1. Why were Leontief s findings considered to be paradoxical?
Leontief assumed that the US was the most capital abundant country in the world after World War II. Under theses conditions, the two-factor (K and L) HO Model would predict that US exports would be capital intensive. His test compared the capital and labor necessary to produce one million dollars of US exports to that required to produce one million dollars of import-competing goods. Leontief's hypothesis: Since U.S. is K-abundant, the K/L idled by a $1 million reduction in exports would exceed the K/L required to produce $1 million of import substitutes. His results: ¨Reducing U.S. exports by $1 million idled $2.6 million in K and 182.3 worker years ($14,300K/worker). ¨Replacing $1 million of imports with US-produced goods required $3.1 million in K and 170 worker years ($18,200K/worker).
This surprising result is known as Leontief's Paradox.
2. Suppose that the information below represents the complete trade data for each country. Use this data to calculate values of IIT for each country. Note that I used a different-looking formula here (from an older edition of the text), but it produces the same answers -- it's algebraically equivalent to the formula in the 7th edition of the text.
Let ej = exports of j, ij = imports of j
Country A (dollars in thousands):
I
Country B (dollars in hundreds):
Country C (dollars in hundreds):
3. Discuss various reasons why we might expect countries to engage in intra-industry trade.
First, transportation costs may be a factor. If two parts of a country are very far apart, it might be logical for one region to export a product while another distant region imports the same product. Second, the data may be misleading. Since import and export data tend to be aggregated across broad categories, a country might be simultaneously exporting and importing goods in the same category although they have very different characteristics. Finally, economies of scale may lead to specialization in narrow product lines (or varieties of a good), with countries exporting several varieties of a product in exchange for different varieties of the same product.
4. Explain carefully how Leontief went about testing the HO model. Why is this an incomplete test of the model?
Leontief compared the factor content of US exports to and imports from the rest of the world in order to test the HO theory. His principle tool was an input-output table constructed to represent the US economy. This table detailed the aggregate transactions among all sectors of the economy. Using the input-output table, he calculated the capital and labor requirements necessary to (a) decrease US exports by $1 million and (b) increase US production of import-competing goods by $1 million. (Since he couldn't measure the actual amounts of labor and capital used by the foreign producers, he calculated the amounts of factors that would be required to produce those same goods in the US.) He then compared the capital and labor requirements necessary for this change in production. He was surprised to find that the amount of capital per worker idled by a reduction in US exports would be less than the amount of capital per worker needed to increase US production of import-competing products.
The HO model explicitly links factor endowments to factor intensities in production, and subsequently links this to trade patterns. Leontief's test was incomplete since it only tested the link between factor intensities and trade patterns, and ignored factor endowments. This was largely the result of inadequate data on endowments. (It is important to note that the incomplete nature of the test is distinct from the criticism of its basic assumption that US input-output tables could be used to describe the production technology in other countries.)
5. Discuss the merits of the alternative reconciliations of Leontief's findings. Why do you think so much effort was expended in trying to reconcile Leontief s findings with the HO model?
a) Leontief's explanation that American labor was more productive than labor
in the rest of the world is logical, although his choice of a factor of three
(times as productive) was arbitrary and unsupported by evidence.
b) Vanek criticized Leontief's omission of natural resources as a factor of
production. If the US was relatively scarce in natural resources, then it could
expect to import natural resource intensive products, which also tended to be
capital intensive in production. This is also logical, but why should we limit
the analysis to just three factors? Why not more?
c) Travis's argument that the US tariff structure distorted trade is also
logically appealing. US tariffs were higher on
labor-intensive imports. Unfortunately, it is difficult to test his hypothesis since we can't measure what imports
would have been in the absence of tariffs.
d) Comparisons of expenditure patterns across countries indicate that
differences in tastes and preferences could be significant in overturning HO
predictions, although no convincing demonstration has yet
been presented.
An enormous amount of effort has been expended trying to reconcile Leontief's findings with the HO model principally because the model is logical and intuitively appealing. Using a plausible set of assumptions, it is concise and complete, and offers reasonable explanations for observed economic behavior. Further, welfare implications are easily read, and the model offers clear policy prescriptions.
6. How else might the HO model be tested? (Hint: factor price equalization). What would you expect to find if you were to test this proposition with real world data? Would this necessarily refute the model?
One could test the prediction that factor prices will be equalized by free
trade in goods. We should expect to find that factor prices are not equal, for a
variety of reasons: Free trade does not prevail, but is distorted by tariff and
non-tariff barriers. Moreover, labor productivity varies greatly across
countries, as do production processes for similar goods.
Instead, we might want to test whether trade liberalization tends to move factor
prices toward equality.
7. Explain how each of the alternative models of comparative advantage explains the Leontief Paradox.
Human skills: Rather than comparing relative endowments of capital and labor, we should focus on endowments and intensities of skilled and unskilled labor. Since the US has a more highly trained and skilled work force relative to many other countries, US exports tend to be skilled-labor intensive.
Product cycle model: The stage where goods are invented and tested in the market place requires frequent modification of production techniques, and will therefore be relatively labor intensive. The US has had a comparative advantage in product development. When production is standardized in later stages, it tends to become more capital-intensive. Production may be relocated in another country. The well-established US market for this product would then import this relatively capital-intensive good.
Similar preferences: Linder rejects the use of the (supply-oriented) HO Model to explain trade in differentiated goods. Instead, he hypothesized that demand explains such trade. Producers in a country try to satisfy consumers' tastes. When that country opens to trade, the desire for a variety of products (though basically similar in nature) leads to trade between countries with similar production and consumption patterns. Thus, even though the US is relatively capital abundant country we may import capital intensive goods simply because we like them.
8. Would the Linder hypothesis provide a convincing explanation for the pattern of international trade in wheat? in coal? Explain why or why not.
Linder's hypothesis is that consumers prefer to choose from a variety of
goods with slightly different characteristics, and that international trade
allows us to obtain this variety. Since both wheat and coal are relatively
homogeneous products, neither would seem to be a good candidate for Linder's
model. Linder uses an HO Model to explain trade in such commodities.