1. Tests of Trade Models: The Leontief Paradox and its Aftermath
Chapter 5
Tests of Trade Models: The Leontief Paradox and its Aftermath

2. Topics to be Covered Test of the Classical Model
Tests of the Heckscher-Ohlin Model
Leontief Paradox
Reconciliations of Leontief’s Findings
More Tests of the HO Model
Human Skills Theory
Product Life Cycle Theory
Similarity of Preferences Theory
Intra-industry Trade
Increasing Returns and Imperfect Competition
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3. Test of the Classical Model
G.D.A. MacDougall (1951)
U.S. and U.K. exports and labor productivity data for 25 industries in 1937
Hypothesis: Since U.S. wages were twice U.K. wages, then U.S. will have comparative advantage in those industries where U.S. labor is more than twice as productive as U.K. labor.
Finding: Hypothesis supported in 20 out of 25 industries.
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5. Criticisms of the MacDougall Study
Used U.S. and U.K. trade with rest of the world instead of U.S.-U.K. bilateral trade
HO theory can also explain results
Ignored other variables such as transport costs, product differentiation, and trade barriers
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6. Test of the Heckscher-Ohlin Model
W. Leontief (1951)
Built input-output model for 200 U.S. industries for 1947
Assumed U.S. was the most K-abundant country
Used U.S. exports and import substitutes
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7. Input-Output Table
A table that details the sales of each industry to all other industries in an economy.
A spreadsheet with column entries showing purchases made by a specific industry from all other sectors, and row entries showing sales by a specific industry to all other sectors.
Also contains the labor and capital requirements for a fixed amount of output of a given industry.
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8. Leontief’s Test and Results
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.
Results:
Reducing U.S. exports by $1 million idled $2.6 million in K and years per worker.
Replacing $1 million of imports required $3.1 million in K and 170 years per worker.
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9. Leontief Paradox
The finding that U.S. exports tend to be more labor-intensive than U.S. imports, while U.S. imports are relatively more capital-intensive than U.S. exports.
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10. Reconciliations of the Leontief Paradox
U.S. workers are more productive than foreign workers (Leontief)
A third factor, natural resources, is not considered (Vanek)
U.S. tariffs on labor-intensive goods are high (Travis)
The identical tastes assumption is violated
Leontief used data on U.S. import- competing goods
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11. Other Tests of the HO Model
Leontief using 1951 data and Baldwin using 1962 data found the paradox; Stern and Maskus found no evidence.
Paradox was also found in tests of foreign countries (Japan, Canada, India).
Results of tests on East Germany and former Soviet Union were consistent with HO theory.
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12. More Recent Tests of HO Model
Since the 1980s, more tests have been conducted because:
Earlier studies were incomplete since these did not link trade patterns with factor endowments
Using a multifactor version of the HO model, Leamer (1980) showed that trade patterns and factor endowments were related to each other
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13. More Recent Tests (cont.)
Two studies attempted to test the links between endowments and intensities to trade patterns:
Maskus (1985)
Bowen, Leamer, and Sveikauskas (1987)
Both studies found contradictory results.
Other studies which relaxed HO assumptions had better results.
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14. Alternative Theories Human Skills Theory Product Life Cycle Theory
Similarity of Preferences Theory
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15. Human Skills Theory Donald Keesing (1966)
Emphasizes differences in endowments and intensities of skilled and unskilled workers.
Explains the Leontief paradox: Since the U.S. has highly trained, educated workers relative to other countries, U.S. exports tend to be skilled-labor intensive.
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16. Product Life Cycle Theory
Raymond Vernon (1966)
Comparative advantage may shift over time from one country to another due to product life cycle
Stages of the cycle:
Product is invented and introduced in home country
Product becomes standardized
Foreign production begins
Comparative advantage lost to foreign firms
Model has limited applicability
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17. Similarity of Preferences Theory
Stefan Linder (1961)
Trade occurs among rich countries (with similar standards of living) due to similar tastes and product differentiation
Linder’s theory applies only to differentiated manufactured goods
Linder finds nothing paradoxical about Leontief’s finding
The model explains intra-industry trade
Evidence is mixed
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18. Intra-industry Trade
The simultaneous import and export of similar types of products by a country.
Examples: computers, cars, planes
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19. Grubel-Lloyd Index A measure of intra-industry trade given by:
The index ranges from zero to 100 with a value of 100 indicating all trade of a country is intra-industry.
As shown in Table 5.3 following, countries with the highest degree of intra-industry trade are primarily industrialized countries.
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21. If a Country Has Comparative Advantage in a Good, Why Would the Country Import It?
Transportation costs
Data aggregation and categorization problems
Increasing returns to scale and imperfect competition
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22. Increasing Returns to Scale
Increasing returns to scale exist when a proportionate increase in the use of all inputs result in a greater than proportional increase in output.
If one or more industries in an economy have increasing returns to scale, then the country’s PPF will be convex in shape (Refer to Figure 5.1 next)
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24. Increasing Returns and Gains from Trade
Trade allows countries to specialize in, and benefit from, industries with increasing returns to scale
(Figure 5.2 on next slide)
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26. Increasing Returns and Imperfect Competition
With increasing returns, the actions of one firm can have effects on other firms.
Imperfectly competitive markets (monopolistic competition, oligopoly, monopoly), rather than perfect competition, prevail.
Increasing returns to scale and imperfect competition can explain intra-industry trade.
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27. Conclusions The world is a very complicated place.
Developing direct tests of international trade models is difficult due to restrictive assumptions, data, and measurement problems.
International economics is an evolutionary science.
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28. Additional Chapter Art

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