More pictures from Knossos

Three positions of bull-leaping sports. Bulls were worshiped by Phoenicians and Canaanites in Palestine.

Water jars. Cretans carried water with these jars to the ritual baths.
Life in the Knossos Palace, a restored mural.
Linear B tablet (Omniglot) with syllabaries, partly deciphered, similar to hiragana). A precursor of alphabet.

HE Heckscher-Ohlin theory states that each country exports the commodity which uses its abundant factor intensively. The HO theory was generally accepted on the basis of casual empiricism. Moreover, there wasn't any technique to test the HO theory until the input-output analysis was invented.

          What: The first serious attempt to test the theory was made by Professor Wassily W. Leontief in 1954.

          Result: Leontief reached a paradoxical conclusion that the US—the most capital abundant country in the world by any criterion—exported labor-intensive commodities and imported capital- intensive commodities. This result has come to be known as the Leontief Paradox. Leontief took the profession by surprise and stimulated an enormous amount of empirical and theoretical research on the subject.

          How: To perform the test, Leontief used the 1947 input-output table of the US economy (He received his Nobel prize for his contribution to input-output analysis later). He aggregated industries into 50 sectors, but only 38 industries produced commodities that enter the international markets, and the remaining 12 sectors were created for accounting identities and nontraded goods. He also aggregated factors into two categories, labor and capital. He then estimated the capital and labor requirements to produce:

          One million dollars' worth of the typical exportable and importable bundles in 1947.

Capital Requirement Labor Requirement
Exports aKx = 2.550780 aLx = 182.313 man-years
Imports aKm = 3.091339 aLm = 170.114 man-years

kx = aKx/aLx = $14,300

km = aKm/aLm = $18,200

          The US seems to have been endowed with more capital per worker than any other country in the world in 1947. Thus, the HO theory predicts that the US exports would have required more capital per worker than US imports. However, Leontief was surprised to discover that US imports were 30% more capital-intensive than US exports,

km = 1.30 kx.

          At first, Leontief was criticized on statistical grounds. Swerling (1953) complained that 1947 was not a typical year: the postwar disorganization of production overseas was not corrected by that time.

Leontief's Second Test

          In 1956 Leontief repeated the test for US imports and exports which prevailed in 1951. In his second study, Leontief aggregated industries into 192 industries. He found that US imports were still more capital-intensive than US exports. US imports were 6% more capital-intensive

(km = 1.06 kx).

Baldwin's Third Test

          More recently, Professor Robert Baldwin (1971) used the 1962 US trade data and found that US imports were 27% more capital-intensive than US exports. The paradox continued.

km = 1.27 kx.

Trade Patterns of Other Countries

JAPAN

          Tatemoto and Ichimura (1959) studied Japan's trade pattern and discovered another paradox. Japan was a labor-abundant country, but exported capital-intensive goods and imported labor- intensive goods. Japan's overall trade pattern was inconsistent with HO.

Explanation: They said that Japan's place in the world was somewhere between advanced and LDCs.

25% of Japan's exports went to advanced industrial countries.
75% of exports went to LDCs.

For the US-Japan trade, the trade pattern was consistent with HO prediction.

Japan-LDC, consistent.

East Germany

          Stolper and Roskamp (1961) applied Leontief's method to the trade pattern of East Germany. East Germany's exports were capital-intensive. About 3/4 of EG's trade was with the communist bloc, and EG was capital abundant relative to its trading partners. Thus, the EG case was consistent with the HO theory.

CANADA

          Wahl (1961) studied Canada's trade pattern. Canadian exports were capital-intensive. Most of Canadian trade was with the US. The result was inconsistent with HO.

INDIA

          Bharawaj (1962) studied India's trade pattern. India's exports were labor-intensive. Consistent with HO theory.

          However, Indian trade with the US was not. Indian exports to the US were capital-intensive.

Explanations for the LP

triball Leontief: US was more efficient

          Leontief himself suggested an explanation for his own paradox. He argued that US workers may be more efficient than foreign workers. Perhaps U.S. workers were three times as effective as foreign workers. Note that this increased effectiveness of the American workers was not due to a higher capital-labor ratio, because we assume that countries have identical technologies and hence identical capital- labor ratios.

