Heckscher-Ohlin theory is known as modern theory of international trade. It was first formulated by Swedish economist Heckscher in 1919 and later on fully developed by his student Ohlin in 1935. Heckscher-Ohlin theory, also called the factor endowments theory of international trade, attempts to explain that international trade is simply a special case of inter-local or inter-regional trade, and there is no need for a separate theory of international trade.
It emphasises that differences in factor endowments, and not differences in factor efficiency as maintained in the classical theory, are the true basis of international trade.
The following are the general features of the modern theory of international trade:
i. No Need for a Separate Theory:
According to the classical economists, international trade was basically different from internal trade. Therefore, there is a need for a separate theory of international trade. The difference between the international trade and internal trade arises due to various types of differences between the countries, such as- (a) differences in efficiency in producing different goods; (b) immobility of factors of production; (c) barriors caused by distance and other physical factors; (d) use of different currencies; (e) existence of artificial barriers, such as customs duties and other restrictions on trade; etc.
All such differences exist between the countries and not within a country, and hence a need for a separate theory of international trade. Ohlin, on the contrary, believes that there is no basic difference between local or inter-regional trade and international trade, and no separate theory of international trade is needed. He remarked- “International trade is but a special case of inter-local or inter-regional trade.”
The similarity between internal trade and international trade is clear from the following points- (a) Immobility of factors is not a special feature as between countries, but can exist even in different regions of the same country; (b) similarly, labour and capital can move both within a country as well as between the countries; (c) cost of transport is always there in both internal and international trade; (d) existence of different currencies does not pose any problem for international trade because different currencies are connected with each other through a system of exchange rate.
Thus, there is no basic distinction between inter-regional trade and international trade, and there is no justification for a separate theory of international trade. The same general theory of value which explains the inter-regional trade can also be applied to international trade.
ii. A General Theory of Value:
Heckscher-Ohlin theory is considered as a general equilibrium theory of value at the international level. According to the theory of value, at the equilibrium level, demand is equal to supply and commodity price is equal to average cost of production.
Heckscher-Ohlin theory emphasises the mutual interdependence of the prices of commodities, the prices of factors of production, the demand for commodities, and the demand and supply of factors of production in international trade. Thus, while Marshall explains the time- dimension of general theory of value, Heckscher-Ohlin theory explains the space-dimension (i.e., international trade) of the general theory of value.
Heckscher-Ohlin theory supplements, and not supplants, the Ricardian comparative cost theory of international trade. According to the Ricardian theory, the differences in the comparative costs provide the foundation on which the international trade is possible. But, it does not tell- why do the costs differ?
Ohlin’s theory not only accepts the comparative advantage as the basis of international trade, but also further develops the Ricardian theory by providing answer to the above question.
According to him, the difference in comparative costs are due to- (a) different prevailing endowments of factors of production; and (b) the fact that the production of various commodities requires that the factors of production be used with different degrees of intensity. Thus, Ohlin’s theory starts where the Ricardian theory ends,
iv. Factor Endowments Theory:
Heckscher-Ohlin theory is known as factor endowments theory or factor proportions theory because it emphasises the interplay between the proportions in which different factors of production are available in different countries, and the proportions in which they are used in producing different goods. True basis of international trade is to be found in the comparative advantage that emerges due to the difference in the factor endowments.
v. Statement of the Theory:
The Heckscher-Ohlin theory states that a country has a comparative advantage in the good that is relatively intensive in the country’s relatively abundant factor. The theory emphasises- (a) that it is not merely the differences in costs (as the classical theory believes), but differences in prices that become the basis of trade; (b) that the differences in costs are not due to differences in factor efficiency, but due to the differences in the quantities of factors of production; (c) that comparative advantage arises when abundant factor is utilised intensively and scarce factor sparingly; and (d) that it is partial specialisation that will lead to the full utilisation of factors of production, while complete specialisation will leave some quantities of the factors of production unutilised.
vi. Pattern of Trade:
The Heckscher-Ohlin theory explains the pattern of world trade on the basis of differences in factor endowments. In the labour-abundant countries, wages are likely to be low relative to the cost of other factors of production. Cheap and abundant labour utilised in the production of labour- intensive goods provides sufficient justification for exporting these goods to other countries where labour is scarce and relative wages are higher. The same is true for other factors of production.
vii. Other Related Theorems:
Besides the Heckscher-Ohlin theorem, the modern theory also includes three other closely related theorems:
(a) Factor-Price Equalisation Theorem:
An important implication of the Heckscher-Ohlin theorem is that free international trade between two countries will cause factor prices in the countries to become more equal. If both countries continue to produce both goods with free trade, their factor prices will actually be equal.
