Rehabilitating the Factor-Proportions Hypothesis

The Heckscher-Ohlin theory of international trade remains an enigma. 
Despite being falsified on numerous counts [1] [2], it persists as the core 
theory of international trade, found both in undergraduate and graduate 
textbooks, not to mention in much research and policy. However, while it has 
failed to be confirmed by the data, the notion that factor proportions motivate 
trade, whether at the regional or national level, continues to hold sway. This 
paper is an attempt at rehabilitating the factor proportions hypothesis (FPH) 
as a theory of interregional and international trade. An alternative 
formalization, based on evolutionary principles (endogenous technology, mobile 
capital and labor), is presented and is used to rationalize the paradoxical 
findings of HOH empirical tests. The predictions are then tested using a 
variety of techniques. It concludes by examining the policy implications.


Introduction
Despite being rejected empirically, the Heckscher-Ohlin (H-O) theory of international trade remains at the core of trade theory and, to a certain extent, trade policy, owing in large measure to its intuitive appeal. The idea that trade is based on relative factor proportions is universal, cutting across cultures, time and space. This paper is an attempt to rehabilitate the Factor Proportions Hypothesis (FPH) of international trade. However, unlike recent attempts (Trefler 1995, Trefler andZhu 2000), it seeks to recast the theory from first principles. The gist of our argument is simple, namely that the failure of H-O trade theory owes in large measure to a theoretical misspecification. More to the point, the 20 th century witnessed paradigm changes in economic fundamentals. Fueling these were two developments, namely modernity (Bresnahan andTrajtenberg 1995, Helpman andTrajtenberg 1996) with the accompanying vertical and horizontal production differentiation, and secondly the development of the transnational vertically-and horizontally-integrated corporation (Hymer 1976, Dunning 1981). Both we argue had far-reaching implications for the factor-proportions theory of trade. For example, the ability to innovate complete with the resulting process and product technologies would now vary across regions and countries and like other endowments would become a key determinant of trade patterns. Unfortunately, these were ignored by both Eli Heckscher and Bertil Ohlin, and later by Paul Samuelson and others.
It will be shown that when the factor-proportions theory of international trade is set in the appropriate theoretical construct (e.g. one that includes a region/country's ability/endowment to innovate and vertical specialization and the presence of multinational and multiregional value chains), then most if not all of its predictions are borne out by the data. Moreover, it is shown that by doing so, it is no longer necessary to resort to a set of unrealistic assumptions (e.g. immobility of capital and labor) to generate predictions.
Other than incorporating the idea of endogenous technological change (product and process) and the transnational firm into the corpus of H-O theory, this paper innovates in other important areas, notably in terms of the value chain per se. Traditionally, value chains are exogenously given. That is, for a given product, a value chain complete with its multiple vertical links is defined. We endogenize value chains by adding what we refer to as the visions-link which as its name indicates, consists of that stage at which the value chain for a given product is conceived of. As it precedes the value chain chronologically speaking, it is assumed to lie at the beginning (apex) of the vertical value chain. We shall refer to this as the visions-based value chain (VBVC).
Another important innovation is the concept of vertical comparative advantage (Beaudreau 2011). Since time immemorial, the notion of horizontal comparative advantage has dominated the debate over trade. Implicitly, it has been assumed that goods are produced entirely in a given legal jurisdiction (state, country, etc). The emergence and growth of the transnational firm has invalidated and continues to invalidate this assumption (WTO 2010). 1 As such, regions and countries do not www.videleaf.com have a comparative advantage in the production of goods, but rather, a comparative advantage in a particular sub-process (link) or stage of production of goods. For example, resource rich regions-countries will have a vertical comparative advantage in the upstream resource links.
As our model allows for perfectly mobile capital and labor (traditional factors), the question of long-run vertical comparative advantage arises. If capital and labor are free to migrate, then factor-price equalization will remove any and all forms of comparative advantage, and ultimately end trade altogether (Mundell 1957) or so it was believed. To address this problem, two forms of comparative advantage are examined, namely structural comparative advantage and arbitrage comparative advantage. The former includes the ability to conceptualize value chains (goods and services) and natural resources, while the latter includes a capital-, labor-, or energybased comparative advantage.
The paper is organized as follows. Section I presents a brief history of the FPH, focusing on its evolution over time, especially in the 20 th century. This is followed by our model (Section II), which we refer to as the generalized factor proportions hypothesis (GFPH). Its general nature owes to the fact that technology is endogenous and, more importantly, is determined by a country's endowment of visionaries and scientists. The predictions of the model are then used to -ratonalize the paradoxical findings of HOH empirical tests. In Section III, various trade indices (regional and international) are used to support the predictions of the model. Specifically, the GFPH predicts that regions and countries that are relatively well endowed with visionaries and scientists will export what Elhanan Helpman referred to as Headquartering Activity (Helpman 1984); that regions and countries that are relatively wellendowed in natural resources will export upstream value added; and that states and countries that are well endowed with labor will export mid-stream value added (manufacturing activity).
since time immemorial been vertical in nature. Early empires can be seen as country-wide value chains. www.videleaf.com Section IV examines the policy implications of global value chains and vertical comparative advantage (WTO 2010).

