Neo-Factor Proportions Theory

Extending Leontief’s view, some of the economists emphasize on the point that it is not only the abundance (scarcity) 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 analyse the trade theory in a three-factor framework instead of two-factor framework taken into account by Heckscher and Ohlin. The third factor manifests in the form of:

  1. Human capital: It is the result of better education and training.Human capital should be treated as a factor input like physical labor 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.
  2. 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. Keesing (1965, 1971) computed the direct skill requirements for production of 1957 manufactured exports and imports for 9 countries and 15 manufacturing sectors. The study revealed that labour is a non-homogeneous factor and it is the differing quality of labour in terms of sills that determines the pattern of international trade.
  3. 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.
  4. Research and Development: Last but not least, R&D activity is positively associated with the competitive ability of manufacturing industries. It is proxy for trade advantage, meaning that a country with large expenditure on R&D possesses a comparative trade advantage. Krugman and Obstfeld (1994) deal both with the process innovation and the product innovation. The process innovation hypothesis examines how different countries ranked on the basis of technological level and how goods are ranked by technological intensity. The higher ranked countries always maintain an absolute advantage over low ranked countries. Again, their model with product innovation demonstrates that the process of innovation goes on continuously. A technologically advanced country exports newly innovated goods where its innovation continues to remain its monopoly. It imports “old” goods where the technology has already been imitated by producers in other countries.

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