The Heckscher-Ohlin Model: Leontief Paradox

 After showing the effect of endowment differences (focus on factor endowments and factor intensity),
list the assumptions of the Heckscher-Ohlin model and state the Heckscher-Ohlin Theorem
 Leontief Paradox: Describe Leontief’s test of the Heckscher-Ohlin model, his result and its possible
explanations

The Heckscher-Ohlin trade model builds on the neoclassical supply-side theories. It adopts and
maintains three assumptions about production characteristics in each country:

1. The production functions for goods X and Y exhibit constant returns to scale. These
production functions, which are the same in both countries, differ in relative usage of capital
and labor.
2. There are fixed total supplies of the two factors, labor and capital, which are homogeneous
and perfectly mobile between industries within each country. However, they are perfectly
immobile between countries.
3. There are no market distortions such as imperfect competition, labor unions, or taxes that
would influence production or consumption decisions.

Factors are fully employed.

When expanding the model to allow for trade, two additional assumptions are required:

1. Preferences in both countries are taken to be identical and homogeneous

2. Countries are assumed to differ in relative factor endowments

Factor endowments are specifically defined in terms of the ratios between capital stocks and labor
forces in the two countries. For example, if the capital-labor ratio of Country H is higher than it is in
Country F, we say that Country H is relatively capital-abundant ( and labor-scarce) while Country F is
relatively labor-abundant (and capital-scarce) => (K/L)h > (K/L)f

Factor intensities refer to the capital-labor ratios used in different industries at a common set of factor prices.
For example, good Y is relatively capital-intensive and good X is higher in the former sector: (K/L)y > (K/L)x
The Heckscher-Ohlin model is a model with two countries, two goods and two factors (or the 2x2x2
model). The goal of this model is to predict the pattern of trade in goods between two countries,
based on their differences in factor endowments.

The Heckscher-Ohlin model makes a series of strong assumptions:

 Identical technologies across countries

 Identical and homothetic tastes across countries
 Differing factor endowments
 Free trade in goods (but not in factors
 No factor-intensities reversals

Let’s assume that Country H is relatively labor-abundant (and capital-scarce) while Country F is
relatively capital-abundant (and labor-scarce) => (L/K)h > (L/K)f. We also assume that good X is
labor intensive. The countries engage in free trade. Thus, under the assumptions of the
model Country H will export good X and Country F will export good Y. In order to derive thee
pattern of trade between the countries we have to establish the relative product price in
each country without any trade, or in autarky. Then the pattern of autarky prices can be
used to predict the pattern of trade: a country will export the good whose free trade price is
higher than its autarky price, and import the other. This leads us to:

The Heckscher-Ohlin Theorem: Each country will export the good that uses its abundant factor
intensity.

Leontief’s Paradox

Leontief (1953) was the first to confront the H-O model with data. He had developed the set
of input-output accounts for the U.S. economy, which allowed him to compute the amounts
of labor and capital used in each industry in 1947. He utilized that data to compute the
amounts of labor and capital used in the production of $1 million of U.S. export and imports.
In that year the United States was unquestionably the most capital-abundant nation in the
world and was certainly capital-abundant and labor-scarce relative to the rest of the world.
Thus, the expectation was that exports were capital-intensive. Nevertheless, Leontief
discovered that the capital-labor ratio in U.S. import exceeded that in U.S. exports by some
23%. This unexpected outcome has been labelled the Leontief paradox.

A wide range of explanations have been offered for this paradox:

 U.S. and foreign technologies are not the same;

 By focusing only on labor and capital, Leontief ignored land
 Labor should have been disaggregated by skill (since U.S. export are intensive in
skilled labor)
 The data for 1947 may be unusual, since WW2 had just ended
 The U.S. was not engaged in free trade, as the H-O model assumes