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Leontief Paradox

and Development
of Trade Theory
W. W. Leontief was an economist who
won a Nobel Prize in Economics in
1973 for his work on input-output
tables. Input-output tables analyze the
process by which inputs from one
industry produce outputs for
consumption or for inputs for another
industry. With the input-output table,
one can estimate the change in demand
for inputs resulting from a change in
production of the final good.
Wassily Wassilyovitch Leontief
(1905~1999)
Leontief used input-output analysis to study the characteristics of trade flow
between the U.S. and other countries, and found what has been named
Leontief's paradox; "this country resorts to foreign trade in order to
economize its capital and dispose of its surplus labor, rather than vice versa,
i.e., U.S. exports were relatively labor-intensive when compared to U.S. imports.
This is the opposite of what one would expect, considering the fact that the
U.S.'s comparative advantage was in capital-intensive goods.
Science or Pseudoscience
The significance of any theory consists in the fact that the
theory must be a faithful representation and a scientific
summation of the specific practices. In addition such scientific
theory could be used to effectively guide the actual
performances and development of the practices.
Otherwise, if the theory separates far away from the actual
practices, the so-called theory must be either one of the
following two cases:
(1) There is no necessity for the theory to continuously exist or
it would have been a pseudoscience;
(2) It must be necessary to revise or readjust the theoretical
assumptions on which the theory had been established so that
the theory could maintain its rational crux on the even more
scientific basis.
Development of Theory
To a an on the se oscience an the rocesses
of re-exa inin the theoretical ass tions
re resent evelo ent an refine ent of a
artic lar theory.
All of these sho l e one on the asis of
e irical test of the theory.
In other or s, there is no nee to have a
s erstitio s elief in the existin concl sions of
any theory.
On the contrary, in or er to have the theory
evelo e an refine , it is necessary to exec te
e irical test of it.
Empirical Test of Factor Endowment Theory
The rinci le of co arative a vanta es erive fro
classical Ricar ian o el erfor s as the theoretical
ase of factor en o ent theory intro ce y
Heckscher an Ohlin, the ain tren of international
tra e theory.
In other or s, since the co arative a vanta es, no
atter fro here they co e, f nction as the ost
i ortant theoretical re-req isites of international
tra e, econo ists have een intereste in the extent to
hich the eneral concl sions of Ricar ian o el an
H-O Mo el are realize in international tra e.
In artic lar, econo ists foc se on if a co ntrys tra e
reality consistent ith the asic rinci les of factor
en o ent theory.
The Stare Tongue-tied Discovery by Leontief
Thro ho t his life Leontief ca ai ne a ainst theoretical
ass tions an non-o serve facts (the title of a s eech
he elivere hile resi ent of the A erican Econo ic
Association, 1970-1971).
Accor in to Leontief too any econo ists ere rel ctant
to et their han s irty y orkin ith ra e irical
facts. To that en Wassily Leontief i ch to ake
q antitative ata ore accessi le, an ore in is ensa le,
to the st y of econo ics.
In a 1953 article y Leontief sho e , sin in t-o t t
analysis, that . . ex orts ere relatively la or-intensive
co are to . . i orts.
This as the o osite of hat econo ists ex ecte at the
ti e, iven the hi h level of . . a es an the relatively
hi h a o nt of ca ital er orker in the nite tates.
Leontiefs iscovery as ter e the Leontief Para ox.
Leontiefs First Test
One million dollars' worth of typical exportable and importable in 1947
(K/L)
x
= K
x
/ L
x
= $14,300
(K/L)
m
= K
m
/ L
m
= $18,200
The US is believed to be endowed with more capital per worker than any other
country in the world in 1947. Thus, the H-O theory predicts that the US exports
would have required more capital per worker than US imports. However, Leontief
was surprised to discover that US imports were 30% more capital-intensive than
US exports,
(K/L)
m
= 1.30 (K/L)
x
.
( ee: W. Leontief, Do estic Pro ction an Forei n Tra e: The A erican Ca ital
Position Re-exa ine , Proceedings of the American Philosophical Society 97, e te er
1953.)
