Economics Assignment: Factor Endowment Theory in Saudi Arabia & India

This economics report examines the trade relationship between Saudi Arabia and India, focusing on the application of the factor endowment theory. The report begins by introducing international trade and the core concepts of comparative and absolute advantage, essential for understanding tra...Read More

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ECONOMICS ASSIGNMENT

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Contents
1.0 Introduction..........................................................................................................................3
2.0 Impacts of resource endowment to comparative advantage................................................3
3.0 Is the factor endowment theory is a good predictor.............................................................4
4.0 Additional trade theory for the explanation of trade pattern................................................4
5.0 Conclusion............................................................................................................................5
Reference....................................................................................................................................6

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1.0 Introduction
Trade is a transaction of goods and services between two economies of the world in exchange
for foreign currency. The theory of international trade shows that the gains from the trade are
positive for both the economies engaged in international trade. The paper aims to discuss
different concepts regarding international trade forcing on the concept of factor endowment
theory. The theory states that the comparative advantage of each of the economies decides the
specialisation in production and the transaction happens accordingly. In this study, trade
partnership of Saudi Arabia and India has been discussed to understand the trade pattern as
per the factor endowment theory.
2.0 Impacts of resource endowment to comparative advantage
The factor endowment theory talks about comparative and absolute advantages. Absolute
advantage is the benefit when an economy can produce a certain good at the lowest cost. On
the other hand, the comparative advantage is when a country can produce a certain good at
the lowest opportunity cost (Abedini & Péridy, 2018). If the opportunity cost is low, the
country will specialise in the production of that good and export it to the partner country.
Saudi Arabia
Saudi Arabia has an abundance of oil underneath its ground and this has been providing the
government of the country with high tax revenue (Ramady, 2013). There is another source of
income of the government as well such as the manufacturing sector which is very small in
size. Therefore, the opportunity cost of producing an extra barrel of oil is relatively low for
the small size of the manufacturing sector (Adão, 2015). Therefore, the high endowment of
oil in Saudi Arabia provides a comparative advantage to the country for producing oil in large
scale and exports it to India. Compared to India, the relative cost of producing oil is much

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lower in the case of Saudi Arabia and hence the theory says that Saudi Arabia should export
oil to India.
India
India, on the other hand, has a reasonable size of the manufacturing sector and the smaller
size of the oil reservoir compared to Saudi Arabia. India exports ceramic products to Saudi
Arabia made in the manufacturing sector of the Indian economy (Carter, 2016). The economy
of India is abundant in labour being the second most populous countries in the world, unlike
that of Saudi Arabia. Thus, labour cost is low and oil production cost is very high in case of
India. Therefore, the relative cost of producing ceramic products in the Indian manufacturing
sector is low providing a comparative advantage to India in producing that product (Chaney,
2018). Therefore in the case of India as well, the endowment of resources determines the
comparative advantage and the products that should be exported from India to Saudi Arabia.
3.0 Is the factor endowment theory is a good predictor
Saudi Arabia
The factor endowment theory is a basic model of two factors two good two country economy.
In the case of Saudi Arabia, only one product is the most exported and that is oil. Oil
comprises 96% of the overall volume to export from Saudi Arabia from the other nations of
the world (Dibooğlu & Aleisa, 2014). The factor endowment theory says that an economy
should only export that product in which it has a comparative advantage. Therefore the factor
endowment theory is a good predictor of the trade pattern in the case of Saudi Arabia. The
factor endowment theory also states that the relative cost of production of the exported
product needs to be lower than the partner country. This also holds from the trade pattern and
activity of Saudi Arabia.

