The Empirical Economics Letters, 7(5): (May 2008) ISSN 1681 8997

How Important is Water Endowment for Trade in

Agricultural Products?
Gairuzazmi M. Ghani
Department of Economics, KENMS, International Islamic University Malaysia
P.O. Box 10, 50728 Kuala Lumpur, Malaysia
Email: gairuzazm@iiu.edu.my
Abstract: Water is an important input for the production of agricultural products.
Hence, following the Heckscher-Ohlin model and the virtual water hypothesis,
relatively water abundant countries will have comparative advantage in agricultural
products. We show that water endowment does play a role in determining agricultural
products’ comparative advantage, especially for net importing countries.
Keyword: Virtual Water, Trade Patterns, Agricultural Trade, and Hecksher-Ohlin.
JEL Classification Number: Q17, Q25, and F18.

1. Introduction
We show that water endowment plays a role in determining comparative advantage in
agricultural products, especially for net importing countries. Across sectors, agriculture is
the most intensive water user, accounting for more than 70 percent of global fresh water
withdrawal1. Water endowment across countries also differs, hence, following the
Heckscher-Ohlin (HO) model; water endowment is important in explaining comparative
advantage in agricultural products. Furthermore, the virtual water (VW) hypothesis shows
that a country can reduce its water withdrawal substantially by importing the embedded
water in the agricultural products instead of producing them domestically. Virtual water is
thus an alternative water source, next to domestic water sources. At the global level, trade
also save water if exporters use water more efficiently than importers, or when exporters
cultivates under rain-fed conditions, while importers rely on irrigated agriculture. The
importance of water in the agricultural sector, the potential global water saving because of
trade and the differences in water endowment across countries, justify the study’s objective
in examining the importance of water endowment in determining comparative advantage in
agricultural products.
2. Trade in Agricultural Products and Water Endowment – Background
Even though water is an important factor of production for agricultural products, the
literature on international trade has not examines the importance of water directly. The

1
Withdrawal is the gross amount of water extracted from any sources either permanently or
temporarily for agriculture, domestic or industrial use.
The Empirical Economics Letters, 7(5): (May 2008) 506

exceptions are Hakimian (2003) and Sayan (2003). They show that water endowment is
important in determining the direction of trade in agricultural products for the Middle East
and North African countries. However, the results from Hakimian (2003) are sensitive to
the definition of water used. On a related literature, Leamer (1984) who study the sources
of international comparative advantage across industries, and, Peterson and Valluru (2000)
who study the effect of government policy interventions on agricultural comparative
advantage, indirectly test the importance of water endowment by embedding water in the
type of lands. Meanwhile the literature on virtual water (see Hoekstra, 2007) measure water
used in the production of different products, but not the direction of trade or the importance
water in determining comparative advantage in agricultural products.

2.1. Importance of Water for Agriculture

Agricultural sector accounted for about 70% of global fresh water withdrawals in 2000.
This is in contrast to the industrial sector, which accounted for 20% of withdrawals, and
household use which accounted for 10%. For developing countries, on average, agricultural
sector accounted for 81% of water withdrawals, but it only accounted for 45% of
withdrawal for developed countries. The difference is because the share of agricultural
sector in developed countries is small compared to developing countries. In term of output,
agricultural sector accounted for 15.4% of GDP in developing countries, while it accounted
for 1.7% of GDP in developed countries2. The disproportionate share of water use by
agricultural sector and the output from agricultural sector further highlight the intensity of
water used for agricultural production. The intensity of water usage can be further
demonstrated at the disaggregated product level. It takes between 500 to 4,000 liters of
crop water to produce one kilogram of cereal (Fraiture et al., 2004). About 1-2 m3 of water
are needed to produce 1 kg of grain3, 16 m3 of water are needed for 1 kg of beef and 105
kg of water to produce 1 kg of potatoes (Chapagain & Hoekstra, 2003).

