Leontief Paradox (Rima)

a) Write a short note on Leontief Paradox.
Ans:
Definition:
Leontief paradox refers to the paradoxical findings of
W.W. Leontief that the United States of America exported relatively
labour-intensive goods and imported relatively capital-intensive
goods from the rest of the world in the immediate post–World War
II period so that its trade pattern was not consistent with its capital
abundance.
Analysis:
The foremost empirical test of the HO theorem was done
by Leontief (1954). Using the data for exports and imports of the
United States after World War II, he observed that it was exporting
relatively labour-intensive goods to the rest of the world. But the
United States was by far the most capital-abundant country in the
world. Given the export composition of the United States in 1947,
Leontief estimated labour and capital requirements for producing a
bundle of export goods to be worth USD 1 million. On the other
hand, observing the import composition of its imports, he estimated
labour and capital required to produce USD 1 million worth of
imports if these were produced in the United States instead of being
imported. His estimates showed that domestic production of the
imported goods would have required 30 per cent more capital per
worker than what the production of export goods required. He
repeated his tests for 1951 and observed a similar pattern of trade
though the relative capital intensity of import replacement was
substantially less than what it was in 1947. Hence, he concluded that
the United States was importing relatively capital-intensive goods.
This observation, known as the Leontief Paradox, raised
considerable interest among trade theorists to reconcile it with the
HO theorem that a capital abundant country should export relatively
capital intensive goods. Further tests for 1962 data supported the
paradox, but for 1972, Stern and Maskus (1981) observed the
paradox to vanish for the United States. Leontief’s test, when
applied to other countries’ trade data, yielded similar paradoxical
results. Pattern of trade in more recent times for China and India, for
example, also provide indirect evidence that a country’s trade pattern
may not be fully consistent with its endowment pattern. Despite
these countries being unskilled labour-abundant countries, their
basket of exports even to the skilled-labour-abundant countries
contains a large proportion of high-technology and skill-intensive
commodities.
A theoretical reconciliation of the Leontief Paradox with the

HO theorem was offered primarily in terms of a stronger taste bias,
factor intensity reversal, and cross-country technology differences.
As explained in the earlier chapters, if consumers in a labour-
abundant country have a very strong taste bias in labour-intensive
commodities, the country may end up exporting capital-intensive
commodities. In case of factor intensity reversal, on the other hand,
referring back to Figure 6.10, when the endowment differences of
the countries are too large, relative wages in the two countries differ
in a way that textiles are produced with relatively labour-intensive
techniques in the home country but by relatively capital-intensive
techniques in the foreign country. Thus, if the capital and labour
required to produce import replacements in the foreign country are
measured, as Leontief did, it will appear that the foreign country
being relatively capital abundant imports relatively capital-intensive
textiles.
Leontief’s own position regarding the paradox, however, was
that the United States was technologically quite advanced and its
workers were more productive compared to most of the countries.
This led to a pattern of comparative advantage for the United States
that was not consistent with its endowment pattern. His position,
which was later supported empirically by Trefler (1993) in a
generalized test as explained below, is illustrated in Figure 7.1. As
assumed earlier in Chapter 6, the foreign country (the United States
in Leontief’s test) has a larger stock of physical capital than the
home country but the same endowment of labour. But suppose
foreign workers are more productive in all lines of production than
the home workers. Thus, in productivity or efficiency units, the
foreign country has a larger endowment of labour and can produce
more of both goods than the home country. This is shown by the
higher broken labour constraint line for the foreign country. If the
labour productivity difference is too large, the foreign country
appears to be relatively labour-abundant when measured in
efficiency units and thus produces larger units of textiles relative to
computers than the home country. This is illustrated in Figure 7.1 by
the production bundle P* and this supply bias in textiles causes its
pre-trade relative price to be smaller than the price in the home
country. Hence, the foreign country exports textiles, which seems to
be at odds with the HO theorem when its factor abundance is
measured in physical units, but is consistent with the theory when its
factor abundance is measured in efficiency units (or in productivity-
augmented units)

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a) Write a short note on Leontief Paradox.

A theoretical reconciliation of the Leontief Paradox with the

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