This chapter explores a two-country model where money serves as a store of value. It shows that imbalanced trade is the norm. It emphasizes that a surplus country absorbs its trading partner’s fiscal expansion because every country gains from trade. But the deficit country is in a stronger bargaining position since it has a greater role for money as a store of value under autarky. In dividing the gains from trade equally, the surplus country is willing to tax its own residents as a part of the cost of gaining access to the world trading system.

We develop two simple modifications of Heckscher-Ohlin-Vanek theory for countries with heterogeneous technologies: virtual endowments and modified Rybczynski effects. Virtual endowments predict factor trade using a reference country’s technology. Modified Rybczynski effects show the domestic factor content of changes in foreign endowments. The empirical implications are striking. There is no missing trade, and we predict the direction of trade with significance levels exceeding 99%. We make no assumptions about home bias in consumption, not traded goods, trade costs, or trade in intermediate inputs. We make no corrections to measured endowments and estimate nothing; the data speak for themselves.

Exploiting recent international data on factor usage by sector, we provide the first direct test of Leontief’s notion of factor-specific productivity differences. This test strongly rejects Trefler’s (1993) generalization of Leontief’s idea. Hence tests of the Heckscher-Ohlin paradigm cannot be based upon such simple technological differences across countries.
 
 

Technology matrices are measured with error when researchers combine data on intermediate inputs with those on direct factor requirements from disparate sources. This error is compounded when factor prices differ across countries, since it is no longer appropriate to measure factors in homogeneous physical units. It is more accurate empirically and more cogent theoretically to compute flows of factor services, measured at local factor prices that incorporate international productivity differences. In the long run, production techniques adapt so that every country is competitive in almost every good. Since capital and labor are complementary inputs in
almost every industry, a country that is physically scarce in a factor may well be measured as abundant in its services.