According to the HO theory, the basis for the movement of goods and services (in

Question

According to the HO theory, the basis for the movement of goods and services (international trade) across national boundaries is the differences in the opportunity costs of production (which translates into differences in the prices of goods and services being traded). Just like goods and services, we also know that both Labor and Capital move across national boundaries (from one country to another country). Briefly state what underlies (explains) the international movement of factors of production (i.e., why labor and/or capital moves from one country to another country?).

Explanation / Answer

In the 18th and 19th century mercantilism was dominant in the international trade. So each country was trying to have trade surplus which even led to wars such as 'Opium War'. In that period, tea became very popular drink in Britain and she has to import it from China and it has devloped trade deficit. Britain then waged a war to sell opium to negate that.

In modern and globalized world trade surplus is not that much advantageous because of law of diminishing return. Any trade surplus country can accumulate forex reserve but it will increase inflation and higher wages will erode its labor competitivity. If there are not that much option then the capital would have to be invested in foreign countries. Among the factors of production, capital is most freely movable.

Now suppose that if a country has a labor intensive industry but it is in short of skilled laboe may be because of low polpulation or higher wages then it wion't have any option but to hire workers from foreign country. US is very much dependent on legal or illegal migrants from Mexico in manufacturing jobs and legal workers from India in information technology related jobs.

Acapital surplus country thus can earn returns on its investment. Many countries now have set up sovereign funds to tap such opportunities. In the same way, labor surplus countries gain from remittances from its citizens abroad.

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