Tests of the Classical and HO

1
Tests of the Classical and HO

• Tests of the Classical and HO international
  models have provided us a bag of mixed and
  confusing results. As a result, many have tried
  to test them.

2
G.D.A. MacDougall

• He tested the Classical theory of international
  trade. Specifically, he wanted to test

3
G.D.A. MacDougall

• He tested the Classical theory of international
  trade
• complete specialization

4
G.D.A. MacDougall

• He tested the Classical theory of international
  trade
• complete specialization
• mutual gain from international trade

5
G.D.A. MacDougall

• He tested the Classical theory of international
  trade
• complete specialization
• mutual gain from international trade
• MacDougalls hypothesis was that in those
  industries where labor productivity (after
  adjusting for wage differentials) in the U.S.
  relative to that of U.K. are higher, U.S. export
  should be higher.

6
G.D.A. MacDougall

• He divided U.S. and U.K.'s industry output by the
  labor input used in their production.

7
G.D.A. MacDougall

• He divided U.S. and U.K.'s industry output by the
  labor input used in their production.
• The Average Labor Productivity, APL, was used to
  find a measure of relative labor productivity in
  both countries.
• The APL was then compared to the relative wage
  rates in both countries.

8
G.D.A. MacDougall

• He divided U.S. and U.K.'s industry output by the
  labor input used in their production.
• The Average Labor Productivity, APL, were used to
  find a measure of relative labor productivity in
  both countries. The APL was then compared to the
  relative wage rates in both countries.
• At the time, U.S. wage rate was twice higher than
  that of U.K. Therefore, theoretically, he argued
  that if there is a comparative advantage for
  either country, APL in the US must be more than
  twice that of UK to compensate for the higher
  wage rates in the U.S.

9
G.D.A. MacDougall

• He found that in 20 out of 25 cases the general
  hypothesis was true. Wherever the U.S. has a
  higher labor advantage, it exported more. This
  confirms that there is direct relationship
  between labor productivity and exports. The
  higher labor productivity, the higher exports.

10
G.D.A. MacDougall

• But this is not a confirmation of the Classical
  model because
• Classical theory tries to explain the trade
  between two countries and not from two countries
  to a third country.

11
G.D.A. MacDougall

• But this is not a confirmation of the Classical
  model because
• Classical theory tries to explain the trade
  between two countries and not from two countries
  to a third country.
• This test does not rule out HO model. under a
  same conditions HO model would predict a same
  thing.

12
G.D.A. MacDougall

• But this is not a confirmation of the Classical
  model because
• Classical theory tries to explain the trade
  between two countries and not from two countries
  to a third country.
• This test does not rule out HO model. under a
  same conditions HO model would predict a same
  thing.
• The model does not control for the influence of
  other factors such as

13
G.D.A. MacDougall

• But this is not a confirmation of the Classical
  model because
• Classical theory tries to explain the trade
  between two countries and not from two countries
  to a third country.
• This test does not rule out HO model. under a
  same conditions HO model would predict a same
  thing.
• The model does not control for the influence of
  other factors such as
• transportation cost,

14
G.D.A. MacDougall

• But this is not a confirmation of the Classical
  model because
• Classical theory tries to explain the trade
  between two countries and not from two countries
  to a third country.
• This test does not rule out HO model. under a
  same conditions HO model would predict a same
  thing.
• The model does not control for the influence of
  other factors such as
• transportation cost,
• product differentiation,

15
G.D.A. MacDougall

• But this is not a confirmation of the Classical
  model because
• Classical theory tries to explain the trade
  between two countries and not from two countries
  to a third country.
• This test does not rule out HO model. under a
  same conditions HO model would predict a same
  thing.
• The model does not control for the influence of
  other factors such as
• transportation cost,
• product differentiation,
• trade barriers

16
Tests of HO model

• Leontif test
• The most famous test of the HO model was done by
  Wassily Leontief. He used input-output tables to
  see whether HO theory of international trade
  could be verified. The input-output shows the
  interrelationship among all industries.
• Input-output explains the flows of goods and
  services among every sector of the economy. It
  shows intraindustry and intraindustry sales of
  output.

17
Tests of HO model

• Leontif test
• Leontief conducted an experiment to see what are
  K and L requirements if the U.S. decided to
  reduce exports and use the factors of production
  saved to reduce imports by a same amount. That
  is increase imports competing goods and reduce
  exports.

18
Tests of HO model

• He showed that if production of import competing
  goods are increased by one million dollars, we
  need
• 170 man years of labor
• 3.1 millions of capital.