(b) Stolper-Samuelson Theorem:
This theorem links international trade to the domestic distribution of income. It states that an increase in the relative price of the labour- intensive good will increase the labour price relative to both commodities prices and reduces the other factor prices relative to both commodity prices.
(c) Rybczynski Theorem:
This theorem relates trade with economic growth. It states that at constant prices, an increase in one factor endowment will increase by a greater proportion the output of the good intensive in that factor and will reduce the output of the other good.
Ohlin’s simplified model is based on the following assumptions:
(i) It is a 2 x 2 x 2 model. That is, there are two countries (A and B); there are two commodities (X and Y); there are two factors of production (labour and capital).
(ii) Country A is labour-abundant and country B is capital-abundant.
(iii) Similarly, commodity X is labour-intensive and commodity Y is capital intensive.
(iv) There is perfect competition in both commodity market and the factor market.
(v) There is full employment.
(vi) Factors of production are perfectly mobile within each country but perfectly immobile between the countries.
(vii) There are no transport costs.
(viii) Production functions are different for different commodities, but are similar for each commodity in both countries.
Heckscher-Ohlin theory is the factor endowment theory which explains the pattern of comparative advantage and hence the pattern of trade in terms of factor endowments. The theory states that a country has a comparative advantage in the production and export of the good that is relatively intensive in the country’s relatively abundant factor.
In other words, the theory predicts that goods requiring greater amounts of labour should be produced in countries where labour is abundant relative to other factors of production, and where the labour costs are therefore low relative to cost of other factors. These countries then export labour-intensive goods to other countries where labour is relatively scarce and labour costs are relatively high.
In the words of Ohlin- “Generally, abundant factors are relatively cheap, scanty factors are relatively dear, in each region. Commodities requiring for their production much of the former and little of the latter are exported in exchange for goods that call for factors in the opposite proportions. Thus, indirectly, factors in abundant supply are exported and the factors in scanty supply are imported.”
(i) Two countries A and B involve in trade if relative prices of goods X and Y are different. According to Ohlin, “the immediate cause of inter-regional trade is always that goods can be bought cheaper from outside in terms of money than they can be produced at home.”
(ii) Under competitive market conditions, prices are equal to average costs. Thus, relative price differences are due to cost differences.
(iii) Cost differences exist because of the factor-price differences in the two countries.
(iv) Factor prices are determined by factors’ supply and demand. Assuming a given demand, it follows that a capital-rich country has cheaper capital or lower capital price and a labour-abundant country has a relatively lower labour price.
(v) Each country has an advantage in the production and export of goods into which enter considerable amounts of factors, abundant and cheaper in that country.
Let us illustrate Heckcher-Ohlin theory with an example of two countries India and England. Suppose in India labour is in plenty and cheap, while capital is scarce and costly. On the other hand, England is capital-rich, but labour-poor. Further suppose wheat and cloth are two goods, former being labour-intensive and latter being capital-intensive. Thus, India will specialise in labour- intensive good wheat which can be relatively cheaply produced here.
On the other hand, the production of capital-intensive cloth will be relatively cheaper in England. Hence the trade will occur between India and England. Indian will import cloth from England and export wheat; England will import wheat from India and export cloth.
Putting the same thing in another way, India’s import is indirectly an import of scarce factor capital and its export is indirectly an export of abundant factor labour; England indirectly imports her scarce factor labour and exports here abundant factor capital.
Thus, Heckscher-Ohlin theory concludes that:
(a) The basis of international trade is the difference in commodity prices in the two countries.
(b) Differences in commodity prices are due to cost differences which are a result of differences in factor endowments in the two countries.
(c) Labour-rich country specialises in labour-intensive goods and exports them. Capital-abundant country specialises in capital- intensive goods and exports them.
The basis of international trade lies in the differences in relative commodity prices which ultimately depend upon differences in relative scarcities of factors of production in the two countries. Relative price differences lead to absolute price differences when a rate of exchange is fixed.
It is only when a rate of exchange between two currencies has been established that one can ascertain whether a factor is cheaper or dearer in one country than in another. This can be illustrated with the help of Table-1.
