The 'New Factor Endowments' for the modern economy
By: Amit Bhushan Date: 23rd July 2014
The traditional factor endowment theory focuses upon natural resources and their abundance as criteria that impacts 'manufacturing' and exports/trade from a country. A country's factor endowment is commonly understood as the amount of land, labor, capital, and entrepreneurship that a country possesses and can exploit for manufacturing. Countries with a large endowment of resources tend to be more prosperous than those with a small endowment, all other things being equal. The development of sound institutions to access and equitably distribute these resources, however, is necessary in order for a country to obtain the greatest benefit from its factor endowment.
Now in a arena with capital and entrepreneur being mobile and with Transnational corporations dominating business scenario with their own brand of intra-preneurship with its own set of reward mechanism, its high time the that the economist take a relook at the HECKSCHER-OHLIN THEORY of Factor endowments. The theory had several loop holes since beginning and it never really explained many economic phenomenons. So its time when the economist attempt to identify the factors that really matter for economic development rather than stick with old factors that may not have much impact and have failed to explained many observations.
The new factors could be such as availability of required land or better still 'work space' (since land use is what creates work space and this is subject to Floor Space Index and types of land usage supported there under; FSI also brings in focus requirement of industrial/commercial support structure rather than barren land), labour with necessary training/skills especially with technologies and languages to perform needed work, Access to raw materials and to markets and infrastructure including payments infra has a big role to play here (Infra has a role in work space area as well and includes communication, transport & logistics including support for industrial/commercial works & livable conditions for workers), supportive taxonomy which supports incentives for entrepreneurs (this should balance incentives for domestic as well as foreign entrepreneurs; incentives for foreign entrepreneurs are also necessary so than they bring in new concepts/technologies as well as risk bearing abilities) and availability/access of technologies. There can also be some additional factors such as 'domestic standards' for products and services which impact market access and competitiveness of businesses and cost of energy which has impact on cost of production and its price as products & services reach the end consumer and therefore overall demand for the produce. The other factors are security for people, processes and material for entrepreneurs as well as external peace for comfort & trade facilitation of the entrepreneurs. The idea is that Capital as well as big business is mobile. Capital moves freely to seek best returns while big business also moves to best locations failing which it gets whittled down in a competitive global economy. What such capital needs is a transparent & consistent regulatory set up which ensures that required returns can be siphoned off to any preferred country of investors (which is were the emerging economies have generally failed but now South Asian economies including China seem to be turning a new leaf). It is the labour which finds it difficult to move especially cross border movement due to regulations and also due to cultural factors. Similarly small entrepreneurs and innovators also find it difficult to change locations in part due regulatory & cultural reasons and also due to personal/human reasons.
It can be said with some degree of confidence basis observations that if a country achieves cost effectiveness in the above mentioned factors, its economy is likely to witness healthy growth and prosperity due to rise in business activity. However it should be noted that achieving cost competency in all the above goals may not be possible since things may work at cross purposes i.e. creation of a supportive taxonomy may not leave adequate revenue for government to create infrastructure or reducing currency value to gain external markets may yield high domestic inflation as well as high cost of imports with other attendant problems such as labour. Also, focus to develop reserves for energy resources for say petroleum may cause neglect of the development of inland waterways and become a source of disadvantage and one can go on & on. Also a sustained growth in business activity may itself lead to rise in labour rate or its shortage as well as change in the nature of demand and therefore higher degree of technological obsolesce which may make businesses uncompetitive. Such a phenomenon may require the country to adjust taxonomy or currency value adjustments to fix temporary problems with attendant longer term consequences.
So the focus of the leadership, which is concerned to develop the economy should be to try and understand the play and impact of each of these forces and evolve a healthy balance in these factors which should lead to growth in economy and prosperity. The other area could also be development of the institutional framework which ensures a healthy movement of Capital as well as easier flow for entrepreneurs (across country borders), since these factors cannot be expected to solve by itself without the support from the government of the day. Ensuring cross country movement of raw materials and market access to achieve optimization of sourcing costs as well as transaction cost should also be the focus area for the government.
