Factor Mobility Theory

Introduction:
Factor mobility refers to the ability to move factors of production—labor, capital, or
land—out of one production process into another. Factor mobility may involve the
movement of factors between firms within an industry, as when one steel plant closes
but sells its production equipment to another steel firm. Mobility may involve the
movement of factors across industries within a country, as when a worker leaves
employment at a textile firm and begins work at an automobile factory. Finally,
mobility may involve the movement of factors between countries either within
industries or across industries, as when a farmworker migrates to another country or
when a factory is moved abroad.
The standard assumptions in the trade literature are that factors of production are freely
and costless mobile between firms within an industry and between industries within a
country but are immobile between countries.
The rationale for the first assumption—that factors are freely mobile within an
industry—is perhaps closest to reality. The skills acquired by workers and the
productivity of capital are likely to be very similar across firms producing identical or
closely substitutable products. Although there would likely be some transition costs
incurred, such as search, transportation, and transaction costs, it remains reasonable to
assume for simplicity that the transfer is costless. As a result, this assumption is rarely
relaxed.
The assumption that factors are easily movable across industries within a country is
somewhat unrealistic, especially in the short run. Indeed, this assumption has been a
standard source of criticism for traditional trade models. In the Ricardian and
Heckscher-Ohlin models, factors are assumed to be homogeneous and freely and
costless mobile between industries. When changes occur in the economy requiring the
expansion of one industry and the contraction of another, it just happens. There are no
search, transportation, or transaction costs. There is no unemployment of resources.
Also, since the factors are assumed to be homogeneous, once transferred to a
completely different industry, they immediately become just as productive as the
factors that had originally been employed in that industry. These conditions cannot be
expected to hold in very many realistic situations. For some, this inconsistency is
enough to cast doubt on all the propositions that result from these theories.
Another important aspect of factor mobility involves the mobility of factors between
countries. In most international trade models, factors are assumed to be immobile across
borders. Traditionally, most workers remain in their country of national origin due to
immigration restrictions, while government controls on capital have in some periods
restricted international movements of capital. When international factor mobility is not
possible, trade models demonstrate how national gains can arise through trade in goods
and services.
Of course, international mobility can and does happen to vary degrees. Workers migrate
across borders, sometimes in violation of immigration laws, while capital flows readily

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across borders in today’s markets. The implications of international factor mobility
have been addressed in the context of some trade models. A classic result by Robert A.
Mundell (1957) demonstrates that international factor mobility can act as a substitute
for international trade in goods and services. In other words, to realize all the gains from
international exchange and globalization, countries need to either trade freely or allow
factors to move freely between countries.

What is Factor Production?

Factors of production is an economic term that describes the inputs used in the
production of goods or services to make an economic profit. Factors of production are
the inputs needed for creating a good or service, and the factors of production
include land, labor, entrepreneurship, and capital. The factors of production are
resources that are the building blocks of the economy; they are what people use to
produce goods and services.

The modern definition of factors of production is primarily derived from

a neoclassical view of economics. It amalgamates past approaches to economic theory,
such as the concept of labor as a factor of production from socialism, into a single
definition.

4 Factors of Production:
There are four factors of production—land, labor, capital, and entrepreneurship.

Land as a Factor of Production:

Land includes all of the natural resources available to create supply, such as raw ground
and anything that comes from it. It can be a non-renewable resource. That
includes commodities such as oil and gold. It can also be a renewable resource, such as
timber. Once man changes it from its original condition, it becomes a capital good. For
example, crude oil is a natural resource, but gasoline is a capital good. Farmland is a
natural resource, but a shopping center is a capital good.

The income earned by owners of land and other resources is called rent. The United
States is blessed with an abundance of easily accessible natural resources, including
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fertile land and water. It has miles of coastline, lots of oil, and a moderate
climate. That’s an advantage over Canada, which has similar natural resources, but they
are not always as accessible due to permafrost covering parts of the country's land.
Climate change is beginning to alter that, thawing permafrost in some areas and
increasing access to oil and other natural resources. Climate change also will make it
harder for Canada to utilize natural resources in some regions.

