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(General Equilibrium Theory by Heckscher and Ohlin):

Introduction:

Professor Bertil Ohlin and Heckscher have criticized the Ricardo’s Comparative Costs Theory. They regard cost theory as unrealistic because it does not take into account complete cost differences. Moreover they say, it is based on the assumption of the comparative immobility of factors of production between the countries which is not correct. In addition to this, the cost theory is based on the assumption of static conditions. Since the present day world is highly dynamic, this cost theory is, therefore, useless and so is rejected.

The modern theory of international trade also named as the General Equilibrium Theory of International Trade was developed by two Swedish economists, Heckscher and Ohlin.

According to these economists, the main cases and the regulator of international trade is the differences in the relative prices of the commodities between the countries. The differences in the prices of goods arise due to:

(i) Difference in climatic and technical know how.

(ii) Difference in the allocation of resources for the production of goods.

(iii) Variation in the demand for and supply of commodity as well as the demand for and the supply of the required factors.

According to Ohlin:

If a country has an abundant supply of a factor or factors relative to another, they will be available to the firms at cheaper prices. The costs of production of the goods which require these abundant factors will be comparatively low. A region, therefore, allocates its resources in accordance with the comparative advantage and specializes in the production of the commodities which require cheap factors. It exports these commodities and imports those goods which are cheaper in other countries due to the availability of abundant factors required for the production of those goods.

The trade between the regions continues till the differences in factor supplies is offset by a difference in their demand conditions. Trade of goods between the countries, is, thus, determined inter alia by the equilibrium of the demand and supply of respective commodities in a country. This principle also applies to inter-regional trade. Thus according to them:

“International trade is but a special case of inter-local or inter-regional trade”.

Explanation with Example:

Ohlin theorem is now explained by taking two trading countries Pakistan and Japan. In Pakistan, as we know, land is relatively abundant and capital is relatively scarce. Conversely, in Japan capital is relatively abundant and land relatively scarce.

Pakistan due to relatively abundant supply of land and farmers is able to produce agricultural goods, cotton and wheat at lower prices than Japan. Japan, on the other hand, having relatively an abundant supply of capital and know-how, produces machinery at cheaper cost. If Pakistan specializes in the production of wheat and cotton and Japan in machinery, both the countries will gain from increased output and lower prices of the products of each country.

The specialization and trade between Pakistan and Japan will continue so long as the differences in the relative prices of the factors exist. When due to increased demand for each other goods, the resource prices are equalized, trade is then not gainful to both the countries.

Criticism:

The factors proportion theory of trade put forward by Ohlin has been criticized on the following grounds:

(i) Based on over simplified assumptions: The theory is based on oversimplified assumptions which are unrealistic.

(ii) Partial equilibrium analysis: According to Haberler, the General Equilibrium theory gives a partial equilibrium analysis of international trade. In the real world selling costs, international organization of industries, etc., have a direct bearing on trading countries. Trade does not originate in response to differences in the relative prices of the commodities alone.

(iii) Ignores transport cost: Ohlin s theory ignores the transport costs winch have an important bearing on international trade.

(iv) A complement theory: Haberler is of the view that Ohlin’s theory can be regarded a complement and not a substitute of the classical theory of comparative cost.

Summing up:

We can say that the Ohlin’s Theorem provides a deep insight into the nature of international trade. It takes the aspects which so far have not been touched by the old theories. It is, so far the best of all possible explanation.