While the theory still needs to be evolved (by researchers); and may still not be able to explain 'all' the relevant economic phenomenon. For example, the movement of labour within a country also happens generally from rural to urban areas and is difficult to reverse even with development of support structure for people such as communications, roads, hospitals, entertainment and schools. The labour continues to expect additional economic incentives due to perception problem not explained by the Factor endowments or even by the 'new factor endowments' since this tends to look only at hard factors rather than soft factors or other human considerations such as barriers to absorb in locality due to language/dialect or for culture/value system. There is difficulty to move skilled labour from developed to developing world as well. Therefore inclusion & exclusion set for the theory needs to be identified. However the big difference between the new and the old theory is that the governance of the country is a factor in the new theory while in the old theory, governance of a country has very little implication on the growth and productivity. The emphasis on the government to create or unleash factors of growth through suitable regulatory interventions in the market/economy is the new paradigm and area to focus upon while natural resource base of the country continues to play their role but which is generally limited.
For service industries, the cost of production of service includes factors such as employee time cost in man-hour, workspace costs or overheads, machine time costs, idle time (for machine & manpower, since it is unavoidable in service sector), marketing/distribution costs and margins to be uploaded. The workspace costs can be deemed to include costs of power, water, sanitation, communications etc. Some amount of travel by customer as well as employees may also be factored and the cost of interest on borrowing/finance should be considered. If the overall cost is low for a country, it is competitive; however to export the services, the country will need to develop brand value for enterprise, easy enforcement of contracts and fair treatment practices by market participants that are well accepted by markets/especially the target audience including those from different countries. The need for brand value and contract enforcement is much higher in case of services rather then product due to consumption pattern as well as market practice.
For goods, the cost will include cost of procurement or ability to source raw material and components, cost of processing, cost of storage (including for finished goods), cost of marketing/distribution and margins. The capital costs of factory which could be very high including costs of power, water, sanitation, communications etc. The travelling cost could be low but the cost of interest on borrowing/finance should be high considering the capital required for set up. If the overall cost is low for a country, it is competitive; however for exports, it must have flexibility to meet the product standards followed in different countries and should be able to command brand value for its produce. The products may also face high transaction costs for market entry including competitive barriers for market development and may require some element of support for contract enforcement but this may not be as complicated as in case of services except in high value goods or where sophisticated warranties are market norm. The ability of a country's manufacturers to move to high value goods under sophisticated contractual obligations depict their maturity to move up the ladder where as there could exist a bunch of countries still playing the commodity game even in manufacturing by playing at the bottom rung of the game.
The new factor endowments theory thus should bring out actionable factors where government leadership can act to make a difference by clearly identifying factors and policy set that the leadership would/could work upon in order to make a difference.
By: Amit Bhushan Date: 23rd July 2014
The traditional factor endowment theory focuses upon natural resources and their abundance as criteria that impacts 'manufacturing' and exports/trade from a country. A country's factor endowment is commonly understood as the amount of land, labor, capital, and entrepreneurship that a country possesses and can exploit for manufacturing. Countries with a large endowment of resources tend to be more prosperous than those with a small endowment, all other things being equal. The development of sound institutions to access and equitably distribute these resources, however, is necessary in order for a country to obtain the greatest benefit from its factor endowment.
Now in a arena with capital and entrepreneur being mobile and with Transnational corporations dominating business scenario with their own brand of intra-preneurship with its own set of reward mechanism, its high time the that the economist take a relook at the HECKSCHER-OHLIN THEORY of Factor endowments. The theory had several loop holes since beginning and it never really explained many economic phenomenons. So its time when the economist attempt to identify the factors that really matter for economic development rather than stick with old factors that may not have much impact and have failed to explained many observations.
The new factors could be such as availability of required land or better still 'work space' (since land use is what creates work space and this is subject to Floor Space Index and types of land usage supported there under; FSI also brings in focus requirement of industrial/commercial support structure rather than barren land), labour with necessary training/skills especially with technologies and languages to perform needed work, Access to raw materials and to markets and infrastructure including payments infra has a big role to play here (Infra has a role in work space area as well and includes communication, transport & logistics including support for industrial/commercial works & livable conditions for workers), supportive taxonomy which supports incentives for entrepreneurs (this should balance incentives for domestic as well as foreign entrepreneurs; incentives for foreign entrepreneurs are also necessary so than they bring in new concepts/technologies as well as risk bearing abilities) and availability/access of technologies. There can also be some additional factors such as 'domestic standards' for products and services which impact market access and competitiveness of businesses and cost of energy which has impact on cost of production and its price as products & services reach the end consumer and therefore overall demand for the produce. The other factors are security for people, processes and material for entrepreneurs as well as external peace for comfort & trade facilitation of the entrepreneurs. The idea is that Capital as well as big business is mobile. Capital moves freely to seek best returns while big business also moves to best locations failing which it gets whittled down in a competitive global economy. What such capital needs is a transparent & consistent regulatory set up which ensures that required returns can be siphoned off to any preferred country of investors (which is were the emerging economies have generally failed but now South Asian economies including China seem to be turning a new leaf). It is the labour which finds it difficult to move especially cross border movement due to regulations and also due to cultural factors. Similarly small entrepreneurs and innovators also find it difficult to change locations in part due regulatory & cultural reasons and also due to personal/human reasons.
