Factor Endowment Theory and Trade Patterns of Saudi Arabia and USA

The paper examines the impacts of the sub-concepts such as the comparative advantage on the trade pattern between Saudi Arabia and the USA using the trade theory of factor endowment. It also justifies the factor endowment theory as a predictor of trade and suggests additional trade theories that can be applied. The subject is Economics and the assignment type is Global Trade Economics.

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ECONOMICS ASSIGNMENT
GLOBAL TRADE ECONOMICS

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Contents
Introduction................................................................................................................................3
Impacts of resource endowment on comparative advantage......................................................3
Justification of factor endowment theory as a predictor of trade...............................................4
Additional trade theories that can be applied.............................................................................4
Conclusion..................................................................................................................................5
Reference....................................................................................................................................6

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Introduction
International trade is a channel through which economies around the world engages in the
transaction of goods and services. The trade theories suggest that trade results in the increase
in the welfare of societies. The paper aims to focus on the specific trade theory of factor
endowment theory taking the case of Saudi Arabia and the USA. Using the theory, the paper
examines the impacts of the sub-concepts such as the comparative advantage on the trade
pattern between the two countries.
Impacts of resource endowment on comparative advantage
The trade theory of factor endowment states that a country must have a product for which the
opportunity cost of production is lowest compared to the other country. Dibooğlu & Aleisa
(2014) stated that opportunity cost is referred to as the cost given up by an economic entity in
the pursuit of consumption of another good. The comparative advantage is an advantage to a
country when it can produce a product at lower opportunity cost than the other countries. El
Mallakh (2015) noted that there is at least one product which will be there which requires low
opportunity cost for that country relative to another county.
Saudi Arabia
For Saudi Arabia, the endowment is mainly in the form of oil. Therefore the country has a
low opportunity cost in the production and process of oil. It provides the economy of Saudi
Arabia a comparative advantage over the partners such as the USA. Due to the abundance of
oil in the country, the cost of labour in the industry is also low and hence Saudi Arabia
produces oil for the USA (Ramady, 2013). Therefore, the huge endowment of oil helps in the
determination of the specialisation in the case of Saudi Arabia. The relative cost of exporting
the oil from the Saudi Arabian economy is lower than the other trader partners due to the
abundance of oil and the labours having expertise in the oil industry of the country.
USA
The abundance of the resources also influences the specialization of the USA as well. The
USA is known to have huge capital availability for large production of machinery. Abedini &
Péridy (2018) noted that the technology available to the US helps it to produce modern
machinery at a cheap cost. Thus, the opportunity cost of producing the machinery is low in
the economy of the USA and hence this country exports advanced machinery with state of the

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art technologies to Saudi Arabia. Thus, the abundance of technology and capital allows the
USA to have a comparative advantage on the production of the machinery over the partners.
Justification of factor endowment theory as a predictor of trade
Saudi Arabia
Factor endowment theory is one of the most used trade theories in the world for its simplicity.
It states that a country only exports that good in which it has a comparative advantage. In the
case of Saudi Arab, this theory exactly predicts the trade pattern. 94% of all the exports of the
country is oil and related product (Carter, 2016). The theory focuses on the two-factor model
which is also used in the case of Saudi Arabia as well. Two of the main resources used for oil
production and exportation are the capital and labour. The theory also focuses on the gains
from the trade which is positive if the assumptions are adhered. Saudi Arabian economy
survives on the revenue it generates from the oil sector of the country and hence the theory
accurately predicts the trade pattern of this country.
USA
In the case of the USA, the theory just provides the basics and fails to predict the trade
patterns of the country. The USA exports a huge number of products and services to Saudi
Arabia which deviates from the theories of factor endowment (Feenstra, 2015). The USA
exports machinery, foods and pharmaceuticals to the Saudis. Another point the theory of
factor endowment fails to predict is the pattern of the international trade of the USA. It says,
the country exports the products which are intensive in the factor that is abundant in the
country. Hoefele, Schmidt‐Eisenlohr & Yu (2016) stated that one of the major factors that are
in abundance in the case of the USA is the arable land and agricultural workers. Despite that,
foods and the beverages whose production is intensive in land and labour is not the most
exported product from the USA to Saudi Arabia. Hence, the factor endowment theory fails in
the case of USA to predict the trade pattern.
Additional trade theories that can be applied
Saudi Arabia
One of the other theories that can be used to predict the trade pattern of Saudi Arabia with the
USA is the product life cycle theory. It states that the economies start exporting goods and
service very early and over the time it develops a complete system andinfrustructure in the

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home market that further reduces the relative cost of exporting that product. This theory also
explains the trade pattern of Saudi Arabia very well as the country started exporting oil very
early in the 20th century and since then has developed infrastructure that helps in the
reduction of the relative cost now (Chaney, 2018). However, one of the limitations of the
theory is that it fails to capture the innovation and flexibility in the process that is important
for the explanation of the growth. One of the important aims for the country is the vision
2030 which has the aim to reduce the dependence on the oil revenue before the year 2030.
The theory of the factor endowment in the context of international trade needs to be scrapped
if diversity needs to be implemented (Neary, 2016). One of the disadvantages of the factor
endowment theory is that it says a country can export only one good in which it has a
comparative advantage, which is not possible in real life. The government of Saudi Arabia is
also looking to diversify the source of the government revenue in the near future that will
reduce the application of the factor endowment theory in case of this country.
USA
Another trade theory that can explain the pattern of the USA is the national competitive
advantage theory. This theory states that the trade pattern of an economy depends upon that
industry which is upgradable and has the innovation capacities. There can be more than one
sector of the economy which can provide more innovation and hence comparative advantage
in producing that product. The economy of the USA has more than one industry where it can
innovate in order to achieve the national comparative advantage over the other trade partners
of the world (Adão, 2015). This includes heavy machinery, pharmaceuticals food processing
and many more. However, one of the biggest disadvantages of this trade theory is that it does
not capture the production of that good whose resource in abundance in particular case of that
country.
Conclusion
Therefore, the paper furnishes the trade patterns of two of the trade partners of the world. It
shows that different theories of trade explain different trade patterns of different countries of
the world. The factor endowment theory studied in this paper almost accurately captures the
only export of oil products by Saudi Arabia. However, the theory fails to predict the trade
pattern in the case of the USA. The paper also shows that there are other trade theories can
also be applied to explain the patterns of the USA such as the national comparative advantage
theory which can explain the many good exportation patterns of that country.

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Reference
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