Endowments , Factor Prices , and Skill-Biased Technology : Importing Development Accounting into HOV *

International differences in productivity, endowments and factor prices are essential for understanding cross-country patterns of income and growth, yet have proven of limited value for understanding the factor content of international trade. Part of the reason is that international trade empirics have failed to explain why there are such large international differences in unit input requirements of skilled and unskilled labor: Are the differences due to substitution effects associated with international differences in productivity adjusted factor prices or to factor-augmenting international technology differences? To answer these questions we develop a parsimonious general equilibrium Heckscher-Ohlin-Vanek (HOV) model featuring international technology differences and a failure of productivity adjusted factor price equalization. The three core equations of our model fit data for skilled and unskilled labor in 38 countries, and identify the relative contributions of substitution effects vs. factor-augmenting technology differences. We then show that our estimates of technology differences and skill bias are very similar to estimates obtained using approaches in the directed technical change and development accounting literatures. *We are deeply indebted to David Weinstein for help throughout this project. We also thank Daron Acemoglu, Matilde Bombardini, Arnaud Costinot, Alan Deardorff, Dave Donaldson, Gene Grossman, Keith Head, Elhanan Helpman, Angelo Melino, Andrés Rodríguez-Clare, Jonathan Vogel, and seminar participants at Barcelona GSE Summer Forum, Berkeley, Colorado, Columbia, Essex, LSE, the NBER (ITI), Oxford, Simon Fraser, Toronto, UBC, UC Santa Cruz, the West Coast Trade Conference (Stanford), Western Economic Association (Hawaii) for helpful comments and suggestions. Peter Morrow thanks the Economics Department at the University of California, Berkeley where he was a Visiting Scholar. Trefler thanks the Canadian Institute for Advance Studies (CIFAR) Program in Institutions, Organizations and Growth. Both authors thank the Social Sciences and Humanities Research Council of Canada (SSHRC). †Department of Economics, University of Toronto, (peter.morrow@utoronto.ca). ‡Rotman School of Management, University of Toronto, CIFAR, NBER (dtrefler@rotman.utoronto.ca). International differences in productivity, endowments and factor prices are essential for understanding cross-country patterns of income and growth, yet have proven of limited use for understanding the factor content of international trade. The development accounting literature has shown that richer countries are more productive and that this productivity advantage is more pronounced for skilled than unskilled labor i.e., technology differences are factor-augmenting and skill-biased (Caselli, 2005, Caselli and Coleman, 2006, Caselli and Feyrer, 2007, Caselli, 2016). The directed technical change literature has shown that this skill bias is systematically related to factor endowments: Relatively skill-abundant countries should have relatively low skilled wages, but nevertheless direct innovation towards improving the productivity of skilled labor. (See Acemoglu, 1998, Caselli and Coleman, 2006, and Acemoglu, 2009. For open-economy empirics see Acemoglu and Zilibotti, 2001 and Blum, 2010). In contrast, when explaining the factor content of trade, the international trade literature has not been able to establish a cohesive empirical relationship between endowments, factor prices, and factor-augmenting productivity e.g., Trefler (1995), Gabaix (1997), Davis and Weinstein (2001) and Nishioka (2012). These and other papers look at pieces of the relationship, but not its entirety: Trefler (1995), Davis and Weinstein (2001) and Nishioka (2012) argue that endowments matter for the factor content of trade, Davis and Weinstein (2001) and Fadinger (2011) argue that factor prices matter, and not since Trefler (1993) has anyone seriously argued that factor-augmenting productivity matters.1 We argue that a parsimonious extension of the Heckscher-Ohlin-Vanek (HOV) model not only lines up well with the data, but also matches a large number of facts documented in the development accounting and directed technical change literatures. We aim to take the relationship between endowments, factor prices, and factor-augmenting productivity documented in our opening paragraph and introduce it into HOV empirics. Our starting point is a question that comes out of the contrast between Davis and Weinstein (2001) and Trefler (1993): Are international differences in the use of skilled and unskilled labor due to (1) substitution effects associated with international factor price differences as in Davis and Weinstein (2001) or (2) factor-augmenting international technology differences as in Trefler (1993)? To investigate, we introduce factor-augmenting international productivity differences into a multi-sector HOV model and consider an equilibrium without factor price equalization. This model explains four phenomena. First, it fits the entire supply-side content of the HOV model, by which we mean the following: (a) it does very well fitting a Techniques equation relating international differences in factor demands (‘techniques’) to international differences in wages and technology; (b) it also does very well fitting a Wage or factor market clearing equation relating international differences in factor prices to international differences in endowments and technology; and, (c) it provides a very good fit of the Vanek equation relating the factor content of trade (itself a function of factor prices and technology) to endowments, provided we treat Government Services as nontradable. These three equations describe the entire supply side of the model so there are no other equations we can exploit to answer our international trade question about the relative roles of substitution effects 1Marshall (2012) is a rare exception. Additionally, Romalis (2004) relates the structure of production to endowments and Burstein and Vogel (forthcoming) relate endowments to relative factor prices.