Leontief paradox (1953)

Russian-born economist Wassily Leontief (1906-1999) devised this contradiction of the Heckscher-Ohlin trade theory.

Trade is determined by the relative abundance of factors of production in each economy. Leontief discovered that despite the USA being endowed with an abundance of capital, its exports were labor intensive and imports capital intensive.

Also see: factor-price equalization theorem, rybczynski theorem

Source:
W W Leontief, ‘Domestic Production and Foreign Trade: The American Capital Position Re-examined’, Proceedings of the American Philosophical Society, vol. XCVII (September, 1953), 332-49

Measurements

• In 1971 Robert Baldwin showed that U.S. imports were 27% more capital-intensive than U.S. exports in the 1962 trade data, using a measure similar to Leontief’s.^[2][3]
• In 1980 Edward Leamer questioned Leontief’s original methodology for comparing factor contents of an equal dollar value of imports and exports (i.e. on real exchange rate grounds). However, he acknowledged that the U.S. paradox still appears in Baldwin’s data for 1962 when using a corrected method comparing factor contents of net exports and domestic consumption.^[4][5]
• A 1999 survey of the econometric literature by Elhanan Helpman concluded that the paradox persists, but some studies in non-US trade were instead consistent with the H–O theory.
• In 2005 Kwok & Yu used an updated methodology to argue for a lower or zero paradox in U.S. trade statistics, though the paradox is still derived in other developed nations.^[6]

Responses to the paradox

For many economists, Leontief’s paradox undermined the validity of the Heckscher–Ohlin theorem (H–O) theory, which predicted that trade patterns would be based on countries’ comparative advantage in certain factors of production (such as capital and labor). Many economists have dismissed the H–O theory in favor of a more Ricardian model where technological differences determine comparative advantage. These economists argue that the United States has an advantage in highly skilled labor more so than capital. This can be seen as viewing “capital” more broadly, to include human capital. Using this definition, the exports of the United States are very (human) capital-intensive, and not particularly intensive in (unskilled) labor.

Some explanations for the paradox dismiss the importance of comparative advantage as a determinant of trade. For instance, the Linder hypothesis states that demand plays a more important role than comparative advantage as a determinant of trade—with the hypothesis that countries which share similar demands will be more likely to trade. For instance, both the United States and Germany are developed countries with a significant demand for cars, so both have large automotive industries. Rather than one country dominating the industry with a comparative advantage, both countries trade different brands of cars between them. Similarly, new trade theory argues that comparative advantages can develop separately from factor endowment variation (e.g., in industrial increasing returns to scale).