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a) Explain how in the Hecksher Ohlin (H.O.) theory of trade, factor rewards will equalise over time (Factor Price Equalisation) with free trade.

b) Discuss how tariff protectionist measures affect the welfare of a small country and examine the income distribution effects that would follow from such a policy.

Factor Rewards Will Equalize Over Time with Free Trade

At present times, international trade is an important concept in the area of economics. International trade refers as the exchange of capital, commodities, and services athwart global borders or regions. Moreover, free trade is fundamental to trade or exchange goods and services between different nations of the world. Free trade widely contributes in the positive economic growth as well as development of the nations. The theories of trade play important roles to describe the important concepts related to international trade and free trade. Apart from this, the research report is useful to explain that how in the Hecksher Ohlin theory of trade, factor rewards will equalize over time with free trade. Furthermore, this report is valuable to describe that how tariff protectionist measures affect the welfare as well as income distribution of a small country or small nations.

a) Factor Rewards Will Equalize Over Time with Free Trade

In today’s more globalized business era, international trade is essential for the expansion of business organizations in the international market. International trade plays a major role in the economic growth and development of nations. It has reduced the trade barriers and improved trade among nations (Atkinson, Dietz, Neumayer and Agarwala, 2014). Along with this, there are numerous theories of international trade. These theories portray the facts, concepts, tactics, methodologies, etc. related to international trade. Mercantilism theory, comparative advantage theory, absolute advantage theory, and Hecksher Ohlin theory are the major classical theories of international trade. Among these theories, Hecksher Ohlin theory of trade has its own important in the international trade. In other words, it can be said that, Hecksher Ohlin theory of trade is one of the most important theory of international trade. It is also recognized as ‘H-O Model’ ‘Factor Proportions Model’ ‘Factor-Price Equalization Theorem’ or ‘H-O Theory’ of international trade. The ‘H-O Theory’ was designed in the 1920s by two Swedish economists named as: Ell Heckscher and Bertil Ohlin (Durlauf and Blume, 2016).

On the other hand, the H-O model is the only model that explains lots of realistic characteristics of production those are not considered by the other theories of international trade. This model involves all the major factors that may influence trade among nations either in a positive or in a negative manner. The H-O theory describes that international trade takes place just because of the commodities differences and production differences among nations. Moreover, labor, capital, and land are the major factors that create differences between the production and commodities of different nations. The H-O model expands the number of production factors to improve the production capacity of nations (Van Marrewijk and Ottens and Schueller, 2012). According to this model, capital and labor are two important factors of productions that are essential to produce final goods. The area of capital is not limited in the context of production. The H-O model states that all the things that are essential for production such as: equipments, machines, tools, buildings, conveyers, conveyers, etc. are measured as capital.

Tariff Protectionist Measures Affect the Welfare of a Small Country

In addition to this, H-O model plays a major role to portray the connection between prices of output and factor rewards such as: real wages as well as real returns to capital. The developer of the H-O model initially stated that, trade will balance factor rewards to provide the required production factors in fixed proportions (Dee and Ferrantino, 2005). By using this theory, they insist that factor price equalization is an unavoidable result of trade. According to this theory, factor rewards will equalize eventually with free trade. Along with this, H-O model theory of trade is strongly related to the theorem of factor price equalization. In the context of the trade, factor price equalization states that the prices of similar factors of production would be equalize across countries because of international trade in commodities. As per the theorem, capital and labour   are essential goods as well as factors of production. Each and every nation faces the issue related to the same commodity prices. The main reason behind it is that, all these nations are free to trade in the international market. They use the same technologies to produce and trade homogeneous goods/ commodities in the international market (Brakman and van Marrewijk, 2015). So, it can be believed that, with free trade of commodities among nations, factor prices or rewards will be equalize across countries in the end.

