2. Testing the H-O-S Model

3. Leontief’s Test 1950s: Leontief conducts the first important test of H-O-S 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-S 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-S 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 focussed on trying to explain the paradox Do any of these explanations “rescue” the H-O-S 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 So 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-S 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 So what?

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)

17. 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-S 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 rel. skilled labor-abundant, this suggests that the H-O-S 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-S model appears to be serviceable

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

24. More Recent Tests of H-O-S Stern and Maskus (1981) looked at exports and imports for 128 different U.S. industries They estimated the following regression equation: (X - M) = -18.54 - 0.08K + 0.06H - 2.83L

25. More Recent Tests of H-O-S (X - M) = -18.54 - 0.08K + 0.06H - 2.83L 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-S 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. Testing H-O-S: The Bottom Line The H-O-S has flaws, especially in its most simplistic forms It is still a model that can explain real world trade patterns