An Empirical Test of the Dixit-Norman Approach to Factor Price Equalisation, Using Co-Integration Techniques

Factor price equalisation in the Dixit-Norman approach occurs when the international trade equilibrium reproduces allocations and output of the integrated world economy (IWE), in which the trading countries would form one economy with perfectly mobile goods and factors. Based on this concept, Deardorff (1994), gives a necessary condition for factor price equalisation, which can be straightforwardly tested, provided one has an idea of the IWE. We argue that this test can be performed for a set of countries, if one disposes of an external reference economy, comparable in size, technology and tastes. By considering Germany as such, the original EC members less Luxembourg and Italy, fulfill this requirement and seem a suited case to perform this test. Data are used from the International Sectoral Database of the OECD. Concerning the estimation technique, we prefer co-integration estimation to OLS and SURE, as endogenity of variables is likely and, anyway, variables are not stationary. This is verified by univariate Dickey Fuller unit root tests. Using the coefficient restrictions, estimation is performed with the factor endowments of two remaining countries (France and Belgium) and German sector allocations. Finally, factor price equalisation is checked by testing the appropriate coefficient restrictions, following Johansen (1995) and Johansen and Juselius (1994). Concluding, we find no evidence of a long term trade equilibrium with factor price equalisation for the countries considered