Leontief Paradox

More pictures from the Knossos Palace

Life in the Knossos Palace

Three positions of bull-leaping sports. Bulls were worshiped by the Phoenicians and Canaanites in Palestine.

Water jars. Cretans carried water with these jars to the ritual baths.

Life in the Knossos Palace, a restored mural.

Linear B tablet

Linear B tablet (Omniglot) with syllabaries, partly deciphered, similar to Japanese syllabary, hiragana). A precursor of the alphabet.

1. Leontief Paradox

Leontief attended University of Leningrad in 1921, and received a doctoral degree at the Friedrich University in Berlin in 1928. Wassily Leontief received a Nobel prize in 1973 for his contribution to the input-output analysis. Four of his students, Paul Samuelson, Robert Solow, Vernon Smith, Thomas Schelling also received Nobel prizes.

The Heckscher-Ohlin theory states that each country exports the commodity which intensively uses its abundant factor. The HO theory was generally accepted on the basis of casual empiricism. Moreover, there wasn't any technique or computers to test the HO theory until the input-output analysis was invented by Leontief.

The first Empirical Test of the HO theory

The first serious attempt to test the theory was made by Professor Wassily W. Leontief in 1953.

Leontief took the profession by surprise and his research stimulated an enormous amount of empirical and theoretical research on the subject.

How

To perform the test, Leontief constructed the 1947 input-output table of the US economy (He received his Nobel prize for his contribution to input-output analysis later). He aggregated industries into 50 sectors, but only 38 industries produced commodities that enter the international markets, and the remaining 12 sectors were created for accounting identities and nontraded goods. He also aggregated factors into two categories, labor and capital. He then estimated the capital and labor requirements to produce:

capital-labor ratios

k_x = a_Kx/a_Lx = $14,300 (exports)

k_m = a_Km/a_Lm = $18,200 (imports)

The US seems to have been endowed with more capital per worker than any other country in the world in 1947.

Thus, the HO theory predicts that the US exports would have required more capital per worker than US imports. However, Leontief was surprised to discover that US imports were 30% more capital-intensive than US exports,

k_m = 1.30 k_x.

Criticism

At first, Leontief was criticized on statistical grounds.

Boris Swerling (1953) complained that 1947 was not a typical year: the postwar disorganization of production overseas was not corrected by that time.

Tokyo bombing (Operation meetinghouse), March 10, 1945, National Museum of Western Art (国立西洋美術館), Tokyo

Leontief's Second Test

In 1956 Leontief repeated the test for US imports and exports which prevailed in 1951. In his second study, Leontief aggregated industries into 192 industries. He found that US imports were still more capital-intensive than US exports. US imports were 6% more capital-intensive (k_m = 1.06 k_x). (The transition of the US economy from a wartime to a peacetime economy was not complete until the 1960s.)

Baldwin's Third Test

More recently, Professor Robert Baldwin (1971) used the 1962 US trade data and found that US imports were 27% more capital-intensive than US exports. The paradox continued. [There were some computational problems in this study.]

k_m = 1.27 k_x.

Afterwards, there were no new empirical studies on US trade.

These studies should have been made at lease one generation (20 years) had passed after the war.

Implications of fragmentation

Trade data during the 1980s would have been more appropriate to test the HO theory. By the 1990s, the patterns of world trade changed significantly due to the third industrial revolution, which encouraged fragmentation of large-scale manufacturing industries.

Consequently, the assumption of identical production technologies was no longer relevant. A few firms had to maintain comparative advantages in one of the fragmented stages.

For example, iPhones are assembled in China using 178 components manufactured in different countries. In the case of iPhone 13, battery developed by Sunwoda electric, the display by Samsung and LG, and the glass casing by Corning, USA, assembling done in India.

