Academic journal article The Lahore Journal of Economics

Relative Factor Abundance and Relative Factor Price Equality in Punjab

Academic journal article The Lahore Journal of Economics

Relative Factor Abundance and Relative Factor Price Equality in Punjab

Article excerpt

(ProQuest: ... denotes formulae omitted.)

1. Introduction

Factor price equalization (FPE) is a central result of international trade theory. The Heckscher-Ohlin-Samuelson (HOS) theorem illustrates that trade in goods will lead to the equalization of factor prices across countries. In the absence of international trade, countries are bound to use the scarce factor in the production of goods and this receives a relatively high return. In international trade, however, countries will focus on goods that are intensive in the abundant factor and import goods that are intensive in the scarce factor; this results in the equalization of factor prices because the scarce factor is now available as an imported good.

Given that factors of production are embodied in goods, the movement of goods will lead to FPE. FPE is an important determinant of workers' receptiveness to international trade and patterns of labor mobility across regions. The geographic concentration of inputs then governs the pattern of distribution of investments in terms of setting up industries across the world.

FPE is more likely to occur within a region or country because its two major determinants, factor mobility and goods mobility, are higher within a country than at a cross-country level. The question of FPE is also relevant at a regional level where it may determine government policies for national development plans. Moreover, variation in factor prices in a country leads to the movement of labor and industries to regions with higher incentives. Industry location is determined by factor prices because regions endowed with an abundant factor will have more industries that use that factor intensively.

Using the methodology developed by Bernard, Redding, and Schott (2009), this study investigates whether relative factor prices equalize across Punjab, Pakistan. Given that firm-level studies on Pakistan have received limited attention, this paper contributes to the literature by testing for relative factor price equality (RFPE) applied to a unique dataset. It would be interesting to see if the results of this analysis are in congruence with what the literature has already established. Pakistan is a developing country and it is inherently different from all the countries for which Bernard et al. (2009), among others, have tested for relative price equality.

The test is based on the "lens condition" developed by Deardorff (1994). The technique applied by Bernard et al. (2009) is used to check for the existence of factor lumpiness by testing to see if the relative wage bill for production to nonproduction workers equalizes across Punjab. Production or "blue-collar" workers are directly involved in producing goods, whereas nonproduction or "white-collar" workers are not involved directly in production.

RFPE is different from absolute factor price equalization (AFPE), for which the return on similar factors should equalize, for instance, the wages of nonproduction workers across regions. RFPE requires that relative factor prices should equalize rather than absolute factor prices, for instance, the relative wages of nonproduction to production workers across countries. RFPE allows us to control for interregional productivity differences because regions with higher productivity will pay more to both types of workers while the relative wage remains the same.

2. Literature Review

The literature review examines the lens condition, tests for AFPE, and tests for RFPE.

2.1. The Lens Condition

Deardorff (1994) developed the lens condition to test FPE, using the concept of an integrated world economy (IWE) introduced by Dixit and Norman (1980). In an IWE, factors and goods across the world have perfect mobility and equilibrium is achieved under one set of equilibrium prices of goods and factors, techniques of production, and equilibrium quantities of goods demanded. Dixit and Norman argue that FPE is possible if, in the absence of factor mobility, it is possible to distribute factors in a country using certain techniques of production to replicate the outputs produced under the IWE. …

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