An Empirical Demonstration of Classical Comparative Cost Theory

Abstract

E CONOMIC theory can be regarded as consisting of a number of models designed to explain economic phenomena and to yield predictions for the future. Any choice among alternative models should be based on their explanatory valuea model (or hypothesis) can be regarded as superior to another if it better explains actual phenomena and it is more helpful in predicting future events. theory of international trade abounds in theoretical models, some of them complementary, others conflicting. Alternative approaches towards explaining the causes of international specialization are followed, for example, by classical economists on the one hand, and by Heckscher and Ohlin on the other. While the hypothesis advanced by the former presupposes the existence of inter-country differences in production functions, the latter assume identical production functions and qualitatively identical factors of production in the trading countries and attribute international specialization to differences in factor endowments. empirical testing of the Heckscher-Ohlin hypothesis by Leontief led to inconclusive results, and the interpretations and explanations given to the Leontief paradox have demonstrated that the assumptions of this model require modification.' In the present paper, we will not attempt to test the Heckscher-Ohlin hypothesis, but will rather inquire into the validity of the classical model. According to the original formulation of the classical theory, comparative advantage based on relative productivity differentials determines international specialization. It has subsequently been realized that inter-country differences in the wage structure and in the capital-labor ratios of various industries may compensate for productivity differentials; a country possessing a relative productivity advantage in a particular industry may still import the commodity in question if it paid relatively higher wages and/or had higher capital costs per unit of output in that industry.2 Still, the defenders of classical theory among others, Taussig expressed the opinion that the latter factors are not sufficiently important to warrant significant changes in the trade pattern as determined by relative differences in productivity.3 Let us adopt the following notation: C= unit cost A = labor input per unit of output W wage rate T ratio of capital plus labor costs to labor costs Subscripts I and II refer to country I and country II, respectively. Capital letters refer to commodity X, small letters to commodity Y. modified classical hypothesis can now be written: If A, a, < , (I) All all it is likely also that CI CI , , (2) CIw CIl when the latter exDress'ion is equivalent to * This paper was prepared during the tenure of a research grant from the Economic Growth Center at Yale University in the summer of ig6i. author wishes to express his appreciation to Marnie Mueller who has cheerfully borne the burden of data collecting and computations and also made helpful comments on an earlier version of the paper. Further thanks are due to Michael Lovell for valuable suggestions and criticism. 1 W. W. Leontief, Domestic Production and Foreign Trade: American Capital Position Re-examined, Economia Internazionale, (February 1954), 9-38; Proportions and the Structure of American Trade: Further Theoretical and Empirical Analysis, this REVIEW, XXXVIII (November I956), 386-407. Also, P. T. Ellsworth, The Structure of American Foreign Trade: A New View Examined, this REVIEW, XXXVI (August I954), 279-285; Stefan Valavanis-Vail, Leontief's Scarce Factor Paradox, Journal of Political Economy, LXII (December I954), 523-528; N. S. Buchanan, Lines on the Leontief Paradox, Economia Internazionale (November I955), 79I-794; and the discussion in the supplement to the February I958 issue of this REVIEW, by Stefan Valavanis-Vail, Romney Robinson, G. A. Elliott, Beatrice Vaccara, and W. W. Leontief, III-I22. 2 For references, see Jacob Viner, Studies in the Theory of International Trade (New York, I937), 493-5I2. 'F. W. Taussig, International Trade (New York, I927), 43-68.