The Leontief Paradox and the New Trade Theory

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The Leontief Paradox and the New Trade Theory
The Leontief Paradox seemingly undermined the Factor Proportions theory of international trade and stimulated additional research that has improved our understanding of how trade takes place in theory and in practice. Two types of New Trade theories have emerged. 1. Adapting H-O to Contemporary Patterns of Trade. • Human Capital Theory: Knowledge and skills (Human Capital) are much more important in production today than they were in Ricardo’s day or even when Heckscher and Ohlin studied trade. Countries like the United States and Japan are abundant in Human Capital (highly educated and trained workers) and export Human Capital intensive products such as computers and aerospace equipment. The H-O theory still holds for these products once we recognize that different countries have different relative endowments of Human Capital. • Product Life Cycle Theory: Raymond Vernon’s theory that U.S. multinational corporations produce high tech products at home when they are Human Capital intensive, then export them to other wealthy (human capital abundant) countries, then finally import them when they have become standardized, which means that they intensively use semi-skilled labor rather than highly skilled labor. The H-O theory does explain the product cycle. Leontief was confused when he saw the U.S. importing products it used to export, not realizing that they had gone through a “factor intensity reversal.” • Intra-Industry Trade: Once upon a time trade involved mainly exchange of whole products such as autos and airplanes and economic theories tried to explain this type of trade. Today, however, the production of goods is increasing fragmented, with products shipped back and forth across national borders (see the Boeing 787 handout). Now, for example, capital intensive automobile engine blocks parts may be manufactured in capital abundant Canada, then shipped to labor abundant Mexico for sub-assembly, then shipped to...
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