2.2. VW and HO
VW is the volume of water required to produce a commodity or service. Allan (1993)
introduced the concept when studying the option of importing virtual water as a partial
solution to problems of water scarcity in the Middle East. Virtual water import, which
come along with food imports, provide a tool to release the pressure on the scarcely
available domestic water resources in the region as the importation of agricultural products
indirectly import water. Meanwhile, following the HO model, trade in goods is an indirect
way of trading factors of production. The HO model is based on two essential premises: (i)

2
Source: World Development Indicators CD-ROM and Pacific Institute. www.worldwater.org
3
1 m3 = 1000 kg
The Empirical Economics Letters, 7(5): (May 2008) 507

countries factor endowments varies, and (ii) resources intensity for production varies for
different products. Applying the HO model to water resource yields similar results to that
of the virtual water hypothesis. Given that production of agricultural products is water
intensive, both the HO model and the VW hypothesis predict a specialization pattern that is
based on imports of agricultural products from relatively water abundant to relatively water
scare countries.

3. Comparative Advantage in Agricultural Products (HO Model)

To justify the empirical approach in explaining comparative advantage patterns, we follow
Leamer (1984) by considering the standard HO theory. Assuming Leontieff technology, the
system of equations that relate factor supplies to factor demands is given as:

K = a K 1Y1 + a K 2Y2 (1)

L = a L1Y1 + a L 2Y2 (2)
where K and L are the amounts of factors, available in a country. These factors varies by
countries and are not mobile internationally. Y1 and Y2 denote the quantity of the two
products produced in the country. aK1, aK2, aL1, and aL1, are the factor intensities determined
by the production technologies of each products, and they represent the units of factors
required to produce a unit of output. Equations (1) and (2) can be generalized to a model
with multiple products and factors of production as long as the latter do not exceed the
number of products, or as long as the model is just identified or under-identified. Hence:

Y = A −1V (3)
where Y is the vector of outputs, V is the vector of endowments and A is the vector of factor
intensities. A is invertable as long as the production technologies are different across
sectors so that the ratios of factor intensities across sectors are not identical. Consequently,
world production is given by:
YW = A −1VW (4)
where YW is the vector of world outputs and VW is the vector of world endowments.
Assuming identical homothetic preference, a country consumption levels (C) is:

C = sYW (5)
where s is the country’s consumption share. Under balanced trade, from (3), (4) and (5), the
vector of net exports is the product of the inverse of the vector of factor intensities across
product clusters and the difference between each country’s vector of endowments and the
world’s vector of endowments, i.e.:
NX = Y − C = A −1 (V − sVW ) (6)
The Empirical Economics Letters, 7(5): (May 2008) 508

A country with balanced trade will export the services of its abundant factors and import
the services of its scarce factors. However, the balanced trade assumption for a single year
can be relaxed when panel data is used. Deardorff (1994) points out that the model holds in
multiple periods as long as trade is balanced over all periods together.

4. Empirical Approach
To examine the importance of water endowment in determining comparative advantage we
estimate the following model, for product cluster i (cereal, animals and tropical
agricultural).
NX jt = α j + A −1V jt + µ jt (7)

where NX is the net export of product cluster i by country j at time t, A is the factor
intensities matrix, V is the matrix of country-specific relative factor endowments and α is
the individual country effect. We use the cluster shares of the sum of the absolute value of
net exports (NXij) as a proxy for net export (see Leamer et al, 1999):
nx ij
NX ij = (8)
∑ nxij
i
where nxij is the net export of product cluster i from country j. The variable NXij ranges
from –1 to +1 where a positive value mean that the country has a comparative advantage
and hence exporting the product, while a negative value mean that the country is a net
importer of the products. We divide the product cluster into (i) raw materials, (ii) forestry,
(iii) tropical agriculture, (iv) animals, (v) cereal, (vi) labor intensive, (vii) capital intensive,
(viii) machine, (ix) chemical (see Leamer, 1984; Xu, 2001). Only the results for
agricultural products i.e cereal, animals and tropical agricultural products are reported. To
measure relative endowment (adjusted for openness) we follow Spilimbergo et al. (1999),
where adjusted relative endowment (REjf) is:
E jf
RE jf = ln * (9)
Ef
And
⎛ ⎞
⎜ E pop ⎡ X + M ⎤ ⎟
∑ ⎜ jf j ⎢⎣ gdp ⎥⎦ ⎟
* j ⎝ j⎠
Ef = (10)
⎛ ⎡X +M ⎤ ⎞
∑ ⎜⎜ pop j ⎢⎣ gdp ⎥⎦ ⎟⎟
j ⎝ j⎠
The Empirical Economics Letters, 7(5): (May 2008) 509

