence to changes in technology. This theorem assumes similar production functions which mean that shifts in technological aspects of a given nation remain static thereby giving an invalid proposition. Both developed and developing nations undergoes through various improvements in terms of technology. The HO negligence on this matter makes the theorem to be inconsistent with realities of change in trade.
Why Economists Use this Model to Analyse Trade Pattern Between Two Countries.
Despite its shortcomings, economists still use the HO model since it provides a very improved process that results in more significant benefits than the traditional theory. The theory provides as effective explanation of the cause of relative differences with regard to international specialisation and costs of products. Unlike the classical theory that only looks into labour as the main factor, the HO model addresses both the supply and demand in explaining and determining pattern of trade and specialisation.
Trade Pattern between the US and Japan
International trade is a crucial part of the world economy. Countless companies and individuals rely on foreign markets to enhance their profits. Also, consumers rely on foreign firms to meet their ever-changing demand for services, resources and goods. The United States and Japan are two the leading nations in terms of economic strengths in the world that have engaged in this form of trade. Their economic success can be attributed to their strong trade relations that seem to develop every day (McMinimy, 2018). The two countries engage in diverse trading activities that range from agricultural products to machineries. Japan is a long term leading exporter of agricultural products to US (McMinimy, 2018). About 1.08 trillion Japanese yen was spent on electrical imports from the US which contrasts the value of imports registered from Peru that were about 3.1 million yen. This depicts strong trade relations between Japan and the US. In 2019, the amount of US imports from Japan amounted to about 143.64 billion dollars. Additionally, Japan’s trade share with the US is about 26.9% of its total trading activities (Ito, 2015).
Can You Apply the HO to the Trade Patterns? Why or Why Not?
Looking at the trade patterns between the two nations, the HO model cannot be applied in their trading activities because trading activities between these countries involve large amounts of exports and imports that include a wide variety of products. The ever-changing needs of consumers have resulted to increased amount of manufactured products and supply of resources that are required by consumers. The technology has greatly influenced product differentiation and specifications to ensure they suit the needs of consumers. However, the HO cannot apply in these two nations since it assumes that the technology is a constant factor that does not result in any changes. Technological advancements and changes have resulted in the development of new products that are much appealing to the consumers. Since these countries are looking forward to produce more superior products and services, they have to rely on technology which is the main aspect of change. Therefore, using this model can result to misleading conclusions since it assumes the technology remains unchanged.
Conclusion
Having looked at the applications of the HO theory and its limitations, it is evident that the theorem tried to determine and explain key reason for comparative advantage of two countries involved the trade of services and goods. However, from the illustrations, the theory seems to be too conditional and vague. It relies on various unrealistic and restrictive assumptions. As such, it is difficult for trade to take place under such circumstances bearing in mind that different countries engage in dissimilar production processes.
Many countries rely on the technology and other economic models in coming up with cost effective production systems that would result in better outcomes for better competitive sustainability.
Reference
Ito, B. (2015). Does electoral competition affect politicians’ trade policy preferences? Evidence from Japan. Public Choice , 165 (3-4), 239-261.Retrieved from: https://search.proquest.com/docview/1843275305?accountid=151051
McMinimy, M. A. (2018). TPP: AMERICAN AGRICULTURE AND THE TRANS-PACIFIC PARTNERSHIP (TPP) AGREEMENT. Current Politics and Economics of South, Southeastern, and Central Asia; Hauppauge , 27 (1/2), 49-72.Retrieved from: https://search.proquest.com/docview/2273102087?accountid=151051
Nápoles, P. R. (2020). The Heckscher-Ohlin theorem and the Mexican economy. A critical view of neoliberal economicsl. El Trimestre Económico , 87 (1), 99-131.Retrieved from: https://search.proquest.com/docview/2345526214?accountid=15105
Tarzi, S. (2016). The Third World and Relative Gains from Global Trade: An Empirical Comparative Analysis of Developed Versus Developing Countries. Journal of Global South Studies , 33 (1), 11-48.Retrieved from: https://search.proquest.com/docview/1764289945?accountid=151051
