In this article we will discuss about the modern theory of comparative advantage. Also learn about its criticisms.
In order to improve Ricardo’s theory, two Swedish economists, Ela Heckscher (l919) and Ohlin (1933) developed a theory which stressed factor endowment as the basis of international trade.
The Heckscher-Ohlin approach to international trade accepts that international trade is based on differences in comparative costs, but attempts to explain the factors which make for differences in comparative costs.
It is assumed that production functions for different goods use factors of production in different proportions but that the production function for any good is similar in all countries. On these assumptions differences in comparative costs in countries can be traced back to factor endowments.
The model holds that a country which has an abundance of, for example, labour it will specialise in the production and export of goods, which are intensive in the use of labour (because it can produce these cheaply) and import goods which are intensive in the use of the country’s scarce factor of production e.g., land or capital.
Criticisms of Modern Theory of Comparative Advantage:
The Heckscher-Ohlin approach has been subject to much empirical testing as to its ability to explain the pattern of trade. The most celebrated test ways conducted by W.W. Leontief, who in 1954 applied his input-output technique to examine the structure of US foreign trade.
He examined the factor composition of US exports and of US imports, as they would be produced in the USA if the USA had to produce them domestically, and came to the surprising conclusion that US exports were labour-intensive and import substitutes were capital intensive.
Since on any definition the USA is a capital-abundant country, the finding appeared to refute the Heckscher-Ohlin theorem and now goes under the name of the Leontief paradox. Despite this paradox, more sophisticated versions of Heckscher and Ohlin’s ideas still provide the most widely accepted theories of international trade.