Factor content of bilateral trade: the role of firm heterogeneity and transaction costs

The article studies the determinants of the factor content in foreign trade in countries from Central and Eastern Europe (CEE). The theoretical model relaxes several important assumptions such as factor price equalization, firm heterogeneity, and introduces technological differences into the standard Heckscher–Ohlin model. Based on the agricultural production and trade data for the CEE, we examine empirically three hypotheses, which relate cross‐country differences in technology, relative factor abundance and transaction costs and market imperfections to the factor content of trade. We find that the first two hypotheses are confirmed by the majority of the developed EU countries, but rejected by roughly one half of the CEE transition country pairs. Second, we find that when accounting for the transaction costs of farm (re)organization, both hypotheses are confirmed by the majority of the CEE country pairs. These findings provide indirect evidence of market imperfections, and particularly, of transaction costs of farm (re)organization in the CEE.