It will reduce water supplies to its oil sands in Alberta, which may lead to a reduction
in production.

Land is a broad term that includes all the natural resources that can be found on land,
such as oil, gold, wood, water, and vegetation. Natural resources can be divided into
renewable and non-renewable resources.

 Renewable resources are resources that can be replenished, such as water,

vegetation, wind energy, and solar energy.
 Non-renewable resources consist of resources that can be depleted in supply,
such as oil, coal, and natural gas.

All resources, whether it is renewable or non-renewable, can be used as inputs in

production in order to produce a good or service. The income that comes from using
land and its natural resources is referred to as rent.

Besides using its natural resources, land can also be utilized for various purposes, such
as agriculture, residential housing, or commercial buildings. However, land differs from
the other factors of production because some natural resources are limited in quantity,
so its supply cannot be increased with demand.

Labor as a Factor of Production:

Labor is human effort that can be applied to production. People who work to repair
tires, pilot airplanes, teach children, or enforce laws are all part of the economy’s labor.
People who would like to work but have not found employment—who are
unemployed—are also considered part of the labor available to the economy.

In some contexts, it is useful to distinguish two forms of labor. The first is the human
equivalent of a natural resource. It is the natural ability an untrained, uneducated person
brings to a particular production process. But most workers bring far more. The skills
a worker has as a result of education, training, or experience that can be used in
production are called human capital. Students who are attending a college or university
are acquiring human capital. Workers who are gaining skills through experience or
through training are acquiring human capital. Children who are learning to read are
acquiring human capital.

Productivity is measured by the amount of output someone can produce in each hour
of work. The income that comes from labor is referred to as wages. Note that work
performed by an individual purely for his/her personal interest is not considered to be
labor in an economic context.

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The following are several characteristics of labor in terms of being a factor of
production:

 First, labor is considered to be heterogeneous, which refers to the idea of how

the efficiency and quality of work are different for each person. It differs
because it depends on an individual’s unique skills, knowledge, motivation,
work environment, and work satisfaction.
 Additionally, labor is also perishable in nature, which means that labor cannot
be stored or saved up. If an employee does not work a shift today, the time that
is lost today cannot be recovered by working another day.
 Also, another characteristic of labor is that it is strongly associated with
human efforts. It means that there are factors that play an important role in
labor, such as the flexibility of work schedules, fair treatment of employees, and
safe working conditions.

The amount of labor available to an economy can be increased in two ways. One is to
increase the total quantity of labor, either by increasing the number of people available
to work or by increasing the average number of hours of work per week. The other is
to increase the amount of human capital possessed by workers.

Capital as a Factor of Production:

Capital, or capital goods, as a factor of production, refers to the money that is used to
purchase items that are used to produce goods and services. For example, a company
that purchases a factory to produce goods or a truck that is purchased to do construction
are considered to be capital goods.

Other examples of capital goods include computers, machines, properties, equipment,

and commercial buildings. They are all considered to be capital goods because they are
used in a production process and contribute to the productivity of work. The income
that comes from capital is referred to as interest.

Below are several defining characteristics of capital as a factor of production:

 Capital is different from the first two factors because it is created by humans.
For example, capital goods like machines and equipment are created by
individuals, unlike land and natural resources.
 Additionally, capital is also a factor that can last a long time, but it depreciates
in value over time. For example, a building is a capital good that can endure for
a long period of time, but its value will diminish as the building gets older.
 Capital is also considered to be mobile because it can be transported to different
places, such as computers and other equipment.

Capital does not consist solely of physical objects. The score for a new symphony is
capital because it will be used to produce concerts. Computer software used by business
firms or government agencies to produce goods and services is capital. Capital may
thus include physical goods and intellectual discoveries.

