The Factor Content of Trade

Study of the factor content of trade has become a laboratory to test our ideas about how the key elements of endowments, production, absorption and trade fit together within a general equilibrium framework. Already a great deal of progress has been made in fitting these pieces together. Nevertheless, the existing research raises a great many questions that should help to focus empirical research in the coming years. Among the more pressing issues is a deeper consideration of the role of intermediates, the role of aggregation biases, and of differences in patterns of absorption. This work should provide a more substantial foundation for future policy work developed within a factor content framework. * The National Science Foundation provided support for the research reported in this chapter. The Factor Content of Trade Donald R. Davis and David E. Weinstein The concept of the factor content of trade originates with Vanek (1968). The original formulation is based on a simple model of international factor price equalization, or what is more precisely termed the “integrated equilibrium” [Helpman and Krugman (1985)]. Under conditions of competition in goods and factor markets, free international arbitrage, common constant returns to scale technologies, and adequate restrictions on the distribution of world endowments, both goods and factor prices will be equalized internationally. Under these conditions, a good will embody fixed amounts of the services of the productive factors, independently of where it is produced. Trade then can be conceived of in two ways. The first is as the overt exchange of goods that traditional theory addresses. Vanek’s contribution was to recognize that we could equally think of trade as the international exchange of the services of factors embodied in those goods. Vanek’s formulation of the problem allowed an extension of the logic of the HeckscherOhlin theory to settings in which the pattern of trade may be indeterminate but in which the net factor content of trade may nonetheless be determinate. Expression of the theory in this form also highlights the deep logic of the Heckscher-Ohlin theory in its focus on the relative availability of factors. When we move beyond a fully integrated world economy, as we do at length below, we will have to take care in defining the factor content of trade appropriate to each setting. A reasonable first question is why we should care about the factor content of trade. We think there are two good reasons. The first is that the study of the factor content of trade is a laboratory for general equilibrium. A first statement of general equilibrium is that the elements of the system should “hang together.” In the case of international trade, the elements of interest