The Factor Proportions Theory: the Significance and its Testing by W. Leontief

The research of factors, influencing product range and volume of international trade, allowed the Swedish scientists E. Heckscher and B. Ohlin in 30-s of XX century to clarify and supplement the key points of the comparative advantage theory and to formulate the concept of factors of production.

Need to seek a new concept of international trade dictated by the fact that the ideas of David Ricardo based on the assumption of a constant cost of production in each country. However, in practice, along with the growth of production and product diversification was an increase of marginal costs, leading Swedish economists to the conclusion of necessity to introduce the growth conditions for replacement cost (relative costs) into the model.

The theory is based on the following preconditions:

• there are two countries; two commodities, one of which is labor-intensive and another one is capital- intensive; and two factors of production: labor and capital;

• technologies in both countries are the same;

• each country in varying degrees endowed with factors of production;

• there is no international movement of factors of production;

• there cannot be the full specialization of countries in production of any product.

The most important assumption of this theory is a different factor intensity of individual commodities (one commodity is labor-intensive, the other one is capital-intensive) and different factor abundant of individual countries (one country has relatively more capital, the other one has relatively less capital).

Factor intensity is an indicator that determines the relative costs of production factors on the product development.

For example, product B is relatively more capital-intensive than the product A, if the ratio of capital to labor in the production of goods is more than the ratio of the same cost of production of the product A.

Factor abundance of the country is an indicator that determines the relative factor endowment of the country.

For example, if you define factor abundance through the absolute size of the factors of production, the country where the ratio of total capital to total labor is greater than in other countries will be considered as capital abundant or capital endowment country.

The essence of the Heckscher-Ohlin theorem is as follows: each country will export that factor abundant goods, for the production of which it uses relatively abundant and cheap factors of production, and will import the goods, which require relatively scarce and expensive resources.

The Heckscher-Ohlin theorem considers trade to be based on comparative advantages and shows that the reason of the differences between the relative prices of goods and the emergence of comparative advantage between countries is the difference in factors endowment.

The Heckscher-Ohlin theorem had further development in the factor-price equalization theorem (the Heckscher-Ohlin-Samuelson theorem). It answers the following question: "If the relative price of labor-intensive goods changes, how will the relative price of the labor change in a labor abundant country, which produces these goods, as well as, if the relative price of capital abundant goods changes, how will the price of capital change in a capital abundant country?"

The essence of the factor-price equalization theorem is as follows: international trade leads to the equalization of absolute and relative prices for the goods, and this, in its turn, leads to the equalization of relative and absolute prices for homogeneous factors of production, whereby there produced these goods in partner-countries.

The theorem has some limitations: it considers the world in static, determining the factors affecting the macroeconomic equilibrium at a certain time, and does not take into account the fact that the absolute amounts of factors of production are different in different countries, and therefore the absolute amounts of income for capital will be greater in the country, which is endowed with more capital. It follows that full equalization of the prices of factors of production as a result of trade is impossible.

However, despite the shortcomings, the factor proportions theory is an important instrument for the analysis of international economy, showing the principle of general equilibrium, which is subject to economic development. This model of international trade proved to be the most suitable for explaining the processes of trade between the parent states and colonies, when the first ones performed as the industrialized countries, and the second ones as agrarian and raw-material-producing appendage.

Nevertheless, in the analysis of trade flows in the "triangle" of the United States - Western Europe - Japan, the Heckscher-Ohlin theorem faces difficulties and contradictions, which attracted the attention of many economists, in particular, the American Nobel Laureate Wassily Leontief. He applied the Heckscher-Ohlin theorem to the analysis of foreign trade of the United States, and by means of several empirical tests he showed that the terms of the theory do not keep in practice. Since the United States was a capital abundant country with relatively high wages, according to the theory, it should export capital-intensive goods, and import labor-intensive ones. However, in reality, they exported more laborintensive goods, and capital intensity of American imports exceeded exports by 30%. This meant that the United States was not capital abundant, but labor abundant. The results of the Leontief's research were named "Leontiefs paradox": the Heckscher-Ohlin theorem is not confirmed in practice, as labor abundant countries export capital-intensive products, and capital abundant countries export labor-intensive products.

W. Leontief explains this paradox by division of labor into skilled and unskilled. The United States exported the goods, whose production in other countries was impossible or inefficient due to the lower labor skill. W. Leontief created the model of "labor skill", according to which, instead of the three factors (capital, land, labor) the production includes four factors: skilled labor, unskilled labor, capital and land. The relative welfare of professional staff and skilled labor predetermine the export of goods, the production of which requires the use of skilled work; and surplus of unskilled labor contributes to the export of goods, the production of which does not need the high qualification.

Nobody can give a convincing answer to the question about the reason of Leontief's paradox. The main explanations are the following: 1947 year, analyzed by Leontief, was not representative; a two-factor model (capital and labor) was used; American tariffs, to a considerable extent, protected domestic labor-intensive industries; human capital was not taken into account. The testing of the Heckscher-

Ohlin theorem, by means of the data of a large number of countries, confirmed the existence of Leontiefs paradox in other countries.