	3. Trade Patterns of Other Countries
JAPAN	Tatemoto and Ichimura (1959) studied Japan's trade pattern and discovered another paradox. Japan was a labor-abundant country, but exported capital-intensive goods and imported labor- intensive goods. Japan's overall trade pattern was inconsistent with HO. (Masahiro Tatemoto and Shinich Ichimura) America's occupation of Japan ended in 1952. Japan and Europe could not produce enough goods for their own people during the post WWII period. Not much trade between the two regions. Explanation: Tatemoto and Ichimura said that Japan's place in the world was somewhere between the advanced economies and LDCs. 25% of Japan's exports went to advanced industrial countries (i.e., North America). Japan's exports to industrial countries were labor-intensive. 75% of exports went to LDCs. Japan's exports to LDCs were capital-intensive (Asia). Europe: German unification in October 1990 raised unemployment above 3 million, and industrial production of Germany fell to less than half the preivious level. Japan was recovering faster than Asia and Europe during the post WWII era. Thus, the US-Japan trade was consistent with HO prediction. Japan- LDC trade was also consistent with the HO theory. While factories had been destroyed by the incendiary bombing, the survivors were high-skilled workers, who were needed to export the capital-intensive goods. Casualties: Japan = 3 million, US = 400,000, Russia = 11 million military personnel + about 10 million civilians.
East Germany	Remains of the Berlin Wall © Stolper and Roskamp (1961) applied Leontief's method to the trade pattern of East Germany. East Germany's exports were capital-intensive. About 3/4 of EG's trade was with the communist bloc, and EG was capital abundant relative to its trading partners. Thus, the EG case was consistent with the HO theory.
South Korea	Hong (1975) analyzed Korea's trade pattern (1966-72), which was consistent with the HO theory.
CANADA	Wahl (1961) studied Canada's trade pattern. Canadian exports were capital-intensive. Most of Canadian trade was with the US. The result was inconsistent with HO.
INDIA	The flower market in Kolkatta© Bharawaj (1962) studied India's trade pattern. India's exports were labor-intensive. Consistent with HO theory . However, Indian trade with the US was not. Indian exports to the US were capital-intensive.

	Explanations for the LP 1. Leontief: US was more efficient
Leontief: US had absolute advantages	(Schwerer) Gustav railway gun during the Battle of Sevastopol © Leontief himself suggested an explanation for his own paradox. He argued that US workers may be more efficient than foreign workers. Perhaps U.S. workers were three times as effective as foreign workers. Note that this increased effectiveness of the American workers was not due to a higher capital-labor ratio, because we assume that countries have identical technologies and hence identical capital-labor ratios. It means that the average American worker was three times as effective as he would be in the foreign country. Given the same K/L ratios, Leontief attributed the superior efficiency of American labor to superior economic organization and economic incentives in the U.S. However, Leontief found very few believers among economists.
trade in Communist bloc (not HO pattern)	Lack of Incentives in the former Soviet Union Communism: marginal income tax rate is 100%. Trade with FSU bloc was neglible. Roughly a quarter of FSU's capital resoures had been destroyed. Marshall Plan aid gave the fund for reconstruction of European countries and the Soviet Union forbade communic bloc to trade with the West. If a surplus developed, it exported the good to another within the bloc.
Empirical evidence	Kreinin (1965) conducted a survey of engineers and managers, and tried to test whether an average American worker is three times as effective as a foreign worker. A realistic difference in effectiveness between the representative workers in the U.S. and those in the foreign countries were about 20-25%. Obviously, this difference does not explain the Leontief Paradox. When comparing the trade patterns of a market economy and a command economy, this explanation may be important. Modern technology is available to Russians, but production in the former Soviet Union is still inefficient due to lack of incentives. When a production technology is developed, the R&D team shows a product can be made. An efficient, commecially viable process for large-scale manufacturing must be further developed.
Evaluation	There might have been some difference in labor efficiency or productivity between the US and the rest of world in 1947. But this should have been relatively insiginficant. This was probably a bad theory. In reality, Leontief's argument amounts to assuming different production technologies. He calculated how much capital and labor inputs were needed if the imports had been produced in the US, insteading of calculating how much inputs were actually used in the source countries.
	Trefler (1993) resurrects Leontief's theory and has proved that when quality indices of factors are incorporated, US exported capital and imported labor services in 1947 (HOV Theorem). This still does not prove, however, that US imports had been more capital intensive than its exports that year.

