Thursday, September 3, 2009

Defying comparative advantage?

Aaditya Mattoo and Arvind Subramanian examined the recent trends in global trade and FDI flows and argue that it is not just the composition of exports but their destination also matters in determining the economic growth performance of countries. They find evidence that contrary to conventional wisdom, many of the recent successful emerging economies have grown not only by following comaprative advantage but also using industrial policies to defy it.

Specifically, they find that the export (or uphill flows) of skills embodied in sophisticated and technology-intensive goods and services, or capital from poorer to richer countries has played an important role in the spectacular growth success of many of these economies. They claim that while conventional theories have seen the "benefits of trade as access to imports and inward FDI, there is a growing recognition that exporting and outward FDI may also confer important benefits".

They point to three reasons for the uphill flow trends. First, domestic industrial and other policies within a few developing countries have led to the growth of pockets of excellence sufficiently endowed with skills and expertise to failitate the emergence of technology intensive goods and services sectors. Second, similar firm-level heterogeneity in productivity and fixed costs of exporting have resulted in the growth of firms involved in uphill exports in emerging economies.

Finally, the authors point to the "international patterns of trade protection, in particular rich country barriers against imports of less skill-intensive products and developing country barriers against imports of more skill-intensive products" as having coming in the way of countries taking advantage of their respective conventional comparative advantages. However, as the authors write, this may have had unforeseen beneficial consequences,

"The larger developing countries may have been inhibited from exploiting their natural comparative advantage — i.e., exporting less skill-intensive products to richer countries and more skill-intensive products to poorer countries... it is possible that increases in uphill sophisticated exports have been possible because protection allowed domestic producers to catch up with foreign producers in terms of competitiveness."

They compare the sophistication of a country’s exports and the average income level of the destination countries for sophisticated exports, against its per capita income for the 1991-2005 period and find that there is an upward shift of the curve between the two time periods, suggesting that exogenous factors (perhaps technology) are increasing the propensity of countries, especially at lower levels of income, to export sophisticated goods to rich trading partners. This shift is clearly much higher for countries at the lower end of the income ladder.

On FDI flows, they find that flows to OECD countries from developing countries like Brazil, India, Malaysia, and South Africa as a share of their GDP are as large as flows from countries like Japan, Korea, and the United States.

They also point to higher productivity gains for firms in developing economies exporting to high income regions and claim that "exports of goods to high income destinations are frequently associated with being part of global production chains that confer important benefits". Further, they point to the example of India to show that "uphill flows could affect growth through induced changes in economy-wide skill acquisition and hence in long-run endowments, creating a self-reinforcing and virtuous cycle". The increased demand for education in India in recent years can be attributed to the perceived "higher returns to human capital, which in turn is a consequence of increased skill-intensive and uphill specialization".

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