Ejf is the endowment of country j in factor f, popj is the population in country j, X is

exports, M is imports and gdp is gross domestic products. In addition to water, we also
include the three traditional factors endowment, namely land, labor, and capital. The data
are of 10 year interval for the period 1970-2000. Data sources are reported in Appendix A.
Suspecting non-linearity we estimate (7) in two steps, firstly we use Logit model where
NXjt is equal to 1 for net exporting countries and 0 for net importing countries. Then we
estimate the fixed and random effects model on the group of net exporting and net
importing countries. Table 1 reports the results for the Logit model. Table 2 and 3 report
the fixed and random effects results for the net exporters and net importers respectively4.
Table 1 show that relative water endowment is statistically significant at conventional level
in explaining the probability of being a net exporter or importer for animal products;
however it is not significant for cereal and tropical agriculture. The second stage of
regressions (Table 2 and 3) shows that for the net exporters, relative water endowment is
not significant; however, for the net importers the coefficient for water endowment is
significant. The results mean that for the net importers, countries which have relatively
small amount of water import relatively more agricultural products; however the
implication cannot be extended to exporting countries. For the exporting countries, water
endowment is not a statistically significant factor in explaining trade in agricultural
products. This may be the case because agricultural products require a certain minimum
amount of water; after the requirement is fulfilled the excess water does not provide any
advantage to the country. The exporting countries have the minimum required level of
water; hence the determination of comparative advantage does not depend on water
endowment but the other factors.

Table 1: Random Effect Logit Model

Cereal Animal Tropical
Water 0.308 0.529** 0.472
Land 1.539** 1.269** -0.487
Capital -0.193 -1.141** -0.988**
Labor -1.526** -0.412 1.162
No. of .Observations 289 290 290
No. of .Groups 91 92 92
χ2 15.79** 20.54** 11.62**
Notes: Dependant Variable is probability of being a net exporter. ** denotes significance at 5% level.

4
Only the coefficient for water endowment is elaborated as the objective of the paper is on the
importance of water.
The Empirical Economics Letters, 7(5): (May 2008) 510

Table 2: Fixed and Random Effects for Net Exporter

Cereal Animal Tropical

Fixed Random Fixed Random Fixed Random
Water -0.105 -0.009 0.003 -0.005 -0.006 0.003
Land 0.024 0.039** -0.059** -0.008 -0.026 -0.034**
Capital -0.023 -0.012 0.010 0.011* -0.052** -0.031**
Labor 0.092 -0.025 0.045 -0.007) 0.018 0.048**
N.Obs 104 104 162 162 174 174
N.Groups 48 48 64 64 64 64
R-squarea 0.104 0.152 0.065 0.163 0.345 0.161
Chi-squareb 7.81* 6.83 34.14**
Notes: a for fixed effect R2 and R2 is overall for random effects. .b Chi square from Hausman test. **
denotes significant at 5% level and * denotes significant at 10% level

Table 3: Fixed and Random Effects for Net Importer

Cereal Animal Tropical

Fixed Random Fixed Random Fixed Random
Water 0.097** 0.013** 0.037** 0.003 0.049** 0.003
Land -0.019 0.012** -0.019 0.002 0.006 0.003
Capital -0.005 0.014** -0.024** -0.003 -0.014 0.001
Labor -0.078** -0.037** 0.012 -0.002 -0.025* -0.008
N.Obs 186 186 128 128 116 116
N.Groups 74 74 50 50 45 45
R-squarea 0.273 0.298 0.085 0.069 0.254 0.013
Chi-squareb 24.74** 5.81 20.37**
Notes: a for fixed effect R2, and R2 is overall for random effects. b Chi square from Hausman test. **
denotes significant at 5% level and * denotes significant at 10% level.

