Factor Endowments

Factor endowments refer to the resources a country possesses. Traditionally, land, labor, capital, and natural resources were considered as important factor endowments determining the prosperity of a nation. A [Page 659]greater endowment of these resources and subsequent exploitation for value-adding activities is expected to lead to more wealth creation and prosperity.

Factor endowments determine the comparative advantage of nations against each other, which subsequently affects the pattern and direction of international trade. There have been several theoretical advancements based on the concept of factor endowment to explain international trade activities. Prominent among these are David Ricardo's theory of comparative advantage and the Heckscher-Ohlin (H-O) model of international trade. The theory of comparative advantage suggests that countries should specialize in products and services in which they have a comparative advantage, even though they may not have an absolute advantage. This theory does not explicitly acknowledge the role played by differential factor endowment in explaining international trade.

The H-O model builds on the theory of comparative advantage to predict that countries will export products for which they have an abundance of input factors and import those for which they lack the input factors. For example, a country with an abundance of capital will export capital-intensive products, whereas a country with an abundance of labor will export labor-intensive products. The H-O model assumes that countries differ only in terms of their factor endowments. Since countries are assumed to be similar in all other aspects, the production costs across different countries will differ depending on the relative factor endowments of a country and the factors needed for the production process. Thus a country with a superior endowment of capital will produce capital-intensive goods cheaper, while a country with a superior endowment of labor will produce laborintensive goods cheaper.

The concept of factor endowment and the H-O model have been widely used to explain international trade between the countries of the north and the south. The countries of the north are traditionally viewed as having superior capital endowment, whereas the countries of the south have an abundance of labor. The flow of capital-intensive goods from the north and the labor-intensive goods from the south in the late 19th and early 20th century can be attributed to their relative factor endowments. The economic prosperity of the countries in Europe and North America are also attributed to their attractive endowments.

However, empirical analyses show that the flow of trade may not always be between countries with different factor endowments. In fact, a large proportion of international trade is between countries with similar factor endowments. Wessily Leontif, in trying to verify the H-O model, found that the United States, in spite of being rich in capital, exported labor-intensive products, which is contrary to the predictions of the H-O model. This observation led many economists to propose changes to the way we look at factor endowments. For example, some suggestions include looking at capital, not just in terms of financial capital but also in terms of human capital.

Labor in the United States may be more productive than other countries, providing the United States with a rich endowment of human capital. Thus, what we consider an export of labor-intensive commodities may in fact be an export of human capital-intensive commodities. Some economists also suggested that the factor endowments may be less important than the demand conditions. This hypothesis, known as the Linder hypothesis, suggests that demand conditions between different countries determine the flow of trade such that countries with similar demand conditions trade with each other.

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