19
Tests of HO model

• Leontif test
• He also showed that a reduction of one millions
  dollars of exports would save
• 182.3 man year of labor and
• 2.6 million dollars of capital.

20
Tests of HO model

• In other words, exports are less capital
  intensive than imports because there is a higher
  capital content in the imported goods and
  services than in the exported goods and services.
  This is exactly the opposite of what HO would
  predict. This became famous as the Leontief
  Paradox.

21
Tests of HO model

• His explanation was that U.S. labor is more
  productive than those of other countries. In
  other words, each unit of labor in more the one
  unit of labor abroad. The U.S. is not a capital
  abundant country as was perceived to be .
  Therefore, US is a labor abundant country and is
  exporting labor intensive commodities.

22
Tests of HO model

• Jaroslov Vanek
• He argued the Paradox is a result of the
  assumption that there are two factors of
  production.

23
Tests of HO model

• Jaroslov Vanek
• He argued the Paradox is a result of the
  assumption that there are two factors of
  production. There is a third factor, natural
  resources. Since the U.S. is scarce in natural
  resources, they are imported.

24
Tests of HO model

• Jaroslov Vanek
• He argued the Paradox is a result of the
  assumption that there are two factors of
  production. There is a third factor, natural
  resources. Since the U.S. is scarce in natural
  resources, they are imported. But natural
  resources are produced using highly capital
  intensive methods. Therefore it seems that the
  U.S. is importing capital intensive goods which
  is not the case.

25
Tests of HO model

• Jaroslov Vanek
• He argued the Paradox is a result of the
  assumption that there are two factors of
  production. There is a third factor, natural
  resources. Since the U.S. is scarce in natural
  resources, they are imported. But natural
  resources are produced using highly capital
  intensive methods. Therefore it seems that the
  U.S. is importing capital intensive goods which
  is not the case. The U.S. is not importing
  capital intensive goods, it is importing natural
  resource intensive goods. When data was
  examined, it turned out to be true.

26
Tests of HO model

• Jaroslov Vanek
• He argued the Paradox is a result of the
  assumption that there are two factors of
  production. There is a third factor, natural
  resources. Since the U.S. is scarce in natural
  resources, they are imported. But natural
  resources are produced using highly capital
  intensive methods. Therefore it seems that the
  U.S. is importing capital intensive goods which
  is not the case. The U.S. is not importing
  capital intensive goods, it is importing natural
  resource intensive goods. When data was
  examined, it turned out to be true. That is the
  U. s. is importing resource intensive
  commodities.

27
Tests of HO model

• Jaro W. P. Travis.
• Travis tried to explain the paradox using the
  argument that the prevailing tariffs distort the
  picture.

28
Tests of HO model

• Jaro W. P. Travis.
• Travis tried to explain the paradox using the
  argument that the prevailing tariffs distort the
  picture. U.S. tariffs
• on the capital intensive commodities tend to be
  lower and

29
Tests of HO model

• Jaro W. P. Travis.
• Travis tried to explain the paradox using the
  argument that the prevailing tariffs distort the
  picture. U.S. tariffs
• on the capital intensive commodities tend to be
  lower and
• tariffs on the labor intensive commodities tend
  to be higher, about over 25.

30
Tests of HO model

• Jaro W. P. Travis.
• Travis tried to explain the paradox using the
  argument that the prevailing tariffs distort the
  picture. U.S. tariffs
• on the capital intensive commodities tend to be
  lower and
• tariffs on the labor intensive commodities tend
  to be higher, about over 25.
• This means increasing the possibility of
  importing more capital intensive goods and less
  labor intensive goods. That is distorting the
  comparative advantage of the U.S.

31
Tests of HO modelAlternatives theories

• Human Skill mode developed by Donald Keesing.
• He argued that the emphasis must be put on the
  intensities of skilled and unskilled labor rather
  than just labor.

32
Tests of HO modelAlternatives theories

• Some countries, like the U.S., have a highly
  skilled labor more than the others. Therefore
  they export commodities that are intensive in
  skilled labor and import commodities that are
  intensive in unskilled labor.

33
Tests of HO modelAlternatives theories

• Irving Kravis provided some support for this
  model. He showed that the high wage industries
  (i.e., those who use skilled labor) in the U.S.
  constitute a large bulk of U.S. exports and low
  wage industries (i.e., those who use unskilled
  labor) in the U.S. constitute a large bulk of U.
  S. imports.

34
Tests of HO modelAlternatives theories

• Product Cycle Model (Raymond Vernon) emphasizes
  the process of by which a product is invented and
  then over time becomes more standardized as
  consumers and producers gain familiarity with its
  services and features.

