Comprehensive Summary of Ohlin’s Theory

The Summary of Ohlin’s Theory:

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. (For, in a country there may be many regions and sometimes two or more countries may form only one region geographically).

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

(i) Products differ in factor requirements.

(ii) Countries differ in factor endowments.

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

4. Differences in relative commodity prices arises due to differences in factor prices and the different proportions of various factors required for producing different goods.

5. Differences 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 cheap 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 products and export some of them to import labour-intensive goods. Likewise, a labour-abundant country will specialise in labour-intensive products and 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 can serve as a partial substitute for factor mobility.

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

As noted before, we know that Ohlin derived the conclusions referred to above on the basis of certain simplified assumptions. However, he claims that, these assumptions can be dropped keeping the conclusions of the theory in tact. He maintains that:

1. The theory can be extended to any number of regions instead of two, without making any change in methods or altering conclusions, but this would only make the theory more complex.

2. For international trade it is not necessary that two regions should have disproportionate factor supply. Even if two regions have identical factor units, there is possibility of specialisation in the two regions because of the existence of a larger market (due to foreign trade) which will permit economies of large scale.

3. There may be qualitative differences in the different factors in the two regions. This may render it difficult to compare the relative differences in the two regions. But this difficulty can be solved by classifying all these factors under different groups, i.e., by the stratification of factors for purposes of interregional comparison. Moreover, since the theory is based on the general theory of value, demand and supply are important for comparison, and hence, it is not necessary condition to assume that factors are homogeneous in both the regions.

4. In the initial analysis transport costs were ignored. But we can easily take these into consideration and find out how they will reduce trade and weaken its effects upon prices. In fact, transport costs and other impediments to trade come in the way of full factor price equalisation tendency of the trade.

5. Another assumption is of constant cost. This is also not very essential for the validity of the theory. Firms can work in diminishing costs or increasing returns in both the countries and yet there may be differences in the relative prices of commodities in the two regions. Thus, the basis of international trade still exists. Diminishing costs or increasing returns increase the scope of international specialisation and trade. But the volume of international trade will be smaller if firms work under diminishing returns or increasing costs in the two regions.

We, however, find that Ohlin did not overcome at least the following two assumptions underlying his theory:

1. Full employment, and

2. Perfect competition.

But this is not a very serious drawback. For, until recently, economic analysis was based on these assumptions. In fact, Ohlin could not have based his theory of international trade without these assumptions. If we try to give up the assumption of full employment, we will have to take into account the effect of cyclical fluctuations on employment and the level of income.

This will make the theory very complicated. Further, Ohlin seeks to extend the principles of general equilibrium analysis to the theory of international trade. But the general theory of value itself is based on the assumption of perfect competition, hence, there was no alternative for Ohlin but to base his theory on the assumption of perfect competition. However, in actual practice, competition is not perfect because of the emergence of international monopoly, absence of free trade or other international impediments to trade etc.

The pattern of international trade, in practice, therefore, gets vitiated as a result of the absence of free trade in the world. But it is not possible for a pure theory of international trade to take into account all these factors at a time.

Thus, barring the assumptions of full employment and perfect competition, all other assumptions are omitted by Ohlin. In this way his theory is better and more acceptable than the classical theory of international trade.