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India
India, unlike the case of Saudi Arabia, exports different types of products to Saudi Arabia and
other countries of the world. The ceramic product in which it has a comparative advantage
over Saudi Arabia is only 39% of the overall export to Saudi Arabia in real-life scenario (El
Mallakh, 2015). Therefore, the resources are devoted to different production, unlike the
theory states. Although the theory accurately predicts the comparative advantage of the
economy it does not explain the different production process ongoing in the economy
simultaneously. Therefore, in the case of India, the factor endowment theory is not a great
predictor of trade pattern.
4.0 Additional trade theory for the explanation of trade pattern
Saudi Arabia
The product life cycle theory is another trade theory that explains the trade pattern of Saudi
Arabia. Life cycle theory states that infrastructure automatically develops when an economy
exports a certain good for a long period. The education system, machinery manufacturing etc
are in line with the oil production in the case of Saudi Arabia. This can also be the reason for
a low relative cost of production of oil in Saudi Arabia (Feenstra, 2015). However, one of the
problems of this theory is that it does not explain the high relative cost of production of other
products and hence is not a complete trade theory to predict the overall pattern of Saudi
Arabian trade. However, it needs to be noted that there is a limitation in this theory that do
not capture the innovative approach of the oil industry of the country.
Saudi Arabia’s Vision 2030 and factor endowment theory
One of the aims of the Saudi Arabian government is the Vision 2030 which focuses on
creating a diversified source of revenue for the government. Hoefele, Schmidt‐Eisenlohr &

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Yu (2016) stated that this is a good move from the side of the government as the sole
dependence on the oil sector makes the economy of Saudi Arabia vulnerable to the changes
in the oil sector. By deviating from the theory of factor endowment, the economy of Saudi
Arabia can diversify the production achieving the goal of the country. Factor endowment
theory states that an economy should only export that product in which it has a comparative
advantage over the partner economy. However, in order to achieve the vision 2030, the
government need to make sure that it receives revenue from a huge number of sources and
hence deviation needs to be done from the factor endowment theory.
India
Global strategic rivalry theory can be the theory that explains the trade pattern of India. The
theory states that local rivalry compels the economy to produce that product with which it can
beat the regional rivals (Neary, 2016). India, in this case, is exporting manufacturing products
to combat the rising demand for the manufacturing products of China. It also explains the
other manufactured goods that are exported in other countries of the world. This economy
also explains the growing service export of country which is not explained by the factor
endowment theory. However, India’s trade pattern is a complex system and hence it is
impossible for a model or a theory to correctly explain or predict the trade pattern of the
economy. Only the basic features of the models and theories are similar to the case of India.
5.0 Conclusion
Therefore the trade relationship between Saudi Arabia and India follows a classical pattern of
factor endowment theory which is more valid for the case of Saudi Arabia. The paper shows
that endowment of the resources determines the comparative advantage of an economy which
is true for both the economies. However, as found out in the paper, the factor endowment
theory fails to predict the overall trade pattern of India. The paper also furnishes how to

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factor endowment theory can help to achieve the vision 2030 of Saudi Arabia in the coming
years.

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Reference
Abedini, J., & Péridy, N. (2018). The Greater Arab Free Trade Area (GAFTA): an estimation
of its trade effects. Journal of Economic Integration, 848-872.
Adão, R. (2015). Worker heterogeneity, wage inequality, and international trade: Theory and
evidence from brazil. Unpublished paper, MIT, 91-97.
Carter, R. (2016). Boat remains and maritime trade in the Persian Gulf during the sixth and
fifth millennia BC. antiquity, 80(307), 52-63.
Chaney, T. (2018). The gravity equation in international trade: An explanation. Journal of
Political Economy, 126(1), 150-177.
Dibooğlu, S., & Aleisa, E. (2014). Oil prices, terms of trade shocks, and macroeconomic
fluctuations in Saudi Arabia. Contemporary Economic Policy, 22(1), 50-62.
El Mallakh, R. (2015). Saudi Arabia: Rush to Development (RLE Economy of Middle East):
Profile of an energy economy and investment. Routledge, 128-130.
Feenstra, R. C. (2015). Advanced international trade: theory and evidence. Princeton
university press, 170-184.
Hoefele, A., Schmidt‐Eisenlohr, T., & Yu, Z. (2016). Payment choice in international trade:
Theory and evidence from cross‐country firm‐level data. Canadian Journal of
Economics/Revue canadienne d'économique, 49(1), 296-319.
Neary, J. P. (2016). International trade in general oligopolistic equilibrium. Review of
International Economics, 24(4), 669-698.
Ramady, M. A. (2013). The Saudi Arabian economy: Policies, achievements, and challenges.
Springer Science & Business Media., 65-74.