Comparative advantage theory, as already gone through, stressed that comparative advantage arises from differences in productivity. But it did not consider as to what makes one country more productive than the other.
Similarly, it was also based on the premise that everyone was employed and after the trade began anyone laid off due to shrinking industry found employment in the expanding one. And that trade causes the price of the export good to go up and of the import to fall, making the nation as a whole better off.
In the twentieth century, many economists have developed a more detailed explanation of trade in which the productivity differences of each country depend on the country’s endowments of inputs or factors, being used to produce each good.
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This is the crux of Factor Endowment Theory. Factor Endowment theory is known with different names, such as, Heckscher-Ohlin theory, The Heckscher- Ohlin-Samuelson theory or the Factor Proportions theory.
The theory has been put forward by Swedish economists Eli Heckscher (in 1919) and Bertin Ohlin (in 1933). They observed that comparative advantage arises from differences in national factor endowments – land, labor, and capital and, that nations are endowed with different levels of each input. Each output has a different level of each input. Each output has a different ‘recipe’ for its production and requires different combinations and levels of the various inputs.
The more abundant a factor a nation has, the lower is its cost. A country will export those goods which make intensive use of locally abundant factors and import the goods that make intensive use of factors which are locally scarce. It must be noted that abundance is relative. A country may be having huge land and labor, but be relatively abundant only in one of the two.
Land-Labor Relationship:
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Countries, like India, have advantage in products that required land and large number of laborers. In a country like Singapore, irrespective of climate and soil conditions, wheat or rice cannot be produced. But Australia and Canada can, due to abundance of arable land. Singapore and Hong Kong are most successful in those industries where technology needs less of land relative to the number of labor employed. Thus, manufacturing locations also seem to substantiate the theory.
Labor- Capital Relationship:
Countries having little capital and more of labor with low investment per worker may have export competitiveness in labor-intensive products. Bangladesh has export competitiveness in readymade garments as the industry does not require much capital investment, and skills, not abundant therein. However, the US exports commercial jet aircraft – a product that requires a huge amount of capital and skills.
