LIONTIEF

PARADOX
GROUP 1
CHIMUSORO, MABUKA, MURINGAZUVA AND DUBE

QUESTION

Using journal papers and Markusen et al, analyze

Chapter 14s Section 14. 1 through to Section 14.4.
In your presentation, answer the following:

a) Explain why Leontiefs result was considered to

be paradoxical. Why do economists consider this
approach to have been only an incomplete test of
the Heckscher-Ohlin model

b) Critically evaluate the various attempts that

have been made to resolve the Leontief Paradox

Trade Theories-complications

They are difficult to test directly eg gains from

trade-there is no autarky data

So many simplifying assumptions which are not

true in real life

Various trade theories should not be seen as

competing hypothesis but rather we must asses
the relative importance and contribution of each

Ricardian Model

Assumes that different technologies in different countries

generate different labour productivities which determine
comparative advantage

The proposition that countries specialize in goods they

export is rejected countries produce even imported
goods and non-traded goods

Economists have not devoted much effort in analysis to

verify that labour productivity difference constitute an
important determinant of trade

His assumptions were too simple ignored transport

costs, imperfect competition and product differentiation

Leontief paradox
Leontief

(1953) did the first and most influential study of the HO

model.
His findings came to be known as the Leontief paradox.
He developed the set of input-output accounts for the U.S. economy,
which allowed him to compute the amount of labour and capital
used in each industry for 1947.
In addition, he utilised U.S. trade data for the same year to compute
the amounts of labour and capital used in the production of $ 1
million of U.S. exports and imports. This calculation requires that we
measure the amount of labour and capital used directly (in export
industries) and indirectly (intermediates input that is used in the
exporting industries).
He found that $2.5 million worth of capital was used in producing $1
million of exports. For labour, 182 person-years were used to
produce the exports. Taking the ratio of these, he found that each
person employed in producing exports was working with $13,700
worth of capital. This result is showed in table 1.

Table 1:Leontiefs Test (1953)

IMPORTS

EXPORTS

Capital ($ million)

$3.1

$2.5

Labour (personyears)

170

182

Capital / Labour
($/person)

$18,184

$13,991

Methodology

To determine the imports side of the calculation, Leontief

simply used the US technology to calculate the amount of
labour and capital used in imports.

This was consistent with the assumption of HO model that

technologies are the same across countries.

However, we can argue that the best way to determine the

imports side of this calculation is to have knowledge of
foreign technologies.

The result of this calculation is given in table 1. We can

observe from Table 1 that the capital/labour ratio used in
imports is higher than the capital/labour ratio found for U.S.
exports.

Under the presumption that the US was capital abundant in

1956, this appears to contradict the HO model.

Incomplete test of the HO model?

Researchers gave a wide of reasons for this paradox.

U.S. and foreign technologies are not the same.

Leontief ignored other factor of production, for example, land.

data for 1947 could be unusual since World War II just ended.

Fourthly, U.S. was not engaged in free trade as HO model

assumes.

Leontief should have separated labour by skill (it would not be

surprising to find that U.S. exports were more skilled intensive).

Despite the wide range of objections, Leontiefs basic

methodology has been reapplied in many works which include
Baldwin (1971), Mitchell (1975), and Stern and Maskus (1981) and
the results have typically reaffirmed the paradox for the early
years but found that it may have disappeared by 1970.

Explanations of the paradox

Assumptions are too strict to be believed

Preferences differ across countries rather than being

homogeneous and identical-some countries may have
strong preferences for goods in their comparative
advantage

It is in adequate to suppose that there are 2 FOP, L

and K, further, L and K differ between countries i.e a
worker in Country A may not share similar
productivity characteristics with a worker in country B

International structure of trade barriers can explain

the paradox i.e no free trade

Studies to resolve the Leontief Paradox

Much

research has been done to try to

resolve the paradox

These

include: Minhas (1962)- Keesing

(1966) ,Baldwin (1971), Mitchell (1975),
Harkness (1978), Learmer (1980) ,Stern
and Maskus (1981), Bowen (1983) ,
Bowen, Leamer and Sveikaukas (1987),
Trefler (1993), Davis, Weinstein, Bradford
and Shimpo (DWDS, 1997), Davis and
Weinstein (2001),

Minhas (1962)-FIR
Minhas

(1962) found evidence that

FIRs are fairly commonplace.