According to Table-1, there are four factors P, Q, R and S in both the countries India and England. Columns (2) and (3) denote factor prices in India and England stated in their respective currencies, i.e., in Rupees and Pounds. It is clear that in both countries, P is cheapest, while S is the dearest factor. However, columns (2) and (3) do not indicate which of the factors are relatively cheaper or dearer in the two countries.
For this, absolute price differences between the two countries must be found. This can be done by the translating the factor prices of one country in terms of the other country, keeping in view the prevailing rate of exchange. When the rate of exchange is £1 = Rs. 20, the factor prices of England in terms of India’s currency is expressed in column (4).
Comparing columns (2) and (4), it is found that factors P and Q are relatively cheaper in England, while factors R and S are relatively cheaper in India. But, if the rate of exchange changes to £1 = Rs. 30, i.e., England’s currency now commands better value in the world market, then we find from column (5) and comparing it with column (2), that only P seems to be cheaper in England, while the rest of the factors are cheaper in India.
Thus, in the first case, India will concentrate on the production of those goods which use large amount of factors R and S, while England will produce goods requiring more use of factors P and Q. In the second case, however, England can produce relatively cheaply only those goods which require more employment of factor P, while India can produce all other goods containing factors, Q, R and S more cheaply.
Thus, absolute price differences known from the exchange rates indicate which of the factors are cheaper and which are dearer in each country, and consequently, in which commodities each country will specialise.
Figure-1 graphically illustrates the Heckcher-Ohlin theory. India has a higher ratio of labour to capital than England. Thus, India is labour-abundant and England is capital-abundant. The term ‘abundance’ is defined in relative sense (i.e., by comparing the ratio of labour to capital in the two countries) so that no country is abundant in everything. Again, wheat is the labour- intensive good and cloth is capital- intensive good.
Because, India is labour-abundant, it will produce a higher ratio of wheat to cloth than England at a given ratio of the price of wheat to that of cloth. In other words, India will have a larger relative supply of wheat than England at a given relative price of wheat. Thus, India’s relative supply curve of wheat (RSI) lies to the right of England’s relative supply curve of wheat (RSE).
The relative demand curve for wheat (RD) has been assumed to be the same for both the countries. In the absence of trade, the equilibrium for India is at point 1 and the equilibrium for England is at point 3. This indicates that, in the absence of trade, the relative price of wheat is lower in India and higher in England.
When India and England trade with each other, their relative prices converge. The relative price of wheat rises in India, declines in England and a new world relative price of wheat is established somewhere between the two pre-trade relative prices (e.g., at point 2). In India, the rise in relative price of wheat leads to a rise in the production of wheat and a decline in its consumption.
So India becomes an exporter of wheat and an importer of cloth. Conversely the decline in the price of wheat leads England to become an importer of wheat and an exporter of cloth. Thus, India (the labour-abundant country) exports wheat (the labour-intensive good); England (the capital-abundant country) exports cloth (the capital-intensive good).
Factor-Price Equalisation Theorem:
An important implication of Heckscher-Ohlin factor endowments theory is that trade tends to equalise factor prices internationally. After free trade, labour-intensive commodities flow from labour-abundant India, while capital-intensive commodities flow from capital-abundant England.
Thus, in India, as a result of trade, the abundant factor (labour) becomes more scarce and its price tends to increase, while the scarce factor (capital) becomes more abundant, and its price tends to fall. Similarly, in England, as a result of trade, the abundant factor (capital) becomes more scarce and its price tends to rise, while the scarce factor (labour) becomes more abundant and its price tends to fall. All this leads to equalisation of factor prices in both countries.
Factor-price equalisation theorem becomes more easily clear if we imagine free trade of goods as free movement of factors of production. When the two countries trade with each other, something more is happening than a simple exchange of goods.
In an indirect way the two countries are in effect trading factors of production. The goods which India sells require more labour to produce than the goods it receives in return. In other words, more labour is embodied in India’s exports than in its imports.
Thus, India exports its cheap labour, embodied in its labour- intensive exports. Conversely, England’s exports embody more capital than its imports and thus England is indirectly exporting its cheap capital.
Thus, as a result of trade, the relative price of labour will rise in labour-rich country India and relative price of capital will rise in capital-rich country England. “Trade may equalise factor prices just as effectively as if the productive factors themselves migrated from countries in which they are in relatively abundant supply to countries in which they are relatively scarce.”