	2. Factor Intensity Reversal
Example	Chinese soldiers on the Burma Road 1943 © If a commodity is produced by a labor-intensive process in the labor-rich country and also by the capital-intensive process in the capital-rich country, then factor intensities are reversed in the production of that commodity. Example: Agriculture is labor-intensive in India but capital-intensive in the US. If the US imports agricultural products, then an LP occurs in the US, because a capital-abundant country is importing the capital-intensive product. If the US exports agricultural products, then an LP occurs in India, because a labor-abundant country, India, is importing the labor-intensive good.
LP is inevitable	In the presence of a FIR, an LP always occurs in one of the countries. Thus, Jones (1956) and Robinson (1956) argued that FIR could have been responsible for the LP in the US.
Empirical relevance	The question is whether FIR is common in the real world. Minhas (1963) investigated 24 industries for which comparable data were available for 19 countries. He found FIRs only in 5 countries. Leontief (1964) reviewed Minhas's book and pointed out that only 17 out of 210 possible reversals did occur for the relevant range of factor prices. Moroney (1967) concluded that FIR has much less empirical importance, albeit theoretically interesting.
Agriculture	Remark: FIR plays an important role only if the trade volume of the industries with reversed factor intensities is large. While there has not been much empirical evidence about the possibility of factor intensity reversals, FIR is real. It may be important when comparing trade patterns between developing and developed economies (e.g. China vs. US). In most developed economies agriculture's share of GDP is less than 1%.(UK = .7%, US = 1.2%, world = 6.1%). US trade surplus in agriculture was about $20 billion in 2014 (about 1/10 of 1% of US GDP.) Thus, FIR is not important empirically, and is not likely to have been responsible for the LP in 1947.

	3. Natural Resources
	Leontief may have oversimplified the production functions and failed to recognize the endowments of natural resources. With three factors of production, the HO model does not predict much. This is because the notion of abundance is well-defined, but factor intensity cannot easily be defined.
"Factor intensities" are difficult to define in higher dimensions. (a topic for graduate students)	copper mine in Arizona © It is possible to have K₁/L₁ > K₂/L₂ and K₁/N₁ < K₂/N₂. We cannot make a statement "A labor-abundant country will export the labor-intensive product" in a three-good, three-factor world, because labor-intensity is not defined in a 3-factor, 3-good industry.
Jaroslav Vanek's Argument (1963)	Suppose the US is poor in natural resources. Assume that the import-competing industry uses capital and natural resources in fixed proportions, i.e., K and L are perfect complements in production. Then apply the HO theory. The US imports natural resource-intensive products, but it appears that the US is importing the capital- intensive goods.
Evaluation	Empirical studies have shown that the natural resource content in typical US imports is greater than that in US exports. But it is difficult to believe that US is poor in natural resources. Vanek's explanation is not empirically convincing.
Factor Abundance is meaningful	In a world of many factors (K, L, N, .... Z), factor abundance can be ranked: K/K^o > N/N^o> ...> L/L^o. where K^o, N^{o, and}L^o are world endowments of capital, natural resources, and labor. In this case, we can say that the HC is (most) abundant in capital, and least abundant in labor.
Heckscher-Ohlin-Vanek Theorem	When there are more goods than factors (n > 2), the pattern of trade is not predictable. The focus is then on indirect factor trade. A country exports its abundant factors through trade in goods. Let a = Y/(Y + Y) be the home country's share of world income. Then the HC is abundant in capital, if K/(K + K) > Y/(Y + Y*) ≡ a. For instance, India's GDP is about $2 trillion and its share of gross world product ($70 trillion) is 1/35. India's population share is 1/7, which is greater than 1/35. Thus, India is abundant in labor, and HOV Theorem predicts that India will export labor services to the Rest of the World. The HOV Theorem states that if trade is balanced, a country exports (the services of) its abundant factors through trade in goods. China's labor share = 1.4 billion/7 billion = 0.2 China's income share = 1/7 (about 14%). 0.2 > 1/7. (China is abundant in labor). China will export labor services through international trade. China's share of Rare Earth Elements (lanthanides + scandium and yttrium) = 90%. In this case, HOV states China exports REEs. The purpose of trade is to export the abundant factors.
Remark	1. If factor prices are equalized, the definition of factor abundance makes sense, since income is the sum of factor incomes. Y = wL + rK + sN + ... In a world of two factors, if factor prices are equalized (w = w* and r = r) K/K > Y/Y* if and only if K/K* > L/L. Thus, one can say that the above is a more general definition of factor abundance. (If a country's labor share is greater than income share, it is abundant in labor.) 2. Trade theory is supposed to predict the patterns of output trade. As the number of outputs increases, it becomes exceedingly difficult to predict the patterns of output trade. Thus, HOV was not even a result that economists were looking for. 3. Nevertheless, HOV theorem predicts the indirect* trade of factors through output trade. If HOV prediction is not materialized in the real world, it is an indication that there is a serious distortion in the economy. In this sense, HOV Theorem does provide a guide to trade policy; a trade policy should not encourage exports of scarce resources and imports of abundant resources.

