The purpose of this paper is to investigate the comparative advantages of the United States of America (USA) and the Kingdom of Saudi Arabia (KSA) based on the factors endowments theory. Comparative advantage can be determined by the level of accumulated skills and capital, natural resources or climate, differences in technology or even abundance of cheap labor. KSA is richly endowed with huge oil and gas deposits that have made it one of the richest nations in the world. I established that resource endowments tend to increase a nation’s comparative advantage. International trade is best explained by the differences in nations’ natural resource endowments. Indeed, this is what prompts nations to specialize and export those goods or services where they have a significant comparative advantage. The factor endowment theory is also a good predictor of trade patterns based on the study of KSA and the USA.
Critical Analysis of Factor Endowment Theory
Impact of Resource Endowments on Comparative Advantage
There are significant differences in natural resource endowments across different countries. Trade helps to address the unequal geographical distribution of these assets. In explaining international trade, a nation’s relative resource endowment strongly influences the focus of its comparative advantage. Changes in a nation’s factor endowment directly affect its comparative advantage. Countries tend to export those goods that require intensive use of the abundant and cheap factors of production. Consequently, countries import goods that require intensive use of the scarce and expensive factors of production (Marjit& Mandal, 2016). Resource endowments have had a significant impact on the comparative advantage situation of the Kingdom of Saudi Arabia (KSA) and the United States of America (USA).
The competitiveness of a country’s economy is directly proportional to its level of productivity, which is partly influenced by natural resource endowments. Generally, resource endowments increase the comparative advantage of a nation, albeit under good political leadership (Ohyama, 2016).KSA is richly endowed with huge oil deposits that are the chief source of its comparative advantage. According to the Organization of the Petroleum Exporting Countries (OPEC), 18 percent of the world’s petroleum reserves are in KSA. The abundance of oil in the kingdom has led to crude oil dominating the country’s export basket. A cursory examination of KSA’s foreign exchange earnings of confirms that the oil and gas sector alone accounts for approximately 70 percent of the total receipts. The export earnings have greatly helped to speed up development in the country and to create employment opportunities. KSA exports to countries that are lacking petroleum and gas.
On the other hand, the USA is richly endowed with capital, skilled labor, and technology. The country enjoys an abundance of research and development scientists and a highly skilled labor force. Indeed, this explains why the USA has a net export surplus or comparative advantage in goods/services that have intensive research and development cycles and require highly skilled human input. The general infrastructure and educational institutions are also far advanced compared to other developing countries. The USA is also rich in coal and metal ore and, as such, has a vibrant manufacturing sector. Gains from trade have been efficiently used to develop the capital intensive sectors.
Is the Factor Endowment Theory a Good Predictor of Trade Patterns?
In practice, the factor endowment theory is good, if not perfect,predictor of trade patterns. Several studies have shown that countries export the few commodities that are in plentiful. Differences in resource/factor endowments enable specialization by countries, which, in turn, allows them to export those commodities wherein they possess a competitive advantage (Schumacher, 2012). Oil-dependent KSA does not have a much-diversified export base. The presence of oil in abundance has led to its exportation. Even the current situation in the global markets is consistent with this argument. For instance, Nigeria is also an oil-rich country whose export basked it dominated by petroleum earnings. The United States is more capital abundant relative to KSA. It is also richly endowed in natural resources, which is a major reason why it has remained an economic superpower over the better part of a century.
The USA is unusually rich in coal and metal ore. It’s extractive industry has made a significant contribution to American economic development. The country is also one of the largest exporters of steel in the world. The US has shown a large degree of export diversification due to the abundance of capital and highly skilled labor.It has a well-advanced infrastructure that has facilitated the production of innovative products and services that are traded with other countries. Further, the country enjoys economies of scale and advanced technology that enable it to use less capital and labor to produce export commodities (Ito, Rotunno&Vézina, 2017). The advanced technology has enabled it to specialize in more complex commodities for export which has, in turn, opened up greater potential for growth and enhanced resilience against global fluctuations.