Capital Requirement Labor Requirement
Exports K
x
= 2550780 L
x
=182.313 man-years
Imports K
m
= 3091339 L
m
=170.114 man-years
Leontiefs Second Test
One million dollars' worth of typical exportable and importable in 1951
Capital Requirement Labor Requirement
Exports
x
6 L
x
man-years
Imports
m
3 3 L
m
6 man-years
( /L)
x

x
/ L
x
$ ,9
( /L)
m

m
/ L
m
$ 3,
( /L)
m
. ( /L)
x
In 1956 Leontief repeated the test for US imports and exports which prevailed in
1951. In his second study, Leontief aggregated industries into 192 industries. He
found that US imports were still more capital-intensive than US exports. US
imports were 5.7% more capital-intensive. The degree had been reduced but the
paradoxical conclusion remained.
(See: W. Leontief, Factor Proportions and the Structure of American Trade: Further
theoretical and empirical analysis, Review of Economics and Statistics 38, no. 4 November
1956.)
Leontiefs Comments on His Discovery
Facing such a stare ton e-tie paradoxical
conclusion Leontief surprisingly pointed out:
These figures show that an average million
dollars worth of our exports embodies
considerably less capital and somewhat more
labor than would be required to replace from
domestic production an equivalent amount of our
competitive imports.
Americas participation in the international
division of labor is based on its specialization on
labor intensive, rather than capital intensive, lines
of production.
In other words, this country resorts to foreign
trade in order to economize its capital and dispose
of its surplus labor, rather than vice versa.
The widely held opinion thatas compared with
the rest of the worldthe United States economy
is characterized by a relative surplus of capital
and a relative shortage of labor proves to be
wrong. As a matter of fact, the opposite is true.
Who can tell me
who I am?
Baldwin Test (See: Robert E. Baldwin, Determinants of the Commodity
Structure of U.S. Trade, American Economic Review 61, no. 1 March
1971.)
One million dollars' worth of typical exportable and importable in 1962
(K/L)
x
= K
x
/ L
x
= $14,321
(K/L)
m
= K
m
/ L
m
= $17.916
(K/L)
m
= 1.251 (K/L)
x
Capital Requirement Labor Requirement
Exports K
x
= 187 000 L
x
=131 man-years
Imports K
m
= 2132000 L
m
=119 man-years
Professor Ro ert E. Bal in (1971) se the 1962 tra e statistics to al ost
entirely re eat hat Leontief i y sin the ata of 1947 an 1951. Bal in
fo n that ca ital/la or ratio for ex orts as a o t $14200 hereas
ca ital/la or ratio for i orts as a o t $18000. In other or takin
tra e in 1962 into consi eration i orts ere 26.8% ore ca ital-
intensive than ex orts hile ex orts ere 26.8% ore la or intensive
than i orts. Fifteen years ast t the ara ox contin e .
Other Empirical Tests after Leontief
Test of Tate oto an Ichi ra ( ee: M. Tate oto an .
Ichi ra, Factor Pro ortions an Forei n Tra e: The Case of
Ja an, Revie of Econo ics an tatistics, no 41 Nove er
1959)----Para ox Exists.
Test of tol er an Roska ( ee: Wolf an F. tol er an Karl
Roska , "In t-O t t Ta le for East Ger any, ith
A lications to Forei n Tra e." B lletin of the Oxfor Instit te
of tatistics, Nove er 1961.) ----No Para ox.
Test of Wahl ( ee: D. F. Wahl, "Ca ital an La or Req ire ents
for Cana a's Forei n Tra e," Cana ian Jo rnal of Econo ics
an Political cience, A st 1961.)---- Para ox Exists.
Test of Bhara aj ( ee: R. Bhara aj, Factor Pro ortions an
the tr ct re of In ia- . . Tra e, In ian Econo ic Jo rnal,
Octo er 1962.)---- Para ox Exists.
Effect of Different Labor Efficiency
Leontief hi self favore H-O theory. He trie to rovi e so e
ex lanation y stressin the ifferent efficiency in the an the
other co ntries.
