Why Trade - The Heckscher-Ohlin Trade Theory

Bertil Ohlin was born in 1899. At the age of five, Bertil was very fond of calculating the cost of the various cakes his mother baked. Because mathematics was his favorite subject in school, he decided to study mathematics, statistics, and economics in college. After graduating from college, Bertil Ohlin enrolled at the Stockholm School of Economics, where he studied under the guidance of the economics historian Eli Heckscher. Together they developed the pathbreaking Heckscher-Ohlin theory in the 1920s. Many years later, in 1977, Bertil Ohlin was awarded the Bank of Sweden Prize in Economic Sciences in Memory of Alfred Nobel for his contribution to the theory of international trade, based on the work he did with Heckscher. Eli Heckscher, who died in 1952, did not share the prize since it is not awarded posthumously. Instead Ohlin shared the prize with the British economist James E. Meade.

The Heckscher-Ohlin Trade Theory :
The Heckscher-Ohlin theory explains why countries trade goods and services with each other. One condition for trade between two countries is that the countries differ with respect to the availability of the factors of production. They differ if one country, for example, has many machines (capital) but few workers, while another country has a lot of workers but few machines. According to the Heckscher-Ohlin theory, a country specializes in the production of goods that it is particularly suited to produce. Countries in which capital is abundant and workers are few, therefore, specialize in production of goods that, in particular, require capital. Specialization in production and trade between countries generates, according to this theory, a higher standard-of-living for the countries involved.

Gains from Trade
By specializing in production, and by trading with other countries, it is possible for countries to increase their incomes. Even though countries as a whole benefit from specialization and international trade, all groups in society, workers and capitalists, do not gain according to the Heckscher-Ohlin theory. If international trade leads a country to specialize in producing goods that require lots of workers and little capital, such a specialization increases wages (which benefits the workers) but decreases the income of the capital owners. But the country as a whole benefits because the gain of the workers is bigger than the loss of the capital owners

The Heckscher-Ohlin theory says that two countries trade goods with each other (and thereby achieve greater economic welfare), if the following assumptions hold:
a)The major factors of production, namely labor and capital, are not available in the same proportion in both countries.
b)The two goods produced either require relatively more capital or relatively more labor.
Labor and capital do not move between the two countries.
c)There are no costs associated with transporting the goods between countries.
The citizens of the two trading countries have the same needs.

(source: http://nobelprize.org/economics/educational/trade/)