	4. Tariffs and Transport Costs
	William Travis (1964) argued that tariff may have been responsible for the LP. However, tariffs tend to reduce trade volume, but not reverse the commodity trade pattern. In other words, an import tariff cannot induce a country to export goods that intensively use its scarce factor. It would only reduce the volume of goods which it would export in the absence of a tariff.
	Baldwin (1971) showed that this indeed was the case. Without tariffs, the capital-labor ratio of imports would have fallen by 5%, which is not sufficient to resolve the LP. ©
Remark	Tariffs and transport costs both tend to reduce the volume of trade, but not reverse the pattern of trade. No reversal of trade Instead of importing petroleum from the Middle East, the US now exports natural gas and oil to other countries. This trade reversal is not caused by an increase in tariff but by the discovery of abundant shale oil and fracking technology.

5. Demand Bias

A capital-abundant country need not export the capital-intensive good if her tastes are strongly biased toward the capital-intensive goods. Thus, the LP can be explained if the US had a strong consumption bias toward the capital-intensive goods.
Stefan Valavanis-Vail (1954)

Nihonbashi fish market, now Tsukiji market)

Tsukiji fish market ©

A blue fin tuna was sold for a record $3 million in Jan 2017. (about 500 pounds, $5000 per pound).

Nihonbashi (Japan bridge) fish market is the predecessor of today's Tsukiji fish market with over 60,000 employees. Its annual sales exceeds $40 billion.

US spends 6.5% on food, Japan 13.5%, China 25.5%. The relative price of food tends to be higher in developing countries.

Example of demand bias

cacao beans ©

In 1819 Francois-Louis Cailler established one of the first chocolate factories in Switzerland. Cailler Swiss Chocolate is the oldest brand of Swiss chocolate still in existence, and Switzerland leads the world in per capita annual chocolate consumption, 22.5 pounds per person! (Swiss Chocholate). Per capita consumption of chocolates is less than 5 pounds in the United States.

©

Per capita consumption of seafood in Japan is 60 kgs per year while that of the US was about 15 pounds in 2001. Thus, the Japanese people consumes 9 times more seafood than Americans per person.

However, when commodities are broadly classified (e.g., housing, foods, transportation, etc.), consumer tastes are the same across trading countries.

Jones Jones (1956, University of Rochester) argued that demand bias could be an explanation. However, no one argued that demand bias was a cause of the LP.

Empirical studies on Demand Bias (1) Houtthakker's studies (1957, 1960, 1963) suggest that there is considerable similarity in demand functions among countries.
(2) As per capita income increases, consumption of the labor-intensive goods (such as services) tends to increase while that of the capital- intensive goods decreases. (That is, the labor intensive goods are luxury goods. Consumers develop a sweet tooth for labor-intensive goods as income increases.) If there had been a consumption bias in the US in 1947, the bias must have been toward increased consumption of the labor-intensive goods. Therefore, consumption bias would have reinforced the HO prediction that US would import the labor-intensive goods.
Thus, demand bias is NOT a good explanation for the LP.

