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Two Factor Heckscher-Ohlin Model

1. Two countries: home and foreign.

2. Two goods: cloth and food.

3. Two factors of production: labor and capital.

4. Mix of labor and capital used varies across goods.

5. The supply of labor and capital in each country is constant and varies across countries.

6. Both labor and capital can move across sectors, equalizing their returns (wage and rental rate) across
sectors.

7. Countries have the same technology and the same consumer tastes.

Example 5.1 Factors and Output • Suppose 2 hours labor and 2 units capital required to produce 1 yard
of cloth, while 1 hour labor and 3 units capital required to produce 1 pound of food. • The United States
has 2,000 labor and 3,000 capital.

Θ This theory is based on a different explanation of comparative advantage put forward by

Swedish economists Eli Heckscher and Bertil Ohlin.

Θ It is also called factor-proportions theory, factors in relative abundance are cheaper than factors
in relative scarcity.

Θ They stated that comparative advantage arises from differences in national factor endowments.

Θ Factor Endowment:

“It is the extent to which a country is bestowed with such resources as land, labor and capital.”

Θ Countries have varying factor endowments and different factor endowments explain differences
in factor costs, abundance of a factor lowers its cost.

GLOBAL IMPLICATIONS

 It implies that a country will export goods that use locally abundant factors intensively, and
import goods that use its scarce factors intensively. In the two-factor case, it states: “A capital-
abundant country will export the capital-intensive good, while the labor-abundant country will
export the labor-intensive good.”

 The assumption is that two countries are identical, except for difference in resource
endowments. This also implies that the aggregate preferences are the same.

 The relative abundance in capital will cause the capital-abundant country to produce the capital-
intensive good cheaper than the labor-abundant country and vice versa.
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 Pattern of trade in world economies:

1. United States is the most capital-abundant country in the world by any criterion, exhibits low
cost capital and imports labor-intensive products. It is also a substantial exporter of agricultural
goods by virtue of its abundant arable land.

2. China leads the world in in the export of goods produced in labor-intensive manufacturing
industries, such as textile and footwear. This reflects China’s relative abundance of low cost
labor.

Land-Labor Relationship:

• In Hong Kong and Netherlands land prices are very high because it is in demand, it is why
neither Hong Kong nor Netherland excels in the production of goods requiring large amounts of
land such as wool or wheat. Australia and Canada produce these goods because land is
abundant compared to the number of people .

Labor-Capital Relationship:

• In countries where there is little capital available for investment and where the amount of
investment per worker is low, managers might expect cheap labor rates and export
competitiveness in products requiring large amounts of labor relative to capital.

• Iran, (where labor is abundant compared to capital) excels in the production of homemade
carpets.

• Exports of emerging economies, show a high intensity of less skilled labor.

PAKISTAN’ FACTOR ENDOWMENT

• Apart from conventional factors there is an unending list of factor endowments such as energy,
natural resources, knowledge, technology etc.

• Pakistan is still paying tributes to the misadventure of nationalization by Bhutto regime in 1970s.

• Due to lack of rapid industrialization , Pakistan has exported its manpower (the labor factor).

• Fertile land of Pakistan has turned out to be a factor endowment. Pakistan’s exports contain
chiefly agricultural produce. 60% exports consist of textile products (raw & value-added).

Differentiating Heckscher-Ohlin Theory from Comparative Advantage

• Like David Ricardo’s theory it also argues that free trade is beneficial.

• Unlike absolute concept of comparative advantage, however, Heckscher-Ohlin theory argues

that the pattern of international trade is determined by differences in factor endowments,
rather than differences in productivity.
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Engro Corp. – Emerging Corporate Leader

 Engro Corp. is the holding company of Engro Fertilizers, Engro Foods, Engro ExImp, Engro
Powergen, Engro Chemicals & Polymer, Avanceon Ltd. and Engro Vopak Terminal.

 Engro Foods Limited was officially launched as a fully owned subsidiary of Engro in 2004. Using
dairy as a stepping stone to enter into the food business, the Company has established state-of-
the-art processing units in Sukkur and Sahiwal, along with an ice cream production facility in
Sahiwal.

Prospects of Pakistan based MNE

 Top quality brands like Olper’s, Olwell, Tarang, Omore and Owsum have been successfully
launched under the helm of Company’s dairy products. To support these brands and their
highest standards of quality, Engro Foods has invested heavily in milk processing and milk
collection infrastructure.

 With an acquisition of Al Safa – a fast growing and established Halal meat brand – Engro Foods is
now venturing into North American market starting from Halal Foods category. The new
organization, Engro Foods Canada Ltd. with a subsidiary Engro Foods USA, LLC, intends to
aggressively grow the business in this market.

 With the vision of Elevating Consumer Delight Worldwide, Company’s significant focus will be
towards the global operations in the years to come.

 Engro Foods is in stiff competition with the Swiss based Nestle in packaged milk products and
with Walls (Unilever) in icecream.

ISMAIL INDUSTRIES

 The products of Ismail Industries (being the largest confectionary of Pakistan) exhibits growth
stage owing to their vast domestic demand and increasing exports.

 Snackcity, Kurleez and Fritolays (Pepsi-Cola International) are having cut throat competition in
snack foods industry.

 It is due to growing popularity of Kurleez ridged Crinkle Crisps that FritoLay has launched a new
ridged chips brand “WAVY”.

PORTER DIMOND

 Michael E. Porter is a prominent economist and a Harvard Business School fellow. His
popularized works are competitive advantage and five forces model .
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 It explains why MNCs go worldwide. The Porter’s diamond shows the interaction of four
conditions that usually need to be favorable if an industry in a country is to gain a global
competitive advantage.

 Porter analyzed case studies of more than 100 firms and found that the firm that succeeds in
global markets first succeeded in intense domestic competition.

Demand conditions in the home market can help companies create a competitive advantage, when
sophisticated home market buyers pressure firms to innovate faster and to create more advanced
products than those of competitors.

I. Size of Market

II. Sophistication of consumers

III. Media exposure of products

Japan’s electronic products are regarded at high value around the globe.

Factor conditions are human resources, physical resources, knowledge resources, capital resources and
infrastructure. Specialized resources are often specific for an industry and important for its
competitiveness. Specific resources can be created to compensate for factor disadvantages.

I. Abundance of Natural Resources

II. Education and Skill Levels

III. Wage Rates

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Netherland enjoys 59% share of the world’s cut-flower market.

Related and supporting industries can produce inputs which are important for innovation and
internationalization. These industries provide cost-effective inputs, but they also participate in the
upgrading process, thus stimulating other companies in the chain to innovate

• Existence of supplier clusters

German engineering firms such as Siemens are world leaders in sophisticated engineering products.

Firm strategy, structure and rivalry constitute the fourth determinant of competitiveness. The way in
which companies are created, set goals and are managed is important for success. But the presence of
intense rivalry in the home base is also important; it creates pressure to innovate in order to upgrade
competitiveness

I. More number of companies in same industry.

II. Intensity of competition.

III. Public or private ownership.

Italian shoes are in vogue in every nook and corner of the world since decades.