In the same manner, the Hecksher Ohlin theory of trade declares that at what time the prices of the produced commodities are even among countries, and when they move to trade; at that time the prices of production factors such as: capital, labor, etc. would be automatically equalize among countries (Atkinson, Dietz, Neumayer and Agarwala, 2014). The theorem further states that just because of free trade, if all the nations would use same technologies and also produce homogeneous commodities; then the situation of perfect competition will arise in the markets. Moreover, in a perfect competition market, business firms get prices on the basis of their marginal productivity; and it depends on the production prices of the commodities. If nations set different prices; then the marginal productivities as well as wages & rents of nations would be influenced in a negative manner. The value of marginal products will be equalized only when the nations are in free trade and set same prices of their commodities. So, it can be said that, factor rewards will match ultimately with free trade; and nations around the world will share the same wage as well as rental rates to improve their productivity and also to enjoy the advantages of free trade in an effectual manner (Gandolfo and Trionfetti, 2013). Hence, the theorem affirms that free trade will make equal the wages of human resources; and the rents received on capital all over the world.

Income Distribution Effects of Tariff Protectionist Measures

On the other hand, the Hecksher Ohlin (H.O.) theory of trade describe that, nowadays, international trade has become essential for the growth and success of the business organizations. It is required for the positive economic growth and development of nations. But, there are some major factors that may influence trade in a negative manner. For case, the major factor is that the movement of goods as well as the mobility of production factors is imperfect across nations. This imperfection may either more or less from one nation to the other nation. So, in this situation, perfect mobility of production factors is required for the free movements of goods in both domestic and global markets (Becker and Gundlach, 2006). But, the nations are obliged to set same production factor prices to trade under the hypothesis of perfect mobility of factors. In this case, commodity trade will equalize the factor prices of production. Hence, it can be believed that, the factor price equalization is a significant consequence of the H.O. theorem; and factor rewards will equalize ultimately with free trade.

In addition to this, the factor price equalization is a central concept of the Hecksher Ohlin (H.O.) theory of trade.  With the help of this concept, Hecksher Ohlin theory predicts that free trade has a redistributive effect on factor rewards of nations at the global level. The theorem states that if trade of commodities is a perfect alternate for international factor mobility then factor rewards will automatically equalize with free trade (Zhang, 2008). Apart from this, the factor-price equalization theorem clearly states that at what time the costs of the produced commodities are constant among countries when they move to free trade, at that time the costs of the factors such as: labor and capital will also be even among nations.  Moreover, according to the H. O. theory of trade, different nations may decide different prices for their produced goods. These price differences are enough to create a variation in wages and rents among countries as these price differences have effects on the marginal productivity of nations.  A difference in wages and rents influences the capital-labor ratios in each industry; and consequently the wage as well as rental rates will be different from one country to other country.  But, if the governments of nations allow free trade among nations then prices of commodities will become equal among nations. As, two or more countries will share the same marginal productivity relationships; then just one set of wage & rental rates may delight these associations for a given set of production prices (Morales Meoqui, 2010). Thus, free trade will only equalize goods prices and factor rewards such as: wage as well as rental rates appropriately.

Conclusion

In the same manner, the Hecksher Ohlin (H.O.) theorem or factor price equalization theorem of free trade develops a strong relationship between commodity as well as factor prices. Under this theorem of free trade, at what time commodities prices are even between countries, at the same time as in free trade, at that time the factor prices including capital and labor will also be constant between the nations (Bowen, Hollander and Viaene, 2012). The theory further states the nations are obliged to follow some restrictive assumptions to take advantages of equalization at the time of free trade. But, these assumptions are hardly ever fulfilled by the nations in real. According to the H.O. theory, all the nations must show their interests in the obligation of these assumptions to take advantages of free trade in an effectual manner. It is because of free trade is only the most important factor that contributes to bring factor prices of different nations nearer to each other regardless of the nonexistence of factor movements (Wälde, 2013). In this way, if the assumptions for factor price equalization are followed by the nations at the time of free trade; then factor rewards will also be balance eventually with free trade as stated in the factor price equalization theorem.

b)  Tariff Protectionist Measures Affect the Welfare and Income Distribution of a Country

In the field of the economics, protectionism refers as the economic policy that controls trade between two or more nations. Quotas, tariffs, etc. are numerous methods related to protectionism; these methods restrain trade between nations. Along with this, it is a major type of trade policy that restricts unfair competition between nations. Tariffs protectionist measures are widely used to restrict trade, mainly imports. In recent years, protectionism has marked itself throughout popular anti-globalization as well as anti-immigration movements (Hallaert, 2010). Tariff protectionist is a defensive measure that is encouraged by political motivates of nations. Tariff protectionist measures mainly works for short time period. But, they turned into destructive measures for the long time period. These tariff protectionist measures make the countries less competitive in the international trade.