FPH: Literature Review
The idea behind the FPH and HOH is relatively simple, not to mention intuitive, namely that if someone has more of something relative to another thing than someone else, then should trade occur, his/her something will be traded against the other thing. It matters little what the something actually is. It could be material as it could be immaterial. Examples include: charm for sustenance, organization for security, and/or affection for wealth. In this section, we examine the FPH and HOH from a historical perspective, focusing our attention on three periods, namely the classical period (prior to HOH), the 20 th Century and the 21 st Century. Within each period, we will be interested in ascertaining both the breadth of the endowment (i.e. the basis of trade) and its relationship to trade in general. For example, is it restricted to material factor inputs (capital and labor) or does it extend beyond?
Trade is inherently based on the presence of asymmetries. This is true of all forms of trade, whether they be material in nature or not. For example, it holds in human relationships, where differences across individuals are a source of attraction and a basis for trade. Which leads us to our first observation, namely that because of its intuitive nature, the FPH is probably as old as human thought in general, and intellectual endeavors (writing) in particular. Put differently, any treatise, written or other, of trade would have invariably considered factor proportions as a-if not the-basis for trade. This being said, let us turn to the question of paternity, proper. When and where did the modern FPH arise? And under what circumstances? As in all cases involving intellectual paternity, the evidence is sparse and inconclusive. Bertil Ohlin himself attributed the HOH to -Frenchworks,‖ specifically to the writings of Jean-Charles Léonard Sismonde de Sismondi who in -De la Richesse Commerciale -that the comparative abundance of capital and labour in different countries determines their territorial specialisation as between industries requiring relatively much labour and those requiring relatively much capital.‖ Simon Power however takes issue with this view, arguing that -De la richesse commerciale‖ is a work lacking in originality, being a popularization of the ideas of Adam Smith.
He speculates that perhaps Ohlin was referring to earlier French writers, pointing specifically to Turgot to whom the following quote is attributed: Effectively, all one need do is to reflect upon the immense quantity of charcoal used in the reduction of metal and the equally immense quantity used in the production of iron, to convince oneself that however abundant the mineral, it cannot be brought into production unless it happens to be located near a large quantity of wood and that the wood has little value. . . . The production and sale of iron is assigned by nature to new nations, nations which possess vast untouched forests, far from all outlets, where one finds it advantageous to burn an immense quantity of wood for the sole value of the salts that one gains from washing the remaining cinders. This commerce, weak in England, still flourishing in France, much more in Germany and in the North, should, following the natural course of events, be taken up in Russia, in Siberia, and in the American colonies, until such time as they themselves become highly populated, and all nations find themselves in equilibrium, and until the increase in the price of iron is strong enough to renew interest in its production in those countries where it had been abandoned, the result of not being able to compete with the poorer nations. (Power 1987, 293) He then goes on to dispel this view, pointing out that Turgot himself was strongly influenced by the English economist Josiah Tucker. He concludes by noting that the HOH has a -far longer history that Ohlin was aware of, and it would seem most unlikely that it was first touched upon….in French works.‖ We agree and hasten to add that the equivocal nature of its historical antecedents speaks in large measure to the intuitive nature of the FPH. We would go further and add that the FPH is as old as trade itself, extending back millennia to the early empires and beyond.
It is interesting to note that Eli Heckscher was first and foremost an economic historian and author of a highly regarded -history‖ of mercantilism. It could be argued that anyone studying the history of early empires could not but hold the FPH as the guiding principle underlying world trade.
This brings us to Eli Heckscher's seminal 1919 paper in which he presents the HOH for the first time. Specifically, he examined trade through the prism of factor proportions, focusing on three inputs, namely land, labor and capital. Technology was assumed to be symmetric, making for the situation in endowments and factor intensities determined trade flows.
Clearly, this assumption was critical. Unlike the Ricardian model where comparative advantage was based in large measure on technological asymmetries, Heckscher had leveled the playing field, so to speak. With the benefit of hindsight, this assumption seems both misguided and misplaced. After all, Heckscher was an economic historian, having written the history of British industrialization. But more importantly, Heckscher wrote at a time of massive technological change in the form of the second industrial revolution. Ironically, he was unable-or unwilling-to acknowledge a nation's endowment in science as a possible source of comparative advantage. www.videleaf.com The second industrial revolution witnessed paradigm process and product innovations, not to mention the shift of economic, military and political power to the United States. U.S.-based multinational firms with their new process and product technologies conquered the planet, including Sweden. Great Britain was in decline, as was most of Europe. In short, if there was one factor endowment that marked to the point of defining Heckscher's era, it was the ability to innovate in general, and the U.S.' ability to innovate in particular. 2 One could go as far as to argue that Heckscher was in the wrong place at the wrong time. The early 20 th century was anything but a period of stable (read: unchanging) technology. In fact, it could be argued that most of the 20 th century was characterized by, to the point of being defined by, changing processes and changing products.
Not surprisingly, the HOH performed poorly, empirically speaking (Leontief 1953, Bowen, Leamer andSveikauskas 1987). After all, proprietary technological change against a backdrop of global vertical integration violated two of the model's most important assumptions, namely symmetric technology and immobile factors. In the late 1990s, an attempt was made to -salvage‖ the HOH by invoking country-wide technology and preference asymmetries (Trefler 1995, Trefler and Zhu 2000, Davis and Weinstein 2001. Using a 1983 data set consisting of nine factors and 33 countries, he like Bowen, Leamer and Sveikauskas was unable to corroborate the HOH. In fact, he went further, pointing out the presence of -missing trade,‖ which by definition is the absence of trade despite a nonnegligible factor endowment. Also, he found that rich countries (i.e. the North) were scarce in most factors, while poor countries were abundant. Pushing the analysis further, he invoked two possible explanations, namely higher productivity in the North and asymmetric preferences. Both hypotheses were tested and confirmed by the data. Davis and Weinstein showed that when the HOH is modified to permit technical differences, a www.videleaf.com breakdown of factor price equalization, the existence of nontraded goods and costs of trade, it is consistent with the data for 10 OECD countries.
The problem with this literature, however, is its apologetic nature. In fact, the HOH as originally formulated by Heckscher and Ohlin is barely recognizable. The HOH was about trade being determined by relative factor endowments (capital and labor) in a world of symmetric technology. In their model, trade is determined by a host of other factors, the origins of which are exogenous to the model. This is where our works enters. Namely, if (i) technology is indeed asymmetric as Trefler, Davis and Weinstein contend and (ii) technology is not exogenous, but rather is determined by a country's endowment of visionaries and scientists, then it stands to reason that a more complete reformulation of the FPH would include the determinants of technology as legitimate factor inputs and hence causes of comparative advantage and trade.
While these authors have addressed the question of technology and other possible ex-post rationalizations, they have failed to address two important shortcomings of the HOH literature in general, namely, the presence of global value chains (throughout the period under study, namely the 20 th century), the use of value-of-shipments as opposed to value added data and its aggregative nature. For example, Trefler assumes that all firms and all sectors of the U.S. economy have the same productivity advantage over their foreign rivals. U.S. copper mines are twice as productive as foreign ones despite the fact that in many cases, the latter are owned and operated by U.S. firms. Lastly, because HOH (or alternatively HOV) empirical tests use value-ofshipments data (WTO 2010), they invariably yield biased and unreliable results. In fact, one could go as far as to argue that value-of-shipments data explains the -mystery‖ of the North's sizeable trade volumes in the face of what are few abundant factors. More specifically, they bias the value of the North's exports upwards. Ideally, large-scale HOH tests should use value added-based export and import data. www.videleaf.com This paper attempts to deal with these problems, both theoretically and empirically, First, it begins with a complete or general formalization in which both material (land, labor, capital, energy) and immaterial (the propensity to innovate) factor endowments are considered at the industry level. The result ( the generalized factor proportions hypothesis -GFPH) is a more complete and far-reaching theory of international trade, one that is both intuitive and practical and one which includes Eli Heckscher and Bertil Ohlin's version as a special case.