Factor-equalisation theorem is graphically illustrated in Figure-2. In this figure, WLCK1 is the resource box of India, indicating that it is heavily endowed with labour. WKC1L1 is the resource box of England, indicating that it has abundance of capital. WAMC is India’s efficiency locus, describing the set of output alternatives for the production of wheat and cloth depending upon different production possibility curves.
It is a concave curve which means that wheat is labour- intensive and cloth is capital- intensive. Any point closer to the cloth origin shows greater production of wheat. Pre-trade equilibrium of India is at point A in view of its demand for wheat and cloth. Similarly, WNBC1 is England’s efficiency locus and point B is its pre-trade equilibrium position.
Note that point A is closer to labour axis than point B which implies that India adopts more labour- intensive techniques in producing both wheat and cloth than England. Conversely, England employs capital- intensive techniques to produce both the goods.
When international trade occurs, India, the labour-rich country tends to specialise increasingly in the labour-intensive wheat and move to point M on its efficiency locus. Similarly, England, the capital rich country, moves to point N and increases the production of capital-intensive product, cloth.
Trade will grow between India and England until the prices of the two goods are equal in the two countries at M and N respectively. With no change in technologies and other production conditions, the proportions of labour and capital used in the production of the two goods are equal for both countries, and the prevailing ratios of returns of capital to returns of labour must therefore also be equal.
To sum up:
(a) Labour-Abundant Country (India):
Proportions of labour and capital used in Wheat = slope of WA
Proportions of labour and capital used in Cloth = slope of CA
(b) Capital-Abundant Country (England):
Proportions of labour and capital used in wheat = slope of WB
Proportions of labour and capital used in Cloth = slope of C1B
Since, in absence of trade, proportions of labour and capital used to produce goods in both countries are different, this implies that ratio of labour price to capital price in both countries is different. In the labour- abundant country (India), labour price is low relative to capital price. On the contrary, in the capital-abundant country (England), capital price is low relative to labour price.
(a) Labour-Abundant Country (India):
Proportions of labour and capital used in Wheat = slope of WM Proportions of labour and capital used in Cloth = slope of CM
(b) Capital-Abundant Country (England):
Proportions of labour and capital used in Wheat = slope of WN (= slope of WM)
Proportions of labour and capital used in Cloth = slope of C1N (= slope of CM)
Since, after trade, proportions of labour and capital used to produce goods in both countries are equal, this implies that the ratio of labour price to capital price in both countries is equal.
Thus, international trade leads to factor price equality.
In short, international trade leads to the following effects:
(i) Commodity prices are equalised between the two countries.
(ii) In each country, the economic structure, in the form of output combinations, shifts in the direction of increased specialisation in the production of that commodity which use relatively more of abundant factor.
(iii) The relative returns to the more abundant factor have increased relatively, while relative returns to the scarcer factor declines in both countries. This leads to the equalisation of the factor prices in the two countries.
(iv) The factor proportions (or factor intensities) used in the production of both commodities become identical for both countries.
The Heckcher-Ohlin theory and the factor-price equalisation theorem can be illustrated alternatively through Figure-3.
In Figure-3, PP curve represents the relative factor-commodity price curve. It indicates basic relationship- (a) between relative commodity costs and relative commodity prices; and (b) between relative factor prices and relative commodity costs.
Assuming labour and capital prices fully determine the costs of producing wheat and cloth in both India and England, there is a positive relationship between relative labour prices (i.e., labour price/ capital price) and relative cost of producing labour-intensive commodity wheat (i.e., wheat cost/cloth cost). A rise in the labour price relative to capital price increases the cost of the labour-intensive good (wheat) relative to that of the capital-intensive good (cloth).
(i) The slope of PP curve depends upon relative factor intensities.
(ii) Since the curve shows a technological relationship and because the two countries have the same technology, the curve applies to both the countries. Since factors are not internationally mobile, both the countries maybe at different points on the PP curve depending upon the relative abundance of a factor (labour) in these countries.
(iii) A relation exists between the costs of wheat and cloth and the prices of these goods. The price of a commodity must be equal to its cost in the long run equilibrium. Thus, if the ratio of labour price to capital price in India is OL1, and if wheat and cloth both are produced in India, then OW1 must equal the relative price of wheat in terms of cloth.
But, if a commodity is not actually produced, cost can exceed price. Thus, if India specialises in wheat, its relative price of wheat in terms of cloth will be more than OW1 and if India specialises in cloth, the relative price of wheat in terms of cloth will be less than OW1.
