Critical Evaluation of Heckscher-Ohlin Theory of International Trade

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1. A significant difference between the classical and the modern approach is that, the former consisted primarily of propositions about the relative prices of goods; the latter offers a series of propositions about the relative prices of factors.

2. It also appears that, the classical theory was an attempt at establishing the welfare propositions of trade theory. It stressed that territorial specialisation based on comparative advantage leads to an increase in the welfare of the world as a whole.

On the other hand, Heckscher-Ohlin theory makes a positive contribution to economics. It makes a scientific attempt to explain the structure of international trade and reveals the ultimate base of international trade as the differences in factor endowments in different regions. Evidently, Heckscher-Ohlin theory concentrates on the bases of trade, whereas, the classical theory tried to demonstrate the gains from international trade.

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3. The factor proportions theorem of Ohlin also reveals the classical lacuna of placing emphasis on the quality of a single factor, labour, as playing a key role in determining comparative advantage.

According to the new theory, it is the differences in quantity of all factors and not their quality in different regions which matter much in the emergence of international trade.

It lays down explicitly that factor combinations vary widely for different goods and that different regions are differently endowed with a variety of factors of production just as at one time, one factor and in others another will be of greater importance in providing a comparative cost advantage for particular goods in a particular region.

4. Another merit of the Heckscher-Ohlin model according to Prof. Lancaster, is that it provides a satisfactory answer to the question regarding the future of trade. In the classical analysis, the comparative costs differences as between two countries are due to differences in the skill and efficiency of labour, or some such accidental factors.

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It thus, implies that in future there will no longer be any trade between two countries when they have mastered each other’s techniques and skill and when labour becomes equally efficient in both the countries. But Ohlin’s theory asserts that trade would never cease even if there is perfect transmission of knowledge and techniques and migration of labour. This is because, according to his theory, trade between two regions takes place because of differences in relative commodity costs which results from:

(i) Relative differences in factor prices; and

(ii) Relative differences in factor requirements in the production of different commodities.

5. Besides, while the classical doctrine failed to answer why there should be differences in comparative costs, the factor-proportion analysis of Ohlin explains why differences in comparative advantage will exist and deduces the resulting pattern of productivities and specialisation.”

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In the Ricardian model, comparative cost differences are viewed under the assumption that identical absolute combinations of the factors devoted to the production of a single good would produce different amounts of that good in different countries, and therefore, the relative domestic costs of production of different goods tend to vary among nations leading to a comparative advantage in some goods over others.

In other words, the Ricardian theory assumed that the comparative cost difference existed because the production function for a given good varied from one country to another and the extent of variation differed in respect of the two goods.

On the other hand, the Ohlinian model assumes that the production function of a given commodity is identical from country to country, but it varies from commodity to commodity. For example, some goods are labour-intensive, while some are capital-intensive. According to Ohlin’s theory thus, this factor-intensive difference in the production functions of two goods, in conjunction with explicit difference in relative factor endowments of the countries, accounts for international difference in comparative costs of production.

In this way, the modern theory of international trade represents a genuine break with and considerable improvement upon the classical dogma of comparative costs.

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Shortcomings :

1. Some critics hold that the factor proportions theory of Ohlin is unrealistic because it is based on over-simplified assumptions like those of the classical doctrine. This is true regarding his initial model of explaining the theory. But he simplified the model only in order to find out the minimum difference between countries which would be sufficient to initiate trade.

This minimum difference is a difference in the relative endowment of factors between regions. Once this is recognised, in Ohlin’s theory, the apparent vices of the model turn out to be its virtues. Because, the theory is applicable to the phenomena even after removing all the assumptions underlying the model. It asserts that the ultimate base of international trade is the difference in proportions between qualitatively identical factors in the two regions.

2. According to Haberler, though, the location theory of Ohlin is less abstract and operates ‘closer to reality’, it has failed to develop a comprehensive general equilibrium concept. It is, by and large, a partial equilibrium analysis.

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Thus, relative differences in demand conditions (in factor and commodity markets) between two countries also provide an explanation of the basis of trade. In this sense, differing factor endowments (Ohlin’s hypothesis) become just one of the many possible explanations.

4. Some critics, however, feel that, if differences in consumer’s preferences and demand for goods are recognised, the commodity price-ratios will fail to reflect cost-ratios. Under this situat

3. In his basic model, Ohlin assumes that relative factor prices would reflect exactly relative factor endowments. That means, in the determination of factor prices, supply is more significant than demand. But if demand forces are more important in determining the factor prices, probably the capital-abundant country will export the labour-intensive good. For the price of capital relative to.

ion, the trade pattern will not correspond to the basic theorem of Ohlin.

5. To some critics differences in relative factor endowments (the basic content of Ohlin’s model) are one of the many possible explanations for the commodity price differences underlying international trade. Commodity prices may differ even when there are either differing factor qualities, differing production techniques, increasing returns to scale or differences in the consumer’s demand for the products in two countries. Ohlin does recognise this point and concludes that, though, there are many such reasons for the international differences in the commodity prices, unequal factor endowments seem to be the predominant element in any explanation of the basis of international trade.

6. Wijanholds, however, opines that it is not that factor prices which determine costs thus, commodity prices as assumed by Ohlin, but it is the commodity prices that determine factor prices. To him, prices of products are determined basically by their utility to the buyers (the demand force in the market), while prices of factors like raw materials, labour etc. are after all dependent on the demand and prices of final goods produced by them (since their demand being derived demand).

He, further, maintains that both the comparative costs theory and the factor proportions theory are defective because they start from differences in costs of production; the former measures the difference in terms of labour-costs and the latter in money terms. But the real logical approach is to start with prices of commodities, because, “prices are the only things we may accept as data.

Everything else has to be derived there from.” And prices of goods (in the market) are primarily determined by their utility to the consumers. Thus, it is the prices of goods which fundamentally determine the places at which each unit of labour, capital etc., is to be employed. Each unit of a factor will be employed where it can command the highest reward (monetary returns), which in turn depends on the quantity of goods produced with it (i.e., its marginal physical productivity) and the price of goods in the market paid by the consumer.

According to Wijanholds, this principle holds good for the division of labour within an industry or within a country as well as between countries. To him thus, though, differences in ability or efficiency of a factor do play their part in territorial specialisation, it is not every decisive or ultimate cause as has been assumed by Ricardo. Ricardo’s analysis was erroneous because it concentrated solely on costs and totally neglected utilities of commodities. Wijanholds thus, concludes that the principle of comparative costs underlying the theory of international trade should be replaced by the law of “Comparative Returns” as the basis of geographical specialisation.

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