II-Analytical Framework
For our purposes, the -problem‖ of international trade will be viewed as an optimal assignment problem where the social planner maximizes social welfare by assigning the production of goods (and services) to regions or countries on the basis of -comparative advantage.‖ In so doing, he maximizes the overall, system-wide gains from trade, thus maximizing welfare. In this paper, the social planner is replaced by individual firms that solve a similar optimal assignment problem. Specifically, the firm will localize in geographical space, the various vertical stages (or links) of the production value added chain on the basis of comparative advantage.
Our starting point is the vision-augmented value chain (VBVC) which consists of the vision (of the product and/or process, and the n vertical stages which together comprise the relevant value chain (Beaudreau 1989(Beaudreau , 2011. The former is defined in Lancasterian characteristic space consisting of the set of characteristics that define a product/service, while the latter consists of a multi-link, value chain (value tree), each defined by a specific material process. To capture the evolutionary character of VBVCs over time and consequently of trade (Nelson and Winter 1982), we consider a three-stage model. In the first stage, VBVCs are conceived of by visionaries/entrepreneurs/managers. Typically, this will involve either a new product and/or a new process and will be the result of a -vision-creating processes.‖ Conceptually, they can result from (i) an individual's imagination (e.g. Henry Ford, George Westinghouse, Nikolai Tesla), (ii) from informal R&D, and/or (iii) from formal R&D www.videleaf.com (i.e. R&D laboratory). The result is a set of VBVCs that run across industries and sectors. In the second stage, VBVCs take form with the creation of vertically-integrated value chains localized across regions/countries, the latter being defined primarily in terms of relative factor endowments and relative factor prices. Put differently, the value chain takes shape in time and space. In the third stage, VBVCs produce, sell and report earnings and a filter is then applied. Those that are profitable/successful go on to the next round/period and enter the set of VBVCs, while the others are meted out. In the next round/period, a similar three-stage process occurs with the surviving VBVCs and new ones that will have conceived of. Accordingly, there is no equilibrium in the conventional sense as new VBVCs are forever being conceived of while some VBVCs are being meted out. 3 We now turn to the Stage 2 optimization problem. Let v ij represent value link i of chain j, where i=1,2,3,.....m j , m j being the number of links in the j th value chain. Equation 1 describes Stage 2 link ij's process technology, defined over three inputs, ρ ij , natural resources, k ij capital and n ij labor. 4 Factor intensities are assumed to vary across links and across value chains. In general, upstream links (primary sector) are resource and capital intensive, while manufacturing links (secondary sector) are more labor intensive (however, increasingly less so, with the advent of 3 This framework is consistent with the -evolutionary regime‖ in evolutionary economics, defined by the following three-phase sequence: In the first phase, generic ideas originate; in the second phase, macroscopic (population-level) adoptions governed by various mechanisms (selection, path dependence, learning effects etc.) occur; in the third phase, stabilization based on highfrequency adoption, happens. 4 Energy enters the analysis via resources. However, in addition to being a factor input, it is also a link (sub-link) for each of the m j links. The idea here is simple. Energy rich regions/country will hold a vertical comparative advantage in the extraction/refinement of the energy in question. However, once extracted and transformed (refined/transported), it will enter each of the remaining m j links as a factor input (not an intermediate product or semi-finished good). Hence, energy sources will be a factor in structural vertical comparative advantage (e.g. Saudi Arabia); however energy products per se will constitute links/sub-links for all other activities. However, in cases where the energy in question is immobile (e.g. hydroelectricity), it stands to reason that energy can, conceptually speaking, constitute a source of a structural vertical comparative advantage. www.videleaf.com control technologies). Lastly, downstream links (e.g. advertising, distribution and marketing) are highly labor intensive (Beaudreau 1989). Equation 2 describes the corresponding Leontief, fixedproportions process technology where α ij corresponds to the ratio of resources per unit of link ij value added, α kij corresponds to the ratio of capital per unit of link ij value added, and α nij corresponds to the ratio of labor per unit of link ij value added.
The corresponding unit cost of Stage 2 link ij in region/country l can be formalized as Equation 3 where p  , p k , and p n are the corresponding link location-specific factor prices. describes the corresponding cost equation (Stages 1 and 2) for a given region/country (i.e. l). 5 K corresponds to the fixed cost of the VBVC (cost of the vision). 6 As such, the unit VBVC cost is a decreasing function of q j , the quantity of the final good/service produced. Here, the β ij 's correspond to the relevant Leontief 5 Here, it is assumed that all links are localized in the lth region/country. Later, we relax this assumption and allows for multi-localization value chains (i.e. more than one l). 6 Here, it is assumed that K is an up-front cost and not a residual in the Knightian sense. This assumption could be relaxed without affecting the results. In other words, factor payments to the "visionaries" could be part upfront, and part residual. Think of Steven Jobs drawing a salary from Apple as well as cashing in on higher-than-anticipated earnings via stocks or stock options.
value-chain input-output parameters. That is, to the units of link i output in the jth value chain.
We now proceed to formalize the process of link localization-that is, the localization in geographical space of the m j Stage 2 links of the representative value chain. Specifically, link localization is modeled in terms of classical optimization behavior where the firm (owner(s) of the relevant VBVC) maximizes profits/minimize costs by choosing localizations for each of the i Stage 2 links across the set of regions and countries. The relevant optimization problem (Equation 6) is relatively straightforward and consists of choosing link localizations l ij for all i=1, 2, 3, 4, …..m j in such a way so as to maximize overall value-chain profits. This differs somewhat from the conventional profit maximization problem in that here the firm (VBVC) chooses localizations for its links given the set of region/country factor prices, and not optimal quantities of factor inputs for each link of a given value chain. We believe that this approach describes well the potential firm's problem in a multi-region/country setting. Technology is Leontief in nature, leading firms to choose localizations (i.e. l ij 's), not relative factor input quantities (Markusen and Maskus, 1999) Consequently, the localization of the various Stage 2 links that comprise a given value chain will be based on the concept of relative factor abundance as measured by relative factor input prices. 8 For example, regions/countries that are labor abundant (e.g. Asia, India, Mexico) will/should have lower-than-average wages and, as such, will/should attract investment on the part of firms wanting to localize their labor-intensive links there. The presence of trade barriers will, as such, affect the outcome, forcing firms to localize production links in a sub-optimal fashion. Tariffs on imports of natural resources, semi-finished or finished products will, in general, favor home region/country investment for obvious reasons, as will various investment incentives (subsidies, tax incentives, local-content clauses). Likewise, restrictions on natural resource exports (unprocessed) will favor home region/country investment also. That is, the representative VBVC will localize more Stage 2 links in the natural resource-abundant region. 9 In the third and final stage, the market (consumers) selects from among the available VBVCs. Successful VBVCs will cover their costs and earn non-negative profits, while unsuccessful ones will be forced out. This corresponds to the selection stage (Nelson and Winter, 1982). Successful VBVCs will continue into the next stage, while unsuccessful ones will be forced out of the market, at least in their current incarnation. In some cases, the failure of a specific VBVC may be met with revisions/modifications, or the VBVC may be simply dismantled and sold-off. As it turns out, this is a common occurrence. Large, multi-VBVC corporations oftentimes sell off some of their divisions (e.g. IBM selling its PC division to Le Novo, Bombardier selling its recreational products division to Bain Capital), focusing on either the most profitable ones, or ones that are related to their -core activities.‖ www.videleaf.com

