Chapter 3: Factor
Advantages
Keith Head
Sauder School of
Business
Objectives of this chapter
• Show how factor abundance gives rise to
comparative advantage
• Identify sources of superior factor quality.
• Show how changing factor intensities
shifts comparative advantages over time.
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Defining Factor Advantages
A location has a factor advantage for a
product if the unit factor costs are lower
than alternative sites.
A location (country, region) is more likely to
offer factor advantages for producing X if
• the factors used intensively to make
product X
• are relatively abundant there.
Factors and Products: What’s the
difference?
• Products: goods and services
– Tradeable (in most cases)
– Made by factors using intermediate
inputs (i.e. non-final products).
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Factors and Products: What’s the
difference?
• Factors of production: things that create
products and earn incomes for their
owners, namely labour (L) and capital (K).
– Limited mobility across countries (in most
cases)
– Not incorporated into the products they make,
a single factor makes a stream of products.
5 Kinds of Capital
• Natural capital: land and sub-soil
resources.
• Physical capital: machinery, buildings
• Human capital: schooling, experience
• Intellectual capital: patents, brands
• Social capital: associations, relations
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Factor Intensity
• The relative importance of one factor
versus others in production in an industry,
usually compared across industries.
• Measured as share of value-added going
to a particular factor. (so excludes indirect
factor use)
• Indirect factor use is when intermediate
inputs use a factor intensively (e.g.
sawmills, wineries).
Examples of intensive use
• Telephone apparatus and pharmaceuticals use
high-skill workers (measured as “administrative
employees”) intensively (37% and 21% of Valueadded, respectively)
• Footwear and furniture use low-skilled labour
intensively (39%, 38%)
• Aluminum and Petro-refining use other factors
(mainly physical capital) intensively.
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Factor Advantages depend on relative
abundance!
• Ratio test (2 countries, 2 factors):
– Home is capital abundant when home’s K/L ratio
is larger than the K/L ratio in the foreign country.
– Relativity: K-abundance implies L-scarcity.
• Shares test (Many countries, many factors):
– Home is abundant in factor F when home’s
share of the world supply of factor F exceeds
home’s share of world income (GDP).
Example 1: Crop Land
Country
Crop Land
M hec
Labour
M
Income
Tr$
Canada
45.5
16
.57
USA
188
136
7.1
World
1465
2784
27.7
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Example: Crop Land
• US has “absolute” abundance compared
to Canada because
188 m hec > 45.5 m hec
• If the second factor is labour, then Canada
is relatively land-abundant:
CaLand/CaLabour >USLand/USlabour
45.5/15 =3 > 188/136=1.4.
Example: Crop Land (cont’d)
• Applying the shares test, Canada is crop-land
abundant vs the world because its share of world
crops, 3%, exceeds its share of world income, 2%.
• US appears* crop-land scarce since 13%<26%.
* But US crop-land is more productive (due to greater
use of fertilizers and tractors than crop-land in less
dev countries.
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Example 2: Education
Univ-ed
Workers
China
18m
Share
of Wld
Uni-ed
8%
U-ed/
Non U
.02
Share
of Wld
Inc
3%
India
16m
7%
.03
1.5%
France
3.8m
2%
.10
4%
Factor abundance paradox
• U of T economist Dan Trefler discovered rich
countries seem to be scarce (by the shares test)
in most factors.
• How can this be?
– Rich country factors have higher productivity.
– Rich countries have complementary physical and
social infrastructure.
• What to do? Also apply ratio tests.
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Factor Advantages Summary
• Factor advantage is a “matching” process.
– Choose the right country for each product
– “Intensive user seeks abundant factor”
• Absolute abundance is not enough:
– Bigger isn’t better in the FA world.
– Proportions are the key.
Michael Porter’s Critique
• Traditional factor abundance won’t lead to
sustained competitive advantage.
– Abundance encourages wastefulness, scarcity induces
effort and innovation
– Innovations can offset problems caused by factor
disadvantages
– Basic factors are available in many places so having
them doesn’t make you unique.
• Competitive advantage in core firm activities
arises from industry clusters that foster
development of advanced, specialized factors.
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Types of Factors
Origin of factor
Specificity
to
individual
industries
Basic
(endowed)
Advanced
(manmade)
Generaluse
I
II
Industryspecific
III
IV
Examples of Factor Types
• Type I (basic, general use)
– Unskilled labour, pasture land
• Type II (advanced, general use)
– Bachelor of commerce degree
• Type III (specific, basic)
– Oil well (Æ specific to crude oil extraction
industry)
• Type IV (specific, advanced)
– UC Davis enology dept., Danish diabetes
treatment centres.
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Factor Advantages, revisited
• Porter is probably wrong when he argues
that abundance is bad and scarcity is
helpful.
• Porter is certainly right to say that factor
quality also matters.
• Porter is also right to emphasize the
special role of regional industry clusters:
e.g. IT services in Bangalore.
International Product Life Cycles
I.
Product produced and consumed in the
(advanced) inventing country. Other
advanced countries import it.
II. Production spreads to other advanced
countries.
III. Production re-locates out of advanced
countries into a low-wage nation.
z Advanced countries import it.
z Next generation product invented.
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The International Product Life Cycle
Example: photocopiers
STAGE I: New product
• 1938: invented by Chester Carlson in
Queens, NYC
• 1949: First “xerographic” copier introduced
by Haloid Company (later Xerox)
• 1953: Sales subsidiary established in
Canada.
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Example: photocopiers
STAGE II: Maturing product
• 1956: Rank-Xerox joint venture established in
UK.
• 1962: Fuji-Xerox joint venture established in
Japan.
• 1965: Rank-Xerox opens manufacturing plant
in the Netherlands.
• 1974: Rank Xerox opens factories in Spain
and France.
• Various: Other companies such as Canon
(Japan) and Olivetti (Italy) introduce
photocopiers
Example: Photocopiers
Stage III: Standardization
• 1965: Xerox do Brasil founded (3 factories)
• 1987: Xerox Shanghai J.V. formed to make
copiers in China.
• 1988: 2,000,000th Xerox copier is produced.
• 1993: Xerox do Brasil Ltda. wins National
Quality Award in Brazil.
• 2000: all Asian operations sold to Fuji-Xerox.
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Canadian Imports of Photocopiers
US Imports of Photocopiers
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Understanding IPLCs
What causes the move from stage I to stage
II? That is, why does production spread to
other advanced countries?
– Inventing firm wants production closer to
consumers
– Rival firms license or imitate or wait for patent
expiration
Understanding IPLCs
What causes the move from stage II to stage III? That
is why does production relocate to less developed
countries?
– Dubious answer: standardization makes demand curves
more price-sensitive, competition “forces” inventing firms
to seek low costs.
– Good answer: standardization changes factor intensities.
• skilled-labour (human capital) intensity falls as manufacturing
process is “routinized”
• unskilled-abundant (human capital-scarce) countries gain
comparative advantage because of factor advantages for
unskilled-intensive activities.
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