On the other hand, tariffs are the most common type of obstacle to trade. Tariff protectionist measures mainly have an effect on the welfare of small countries. These tariff protectionist measures affect the economy as well as people of a small country. These are numerous affect of these tariff protectionist measures those directly have numerous major effects on the welfare of a small country. The consumers of small countries are negatively influenced due to these tariff protectionist measures (Kowalski, 2005). The welfare of consumers of importing country is worse-off because of these tariffs. An increased in the domestic price of imported commodities as well as domestic substitutes may decrease consumer surplus that will influence the welfare of small countries in an automatic manner.

In addition to this, it is well-known that, a small country does not have enough funds to spend on welfare activities. It makes all its possible efforts to improve the economy of the nation. The improved economy is a sign of prosperity of a nation (Epps and Green, 2010). But, these tariffs protectionist measures reduce the profits of the nation. Tariffs are the taxes that nations have to pay on imported products. If a small country will pay huge amount as taxes then it will automatically influence the economy as well as financial growth of a small nation in a negative manner. Along with this, the consumers of a small country will be obliged to pay high prices for these imported commodities. These high prices will influence consumer surplus in a negative manner. But, the other fact is that there can be seen an increase in the surplus of domestic producers. It is because of these domestic producers are protected from low-priced imports; and also get higher prices for their products. They will not receive such high prices in the absence of the tariffs (V. C. Nye, 2007). But, these tariffs measures only protect the producers surplus; and as a consequence, it will be measured a welfare loss of a small country. The below graph is helpful to show the effect of tariff protectionist measures on the prices of commodities; that directly influence consumer surplus and producer surplus in a negative and positive manner respectively.

In the same manner, the effects of these tariff protectionist measures are obvious and manifold on a small country. These protectionisms have need of resources such as: tax revenues that a small country is unable to pay. These things influence both the productivity as well as profitability of a small nation (Razzaque and Laurent, 2008). Along with this, these tariff protectionist measures take resources away from natives as well as households, who are already bound to pay face higher prices for the imported goods. In consequence, the overall consumption of imported good falls in consequence of the drop of sales in the imported country. Outputs in a small country decreased because of the decline of sales within the protected nation. These decreased outputs have negative effect on the income of nation. Moreover, uncertainties in trade policies spoil growth of the organizations; and they cannot decide that how much they need to invest to remove future trade barriers in an effectual and a more comprehensive manner (Kraus, 2013). In this way, it can be believed that, these tariff protectionist measures have a negative impact on the overall welfare of a small country or small countries. These measures influence the productivity as well as profitability of these small countries.

In addition to this, tariff protectionist measures affect income distribution of nations either in a positive or a negative manner. The income of a small country reduces because of these tariff measures (Goldberg and Pavcnik, 2016). Moreover, these measures increase the income of large countries. It is because of small nations are obliged to pay high costs to follow these tariff protectionist measures; these reduce the incomes of these nations in a direct manner. Small nations have to pay high costs of the imported goods or commodities. These high costs reduce the incomes of small nations and also improve the incomes of export nations. Moreover, just because of these tariff measures, small nations face lots of trade restrictions; and these trade restrictions reduce employment level within these nations (Lukauskas, Stern and Zanini, 2013). A decline in imports reduces the domestic incomes of the protectionist country. It is because of the decreased imports reduce foreign incomes by reducing the demand of exports within nation. The decreased demand of exports condenses the domestic incomes of a small nation in an automatic manner. Apart from this, in a small nation, the costs of local jobs and firms throughout tariffs as well as quotas are more than the cost of retraining employees and rescheduling jobs as well. The costs of subsidies are also high in small nations rather than the costs of changing production to domestic industries. Moreover, tariff protectionist measures such as: quotas, tariffs, and subsidies dispirit innovation as well as advancement in home nations or small nations (Mavroidis, 2015). The absence of innovation and improvement has a negative effect on the social as well as economic welfare of a small country.

