The Theory of Factor Proportions

Product Cycle
New Trade Theory
National Competitive Advantage

intensively use factor endowments which are locally abundant
Corollary: import goods

made from locally scarce factors
Note: Factor endowments can be impacted by government policy - minimum wage
Patterns of trade are determined by differences in factor endowments - not productivity
Remember, focus on relative advantage, not absolute advantage

export those goods that require resources (factors) that are abundant

(and thus cheapest) and import those goods that require resources that are in short supply
Example:
Australia – lot of land and a small population (relative to its size)
So what should it export and import?

(X&Y), two factors of production (labor & capital).
Used to illustrate

the theory in a two-dimensional figure.
Both nations use the same technology in production.
Means both nations have access to and use the same general production techniques.
Commodity X is labor intensive and Y is capital intensive in both nations.
Means the labor-capital ratio (L/K) is higher for X than Y in both nations at the same relative factor prices.

scale in both nations.
Means that increasing the amount of L

and K will increase output in the same proportion
There is incomplete specialization in production in both nations.
Means that even with free trade both nations continue to produce both commodities. This implies neither nation is very small.
Tastes are equal in both nations.
Means demand preferences are identical in both nations. When relative prices are equal in the two nations, both consume X&Y in the same proportion.

factor markets in both nations.
Means that producers, consumers, and traders

of X&Y in both nations are each too small to affect prices of commodities. Also, in the L-R commodity prices equal their costs, leaving no economic profit.
There is perfect factor mobility within each nation but no international factor mobility.
Means K&L are free to move from areas and industries of lower earnings to those of higher earnings until earnings are the same in all areas, uses and industries of the nation. International differences in earnings persist due to zero international factor mobility in the absence of international trade.

obstructions to the free flow of international trade.
Means specialization in

production proceeds until relative (and absolute) commodity prices are the same in both nations with trade. If transportation costs and tariffs were allowed, specialization would proceed only until prices differed by no more than the costs and tariffs on each until of the commodity traded.

nations.
Means there are no unemployed resources in either nation.

International

trade between the two nations is balanced.
Means that the total value of each nation’s exports equals the total value of the nation’s imports.

(capital abundant) should specialize in the production and export of

that product which is relatively labor intensive (capital intensive)

price equalization
Distribution of income
Factor growth and output patterns

the production of machines (capital intensive).
India (labor abundant) has comparative

advantage in production of cloth (labor intensive).

(disadvantage) and export (import) goods whose production intensively uses its

relatively abundant (scarce) factor of production.

in the abundant factor.
The U.S. exports goods that are capital

intensive.
Gains from trade are realized when a country exports goods based on its comparative advantage and imports goods based on comparative disadvantage.

endowed with
land. Therefore USA exports farm (land-intensive) products. Singapore

is relatively well endowed with marine traffic locational resources. Therefore, Singapore exports shipping, marine insurance, ship repair plus many derivative services.

Germany are
relatively well endowed, after histories
of much investment,

with non-human
productive resources or capital.

Therefore, they export capital-intensive
manufactured goods.

are the world’s
two biggest exporters of agricultural
products. Land intensive?
Leontief

(Nobel laureate) discovered (1960s)
after extensive data crunching that the USA
exports labor intensive goods; to Japan?
To China? To Luxembourg? To India?

Maybe US labor is (was) human capital
intensive. US endowment

of capital
intensive labor is (was) relatively large by
international standards.
Hence, labor intensive exports were really human capital intensive. Try that one on the shop floor at Toyota City!

be relatively abundant in the
United States & other developed

countries,
labor in general is relatively scarce.
This has many implications with respect to trade policy, income distribution and other
matters.

to capital tend to
equalize across trading nations. Is this
true? Are

your wages determined in
Bangladesh? Are low-skilled US workers
vulnerable? Many who were on the streets
of Seattle & Honolulu think so.

as
an embodiment of natural and acquired
skills or sources of

productivity. The skills
are heterogeneous; some are highly
competitive internationally, others are
company or geographically specific.
Globalization transforms the specific into
global, but the transformation is incomplete.

be global and to
correlate with mobility.
Medium and low

tech skills tend to be more local and less mobile.
However, a major exception may
be many low tech skills in the First World
which are highly substitutable for skills
that exist widely in the Third World.

in the First World embodies, on average, a greater concentration

of skill units than that embodied in Third World labor.
If this is true, wages of low-skilled labor will remain higher in the First World, even if
global competition forces relative
equalization.

residents or through foreign
direct investment (FDI) leads to falling
returns.

Resulting excess capacity in Asian
countries caused falling returns & inability
to pay off loans. Asia ceased to be a
better investment than developed countries.

in JPN.
Free trade enables USA to share its land
globally, in

an environment in which land
is not so abundant. Hence, US farm income
rises. However, US abundance swamps
JPN’s scarcity causing JPN’s farm income
to fall.

monopoly, free of USA’s
abundant competition and raises JPN’s
farm income

(lowers USA’s income).
Of course, JPN’s consumers pay more.
Farmers and related industries win;
consumers & others lose.

USA’s software, hardware &
entertainment output are produced by
industries relatively well

endowed with
key inputs. Owners of these key inputs
profit from globalization if exporters, but
lose if importers.

goods prices
are set by large, global markets. Hence,
if, for example,

population (labor force)
rises, labor-intensive industries will
grow and capital-intensive industries
will shrink.

in
developing its physical & human capital
stocks, capital and high-skill labor-
intensive

industries will grow and low-
skill labor industries will shrink. This
sounds rather like Japan, Korea, Singapore
and other countries in the early stages of
their development.