Heckscher-Ohlin Theory
1. Over-simplified explanation of trade:
This theory explains trade between only two countries, in two commodities produced by only two inputs.
Thus, it is a 2 x 2 x 2 trade model. In practice, however, trade takes place between many countries and in many commodities which are produced by several inputs.
Consequently, the theory cannot explain the actual complex trade pattern. It is an over-simplified explanation of trade.
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2. Trade between countries of similar not dissimilar endowments:
According to this theory, a country will produce and export that commodity in whose production relatively large amount of its abundant factor is used.
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Thus, trade occurs due to differences in factor proportions between nations. Trade will not occur between regions or countries endowed with similar relative factor endowments.
For example, if the two countries are identical in capital and labour abundance they would not trade. This claim is false as a substantial part of world trade takes place between countries with similar factor endowments.
For example, in 1960 exports of manufactured goods to one another of the 10 industrially developed capital rich and poorly endowed with labour countries accounted for about 25 per cent of their total exports and for about 50 per cent of their exports of manufactured goods.
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Although the relative factor endowments, especially with regard to labour, among these ten nations were rarely enough (except the USA vis-a-vis the others) to explain specialisation by themselves.
Heckscher-Ohlin theory is not competent to explain specialisation and trade in manufactures between these countries.
3. Neglect of cost-influencing factors:
In fact, international trade takes place due to differences in the relative prices of commodities between different regions which may be due to cost differences.
Differences in costs of different products between different regions arise from many factors including transport costs, economies of scale and external economies.
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Ohlin was mistaken to make the simplifying assumption that regional differences in factor proportions uniquely determined specialization and trade.
His theory is faulty as an explanation of specialization and trade because it ignores several other factors like transport costs, economies of scale, external economies etc. which account for the differences in costs and consequently in the prices of products between different regions.
P.T. Ellsworth has correctly stated that “With several causes operating simultaneously upon costs, it becomes a matter of adding up the influence of all cost-reducing and increasing forces to arrive at a net result.
More concretely, comparative advantage becomes a net cost advantage, in the reckoning of which one must take into account differences in labour costs, in capital costs, in natural resource costs, and also the costs of transporting raw materials (sometimes several from different locations), fuel, and the finished product, as well as the cost-reducing influence of economics of scale and of external economies.”
Not taking into account all the various cost-influencing forces Heckscher-Ohline theory is unable to develop a general equilibrium system. Therefore, it is a partial equilibrium analysis.
4. Neglect of the role of product differentiation:
If there is product differentiation, trade may take place even if the two countries are similarly endowed with the productive agents.
For example, English cutlery finds a market in Germany and German cutlery is sold in ‘England’. Swedish economist Staifan Burenstam Linder has developed the theory of trade in manufactures which states that countries with similar tastes and with roughly the same level of income will trade substantially with each other exchanging one differentiated product against another.
The bulk of the trade that takes place between the developed nations in automobiles, electronic and other manufactured goods is explained by theory.
Thus, Italian Fiats are exported to England while British Fords are sold to Italy. German Volkswagens find a good market in the USA while Peugeots are sold to Germany.
The gains from trade in these exports and imports are, however, relatively limited. These are measured by how much the price of exports would fall or the price of import- substitutes would rise if no trade took place in these differentiated goods.
5. Prices of commodities are not determined by the factor costs of production:
H. W. J. Wijanholds criticized the Heckscher-Ohlin theory on the ground that the prices of commodities are not determined by the factor costs of production.
He maintained that the relation is quite the reverse. The prices of commodities are determined by their utility to the consumers. The prices of raw materials and labour ultimately depend on the prices of final goods.
6. No mention of by-products:
Heckscher-Ohlin theory does not mention anything about the by-products. In influencing the structure and direction of international trade sometimes the by-products are more important than the main final products.
7. Static-equilibrium analysis:
This theory rests on the static assumptions of fixed quantities of factors of production, given consumer incomes and tastes, given production functions, etc.
The conclusions drawn from the static equilibrium analysis cannot be applied to a dynamic economy characterized by changes in tastes, technical knowledge and relative factor endowments over time.
This theory neglects the problems of long-run historical developments and their impact on the nature and pattern of international trade.
