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 Leontiefs 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

Lets 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. Leontiefs 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