5. Conclusion
Water is important in the production of agricultural products. Following the HO model and
the virtual water hypothesis, relatively water abundant countries will have comparative
advantage in agricultural products. We show that results of the two models support
especially for net importing countries. For animal products water endowment does explain
the probability of being a net exporter or importer.
The Empirical Economics Letters, 7(5): (May 2008) 511

References
Allan, J.A., 1993, Fortunately there are Substitutes for Water Otherwise our Hydro-
Political Futures would be Impossible, In Priorities for Water Resources Allocation and
Management, London, United Kingdom, pp. 13–26.
Baier, S., Dwyer, G. and Tamura, R., 2006, How Important are Capital and Total Factor
Productivity for Economic Growth, Economic Inquiry, 44, 23-49.
Chapagain and Hoekstra, A.Y., 2003, Virtual Water Trade: A Quantification of Virtual
Water Flows between Nations in Relation to International Trade of Livestock and
Livestock Products, Virtual water trade Proceedings of the International Expert Meeting on
Virtual Water Trade Ed. A.Y. Hoekstra.
Fraiture, C., Cai, X., Amarasinghe, U., Rosegrant, M. and Molden, D., 2004, Does
International Cereal Trade Save Water? The Impact of Virtual Water Trade on Global
Water Use, International Water Management Institute.
Hakimian, H., 2003, Water Scarcity and Food Imports: An Empirical Investigation of the
'Virtual Water' Hypothesis in the MENA Region, Review of Middle East Economics &
Finance, 1, Article 1.
Leamer, E.E., 1984, The Sources of International Comparative Advantage, MIT Press,
Cambridge, MA.
Leamer, E.E., Hugo Maul, H., Rodriguez, S., and Schott, P., 1999, Does Natural Resource
Abundance Increase Latin American Income Inequality? Journal of Development
Economics, 59, 3-42.
Peterson, E.W.F., and Valluru, S.R.K., 2000, Agricultural Comparative Advantage and
Government Policy Interventions, Journal of Agricultural Economics, 51, 371-87.
Sayan, S., 2003, H-O for H2O: Can the Hecksher-Ohlin Framework Explain the Role of
Free Trade in Distributing Scarce Water Resources Around the Middle East? Review of
Middle East Economics & Finance, 1, Article 2.
World Bank., 2003, World Development Indicators CD-ROM.
The Empirical Economics Letters, 7(5): (May 2008) 512

Appendix A: Data Sources

Variable Description Source
Import and Export Value 1. Raw Materials (SITC 27, 28, 32, UN COMTRADE.
34, 35 and 68)
2. Forest Products (SITC 24, 25, .63
and 64)
3. Tropical Agriculture (SITC 5, 6,
7, 11 and 23)
4. Animal Products (SITC 0 to 3,
21, 29, 43, and 94)
5 Cereals, Oil, Textile Fibers, Tobaco
and others (SITC 4, 8, 9, 12,
22, 26, 41, and 42)
6. Labor Intensive (SITC 66, 82 .
to 85, 89, 91, 93 and 96)
7. Capital Intensive (SITC 61, 62,
65, 67, 69 and 81)
8. Machinery (SITC 71 to 79, 87,
88 and 95)
9. Chemicals (SITC 51 to 59)
Water Endowment Natural renewable water resources- World Resource Institute
the sum of internal and external
renewable water resources. It
corresponds to the maximum
theoretical amount of water available
for a country on an average year on a
long reference period.
Capital Baier, Dwyer, and Tamura
(2006).
Labor Baier, Dwyer, and Tamura
(2006)
Arable Land World Development Indicators
The Empirical Economics Letters, 7(5): (May 2008) 513

Appendix B: List of Countries

Algeria Egypt Madagascar Senegal
Angola El Salvador Malawi Sierra Leone
Argentina Ethiopia Malaysia Singapore
Australia Finland Mali Somalia
Austria France Mauritania Spain
Bangladesh Germany Mauritius Sri Lanka
Belize Ghana Mexico Sudan
Benin Greece Mozambique Sweden
Bolivia Guatemala Nepal Switzerland
Botswana Haiti Netherlands Syria
Brazil Honduras New Zealand Tanzania
Burkina Faso Hong Kong Nicaragua Thailand
Burundi India Niger Togo
Cameroon Indonesia Nigeria Trinidad and Tobago
Canada Ireland Norway Tunisia
Central African Republic Israel Pakistan Turkey
Chad Italy Panama Uganda
Chile Ivory Coast Papua New Guinea United Kingdom
Colombia Jamaica Paraguay USA
Congo Japan Peru Uruguay
Costa Rica Jordan Philippines Venezuela
Denmark Kenya Portugal Zaire
Dominican Republic South Korea Rwanda Zambia
Ecuador Liberia South Africa Zimbabwe