          It means that the average American worker is three times as effective as he would be in the foreign country. Given the same K/L ratio, Leontief attributed the superior efficiency of American labor to superior economic organization and economic incentives in the U.S. However, Leontief found very few believers among economists.

          Kreinin (1965) conducted a survey of engineers and managers, and tried to test whether an average American worker is three times as effective as a foreign worker. A realistic difference in effectiveness between the representative workers in the U.S. and those in the foreign countries were about 20-25%. Obviously, this difference does not explain the Leontief Paradox.

          When comparing trade patterns of a market economy and a command economy, this explanation may be important. Modern technology is available to Russians, but production in the former Soviet Union is still inefficient due to lack of incentives.

          Evaluation: There might have been some difference in labor efficiency or productivity between the US and the rest of world in 1947. But this should have been relatively insiginficant. This was probably a bad theory.

          Remark: Trefler (1993) resurrects Leontief's theory and has proved that when quality indices of factors are incorporated, US exported capital and imported labor services in 1947 (HOV Theorem). This still does not prove, however, that US exports had been more capital intensive than its imports that year.

 

triball Factor Intensity Reversal

          If a commodity is produced by a labor-intensive process in the labor-rich country and also by the capital-intensive process in the capital-rich country, then factor intensities are reversed in the production of that commodity.

          Example: agriculture is labor-intensive in India but capital-intensive in US.

          In the presence of FIR, the HO theory cannot hold for both countries. That is, an LP always occurs in one of the countries. Thus, Jones (1956) and Robinson (1956) argued that FIR could have been responsible for the LP in the US.

          The question is whether FIR is common in the real world. Minhas (1963) investigated 24 industries for which comparable data were available for 19 countries. He found FIRs only in 5 countries.

          Leontief (1964) reviewed Minhas's book and pointed out that only 17 out of 210 possible reversals did occur for the relevant range of factor prices. Moroney (1967) concluded that FIR has much less empirical importance, albeit theoretically interesting.

          Remark: Moroney was probably correct when comparing trade patterns with similar countries, or among developed economies. Capital-labor ratios are likely to be similar among developed economies and their resource endowments might be in the same cone of diversification.

 

While there has not been much empirical evidence about the possibility of factor intensity reversals, FIR is real. It may be important when comparing trade patterns between developing and developed economies (e.g. China vs. US).

Natural Resources

          Leontief may have oversimplified the production functions and failed to recognize the endowments of natural resources. With three factors of production, the HO model does not predict much. This is because the notion of abundance and intensity must be redefined.

Possibilities: factor abundance and intensity

K/L > K*/L* and K/N < K*/N*

K1/L1 > K2/L2 and K1/N1 < K2/N2.

Jaroslav Vanek's Argument (1963):

          Suppose the US is poor in natural resources. Assume that the import-competing industry uses capital and natural resources in fixed proportions, i.e., K and L are perfect complements in production. Then apply the HO theory. The US imports natural resource-intensive products, but it appears that the US is importing capital- intensive goods.

          Empirical studies have shown that the natural resource content in typical US imports is greater than that in US exports. But it is difficult to believe that US is poor in natural resources. Vanek's explanation is not empirically convincing.

Factor Abundance

In a world of many factors (K, L, N, .... Z), factor abundance can be ranked:

K/K* > N/N*> ...> L/L*.

          In this case, we can say that the HC is (most) abundant in capital, and least abundant in labor.

alarm clock
Heckscher-Ohlin-Vanek Theorem A country exports its abundant factors through trade in goods.

Let a = Y/(Y + Y*) be the home country's share of world income. Then the HC is abundant in capital, if

K/(K + K*) > a.

Of course, this definition can be extended to any other factors. According to this definition, it is possible for a country to be abundant in more than one factors. The HOV Theorem states that if trade is balanced a country exports its abundant factors through trade in goods.

Remark 1. If factor prices are equalized, the definition of factor abundance makes sense, since income is the sum of factor incomes.

Y = wL + rK + sN + ...

