Tunetra Economics International Factor endowments and specializations

International Factor endowments and specializations

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The classical comparative advantage theory of free trade is a static model based. strictly on a one-variable-factor (labour cost), complete-specialisation approach to demonstrating the gains from trade. This nineteenth-century free-trade model, primarily associated with David Ricardo and John Stuart Mill, was modified and refined in the twentieth century by two Swedish economists, Eli Hecksher and Bertil Ohlin, to take into account differences in factor supplies (mainly land, labour, and capital) on international specialisation. The Hecksher-Ohlin neo classical (or variable-proportions) factor endowment trade theory also enables us to describe analytically the impact of economic growth on trade patterns and the impact of trade on the structure of national economies and on the differential returns or payments to various factors of production.

Unlike the classical labour cost model, however, where trade arises because Of fixed but differing labour productivities for different commodities in different countries, the neoclassical factor endowrment model assumes away inherent differences in relative labour productivity by postulating that all countries have access to the same technological possibilities for all commodities. If domestic factor Prices were the same, all countries would use identical methods of production and would therefore have the same relative domestic product price ratios and fact or productivities. The basis for trade arises not because of inherent technological differences in labour productivity for different commodities between different countries but because countries are endowed with different factor supplies, Given-relative factor endowments, relative factor prices will differ (e.g., labour will be relatively cheap in labour-abundant countries), and so will domestic commodity price ratios and factor combinations. Countries with cheap labour will have a relative cost and price advantage over countries with relatively expensive labour in commodities that make intensive use of labour (e.g., primary products). They should therefore focus on the production of these labour-intensive products and export the surplus in return for imports of capital-intensive goods. Conversely, countries well endowed with capital will have a relative cost and price advantage in the production of manufactured goods, which tend to require relatively large inputs of capital compared with labour. They can thus benefit from specialisation in, and export of, capital-intensive manufactures in return for imports of labour-intensive products from labour-abundant countries. Trade therefore serves as a vehicle for a nation to capitalize on its abundant resources through more intensive production and export of commodities that require large inputs of those resources while relieving its factor shortage through the importation of commodities that use large amounts of its relatively scarce resources.

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