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Factor Proportions Theory or Heckschar and Ohlin Model

The theory was compounded by two Swedish economists, Eli Heckscher and Bertil Ohlin.  The theory explains that a country should produce and export a commodity that primarily involves a factor of production abundantly available in the country.  For example, country ‘A’ has large population and large labour resources. Thus it will be able to produce the goods at a lower cost using a labour intensive mode of production. Country ‘B’ has abundance of capital but is short of labour resources and will specialize in goods that involve a capital intensive mode of production.  After the trade, both the countries will have two types of goods at the lest cost.  Mr. Samuelson went a few steps ahead saying that in this way the prices of factors of production tend to equalize among different countries.  Leontief found in his empirical study that the USA being the capital abundant economy, exported labour intensive goods.  But he was of this view that such possibilities could not be ruled out because the USA was able to produce labour intensive goods in a capital intensive fashion.

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Neo-Factor proportion Theory

Extending Leontief’s view, some of the economist emphasis on the point that it is not only the abundance of a particular factor, but also the quality of that factor of production that influences the pattern of international trade. The quality is so important in their view that they analysis the trade theory in a three-factor framework :

(a)   Human capital :  It is the result of better education and training.  Human capital should be treated as a factor input like physical labour and capital.  A country with human capital maintains an edge over other countries with regards to the export of commodities produces with the help of improved human capital.

(b)   Skill Intensity :  The skill intensity hypothesis is similar to human capital hypothesis as both of them explain the capital embodied in human beings.  It is only empirical specification that differs.

(c)   Economies of Scale :  It explains that with rising output, unit cost decreases.  The producers achieve internal economies of scales. A country with large production possesses an edge over other countries with regards to export.  However, a small country can reap such advantages if it produces exportable in large quantities.

 National Competitive Advantage 

The theory is compounded by Porter.  This theory explains that countries seek to improve their national competitiveness by developing successful industries.  The success of targeted industries depends upon a host of factors that are termed the diamond of national advantage.  The factors are :

(a)   Factor Conditions :  It show how far the factors of production in a country can be utilised successfully in a particular industry.  This concept goes beyond the factor proportion theory and explains that an availability of the factor of production per se is not important, rather their contribution to the creation and upgradation of products is crucial for competitive advantages.

(b)   Demand Condition :  The demand for the product must be present in the domestic market from the very beginning of production.  Porter is of view that it is not merely size of the market that is important, but it is intensity and sophistication of demand that is significant for competitive advantage.

(c)   Related and Supported Industries :  The firm operating along with its competitors as well as its complementary firms gathers benefit through a close working relationship in form of competition or backward and forward linkage.

http://www.govindam.org/

(d)   Firm Strategy, Structure and Rivalry :  The firm’s own strategy helps in augmenting export.  There is no fixed rule regarding the adoption of a particular strategy.  It depends on the numbers of factors present in the home country or the importing country.

Limitations :   There are various criticism put forth against Porter’s theory :

(a)   There are cases when absence of any factors embodied in Porters diamond does not affect the competitive advantage.  For example, when a firm is exporting its entire output, the intensity of demand at home does not matter.

(b)   If the domestic supplier of input is not available, the backward linkage will be meaningless. 

(c)   Porter’s theory is based on empirical findings covering 10 countries and four industries.  A majority of countries in the sample have different economic background and don’t necessarily support the findings.

 (d) Availability of natural resources, according to Porter are not the only conditions for attaining competitive advantage. And there must be other factors too for it.  But in 1985, some Canadian industries emerged on the global map only on the basis of natural resources.

(e)   Porter feels that sizable domestic demand must be present for attaining competitive advantage. But there are industries that have flourished because of demand from foreign sales.

http://www.govindam.org/

Summary: Nevertheless these limitations do not undermine the significance of Porter’s theory.