Exam 4: Factor Endowments and the Commodity Composition of Trade

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In this case, capital is called a specific factor because its use is specific to the production of various goods. When trade opens up, the industry with a comparative advantage expands and the industry with comparative disadvantage contracts; if all capital is immobile, owners of the specific capital used to produce exports gain as the industry expands production. The owners of the specific capital used to produce import competing goods lose as production contracts. However, the income effect on the mobile or variable factor labor is indeterminate.

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A country's comparative advantage can change over time. South Korea is a good example of a country changing its factor endowments and its comparative advantage. In the mid 1960s, the capital stock per worker in South Korea was approximately $2,000. By the early 1990s it was nearly $18,000. Less than 40 years ago, South Korea was a very poor developing country. GDP per capita at the end of the Korean War was less than $800. In less than 40 years, GDP per capita had increased to $7,251. Some of this progress can be attributed to the relative openness of the Korean economy. In the early 1950s exports plus imports as a percentage of GDP were a little more than 10 percent. By 1990 they were more than 60 percent. India is a good study in contrast. In the 1950s, India's GDP per capita was only slightly lower than South Korea's. India, like South Korea, was a labor-abundant country with a low capital stock per worker. The level of openness in the two economies was also similar in the early 1950s. Today India is still a poor, labor-abundant economy for many reasons. However, at least part of the story can be found by contrasting the rates at which the two economies opened themselves up to trade over the last 40 years.

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There are a number of possible explanations for Leontief's results. One is that some imports are not based on an abundance of labor or capital, but depend on the possession of natural resources, such as oil, diamonds, bauxite, and copper. Many of these natural-resource industries use highly capital-intensive production techniques to extract the product and since the U.S. imports many natural resources, this would help to explain why U.S. imports are capital intensive. Second, U.S. trade policy may have biased the results. Many of the most heavily protected industries in the U.S. are labor-intensive. The effect of imposing trade restrictions on certain labor-intensive goods would be to diminish U.S. imports of labor-intensive products and reduce the overall labor intensity of U.S. imports. Third, Leontief's test, which found that U.S. exports were labor intensive, was based on the simple two-factor version of the factor-proportions model. This simple model assumes that labor is homogeneous or that one unit of labor is like any other unit of labor. However, much of the U.S. labor force is highly skilled or possesses human capital. When human capital is taken into account, U.S. exports do not appear to be labor intensive, but appear to be human-capital intensive. Fourth, U.S. exports also appear to be intensive in technology, which is somewhat different from capital, labor, or human capital. U.S. exports have been shown to be intensive in research and development (R&D). The level of R&D in an industry is a coarse measure of the level of technology. As a result of this research, we can use the factor-proportions theory with some confidence. Most empirical evidence indicates that the basic reasoning embodied in the factor-proportions theory is correct. We just need to broaden the concept of factors of production to include factors other than capital and labor.