Friday, August 28, 2009

Ohlin’s Theory of International Trade

The modern theory of international trade is an extension of the general equilibrium theory of value. This analysis known as the “factor-proportions analysis” has been given by Bertil Ohlin and it has replaced the comparative cost theory. We know that the price of a commodity is determined by the demand for and supply of it, i-e the preferences and incomes of consumers, on the one hand and production possibilities, on the other. At the point of equilibrium the demand and supply will be equal to each other and also the price of the commodity equals its cost of production per unit.

The cost of production is composed of the prices paid for the factors required for the production of the commodity. There factors prices determine the consumer’s incomes from which arises the demand for the commodity. Ohlin thus points out the mutual interdependence of prices of the commodities, the prices of the required factors, the demand for the commodity as well as demand for and supply of the factors. Just as individuals specialise in some economic activity or activities in which they have comparative advantage on the basis of their talents and aptitudes, similarly countries specialise in the production of certain commodities in which they have comparative advantage on the basis of factor endowments. Just as difference in individual capabilities is the cause of exchange between individuals, similarly difference in the factor prices is the cause of inter-regional or international trade. The analysis which is applicable to single market in a region or in a country, Bertil Ohlin extends to the determination of values internationally or exchange between different regions or countries.

Thus Ohlin observes “International trade is but a special case of inter-local or inter regional trade”. Hence according to Ohlin there is no need to have a separate theory of international trade. He says that the same fundamental principle holds good for all trade, whether it is trade between individuals of the same country or between different nations. Thus in Ohlin’s opinion there are no fundamental differences but only quantitative difference between inter-regional and international trade.

We may summarise the main points of Ohlin’s theory as follows.

1. International trade is a special case of inter-regional trade. Thus the terms inter-regional and international trade can be substituted for each other.

2. Heckscher-Ohlin approach is based on two suppositions.

(i) Products differ in factors requirements.

(ii) Countries differ in factors endowments.

3. The immediate cause of international trade is the difference in relative commodity prices in the two regions.

4. Difference in relative commodity price arise due to difference sin factor prices and the difference proportions of various factors required for producing different goods.

5. Difference in factor prices are caused by differences in factor endowments and their relative scarcities in the two regions.

6. When rate of exchange is established, relative price differences are translated into absolute price differences. This will indicate which of the factors are cheaper and which dear in each region and therefore in what commodities each region should specialise. Evidently a capital-abundant country will tend to specialise in capital-intensive and shall export some of them to import labour-intensive goods. Like wise a labour-abundant country will specialize in labour-intensive products and shall export some of them in order to import capital-intensive goods.

7. Since factors of production are immobile between two countries, free mobility of commodities in international trade, according to Ohlin can perve as partial substitute for factor mobility.

8. Further free trade will also lead to a partial equalization of relative (and absolute) factor prices. Due to transport costs and other impediment in practice, complete factor price equalization is improbable.

This theory is applicable to any number of regions without affecting its conclusions. Even if the regions are identical as regards factor endowments it will still be profitable for them to enter into international exchange, because extension of the market would offer them economies of scale. The qualitative difference in the factor of production facilitates their classification for the purpose of international comparison. Ohlin takes into full account transport costs and relative scarcities of the factors of production to determine international price relationship. He points out barriers to inter-regional mobility of productive factors. He also explains how factor movements can take the place of movements of goods.

Superiority of Ohlin’s Theory Over The Classical Theory.

Ohlin’s theory is an improvement over the classical theory of international trade in many aspects.

(i) Ohlin’s theory is superior to the classical theory in that it regards international trade as a special case of inter-regional or inter local trade as distinct from the classical theory which considers international trade totally different from domestic trade.

(ii) The Ohlin analysis is cast within the framework of the realistic general equilibrium theory of value. It frees the classical theory from the defunct and unrealistic labour theory of value.

(iii) The Ohlin theory takes two factors labour and capital as against the one factor (labour) of the classical theory and is thus superior to the latter.

(iv) Again the Ohlin theory is superior to the classical theory in that it regards differences in factor supplies as basic for determining the pattern of international trade while classical theory takes no notice of it.

(v) The Ohlin theory is more realistic because it is based on the relative prices of factor supplies as basic for determining the pattern of international trade while classical theory takes no notice of it.

(vi) The Ohlin theory considers differences in relative productivities of a labour and capital as the basis of international trade, while the classical theory takes the productivity of labour alone. Hence the farmer is more realistic than latter.

(vii) Another merit of Ohlin theory is that is based on differences in factor endowments in different countries as against the quality of one factor labour in the classical theory. Thus farmer is superior because it lays emphasis not only on quality but also on the quantity of factors in determining international values.

(viii) According to Samuelson the Classical theory could not explain the causes of differences in comparative advantage the merit of Ohlin theory lies in explaining the same satisfactorily.

(ix) The Classical theory demonstrates the gains from trade between the two countries. This is related to the welfare theory. On the other hand the Ohlin’s theory is scientific and concentrates on the basis of trade. It thus partakes of the positive theory.

(x) According to Haberler, the Ohlin theory is a location theory which highlights the importance of the space factor in international trade while the classical theory regards the different countries as space less markets, thus the former theory is superior to latter.

(xi) The Ohlin theory is especially based on the assumption of production functions of the two countries. On the other hand, the classical theory is based on differences in the productions of trading countries.

(xii) Ohlin theory is more realistic than the classical theory in that the former leads to complete specialization in the production of one commodity by one country and by the other commodity by the second country when they enter into trade with each other. By contrast the trade between two countries may or may not lead to complete specialization in the classical theory.

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