Page 61 - DECO503_INTERNATIONAL_TRADE_AND_FINANCE_ENGLISH

Unit 4 : Modern Theories of International Trade : Theorem of Factor Price Equalization, H-O Theory, Kravis and...

In Figure 4.12, the isoquants for steel and cloth, are tangent to each other at point Q; and the factor Notes
intensities of the two products reverse themselves on either side of point Q. Given the factor price
ratios of country A represented by the lines P P , cloth has a higher capital labour ratio (K/L) as
0 0
compared to steel in country A. This is indicated by the vectors OC and OA. In country B, however,
steel has a higher K/L ratio than cloth, and this is indicated by the two vectors OB and OD. In other
words, cloth is capital-intensive and steel labour-intensive in country A, whereas in country B steel is
capital-intensive and cloth labour-intensive. This is another case of factor intensity reversal. Factor-
intensity reversal can also be demonstrated as in Figure 4.13.

a
P 0 b
A

H
B
Capital P 1

C
G
b (Steel)
a (Cloth)
D

O P 0 Labour P 1

Figure 4.13: Factor intensity reversal once again.
Country A’s factor price ratio line is P P and country B’s similar line is P P . The isoquant for cloth is
1
1
0
0
the line aa, and for steel, it is the bb line. The two vectors OA and OB represent K/L ratios in the
production of cloth and steel in country A, and the other two vectors OC and OD show the similar
ratios for the two goods in country B. It can be easily seen that cloth is capital-intensive in country A
but labour intensive in country B, and steel is labour-intensive in country A while it is capital-intensive
in country B. The two isoquants cut each other twice—at point H and G.
The assumptions of identical production functions in the two countries and of the non-reversability
of factor intensities, are necessary for the validity of the Heckscher-Ohlin prediction. The question,
then, is whether factor reversal is common in the real world. Minhas, Leontief, Moroney and others
have carried out extensive empirical investigations into this question and their findings are conflicting.
Minhas, for example, investigated 24 industries for which comparable data could be obtained for 19
different countries, and found factor reversal in 5 cases. Leontief and Moroney are critical of Minhas’s
findings, and in fact, Moroney concludes that factor intensity reversal “has much less empirical
importance than theoretical interest”.
The phenomenon of reversal of factor intensity, if provided widespread, would rob the Heckscher-
Ohlin model its predictive significance concerning the structure and direction of commodity trade.
Leontief Paradox and Other Leontief-Type Tests

The first comprehensive and detailed examination of the Hecksher-Ohlin theorem was the one
undertaken by Leontief. You will recall that the theory of factor proportions predicted that the capital
abundant country exported capital-intensive goods and imported labour-intensive goods, and the
labour surplus country did the opposite. It is commonly agreed that the United States is a capital rich
and labour scarce country. Therefore, one would expect exports to consist of capital-intensive goods
and imports to consist of labour-intensive goods. Leontief made an extensive study of the US structure
of trade and the results were startling. Contrary to what the Heckscher-Ohlin theory had predicted,

LOVELY PROFESSIONAL UNIVERSITY 55