The assumptions of fixed factor endowments and unchanging technology cannot be defended. None of a country’s factor is fixed for all time to come.
As a result of growth of population and improvement in labour skills, a total labour force grows over time.
In recent times, world’s underdeveloped countries have experienced rapid population growth due to improved public health services.
Similarly, a nation’s capital stock is augmented due to increased saving and capital accumulation due to income redistribution in favour of the people with high marginal propensity to save and through increase in productivity.
Even natural resources are not fixed for ever as their supply may be either augmented due to new discovery and exploration or depleted through exhaustion.
For example, due to the discovery of oil in the early years of this century Venezuela became one of the world’s principal oil exporters.
On the other hand, ekhaustion of iron ore deposits in the USA transformed that country’s economy from one of self-sufficiency to one of increasing dependence on imports in the matter of iron ore.
Even land can expand in an economic sense through changes in technology which may make useful abandoned and exhausted mines and make land-eroded by afforestation worth-exploiting through capital investment.
However, the indisputable fact that factor supplies can increase or decrease would be of no significance for international trade and specialization, if the relative factor supplies of different countries remained unaltered.
Changes in factor supplies of different nations may change the relative factor endowments of different countries overtime.
The effect of such changes in a country’s factor endowments can be easily seen in terms of the shifts in her production possibilities curve which will influence the structure of international trade.
8. Neglect of the influence of technological progress on trade:
The assumption of identical production functions in two countries is plausible only in a static world in which the technical conditions of production remain constant.
Any production function is available for exploitation by any potential user barring exceptional cases of very few well-guarded industrial secrets and patented production processes which their owners will into license.
There are no industrial secrets, in the long run. Even the patents and copyrights expire after a certain time lapse.
10. Units of the factors of any particular category are not homogeneous in quality:
Jacob Viner and others have criticized Ohlin’s assumption that units of the factors of any particular category, such as’ labour’ are homogeneous in quality everywhere.
From this assumption follows the wrong corollary that the production functions are everywhere identical if expressed in terms of common classifications of factors which are everywhere homogeneous in quality.
Therefore, the H-0 theory leaves no scope in the analysis for any influence on trade of the qualitative differences between the factors in the different countries.
11. No validity of the premise of lack of international factor mobility:
John H. Williams has argued that international factor mobility was, in fact, greater between countries than within a single country.
Supporting him Jonathan V. Levin argued that the recent development of “export economies” proves the fact of international factor mobility.
The entry of export economies into international trade was thrust upon them by a sudden invasion of foreign entrepreneurs who brought with them the necessary capital, managerial skill, technical and common labour needed for the development of export industries.
The extraction of petroleum in the Middle East, Sumatra and Venezuela owes its development to foreign capital, enterprise and skilled labour.
Mineral industries in Mexico and copper mining in Chile are examples of export industries whose development has been due to international factor mobility.
12. Trade due to differences in consumer preference:
Despite identical factor proportions in different countries, trade may take place if the consumer preferences are not identical, i.e. if consumer tastes in the two countries are different for various reasons.
13. Different relative factor endowments with identical taste patterns do not ensure orthodox trade pattern envisaged by the H-o trade model:
If two countries have different production possibilities curves and identical tastes, trade may be unorthodox if one of the two goods has a negative income elasticity of demand, i.e., if one of the two goods is an inferior good.
In such a situation, trade will follow an unorthodox pattern in the sense that the capital-rich country exports labour-intensive goods, a conclusion which refutes the H-0 theory.
14. Unrealistic:
Critics argue that since the factor-proportions theory is unrealistic, as it is based on assumptions of perfect competition, full employment of resources, identical production functions, absence of transport costs, absence of product differentiation, etc.
It has no relevance in the real world. However, Lancaster argues that “the model occupies the very centre of international trade theory for reasons unconnected with its realism and indeed strengthened by the very properties which have been subject to so much criticism.”
15. Too simple:
The H-O trade model is too simple to explain the ‘reason of trade’ and ‘future of trade’. Talking about its user simplicity Lancaster has stated that “it is in fact the simple model of international trade with just as the two-commodity indifference curve is the simple model of consumer’s behaviour.”
According to Lancaster, the H-O trade theory deserves a place at the centre of international trade theory.