Conclusion

On the base of the above analysis, it can be said that, international trade and free trade play numerous important roles in the growth of the economy and GDP of nations. Free trade has offered the biggest platform for the growth of the organization in the international market. Along with this, it is also observed that, Hecksher Ohlin theory of trade is an important theory of international or free trade. It is because of it involves all the factors that are essential to produce commodities in an effectual and a significant manner. The H.O. theory affirms that factor rewards such as: capital and labor of nations will be equalize with the concept of free trade. Apart from this, it is also analyzed that, tariff protectionist measures create trade barriers among nations. These measures impose taxes or custom duties on the commodities. The business organizations do not show their interests to buy these high prices goods. These tariff protectionist measures have negative effects on the economy, GDP, employment, welfare, income distribution, productivity, and profitability of small nations.

References

Atkinson, G., Dietz, S., Neumayer, E. and Agarwala, M. (2014). Handbook of Sustainable Development: Second Edition. USA: Edward Elgar Publishing.

Becker, D.T. and Gundlach, E. (2006). Notes on factor price equality and biased technical change in a two-cone trade model (No. 68). Thünen-series of applied economic theory.

Bowen, H.P., Hollander, A. and Viaene, J. (2012). Applied International Trade. China: Palgrave Macmillan.

Brakman, S. and van Marrewijk, C. (2015). Factor prices and geographical economics. Handbook of Research Methods and Applications in Economic Geography, p.67.

Dee, P.S. and Ferrantino, M.J. (2005). Quantitative Methods for Assessing the Effects of Non-tariff Measures and Trade Facilitation. USA: World Scientific.

Durlauf, S.N. and Blume, L.E. (2016). The New Palgrave Dictionary of Economics. USA: Springer.

Epps, T. and Green, A. J. (2010). Reconciling Trade and Climate: How the WTO Can Help Address Climate Change. USA: Edward Elgar Publishing.

Gandolfo, G. and Trionfetti, F. (2013). International Trade Theory and Policy. USA: Springer Science & Business Media.

Gans, J., King, S., Libich, J., Byford, M., Mankiw, G. and Stonecash, R. (2014). Principles of Economics PDF. Australia: Cengage Learning Australia.

Goldberg, P.K. and Pavcnik, N. (2016). The effects of trade policy. Handbook of Commercial Policy, 1, pp.161-206.

Hallaert, J.J. (2010). Economic Partnership Agreements: Tariff Cuts, Revenue Losses and Trade Diversion in Sub-Saharan Africa. J. World Trade, 44, p.223.

Kowalski, P. (2005). Impact of changes in tariffs on developing countries' government revenue. Available At: https://www.gtap.agecon.purdue.edu/resources/download/2115.pdf [Accessed On: 20th May 2015]

Kraus, C. (2013). Import Tariffs as Environmental Policy Instruments. USA: Springer Science & Business Media.

Lukauskas, A., Stern, R.M. and Zanini, G. (2013). Handbook of Trade Policy for Development. UK: OUP Oxford.

Mavroidis, P.C. (2015). The Regulation of International Trade: GATT. London: MIT Press.

Morales Meoqui, J. (2010). Classical Free Trade: A Policy Towards Economic Growth and Development (Doctoral dissertation, WU Vienna University of Economics and Business).

Razzaque, M.A. and Laurent, E. (2008). Global Rice and Agricultural Trade Liberalisation: Poverty and Welfare Implications for South Asia. USA: Commonwealth Secretariat.

C. Nye, J. (2007). War, Wine, and Taxes: The Political Economy of Anglo-French Trade, 1689-1900. USA: Princeton University Press.

Van Marrewijk, C. and Ottens, D. and Schueller, S. (2012). International Economics. UK: OUP Oxford.

Wälde, K. (2013). Convergence, Divergence and Changing Trade Patterns: Theoretical Inquiries into the Role of Preferences, Factor Accumulation, Technological Change and Government Intervention. USA: Springer Science & Business Media.

Zhang, W. (2008). International Trade Theory: Capital, Knowledge, Economic Structure, Money, and Prices over Time. USA: Springer Science & Business Media.

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