The GFPH and Vertical Comparative Advantage
This simple approach allows us to generate a number of predictions regarding regional/national vertical comparative advantage. More specifically, region/country-based vertical comparative advantage (Stages 1 and 2 combined) will be based on the relative endowments of four factor inputs, namely (i) the ability to generate VBVCs (knowledge), (ii) natural resources, (iii) capital and (iv) labor. The ability to generate VBVCs refers to a region/country's ability to literally come up with new products and processes-in short, innovate (Stage 1). This will depend on a number of factors-social, cultural, historical and economic (Lundstedt and Colagzier, 1982;Beaudreau, 1989;Griffiths and Kickul, 2008). Implicit here is the notion that regions/countries differ in their ability to innovate.
Here, we combine Stages 1 and 2. Specifically, an additional link (i.e. the conception of the VBVC) is added to the m j Stage 2 links. By combining both the attributes of a region/country (as defined by its endowments of the five factor inputs), with the exigencies of the value chain (for all m j +1 links), we can formalize link localization in terms of a simple assignment problem. That is, assign a particular link to its most likely localization. In other words, links that are labor intensive will be localized in labor-abundant regions/countries, those that are capital intensive will be localized in capital-abundant countries, etcetera. 10 Equation 7 formalizes this process in probabilistic terms. Specifically, p ijl , the ex-ante probability that link ij will be localized in region/country l, is modeled as an increasing function of the -technological exigencies‖ of link ij as they relate to the factor endowment of region/country l, defined as the inner product of the various factor intensities (i.e. the αs) and the ratio of region/country l's endowment to the overall world endowment. 11 Accordingly, if α κ is high, and κ l /κ w is low, then the probability that region/country l will attract the -conception of‖ VBVCs link will be low. That is, the region/country in question doesn't have the wherewithal to attract -conception of‖ VBVC links. Alternatively, if α k is high, and k l /k w is also high, then the probability that region/country l will attract the -conception of‖ VBVCs link will be high. As a rule, the more a region/country is well-endowed in a factor input, the greater is the probability that it will attract a link that makes intensive use of it. 12 If region/country l is capital abundant (i.e. its relative share of the overall world capital stock is non-negligible), then it will attract capital-intensive links.
This approach to link localization and vertical comparative advantage is probabilistic in nature. That is, relative factor abundance increases the ex-ante probability that a region will attract a compatible link. As such, a capital-abundant region may or may not attract capital-intensive links; however the presence of a low cost of capital will increase the ex-ante probability. 13 Equation 7 captures the essence of the generalized factor proportions hypothesis. 14 Whereas the HOH assumes that technology exists and is free, the GFPH model endogenizes it (i.e. Stage 1) and renders it proprietary (i.e. analogous to the notion of ownership advantage in the multinational firm literature- (Hymer 1976, Dunning 1981). Certain regions/countries will hold a vertical comparative advantage in the -conception of‖ VBVCs. Consequently, they will be home to the resulting corporations 12 Econometrically speaking, it consists of a Probit (0-1) model with the various factor intensities and factor endowments as the independent variables. 13 Equation 4 could be used to study both industrial and commercial policy. Specifically, it could be used to analyze and/or guide decisions to either finance or subsidize the presence of certain links on their territory. Another way of looking at this is that governments must combine the -winning combinations‖ for investment to occur-that is to maximize p ijl . 14 Another way of looking at Equation 7 is as an expression of factor proportions-based (link) localization theory. That is, one in which factor abundance constitutes the basis of localization decisions made within large, vertically-integrated multinational firms. www.videleaf.com (headquarters). 15 A good example is Silicon Valley in California, or Bangdalore in India. It is important to note that theoretically speaking, the localization of the first link will have no bearing on the localizations of the ensuing m j Stage 2 links.

Sectoral/Strands of Links Comparative Advantage
Sectoral comparative advantage can be defined as -entire‖-value chain comparative advantage and corresponds to the notion of horizontal comparative advantage found in classical and neoclassical trade theory. As our value chains are the sum of the m j +1 Stage 1 and 2 links, and strands of links, it stands to reason that sectoral horizontal comparative advantage can be defined and estimated for each localization (region and/or country). 16 For example, for region/country A to have a horizontal comparative advantage in value chain j, its relative final-good price (vis-à-vis value chain s) would have to be lower than in region/country B. 17 That is, the cost of localizing all m j +1 links in region/country A, relative to the same cost of a numéraire good (i.e. s), would have to be less than in region/country B.
In the context (and historical context) of globally-dispersed value chains, the very meaning of horizontal comparative advantage is very much in question (Hummels, Rapoport and Yi, 1998;Hummels, Ishii and Yi, 2001;Reimer, 2006;Johnson, 2008;Johnson and Noguera, 2008). It is our view that value chains have been rarely region/country specific, are rarely region/country specific and will no doubt continue to be rarely region/country specific. Since time immemorial (i.e. early trade empires), value chains have been geographically dispersed, making conventional horizontal comparative advantage a largely irrelevant (theoretically and empirically) and meaningless 15 Clearly, with time some VBVCs will enter the public domain and become -free goods,‖ however for our purposes, we will assume that all VBVCs are proprietary in nature. 16 Note that in both the Ricardian and Heckscher-Ohlin models, the Stage 1 link (conception of VBVC) is absent, making for only Stage 2 links. 17 This assumes that both regions can come up with comparable VBVCs. If not, then comparisons are meaningless. www.videleaf.com concept. For example, nineteenth-century Great Britain did not have a horizontal comparative advantage in textiles, but rather, had two vertical comparative advantages, namely a Stage 1 knowledge-based vertical comparative advantage in the conception of high-throughput, value chains and secondly, a Stage 2 vertical comparative advantage in the processing of the various fibers imported from its colonies (Beaudreau, 2004).
The emphasis on either defining or deriving sectoral horizontal comparative advantage at the country level, we believe, is, in large measure, to blame for the failure of comparative advantage to make important inroads in the empirical trade and policy literature (Beaudreau 2011). The value chains and the material processes that characterize most material processes are infinitely more complex than the trivial production functions/relationships found in international trade text books. Moreover, as pointed out, from time immemorial, value chains have been dispersed across regions/countries, making horizontal comparative advantage little more than an abstraction (Beaudreau 2011).

