160 FAQ

Land, labor, and capital are the factors of production. All goods and services in an economy are made from some combination of these three. A state's factor endowment is its holding of these factors relative to one another and to the world economy. In any economy, some factors are relatively more abundant than others. Canada, for example, is relatively well endowed with capital and is very well endowed with land, but is very poorly endowed with labor. Bangladesh is very well endowed with labor - at least, with unskilled labor - but capital and land are both scarce. Following the general law of scarcity, scarce factors can demand a higher price. For labor, this is wages; for capital this is interest rates or rates of return. Abundant factors, on the other hand, before trade can demand a very low price. Any holder of that factor who tries to demand a high price will not find buyers; buyers will just search for one of the many other holders who is asking a lower price.

[Note on Terminology: By definition, any state that is poor or developing is scarce in capital. Capital is what we commonly understand as 'wealth'; countries that lack capital lack wealth.]

Hecksher and Ohlin reached the conclusion that since the abundant factor is cheap in a given country, that country's comparative advantage will be in products that use the abundant factor extensively. Because labor is cheap in Bangladesh, labor-intensive products are relatively cheap to make there - particularly compared with their cost to make in, say, Canada. This will lead Bangladesh to specialize in exporting things that are labor-intensive: it can produce labor-intensive goods and services more cheaply than many other states, even once the cost of shipping the products is included. Once Bangladesh starts to trade, demand for its labor-intensive products comes from both the domestic market and also from the world market. This higher demand for the abundant factor - which is nowhere near as abundant on the world market as it is in Bangladesh - translates into higher prices for Bangladeshi labor-intensive goods on the world market than in the domestic market. They can sell the goods for higher prices abroad because even with the mark-up (over Bangladeshi domestic prices), the goods are still cheaper than the importing countries can produce for themselves.

Canada, on the other hand, has an abundance of land - particularly land that is good for farming. Farming used to be labor intensive, but since the early 1900s developments in technology have allowed Canada to substitute capital for some of the labor needs: tractors and combines replace people. Since capital is abundant in Canada as well, it too was cheap. The combination of cheap land and cheap labor-replacing capital has given Canada one of the most efficient (read, least expensive) agriculture sectors in the world. If Canadian farmers tried to sell all their wheat in the domestic market, they would only be able to get a very low price because they had so much of it available. By selling some of their wheat on the world market, they can boost the price they get on the domestic market and also get a good price on the world market, where countries with less efficient agriculture sectors go to buy wheat and other products more cheaply than they can grow them for themselves.

After World War 2, Stolper and Samuelson added to this by noting the logcial extension that if the price for the abundant factor's goods was increasing, then the income to those who own that factor would increase as well. Those who hold the abundant factor (or whose incomes depend on using that factor intensively) would benefit from trade because trade increases their incomes; they would thus band together to promote free trade. On the other hand, those who hold the scarce factor (or use it intensively) find that they are now competing with foreign holders of the same factor, where it may not be as scarce. For example, think about Bangladeshi farmers. Before trade, the price of agriculture products in Bangladesh was rather high: land was scarce, so the amount of agriculture was limited, and the scarcity of agriculture products brought their price up in the markets. When Bangladesh starts trading with Canada, though, Bangladeshi consumers can choose to buy Canadian agriculture products, which are substantially cheaper (and so the consumers can buy more of them). Less business for Bangladeshi farmers at their old prices leaves them the options to lower their prices, or else to close. Either option lowers their income, which makes us expect that land-based or intensive land-using individuals would protest free trade in Bangladesh. The HO-SS model thus predicts that we should see cleavages (social/political divisions) based around factor ownership. Holders (or intensive users) of plentiful factors will profit from free trade; holders (or intensive users) of scarce factors will suffer from free trade. [Note for Memory: Match the P's and S's to recall who benefits and who is harmed. The two S's in 'scarce' and 'suffer' remind us that it goes with the Stolper-Samuelson model.]

A very key assumption from the HO-SS model, however, may or may not hold in practice. HO-SS assumes, as was reasonable through much of the early 20th century, that factors were in general mobile across sectors. Mobile factors can change industries (i.e., move between sectors) easily and at very little cost. Unskilled labor in an assembly line, for example, can pull a lever, push a button, or tighten a screw in a car, a toaster, a sewing machine, etc., with very little retraining time or cost. Cash is a mobile form of capital. Other forms, though, are substantially less mobile: recovering one's investment in a steel mill to invest in another industry, for example, requires selling the steel mill to someone else. An assembly line used to produce stereos today cannot begin producing cars tomorrow. Labor that is specific to a particular industry, like most forms of skilled labor, is usually stuck in that particular industry.

Viner noticed this. He built on Ricardo's theory of comparative advantage to produce a prediction that when exposed to free trade, less-efficient industries (those which depend heavily on factors that are relatively scarce) will be under pressure to produce more cheaply. Unless they can lower their costs to meet those of producers where the same factors are abundant, they will eventually be pushed out of business. For example, US steel producers in the 1970s were faced with competition from the developing world. Labor there was much cheaper, since it was substantially more plentiful (lower cost of living plus labor is the relatively scarce factor in the US). Capital was more expensive, so the plants cost more to build, but the newer plants used much more efficient technology than the older US plants. As a result, foreign steel was substantially cheaper than American steel, so many firms (in the US and elsewhere) bought their steel from non-American producers. US producers were unable to reduce their costs: labor costs were high and fixed as a result of union labor contracts, and shareholders were not willing to pay the high costs of investing in newer technology. As a result, a large share of US steel firms were uncompetitive; they couldn't sell their goods and so they had to close.

While this was happening, US steelworkers and US steel plant owners banded together to lobby for protection. Because steelworkers lacked skills to do anything other than work steel, and steel plant owners were unable to use their factories to produce anything other than steel, both factors had a vested interest in the health of the industry. When we relax the assumption that factors are mobile and allow them to be specific to a particular industry (immobile), then, the result is that we expect to see sector-based political coalitions.