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FACTOR ENDOWMENT THEORY

 

The principles of absolute and relative advantage provide a primary basis for trade to occur, but the usefulness of these principles is limited by their assumptions. One basic assumption is that the advantage, whether absolute or relative, is deter- mined solely by labor in terms of time and cost. Labor then determines comparative production costs and subsequent product prices for the same commodity.

If labor is indeed the only factor of production or even a major determinant of product content, countries with high labor cost should be in serious trouble. An interesting fact is that Japan and Germany, in spite of their very high labor costs, have remained competitive and have performed well in trade. It thus suggests that absolute labor cost is only


Figure 2.2 Absolute advantage without relative

advantage (identical domestic exchange ratios)

 

one of several competitive inputs that determine product value. Tables 2.2 and 2.3 show incomes, working hours, and vacation days across major cities.

It is misleading to analyze labor costs without also considering the quality of that labor. A country may have high labor cost on an absolute basis; yet this cost can be relatively low if productivity is high. Countries with low wages tend to have low pro- ductivity. Any subsequent productivity gains usually result in higher wages and currency appreciation.

Furthermore, the price of a product is not necessarily determined by the amount of labor it embodies, regardless of whether or not the effi- ciency of labor is an issue. Since product price is not determined by labor efficiency alone, other factors of production must be taken into considera- tion, including land and capital (i.e., equipment). Together, all of these production factors contribute significantly to the creation of value within a particular product.

One reason for the importance of identifying other factors of production is that different com- modities require different factor inputs and that no country is well endowed in all production factors. The varying proportion of these factors embodied in various goods has a great deal of impact on what a country should produce. Corn, for instance, is best produced where there is an abundance of land (rel- ative to labor and capital), even though corn can be grown in most places in the world. Oil refining, in contrast, requires relatively more capital and


 

 

Table 2.2 Wage levels around the globe

 

City Gross, Net, City Zurich = 100 Zurich = 100 Gross, Zurich = 100 Net, Zurich = 100
Zurich 100.0 100.0 Singapore 26.8 28.3
Copenhagen 98.9 74.8 Dubai 26.4 35.2
Basel 97.7 95.8 Lisbon 23.6 25.1
Oslo 94.9 87.0 Manama 22.8 29.4
Geneva 91.1 88.5 Ljubljana 21.2 17.6
New York 84.7 78.6 Johannesburg 19.1 20.0
Lugano 84.3 85.1 Istanbul 17.9 16.7
Chicago 82.5 81.0 Budapest 16.6 15.6
Los Angeles 72.2 72.9 Kuala Lumpur 14.5 16.3
Frankfurt 70.0 59.9 Warsaw 13.0 11.4
Luxembourg 69.4 75.4 Shanghai 12.8 12.5
Tokyo 68.3 70.5 Santiago de Chile 12.7 14.4
Brussels 67.9 56.0 Riga 12.6 12.2
London 65.6 63.9 Tallinn 12.4 11.9
Amsterdam 64.7 57.0 Prague 11.8 12.4
Stockholm 64.7 56.5 Vilnius 11.2 10.1
Berlin 63.9 54.5 Moscow 11.1 13.4
Dublin 63.5 66.1 Sao Paulo 10.4 11.9
Miami 62.4 63.1 Lima 9.9 11.3
Helsinki 58.2 56.6 Bratislava 9.7 9.8
Vienna 55.8 52.3 Caracas 9.2 11.0
Paris 53.4 52.2 Mexico City 9.2 10.7
Toronto 52.6 48.8 Rio de Janeiro 8.4 9.2
Montreal 50.1 48.0 Bogotá 8.3 10.0
Milan 44.5 40.3 Buenos Aires 7.9 8.7
Sydney 40.2 40.7 Bucarest 7.2 11.9
Barcelona 38.0 41.1 Bangkok 6.9 8.6
Rome 37.1 33.4 Jakarta 6.5 7.8
Madrid 35.3 39.2 Manila 5.4 6.0
Athens 34.6 37.3 Sofia 5.3 5.6
Auckland 34.5 35.3 Kiev 5.0 5.8
Tel Aviv 32.8 33.2 Lagos 5.0 6.5
Taipei 32.3 35.5 Nairobi 4.2 4.8
Hong Kong 31.1 36.4 Karachi 3.5 4.1
Seoul 30.6 30.7 Mumbai 3.1 3.6

Source: Prices and Earnings (Zurich: UBS AG, 2003), 7.