As GDP increases, the share of services increases. The share of services was only 60% in 1960, but has since steadily increased to 80% in 2019 (ag = 1.1%, manufacturing = 20%). Services tend to be nontraded goods.

	6. Human Capital
	Human capital has not been taken into account in evaluating LP. The idea is simple. Human capital is created by education. Education, like investment in physical capital, requires time and uses up resources. Leontief did not include the value of human capital in his calculations. But he argued that US exports were skilled labor- intensive than US imports.
3 × 3?	(i) there are two ways to incorporate human capital. Labor may be divided into to two or more groups: unskilled labor, semi-skilled labor, and skilled labor. First, the US may have been abundant in skilled labor. The US may have been exporting the skilled labor-intensive goods. (However, in a 3 × 3 HO model, we cannot prove that a labor-abundant country will export the labor-intensive good, because which good is "labor-intensive" or "capital-intensive" is not clearly defined in a higher-dimensional world with more than two factors.) (ii) A second way to include human capital: add human capital to physical capital: K = K_o + K_h
How to estimate human capital	ice breaking tanker © No reliable estimates of capital stock. Capital inputs are not homogenous across industries. Total value of US capital stock is about $51 trillion in 2014. The capital-output ratio is about 2.5 in the US. (i) Kravis (1956) found that American workers in the export industries earned higher wages than those in the import competing industries. This difference in wage reflects the existence of human capital. It is more likely that human capital had existed in both industries. However, it is the extra human capital embodied in labor in the export sector that counts here. The value of (extra) human capital embodied in labor is: (w_x - w_m)/r = K_h. High school dropouts: $20,000 High school graduates: $30,000 Bachelor's degree: $59,000 Master's degree: $70,000 Professional degree: $90,000 (+ increased job security + low unemployment rate, 1.5%) Doctor's degree: $84,000 (lower). The premium is a payment toward the extra amount of human capital or skill.
	(ii) Kenen (1965) used 9% discount rate and showed that if the value of human capital were included, the US exports were capital- intensive relative to US imports. This would reverse the LP. However, estimates of human capital is sensitive to the interest rate chosen. Specifically, a lower interest results in a greater amount of human capital in the export sector. If the discount rate is over 12%, this theory does not explain the LP. The wage gap between the two sectors may be due to other factors. Attributing the wage gap to only human capital is unsatisfactory. (Who stole the cookies from the cookie jar?) (iii) Baldwin's (1971) analysis shows that Human capital alleviates the LP, but it does not resolve the paradox.
Evaluation	These analyses show that presence of human capital can play an important role in determining trade patterns between coutries. However, available empirical evidence is not very conclusive either way. It is difficult to argue human capital and physical capital can be added.

7. Trade Imbalance

The HO theory based on the assumption that trade is balanced. To predict the trade pattern when trade is not balanced, much more information is necessary. In general, when trade is not balanced, a capital-abundant country may not export the capital-intensive goods. With a trade surplus, a capital-abundant country such as the US may not only export the capital- intensive goods but also the labor-intensive goods.

Leontief's data show that US exports in 1947 amounted to $16,678 million and imports were $6,177 million. GNP of the US that year was $198,688 million. Thus, the trade surplus was more than 5% of national income.

Suppose that there are three goods, 1, 2, and 3, so that k₁ > k₂ > k₃.

Assume further that when trade is balanced, the US exports good 1 and imports 2 and 3. Then this trade pattern would be consistent with the HO theory.

Suppose now that the US is maintaining a large trade surplus. This trade surplus means that US consumers must reduce consumption of all three goods proportionately (due to homothetic preferences). In the presence of a large trade surplus, it is possible for the US to export the most labor-intensive good. That is, the US may export 1 and 3 and import 2.

In this case, the average capital-labor ratio of the exports (1 and 3) can be lower than that in imports and a Leontief paradox occurs.

