The modern theory of international trade is an extension of the general equilibrium theory of value.
This theory has been put forward by Bertil Ohlin, a Swedish economist, and it has replaced the traditional comparative cost theory.
Just as individuals specialize in economic activity in which they have comparative advantages, similarly countries specialize in the production of certain commodities in which they have comparative advantage on the basis of factor endowments.
Just as differences in individual capabilities are the cause of exchange between individuals, similarly differences in factor prices is the cause of international trade. Bertil Ohlin thus extends the analysis which is applicable to a single market to the determination of values internationally i.e. exchange between different countries.
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Thus, Ohlin observes “International trade is but a special case of inter-local or inter-regional trade.” Hence, according to Ohlin, there is no need to have separate theory of international trade. He says that the same fundamental principle holds good of all trade, whether it is internal trade or international trade. The classical theory of comparative cost is based on the assumption of comparative immobility of the factors of production as between different countries. But Ohlin points out that this immobility is to be found even in different regions of the same country.
According to Ohlin, the immediate cause of international trade is the difference in commodity prices which in turn is due to the differences in factor prices. Goods are purchased because it cheaper to buy them from outside the country.
The establishment of the rate of exchange between the two countries facilitates the comparison between the commodity prices prevailing in the two countries. Thus, in Ohlin’s opinion there are no fundamental differences but only quantitative differences between inter-regional and international trade. Ohlin’s theory represents a departure from the classical theory and marks a great improvement on it.
Gain from International Trade:
The gain from international trade depends on the Terms of Trade i.e., the rate at which the goods of one country are exchanged for the goods of the other country.
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In the example in the above section, in countries A and B, production with equal units of labour and capital would be:
A—20 tooth-brushes and 20 kg of sugar.
B—15 tooth-brushes and 10 kg. of sugar.
Total production in A and B = 35 tooth-brushes and 30 kg. of sugar.
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But if they specialize, A will use both units of productive power for sugar and B for tooth-brushes.
A will thus produce with 2 units of productive power—40 kg. of sugar.
B will produce with 2 units of productive power—30 tooth-brushes.
Comparing the two positions, we find that with specialization, there is a gain of 10 kg. of sugar and a loss of 5 tooth-brushes on the whole. Referring back to our equation, we see that 10 kg. of sugar is equal to 10 tooth-brushes in country A and 15 tooth-brushes’ in B. Deducting the loss of 5 tooth-brushes from this profit, there is a net gain of 5 to 10 tooth-brushes.
How this Gain is Distributed:
This net gain will be normally shared by the two countries.
In the above case, the rate of exchange of the two commodities will be somewhere between:
20 kg. of sugar = 20 tooth-brushes, and
20 kg. of sugar = 30 tooth-brushes.
We are sure of this because A will not accept less than 20 tooth-brushes for 20 kg. of sugar and B will not offer more than 30 tooth-brushes for it, under any circumstances. In between these two limits, the exact rate of exchange will be decided by the relative bargaining power of A and 3. The country which is more anxious to secure the goods of the other will be in a weaker bargaining position, and vice versa.
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In other words, the gain from international trade will be shared according to the reciprocal demand, i.e., the elasticity of the demand of each country for the other’s goods. The ratio of exchange of demand will be anywhere between 20 kg. of sugar to 21—29 tooth-brushes. The gain is thus shared by both countries. But the bigger share goes to that country which has an elastic demand for imports and whose exports have an inelastic demand.