Factor Endowment Theory

Whether one has studied economics or not they have probably heard the phrase ‘factors of production’. The factors of production in an economy are labour, capital, entrepreneurship and land. Another phrase for factors of production is factor endowment. Factor endowments are essentially factors of production used by an economy to make the most of manufacturing. Abundance of these resources often leads to countries becoming prosperous and wealthy nations. However, one cannot generalise this observation as prosperity and growth of a nation is also dependant on equitable access and distribution of resources.

There is a famous theory on factor endowment that is associated to international trade by Hecksher-Ohlin. It comments of the relationship between international and interregional production costs and supply of production factors. The theory states that the differences in the costs of production stems from the differences in the supply of factor endowments.

The Hecksher-Ohlin theory of factor endowment in international trade is used to determine comparative advantage of various countries. According to the theory, a country will have a comparative advantage in a good produced by factors it is abundantly endowed with. While dealing with this theory we must keep in mind that factor endowments are meant to be dealt in ratios. For example, a country may have large amounts of both capital and labour; however, one factor may be proportionally more than the other. This is what makes the difference.

The factor endowment theory has drawn criticism. The assumptions of this theory may be flawed. Let me give you an example to explain. At a point of time, both the United States and East Asia suffered from disproportionate quantities of labour and capital. Though, East Asia began to grow more rapidly than the United States, trade between the two regions grew, when in fact in accordance with the theory it should have fallen.

The theory suffers from several fallacies. One of the most prominent being too many unrealistic assumptions such as no trade between nations, no transportation, trade between only two countries and only two goods being produced. Thus, one can gage that this theory explains only a small fraction of world trade.

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