Does the Heckscher-Ohlin theory of international trade overcome the inadequacies of the Ricardian model?
The Ricardian model of trade, which concerns differences in technology between countries, concludes that everyone benefits from trade, whereas the Heckscher-Ohlin model, which concerns endowment differences, concludes that there will be winners and losers from trade. Change the basis for trade and you may change the outcomes from it.
Until 1817, the logic of comparative advantage in trading was neither a supposition. The existence of the Absolute Advantage Theory of Adam Smith (1776) was widely believed true and impossible to overcome. The strengths of the Absolute Advantages were consequences of sectorial specialization:
-If Country A can produce a set of goods at a lower cost than foreign country B, and if the country B can produce some other set of goods at a lower cost than country A can, then clearly, they have an incentive to trade their relatively cheaper goods and gain from the trade. It comes as a description of trade patterns and provides the rationale to state that it improves the economic welfare.
However, if country A held the absolute advantage on all the produced goods, there would have been no trade incentives for country B, leaving both countries in an autarkic scenario. Let us now suppose a production matrix of units of output per hour of labour:
Under the Smithian conditions, in a ceteris paribus environment, where prices of goods are given by the amount of labour required to produce and are exchangeable one for another, where no transaction costs and taxes apply to the trade, Country A is more efficient in production of both goods ? XA>XB, YA>YB- while country B is inefficient and unwilling to trade one-to-one. In the long-run, Country B will be unable to buy from Country A, lacking resources.
A tiny nail into a big mechanism pushed economists towards a solution, lately found by Ricardo with the Comparative Advantage theory. He numerically demonstrated that if Country A specializes in good X production and Country B specializes in good Y production the global output of both goods could rise. If the appropriate terms of trade were then chosen, both countries could end up in a Pareto improvement. This means that despite the technological inferiority of country B in the production of everything, it may benefit from free trade after specializing in the good it is most competitive on.
As it turned out, specialization in any good did not suffice to make it valid. Ricardo showed that the specialization good in each country should be that good in which the country had a comparative advantage in production. Thus, production costs ? even if in labour terms- do not need to be compared across countries, but the opportunity cost of producing goods across countries.
The opportunity cost is given by the amount of X necessary to be given up in order to produce Y+1; if country B...