The GFPH-Based Vertical Comparative Advantage Taxonomy
Our approach easily lends itself to various taxonomies of regional/national vertical comparative advantage, starting at the very top/beginning of value chains (Stage 1), namely the ability of a region/country to generate/conceive of VBVCs (i.e. visions). Specifically, it can be argued that certain regions/countries will have a vertical comparative advantage in generating/conceiving of firm visions defined as products and their associated production processes (i.e. the business process). This is analogous to what Elhanan Helpman referred to as Headquartering Activity (Helpman 1984) and consists of the ability to generate new visions (i.e. new products, new processes). Its presence will depend on a number of factors, including R&D expenditure, education, and the overall level of innovation in the region/country (Lundstedt and Colgazier, 1982;Beaudreau, 1989;Griffiths and Kickul, 2008). Other regions/countries will have a Stage 2 vertical comparative advantage in natural resources based on their endowments. www.videleaf.com These include metallic and non-metallic ores, various chemical elements, energy and other carbon-based products (biomass). We assume that both of these vertical comparative advantages are, in the spirit of the Heckscher-Ohlin approach, exogenous (at least in the short run) and immobile. That is, the Stage 1 capacity to generate VBVCs not the VBVC itself, and natural resources will be considered immobile across localizations. 18 The former owes to the social, political, historical and economic nature of innovation (Lundstedt and Colgazier, 1982;Beaudreau, 1989;Griffiths and Kickul, 2008). Certain regions/countries are, owing to structural factors, more likely to generate Stage 1 VBVCs. What's more, because this advantage is rooted in the social and intellectual fabric of the region/country, it is not transferable (i.e. mobile).
To refine the analysis, we shall distinguish between two types of vertical comparative advantage, namely structural and arbitrage (see Table 1). Structural vertical comparative advantage refers to either the Stage 1 ability to generate VBVCs or to the presence of natural resources (Stage 2). 19 Arbitrage vertical comparative advantage refers to short-run comparative advantage-that is comparative advantage that owes to capital and labor factor-cost price differentials that owe, in turn, to the relative abundance of these factors in the region/country. VBVCs (firms) will as such have a financial interest in localizing the links that use the factor input in question intensively in the region/country. 18 For example, iron ore is assumed to be immobile; however, pig iron or steel is not. Likewise, oil wells are immobile; however, the oil itself is not. There are, of course, exceptions such as hydroelectricity which cannot be transported over long distances. In this case, both the resource and the output are immobile and hence a source of structural comparative advantage. 19 VBVC-based Stage 1 structural vertical comparative advantage is similar but not analogous to classical Ricardian comparative advantage. The latter is technology-based (i.e. knowledge) while the former is process-based (i.e. the process of generating knowledge). One could, however, argue that Great Britain held a structural vertical comparative advantage in steam-based process technologies at the start of the 19 th century as evidenced by the stream of innovations that followed James Watt's original steam engine. Examples include high-pressure steam and Charles Parson's Steam Turbine.
As these factor inputs are mobile, it stands to reason that any resulting vertical comparative advantage will, owing to arbitrage activity, be eliminated over time either by an increase in the demand for the factor in question, by an outflow of the factor input to other regions/countries (as owners of the factor look for a higher return), or by a combination of these two. For example, low wages in a given region/country will prompt labor intensive firms to localize in the region/country but will prompt workers to emigrate to high-wage regions/countries (Mundell 1957). 20 The answer is straightforward: structural comparative advantage. Well-endowed vision-producing and resource regions/countries would have a structural vertical comparative advantage. For example, in a world of perfect labor and capital mobility, Silicon Valley would continue to have a structural vertical comparative advantage in the conception of new IT products. As capital and labor would be identical across regions/countries, it stands to reason that it may or may not actually manufacture these products (e.g. the iPhone which was conceived of in Silicon Valley, but produced globally). Similarly, Milan would continue to have a structural vertical comparative advantage in designing new lines of clothing (fashion). Again, it may or may not manufacture these products. Resource-rich countries like Canada would, in such a world, continue to have a resource-based structural vertical comparative advantage, as would Africa and Australia. Arbitrage vertical comparative advantage would, on the other hand, not exist for obvious reasons. As factors could move across borders instantaneously, responding to factor-price differentials, a single price would emerge. In short, arbitragebased vertical comparative advantages would, in the long run all but disappear, leaving structural vertical comparative advantage as the ultimate arbitrager in so far as interregional and international trade goes. Regions/countries would either have a visions-based vertical comparative advantage, a resource-based vertical comparative advantage, some combination of the two, or no vertical comparative advantage whatsoever. 21 It is important to point out that it is not inconceivable for a region/country to have both a visions-based and resource-based vertical comparative advantage. For example, a region/country could be adept at -conceiving of‖ Stage 1 VBVCs as well as be wellendowed resource-wise. The corresponding Stage 2 manufacturing activity could, however, be localized elsewhere.
Hence, one could argue that vertical comparative advantage in the long-run is affected primarily by structural factors, not arbitrage ones, a fact borne out amply by history. Great Britain did not develop a vertical comparative advantage in feedstock processing on account of its capital, labor or energy endowment; www.videleaf.com rather, its vertical comparative advantage owed to its ability to generate new products and processes (i.e. knowledge-based vertical comparative advantage). Once developed, traditional factors (labor especially) found their way to England (from Ireland and Scotland) to oversee the workings of the new power drive technology known as the steam engine. It is also borne out by current industrial policy throughout Western industrialized countries that is based on R&D and product niches (i.e. Michael Porter's -clusters‖ and -diamonds.‖) Also, it validates and refines the Heckscher-Ohlin approach to trade, namely as being based on relative endowments. Specifically, long-run vertical comparative advantage is ultimately based on a region/country's relative endowments of knowledge and resources. Traditional factor inputs, being increasingly mobile, have less bearing on vertical comparative advantage. Good examples of this are the many outsourcing and plant relocalizations of the past two decades. As wages and interest rates adjust, it is quite conceivable that no one region/country hold a vertical comparative advantage in capital-, labor-or energy-intensive industries. Which would leave the two structural vertical comparative advantages.

