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Global Factor Service Trade

Theory strives to be simple, rich, and robust. When it succeeds, it attains extraordinary influence. No doubt this explains the ubiquity of Heckscher-Ohlin theory in the field of international trade, particularly in the Factor Price Equalization (FPE) version of Samuelson (1947).1 Countless theoretical and empirical studies have built on this foundation.

The FPE theory’s most impressive feature is its extraordinary ambition. It proposes to describe, with but a few parameters, and in a unified constellation, the endowments, technologies, production, absorption, and trade of all countries in the world. This juxtaposition of extraordinary ambition and parsimonious specification has made the theory irresistible to empirical researchers.

In recent years, empirical research has focused on a relatively robust version of the theory, embodied in the Heckscher-Ohlin-Vanek (HOV) theorem. The HOV theorem yields a simple prediction: The net export of factor services will be the difference between a country’s endowment and the endowment typical in the world for a country of that size. The prediction is elegant, intuitive, and spectacularly at odds with the data.

Wassily A. Leontief’s (1953) “paradox” is widely regarded as the first blow against the empirical veracity of the factor proportions theory. Confirmation of the paradox in later work led Keith E. Maskus (1985) to dub it the “Leontief commonplace.” In one of the most widely-cited and seemingly-damning studies, Harry P. Bowen et al. (1987) report that the factor services a country will on net export are no better predicted by measured factor abundance than by a coin flip.

In a series of important contributions, Daniel Trefler (1993, 1995) explores a variety of departures from the standard FPE model. While Trefler’s results appeared promising, Xavier Gabaix (1997) shows that they fail to bring the theory and data into reasonable congruence. Donald R. Davis, David E. Weinstein, et al. (1997) do report positive results for the HOV model. However they accomplish this by restricting the sample for which FPE is assumed to hold to regions of Japan and by remaining agnostic about the degree to which the FPE framework can be extended across nations. In sum, a half-century of empirical work has failed to find simple amendments that allow the theory to provide a unified description of the international data.

Nevertheless, the effort has been instructive. A lasting contribution of Trefler (1995) is his identification of systematic discrepancies between the theory and the international data. Chief among these is the so-called “mystery of the missing trade.” In simple terms, the mystery is that measured factor service trade is an order of magnitude smaller than predicted factor service trade based on national endowments. To date, the mystery remains one of the great challenges in understanding the international data (cf. Gabaix 1997). bad credit signature loans utah