35
Tests of HO modelAlternatives theories

• Raymond Vernon argues that when a product is in
  its primitive stage of being invented, it is a
  highly labor intensive commodity. So, before the
  commodity becomes standardized, the inventing
  country has a comparative advantage.

36
Tests of HO modelAlternatives theories

• The inventing country (firm or industry), in the
  process of inventing the commodity will not
  invest heavily in the production until it is
  certain that there is a market for the product.
  As the commodity becomes known and standardized,
  convenient and popular features of the product
  are identified, heavy investment in its
  production will take place and large scale
  production of the commodity will begin.

37
Tests of HO modelAlternatives theories

• initially, the inventing country has the
  comparative advantage in the product. But as the
  low cost, large scale production of the commodity
  begins, the inventing country will loose its
  comparative advantage and start to import the
  commodity from abroad. So while the inventing
  country had the comparative advantage, it was
  labor intensive but after the process of
  standardization was completed the commodity
  becomes more and more capital intensive.
  Therefore it appears that the inventing country
  is exporting labor intensive commodity.
• Even though this might be true for some
  manufacturing commodity, it is not true as a
  general rule. There are some commodities, such
  as aircraft and computers, that the U.S. took the
  lead and kept the lead.
• Similarity of Preferences (Steffan Linder)
• Thesis a model which emphasizes the demand side
  of the product as the determining factor for
  trade in differentiated products. This is in
  sharp contrast with the comparative advantage
  argument which is solely based on the supply side
  of the equation.
• Linder argues that in each country commodities
  are made to match the taste and the preferences
  of the local market. This means a different
  product is produced in each country. Even though
  the difference might be slight, it is different.
  International trade provides a means of consuming
  this slightly different goods. This explains why
  rich countries trade with each other and poor
  countries trade with other most.
• This is in sharp contrast with the prediction of
  HO model which predicts countries would gain most
  if they traded with those with the most different
  TOT. Several points must be noted in this
  respect
• 1-- the theory only applies to the differentiated
  products.
• 2-- He finds nothing paradoxical about the
  Leontief's findings. This is, he would argue,
  what you should expect to happen. Countries with
  similar endowment producing and trading similar
  things with each other.
• 3-- There is a little empirical support for the
  theory.
• 4-- The support for the theory comes mostly from
  the data on the intraindustry trade.
• Even though intraindustry trade provides some
  support for Linder's similarity of preference
  argument, it is not conclusive because

38
Tests of HO modelAlternatives theories

• initially, the inventing country has the
  comparative advantage in the product. But as the
  low cost, large scale production of the commodity
  begins, the inventing country will lose its
  comparative advantage and start to import the
  commodity from abroad.

39
Tests of HO modelAlternatives theories

• So the inventing country had the comparative
  advantage when it was labor intensive, but after
  the process of standardization was completed the
  commodity becomes more and more capital
  intensive. Therefore it appears that the
  inventing country is exporting labor intensive
  commodity.

40
Tests of HO modelAlternatives theories

• Even though this might be true for some
  manufacturing commodity, it is not true as a
  general rule. There are some commodities, such
  as aircraft and computers, that the U.S. took the
  lead and kept the lead.

41
Tests of HO modelAlternatives theories

• Similarity of Preferences (Steffan Linder)
• This is a model which emphasizes the demand side
  of the product as the determining factor for
  trade in differentiated products. This is in
  sharp contrast with the comparative advantage
  argument which is solely based on the supply side
  of the equation.

42
Tests of HO modelAlternatives theories

• Similarity of Preferences (Steffan Linder)
• Linder argues that in each country commodities
  are made to match the taste and the preferences
  of the local market. This means a different
  product is produced in each country. Even though
  the difference might be slight, it is different.

43
Tests of HO modelAlternatives theories

• Similarity of Preferences (Steffan Linder)
• Linder argues that in each country commodities
  are made to match the taste and the preferences
  of the local market. This means a different
  product is produced in each country. Even though
  the difference might be slight, it is different.
  International trade provides a means of consuming
  this slightly different goods. This explains why
  rich countries trade with each other and poor
  countries trade with other most.

44
Tests of HO modelAlternatives theories

• Similarity of Preferences (Steffan Linder)
• This is in sharp contrast with the prediction of
  HO model which predicts countries would gain most
  if they traded with those with the most different
  TOT.

45
Tests of HO modelAlternatives theories

• Similarity of Preferences (Steffan Linder)
• Several points must be noted in this respect
• 1-- the theory only applies to the differentiated
  products.

