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MGT520 - International Business - Lecture Handout 22

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Factor Proportions Theory:

Factor proportions theory states that countries produce and export goods that require resources (factors) that are abundant (and thus cheapest) and import goods that require resources in short supply. Thus, the theory focuses on the productivity of the production process.

Labor versus Land and Capital Equipment:

  1. Factor proportions theory breaks resources into two categories: 1) labor and 2) land and capital equipment. It predicts that a country will specialize in products that require labor if the cost of labor is low relative to the cost of land and capital, and vice versa.
  2. Factor proportions theory is conceptually appealing (e.g., Australia has much land and a small population; its exports consist of products that require much land while imports consist of manufactured and consumer goods).

Evidence on Factor Proportions Theory: The Leontief Paradox:

  1. Factor proportions theory is not supported by studies that examine trade flows.
  2. Wassily Leontief tested whether the U.S., which uses an abundance of capital equipment, exports goods requiring capital-intensive production and imports goods requiring labor-intensive production. His research found that U.S. exports require more labor-intensive production than its imports. This apparent paradox is called the Leontief paradox.
  3. One explanation is that factor proportions theory considers a country’s production factors to be
    homogeneous—particularly labor. But labor skills vary greatly within a country.

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MGT520 - International Business - Lecture Handout 11

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The Determinants of Economic Development:

  1. Different countries have dramatically different levels of development, as shown in Map 2.1. GDP/capita is a good yardstick of economic activity, as it measures average value of the goods and services produced by an individual.
  2. But GDP/capita does not consider the differences in costs of living. The UN's PPP index as shown in Table 2.1 shows the differences in the standards of living of people in different countries.
  3. A problem with both GDP/capita and PPP is that they are static in nature. From an international business perspective it is good to look at the rate of growth in the economy as well as the status of its people. Map 2.3 shows that some of the fastest growing countries economically are those have been slower to develop.
  4. A broader approach to assessing the overall quality of life in different countries is the Human Development Index. This is based on life expectancy, literacy rates, and whether (based on PPP indices) incomes are sufficient to meet the basic needs of individuals. Map 2.4 shows the Human Development Index. Notice that some of the worse off countries are heavily populated and have rapidly expanding populations.
  5. What is the relationship between political economy and economic progress? This is a difficult issue. One thing that is generally accepted is that innovation is the engine of long-run economic growth. Another thing that we have come to generally accept in recent years is that a market economy is better at stimulating innovation than a command economy that does not have the same types of incentives for individual initiative.

  6. Read more: MGT520 - International Business - Lecture Handout 11