1. Empirical Tests of the Factor Endowments Approach
Chapter 9
Empirical Tests of the Factor Endowments Approach
McGraw-Hill/Irwin
Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.

2. Learning Objectives
Analyze the failure of U.S. trade patterns to conform to H-O predictions.
Examine possible explanations for the U.S. trade paradox.
Describe issues arising from multi-country H-O tests.
Assess the role of trade in generating growing income inequality in developed countries.

3. Leontief’s Test
1950s: Leontief conducts the first important test of H-O.
Using U.S. data Leontief calculated
average amount of capital and labor embodied in U.S. exports.
average amount of capital and labor embodied in U.S. imports.

4. Leontief’s Test
Presumably, the U.S. was relatively K-abundant at that time.
Therefore, according to the H-O model, the U.S. should tend to export K-intensive products, and import L-intensive products.
That is, the capital-labor ratio for U.S. exports should be greater than the capital-labor ratio for U.S. imports.

5. The Leontief Paradox Leontief found something surprising:
(K/L)exports = $13,991 per person-year
(K/L)imports = $18,184 per person-year
This is the opposite of what the H-O model predicts.
This finding came to be known as the Leontief Paradox.

6. The Leontief Paradox
To see this from another angle, consider the Leontief statistic
[(K/L)imp]/[(K/L)exp]
If H-O-S is correct, this statistic should be less than one for the U.S.
However, Leontief found the statistic to be ($18,184/$13,991) or about 1.3.

7. Explanations for the Leontief Paradox
Much research since Leontief’s time has focused on trying to explain the paradox.
Do any of these explanations “rescue” the H-O model, or is the model just wrong?

8. Explanation #1: Demand Reversals
Recall: when the K-abundant country has very strong domestic demand for the K-intensive product, and the L-abundant country has very strong domestic demand for L-intensive products, there can be a demand reversal: the K-abundant country will export the L-intensive product because it has the relative cost advantage in it.

9. Explanation #1: Demand Reversals
Therefore, the H-O theorem breaks down.
If demand reversals are commonplace, we might expect the U.S. to export relatively labor-intensive products.

10. Explanation #1: Demand Reversals
So: is there any evidence for widespread demand reversals?
No. Demand patterns are actually quite similar, at least among industrialized countries.
Furthermore, demand reversals imply that U.S. wages should be low. This would be a hard argument to support.
We need to look further to explain the paradox.

11. Explanation #2: Factor Intensity Reversals
Recall: a FIR occurs when a good is relatively K-intensive at one set of factor prices, but relatively L-intensive at another.
If FIRs occur often, the H-O theorem cannot be valid for both countries, and so we might expect the Leontief paradox.

12. Explanation #2: Factor Intensity Reversals
Minhas (1962) found evidence that FIRs are fairly commonplace.
Later work by Hufbauer (1966) and Ball (1966) suggests that Minhas overstated the matter; there may be some FIRs in the real world, but not as many as Minhas suggested.
It would seem that if there is an explanation of the Leontief paradox, it lies elsewhere.

13. Explanation #3: The U.S. Tariff Structure
The H-O model assumes free trade, but in fact there are barriers (e.g., tariffs).
The Stolper-Samuelson theorem leads us to expect that the owners of the scarce factor will be protectionist.
In the U.S., this will likely mean that it is L-intensive imports that are being kept out.

14. Explanation #3: The U.S. Tariff Structure
The tariff structure could make the Leontief statistic artificially high, and perhaps lead to the paradox.
Consider an example:

15. Explanation #3: The U.S. Tariff Structure (An Example)
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16. Explanation #3: The U.S. Tariff Structure (An Example)
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17. Explanation #3: The U.S. Tariff Structure (An Example)
Suppose that (K/L)exp = $16,000.
Then the fact that tariffs exist means that the Leontief statistic is $18,333/$16,000 = 1.14; it would have been $14,500/$16,000 = 0.9 under the assumption of free trade.
This means that Leontief’s paradox might be the result of tariffs, and isn’t evidence against the H-O model.

18. Explanation #3: The U.S. Tariff Structure
A study by Baldwin (1971) suggests that (K/L)imp for the U.S. would be about 5% lower if we allow for the tariff structure.
This would lower Leontief’s statistic from 1.3 to 1.23.
This lessens the extent of the paradox without explaining it all.

19. Explanation #4: Adding Other Factors of Production
Keesing (1966) suggests subdividing labor into eight skill categories.
He found that the U.S. exports a lot of skilled labor-intensive products; it is the unskilled labor-intensive products that we tend to import.

20. Explanation #4: Adding Other Factors of Production
Since the U.S. is relatively skilled labor-abundant, this suggests that the H-O model does explain trade accurately: the Leontief Paradox disappears.
Later studies have supported this finding.

21. Explanation #4: Adding Other Factors of Production
Leontief (1956) and Hartigan (1981) found that adding natural resources as a factor of production eliminates the paradox.
However, Baldwin (1971) found that adding natural resources does not completely eliminate the paradox.

22. The Leontief Paradox: The Bottom Line
Allowing for demand reversals, FIRs, the tariff structure and natural resources as a factor of production may lessen the extent of the paradox.
Allowing for different levels of skill in the labor force does seem to eliminate the paradox.
The H-O model appears to be serviceable.

23. Tests of the H-O Model for Other Countries
Many studies provide support for H-O
Stolper and Roskamp (1961): East Germany
Tatemoto and Ichimura (1959): Japan
Rosefielde (1974): USSR
Other studies did not support H-O
Wahl (1961): Canada
Bharadwaj (1962): India

24. More Recent Tests of H-O
Stern and Maskus (1981) looked at exports and imports for 128 different U.S. industries.
They estimated the following regression equation:
(X - M) = K H L

25. More Recent Tests of H-O
(X - M) = K H L
Interpretation:
the more K an industry uses the less is exported.
the more labor an industry uses the less is exported.
the more human capital an industry uses the more is exported.
This is basically the same finding as Keesing’s.

26. More Recent Tests of H-O
Harkness and Kyle (1975)
added natural resources to the regression equation.
found similar results: the Leontief paradox can be resolved by considering other factors besides just K and L.

27. More Recent Tests of H-O
Maskus (1985), Bowen et al. (1987), Gourdon (2009), and Muriel and Terra (2009) have also added multiple factors of production.
In general, their results conform with the predictions of the H-O model.

28. More Recent Tests of H-O
However these “H-O – friendly” studies have been called into question.
Differences between calculated and actual factor abundances.
Trefler’s “home bias.”

29. Testing H-O: The Bottom Line
The H-O model has flaws, especially in its most simplistic forms.
It is still a model that can explain real world trade patterns.

30. The H-O Model and Income Inequality
Over the past several decades, income and wage inequality have been rising in the U.S. and in Europe.
Since the this period also involved rising levels of involvement in international trade, some argue that trade has caused the inequality.
While trade may play a role in this, most economists believe it is not a dominant role.