International trade is the exchange of goods and services across international countries, where it represents a significant share of GDP.
World trade has seen a huge amount of growth during the last few years. It is important to understand and keep this in mind because it shows that classical theories of trade such as factor proportions may not be able to explain today’s trade because they cannot completely explain some modern concepts of today’s trade.
Factor proportions theory (Eli Keckscher, 1879–1952 & Bertil Ohlin, 1899–1979)
The factor proportions Heckscher — Ohlin Theory (H-O model) of trade is comparative costs should differ between countries, cause of the difference of factor endowment. It was left to the Neo-Classical school with two economists: Eli Heckscher and Bertil Ohlin. They explained differences in the factor proportions production of different goods. Different goods require for their production different proportions of the various factors of production (land, labour, capital).
Some at the same time countries have different amounts of these factors and that way prices of these factors will differ in different countries.
For example, South Korea which has a lot of capital will export capital intensive good, and China has a cheap labour. This theorem also shows that difference in resource endowments is one reason of a country’s specialization.
In the Factor proportions theory, it is important to state the assumptions on which the theory is based. These may be listed as follows:
- Trade takes the form of an exchange of two goods, which use just two factors in their production, between two countries — models called 2x2x2.
It means between two countries are exchange of two goods using only two factors.
For example United Kingdom and France produce only two good and exchange only together. This is not really what happens because United Kingdom produces different products and co-operates with lots of countries. This theory is not really true.
- Products are homogenous — it is when countries are making a same products.
It is not because different countries are making a different products and quality. China product’s have a low quality then German product’s.
Each country has the same production function for a particular good — The proportions within which factors are combined are the same regardless of where that product is produced.
- Products and factor market (except land) are mobile in country but immobile between countries. Products and factor market are mobile in country and between the countries. For example South Korea invested in Europe as Chinese people are travelling for better jobs in Europe or in USA.
- Costs of transportation and no trade commodities — include all the costs of transferring goods from one country to another. Goods which are a homogeneous will be traded internationally only if price difference in the two nations exceeds the cost of transporting the good from one nation to the other. Transport and logistic costs explains why most goods are not treaded at all internationally. These are referred to as no traded goods and services. For example bottle of Coca-Cola 0.5l. costs same price in London and in Huddersfield. However in specific service for example hair dresser is cheaper in Huddersfield than in London.
- Exist no tariffs, or other obstructions to the free flow of international trade — It is not true because is a lot of barriers on international market. However some states are in the unions without barriers or other obstructions.
- Equal access to the same technology knowledge for all the countries — countries are assumed to possess a given and constant amount of the various factors of production. Technological change cannot in the long run give any country a source of relative benefit in exacting good or motion.
- Consumer preferences are the same in all countries — Difference in preferences cancel out the effect on relative prices of different factor costs. This theory absolutely not true.
After looking at the above factors we can understand that this theory does not completely apply to modern trade patterns. Some factors like rising transportation costs and increased tariffs reject this theory for modern trade. Trade economists believe that this theory is not good enough for explanation of trade. The theory only can explain trade between developed and not developed countries but it cannot explain trade between countries at a stage of same development.
Intra Industry Trade:
In the factor proportions theory the products involved in trade were of different industries, where trade is based in differences in comparative costs. Where countries exchange products belonging to different industries, this is called inter-industry trade. But, in the modern world is of a different kind.
For example France and Germany are producing same products (cars) but France made Peugeot (cheaper) and distribute in Germany. Germany produces BMW (luxury) and distribute in France.
The new trade theory explained Intra industry trade and that the do theory explains the Inter Industry Trade is principally between developing country.
The Stolper-Samuelson Theorem
This theory is about Factor Price Equalization, the result of trade between two countries which specialized in two different commodities. Paul Samuelson demonstrated that one of the consequences of countries with different factor prices and product prices. This theorem was shows how tariffs would influence the incomes of workers and capitalists within country. Mr. Paul Samuelson demonstrated the consequence of two countries which trade together. Indeed, in his point of view the prices of the two different factors will be equalized. For instance, France export cars in Germany and Germany export wheat in France. Both factor needed are respectively Capital and Land. In the point of view of Mr. Samuelson, the price of the Capital in France will equalize the one in Germany and vice versa. For him this is due to the fact that French capital become scarce and the German become abundant.
“The Stopler-Samuelson Theorem is always true for small nations and is usually true for large nations as well. However, for large nations the analysis is further complicated by the fact that they affect world prices by their trading” (Salvatore, 2004).