Later

work by Hufbauer (1966) and Ball

(1966) suggests that Minhas
overstated the matter; there may be
some FIRs in the real world, but not as
many as Minhas suggested.

It

would seem that if there is an

explanation of the Leontief paradox, it
lies elsewhere.

Baldwin (1971)

Baldwin examined the factor content of U.S. trade for

1962, using a wide range of factors and distinguishing
between physical and human capital

He found those industries using more scientist,

craftsmen and foreman, or farmers relative to total
workers tended to have higher exports. This was
consistent with the U.S. economy as the U.S. is abundant
in skilled-labour and land. He also found that the
inclusion of human capital significantly weakened the
Leontief Paradox, but was not sufficient to reserve it.

He also reported that the exclusion of natural resourcebased products almost eliminated the paradox

The U.S. Tariff Structure

The

tariff structure could make the Leontief statistic artificially

high, and perhaps lead to the paradox.

Suppose

that (K/L)exp = $16,000.

Then

the fact that tariffs exist means that the Leontief statistic
is $18,333/$16,000 = 1.14; it would have been
$14,500/$16,000 = 0.9 under the assumption of free trade.

This

means that Leontiefs paradox might be the result of tariffs,

and isnt evidence against the H-O model

study by Baldwin (1971) suggests that (K/L)imp for the U.S.

would be about 5% lower if we allow for the tariff structure.

This

would lower Leontiefs statistic from 1.3 to 1.23.

This

lessens the extent of the paradox without explaining it all.

Keesing (1966)

Keesing used a simple model incorporating almost all the

assumptions of the HO model except he classified factors of
production into unskilled labour and one or more skilled labour

He computed labour requirements by skill category of 14

countries exports and imports, computed as though the
goods that they traded were all produced with U.S. skill
combinations.

He found that the U.S. exports a lot of skilled labor-intensive

products; it is the unskilled labor-intensive products that we
tend to import.

He confirmed that U.S. comparative advantage centres in

industries involving a higher percentage of skilled- labour and
a low percentage of unskilled labour.

Harkness and Kyle (1975)

added natural resources to the regression equation.

found similar results: the Leontief paradox can be

resolved by considering other factors besides just K
and L.

Harkness (1978)

Harkness amended the HO model to accommodate many goods

and many factors and where factor prices are not necessarily
equalized.

He examined the theoretical relationship between net

commodity trade and net factorservice trade, on the one hand
and relative factor abundance on the other. He produced an
estimate of the US relative factor abundance ranking by
computing the proportionate net export of factor services for
every factor.

On the basis of several versions of this test, Harkness (1978)

concluded that the HO was consistent with U.S. data.

Weakness? The study was conducted for the year 1958 on all U.S
commodities. However, he used the same set of data to
compute the estimate for U.S relative factor abundance and the
regression analysis. Therefore, we can argue that there was a
low probability that he could end up getting a negative
correlation between the two estimates.

Adding Other Factors of

Production
Leontief

(1956) and Hartigan

(1981) found that adding natural
resources as a factor of production
eliminates the paradox.

However,

like we said earlier,

Baldwin (1971) found that adding
natural resources does not
completely eliminate the paradox.

Learmer (1980)

Leamer (1980) provided the definitive critique of

the Leontief paradox: it turned out that Leontief
has done the wrong test!

He adopted a different approach by comparing

the capital labour ratio in U.S. production with
U.S. consumption rather than U.S.exports
compared with imports.

He found the capital labour ratio being higher for

production than for consumption.

This turned out to be consistent with the U.S. in

1947 contrary to what Leontief concluded. Thus,
there was no paradox at all!

Stern and Maskus (1981)

Stern

and Maskus (1981) looked at exports and imports for

128 different U.S. industries.

They

estimated the following regression equation: (X - M) =

-18.54 - 0.08K + 0.06H - 2.83L

Interpretation:

the more K an industry uses the less is exported.

the more labor an industry uses the less is exported.

the more human capital an industry uses the more is

exported.

This is basically the same finding as Keesings.

