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Factor price equalization beyond a "cubic" world.

Article Excerpt
Summary. The importance of factor price equalization (FPE) is widely recognized in economics. The FPE theorem states that, absent any factor intensity reversal, factor prices are equal across countries with identical technologies and product mixes. In a two-factor-two-good-two-country Heckscher-Ohlin model this is equivalent to countries' factor endowments being contained in the diversification cone defined by goods' factor intensities. This paper identifies a condition, stated in terms of the allocation of factor endowments across countries relative to the demand for and the factor intensities of goods, that is necessary and sufficient for FPE in a world with arbitrary number of countries, goods and factors.

Keywords and Phrases: General equilibrium, International trade, Heckscher-Ohlin theory, Factor price equalization, Factor price insensitivity, Integrated world economy, Envelope condition.

JEL Classification Numbers: F1.

1 Introduction

The importance of factor price equalization (FPE) or the lack of it is widely recognized in theories and empirical analyses of international trade and their policy implications (see Davis and Weinstein, 2001a; Leamer and Levinsohn, 1995). In its simplest terms the FPE theorem states that factor prices are equal across countries with identical technologies, identical product mixes and no factor intensity reversals. In the two-factor-two-good-two-country (1) (2 x 2 x 2) Heckscher-Ohlin (H-O) model FPE is equivalent to the condition that countries' factor endowments lie in the cone of diversification defined by the goods' factor intensities.

Higher dimensional issues related to fundamental propositions of the theories of international trade point to the practical relevance of the logical structure that has dominated trade theory for more than half a century. (2) Samuelson (1949), in a 2 x 2 x 2 H-O model, established that in the absence of factor intensity reversal countries' factor endowments must differ by less than the goods' factor intensities for FPE to hold and suggested that addition of more goods will increase the likelihood of FPE. Since then this idea has been extended in many important ways. McKenzie (1955) generalized the idea to state that for FPE to hold country endowments must lie in the cone of diversification defined by the factor intensities. Johnson (1967) formalized the idea that the likelihood of FPE increases with a rise in the number of goods. Dixit and Norman (1980) argued that the question of whether a rise in the number of goods raises the probability of FPE is simply not a precisely stated question. Wu (1987) provided a necessary condition for the absence of FPE in a model with two factors, two countries and many goods.

The number of goods, factors and countries is indeed an arbitrary matter (see Ethier, 1984). The contribution of this paper lies in identifying a condition that is necessary and sufficient for FPE in a world with arbitrary number of countries, goods and factors. (3) Building...

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