In a world of two factors, if factor prices are equalized (w = w* and r = r*)

K/K* > Y/Y* if and only if K/K* > L/L*.

Thus, one can say that the above is a more general definition of factor abundance.

2. Trade theory is supposed to predict the patterns of output trade. As the number of outputs increases, it becomes exceedingly difficult to predict the patterns of output trade. Thus, HOV was not even a result that economists were looking for.

3. Nevertheless, HOV theorem predicts the indirect trade of factors through output trade. If HOV prediction is not materialized in the real world, it is an indication that there is a serious distortion in the economy. In this sense, HOV Theorem does provide a guide to trade policy; a trade policy should not encourage exports of scarce resources and imports of abundant resources.


Factor Intensities

In higher dimensional world, factor intensities are difficult to define as indicated above. Even in the three-factor, three-good world, it is not possible to define factor intensities to enable us to predict "a capital-abundant country will export the capital-intensive good."

Tariffs and Transport Costs

Travis (1964) argued that tariff may have been responsible for the LP. However, tariffs tend to reduce trade volume, but not reverse commodity trade pattern. In other words, an import tariff cannot induce a country to export goods that intensively use its scarce factor. It would only reduce the volume of goods which it would export in the absence of a tariff.

          Baldwin (1971) showed that this indeed was the case. Without tariff, the capital-labor ratio of imports would have fallen by 5%, which is not sufficient to resolve the LP.

Demand Bias

          A capital abundant country need not export the capital-intensive good if her tastes are strongly biased toward capital-intensive goods. Thus, LP can be explained if the US had a strong consumption bias toward the capital-intensive goods.

          In 1819 Francois-Louis Cailler establishes one of the first chocolate factories in Switzerland. Cailler Swiss Chocolate is the oldest brand of Swiss chocolate still in existence, and Switzerland leads the world in per capita annual chocolate consumption, 22.5 pounds per person! (History of Swiss Chocholate). Per capita consumption of chocolates is less than 5 pounds in the United States. Per capita consumption of seafood in Japan is 60 kg per year while that of the US was about 15 pounds in 2001. Thus, the Japanese people consumes 10 times as much seafood as Americans per person. When commodities are narrowly classified, there exists a considerable difference in tastes and consumption patterns between trading countries.

Jones (1956, University of Rochester) argued that demand bias could be an explanation. However, no one argued that demand bias was a cause of the LP.

(1) Houtthakker's studies (1957, 1960, 1963) suggest that there is considerable similarity in demand functions among countries.

(2) As per capita income increases, consumption of the labor-intensive goods (such as services) tends to increase while that of the capital- intensive goods decreases. (That is, labor intensive goods are luxury goods. Consumers develop sweet teeth for labor-intensive goods as income increases.) If there had been a consumption bias in the US in 1947, the bias must have been toward increased consumption of the labor-intensive goods. Therefore, consumption bias would have reinforced the HO prediction that US would import labor-intensive goods. Thus, demand bias is NOT a good explanation for the LP.

       
 

Nihonbashi (Japan bridge) fish market is the predecessor of today's Tsukiji fish market with over 60,000 employees. Its annual sales exceeds $40 billion.
   

triball Human Capital

          Another factor that may be taken into account in evaluating LP is human capital. The idea is simple. Human capital is created by education. Education, like investment in physical capital, requires time and uses up resources.

(i) there are two ways to incorporate human capital. Labor may be divided into to two or more groups: unskilled labor, semi-skilled labor, and skilled labor. First, the US may have been abundant in skilled labor. The US may have been exporting skilled labor-intensive goods. (However, a 3 x 3 HO model does not predict that a labor abundant country will export the labor intensive good, because which good is "labor-intensive" or "capital-intensive" is not clearly defined in a higher-dimensional world.)

(ii) A second way to include human capital: add human capital to physical capital:

K = Ko + Kh

  1. Leontief did not include the value of human capital in his calculations. But he argued that US exports were skilled labor- intensive than US imports.

  2. Kravis (1956) found that American workers in the export industries earned a higher wage than those in the import competing industries. This difference in wage reflects the existence of human capital.

