Leontief Paradox W. W.

Leontief was an economist who won a Nobel Prize in Economics in 1973 for his work on input-output tables. In a 1953 article, using input-output analysis, Leontief showed that U.S. exports were relatively labor-intensive compared to U.S. imports. This was the opposite of what economists expected at the time (H-O theorm), given the high level of U.S. wages and the relatively high amount of capital per worker in the United States. Leontief himself favored H-O theory. He tried to provide some explanation by stressing the different efficiency in the US and the other countries. He argued that US workers might be more efficient than foreign ones. As Leontief suggested that perhaps U.S. workers were three times as effective as foreign workers. He said in his paper in any combination with the given quantity of capital, one man-year of American labor is equivalent to, say, three man-years of foreign labor. 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 remarkable entrepreneurship, superior economic organization and environment full of economic incentives in the U.S. However, Leontief found very few followers among economists. Even Leontief himself submitted that he had made a plausible alternative assumption

Test of Tatemoto and Ichimura -- The Case of Japan, Review of Economics and Statistics, no 41 November 1959)----Paradox Exists. Test of Stolper and Roskamp (See: Wolfgang F. Stolper and Karl Roskamp, "Input-Output Table for East Germany, with Applications to Foreign Trade." Bulletin of the Oxford Institute of Statistics, November 1961.) ----No Paradox. Test of Wahl (See: D. F. Wahl, "Capital and Labor Requirements for Canada's Foreign Trade," Canadian Journal of Economics and Political Science, August 1961.)---- Paradox Exists. Test of Bharadwaj (See: R. Bharadwaj, Factor Proportions and the Structure of India-U.S. Trade, Indian Economic Journal, October 1962.)---- Paradox Exists.

Effect of Different Labor Efficiency Factor Intensity Reversal Natural Resources See: Jaroslav Vanek, The Natural Resource Content of the United States Foreign Trade 1870-1955, Cambridge, MA: MIT Press, 1963. Jaroslav Vanek argued that Leontief may have oversimplified the production functions and failed to recognize the endowments of natural resources. With three factors of production, the typical H-O model does not predict much. This is because the notion of abundance and

intensity must be redefined. Let N stands for natural resources we could have some N-abundant and N-scarce countries. Also we could have N-intensity good. If an N-abundant country exports N-intensive good while an N-scarce country imports Nintensive good, no Leontief Paradox. Relations between natural resources and capital inputs In the actual production processes of natural resource-intensive goods there must be complementary relations between natural resources inputs and capital inputs and in the most part of such production processes capital and natural resources cannot be substituted for each other. The so-called N-intensive goods are basically produced in considerably capital-intensive methods. Typical natural resource intensive good, petroleum and oil products, in every stage of the production processes, including exploitation, extraction, refinement, transportation, as well as manufacturing, storing (usually tanking) and carriage (usually piping) of different types of oil products (gasoline, diesel, natural gas, and so on) a large volume of capital in terms of an array of specific machinery and equipments must be used. It is impossible for a country with an abundant capital endowment, such as the United States, to substitute the relatively expensive precious natural resources with the relatively cheap capital inputs. US Trade Pattern Consistent with H-O Model There are at least two reasons for the US to import large volume of N-intensive goods. Economic consideration. To import such goods from abroad must be considerably cheaper than to domestically produce them. Strategic consideration. To establish the national strategic reserve of some important natural resources is to the national benefit of the United States. As an N-scarce country the US naturally imports a great volume of N-intensive goods from abroad. No paradox here. Because of the specific relation between natural resources and capital inputs the US seems to import capital-intensive goods if we have no consideration of natural resources when analyzing its trade pattern. Leontief Paradox is nothing but a misunderstanding. Human Capital Nations and individuals invest in their future not only by accumulating physical capital, such as plant buildings, equipments, and inventories, but also by spending on education,

training, and other investments that are embodied in human form, that is, human capital. Human capital investment acquires an appropriate rate of return in terms of relatively higher wage rate. The general level of wage rate is higher in those industries in which human capital is employed in a relatively larger proportion. Equivalently, higher wage rate of a particular country means it must be endowed with relatively abundant human capital because of the developed higher learning education and the advanced social service system. False Appearance Makes the Paradox When we insert a new factor of human capital into the trade model, trade pattern of the United States must be completely reexamined. At first, the US must be regarded as to be abundant in human capital endowment. The relevant statistics suggest that a typical US laborer has an average more years of education than a foreign worker. Thus the US laborers earn a relatively higher salary than their foreign competitors. Taking advantages of its abundant human capital the US may have been exporting human capital-intensive goods to the other countries. Such sorts of the US trade is consistent with the basic prediction of the H-O theory no paradox at all. Unfortunately, the effect of human capital, generally higher wage rate had been falsely concluded as more labor input by Leontief. That false appearance must be the reason for Leontief Paradox. Peter Kenen in 1965 calculated the value of extra human capital and reexamined trade pattern of the US. He suggested that if the value of human capital were included, the US exports were capital-intensive relative to US imports. This would reverse the Leontief paradox. Skills of Labor A nations labor force is far from homogeneous but rather consists of many skill groups. Some economists, such as Donald Keesing, have sought the explanation of trade patterns in endowments of skills. The basic point is that the use of labor as factor of production may involve a category that is too aggregative, since there are many different kinds and qualities of labor. Keesing divided the US labor in production into the following eight different categories (They are listed in a descending order of skills): 1. Scientists and Engineers ; 2.Technicians and Draftsmen; 3.Other Professional; 4. Managers; 5.Skilled Laborers; 6.Other Skilled Handworkers; 7.Marketing Personnel and 8.Semiskilled and Unskilled Laborers. Keesing argued the first seven categories could be skilled labor while the last category must be unskilled labor.