He ar e that orkers i ht e ore efficient than forei n ones.
As Leontief s este that erha s . . orkers ere three ti es as
effective as forei n orkers.
He sai in his a er in any co ination ith the iven q antity of
ca ital, one an-year of A erican la or is eq ivalent to, say, three
an-years of forei n la or. It eans that the avera e A erican
orker is three ti es as effective as he o l e in the forei n
co ntry.
Given the sa e K/L ratio, Leontief attri te the s erior efficiency
of A erican la or to remarkable entrepreneurship
, s erior econo ic or anizationan
environ ent f ll of econo ic incentives
in the . .
Ho ever, Leontief fo n very fe follo ers a on econo ists. Even
Leontief hi self s itte that he ha a e a la si le alternative
ass tion
Factor Intensity Reversal
See: B. S. Minhas: The Homohypallagic Production Function, Factor-
Intensity Reversals and Heckscher-Ohlin Theorem
, Jo rnal of Political
Econo y 70, no.2, A ril 1962.
a
m
k
a
t
k
b
b
t
k
b
m
k
b
m
l
b
t
l
' a
a
t
l
a
m
l
If a co o ity is ro ce y a la or-intensive rocess in the
la or-rich co ntry an also y the ca ital-intensive rocess in
the ca ital-rich co ntry, then factor intensities are reverse in
the ro ction of that co o ity.
A ca ital a n ant Co ntry
A an a la or a n ant
Co ntry B ill res ectively
ake ro ction ecisions
follo in the la of
econo ic efficiency. B t
factor intensity reverses.
Act ally, these t o co ntries sel o tra e ith each other, instea , they oth
ex ort their co aratively a vanta eo s oo s to the thir co ntry.
Agriculture is labor-intensive in India but capital-intensive in the United States.
Since India is surely a labor abundant
country agricultural production in India
must be a typical labor-intensive
process. While because of very
relatively high wage rate and a
relatively low price of capital the United
States tends to substitute labor input
with a great deal of agricultural
machinery.
If the United States imports agricultural
products from abroad, then it looks like to
import some capital-intensive goods, a
Leontief paradox occurs in the US,
because a false appearance shows that a
capital abundant country is importing
capital-intensive products.
If the United States exports agricultural
products to India, that is true in the US-
Indian bilateral trade, then a Leontief
paradox occurs in India, because a widely
recognized labor-abundant country, India,
is importing some labor-intensive goods.
Natural Resources
See: Jaroslav Vanek, The Natural Resource Content of
the United States Foreign Trade 1870-1955,
Ca ri e, MA: MIT Press, 1963.
Jaroslav Vanek ar e that Leontief ay have
oversi lifie the ro ction f nctions an faile to
reco nize the en o ents of nat ral reso rces. With
three factors of ro ction, the ty ical H-O o el oes
not re ict ch. This is eca se the notion of
a n ance an intensity st e re efine .
Let N stan s for nat ral reso rces e co l have so e
N-a n ant an N-scarce co ntries. Also e co l have
N-intensity oo .
If an N-a n ant co ntry ex orts N-intensive oo
hile an N-scarce co ntry i orts N-intensive oo , no
Leontief Para ox.
Relations between natural resources and capital inputs
In the act al ro ction rocesses of nat ral reso rce-
intensive oo s there st e co le entary relations
et een nat ral reso rces in ts an ca ital in ts an in
the ost art of s ch ro ction rocesses ca ital an
nat ral reso rces cannot e s stit te for each other.
The so-calle N-intensive oo s are asically ro ce in
consi era ly ca ital-intensive etho s.
Ty ical nat ral reso rce intensive oo , etrole an oil
ro cts, in every sta e of the ro ction rocesses,
incl in ex loitation, extraction, refine ent, trans ortation,
as ell as an fact rin , storin ( s ally tankin ) an
carria e ( s ally i in ) of ifferent ty es of oil ro cts
( asoline, iesel, nat ral as, an so on) a lar e vol e of
ca ital in ter s of an array of s ecific achinery an
eq i ents st e se .
