Tim Worstall on Stopler-Samuelson: Meet the Leontiff Paradox

Tim Worstall suggests that free trade will naturally lead to rising income inequality in the U.S., but we really should see this as a good thing:

The theory is the Stolper-Samuelson Theorem. Stripped to its essentials this says that we would expect the process of globalization to have the following effect: it will lower wages in the US and raise corporate profits (more precisely, returns to capital). In the poor countries that the US is trading with it will have the opposite effect

In other words, workers in the U.S. make more than workers in places like China and Mexico because the U.S. has a higher capital to labor ratio. Free trade will tend to equalize wages internationally, which means Mexican and Chinese wages will rise as U.S. wages will fall. It’s called the Factor Price Equalization theorem:

The fourth major theorem that arises out of the Heckscher-Ohlin model is called the factor-price equalization theorem. Simply stated the theorem says that when the prices of the output goods are equalized between countries as they move to free trade, then the prices of the factors (capital and labor) will also be equalized between countries. This implies that free trade will equalize the wages of workers and the rents earned on capital throughout the world. The theorem derives from the assumptions of the model, the most critical of which is the assumption that the two countries share the same production technology and that markets are perfectly competitive.

Worstall is relying on a very simple two-good, two-factor of production theorem where all workers are homogenous. He is seemingly unaware of the Leontiff Paradox.

Leontief reached a paradoxical conclusion that the US – the most capital abundant country in the world by any criterion – exported labor-intensive commodities and imported capital- intensive commodities. This result has come to be known as the Leontief Paradox. Leontief took the profession by surprise and stimulated an enormous amount of empirical and theoretical research on the subject.

Greg Mankiw seemed to enjoy Worstall’s post. While I also found it interesting, I would hope that the economics students at Harvard go well beyond the Heckscher-Ohlin model when they take international economics. Especially when Worstall and Mankiw use an oversimplified model of international trade to talk about morality. I’m sorry fellows, but I’d rather listen to my preacher when it comes to questions of morality.