There is an evolution of the factor quantities within country. Specializations can occur between the new input and the last input.
The first economist who put forward the idea about how technological change can influence patterns of trade was Posner. His argument is the fact the level of technology was different among countries.
Posner identified two kinds of time lags. The first is demand or reaction lag is the time it takes for consumers to lower cost suppliers. The quicker they respond, the faster countries be able to product grow and other countries will be forced to react by innovation. Secondary is imitation lag is the time when it will take producers from other countries to imitate the initial innovating firm.
Product Life-Cycle Model of Trade
It is complementary with HOS theory, because it explains that the entire countries do not have the same level of technology. However, it shows how the technology is provided in the world.
According to Vernon, innovations play an important role on the materialization of new products. In industries where product innovation is important (e.g. technologies electronics, etc.) the product will have a limited market life. The product life cycle of Vernon have three district phases.
- The product stage, all products are located in the innovating country for some different reasons. First the products are only for home market. “Patent laws will protect innovator from his product being copied or replicated by rivals” (Grimwade, 2000).
- The maturing product stage later the products has maturity. Patent’s was experience and other producers started to copy it. The Producer must give down price. Innovation firms must start to use export without any tariffs and costs on logistic.
- And the last the Standardisation stage by the time products has standardisation. The price must by the maximum which accept people. “Exports from the innovating country decline and imports increase until, eventually, the innovating country becomes a net importer of product” (Grimwade, 2000).
The above theories clearly show the effect that technology has to modern patterns of trade. They also point out the major weakness in the neo-classical theory of factor proportions that does not include the issue of technology related to trade. Technology is an important part of modern trade and cannot be ignored.
Monopolistic Competition Theory
Many firms sell similar products, this theory explain the firms are very elastic. Small price change leads to a large change in the firm’s sales. There are many firms selling a differential product and entry.
Economies of Scale theories
By the size of domestic market can the optimum level of output. However, most markets were perfectly competitive said neo-classical theory. External economies of scale it is recognize the importance of a second type of scale economy.
In the simple model suggested by Linder, producers initially produce their product for local consumption and, therefore, only produce goods, for which there exists a strong local demand. This is because of lack of information about demand. Large number of trade in manufactured goods occurs among developed countries with similar aspect endowments and similar levels of per capita income. Demand theory is the exact opposite of the kind of trade predicted by the neo-classical model.
Porters Diamond of national Advantage
Other classical theories of trade such as the factor proportions one which proposes that comparative advantage is in the factor endowments that a country may be fortunate enough to take over. Michael Porter argued that a nation can create new advanced factor with skilled labour, strong technology.
Figure 1: Porter’s Diamond
Firm strategy — it is individual, all firm have their own strategy. They make an individual strategy, about these opinions. Many firms have a good strategy (e.g. company -Microsoft) but sometimes they have a bad strategy and when they have capital they can change this strategy (e.g. company — Lewis Strauss).
Demand conditions — it is same price for example mobile phone products of Nokia and Samsung they have a same function, so they make give a same price and clients are buying just only for name or design.
Related and supporting industries — An example of this is Silicon Valley in the USA. Many firms there are doing the same things and sometimes helping together or working together. Sometimes they sell products which are made together.
There are three very important factors in every business. Factor proportion theory has too.
‒ Land — how much a company would like to invest in land? How much cost land what they have.
‒ Labour — which labour they need with example how qualified they should be and how much they expect to pay.
‒ Capital — is internal (debt) or external (loan).
After looking at the different theories of contemporary trade, it’s seen that factor proportion theory does not really work in the real today’s world. Many factors are in conflict with reality. Theories was made in a time total different than today. Many firms have modern technology and this is for them holds their advantages but they can lose benefits very easy in international trade. The theory does make a basis for us to understand international trage but the quickly changing times means that there are now gaps in the theory. There is not any single theory that can explain all trade, however all of these theories when connected together are better to help us understand modern trade.
- Grimwade, N.G. (2000), International trade: New patterns of trade, Production and Investment. Taylor and Francis Group, Great Britain
- Salvatore D. (2004), International Economics, John Wiley & Sons, Inc, America
- Oregon Business Council, 2008 http://www.oregonclusters.org/images/porter_diamond3.gif, Date accessed at 29.02.2008
- Skaspa, Strategicky manazment, http://referaty.atlas.sk/odborne_humanitne/ekonomia/9845, Date accessed 01.03.2008