It can be said with some degree of confidence basis observations that if a country achieves cost effectiveness in the above mentioned factors, its economy is likely to witness healthy growth and prosperity due to rise in business activity. However it should be noted that achieving cost competency in all the above goals may not be possible since things may work at cross purposes i.e. creation of a supportive taxonomy may not leave adequate revenue for government to create infrastructure or reducing currency value to gain external markets may yield high domestic inflation as well as high cost of imports with other attendant problems such as labour. Also, focus to develop reserves for energy resources for say petroleum may cause neglect of the development of inland waterways and become a source of disadvantage and one can go on & on. Also a sustained growth in business activity may itself lead to rise in labour rate or its shortage as well as change in the nature of demand and therefore higher degree of technological obsolesce which may make businesses uncompetitive. Such a phenomenon may require the country to adjust taxonomy or currency value adjustments to fix temporary problems with attendant longer term consequences.
So the focus of the leadership, which is concerned to develop the economy should be to try and understand the play and impact of each of these forces and evolve a healthy balance in these factors which should lead to growth in economy and prosperity. The other area could also be development of the institutional framework which ensures a healthy movement of Capital as well as easier flow for entrepreneurs (across country borders), since these factors cannot be expected to solve by itself without the support from the government of the day. Ensuring cross country movement of raw materials and market access to achieve optimization of sourcing costs as well as transaction cost should also be the focus area for the government.
While the theory still needs to be evolved (by researchers); and may still not be able to explain 'all' the relevant economic phenomenon. For example, the movement of labour within a country also happens generally from rural to urban areas and is difficult to reverse even with development of support structure for people such as communications, roads, hospitals, entertainment and schools. The labour continues to expect additional economic incentives due to perception problem not explained by the Factor endowments or even by the 'new factor endowments' since this tends to look only at hard factors rather than soft factors or other human considerations such as barriers to absorb in locality due to language/dialect or for culture/value system. There is difficulty to move skilled labour from developed to developing world as well. Therefore inclusion & exclusion set for the theory needs to be identified. However the big difference between the new and the old theory is that the governance of the country is a factor in the new theory while in the old theory, governance of a country has very little implication on the growth and productivity. The emphasis on the government to create or unleash factors of growth through suitable regulatory interventions in the market/economy is the new paradigm and area to focus upon while natural resource base of the country continues to play their role but which is generally limited.
For service industries, the cost of production of service includes factors such as employee time cost in man-hour, workspace costs or overheads, machine time costs, idle time (for machine & manpower, since it is unavoidable in service sector), marketing/distribution costs and margins to be uploaded. The workspace costs can be deemed to include costs of power, water, sanitation, communications etc. Some amount of travel by customer as well as employees may also be factored and the cost of interest on borrowing/finance should be considered. If the overall cost is low for a country, it is competitive; however to export the services, the country will need to develop brand value for enterprise, easy enforcement of contracts and fair treatment practices by market participants that are well accepted by markets/especially the target audience including those from different countries. The need for brand value and contract enforcement is much higher in case of services rather then product due to consumption pattern as well as market practice.
For goods, the cost will include cost of procurement or ability to source raw material and components, cost of processing, cost of storage (including for finished goods), cost of marketing/distribution and margins. The capital costs of factory which could be very high including costs of power, water, sanitation, communications etc. The travelling cost could be low but the cost of interest on borrowing/finance should be high considering the capital required for set up. If the overall cost is low for a country, it is competitive; however for exports, it must have flexibility to meet the product standards followed in different countries and should be able to command brand value for its produce. The products may also face high transaction costs for market entry including competitive barriers for market development and may require some element of support for contract enforcement but this may not be as complicated as in case of services except in high value goods or where sophisticated warranties are market norm. The ability of a country's manufacturers to move to high value goods under sophisticated contractual obligations depict their maturity to move up the ladder where as there could exist a bunch of countries still playing the commodity game even in manufacturing by playing at the bottom rung of the game.
The new factor endowments theory thus should bring out actionable factors where government leadership can act to make a difference by clearly identifying factors and policy set that the leadership would/could work upon in order to make a difference.