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Any resource is capital if it satisfies two criteria:
1. The resource must have been produced.
2. The resource can be used to produce other goods and services.

One thing that is not considered capital is money. A firm cannot use money directly to
produce other goods, so money does not satisfy the second criterion for capital. Firms
can, however, use money to acquire capital. Money is a form of financial
capital. Financial capital includes money and other “paper” assets (such as stocks and
bonds) that represent claims on future payments. These financial assets are not capital,
but they can be used directly or indirectly to purchase factors of production or goods
and services.

Entrepreneurship as a Factor of Production:

Entrepreneurship is the secret sauce that combines all the other factors of production
into a product or service for the consumer market. An example of entrepreneurship is
the evolution of the social media behemoth Meta formerly Facebook. Entrepreneurship
is the drive to develop an idea into a business. An entrepreneur combines the other three
factors of production to add to supply. The most successful are innovative risk-takers.

The income entrepreneurs earn is profits. The majority of entrepreneurs in the United
States own small businesses. There are 30.2 million small businesses in the United
States, and 47.5% of employees work for a small business

One reason small businesses do so well is that it's relatively easy to get funded
compared to other countries. Others raise money on the stock market by
issuing an initial public offering. Shares in these companies are called small-cap stocks

The Importance of the Factors of Production:

If businesses can improve the efficiency of the factors of production, it stands to reason
that they can create more goods at a higher quality and perhaps a lower price. Any
increase in production leads to economic growth as measured by Gross Domestic
Product or GDP. GDP is merely a metric that represents the total production of all
goods and services in an economy. Improved economic growth raises the standard of
living by lowering costs and raising wages.

Capital goods include technological advances from iPhones, to cloud computing, to

electric cars. For example, in the last several years, the technology of fracking or
horizontal drilling has led to improved extraction of oil making the U.S. one of the
world's largest oil producers. The innovation couldn't be done without the labor behind
the process, from conceptualization to the finished product.

However, as technology helps to increase the efficiency of the factors of production,

it can also replace labor to reduce costs. For example, artificial intelligence and robotic
machines are used in manufacturing boosting productivity, reducing costly errors from
human beings, and ultimately reducing labor costs.

Of course, nothing gets started without the entrepreneurs who create a vision and the
action steps needed to design the production process. Entrepreneurs combine all the

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factors of production, including buying the land or raw materials, hiring the labor, and
investing in the capital goods necessary to bring a finished product to market.

As Parmenides, a Greek philosopher, famously quipped, "Nothing comes from

nothing." Economic growth results from better factors of production. This process is
clearly demonstrated when an economy undergoes industrialization or other
technological revolutions; each hour of labor can generate increasing amounts of
valuable goods.

Why factors of production moves?

Factor mobility refers to the ability to move factors of production—labor, capital, or
land—out of one production process into another. Factor mobility may involve the
movement of factors between firms within an industry, as when one steel plant closes
but sells its production equipment to another steel firm. Mobility may involve the
movement of factors across industries within a country, as when a worker leaves
employment at a textile firm and begins work at an automobile factory. Finally,
mobility may involve the movement of factors between countries either within
industries or across industries, as when a farm worker migrates to another country or
when a factory is moved abroad.
The standard assumptions in the trade literature are that factors of production are freely
(i.e., without obstruction) and costless mobile between firms within an industry and
between industries within a country but are immobile between countries.
The rationale for the first assumption—that factors are freely mobile within an
industry—is perhaps closest to reality. The skills acquired by workers and the
productivity of capital are likely to be very similar across firms producing identical or
closely substitutable products. Although there would likely be some transition costs
incurred, such as search, transportation, and transaction costs, it remains reasonable to
assume for simplicity that the transfer is costless. As a result, this assumption is rarely
relaxed.
The assumption that factors are easily movable across industries within a country is
somewhat unrealistic, especially in the short run. Indeed, this assumption has been a
standard source of criticism for traditional trade models. In the Riparian and Huckster-
Ohlin models, factors are assumed to be homogeneous and freely and costless mobile
between industries. When changes occur in the economy requiring the expansion of one
industry and the contraction of another, it just happens. There are no search,
transportation, or transaction costs. There is no unemployment of resources. Also, since
the factors are assumed to be homogeneous, once transferred to a completely different
industry, they immediately become just as productive as the factors that had originally
been employed in that industry. Clearly, these conditions cannot be expected to hold in
very many realistic situations. For some, this inconsistency is enough to cast doubt on
all the propositions that result from these theories.