By analyzing the factor endowments of KSA and the USA, it is clear that the factor endowment theory is a perfect indicator of trade patterns. Countries not as rich as the United States have a low degree of export diversification. They tend to specialize in commodities that offer greater comparative advantage (Ayobola, Ekundayo & Muibi, 2018). The abundance of metal/steel ore in the United States explains why the country’s automobile industry is robust. The big three automobile manufacturers (Ford, GM, and Chrysler) are all based in the U.S. It is estimated that 75% of KSA’s revenues come from its oil and gas resources. The recent decline in global oil prices has challenged policymakers to find ways of diversifying the economy to reduce dependence on income from natural resources.
Additional Trade Theories That Can Be Applied
Adam Smith’s theory of absolute advantage can be applied in explaining the relationship between factor/resource endowments and a nation’s comparative advantage. In this theory, Adam Smith emphasized the importance of export specialization in a country’s comparative advantage. He argued that a country should specialize in those commodities that can be produced efficiently. This hypothesis assumes that labor is the only factor of production and that productivity increases when countries specialize in commodities in which they have an absolute advantage. Smith argued that specialization leads to an increase in total production in the long-term. However, there are a few flaws in Smith’s theory. For example, it assumes that there is no mobility of factors of production. It also assumes that there are no trade barriers and economies of scale.
David Ricardo’s theory of comparative advantage, which is an improvement of Smith’s, argues that a country should specialize in those goods that can be produced at a lower opportunity cost. According to Ricardo, comparative advantage is based on the availability of factors of production. The quality and quantity of a country’s factors of production largely determine its comparative advantage. Ricardo’s hypothesis answers the question of how resource endowments impact comparative advantage. However, Ricardo’s theory is also imperfect as it assumes that there is perfect competition in the market, which is rarely the case. It also assumes that the factors of production can be moved from one location to another, which is always not possible.
Aims of Saudi Vision 2030 in Relation to the Factor Endowment Theory
In line with the factor endowments theory, Saudi Vision 2030 recognizes the fact that oil and gas are key pillars of its economy. It aims at sustaining and enhancing the country’s comparative advantages. According to this vision, KSA will balance development and sustainability, thus explaining the kingdom’s effort to diversify its economy and reduce reliance on oil and gas exports (Al, Euchi& Omri, 2018). As mentioned earlier, oil a major driver of economic growth in KSA. The natural resources, which KSA largely depends on for its comparative advantage, including oil, are expected to be exhausted in the next 20 years. Economic diversification strategy is one of the key pillars for achieving Saudi Vision 2030(Kingdom of Saudi Arabia Vision 2030). It will largely contribute to the expansion of the private sector and ensuring the sustainability of vital resources. Therefore, the bottom line of Saudi Vision 2030 is to expand its comparative advantage to other sectors of the economy.
Al, T. A., Euchi, J., & Omri, A. (January 01, 2018). The pillars of economic diversification in Saudi Arabia. World Review of Science, Technology and Sustainable Development, 14, 4, 330.
Ayobola, Charles, Ekundayo, Mesagan, & Saibu Muibi. (January 01, 2018). Resource endowment and export diversification: Implications for growth in Nigeria. Studies in Business and Economics, 13, 1, 29-40.
Ito, T., Rotunno, L., & Vézina, P.-L. (August 01, 2017). Heckscher-Ohlin: Evidence from virtual trade in value-added. Review of International Economics, 25, 3, 427-446.
Kingdom of Saudi Arabia Vision 2030 (2019). Retrieved from https://vision2030.gov.sa/en/programs/NTP
Marjit, S., & Mandal, B. (January 01, 2016). Finite change—Implication for trade theory, policy, and development.
Ohyama, M. (January 01, 2016). Factor endowments and the pattern of commodity and factor trade.
Schumacher, R. (2012). Free trade and absolute and comparative advantage: A critical comparison of two major theories of international trade. Potsdam: Univ.-Verl. Potsdam
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