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. However, there are other areas which deserve to be mentioned in order to round out the discussion. These other areas are the Ricardian model of comparative advantage, Posner’s technological-gap theory and Vernon’s product life-cycle theory.
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 labour costs will be the determinant of trade: the country with the lower labour 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 labour 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 labour 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 labour 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 labour 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 labour productivity was more than 50% of the American. Whenever labour 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.
In most cases, the ratio of US to British exports was higher whenever her ratio of labour productivity was higher. However the dividing line between British and US exporters in third markets was not where American productivity was twice as high as in Britain. In these markets, Britain still had a comparative advantage. The American markets needed a productivity advantage of roughly 2.4 to be even with the British in third markets. The basic explanation MacDougall suggested for this phenomenon was that imperial preferences and other tariff advantages that were enjoyed by countries which were close to her politically could be possible explanations for the advantage that Britain at the time enjoyed in her export markets. Other reasons put forward were that Britain had been the pioneering industrial nation and that her dominance in international finance and her commercial reputation still gave her certain advantages which were difficult to measure but which were still important.1
The Beginning of Input-Output Economics Although the French economist Francois Quesney had formulated a “tableau economique” 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”2 . 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 interindustry or input-output analysis.
Leontief’s 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”3 . The doubt which was cast over this theory became known as the Leontief Paradox.
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 labour and less capital than a representative basket of American imports.
Leontief presented the first working model of input-output economics on the US economy in 1919. for this, he constructed a 46 x 46 sector table. Each sector having both a vertical and a horizontal column. In 1932 the third table for the US economy was constructed with the use of a computer. It comprised only 42 sectors but required 56 computer hours to do the necessary computations.
This 42 sector model is depicted on the following pages. This is a national model which today has 512 sectors. This type of national model is the most advanced form of the input-output model. Generally, however, the type of input-output approach which will be described further on in this writing is adapted to regions. These regional input-output tables describe how regional industries interact with each other and with the outside world, through imports and exports.
There was no doubt that the United States was the country most highly endowed with capital in 1947, so according to the Heckscher-Ohlin theory, it should have been exporting capital-intensive products and importing labour intensive goods. In constructing his table, Leontief was unable to obtain information on the factor intensity of the actual imports to the United States.
However, the Heckscher-Ohlin theory predicts that under free trade and with consequent factor-price equalization, the capital-labour ratio in US import competing goods should be the same as in its imports. Leontief was able to obtain information on the capital-labour ratio in US import-competing goods. He went on to estimate the consequences for the use of factors of production of the United States decreasing its exports and increasing its import substitutes by US$1 million. He took only two factors explicitly into account, capital and labour. When exports are decrease, both capital and labour are released. When production of import-competing goods is increased, both more labour and capital are needed. According to Leontief’s hypothesis, we would expect relatively more capital to be released from the export industries and relatively more labour to be needed by the import-competing industries .