Rehabilitating the Factor-Proportions Hypothesis

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The Heckscher-Ohlin theory of international trade remains an enigma. Despite being falsified on numerous counts (Bowen, Leamer and Sveikauskas 1987, Trefler, 1995), it persists as the core theory of international trade, found both in undergraduate and graduate textbooks, not to mention in much research and policy. Clearly, while it has failed to be confirmed by the data, the notion that factor proportions motivate trade, whether at the regional or national level, continues to hold sway. This paper is an attempt at rehabilitating the factor proportions hypothesis (FPH) as a theory of interregional and international trade. Its main premise is simple, namely that the Heckscher-Ohlin Hypothesis (HOH) is one―but not the only possible―formalization of the FPH. An alternative formalization, based on a more realistic set of assumptions (endogenous technology, mobile capital and labor) is presented and is used to rationalize the paradoxical findings of HOH empirical tests. Supporting data are also provided. It concludes by examining the policy implications.