Reconciling Leontief Paradox with Hechscher-Ohlin Therorem

Reconciling Leontief Paradox with Hechscher-Ohlin Therorem

Learner and Levinsohn (1996) are surely correct when they assert that the H.O theorem is neither correct or incorrect. What then are we to expect empirical testing to do? My view is that I want tests to narrow the bounds of belief that one can sensibly have about the world. Negative results do not render the theory useless. But they do suggest that when considering the data of interest, this particular constellation of assumption may not be helpful in making sense of the world. Negative results are interesting insofar as they rule out otherwise appealing set of assumptions. this also suggests that one look for ways of weakening the strict assumptions of the model are most crucial and to which type of data sets one can sensibly apply the various versions of the theory. this study was actually designed to identify the likely sources of the paradox so that Leontief results could be reconciled with the H.O theory.

Wealth Explanation

The predictions of the international trade are based on traditional sources of comparative advantage. These predictions have been challenged by two major empirical findings Leontief (1953) and Trefler 91995, The Former found that US export in 1947 were labor intensive while later, showed that factor service ride is much smaller than predicted by the H.O.V theory, a fact known as the missing trade mystery.

Wynne (2004) showed that two economics with otherwise equal characteristics but with different levels of wealth will have different comparative advantages. Wealthier economics have a comparative advantage in sectors with financial imperfections because wealthier entrepreneurs are better able to overcome incentive problems in borrowing-lending relations. Better incentives imply lower failure rates. This transits into lower lending rates, inducing entrepreneurs to expand production in the small firm sector and thereby driving the country's comparative advantage.

When technology and world price remain constant, countries converge to steady patterns during the development process. At initial stages, economics exhibit a comparative advantage in the sector characterized by no financial frictions; at more advanced stages, economics export the good produced in the small firm sector. Wynne (2004) argued that wealth could be part of the explanation behind Trefler missing trade mystery and the Leontief Paradox. Trefler (1995) found that, unless empirical exercise has omitted factors that are scarce in poor countries trade is missing. Wynne paper argued that wealth may be that omitted factor.

Leontief (1953) paradox as in a standard trade model, higher total factor productivity (TFP) introduces a force that rends to give comparative advantage to capital intensive sectors. Wynne paper documented it that large firms are capital intensive, implying that countries with higher TFP may have a comparative advantage to produce in the large firm sector. At the same time, countries with a higher TPF are wealthier which tends to introduce a force that gives them a comparative advantage in the labor intensive sector. In other words as suggested by Leontief, TFP (and consequence wealth differences). Introduce conflicting forces that drive comparative advantage in opposite directions. Therefore the model predictions square with Leontief and Trefler's finding because wealth offset (at least partially) the gains form trade predicted by difference in TFP.

Natural Science Explanation

'How long will researchers working in adjoining field abstain from expressing serious concern about the splendid isolation in which academic economics now finds itself/ Wassily Leontief, Noble laureate in economics, asked two decades ago ( leontief 1982). The question is extremely important because economics is the foundation on which most decisions affecting agriculture, fisheries, the environment and indeed, most aspect of our daily lives are based. Natural scientists including biological scientists may have particular views on this or that economic policy but few question the legitimacy of economics as tool.

It is essential to note that economics be based on sound principles and that the policies generated from it have a solid found foundation consequently, major decisions that affect millions of people and most of the world's ecosystem are based on neoclassical economic models that, although internally consistent and mathematically sophisticated, ignore or are not sufficiently consistent with the basic laws of nature. In this, analysis, Hall, Linderberger, Kummel, Kroeger and Eichhorn (2001) brought out the criticisms of neoclassical model which include its unrealistic nature because it was not based on the biophysical world and the laws governing it, especially thermodynamics and the basic assumptions under lying the models used have not been put forth as testable hypotheses but rather as given.

Here it is suggested that a new model of industrial production that they believe should support their criticism and assessment of the important of energy. In their new model the output of the economic system and the maintenance of its components depend upon continuous input of energy into the system, as is true for all organisms and ecosystems.

"Anything as important in industrial life as power deserves more attention than it has yet received from economists...A theory of production that will really explain how wealth is produced must analyze the contribution of the element energy. (Tryon 1927)". The decisive mistake of traditional economics is the disregard of energy as a factor of production (Binswanger and Ledergerber 1974). Models that do not include energy cannot explained the empirically observed growth of output by the growth of the factor inputs labor and capital. There always remains a large unexplained growth residual that formally is attributed to energy. This has led to a criticism of the neoclassical model that it is theory of growth that leaves the main factor in economic growth unexplained (Solow 1994). Labor productivity has been correlated highly with increasing energy use per worker. This has been especially critical in Agriculture (Hall et al 1986). wassily Leontief noted, many economic models are unable "to advance,in any perceptible way, a systematic understanding of the structure and operations of a real economic system, instead they are based on "setts of more or less plausible but entirely arbitrary assumptions" leading to" precisely stated but irrelevant theoretical conclusions" (Leontief 1982). This may also reconcile the Trefler missing trade mystery and the Leontief Paradox which explains the input which is scare in the poor economics.