In addition Keesing contributed the differences in skills of laborers to how many years of education received by different workers. Labor with Different Skills in US Exports and Imports Keesings Conclusion It must a common knowledge that a typical US laborer received more years of education on average than the foreigners and the US possessed substantially more scientists, engineers and the other sorts of skilled labor in the world. Keesing argued that as a skilled labor abundant and unskilled labor scarce country the US trade pattern is consistent with the basic prediction of the H-O theory. There is no paradox. The US Trade Policies William Travis, suggested that the Leontief paradox might be duo largely to tariffs and other forms of protection. There is evidence that, in the United States and some other developed countries labor-intensive industries are relatively heavily protected. Such trade protection must influence trade patterns of those countries. Robert E. Baldwin Baldwin tried to explain what he discovered by considering specific tariff policy and the other relevant trade policies taken by the United States. The US takes a lot of measures to protect its labor-intensive industries and at the same time encourages its capital-intensive goods exports by so many means. Effect of Trade Policies Such mixture of trade policies must have great impacts on the actual trade pattern of the US. On one hand, protectionist policies, especially the high trade barriers, must inevitably hinder the foreign labor-intensive commodities from entering into the US domestic market. Consequently labor intensity of US imports would be relatively reduced. On the contrary, capital intensity of US imports would be relatively increased. On the other hand a set of preferential policies for speeding up US exports would inexorably stimulate exports of US labor-intensive commodities thus relatively increase the proportion of labor-intensive commodities in US total exports and consequently the overall labor intensity of US exports might be relatively increased. R & D Factor Some economists analyzed proportion of R and D investment over the total sale and proportion of scientists and technicians over the total employees in 19 industries of the US. Statistics showed that those industries with the relatively higher such proportions, such as transportation industry, chemical industry, machinery manufacturing industry, and instrument making industry, export more of their products overseas. Those four industries

accounted for 39.1% of the total sale, 72% of the total exports and 89.4% of the total R and D investment of the US manufacturing industries. Therefore, Gruber, Melta and Vernon concluded that those industries with more R and D investment thus an advanced technology are the major exporters of the US. They insisted that the US had developed an advanced risk investment mechanism and constituted a comparatively greater capability of technologic innovation and creation it must enjoy a substantial comparative advantages over the other countries in the hightech industries. This country, the United States of America, produces and exports R and D factor-intensive goods based on its comparative advantages in high-tech industries derived from its relatively abundant R and D factor and meanwhile imports the sorts of products with relatively lower intensity of R and D factor from abroad. The US trade structure is consistent with the basic principle of H-O Model and no paradox at all. The argument of R and D factor presented, to some extent a reasonable explanation of Leontief paradox. Demand Bias Stefan Valavanis-Vail might be a pioneer of this approach. In 1954 he suggested a hypothesis of consumption structures. He argued that there would be possibility in the real world that a capital abundant country did not need to export capital-intensive good if her tastes are strongly biased toward capital-intensive goods. Equivalently, a labor abundant country would import labor-intensive goods from abroad if residents of this country had a very strong bias toward consumption of labor-intensive goods. Thus, Leontief Paradox can be explained if the US had a strong consumption bias toward the capital-intensive goods. Statistics show that the industrial developed countries, typically the United States, indeed have a strong consumption preference to some high quality and thus expensive luxury goods (A relatively capital-intensive approach must be employed in production processes of those goods) since the overall income levels in those countries are much higher than the less-developed countries. In order to meet a great requirement of their consumers many capital-intensive goods have been shipped from abroad. The opposite situation could be found in the less-develop countries with a very low income. Consumption bias in those low-income countries would strongly toward inferior goods

(They are basically labor intensive) and therefore they do import labor-intensive goods from abroad. Theoretical Position of Leontief and His Paradox In summary, Leontiefs research and his paradox not only triggered the extensive empirical tests of factor endowment theory but more importantly, induced more and more economists to do a lot of valuable research in depth in order to give the answer to such riddle. In this process they gave different explanations to the new discovery of Leontief. They either explored the influences of production factors with different qualities or different essentialities on trade pattern of a country, or introduced some new factors into the theoretical framework, or analyzed the possible effects on trade of some distortions in the real economy. Even though they took different methods in their analysis and they also focused on different points, they had a common ground. That is they all advocated the principle of factor endowment theory. They hoped lay a more scientific foundation for factor endowment theory by their research. For this purpose, those economists inserted some new factors, which were abstracted by Heckscher and Ohlin when they established theoretical system of factor endowment theory, into theoretical framework of H-O Model. More valuable is that all of those economists, happen to coincide, accentuated the effects of technical progress on trade pattern. Their research thinking and the conclusions they had reached reflected the actual variations in development of international trade and the world economy. Consequently what they had done in different research developed and refined trade theory particular factor endowment theory. To this extent, we see without Leontief and his paradox it would not be expected that trade theory could have been developed so intensively. Questions and problems How to understand the significance of the empirical testing of trade theory? Why people termed the discovery of Leontiefs study as a Paradox? What does the paradox mean? How did Leontief himself present explanation of the paradox? Try to illustrate the major explanations of Leontief Paradox. Try to describe your own ideas concerning the origin and the reasonable explanation of the Paradox. Try to illustrate the theoretical position of Leontiefs research and discovery in

development of trade theory.