BEYOND COMPARATIVE ADVANTAGE: EMPIRICAL EVIDENCE AND NEW TRADE THEORIES

1. BEYOND COMPARATIVE ADVANTAGE: EMPIRICAL EVIDENCE AND NEW TRADE THEORIES DR NORMAZ WANA ISMAIL

2. Introduction • The previous model refer to trade pattern. • Why does Colombia export coffee? China with apparel/textile, Brazil with steel?, Japan with digital cameras?

3. New Trade Theory • Trade in manufacture goods may respond to influence different from those that affect trade in primary products. • The importance of factor endowments in determining trade pattern in oil or diamonds seems much more obvious than in the case in the bicycles or shoes. • Difference in relative labor productivity probably play a larger role in US exports of computer software than in Saudi Arabian export oil.

4. New Trade Theory • A large and growing share of trade in manufactured goods is intra-industry trade • IIT --- trade in which each country both imports and exports in the same industry.---modify in basic trade model • Some countries tend to trade largely with others of a similar income---particularly in manufactured goods; ---need another alternative trade theory • The US and a few other countries typically produce and export new or high technology products; --also need alternative to trade theory

5. Testing the HOM • What id a country will export goods whose production involves intensives use of its relatively abundant factor and import goods whose production involves intensive use of its scarce factor • This implies that exports as a group should be more intensive in use od the abundant factor than imports as a group

6. LEONTIF PARADOX • Wassily Leontief (1953)-performed the real test of HOM key preposition • Using 1947 US data • US had relative K-abundance manufacturing sectors ; US should export K-intensive product US exports to be about 30% more labor intensive than the import Leontief found: The US export labor-intensive product and imported K-intensive goods.

7. Critics about HOM • HOM does a poor job in explaining overall trade patterns --particularly in manufactured goods Thus, the HOM need some modification

8. Cross-Country tastes differences • Recall from HOM assumption- taste were identical across countries in order to focus on factor endowments’ role in comparative advantage • When taste are identical, the production bias from countries different factor endowments – implies that country will have a Comparative advantage in the good that uses its abundant factor intensively

9. Taste bias might explain Leontief paradoxif residents of US had tastes in the rest of the world, the US price of K-intensive goods would be high • The US would import K-intensive goods and export L-intensive ones • Evidence from ‘home bias’ in consumption – consumers tend to consume more domestically produced goods and fewer imports than we might expect. • For most countries, the observed home bias in consumption is unlikely to overwhelm factor-endowment-based differences in production possibilities • Home bias in consumption does seem to play some role in explaining trade patterns; but it cant single handedly explain the Leontief results

10. Classification of inputs • Most modern production process involve many inputs, some not easily grouped into the capital or labor category. • In the case of US: the inputs classified as Farmland, raw materials, human capital (skilled labor), man-made (non human capital) , unskilled labor • Thus the US factor abundance lies in human capital and farmland • This explain US export success in high technology and R&D intensive industries. • Thus HOM explain really well in explaining trade pattern for many goods.

11. Technology, productivity and specialization • Recall HOM assumed identical in technologies across countries • This implies that completely unrestricted trade, equalized output and factor prices would lead firms in all countries to adopt identical production processes.

12. But technology differences across countries. • Firms that undertaken R&D expenditure necessary to discover an innovative production process typically apply for patents that restrict other forms abilities to use that process (including firm in other countries) • Workers in wealthy countries with adequate food supplies and effective health-care systems may be more productive than workers in poor countries who may lack adequate nutrition and health care. The former Soviet Union– many talented Scientist and engineers – yet highly skilled individual fails to attain the levels of productivity in S.U

13. When consideration of different countries using different technologies, the simple prediction of HOM – based on identical technologies –may not follow the directly but must be amended to take into account of the cross-country differences in production processes. • In fact the most recent empirical works finds that both factor endowment differences emphasized by HOM and the technology differences emphasized by Ricardo have important roles to play in determining actual trade patterns.

14. Critics about Leontief evidence • Edward Leamer shown that Leontief’s technique for testing HOM failed to adjust for the fact that in 1947 –US trade was unbalanced • It is because the value of US export > the value of imports

15. Leamer reformulated the test to compare the factor content of US production and US consumption • If the US was K-abundant ; if HOM was correct –then US production should embody more K relative to L that US consumption More K/L in production --HOM is correct

16. More information refer to: • Yarbrough, B.V. and Yarbrough, R.M. ((2006) The World Economy Trade and Finance, Thomson South-Western, chapter 5.