The GFPH: The Evidence
As pointed out, one of the innovative features of the generalized factor proportions hypothesis is the unit of analysis, namely value added as opposed to goods. Not surprisingly, this will have far-reaching implications in so far as empirical work is concerned. Given the presence of global value chains (both historically and presently), it stands to reason that any and all tests using value of shipments data will be flawed and consequently of little scientific value (regardless of the findings). Ideally, value added data would be required (WTO 2010) for obvious reasons, not the least of which would be to avoid double, triple or quadruple counting. Since the dawning of modernity a century ago, there are few products that are produced entirely in a single region of country. The tendency towards the increasingly geographical fragmentation of value chains was accentuated in the 1980s by the energy crisis and the productivity slowdown. Increasingly, large multinational www.videleaf.com corporations outsourced their manufacturing operations (links in the value chain) to low-wage countries.
As value-added trade data are not available (and unlikely to be available in the near future), we propose an alternative approach to -testing‖ the generalized factor proportions hypothesis presented in this paper. In a nutshell, it consists of (i) reinterpreting the results of existing tests in light of the predictions of the GFPH, and (ii) offering a series of indirect tests à la Bela Belassa of the GFPH as the basis for vertical comparative advantage and hence international trade.

Existing Empirical Results Seen Through the Prism of the GFPH
We begin by reexamining the existing evidence through the prism of the generalized factor-proportions hypothesis. Operationally, this involves reinterpreting evidence in light of anecdotal and other information regarding the localization of the various links in a given value chain.
We begin with Wassily Leontief's early tests of the HOH using U.S. post-war data (Leontief 1953). In the 1950s, Leontief, the father of input-output analysis in the U.S., set out to test the commonly held, Heckscher-Ohlin based prediction that because the U.S. was a capital rich country, its exports would be capital intensive, while its imports would be labor intensive. Not surprisingly, this view subsumed a number of things, notably that U.S. exports and imports were entirely produced in the U.S. and its trading partners, respectively. History, however, shows this to be an erroneous assumption. By the mid 1950s, the U.S. had exhausted many of its resources (iron ore, forests, oil) and had become a net importer. Its strength lay in its ability to transform resources into U.S. VBVC-based commercially-viable goods and services. Cast in terms of value chains, U.S. activity was increasingly concentrated in downstream Stage 2 links (manufacturing).
While a surprise-and indeed a paradox-to most, the fact that U.S. imports were found to be more capital-intensive than its www.videleaf.com exports is consistent with our model. Raw materials are highly capital intensive, while manufacturing is, on average, more labor intensive. The U.S.'s vertical comparative advantage at the time was in (i) the Stage 1-based conception of visions-based value chains, and (ii) mid-stream manufacturing. While absent from Leontief's analysis, we speculate that the R&D intensity of U.S. exports at the time, would have been significantly greater than the R&D intensity of its imports.
It is worth noting that this result is not inconsistent with the commonly-held view (at the time) that the U.S. was wealthier than its trading partners if allowance is made for direct and indirect foreign investment.

The GFPH and Heterogeneity
Like most scholars, trade theorists long for regularity in so far as their results are concerned. In the 1960s and 1970s, most longed to find rich countries exporting capital and importing labor from poorer countries. Instead, they found a hodge-podge of results, some consistent with the theory, while others were abject violations-in short, heterogeneity.
While heterogeneity is anathema to HOH, it is consistent to the point of being predicted by the GFPH. Mobile labor and capital combined against a backdrop of multinational firms (global value chains) are sufficient to generate such results. For example, some multinationals might choose to exploit natural resources at the source (region/country), while others send them for processing elsewhere.
Where the GFPH generates more regularity is with regard to -structural vertical comparative advantage.‖ Specifically, it maintains that the ability to generate VBVCs and natural resources are the two -anchors‖ in so far as net factor exports and imports are concerned. This owes to their immobility. While products and processes can be exported or imported, the ability to conceive them cannot. It predicts that while the traditional factor inputs will yield heterogeneous results, these will not. Regions and countries that are well endowed with visionaries will continue to be net exporters of -headquartering activity,‖ while countries that are well endowed with resources will continue to be net exporters of resources.

Proto-Evidence of GFPH-Based International Trade
In this section, evidence of the GFPH at the regional level (within the U.S.) and at the country level is provided. To begin with, data on R&D spending and headquartering activity by U.S. state will be used to draw inferences about the ability to generate Stage 1 VBVCs. The basic idea here is that R&D and -visions‖ www.videleaf.com are, geographically speaking, collinear. 23 Regions within the U.S. that are R&D rich are also more likely to generate VBVCs. This will be followed by an attempt to draw inferences about country-level vertical comparative advantage from a series of Balassa-like factor intensity indices. It should be kept in mind that these findings are, at best, suggestive given the limitations of the data (value of shipments). We begin with U.S. interstate (inter-regional) trade, the underlying idea being that value chains in the U.S. are geographically dispersed across the fifty states according to vertical comparative advantage. That is, resource-rich states will process and export resources (Stage 2), while knowledge-rich states will, on average, produce and export Stage 1 knowledge/visions (VBVCs). Given the presence of perfect (or near perfect) labor and capital mobility within the U.S. it stands to reason that no one state will have an arbitrage vertical comparative advantage, putting the focus on structural vertical comparative advantages. 24 Two proxies are used for the presence of a knowledge-based, visions-generating structural vertical comparative advantage, namely research and development expenditure by state and, secondly, the number of Fortune 500 companies by state. Both, we argue, are proxies for the presence of a VBVC-generating culture, one that ultimately gives rise to new firms, products/services and material processes. Research and development expenditure by state is used as a proxy for the state's ability to generate VBVCs and hence have the corresponding structural vertical comparative advantage. It is important to note that this does not imply that the state in question will ultimately produce the good/service in question, but rather that the state is the -cradle‖ of the VBVC. Table 4 presents total R&D spending by state for 1997, gross state product (GSP), the ratio of the former to the latter, the state's share of overall R&D (Column 7), the corresponding rank (Column 6), and lastly the number of Fortune 500 firms (Column 23 Although, with the emergence of China and India, G6 multinationals are increasingly localizing R&D links abroad, making this link more dubious. 24 Seen in this light, the internal U.S. market is a metaphor for a world economy characterized by complete capital and labor mobility, one in which structural factors would determine vertical comparative advantage. Perfect labor and capital mobility within the U.S. makes for a situation in which knowledge and resources become the relevant comparative advantage criteria.

