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two countries model (2x2x2 model). There has been extensions to the HO model namely through the Stolper-Samuelson model (1949) and Rybczynski theorem (1955). These theorems postulate that trade leads to the equalisation of relative and absolute factor prices between nations so that there will be internationalisation of prices and wages based on still the restrictive assumptions as those under the HO model.

 

As Faeth (2009) and Seetanah and Rojid (2011) highlight, the first explanations of FDI were based on the models propounded by Heckscher-Ohlin (1933), according to which FDI was motivated by higher profitability in foreign markets with the possibility to finance these investments at relatively low rates of interest in the host country. Ohlin also observed that availability and securing sources of raw materials, flexible and business friendly trade policies as well as accessibility and availability of factors of production were the components influencing FDI inflows into the country.

 

Modern International Trade Theories

 

There have been empirical tests concerning the traditional trade theories namely the Ricardian and HO models. Some tests have gone according to the theories while others have disproved them. For instance Sir Donald MacDougall in 1951 tested the Ricardian theory using the 1937 data for the USA and UK for 25 industry groups whereby it was found that US wages were twice as those for UK resulting in the USA being capital intensive while UK being labour intensive. However, according to Dougall there is incomplete specialisation as opposed to complete specialisation proposed in the Ricardian model. This is based on the fact that tastes are different, products are non-homogeneous, transport costs matter and industry groups are highly aggregated where we can have different model for a particular products like cars and cigarettes. The USA may have comparative advantage in cars but this does not prevent the UK from exporting one or two different models.

 

Sir Donald MacDougall has also in 1960 talked about the benefits and costs associated with private investment from abroad. He pointed out that an increase in FDI will lead to an increase in real income based on the fact that value added to output by foreign capital is greater than the amount appropriated by the foreign investor as foreign capital raises overall productivity in the host country. With FDI, social returns are far greater than private returns based, inter alia, on the

 

following:

 

(a) Domestic labour having a higher real wages;

 

(b) Consumers having better choice with lower prices;

 

(c) Host Government getting higher tax revenue;

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