Rehabilitating the Factor-Proportions Hypothesis

The Heckscher-Ohlin theory of international trade remains an enigma. Despite being falsified on numerous counts [1] [2], it persists as the core theory of international trade, found both in undergraduate and graduate textbooks, not to mention in much research and policy. However, 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. An alternative formalization, based on evolutionary principles (endogenous technology, mobile capital and labor), is presented and is used to rationalize the paradoxical findings of HOH empirical tests. The predictions are then tested using a variety of techniques. It concludes by examining the policy implications.