In the absence of trade, India, the labour-abundant country, is at point 1 and England, the capital- abundant country, is at point 3 on PP curve. The relative labour abundance of India reflects lower pre-trade relative labour price (OL1), and the relative capital abundance of England reflects higher pre-trade relative labour price (OL3).
In the absence of trade, each country must produce both goods for itself, so OW1 represents India’s relative price of wheat in terms of cloth, and OW3 England’s relative price of wheat in terms of cloth. The relative wheat price is lower in India than England. Thus, India has a comparative advantage in wheat and England in cloth.
Factor-Price Equalisation Theorem:
If India and England enter into trade with each other, world prices must be somewhere between the pre-trade prices (say equal to OW2). If each country produces both goods, then OW2 also equals relative costs in both countries and OL2 must therefore equal the relative labour price in both India and England. Since relative factor prices are equal, absolute prices must also be equal.
If either country specialises, factor prices need not be completely equalised because costs need not equal international prices and therefore each other. If, for example, India specialises in wheat production, while England produced both goods, then England’s costs are equal to relative prices OW2, but India’s costs will be somewhat less, say OW2.
In this case, England’s ratio of labour price to capital price is OL2, while that of India is OL2. To conclude, if country specialises, factor prices are not completely equalised, but they are more nearly equal than they would be in autarky (i.e., without trade).
The theorem of factor-equalisation is not realistic because in the real world factor prices are not equalised. It may not sound unrealistic to assume that commodity prices are equalised as a result of international trade, but it is difficult to believe that a complete equalisation of relative factor prices will occur more or less automatically through trade.
Complete factor-price equalisation can occur only under the following restrictive assumptions:
(i) Two commodities are produced in the two countries both without and with trade.
(ii) Identical production techniques prevail in both countries.
(iii) One product is capital intensive and the other is labour intensive.
(v) Both factors of production are qualitatively identical in all respects.
(vi) Both factors are used in the production of both goods.
(vi) No change occurs in the available supplies of productive factors.
(vii) There are no artificial restrictions to trade.
(viii) There are no transport costs.
(ix) Perfect competition prevails in all the markets.
(x) Productive factors cannot move internationally.
I. Unrealistic Assumptions:
Modern theory is unrealistic in nature because it is based on oversimplified and unrealistic assumptions of free trade, perfect competition, full employment and absence of transport costs.
II. Mobility of Factors:
The modern theory also assumes that factors of production are perfectly immobile between countries. This assumption has been criticised on the ground that in reality factors of production have never been immobile internationally.
III. Productive Factors not Homogeneous:
The modern theory assumes that the factors of production are homogeneous in quality between the countries. Labour, for example, is qualitatively identical in two countries. This is quite unrealistic assumption.
IV. Different Production Functions:
Another unrealistic assumption of the modern theory is homogeneous production functions between the countries. In reality, however, production functions for the same product may vary in the two countries.
V. Differentiated Products:
The modern theory is based on the assumption that the two products in the two countries are identical. This is an unrealistic assumption. The products in different countries are usually differentiated.
VI. Static Theory:
The modern theory is static in nature because it is based on the assumption that factor endowments in the two countries are fixed and unchanging in quantity. In the dynamic conditions, the quantity of factor supply may vary.
VII. Demand Side Ignored:
Modern theory pays greater attention to the supply side of international trade. It ignores the demand side. Critics feel that if differences in consumer’s demand for goods are recognised, the commodity price ratios will not reflect cost ratios.
VIII. Trade with Similar Factor Endowments:
According to the modern theory, trade between the two countries occurs only when they have differences in factor endowments. This implies that there would be no trade between the countries having identical factor endowments. But, in reality, international trade takes place even with identical factor endowments.
IX. Commodity Prices Determine Factor Prices:
According to the modern theory, factor prices determine costs and thereby the commodity prices. Wijanhold on the contrary, holds the opposite view. He argues that it is the commodity prices that determine factor prices.
Prices of the commodities are determined by their utility (or demand), while the factor prices are dependent on the demand and prices of the commodities produced by them. After all, the demand for factor of production is a derived demand.
X. Empirically Invalid:
Modern theory fails to explain the Leontief Paradox. According to the modern theory, a capital-rich and labour-scarce country should export capital-intensive goods and import labour- intensive goods. But, the results of an empirical study made by Leontief point out that a capital-rich country like America exports labour-intensive goods and imports capital-intensive goods. This fact invalidates the modern theory.