 

 

Table 2.3 Working hours and vacation days around the globe

 

City Working hours per year Vacation days per year City Working hours per year Vacation days per year
Hong Kong Zurich
Mumbai Basel
Taipei Tokyo
Karachi Riga
Manila Chicago
Mexico City Miami
Seoul New York
Dubai Vilnius
Santiago de Chile Ljubljana
Bangkok Montreal
Jakarta Tallinn
Nairobi Sofia
Istanbul Rome
Lima Lisbon
Kuala Lumpur Rio de Janeiro
Singapore London
Buenos Aires Moscow
Manama Madrid
Los Angeles Dublin
Auckland Stockholm
Budapest Luxembourg
Bucharest Sydney
Caracas Athens
Bogotá Barcelona
Tel Aviv Amsterdam
Kiev Lagos
Shanghai Brussels
Prague Milan
Sao Paulo Helsinki
Lugano Oslo
Johannesburg Vienna
Toronto Frankfurt
Warsaw Berlin
Geneva Copenhagen
Bratislava Paris

Source: Prices and Earnings (Zurich: UBS AG, 2003), 23.


 


relatively less labor and land because of expensive equipment and specialized personnel. In clothing production the most important input factor is that the economy is labor-intensive.

The varying factor inputs and proportions for different commodities, together with the uneven distribution of such factors of production in differ- ent regions of the world, are the basis of the Heckscher–Ohlin theory of factor endow- ment.5 This theory holds that the inequality of relative prices is a function of regional factor endowments and that comparative advantage is determined by the relative abundance of such endowments. According to Ohlin, there is a mutual interdependence among production factors, factor movements, income, prices, and trade. A change in one affects the rest. Prices of factors and subsequent product prices in each region depend on supply and demand, which in turn are affected by the desires


of consumers, income levels, quantity of various factors, and physical conditions of production.

Since countries have different factor endow- ments, a country would have a relative advantage in a commodity that embodies in some degree that country’s comparatively abundant factors. A country should thus export that commodity which is rela- tively plentiful (i.e., in comparison to other com- modities) within the relatively abundant factor (i.e., in comparison to other countries). This exported item may then be exchanged for goods that would use large quantities of the country’s scarce factors if domestically produced. Figure 2.3 lists the Netherland’s well-endowed factors, for example. Table 2.4 shows countries with capital scarcity.6

Therefore, a country that is relatively abundant in labor but relatively scarce in capital is likely to have a comparative advantage in the production of labor-intensive goods and to have deficiencies in the


 

 

Table 2.4 Capital scarcity. Capital endowments and output per capita are much lower in the Central and Eastern European countries than in Western Europe, implying large potential capital inflows into the region.

 

GDP per worker1 Relative marginal Potential inflows3

product of capital2

 

Bulgaria 22.9 19.1
Czech Republic 53.6 3.5
Estonia 31.1 10.3
Hungary 55.7 3.2
Latvia 20.9 22.9
Lithuania 28.5 12.3
Poland 38.6 6.7
Romania 26.9 13.8
Slovak Republic 42.2 5.6
Slovenia 72.8 1.9
Median 34.9 8.5
Minimum 20.9 1.9
Maximum 72.8 22.9

Notes

1 In percent of German GDP per worker (purchasing-power-parity basis).

2 Cobb-Douglas production function.

3 In percent of initial (Pre-flow) GDP.

 

Source: Leslie Lipschitz, Timothy Lane, and Alex Mourmouras, “The Tosovksy Dilemma,” Finance & Development, September 2002, 32.


 

 

 

Figure 2.3 WordPerfect and the Netherlands’ relatively well-endowed factors

Source: Courtesy of the Netherlands Investment Agency and Ogilvy Adams & Rinehart.

 

 


production of capital-intensive goods. This concept explains why China, a formidable competitor in textile products, has to depend on US and European firms for oil exploration within China itself.

Each nation possesses factors of production that may be grouped into these broad categories: human resources, physical resources, knowledge resources, capital resources, and infrastructure. Interestingly or surprisingly, a nation’s abundance of a particu- lar production factor may sometimes undermine


instead of enhance the country’s competitive advantage.7

The quality of human resources is a function of human development. The United Nations Develop- ment Program has prepared the Human Devel- opment Index (HDI) to measure well-being.8 The HDI, ranging from zero (low human development) to one (high human development), is an arithmetic average of a country’s achievements in three basic dimensions: longevity (measured by life expectancy


 


at birth); educational attainment (measured by com- bination of adult literacy rate and enrollment ratio in primary, secondary, and tertiary education); and living standards (measured by GDP per capita in US dollars at purchasing power parity). Both the HDI and per capita income are highly correlated with the other widely used measures of poverty. Table 2.5 shows a list of countries based on the HDI.



Date: 2014-12-21; view: 1405


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