In the early 1900s an international trade theory called factor proportions theory emerged by two Swedish economists, Eli Heckscher and Bertil Ohlin. This theory is also called the Heckscher-Ohlin theory. The Heckscher-Ohlin theory stresses that countries should produce and export goods that require resources (factors) that are abundant and import goods that require resources in short supply. This theory differs from the theories of comparative advantage and absolute advantage since these theory focuses on the productivity of the production process for a particular good. On the contrary, the Heckscher-Ohlin theory states that a country should specialise production and export using the factors that are most abundant, and thus the cheapest. Not produce, as earlier theories stated, the goods it produces most efficiently.
The Heckscher-Ohlin theory is preferred to the Ricardo theory by many economists, because it makes fewer simplifying assumptions. In 1953, Wassily Leontief published a study, where he tested the validity of the Heckscher-Ohlin theory. The study showed that the U.S was more abundant in capital compared to other countries, therefore the U.S would export capital- intensive goods and import labour-intensive goods. Leontief found out that the U.S's export was less capital intensive than import.
Limitations of Heckscher Ohlin Theory
- Unrealistic Assumptions: Besides the usual assumptions of two countries, two commodities, no transport cost, etc Ohlin’s theory also assumes no qualitative differences in factors of production, identical production function, constant return to scale… All these assumptions make the theory unrealistic one
- Restrictive: Ohlin’s theory is not free from constraints. His theory includes only two commodities, two countries and two factors. Thus it is a restrictive one
- One-sided theory: According to Ohlin’s theory, supply plays a significant role than demand in determining factor prices. But if demand forces are more significant, a capital abundant country will export labour intensive goods as price of capital will be high due to high demand for capital
- Static in nature: Like Ricardian Theory the H-O theory model is also static in nature. The theory is based on a given state of economy and with a given production function and does not accept any change
- Wijnhold’s Criticism: According to Wiijnholds, it is not the factor prices that determine the costs of commodity prices but it is commodity prices that determine the factor prices.
- Consumers Demand Ignored: Ohlin forgot an important fact that commodity prices are also influenced by consumer demands
- Haberler’s Criticism: According to Haberler, Ohlin’s theory is based on partial equilibrium. It fails to give a complete, comprehensive and general equilibrium analysis
- Leontief Paradox: Leontief tested H-O theory under US conditions, and found out that USA exports labour intensive goods and imports capital intensive goods, but USA being a capital abundant country must export capital intensive goods than to produce them at home.
Other issues: Factor endowment is not the sole influencing commodity price and international trade. The H-O theory neglects other factors like technology, technique of production, natural factors, different qualities of labour, etc… which can influence the process of international trade.
As arguments continue to grow for the push of free trade, issues persist and slowly hindering the drive for the practice, due to the influence of tariffs and export taxes, as the general image surrounds smaller nations / countries being unable to have much influence on their import and export prices, so they cannot use tariffs or other policies to raise there terms of trade. However Large countries can influence their terms of trade, but in imposing tariffs they run the risk of disrupting trade agreements and...