Scenario B: Balanced Trade

Industries	k_i	Production	Consumption	Export
1	2	400	200	200
2	1	50	200	-150
3	0.5	150	200	-50

Scenario S: Trade Surplus

Industries	k_i	Production	Consumption	Export
1	2	400	100	300
2	1	50	100	-50
3	0.5	150	100	50

US may have exported even the most labor-intensive products to Europe to stave off famine and starvation.

Trade pattern when trade is not balanced

If trade is not balanced, the HO theory cannot predict the trade pattern.

k_x = (300 K₁ + 50K₃)/(300 L₁ + 50L₃) > or < 1 = k_m = k₂

A capital-abundant country with a trade surplus may export even the most labor-intensive product (US in 1947).

A labor-abundant country with a trade surplus may export even the most capital-intensive product (China today)

Question

Had trade been balanced in 1947, would the US have exported capital-intensive goods and imported labor-intensive goods?

Among the 38 industries examined by Leontief, only three industries were importers in 1947. In the remaining 35 industries, the US was an exporter. Casas and Choi (1984) computed the trade pattern that would have prevailed had trade been balanced in 1947. They concluded that the US would have exported capital-intensive goods in the balanced trade situation. That is, US exports would have been more capital-intensive than US imports.

k_x = $12,338 per man year

k_m = $11,231 per man year

References

Bharawaj, R., "Factor Proportions and the Structure of India-U.S. Trade," Indian Economic Journal, October 1962.
Casas, François and E. Kwan Choi, "Trade Imbalance and the Leontief Paradox," Manchester School 52 (1984).
Casas, François and E. Kwan Choi,"The Leontief Paradox: Continued or Resolved?" Journal of Political Economy 93 (1985)
Wahl, D. F., "Capital and Labor Requirements for Canada's Foreign Trade," Canadian Journal of Economics and Political Science, August 1961.
Leontief, Wassily “Domestic Production and Foreign Trade; The American Capital Position Re-examined” Proceedings of the American Philosophical Society, 97 (1953), 332-349.
Stolper, Wolfgang F. and Karl Roskamp, "Input-Output Table for East Germany, with Applications to Foreign Trade." Bulletin of the Oxford Institute of Statistics, November 1961.
Trefler, Daniel, "International Factor Price Differences: Leontief Was Right!," Journal of Political Economy 101 (1993), 961-87.
William. P. Travis, The Theory of Trade and Protection, Cambridge: Harvard University Press, 1964.
Robert E. Baldwin, Determinants of the Commodity Structure of U.S. Trade, American Economic Review 61, no. 1 March 1971
Stefan Valavanis "Vail, Leontief's Scarce Factor Paradox," Journal of Political Economy, Vol. 62,Dec. 1954