8).
Heading the list is California with R&D spending of $41 billion, a GSP of $1 trillion and 52 Fortune 500 firms. Next comes Michigan and New York with $13 and $12 billion in R&D, and 22 and 57 Fortune 500 firms, respectively. Whether measured in terms of Fortune 500 headquarters or R&D spending, there can be little doubt: the -golden state‖ and the -Empire State‖ have an important vertical comparative advantage in the generation of knowledge. One could argue that the first fifteen states on the list (from California to Minnesota) have a similar advantage, albeit of a lesser degree. New Jersey and Massachusetts both have a knowledge-based structural vertical comparative advantage. States in the bottom fifteen, it stands to reason, do not have such an advantage. States such as South Dakota, Wyoming, Alaska and Maine have a comparative vertical disadvantage when it comes to knowledge generation. It also stands to reason that their structural vertical comparative advantage, if it exists at all, will lie with their natural resources. It is well known that most of these states produce and export raw materials.
It is important to keep in mind that these results are suggestive of a pattern, of a trend, and not definitive. That California has a vertical comparative advantage in the -conception of products and processes‖ does not preclude mining activity in the state, nor does it preclude manufacturing. However, given that capital and labor are perfectly mobile within the U.S., one cannot infer the presence of a labor or capital-based arbitrage vertical comparative advantage. Similarly, they do not preclude the emergence of VBVCs in Colorado, Montana or Wyoming. A good example is Minnesota, a longtime resource-rich state that is also the home of 3M, a Fortune 500 company. www.videleaf.com

International Evidence
As previously mentioned, in an ideal world, trade statistics would be reported on a value-added basis, making the task at hand (providing evidence) all the more easier. As the above data on the U.S. economy make abundantly clear, regions and countries are highly heterogeneous in their makeup, making it difficult, if not impossible, to categorize them (e.g. capital abundant, labor abundant, etc.). 25 Large federal political entities like the U.S., Canada, Australia, France, Great Britain and Germany consist of multiple heterogeneous regions, each with any number of vertical comparative advantages. What follows is an attempt at categorizing countries according to their -dominant‖ vertical comparative advantage, despite the limitations to this approach raised in this paper (see Introduction). We begin by examining the relationship between traditional factor intensities (Heckscher-Ohlin) and knowledgebased structural vertical comparative advantage.  These three factor intensities were used to construct Balassa-like indices of the relative factor content of trade. 26 Specifically, weighted (by trade flows) averages of the R&D content, the electric power-labor ratio, and the capital-labor ratio of exports and imports were calculated for 110 countries. The weights in this case were derived using United Nations export/import data by industry. The complete results are presented in Appendix 1. Consider next the four other countries, Japan, Canada, Australia and Norway. 28 The Japanese results are similar to those of the U.S.: a net exporter of R&D and labor and a net importer of capital and energy (resource). Interestingly, it exports more R&D and imports more capital and energy than the U.S., a fact that can be attributed to the more homogeneous structure of its economy-that is, not having raw materials, its activities are concentrated in manufacturing. The U.S. and Japanese cases contrast with the latter three cases where each country is a net importer of R&D and a net exporter of capital and energy (resource). In the case of Norway, a dollar's worth of exports has less than one cent of R&D content, while a dollar's worth of imports has three cents of R&D content. Clearly, Norway's dominant vertical comparative advantage is resource based, a finding corroborated by the generally-accepted view of Norway as a resource-abundant country, especially with its share of North Sea oil. All three are resource-abundant countries which explains the relatively low R&D and high capital and energy 27 That the U.S. both export and import finished goods can be rationalized in terms of the heterogeneous nature of the VBVCs across countries (i.e. differentiated products). 28 Condensed results for 110 countries are presented in the Appendix where the ratio of R&D exports to imports, the ratio of k/n exports to imports and the ratio of e/n exports to imports are presented. We see, for example, that the U.S. R&D exports to imports ratio is 1.3676 (2.79/2.04 from Table 4).   29 Again, this is not to say that all regions within these countries have a resource-based structural vertical comparative advantage, but rather that the countries taken as a whole do. Also, as pointed out earlier, it does not preclude the existence of knowledge-based structural comparative advantages. For example, despite its important resource-based vertical comparative advantage, Canada has knowledge-based vertical comparative advantages in a number of sectors, including transportation, food processing and entertainment. The same holds in the case of Norway which despite its resource-based vertical comparative advantage has a knowledge-based Stage 1 vertical comparative advantage in the machine tool sector.

