The Indo-US trade paradox: Understanding a deficit that really might not be

Reams have been written about the trade between India and the US. No one, however, has noticed a peculiar paradox.

This paradox was first pointed out by Wassily Leontief in 1953 who, after a deep econometric study of US exports, said that contrary to expectation and belief, the US which was a labour scarce and capital abundant country, was exporting things which were labour intensive.

According to standard economic theory it should have been the other way round. The US should have been exporting things that were capital intensive.

The finding sparked off a huge debate amongst international economic theorists and it wasn’t until much later that a plausible solution to this paradox was offered. This was that if you counted skills as human capital, it was perfectly ok for the US to be exporting labour intensive goods. Everyone then sat back and relaxed. But while this is a good explanation it was, in fact, a cop-out because it expanded the definition of capital.

It did, however, serve to validate the proposition that had been put forth by two Swedish economists, Eli Heckscher and Bertil Ohlin, that countries export things in which they have an abundance of either labour or capital. Thus, labour surplus countries would export labour intensive things and capital abundant countries would export capital intensive things.

The paradox

If you examine the structure of India-US trade, however, you will soon find a peculiarity. Both export both types of things to each other.

That is, India while being a labour surplus country, exports capital intensive items such as doctors and software engineers. The US does the same via some of its exports to India, especially those that result from a lot of R&D. According to classical trade theory — which is borne out by the experience of much of the rest of the world — this should not be happening. So why is it? This needs thinking about.

The main issue, of course, is of definitions and measurement. But even if there is broad agreement on definitions, the problem of measurement remains. This comes up in two ways. One is of course the question of how to measure knowledge embedded in a unit of labour. The other is of how to put a value on it.

The first involves a post facto judgement in that its only when that unit of labour turns out to be effective and efficient that the knowledge becomes evident.

The second involves the exchange rate which is itself a function of many other things, not the least of which is the monetary policy of a country, in particular the US because it’s prints the world’s reserve currency.

False debate?

Much of the debate about the modest trade deficit that the US runs with India is because these aspects have not been looked at. Quite apart from the fact that a $20 billion trade deficit is nothing to get worked up about, if proper accounting were done this could become less.

The point is that India is exporting capital in the form of people. And the US is exporting labour in the form of embedded technology. Until these are properly accounted for India and the US will continue to gripe about their trade.

To start down a new path they should compare their trade with China. That will put things in the right perspective and give them an even better reason to cooperate than ‘contain’ China militarily. And what’s more, this is the time to do it when China is on the ropes because of it’s biological warfare programmes’ negative externalities. A good trade deal will put China under even greater pressure.

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