Chapter 5 Tests of Trade Models The Leontief

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

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 Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 2

Test of the Classical Model • G. D. A. Mac. Dougall (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. Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 3

Criticisms of the Mac. Dougall 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 Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 5

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 Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 6

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. Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 7

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 182. 3 years per worker. Replacing $1 million of imports required $3. 1 million in K and 170 years per worker. Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 8

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. Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 9

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. importcompeting goods Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 10

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. Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 11

More Recent Tests of HO Model • Since the 1980 s, 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 Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 12

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. Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 13

Alternative Theories • Human Skills Theory • Product Life Cycle Theory • Similarity of Preferences Theory Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 14

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. Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 15

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 Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 16

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 Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 17

Intra-industry Trade • The simultaneous import and export of similar types of products by a country. • Examples: computers, cars, planes Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 18

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. Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 19

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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 Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 21

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) Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 22

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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) Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 24

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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. Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 26

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. Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 27

Chapter 5 Additional Chapter Art

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