The GFPH and Trade Policy
The Ohlin-Samuelson formalization of the HOH suffers from a number of shortcomings not the least of which is the dearth of policy recommendations. While it offers a convenient framework to study price distortions (tariffs, subsidies) and other marketbased distortions (quotas), it offers little in the way of pro-active policy measures-that is, measures designed to alter fundamentals. In its 2x2x2 version, a country wanting to export more capital-intensive goods (typically referred to as manufactures) has to increase savings with the hope of increasing the rate of capital formation. As technology is free, investment in R&D is irrelevant.
In short, it leaves much to desire, especially in this, the age of R&D, innovation, Michael Porter's diamond, etc. Enter our formalization of the FPH. It is our view that the Generalized FPH model of trade presented here goes a long way to address the shortcomings of the traditional approach, especially with regard to technology, resources, value chains, and knowledge creation in general. Specifically, it is able to rationalize Michael Porter's diamond approach to the competitive advantage of nations in factor-proportions terms. Specifically, by fostering knowledge creation, a country can increase its advantage in the conception of products and processes (and the corresponding value chains).
In this section, we examine the policy implications of the GFPH as presented above. Unlike the HOH, the GFPH has important policy implications. Moreover, as it turns out, most of these are concordant with the policy measures that have been adopted in Western industrialized nations over the course of the past three decades, a finding that further corroborates the GFPH empirically. As argued, GFPH-based vertical comparative advantage can be either structural or arbitrage in nature. In the case of the former, vertical comparative advantage is based on knowledge and/or resources, while in the latter, it is based on labor or capital. As each can be affected by government policy, it stands to reason that vertical comparative advantage as defined here can be viewed as an endogenous variable. 30 We begin by examining the first of two types of vertical comparative advantage, namely structural vertical comparative advantage.
Structural vertical comparative advantage consists of either broadly-defined knowledge-based vertical comparative advantage or broadly-defined natural resource-based vertical comparative advantage. A knowledge-based vertical comparative advantage refers to the ability of a given region/country to generate knowledge in the form of VBVCs . While research and development expenditure is typically invoked as the relevant policy instrument, it is, by no means, the only instrument. As we have argued, knowledge is a cultural phenomenon, one that is intimately tied to cultural values (Lundstedt and Colgazier, 1982;Griffiths and Kickul, 2008 (Beaudreau 1989). Table 7 presents a non-exhaustive list of vertical comparative advantage policy tools, ranging from education, R&D, to tax policy. Given the existence of two types of advantages, there are two types of tools, namely those aimed at structural vertical comparative advantage and those aimed at affecting arbitrage vertical comparative advantage. Structural vertical comparative advantages have the advantage of being more permanent. An arbitrage vertical comparative advantage can, given the mobility of capital and labor, be ephemeral-here today, gone tomorrow. Tax holidays will attract capital; however, it is not clear that the resulting advantage will be permanent, unless of course it can generate some form of localization-specific knowledge which, over the long run, would give rise to a structural vertical comparative advantage. Likewise, immigration and/or high birth rates may result in an arbitrage vertical comparative advantage; however, labor market conditions abroad may evolve in such a way so as to eliminate it. 31 Beaudreau (1989) empirically demonstrated that R&D content in international trade is an increasing function of a number of cultural values, including expenditure on education, number of book titles published, and political and religious freedom. www.videleaf.com Of the policy tools enumerated in Table 7, education and R&D are by far the most utilized. Whereas prior to the 1980's government policy focused on stabilization (Keynesian), since, governments have sought to foster the creation of knowledge with two goals in mind, namely increasing overall growth and generating comparative advantage (OECD 2007). As growth is assumed to be increasing in exports, it stands to reason that countries will want to invest massively in knowledge. Which is precisely what we observe. Governments, ranging from federal to state to municipal have, over the course of the past two decades, adopted policies aimed at generating structural vertical comparative advantages for their city/state/country.
Another important policy implication of our analysis pertains to welfare analysis. In the majority of cases, government-sponsored investment in education and R&D is motivated by a number of considerations, the most important of which is job and wealth creation. For example, the government of Brazil has invested heavily in its aeronautics industry by way of subsidies, loans and tax breaks for Embraer, its premier multinational. However, given the spatially diffuse nature of value chains (i.e. global value chains), it is by no means clear that the creation of a structural vertical comparative advantage will confer wealth upon the region/country. As we have shown, Stage 1 and Stage 2 in our model are completely independent. Regions/countries that develop VBVCs are not necessarily those that will produce the corresponding goods and services. According to John D. Pepper, former chairman of the board of Proctor and Gamble: I will start by discussing the importance of global innovation www.videleaf.com leadership. In our businesses, innovation leadership, not just in the U.S. but globally, is vital to building market leadership and a strong economic position here in the United States. Why? There are two reasons. First, there are major scale advantages that come from being global. We're able to purchase raw and packaging materials from the best and most capable global suppliers. This not only lowers costs but permits suppliers to invest in their own discovery research that can lead to stronger product innovation.
Probably even more importantly, global R&D capability gives us access to leading-edge scientific developments, technologies, and new ideas, wherever they exist. Our competitors scour the world for the best ideas. We must do the same; indeed we must be ahead of them. Otherwise, we will lose our leadership position, not only abroad, but also here in America. This I think we'd all agree is not debatable. (Pepper, 1999, 1)

Summary and Conclusions
Finding the HOH version of the FPH to be theoretically and empirically incomplete, especially with regard to technology (endogenous technological change) and institutions (the presence of geographically-dispersed value chains, immobile factor inputs), this paper set out to rehabilitate the factor proportions hypothesis of trade, be it regional or international. The gist is simple and straightforward, and turns around a fundamental oversight in Eli Heckscher and Bertil Ohlin's pioneering work, namely the absence of endogenous technology and multinational firms. What is surprising is the fact that the 1910s, 1920s and 1930s were decades of massive technological change, which altered trade patters significantly, if not paradigmingly. Once sufficient allowance is made for endogenous technology (specifically via a country's endowment of VBVCs) and for spatially-dispersed value chains, the predictions of the FPH are consistent with the data. Also, the Leontief Paradox is -resolved‖ as are the conflicting and conflicted findings of Harry Bowen, Edward Leamer and Leo Sveikauskas, and Neil Foster, Robert Stehrer and Gaaitzen de Vries.
The resulting General Factor Proportions Hypothesis upholds the view that factor endowments are the basis of trade. It is sufficiently general to allow for both mobile and immobile factors. In its most realistic form, knowledge (read: knowledge generation) and natural resources are viewed as being immobile while capital and labor are mobile, thus giving rise to two types of vertical comparative advantage (VCA), namely structural and arbitrage. As such, regions/countries can be ranked according to their factor proportions-based vertical comparative advantages. Moreover, governments can through the judicious use of policy affect their VCAs. As was shown, the large majority of trade policy measures (i.e. policy instruments) used today are consistent with the predictions and recommendations of the model.
Further, the General Factor Proportions Hypothesis as developed here (i) endogenizes Ricardian trade theory (ii) incorporates the concept of value chain (value bush), and (iii) allows for the presence of multinational firms and value chains. More specifically, Ricardian technology-based comparative advantage is modeled in factor-proportions terms. Regions and countries that are well-endowed with innovative entrepreneurs/managers will generate more product and process-based VBACs resulting in a Ricardian vertical comparative advantage. Unlike traditional approaches that are based on simple neoclassical production functions, this paper innovates by incorporating the concept of value chain, a key concept in this the era of www.videleaf.com globalized production, as well as the multinational firm. Altogether, this makes for a more realistic, not to mention compelling, view of interregional and international trade, one that is consilient with the related fields of business strategy, the multinational firm, and process engineering. www