In conclusion to their paper they proposed directions for

further research- one of the question they posed was How
and why endowments of physical capital, human capital and
labour have changed within the U.S. and our trading partner.

Bowen (1983)

Bowen repeatedly found a significant positive

relationship between resources and differences in trade
composition.

This result did not stand when changes over time was
considered.

The factor-content analysis revealed that over the

period 1961-1977, there was a shift in U.S trade toward
less capital-intensive sectors and thus the U.S relative
exchange of capital with the rest of the world declined.

He also found that the relative availability of skilled

versus unskilled labour is an important determinant of
U.S. trade.

Trefler (1993)

The pessimism regarding the HO model was partially relieved by

Trefler (1993), only to be revived by Trefler (1995).

Trefler asked two key questions:

are there simple amendments in the spirit of HOV that allow the
theory to work?

are the failures systematic?

His first paper follows up on Leontiefs suggestion that the

failure of the HOVmay be due to factor-based differences in
productivity. So, Trefler (1993) allowed all factors in every
countries in his study to differ in their productivities in order to
capture technological differences among countries. The only
exception to this was the U.S., which Trefler used as the
benchmark country, with factor productivities normalised at
unity.

Davis, Weinstein, Bradford and Shimpo (DWDS,

1997).

DWDS postulated that trade can be viewed as the difference

between production and consumption (absorption). Hence, a
theory of international trade must join two theories: a theory of
the location of production and a theory of consumption.

DWDS improved on previous work by starting with a strict HO

model and relaxing assumptions one at a time. This allowed
identifying which assumptions seemed to be crucial in driving the
results.

DWDS also developed an approach that allowed making

predictions when only a subset of the world shared factor price
equalisation (FPE), which they labelled a FPE club

They found that the HO model under the conventional restrictive

assumptions is a poor predictor of the international pattern of
production, hence the net factor of trade. However, this changes
markedly when applied to predictions for the regions of Japan

Davis and Weinstein (2001).

According to them, most of empirical studies of

the HO model relied on the US technology matrix,
which can be considered as one major drawback
of these studies.

Davis and Weinstein got closer to a 100% match

between relative endowments and constructed
factor contents.

One of the main conclusions to be drawn from

their paper, is that technology differences matter.
Hence, we can reject the assumption of identical
technology to find a better fit of the HOV model.

More Recent Tests of H-O

Maskus

(1985), Bowen et al. (1987),

Gourdon (2009), and Muriel and Terra (2009)
have also added multiple factors of
production.

In

general, their results conform with the

predictions of the H-O model.

However

these H-O friendly studies have

been called into question.

Differences

between calculated and actual

factor abundances.

Treflers

home bias.

Demand reversal

Recall: when the K-abundant country has very strong domestic

demand for the K-intensive product, and the L-abundant country
has very strong domestic demand for L-intensive products, there
can be a demand reversal: the K-abundant country will export the
L-intensive product because it has the relative cost advantage in
it and the H-O theorem breaks down.

If demand reversals are commonplace, we might expect the U.S.

to export relatively labor-intensive products.

Any evidence for widespread demand reversals? Demand

patterns are actually quite similar, at least among industrialized
countries so there is no evidence

Furthermore, demand reversals imply that U.S. wages should be

low. This would be a hard argument to support.

This doesn't explain the paradox

Testing H-O: The Bottom Line

The

H-O model has flaws, especially in its most

simplistic forms.

It

is still a model that can explain real world trade

patterns.

Over

the past several decades, income and wage

inequality have been rising in the U.S. and in Europe.

Since

the this period also involved rising levels of

involvement in international trade, some argue that
trade has caused the inequality.

While

trade may play a role in this, most economists

believe it is not a dominant role

The Leontief Paradox: The Bottom Line

Allowing

for demand reversals, FIRs,

the tariff structure and natural
resources as a factor of production may
lessen the extent of the paradox.

Allowing

for different levels of skill in

the labor force does seem to eliminate
the paradox.

The

H-O model appears to be

serviceable.

Tests of the H-O Model for Other Countries

Many

studies provide support for H-O

Stolper and Roskamp (1961): East Germany

Tatemoto and Ichimura (1959): Japan

Rosefielde (1974): USSR

Other

studies did not support H-O

Wahl (1961): Canada

Bharadwaj (1962): India