Abstract
As capital markets have become integrated, factor prices have not converged as expected. This paper provides an explanation. The key observation is that non-specific output risks are borne by capital, making international portfolio diversification a dominant strategy. Capital market integration can elicit many patterns of factor-price response under this circumstance. Factor prices will move in parallel if countries are identical; when countries differ, factor prices may diverge, or even have their relative sizes reversed. The integration of capital markets affects welfare through changes in risk and in overall returns to savings: welfare need not improve.