International outsourcing-the shifting of service activities from one country to another-was not an issue when the factor-price equalization theory was developed. Does the existence of outsourcing change the implications of the theory? Justify your answer.

Question

What will be an ideal response?

Answer 1

POSSIBLE RESPONSE: The Heckscher-Ohlin theory can explain trade in services in the same way it explains trade in physical goods. The factor price equalization theorem demonstrates that factor prices (in particular, wages) will equalize across countries even if factors of production do not migrate from one country to another. Free trade alone is capable of generating this effect of factor-price equalization.

The new phenomenon of international outsourcing reinforces rather than contradicts this theory. International outsourcing, which is a process of shifting business service activities abroad, can be considered a form of international trade whereby industrialized countries import services such as bookkeeping, call centers, and software development from countries such as India and China. These countries are abundant in factors which are intensively used in the production of these services (workers with particular skills). The Stolper-Samuelson theory predicts that the real wages of workers employed by those sectors in the United States will decrease, and the real wage of workers in China and India will increase. This is the type of trend observed since international outsourcing leapt into prominence in the early 21st century.