Leontief Paradox

Wassily W Leontief (1905–99) was the first scholar to empirically test the predictions of the Heckscher-Ohlin (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 [Page 997]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 subvarieties 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.

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