XI. One of Many Explanations:
Modern factor-endowments theory is not the only explanation of international trade. It is one of many explanations. International trade is a complex phenomenon involving so many forces operating on both supply and demand sides of trade.
Important factors influencing the pattern of trade between two countries are- (a) differences in the supply of factors of production; (b) differences in factor efficiency; (c) differences in the state of technology; (e) differences in the economies of scale; (f) differences in population growth; (g) differences in the rate of capital formation; (h) differences in the development of new products, etc. A satisfactory theory of international trade must pay attention to all these factors.
The classical and the modern theories of international trade should not to consider as mutually contradictory or opposing theories. They are complementary to each other. The Heckscher-Ohlin theory is basically an extension of the classical theory, which it both builds upon and complements.
Empirical Evidence of Modern Theory:
Several empirical studies have been made to test the validity of the Heckscher-Ohlin theory.
The most famous and controversial test of the Heckscher-Ohlin theory was made by leontief and was published in 1953. According to the factor-endowments theory, a country should be exporting those goods which intensively use the factors in abundant supply at home and should be importing those goods which intensively use factors in scarce supply at home. The U.S.A., which has a very high capital-labour ratio, can be considered as capital-rich and labour-poor country.
If the factor-endowments theory is correct, then the U.S.A. should export capital-intensive goods and import labour-intensive goods. But, using data for the year 1947, Leontief found that the American exports were labour-intensive and its imports were capital-intensive. This reverse conclusion has been confirmed over the years and is known as Leontief Paradox.
Table-2 shows the factor content of the U.S. exports and imports. The data compares the factors of production used to produce one million dollars worth of the U.S. exports with those used to produce the same value of U.S. imports. Part I of the table shows that Leontief paradox still exists. American exports are produced with a lower ratio of capital to labour than American imports.
Studies based on global data also confirmed the Leontief paradox. For example, Bowen, Leamer and Sveikauskas took a sample of 23 countries and 12 factors of production and calculated the ratio of each country’s endowment of each factor to the world supply.
They then compared these ratios with each country’s share of world income. If factor endowments theory is correct, then a country should export factors for which factor share exceeds the income share and import factor for which it is less. The results are shown in Table-3.
Predictive success refers to the percentage of countries for which net exports of factor runs in the predictable direction.
Table-3 clearly shows that for nearly half of the factors of production (i.e., number 8 to 12) trade ran in the predictable direction in case of less than 50% or more countries. This result confirms the Leontief paradox on a broader level. That is trade does not run in the direction predicted by the Heckscher-Ohlin theory.
Economists have attempted to explain the Leontief paradox and to reconcile the contradictory result with the theoretical prediction:
(i) If human capital as well as physical capital were included in the analysis, the results might have shown the American exports to be capital intensive. In other words, the American labour may be more efficient than foreign labour due to higher educational standards.
(ii) The American workers may be physically more effective than his foreign counterpart because of better health, working conditions, management, entrepreneurship, etc.
(iii) Capital is also embodied in other productive factors.
(iv) If natural resources are included as a third distinct productive factor, it is possible that the results would show America to be both labour-abundant, but natural resources-scarce country. Testing of this hypothesis might substantiate the factor- endowments theory.
(v) Proper testing of Heckscher-Ohlin theory is difficult because of its unrealistic assumptions- For example, (a) full employment conditions do not exist; (b) production functions are not everywhere the same; (c) there are many barriers to trade; (d) in reality, demand plays important role in international trade.
Empirical evidence seems to be more in favour of Ricardian theory than the Heckscher-Ohlin theory part II of Table-2 shows that America exports goods that are more skilled labour intensive and technology intensive than its imports.
These results are consistent with the Ricardian theory according to which trade is largely due to differences in productivity and technology rather than differences in the supply of resources. For example, America exports computers and aircrafts not because its resources are specially suited to these products, but because it is more efficient in producing these goods.
Thus, experience has shown that the classical theory of comparative costs based on different productivity levels emerges as an important determinant of trade patterns. As compared to this, the modern Hackscher-Ohlin theory has limited predictive value. The true position however, is that there exists no cohesive theoretical formulation that can be applied to each and every case with good predictive results.
International trade is too complex a phenomenon, involving so many countries, so many commodities and so many elements operating both on demand and supply sides, to be explained accurately and satisfactorily by an oversimplified theory like the modern factor-endowments theory or the classical theory.