Factor proportions theory – International marketing

The Factor Proportional theory is also known as Factor Endowment theory. This theory was further developed by Samuelson. The theorem is basically a two-country, two-commodity and two-factor model. The conclusion of the theorem is that a country will specialize and export that product which is more intensive in that factor which is more abundant. It will import those goods which, or the other hand, are more intensive in that factor of production is scarce in that country.

The Factor Proportions theory was empirically tested by Leontief. By using input-output tables, Leontief found that a representative basket of US export embodied more labor and less capital than one of US imports. In view of the fact that U.S is the most capital rich country in the world, this result obviously violates the factor Proportion theory.

There have been many attempts to explain this result which has come to be known as Leontief Paradox. One explanation given by Leontief himself is that US labor is three times more efficient than foreign labor and, therefore, if labor input is calculated in terms of its efficiency, the USA will be a labor abundant country. If this is correct, then the Factor Proportions theory will remain valid.

Apart from the doubts created by conflicting empirical results, the basic assumption of two factors has restricted the usefulness of the Factor Proportional theory. The theory can contribute nothing more than a vague knowledge about the ‘nature of international trade’.

Consequently, economists have tried to develop other theories which can explain and predict the commodity composition of a country’s foreign trade. Some of these theories are discussed below:

Human Capital Approach

This theory which is also sometimes known as “skills theory of international trade, has been advocated by a number of economists, especially Becker, Kennen and Kessing. Whereas the Factor Proportions theory considers labor as a homogeneous factor, it is not so in the real world. In fact, for export of manufactures the skill level of labor is a very important determinant. Labor can be basically divided into skilled and unskilled labor. On the basis of empirical testing Kessing concluded that patterns of international trade and location were predetermined for a broad group of manufactures by the relative abundance of skilled and unskilled labor. For example, a developing country which has more abundant supply of unskilled labor will specialize and export those goods which are relatively more intensive in unskilled labor. Imports, on the other hand, will consist of those goods which are more skill-intensive.

Natural Resources

This theory includes resources of a country also in the explanation of its trade structure. The basic hypothesis of this theory is that the country will export those products which are more intensive in that natural resource with which it is relatively more endowed and will import those items which use relatively more of those natural resources which are scarce.

According to these theories, the commodity composition of trade can be explained in terms of relative research efforts and the consequent technologies gaps between the trading partners. A number of economists, especially Vernon have contributed to the development of this theory. It is argued that the industrial countries commit more resources to research and development efforts and, as a result, develop new products. In the initial stage manufacture, these countries will be monopolists and will enjoy easy access to foreign markets. This can explain the trade between the developed and the developing countries as well as trade among the industrialized countries themselves. Subsequently, a process of imitation will start and other countries will start manufacturing the same product. The initial comparative advantage will then disappear and the manufacturing centers in fact can move from the developed to the developing countries which have low labor cost. This has already happened in the case of mature manufactured products with low labor skills intensity, like textiles. Many developing countries of Asia including India have turned into exporters of textiles and other products from being net importers some years ago.