46
Tests of HO modelAlternatives theories

• Similarity of Preferences (Steffan Linder)
• Several points must be noted in this respect
• 1-- the theory only applies to the differentiated
  products.
• 2-- He finds nothing paradoxical about the
  Leontief's findings. This is, he would argue,
  what you should expect that to happen. Countries
  with similar endowment producing and trading
  similar things with each other.

47
Tests of HO modelAlternatives theories

• Similarity of Preferences (Steffan Linder)
• Several points must be noted in this respect
• 1-- the theory only applies to the differentiated
  products.
• 2-- He finds nothing paradoxical about the
  Leontief's findings. This is, he would argue,
  what you should expect to happen. Countries with
  similar endowment producing and trading similar
  things with each other.
• 3-- There is a little empirical support for the
  theory.

48
Tests of HO modelAlternatives theories

• Similarity of Preferences (Steffan Linder)
• Several points must be noted in this respect
• 1-- the theory only applies to the differentiated
  products.
• 2-- He finds nothing paradoxical about the
  Leontief's findings. This is, he would argue,
  what you should expect to happen. Countries with
  similar endowment producing and trading similar
  things with each other.
• 3-- There is a little empirical support for the
  theory.
• 4-- The support for the theory comes mostly from
  the data on the intraindustry trade.

49
Tests of HO modelAlternatives theories

• Similarity of Preferences (Steffan Linder)
• Even though intraindustry trade provides some
  support for Linder's similarity of preference
  argument, it is not conclusive because
• 1-- Border trading. For example, U.S. - Canada
  trade. It is much easier and far more cheaper
  for the eastern states to sell timber to the
  eastern Canadian states and western state in the
  U.S. to buy timber from the western Canadian
  states.

50
Tests of HO modelAlternatives theories

• Similarity of Preferences (Steffan Linder)
• Even though intraindustry trade provides some
  support for Linder's similarity of preference
  argument, it is not conclusive because
• 1-- Border trading.
• 2-- Data aggregation is another problem.
  Intraindustry trade may actually not exist to
  extent that the data shows because the data is
  aggregated. As a result of aggregation, they
  seem to be a same product whereas in reality they
  are different commodities.

51
Tests of HO modelAlternatives theories

• Similarity of Preferences (Steffan Linder)
• Even though intraindustry trade provides some
  support for Linder's similarity of preference
  argument, it is not conclusive because
• 1-- Border trading.
• 2-- Data aggregation is another problem.
  Intraindustry trade may actually not exist to
  extent that the data shows because the data is
  aggregated. As a result of aggregation, they
  seem to be a same product whereas in reality they
  are different commodities. For example apparel
  in an item in intraindustry data. It includes
  tens if not hundreds of items. If they are
  disaggregated, they would be different items.
  But in aggregated form, they are a same thing
  that are trade.

52
Tests of HO modelAlternatives theories

• Similarity of Preferences (Steffan Linder)
• Even though intraindustry trade provides some
  support for Linder's similarity of preference
  argument, it is not conclusive because
• 1-- Border trading.
• 2-- Data aggregation is another problem.
• 3--Increasing return to scale and imperfect
  competition.
• Increasing return to scale means a more than
  proportional increase in output as result of a
  given increase in inputs.

53
Tests of HO modelAlternatives theories

• Similarity of Preferences (Steffan Linder)
• 3--Increasing return to scale and imperfect
  competition. Increasing return to scale means a
  more than proportional increase in output as
  result of a given increase in inputs.
• Assume two countries that produce all their needs
  under autarky. After international trade
  resumes, there will be an opportunity to expand
  ones market.

54
Tests of HO modelAlternatives theories

• Similarity of Preferences (Steffan Linder)
• 3--Increasing return to scale and imperfect
  competition.
• If the firm enjoys increasing return to scale it
  could expand production and undersell the local
  producer in the other country it will do so and
  force other ones out of the market.

55
Tests of HO modelAlternatives theories

• Similarity of Preferences (Steffan Linder)
• 3--Increasing return to scale and imperfect
  competition.
• Therefore, one could observe intraindustry trade
  because those producers that started to expand
  sooner than the other ones will have an advantage
  in the market due to the potential profits due
  increasing return to scale.

56
Tests of HO modelAlternatives theories

• Similarity of Preferences (Steffan Linder)
• 3--Increasing return to scale and imperfect
  competition.
• Therefore one could observe intraindustry trade
  because those producers that started to expand
  sooner than the other ones will have an advantage
  in the market due to the potential profits due
  increasing return to scale. The ones that did
  not realize the potential will be forced out of
  the market. This is not a healthy development
  because it reduces competition and increases
  imperfect competition.