	What's Next? Fragmentation of Industries
The world changed after WWII: Fragmentation	More than half the countries tested show trade patterns inconsistent with the HO theory. In such cases, there must be some problems that offset the HO trade patterns. The HO theory generally explains the trade patterns during the post war periods, say 1970 - 2000 and for trade in. There has not been a new study for the trade patterns after 1980. The HO theory applies today to international trade in bulky goods (foodstuff, forestry products, etc.) and resource extracting industries (various mining industries) (i) Large scale manufacturing industries These industries permit interchangeable parts (hence, the Ricardian model applies) World trade patterns have become a lot more complex: Fragmentation. (e.g., iPhones contain around 178 components, and 95 % are made in China, 80% are made in Zhengzhou. Japanese cars + Korean tires, etc.) Parts can easily be replaced. 8 percent of all purchases are returned ($280 billion in 2016). Automobiles and electronic goods (e.g., smartphones, iPad) 15 - 20 percent of online purchases are returned. Parts may be replaced and repaired goods may be resold at discounted prices. A smartphone contains electronic components like resistors, transistors, capacitors, inductors and diodes connected by wires © Michael Boskin reported said in 1992, it wasn't important whether an economy produced computer chips or potato chips. Chip technology has a greater potential to create new high-tech jobs, whereas the potato chip industry has perfected its production technology, and is likely to be a stagnant industry without further innovations. (ii) Parts are produced in different countries according to their comparative advantages, and assembled in a low-wage country. US manufacturing firms outsource the fragmented processes to low wage countries.
	(iii) Trade in integrated industries (e.g., shipbuiliding, aircrafts) where fragmentation is not allowed. Products are A defective part (e.g., O-ring) disables the whole product. Welding jobs cannot be redone (economic lifespan of an oil tanker = 25 years) Integrated industries export high-tech products (Identical technology assumption does not hold) ⇒back to the Ricardian model. Advaned economies do not share technologies. e.g., French royalties: $10 million per tanker. Gaztransport & Technigaz (GTT) gets 5% royalty for every tanker deisgn. Russian Icebreaker © Ice-breaking tankers cannot be easily repaired en route any more than flat panel displays. Often the disabled boats are junked. Parts cannot be outsourced. Thus, the traditioal HO model applies, but the assumption of identical technologies must be relaxed. (trade under differentiated oligopoly). Shipowners choose quality over low price . The New Supertanker Plague Erika was built in Japan in 1975 is a typical older tank, nearing the end of its life, set sail from Dunkirk, France, carrying 10 million gallons of fuel oil. It was split in half. (Reason: excessive rust) Similarly, MOL Comfort was completed in 2012, but broke into two off the coast of Yemen in June 2013. The industry continues to develop corrosion preventive technology using polymer coatings.

	5. Demand Bias
	A capital-abundant country need not export the capital-intensive good if her tastes are strongly biased toward the capital-intensive goods. Thus, the LP can be explained if the US had a strong consumption bias toward the capital-intensive goods. Stefan Valavanis-Vail (1954)
Nihonbashi fish market, now Tsukiji market)	Tsukiji fish market © A blue fin tuna was sold for a record $3 million in Jan 2017. (about 500 pounds, $5000 per pound). Nihonbashi (Japan bridge) fish market is the predecessor of today's Tsukiji fish market with over 60,000 employees. Its annual sales exceeds $40 billion. US spends 6.5% on food, Japan 13.5%, China 25.5%. The relative price of food tends to be higher in developing countries.
Example of demand bias	cacao beans © In 1819 Francois-Louis Cailler established one of the first chocolate factories in Switzerland. Cailler Swiss Chocolate is the oldest brand of Swiss chocolate still in existence, and Switzerland leads the world in per capita annual chocolate consumption, 22.5 pounds per person! (Swiss Chocholate). Per capita consumption of chocolates is less than 5 pounds in the United States. © Per capita consumption of seafood in Japan is 60 kgs per year while that of the US was about 15 pounds in 2001. Thus, the Japanese people consumes 9 times more seafood than Americans per person. However, when commodities are broadly classified (e.g., housing, foods, transportation, etc.), consumer tastes are the same across trading countries.
Jones	Jones (1956, University of Rochester) argued that demand bias could be an explanation. However, no one argued that demand bias was a cause of the LP.
Empirical studies on Demand Bias	(1) Houtthakker's studies (1957, 1960, 1963) suggest that there is considerable similarity in demand functions among countries. (2) As per capita income increases, consumption of the labor-intensive goods (such as services) tends to increase while that of the capital- intensive goods decreases. (That is, the labor intensive goods are luxury goods. Consumers develop a sweet tooth for labor-intensive goods as income increases.) If there had been a consumption bias in the US in 1947, the bias must have been toward increased consumption of the labor-intensive goods. Therefore, consumption bias would have reinforced the HO prediction that US would import the labor-intensive goods. Thus, demand bias is NOT a good explanation for the LP.
	As GDP increases, the share of services increases. The share of services was only 60% in 1960, but has since steadily increased to 80% in 2019 (ag = 1.1%, manufacturing = 20%). Services tend to be nontraded goods.

Leontief Paradox

Leontief's Second Test

JAPAN

East Germany

Explanations for the LP

1. Leontief: US was more efficient