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Another important aspect of factor mobility involves the mobility of factors between
countries. In most international trade models, factors are assumed to be immobile across
borders. Traditionally, most workers remain in their country of national origin due to
immigration restrictions, while government controls on capital have in some periods
restricted international movements of capital. When international factor mobility is not
possible, trade models demonstrate how national gains can arise through trade in goods
and services.
Of course, international mobility can and does happen to varying degrees. Workers
migrate across borders, sometimes in violation of immigration laws, while capital flows
readily across borders in today’s markets. The implications of international factor
mobility have been addressed in the context of some trade models. A classic result by
Robert A. Mundell (1957) demonstrates that international factor mobility can act as a
substitute for international trade in goods and services. In other words, to realize all the
gains from international exchange and globalization, countries need to either trade
freely or allow factors to move freely between countries. Robert A. Mundell,
“International Trade and Factor Mobility,” American Economic Review 47 (1957):
321–35. It is not necessary to have both. Mundell’s result contradicts a popular
argument that free trade can only benefit countries if they also allow workers to move
freely across borders.

Effects of factor movements:

 Factor movements alter factor endowments-
 Factor movements can be substantial for some countries, and insignificant for
others
 The movement of labor and capital are intertwined (skilled foreign workers)
 Pros and cons of outward and inward migration (Brain drain & Remittances)
 Outward migration can have a negative impact on a country if it involves the
departure of educated people, but if these people then send remittances back
home, it can have a positive effect.

Key Points:
 Factors of production are potentially mobile in three distinct ways:
 Between firms within the same industry
 Between industries within the same country
 Between firms or industries across countries

 A standard simplifying assumption in many trade models is that factors

of production are freely and costless mobile between firms and between
industries but not between countries.
 The immobile factor model and the specific factor model are two models
that assume a degree of factor immobility between industries.

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The Relationship between Trade and Factor Mobility:
The links between trade and factor movements are of increasing importance in a
globalizing environment. Starting with the contributions by Mundell (1957) and
Markusen (1983) the relationship between trade and factor movements has been a
subject for many researchers on a theoretical level. In this section an overview about
different trade models and their implications for the relationship between trade and
factor movement is given.

Ricardian Models:
In Ricardian models8 trade occurs because of differences in production technology. At
free trade each country exports the good for which it has an advantage in productivity.
If there is also free movement of factors, there will be a factor inflow regarding the
factor intensively used in the export sector. The reason is the higher factor reward in
the sector with higher productivity. The initial comparative advantage is enhanced by
the resulting endowment differences. Trade is augmented by factor movements.
Transferred to the case of Germany and its considered migration partners, it seems
unlikely that advances in production technology led to emigration from Germany and
inward capital flows.

Heckscher-Ohlin Model:
In the standard Heckscher-Ohlin model trade occurs due to differences in factor
endowment. Each country has a comparative advantage in that sector of production in
which its abundant factor is intensively used. Trade leads to a convergence of goods
prices which implies factor price equalization. From this it follows that the incentives
for factor movements are reduced. At the assumption of constant good prices changes
in the endowment of the economy’s scarce factor of production is followed by an
expansion of the production in the import sector and a decrease in export sector
production. Thus, factor movement is trade reducing.
Adding trade costs and/or costs for factor movement does not change the result of
substitutability.