It is i ossi le for a co ntry ith an a n ant ca ital
en o ent, s ch as the nite States, to s stit te the
relatively ex ensive recio s nat ral reso rces ith the
relatively chea ca ital in ts.
US Trade Pattern Consistent with H-O Model
There are at least t o reasons for the S to i ort lar e
vol e of N-intensive oo s.
Econo ic consi eration. To i ort s ch oo s fro
a roa st e consi era ly chea er than to
o estically ro ce the .
Strate ic consi eration. To esta lish the national strate ic
reserve of so e i ortant nat ral reso rces is to the
national enefit of the nite States.
As an N-scarce co ntry the S nat rally i orts a reat
vol e of N-intensive oo s fro a roa . No ara ox
here.
Beca se of the s ecific relation et een nat ral
reso rces an ca ital in ts the S see s to i ort
ca ital-intensive oo s if e have no consi eration of
nat ral reso rces hen analyzin its tra e attern.
Leontief Para ox is nothin t a is n erstan in .
Human Capital
Nations an in ivi als invest in their f t re
not only y acc latin hysical ca ital, s ch
as lant il in s, eq i ents, an
inventories, t also y s en in on e cation,
trainin , an other invest ents that are
e o ie in h an for , that is, h an
ca ital.
H an ca ital invest ent acq ires an
a ro riate rate of ret rn in ter s of relatively
hi her a e rate.
The eneral level of a e rate is hi her in
those in stries in hich h an ca ital is
e loye in a relatively lar er ro ortion.
Eq ivalently, hi her a e rate of a artic lar
co ntry eans it st e en o e ith
relatively a n ant h an ca ital eca se of
the evelo e hi her learnin e cation an
the a vance social service syste .
See: Irving Kravis, Wages and Foreign Trade, Review of Economics and Statistics 38, February
1956 and Peter. B. Kenen, Nature, Capital and Trade, Journal of Political Economy 73, October
1965.
Old Campus of
Yale University
False Appearance Makes the Paradox
When e insert a ne factor of h an ca ital into the tra e o el, tra e
attern of the nite States st e co letely reexa ine .
At first, the S st e re ar e as to e a n ant in h an ca ital
en o ent. The relevant statistics s est that a ty ical S la orer has an
avera e ore years of e cation than a forei n orker. Th s the S
la orers earn a relatively hi her salary than their forei n co etitors.
Takin a vanta es of its a n ant h an ca ital the S ay have een
ex ortin h an ca ital-intensive oo s to the other co ntries. Such sorts
of the S tra e is consistent ith the asic re iction of the H-O theory no
ara ox at all.
nfortunately, the effect of human ca ital, enerally hi her a e rate ha
een falsely concluded as more la or in ut y Leontief. That false
a earance must e the reason for Leontief Paradox.
Peter Kenen in 1965 calculated the value of extra human ca ital and
reexamined trade attern of the S. He suggested that if the value of human
ca ital ere included, the S ex orts ere ca ital-intensive relative to S
imports. This ould reverse the Leontief paradox.
Skills of Labor
A nations la or force is far from homogeneous ut rather consists of many
skill groups. Some economists, such as Donald Keesing, have sought the
explanation of trade patterns in endo ments of skills.
The asic point is that the use of la or as factor of production may involve a
category that is too aggregative, since there are many different kinds and
qualities of la or.
Keesing divided the S la or in production into the follo ing eight different
categories (They are listed in a descending order of skills): 1. Scientists and
Engineers ; 2.Technicians and Draftsmen; 3.Other Professional; 4. Managers;
5.Skilled La orers; 6.Other Skilled Handworkers; 7.Marketing Personnel and
8.Semiskilled and nskilled La orers. Keesing argued the first seven
categories could e skilled la or while the last category must e unskilled
la or.
In addition Keesing contri uted the differences in skills of la orers to how
many years of education received y different workers.
