International Economics >> The Heckscher-Ohlin Theory of Trade
The Heckscher-Ohlin Theory of Trade
The comparative advantage (or comparative cost) theory argues that the basis of international trade is the difference in the comparative costs. This theory however does not answer some important questions such as: What causes difference in comparative costs? Why do the production possibility curves of various countries differ? These questions are answered by the Heckscher-Ohlin theory of trade.
Heckscher1 in the 1st quarter and Ohlin in the 2nd quarter of The 20th century attempted to explain the international differences in comparative costs and formulated an alternative trade theory of comparative costs. Their theories are called together as Heckscher-Ohlin theory? of trade. According to the Heckscher-Ohlin theory of trade, the following two factors explain the international differences in comparative costs.
(i) Difference in the factor-endowments. While some countries are labour abundant, others are capital-abundant.
(ii) Different production technique. Production of different goods requires different combination of factor inputs. In other words, production function varies from commodity to commodity. While production of some goods is labour-intensive, production of some others is capital-intensive.
The Heckscher-Ohlin theory of trade has two main objectives:
(i) To predict the trade pattern on the basis of the observable characteristics of the trading countries; and
(ii) To examine the effect of international trade on the factor prices between the trading countries.
Corresponding to these objectives, Heckscher-Ohlin theory proposes two basic theorems.
Theorem I : Heckseher-Ohlin Trade Theorem
The basis of international trade is to be found in the difference between the factor endowments of the different countries. A country specialises in production and exports of a commodity for which it is abundantly endowed with resources. In other words, a country produces .and exports a commodity whose production requires the intensive use of its relatively abundant and cheap factors. In exchange, it imports a commodity whose production requires intensive use of its relatively I scarce and expensive resources. This proposition is known as Heckscher-Ohlin Theorem of trade.
Theorem II: Factor-Price Equalisation Theorem
The international trade makes factor prices tend to equalise between the countries. This in their opinion is the effect of international trade. This proposition is called Factor-Price Equalisation Theorem.
The two theorems constitute the main postulates of Heckscher-Ohlin theory of trade. Theorem I explains the cause of comparative advantage in terms of difference in factor endowments and predicts the trade pattern. Theorem II brings out the effects of international trade and explains why factor prices tend to equalise.
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