Specific-Factors Model:
Models with specific factors account for intersectional immobility of factors. In these
models there are two sectors of production. In each sector one sector specific factor of
production is employed. Furthermore, there is a general factor with free intersectional
movement. Within this framework Venables (1999) has analyzed the effects of trade
liberalization regarding the movement of the general and the specific factors
considering endowment differences and barriers to trade in goods. Apart from the
general result of substitutability in some cases a complementary link between factor
movements and trade is possible under certain conditions.

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Models with Increasing Returns to Scale:
Increasing returns to scale can be external or internal. External increasing returns to
scale occur not in an individual firm but on an industry level. Because every individual
firm is small, the assumption of competitive markets still holds. With free trade and
external increasing returns to scale both countries will specialize in order to gain from
specialization. The reward of the factor intensively used in the respective sector will
increase. Thus, there is an incentive for factors, to move. Factor movement is followed
by an increase in the output regarding both countries and thus an increase of trade.
Factor movements and trade are complements. Internal increasing returns to scale are
considered in the standard model of the” New Trade Theory”. There are two countries
with labor as the only factor of production within two sectors. One sector of production
has constant returns to scale, the other one has internal increasing returns to scale. In
the presence of monopolistic competition and internal increasing returns to scale the
bigger economy will be a net exporter in the monopolistically-competitive sector. The
real factor reward will be higher in this region and this way there will be factor
movement, making the two countries more unequal in endowment and thus increasing
the basis for trade. In this case factor movements and trade are complements. This result
is also supported by two other effects. First a” market access”- effect. That is according
to the” Linder Hypothesis”, that enterprises tend to locate near their biggest markets in
order to reduce transport costs. Second a” cost of living” effect. The more the industry
is concentrated, the lower are the goods prices and the cheaper are the costs of living.
These effects support trade as well as factor movements.

According to trade models that are based on technological differences trade and factor
movements are complements. The opposite is suggested by the standard trade model of
Heckscher and Ohlin. This model suggests that with existing endowment differences
trade and factor movements serve as substitutes. However, the results from extensions
of the Heckscher-Ohlin model are ambiguous. Conclusions drawn from the Specific
Factors Model with endowment differences are also not clear. Here trade and factor
movements may be substitutes or complements, depending on the factor in question, its
mobility and consumption patterns. Models of the New Trade Theory, incorporating
increasing returns to scale and monopolistic competition as well as other agglomeration
forces suggest strongly that trade and factor movements are complementary.

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 Conclusion:
Factors of production are doubtless mobile in 3 distinct ways:
1. Between corporations among a similar business.
2. Between industries among a similar country.
3. Between corporations or industries across countries.
A standard simplifying assumption in several trade models is that factors of production
are freely and gratuitous mobile between corporations and between industries however
not between countries.
The immobile issue model and therefore the specific issue model are two models that
assume a degree of issue immobility between industries.
The ability and cost of factor mobility across industries depends largely on how
widespread the demands are for that particular factor. The ability of a factor to find
employment in a new industry tends to increase as time passes. The ability of a factor
to find employment in a new industry tends to increase as time passes.
Nearly all factors mobility measure immobile across industries within the terribly short
run. As time progresses and at some price of adjustment, factors become mobile across
sectors of the economy. Some factors move additional promptly and at less price than
others. Within the end of the day, all factors square measure mobile at some price. For
employees, complete quality could need the passing of a generation out of the work
force. For capital, complete quality needs depreciation of the unproductive capital
stock, followed by new investment in profitable capital.

References:
1. Markusen, J. R. (1983). Factor Movements and Commodity Trade as
Complements. American Economic Review.
2. Wong, K.-Y. (1986). Are International Trade and Factor Mobility Substitutes.
Journal of International Economics.
3. Markusen, J. R., Melvin, J. R., Kaempfer, W. H., & Maskus, K. E. (1995).
International Trade: Theory and Evidence. McGraw -Hill.
4. Mundell, R. A. (1957). International Trade and Factor Mobility, American
Economic Review.

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