See: Donald Keesing, Labor Skills and Comparative Advantages, American
Economic Review 56, no. 2, May 1966.
Labor with Different Skills in US
Exports and Imports
Keesi f t t i eri t ere s siti e
rrel ti et een t e r nking f t e r ti s f
exports over t e tot l output of n industr , t t is (X
/ T )
i
, nd t e ove list of l or it different skills.
In ot er ords t ose industries in t e it ore
skilled l or ould ve exported l rger proportion
of t eir output to road.
Keesing also found t at skilled labor
(Categor 1 till 7) accounted for 55% of t e
total labor requirement in t e exports of
manufacturing goods ich is higher than the
same ratio for the import substitutes. In
the imports unskilled labor is required in a
relativel larger proportion. Thus it can be
said that the is exporting skilled labor-
intensive goods hile importing unskilled
labor-intensive goods.
Keesings Conclusion
It must a common knowledge that a typical
S la orer received more years of education
on average than the foreigners and the S
possessed substantially more scientists,
engineers and the other sorts of skilled
labor in the world.
Keesing argued that as a skilled labor
abundant and unskilled labor scarce
country the S trade pattern is consistent
with the basic prediction of the H-O theory.
There is no paradox.
The US Trade Policies
William Travis, suggested that the Leontief paradox might be
duo largely to tariffs and other forms of protection. There is
evidence that, in the nited States and some other developed
countries labor-intensive industries are relatively heavily
protected. Such trade protection must influence trade patterns
of those countries.
Robert E. Baldwin Baldwin tried to explain what he discovered
by considering specific tariff policy and the other relevant
trade policies taken by the nited States. The S takes a lot of
measures to protect its labor-intensive industries and at the
same time encourages its capital-intensive goods exports by so
many means.
See: William. P. ravis, he heory of rade and Protection, Cambridge: Harvard
University Press, 1964 and Robert E. Baldwin, Determinants of the Commodity
Structure of U.S. rade, American Economic Review 61, no. 1 March 1971.
Free trade, fare trade or no trade?!
Effect of Trade Policies
Such mixture of trade policies must have great impacts on the
actual trade pattern of the S.
On one hand, protectionist policies, especially the high trade
barriers, must inevitably hinder the foreign labor-intensive
commodities from entering into the S domestic market.
Consequently labor intensity of S imports would be relatively
reduced. On the contrary, capital intensity of S imports would
be relatively increased.
On the other hand a set of preferential policies for speeding up
S exports would inexorably stimulate exports of S labor-
intensive commodities thus relatively increase the proportion of
labor-intensive commodities in S total exports and
consequently the overall labor intensity of S exports might be
relatively increased.
R & D Factor
Some economists analyzed proportion of R and D investment
over the total sale and proportion of scientists and technicians
over the total employees in 19 industries of the S.
Statistics showed that those industries with the relatively
higher such proportions, such as transportation industry,
chemical industry, machinery manufacturing industry, and
instrument making industry, export more of their products
overseas. Those four industries accounted for 39.1% of the
total sale, 72% of the total exports and 89.4% of the total R and
D investment of the S manufacturing industries.
Therefore, Gruber, Melta and Vernon concluded that those
industries with more R and D investment thus an advanced
technology are the major exporters of the S.
See: W. Gruber, D. Melta, R. Vernon, The R and D Factor in International Trade and
Investment of United States IndustryJournal of Political Economy, Vol. 75
February, 1967.
They insisted that the S had developed an advanced risk
investment mechanism and constituted a comparatively greater
capability of technologic innovation and creation it must enjoy a
substantial comparative advantages over the other countries in
the high-tech industries.
This country, the nited States of America, produces and
exports R and D factor-intensive goods based on its comparative
advantages in high-tech industries derived from its relatively
abundant R and D factor and meanwhile imports the sorts of
products with relatively lower intensity of R and D factor from
abroad.
The S trade structure is consistent with the basic principle of
H-O Model and no paradox at all.
The argument of R and D factor presented, to some extent a
reasonable explanation of Leontief paradox.
