Explain the mechanism referred to in the above statement using the Heckscher-Ohlin model. Essay

Words: 1020
Pages: 5

“Trade between advanced countries that are abundant in capital and skill and NIEs (Newly Industrialising Economies) with their abundant supply of unskilled labour was raising the wages of highly skilled workers and lowering the wages of less-skilled workers in the skill- and capital-abundant countries ” (Krugman, Obstfeld and Melitz). Explain the mechanism referred to in the above statement using the Heckscher-Ohlin model.

The Heckscher-Ohlin model is extremely useful when illustrating how endowments of a particular resource can influence trade between economies. The model shows us how comparative advantage is explained somewhat by the relative abundance of certain resources, such as land, labour or capital.
The Heckscher-Ohlin (HO)
…show more content…
For instance, the shoemaker in the above example cannot simply start producing cars with their limited skill set. This immobility of factors means that those who possess the scarce factor cannot quickly or easily substitute their factor for an abundant factor. This widens the earnings gap between these two groups, which in many cases increases economic inequality.
The Heckscher-Ohlin model, unlike the Ricardian model, predicts that factor prices equalise after trade. This is because of the direct relationship between relative prices and factor prices, and due to the fact that relative prices equalise. However, it is important to state that this is a model and does have its limitations when it comes to testing the theory. The model predicts that the two countries produce the same goods, but in reality, countries may produce different goods and may trade with more than one other country. The model also assumes that all countries have the same technology and the same productivity of factors. Again, in reality, economies will have differing levels of technology and will have different productivity levels, which will affect the rates and wages paid to these factors. Transport costs and trade barriers may also prevent the prices of factors and goods equalising.
The effect of trade on the widening of inequality has been a topic of interest among economists in recent years. Empirical evidence seems to support the