International Trade Relations
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The Heckscher-Ohlin theory of comparative advantage was produced as an alternative to the Ricardian model and had an ideological mission: the elimination of the labor theory of value and the incorporation of the neoclassical price mechanism into international trade theory. The empirical validity of the Heckscher-Ohlin model and argues that most of the empirical work aimed at proving the validity of the model by focusing on its power to predict trade patterns is irrelevant. Moreover, the dynamic version of the model, which predicts dynamic structural change in the long run, is based on simple empiricism. Secondly, it exposes the theoretical weaknesses of the model by questioning its treatment of capital and labor. Finally, it challenges the view that the model surpasses the Ricardian model in its ability to predict patterns of trade between low- and high-income countries by demonstrating that the Ricardian model would also anticipate similar trade patterns.
The wider discipline of trade theory within which we find the field of input-output economics consists of four broader areas. Input-output economics, based on the Heckscher-Ohlin theory and defined by the findings of Wassily Leontief forms the biggest most well known part. The Ricardian model, which is the next most important model to that on which input-output economics is based, will be described in some depth for the sake of comparison and to give an alternative insight into the discipline of trade theory.
The Ricardian model then, suggests that labor costs will be the determinant of trade: the country with the lower labor cost in the production of a good will be the exporter of that commodity. This theory was tested in 1952 by MacDougall who used data on 25 products from 1937 to compare labor productivity and exports for the United States and Great Britain. In this way, MacDougall tested whether their relative exports to third countries were connected with their labor productivities. The results which MacDougall found were inconsistent with the simple Ricardian model. However, they are generally interpreted as supporting a more general “Ricardian” argument that differences in relative labor productivities are the determinant of comparative advantage. As long as these differences are due to technology, the model exists as an alternative to the model described previously.
MacDougall found that wage rates in the manufacturing sector were roughly twice as high in the United States as in Britain. Therefore, the United States should be the dominant exporter in markets where her labor productivity was more than twice as high as in Britain. Britain, on the other hand, should be the dominant supplier in any line of production where her labor productivity was more than 50% of the American. Whenever labor productivity in US industry was twice that of its British counterpart, we should expect export shares of the two countries to be roughly equal in third markets.
Although the French economist FranÐ*ois Quesney had formulated a “tableau иconomique” in 1958 which depicted the workings of a farm and Leon Walras and other classical economists formulated general equilibrium models of the economy, none could employ their findings to the solution of problems. Therefore, the beginnings of the discipline of input-output economics are most often referred to as a 1951 paper written by Wassily Leontief.
In this paper, Leontief made a relatively simple point. The boom time after the Second World War had brought with it an indigestible amount of facts. To this Leontief said “we have in economics today a high concentration of theory without fact on the one hand, and a mounting accumulation of fact without theory on the other” (Leontief, 1986). He went on to state that the collusion of the two was the most important task at hand for economists of the day. He made this collusion possible through the analytical method which he called inter-industry or input-output analysis.
Leontiefs findings were revolutionary in many ways, however most importantly because they cast doubt on the Heckscher-Ohlin theory. Under the Heckscher-Ohlin theory, “productive factors are assumed to move from areas of low remuneration to areas of high remuneration, lowering their supply in the first region and raising it in the latter. The workings of the market then raise the earnings of the migrating factor in the land of departure and lower it in the land of arrival, thus tending to equalize factor rewards the world over” (Kreinen, 1991). The doubt which was cast over this theory became known as the Leontief Paradox.
Leontief argued that the Heckscher-Ohlin theory predicts that a country will tend to export those commodities which use its abundant factor of production intensively and import those which use its scarce factor intensively. However, when taking a representative basket of American exports, he discovered that they embodied more labor and less capital than a representative basket of American imports.
However, the Heckscher-Ohlin theory predicts that under free trade and with consequent factor-price equalization, the capital-labor ratio