Leontief Paradox Essay ⋆ Business Essay Examples ⋆ EssayEmpire

Wassily W. Leontief (1905–99) was the first scholar to empirically test the predictions of the HeckscherOhlin (H-O) theorem, one of four main results of the H-O model (credited to Eli Heckscher and Bertil Ohlin). This theorem establishes a relationship between a country’s abundance of factors of production, the intensity with which these factors are used in production, and the country’s trade patterns. It builds on the principle of comparative advantage and states that countries will tend to export those goods that use relatively intensively their relatively abundant factors of production. In other words, a country that is relatively abundant in, say capital, will tend to export goods that are relatively capital intensive.

Leontief conducted a test in 1953 of the predictions of the H-O theorem, for which he utilized 1947 input/output data for approximately 200 industries in the United States. A stylized fact about the post–World War II economy, and 1947 in particular, was that the capital-to-labor ratio in the United States was higher than in any other country. According to the H-O theorem then, U.S. exports in 1947 would, on average, be more capital intensive than imports. In order to test this prediction, Leontief aggregated industries into sectors and used the input-output data to similarly aggregate factors of production in these sectors into two general categories: labor and capital. Using these data, he then calculated estimates of the capital and labor requirements for the production of the typical bundle of exports and imports in 1947.

What Leontief found was in contradiction to the trade pattern predicted by the H-O theorem: U.S. export industries were on average less capital intensive than import-competing industries in 1947. This contradiction became known as the Leontief paradox.

Responses

Since the publication of Leontief ’s paradoxical results in 1953, a voluminous body of both theoretical and empirical literature has emerged on the subject. From this literature, several responses to Leontief ’s paradox can be useful in interpreting the validity of the H-O theorem. The first of these criticizes the choice of data. The argument is that 1947 was not a normal year because the global economy was still recovering from World War II. Leontief ’s response to this criticism was to conduct a second investigation in 1956 using 1951 trade data. His paradoxical findings persisted.

A second response to the Leontief paradox is anchored in the classification of factors of production into two broad categories: labor and capital. This criticism has given rise to the generalized factor-endowment model that takes into account many sub varieties of capital, land, and human factors, and recognizes that factor endowments change over time as a result of technological endowments. Specifically, economists have argued that capital needs to be viewed more broadly to include highly skilled labor as a form of (human) capital. This can help to partly explain Leontief ’s results: exports that were relatively labor intensive can be reinterpreted as relatively human-capital intensive and not necessarily intensive in the use of unskilled labor.

Another response to the Leontief paradox has centered on the role of imperfect competition. The argument here is that trade provides a larger potential market for products, making higher production levels possible (economies of scale), which leads to increased efficiency and competitiveness. This can further help explain Leontief ’s paradox: even though the United States was capital abundant, imports of capital-intensive goods could have been the result of economies of scale achieved by foreign producers that gave them a comparative advantage even if their nation was actually labor (not capital) abundant.

Finally, the role of demand characteristics has also been identified as a potential response to the Leontief paradox. While the H-O theory does well in predicting trade driven by supply conditions (such as trade in natural resources), it does not do as well in predicting the patterns of trade in manufacturing goods that are influenced by domestic demand conditions. The Linder hypothesis (after Staffan Linder) expanded on the H-O theorem by distinguishing between supply and demand characteristics as determinants of trade. If nations have similar per capita income, then they have similar tastes, i.e., they will have overlapping demand structures.

Linder’s hypothesis predicts that nations with similar demand structures are likely to both import and export similar types of manufactured goods. Linder’s contribution can further explain the Leontief paradox: U.S. trade with similar-income countries implies trade in similar goods, i.e., capital-intensive goods made in the United States can be traded for capital-intensive goods made in other countries. For example, intra-industry trade describes much of U.S. export and import patterns today.

In conclusion, Leontief ’s paradoxical conclusion has inspired numerous attempts to replicate his work with data from other periods and countries. Modified forms of Leontief ’s test continue to be examined today and continue to be a standard method for the analysis of trade. Although the H-O theory has undergone many refinements, empirical tests have generally produced mixed evidence in support of this factor endowment theory (and the H-O theorem in particular). Thus the best way to think about the H-O theory is as one that explains a portion, rather than all, of the determinants of trade.

Bibliography:

Indian Economic Association, Inderjeet Singh, and Anil Kumar Thakur, Growth and Human Development: Economic Thoughts of Wassily W. Leontief (Deep & Deep Publications, 2008);
Edward E. Leamer, “The Leontief Paradox, Reconsidered,” Journal of Political Economy (v.88/3, 1980);
Wassily W. Leontief, “Domestic Production and Foreign Trade: The American Capital Position Reexamined,” Proceedings of the American Philosophic Society (v.97/4, 1953);
Wassily Leontief, Erik Dietzenbacher, and Michael L. Lahr, Wassily Leontief and Input-Output Economics (Cambridge University Press, 2009).

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