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4.2. Neo-Classical Theories of Trade

Neo-classical economists by using the concept of “opportunity cost” instead of labor theory value that contains other factors together with labor have revised the model of Ricardo. According to this theory production is the result of all the factors used together. Therefore, cost which is the reverse of productivity is the sum of resources used to produce 1 unit of good and is calculated by adding up all the monetary values of factors used. Opportunity cost of a good is the amount of the foregone production of other good for the increase in the first good by 1 unit.
Accepting that more than one factor involve in the production process it becomes impossible to make a comparison in terms of individual factor productivities between countries because when all the factors are used in the production simultaneously, it is impossible to measure the productivity of one factor by abstracting it from other factors. Production is the result of collective contributions of all the factors used. Therefore individual factor productivities can not be measured but the collective productivity of them. As a result, with the opportunity cost analysis it is shown that international specializations can not be determined with the comparison of individual factor productivities. In neo-classical framework the comparison is done by production cost. The theory adds up a pricing such as 1 unit of wheat=€30 and 1 unit of steel=€10 behind the final figure of 1 unit of wheat=3 units of steel and then reaches to opportunity cost.
Neo-classical trade theory analyzes production capacities and opportunity costs through transformation curves and demand conditions through indifference curves.
On the other hand neo-classical trade theory can not explain different domestic prices among countries. This defect has been debugged by the contributions of Heckscher and Ohlin, Heckscher-Ohlin Theory. According to the theory a country has comparative advantage in the production of the good that necessitates the factor that the country has abundantly. From Heckscher-Ohlin model which is also known as Factor Endowment Theory the theories of Factor Price Equalization, Income Distribution and Rybczynski have been derived.
Factor price equalization theory claims that free trade reveals the same results with the factor markets that equalize the factor prices under perfect international factor mobility even with imperfect factor mobility. Firstly, Heckscher claims that factor prices equate with free trade then Ohlin revised absolute equality as a tendency toward equality and finally Samuelson analytically proved factor price equalization through free trade.
Stolper and Samuelson by contradicting the Ricardo’s most widely-accepted idea for more than a century “free trade is beneficial and protectionism is harmful for all in the country” introduced the foreign trade-related income distribution theory. According to the theory, free trade is beneficial for the factor used intensively in the export sectors and protectionism is beneficial for the factors used in import-substitution sectors. In other words, although an economy suffers from protectionism, people working in the import-substitution sector benefit it. In sum, free trade is beneficial for the abundant factor of the country and protectionism for the scarce factor.
Rybczynski theory, which is derived from Heckscher-Ohlin theory and analyzes the production results of the changes in factor supply, betrays that in a two-good, two-factor and full-employment model when the supply of a factor increases, the production of the good that necessitates this factor intensively increases and the production of the other good that necessitates the other factor intensively decreases because of factor transfers between the sectors.
Although neo-classical trade theory introduces opportunity cost to the theory and there are the theories of Heckscher-Ohlin, Stolper-Samuelson and Rybczynski that complement the theory, it has been criticized because of its deficiencies. The most important of these criticisms is the Leontief Paradox.
Leontief developed the input-output table technique in order to test factor endowment theory and by forming “representative commodity bales” he analyzed 1947 foreign trade data of USA. However, he found the result that the USA which was the most capital intensive country in the world exports labor-intensive goods and imports capital-intensive goods. This result is named as Leontief Paradox and caused the birth of a new literature.