Chapter 4: Post-Heckscher-Ohlin Theories

Weaknesses of the Heckscher-Ohlin Theory

The Heckscher-Ohlin Theory is insufficient to explain a large part of today’s international trade. This insufficiency rests on the unrealistic simplifying assumptions of the Theory itself. New international trade theories, in other words PostHeckscher-Ohlin Theories, have been trying to overcome these weaknesses via relaxing the most inadequate assumptions of the Heckscher-Ohlin Theory. New international trade theories do not reject the Heckscher-Ohlin Theory but instead, improve it. We can analyze the weaknesses of the HeckscherOhlin Theory simply by examining the simplifying assumptions one by one.

1. Two countries, two commodities and two factors of production: In the real world, we deal with a number of countries and a variety of commodities produced with more than two commodities.
2. One of the commodities is labor-intensive and the other one is capital-intensive in both countries: Factor-intensity reversal is a factor that makes the Heckscher-Ohlin Theory invalid.
3. One of the countries is labor-abundant and the other one is capital-abundant: In the real world, it is not that easy to identify factor endowments of the countries.
4. Technology is the same in both countries: In our world today, countries use different levels of technology and this difference itself constitutes the basis of their comparative advantage. However, the basic HeckscherOhlin Theory can be improved by considering technology as a factor of production.
5. There is constant returns to scale in the production of both commodities: In our world today, most of the countries have been seeking to enjoy increasing returns to scale in international trade.
6. There is incomplete specialization in the production in both countries: If international trade leads to a complete specialization in production in one of the trading countries, relative commodity prices will be equalized.
7. Demand preferences are the same in both countries: Along with rapid globalization, demand preferences are more or less the same across countries.
8. There is perfect competition in the commodities and the factor markets in both countries: In our world, it is very hard to find a perfectly competitive market both for the commodities and factors of production.
9. There is free movement of factors of production within each country but no free movement of factors of production between countries: In today’s world, free movement of labor is a matter of fact along with globalization and economic integration initiatives. Free movement of labor allows workers to migrate from the countries in which there is unemployment to the countries where there is shortage of labor supply.
10. There is free trade between the trading countries: In the real world, it is really very hard to assume that international trade is free. Almost all the countries, except Hong Kong impose trade restrictions on their international trade today. The main aims of trade restrictions:
    - Protect domestic producers
    - Collect revenue to the Treasury
    - Adjust balance of payments
    - Implement infant-industry argument
    - Serve for diplomatic relations
11. There is full employment in all resources in both trading countries: The Heckscher-Ohlin Theory is insufficient in explaining international trade when there is incomplete employment in the trading countries.
12. International trade between the trading countries is balanced: In a real world of many commodities, many countries and many factors of production world, it is somehow impossible to expect a balanced international trade between the trading countries.

Effects of Technological Differences on International Trade

Effects of technological differences on international trade are best explained by the Product Cycle Model. Essentially, the Product Cycle Model is related with the life cycle of a new product that is a manufactured commodity and its effects on international trade. The Model divides the life cycle of a new product into five stages.

The first stage is called new-product stage in which the product is produced and consumed only in the innovating country with skilled labor and high technology.

The second stage is the product-growth stage, which is at the XV time frame. In this stage, production is increased in order to meet the rapidly increasing demand. In the product-growth stage, imitating country starts to demand the new product.

The third stage is product-maturity stage, which falls in the VY time frame. In this stage, the new product is standardized and the innovating country may give license to the imitating country to produce the product introduced by itself.

The fourth stage is product-standardization stage, which coincides with the YZ time frame. In this stage, the new product is standardized.

The fifth and the last stage is the product-decline stage, which refers to the time frame starting with Z. In the fifth stage, the production of the new product within the innovating country decreases rapidly since the imitating country undersells it in its domestic market.

International Trade Under Economies of Scale and Imperfect Competition

International trade theory are based on the assumption of constant returns to scale. According to the constant returns to scale in production, increasing the amount of factors of production used in the production of any commodity leads to an increase in the output of that commodity in the same proportion. However, many industries enjoy economies of scale in which production is more efficient with a larger production scale in our world today. Regarding the definition of the economies of scale, doubling the inputs will yield to an output that is more than doubled.

Market Type of Economies of Scale

Economies of scale are classified under two groups: External economies of scale and internal economies of scale. External economies of scale exist when the cost per unit of production depends on the size of the industry. In other words, average cost of production decreases as the scale of the industry increases. Internal economies of scale exist when the cost per unit of production depends on the size of the firm itself. In other words, average cost of production decreases as the scale of the individual firm increases.

External Economies of Scale and International Trade

Marshall presumes that an industrial district can create many advantages to the firms:

• Hereditary skill
• Growth of subsidiaries
• Use of specialized machinery
• Local market for skill
• Introduction to new idea
• Specialized suppliers
• Labor market pooling
• Knowledge spillovers

Internal Economies of Scale, Imperfect Competition, and International Trade

When there are economies of scale that are peculiar to the individual firm, the market type that should be considered is imperfect competition. In imperfect competition, firms can influence the prices of the commodity which they produce. Thus, they are not just price takers as in the perfect competition. Conversely, they can be price setters. The basic type of imperfect competition is monopoly in which there is only one producer.

In monopoly, the firm does not face a competition and thus is the price setter itself. Product differentiation refers to monopolistic competition, which is one of the types of imperfect competition.

Intra-Industry Trade

Intra-industry trade arises when a country both exports and imports within the same commodity classification category. Intra-industry trade is high forthe commodities that require high technology or more sophistication. Main reasons of intra-industry trade:

• Transportation costs
• Scope of commodity classification
• Differences in distribution of income
• International economies of scale
• Product differentiation

Measurement of Intra-Industry Trade

A special point of interest regarding the intraindustry trade is the measurement of it. The level of intra-industry trade is usually measured by the Grubel-Lloyd Index.

The value of the Grubel-Lloyd Index (T) can range from 0 to 1. If T is equal to 0, it means that the country under examination only exports or imports the commodity in question. Since there is no intra-industry trade, it refers to a situation of inter-industry trade. If T is equal to 1, it illustrates that exports and imports of a particular commodity are equal. It denotes that intra-industry trade is maximum.

It should be quoted that it is sometimes difficult to calculate due to the vagueness of the scope of a particular industry. Uncertainty in defining the boundaries and limits of a particular industry can lead to ambiguities on the Grubel-Lloyd Index.