Introduction to the Leontief Paradox: The Heckscher-Ohlin theorem gave a generalisation that the capital-abundant counties tend to export capital-intensive goods while labour- abundant countries tend to export the labour- intensive goods. W.W. Leontief put this generalisation to empirical test in 1953 and found the results that were contrary – to the generalisation provided by the H-O theory. Leontief made use of 1947 input-output tables related to the U.S. economy. 200 groups of industries were consolidated into 50 sectors, of which 38 traded their products directly on the international market. He took only two factors of production— labour and capital. His main empirical results are stated in Table. 8.1. Table 8.1, shows that import replacement industries in the U.S. had been employing 30 percent more of capital than the export industries. The capital-labour ratio was higher in the import- replacement industries than the export industries. It suggested that the exports of United States, generally recognised as the capital-abundant country, were labour-intensive. Leontief therefore, concluded, “American participation in the international division of labour is based on its specialisation in labour 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 labour rather than vice-versa.” In brief, capital-abundant countries export labour- intensive goods and labour-abundant countries export capital-intensive goods. This reflects what is called as ‘Leontief Paradox’ as this conclusion goes against H-O theory. Although the United States is a capital-abundant country, yet its specialisation is found in the labour-intensive commodities. The conclusion derived by Leontief not only surprised himself but startled the academicians throughout the world. The economists undertook intense research for re-examining both the H-O theory and Leontief paradox. The attempts were also made on empirical grounds to reconcile the Leontief analysis with the H-O theory. Several economists investigated the causes of bias in Leontief’s work and exposed the methodological and statistical weaknesses and inaccuracies in his analysis. Loentief Paradox and Evidence Related to Other Countries: 1 The Loentief paradox brought into focus the crucial issue of the validity or otherwise of H-O theory. Many economists conducted Loentief type studies related to other countries. The evidence is, however, not conclusive one way or the other. While some of the empirical studies put a question mark on the validity of H-O theory, the others have gone in favour of it. A study attempted by Tatemato and Ichimura concerning Japan has confirmed the Leontief paradox. Japan even though a labour-abundant country, imported labour-intensive goods like raw materials and exported capital-intensive goods such as automobiles, computers, T.V. sets, watches etc. According to these writers, this pattern of trade is not consistent with the H-O theory. They attributed such a trade pattern to the fact that almost 75 percent of Japan’s exports were directed to the Third World countries which were more capital- scarce that Japan. From their viewpoint, Japanese exports to them were capital-intensive. In contrast to the United States, Japan was labour- abundant and capital-scarce. Consequently her exports to the advanced countries like the United States had a lower capital-labour ratio. In this way, their findings confirmed the validity of H-O theory. The H-O theory found support from a study made by W. Stopler and K. Roskamp concerning the erstwhile East Germany in 1956. Almost 75 percent of her trade was with the countries of the communist block. East Germany was relatively more capital-abundant than the latter. At the same time, her exports to these countries were relatively capital- intensive and imports labour-intensive. D.F. Wahl conducted a study related to the trade pattern of Canada in 1961. This study showed that Canadian exports to the U.S.A, the major trading partner of Canada, were relatively more capital- intensive than her imports. It lent support to the Leontief paradox and contradicted the H-O theory. Another study that provided support to the Leontief paradox was made by R. Bhardwaj in 1961 concerning India’s trade pattern. He showed that Indian exports, in general, were more labour- intensive, while imports were capital-intensive. However, in her trade with the United States, the exports were capital-intensive and imports were labour-intensive. Thus, even this study ran counter to the H-O theory. There can be certain reasons for greater capital- intensity of exports by India and some other LDC’s to the United States. Firstly, these countries depend greatly on the technology imported from the advanced countries, as they do not themselves have an indigenous technology suited to their own factor endowments. The imported technology is highly capital-intensive. As a result, the exported goods have a relatively high capital- labour ratio. Secondly, India relied heavily on the imports of food grains and many other consumer products from the United States until 1970’s. That accounted for high labour-intensity of her imports from the United States. Thirdly, there is a substantial direct foreign investment by MNC’s owned by the United States and the European countries in India and other LDC’s. They generally operate in the export sector and produce goods through highly capital-intensive techniques. That can be one of the reasons for high capital-intensity of their exports, even though they are capital-scarce. Fourthly, there is factor price distortion in the LDC’s, i.e., the factor prices existing in these countries do not necessarily reflect their factor proportions. 2 There is the possibility that labour is over-priced and capital is underpriced in the LDC’s on account of such factors as strong trade union pressures, minimum wage laws, capital consumption allowances and other subsidies on capital and duty free imports of technology and capital goods from abroad. As the over-pricing of labour and underpricing of capital cause factor-price distortion, there is likelihood that the labour-surplus and capital-scarce countries like India export capital- intensive goods and import labour-intensive goods. The Leontief paradox was supported by the study made by M. Diab in 1956 concerning the United States trade with Canada, Britain, Netherlands, France and Norway. This study, relying on Colin Clark’s data, demonstrated that the United States was having a low capital-labour ratio in her exports than the above-mentioned countries. L. Tarshis approached the whole problem indirectly by comparing the internal commodity prices in different countries. The study revealed that the price ratio of capital-intensive relative to labour- intensive goods was lower in the United States and higher in other countries. Since the United States is a relatively capital-abundant country, the result is fully consistent with Heckscher-Ohlin theory. In the empirical studies made by E.E. Leamer in 1980 and 1984, it is suggested that the comparison of K-L ratio in the multi-factor world should be in production versus consumption rather than in exports versus imports. Applying this approach to 1947 Leontief’s data, Learner concluded that K-L ratio was indeed greater in the United States production than the United States consumption. That strengthened the H-O theory and refuted Leontief paradox. The study made by Stern and Maskus in 1981 for the year 1972 confirmed the H- O theory even when natural resource industries were excluded. In a 1987 study, however. Bowen, Learner and Sveikauskas, employed more complete 1967 cross- sectional data on trade, factor input requirements and factor endowments of 27 countries, 12 factors (resources) and several commodities. They concluded that H-O trade theory was valid in about fifty percent cases. It is now sufficiently clear that the empirical studies concerning the Leontief paradox or H-O theory, have provided conflicting conclusions. Until convincing or more conclusive evidence becomes available in support of Leontief paradox, the H-O theory must be deemed as valid. Reconciliation between Leontief Paradox and Heckscher-Ohlin Theory: Although the conclusion given by Leontief was in contradiction to the generalisation given by H-O theory, yet Leontief never attempted to supplant the factor proportions theory. He rather tried to explain the reasons due to which he arrived at a result different from that provided by the H-O theory. Many other economists too attempted to reconcile the Leontief paradox with the H-O theory of international trade. The more prominent explanations in this context are as follows: (i) Labour Productivity: 3 Leontief himself tried to bring about reconciliation between his paradox and H-O theory through the argument that the United States, though a labour-scarce country in strictly quantitative or conventional terms, is actually a labour-abundant country. The productivity of labour in the United States is about three times that of labour in the foreign countries. The higher productivity of the American labour was attributed by him to better organization and entrepreneurship in the United States than in other countries. In view of this, it is not surprising that the labour- abundant United States exports those products, which have relatively greater labour-intensity. There is no doubt that the productivity of labour is higher in the United States than in other countries. But the multiple of three, as assumed by Leontief was clearly arbitrary. In a study conducted by Kreinin in 1965, it was revealed that the productivity of American labour was more than that of the foreign labour only by 20 to 25 percent and not by 300 percent. Given such a situation, the United States cannot be regarded as a labour-abundant country.