Factor Endowments

What is a Factor Endowment?[1]

Heckscher-Ohlin’s Factor Endowment Theory also called Heckscher-Ohlin Model, H-O Model, Factor Endowment Theory, and Factor Proportion Theory is an economic as well as international trade theory that states that a nation should produce and export products for which factors of production the country is rich. A factor endowment, in economics, is commonly understood to be the amount of land, labor, capital, and entrepreneurship that a country possesses and can exploit for manufacturing. Countries with a large endowment of resources tend to be more prosperous than those with a small endowment if all other things are equal. The development of sound institutions to access and equitably distribute these resources, however, is necessary in order for a country to obtain the greatest benefit from its factor endowment.

Assumptions of Factor Endowment Theory[2]

The main assumptions of the H-O model can be mentioned below.

  • Different goods have different factor intensities – for example, textiles and clothing are labor-intensive goods and a semi-conductor is a capital-intensive product.
  • Countries differ with respect to their factor endowments – for example, Nepal has an abundant supply of labor goods relative to capital, whereas the USA has an abundant supply of capital goods relative to labor.
  • Two countries, two goods, and two factors of production.
  • Perfect competition in commodities and factor markets.
  • Constant returns to factors.
  • Given technology is universally available.
  • There are no transport costs, insurance premiums, or exchanges.
  • No control of trade and exchange rates.
  • Factors immobility between countries and factors endowments.
  • Demand conditions are fixed.

Examples of Factor Endowments[3]

A simple example of a factor endowment with respect to land would be the presence of geographic scale or natural resources such as oil. Countries with abundant oil tend to export oil, redirecting internal resources toward producing the factor they have in quantity. As of 2019 data, Angola is an extreme example of such specialization: oil accounts for more than 86% of its exports.

Other countries, such as the Democratic Republic of Congo (DRC), are one of the countries sitting on Africa's copper belt, which holds more than two-thirds of the entire world's cobalt, as per a 2020 USGS report.

Cobalt, used in rechargeable batteries for electronic gadgets like cellphones, laptops, and even electric cars, is in high demand—meaning, countries like the DRC have heavily relied on mining this resource, leading even to political tensions over this resource.

On the other hand, countries such as the United States that own more acreage can diversify their efforts; capitalizing on soil-rich regions for agricultural production, while using the coasts for exports, and taking advantage of a larger population and labor force.

Speaking of labor, labor is a key input in most products, from agriculture to cell phones, and its characteristics affect a country's comparative advantage. An abundant labor force means that a country has a lower opportunity cost of specializing in labor-intensive activities. A highly skilled labor force is more expensive and more productive than an unskilled labor force. For example, as China's labor force has grown more skilled, wages have risen and China has begun specializing in more complex manufactured goods.

Critique of the Factor Endowment Theory[4]

The factor endowment theory, while used to explain overarching notions of comparative advantage, in reality only accounts for a small percentage of world trade. At one time, there were big disparities between labor and capital in the US and East Asia. East Asia began to grow much faster than the US, however trade increased as the two countries became more similar, even though the factor endowment theory would predict that trade should have lessened. This suggests that there must be something other than factor endowments motivating international trade. The assumptions that drive the factor endowment theory may be flawed. It first assumes the same technology, and also assumes arbitrary borders. However, factors like borders play a large role in how much trade occurs; Seattle, for instance, conducts more trade with Boston than it does with Vancouver. Branding also plays a large role in trade; France has been very successful in differentiating its product, wine, from that of other countries, so regardless of factor endowments France will likely continue to specialize in wine and the rest of the world will likely keep buying it from them.

See Also