MODERN THEORY - HECKSCHER-OHLIN APPROACH

•Every country has different factor endowments, thus the costs of these factors differ depending upon their availability. For example, if a country has abundant labor, then the cost of labor would be low in that country.

• According to Heckscher and Ohlin theory, a country would export products, which it produces by using the abundant factor of production. However, it would import goods, which require use of scarce resources. Countries trade with each other because they have different factor endowments.

• For instance, some countries may have more labor and less machinery and some may have more machinery and less labor. In such a case, the country with more labor would specialize in labor-intensive products and export those products to other country.

MODERN THEORY - ASSUMPTIONS

a. Needs of citizens of the two countries are same

b. Transportation cost between the countries is zero

c. Factors of production in both the countries are immobile

d. Factors of production in both the countries are not available in same proportion

MODERN THEORY-CRITICISM

• Oversimplified Assumptions This theory is based upon highly over-simplifying assumptions of perfect competition, full employment of resources, identical production function, constant returns to scale, absence of transport costs and absence of product differentiation. Given this set of assumptions, the whole model becomes quite unrealistic.

• Partial Equilibrium Analysis:- Haberler although recognized Ohlin's theory as less abstract, yet it has failed to develop a general equilibrium concept. It remains, by and large, a part of the partial equilibrium analysis. This theory seeks to explain the pattern of trade only on the basis of factor proportions and factor intensities, while ignoring several other influences such as transport costs, economies of scale, external economies etc., which too exert influence on the cost of production.

MODERN THEORY-CRITICISM

Neglect of Product Differentiation The theory overlooks the role played by product differentiation in international trade. Even when the production agents are identical in two countries, the international trade may still take place due to product differentiation.

• Factor Proportions and Specialization - The theory suggests that the relative factor proportions (or factor endowments) determine the specialization in exports of different countries. The capital-abundant countries export capital-intensive goods and labor-abundant countries export the labor-intensive goods. It implies that trade will not take place between such countries or regions as have similar relative factor proportions. But this is not true.

• Neglect of Factor Demand - The theory assumes that the factor prices are determined by the relative factor endowments of a country. It means the rate of interest should be relatively low and wage rates relatively high in a capital-abundant but a labor-scarce country. The theory fails to take into account the influence of demand for factors on their prices.

Factor Mobility:- This theory assumes that there is absence of international mobility of factors. This assumption is not valid.