In real terms (constant or inflation-
adjusted dollars), total R&D
performance grew 40.5 percent
between 1994 and 2000 at an average
annual real growth rate of 5.8 percent
over the period .
otal 2003 R&D performance in the
United States is projected to be $283.8
billion, up from an estimated $276.4
billion in 2002 and $274.2 billion in
2001.
R&D performance as a proportion of
GDP rose from 2.40 percent in 1994 to
2.69 percent in 2000 as growth in R&D
outpaced the growth of the overall
economy. he ratio of R&D to GDP
peaked in 2001 at 2.72 percent as the
rate of economic growth from the late
1990s slowed. In the subsequent
years, total R&D grew at a slower pace
than the overall economy, resulting in
R&D to GDP ratios of 2.65 percent in
2002 and 2.61 percent in 2003.
Demand Bias
Stefan Valavanis-Vail might be a pioneer of this approach. In
1954 he suggested a hypothesis of consumption structures.
He argued that there would be possibility in the real world that
a capital abundant country did not need to export capital-
intensive good if her tastes are strongly biased toward capital-
intensive goods.
Equivalently, a labor abundant country would import labor-
intensive goods from abroad if residents of this country had a
very strong bias toward consumption of labor-intensive goods.
Thus, Leontief Paradox can be explained if the S had a strong
consumption bias toward the capital-intensive goods.
See: Stefan ValavanisVail, Leontiefs Scarce Factor ParadoxJournal of Political
Economy, Vol. 62Dec. 1954. H. S. Houthakker, An International Comparision of
Household Expenditure Patterns, Commemorating the Centenary of Engels Law
Econometrica, Vol. 25, Oct. 1957. Staffan Linder, An Essay on Trade and
Transformation, Stockholm, Almquist and Wikell, 1961.
Statistics show that the industrial developed countries,
typically the nited States, indeed have a strong consumption
preference to some high quality and thus expensive luxury
goods (A relatively capital-intensive approach must be
employed in production processes of those goods) since the
overall income levels in those countries are much higher than
the less-developed countries.
In order to meet a great requirement of their consumers
many capital-intensive goods have been shipped from
abroad.
The opposite situation could be found
in the less-develop countries with a
very low income.
Consumption bias in those low-income
countries would strongly toward
inferior goods (They are basically labor
intensive) and therefore they do import
labor-intensive goods from abroad.
Theoretical Position of Leontief and His Paradox
In summary, Leontiefs research and his paradox not only
triggered the extensive empirical tests of factor endowment
theory but more importantly, induced more and more
economists to do a lot of valuable research in depth in order to
give the answer to such riddle. In this process they gave
different explanations to the new discovery of Leontief.
They either explored the influences of production factors with
different qualities or different essentialities on trade pattern of
a country, or introduced some new factors into the theoretical
framework, or analyzed the possible effects on trade of some
distortions in the real economy.
Even though they took different methods in their analysis and
they also focused on different points, they had a common
ground. That is they all advocated the principle of factor
endowment theory. They hoped lay a more scientific
foundation for factor endowment theory by their research.
For this purpose, those economists inserted some new factors,
which were abstracted by Heckscher and Ohlin when they
established theoretical system of factor endowment theory,
into theoretical framework of H-O Model.
More valuable is that all of those economists, happen to
coincide, accentuated the effects of technical progress on trade
pattern.
Their research thinking and the conclusions they had reached
reflected the actual variations in development of international
trade and the world economy.
Consequently what they had done in different research
developed and refined trade theory particular factor
endowment theory.
To this extent, we see without Leontief and his paradox it
would not be expected that trade theory could have been
developed so intensively.
Questions and problems
How to understand the significance of the empirical testing
of trade theory?
Why people termed the discovery of Leontiefs study as a
Paradox? What does the paradox mean?
How did Leontief himself present explanation of the
paradox?
Try to illustrate the major explanations of Leontief Paradox.
Try to describe your own ideas concerning the origin and the
reasonable explanation of the Paradox.
Try to illustrate the theoretical position of Leontiefs
research and discovery in development of trade theory.