    It is more likely that human capital had existed in both industries. However, it is the extra human capital embodied in labor in the export sector that counts here. The value of (extra) human capital embodied in labor is:

    (wx - wm)/r = Kh.

  3. Kenen (1965) used 9% discount rate and showed that if the value of human capital were included, the US exports were capital- intensive relative to US imports. This would reverse the LP.

    However, estimates of human capital is sensitive to the interest rate chosen. Specifically, a lower interest results in a greater amount of human capital in the export sector. If the discount rate is over 12%, this theory does not explain the LP.

    The wage gap between the two sectors may be due to other factors. Attributing it to only human capital is unsatisfactory.

  4. Baldwin's (1971) analysis shows that Human capital alleviates the LP, but it does not resolve the paradox.

Remark: These analyses show that presence of human capital can play an important role in determining trade patterns between coutries. However, available empirical evidence is not very conclusive either way.

Trade Imbalance

          Leontief's data show that US exports in 1947 amounted to $16,678 million and imports were $6,177 million. GNP of the US that year was $198,688 million. Thus, trade surplus was more than 5% of national income.

          The HO theory based on the assumption that trade is balanced. To predict the trade pattern when trade is not balanced, much more information might be necessary. In general, in the presence of trade imbalance, a capital abundant country may not export capital-intensive goods. With a trade surplus, a capital abundant country such as the US may not only export the capital- intensive goods but also the labor-intensive goods.

          Suppose that there are three goods, 1, 2, and 3, so that k1 > k2 > k3.

          Assume further that when trade is balanced, the US exports good 1 and imports 2 and 3. Then this trade pattern would be consistent with the HO theory.

          Suppose now that the US is maintaining a large trade surplus. This trade surplus means that US consumers must reduce consumption of all three goods proportionately (due to homothetic preferences). In the presence of a large trade surplus, it is possible for the US to export the most labor-intensive good. That is, the US may export 1 and 3 and import 2.

          In this case, the average capital-labor ratio of the exports (1 and 3) can be lower than that in imports and a Leontief paradox occurs.

Balanced Trade

Industries ki Production Consumption Export
1 2 400 200 200
2 1 50 200 -150
3 0.5 150 200 -50

Trade Surplus

Industries ki Production Consumption Export
1 2 400 100 300
2 1 50 100 -50
3 0.5 150 100 50

kx = (300 K1 + 50K3)/(300 L1 + 50L3) > or < 1 = km = k2

Q: had trade been balanced in 1947, would the US have exported capital-intensive goods and imported labor-intensive goods?

          Among the 38 industries examined by Leontief, only three industries were importers in 1947. In the remaining 35 industries, the US was an exporter. Casas and Choi (1984) computed the trade pattern that would have prevailed had trade been balanced in 1947. They concluded that the US would have exported capital-intensive goods in the balanced trade situation. That is, US exports would have been more capital-intensive than US imports.

kx = $12,338 per man year

km = $11,231 per man year

Remark: If a country has a large trade surplus, it would export those commodities which it would import under the balanced trade condition.

If the US has a large trade deficit, it would import even those commodities which it would export under the balanced trade condition. This distortion can make the US imports more capital-intensive than when trade is balanced.

References

Bharawaj, R., "Factor Proportions and the Structure of India-U.S. Trade," Indian Economic Journal, October 1962.
Casas, François and E. Kwan Choi, "Trade Imbalance and the Leontief Paradox," Manchester School 52 (1984).
Casas, François and E. Kwan Choi,"The Leontief Paradox: Continued or Resolved?" Journal of Political Economy 93 (1985)
Wahl, D. F., "Capital and Labor Requirements for Canada's Foreign Trade," Canadian Journal of Economics and Political Science, August 1961.
Stolper, Wolfgang F. and Karl Roskamp, "Input-Output Table for East Germany, with Applications to Foreign Trade." Bulletin of the Oxford Institute of Statistics, November 1961.
Trefler, Daniel, "International Factor Price Differences: Leontief Was Right!," Journal of Political Economy 101 (1993), 961-87.

Boulevard of Italians, Morning, Sunlight by Camille Pissaro (1897), Washington National Gallery