STRUCTURAL CHANGES IN INTERNATIONAL TRADE: INTER-INDUSTRY SHIFTS IN COMPARATIVE ADVANTAGE

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1 Studies in Business and Eonois STRUCTURAL CHANGES IN INTERNATIONAL TRADE: INTER-INDUSTRY SHIFTS IN COMPARATIVE ADVANTAGE BURNETE Sorin Luian Blaga University of Sibiu, Roania Abstrat: The onteporary industrial onfiguration entered on intra-fir trade and ross border oodity hains has ade oparative advantage look like a rusty onept. Prior to globalization, shifts in oparative advantage ould our ainly aross industries, ausing lear-ut hanges in ountries speialization patterns. By ontrast, hen fators of prodution are alloed to ove freely aross national boundaries, the piture gets soehat fuzzy: the oparative advantage onept requires a different approah that should take into aount the inreasing disintegration of prodution proesses and spreading of eonoi ativities aross the globe. Due to their relatively high obility and propensity for outsouring, labor-intensive industries visibly epitoize this proess, hih is going on in any parts of the orld, inluding Central and Eastern Europe. Keyords: oparative advantage, labor-intensiveness, international speialization, outsouring 1. Introdution Aording to Heksher & Ohlin s ell-knon fator-proportion theory, laborintensiveness is a generi attribute for the goods hose prodution requires a higher ratio of labor to other fators of prodution (land, apital, tehnology, skills, knoledge et.) relative to other types of goods. Historially, industries that turn out suh goods, e.g. the prodution of textiles, lothing, footear, sports equipent, toys et. have been building bloks of industrial developent and, not infrequently, spearheads of exports expansion, for any ountries of the orld. Fro a purely theoretial perspetive, the international trade in labor-intensive goods fits the international produt yle hypothesis (Vernon, 1966): initially developed in the West to hundred years ago, industries that use an s labor ith relative intensiveness have been gradually pushed toard Seond and Third orld ountries, here lo-skilled labor is still in relative abundane Studies in Business and Eonois

2 Studies in Business and Eonois This paper deals ith the oparative advantage priniple and its relevane in ters of international speialization, ith partiular fous on the trade in labor-intensive goods. The analysis spans to distint periods: before respetively under globalization. In the forer period, Riardian-type inter-industry speialization patterns ere predoinant in international trade. The industrialization proess that unfolded in any parts of the developing orld after the Seond World War paved the ay for the groth in developing ountries exports of labor-intensive goods thereby aking oparative advantage in this kind of goods shift fro industrialized to developing ountries. 1 Afterards, oparative advantage ontinued to shift to ever less developed eonoies of the developing orld. Crook (2006) synthesized the atter: Often, as developing ountries gro, they ove aay fro labor-intensive anufatures to ore sophistiated kinds of prodution: this akes roo in the arkets they previously served for goods fro ountries that are not yet so advaned. By oparison, under globalization, the proinent tendeny is that prodution proesses should be broken don into separate parts that an be loated in ountries in hih fator pries are ell athed to the fator intensity of the partiular fragents (Jones, Marjit, 2001). The inreasing fragentation of prodution has given rise to a different kind of international division of labor, hih as suggestively depited by Krugan et al. (1995): a good is produed in a nuber of stages in a nuber of loations, adding a little bit of value at eah stage. In this ne ontext, although the labor-intensive setor is still highly obile due to its relatively high propensity for outsouring 2, it is no longer entire industries that are on the ove but ere segents of the oodity hain that use an s ork ith relative intensity. In the pre-globalization era, sine ountries endoent ith resoures ere presued fixed and fators of prodution ere iobile internationally, hanges in the struture of international trade ould ost often our as a result of exogenous influenes suh as trade poliy easures or regional integration trends, hih exerted diret or indiret influene on goods and fator pries. Shifts in oparative advantage ere essentially of inter-industry type and depended on differenes aong prodution setors ith respet to elastiity of fator substitution. By ontrast, under globalization, shifts in oparative advantage are taking plae ithin individual industries and are related to prodution sharing-type agreeents hereby a flo of skilled-labor intensive ativities are transferred by ultinationals to subontrating firs in eerging eonoies. Coparative advantage ill thus not ste fro ere heap unskilled labor but fro the ability of the subontrating fir to auulate the required expertise and kno-ho that should allo the to arry out an inreased nuber of high valueadded ativities and ontrol larger portions of the international value-hain. The relative age of skilled labor (the ratio beteen the levels prevailing in the to ountries) is a key-variable. Studies in Business and Eonois

3 Studies in Business and Eonois 2. Produtivity and ages: key deterinants of oparative advantage To hundred years ago, David Riardo applied the oparative advantage priniple to international trade: Under a syste of perfetly free oere he rote eah ountry naturally devotes its apital and labor to suh eployents that are ost benefiial to eah. (Riardo, 1996) The key ords fro the ited phrase are naturally devotes, suggesting that oparative advantage is in fat, ore than a priniple; it is a la governing the international trade syste in its entirety. Sholars identified ertain liits of the original odel, notithstanding its great intuitive poer: firstly, it as built on one produtive input only, labor. It is therefore diffiult, as Bhagati (1964) noted, to adapt the one-fator, Riardian approah to the ulti-fator real orld. Seondly, the odel fails to explain hy differenes in oparative advantage ill exist and ipliitly, the resulting pattern of produtivities and speialization (Sauelson, 1948). Moreover, the onept ust be extended to the trade in the servies of fators of prodution. (Deardorff, 1980) In the ourse of tie, oparative advantage ae to be ever ore losely onneted to ountries export shares in international trade ith various types of goods. Balassa (1989), using export shares (as proxies of export perforane) found a strong orrelation beteen export shares and produtivity but no signifiant orrelation beteen export shares and ages. Yet despite this unexpeted result, it ould be rong to onlude that ages play no role in oparative advantage deterination, although it is by no eans easy to explain hy are exports perforanes tightly orrelated ith produtivity but hardly or not orrelated ith ages. Roberts (2004) onsiders that ages in poorer ountries are uh loer not neessarily beause of loer produtivity relative to developed ountries but beause of the huge supply of labor they are endoed ith, hih obviously exeeds deand. 3. Inter-industry shifts in oparative advantage Suppose n ountries (1, 2 n) produe to types of goods, say, lothing (X) and anufatures (Y) 3, using to fators of prodution, labor and apital. Fators are assued to be perfetly obile inside eah ountry but iobile aross ountries. Perfet opetition, onstant returns to sale and idential tastes are presued; transportation osts are ignored. 4 If the X setor is labor-intensive and the Y setor is apital-intensive, the folloing general inequality holds for all the n ountries: x x > l x l k x k (1) here: Studies in Business and Eonois

4 Studies in Business and Eonois x, x, x, x = prodution oeffiients, easuring the aount of labor (l) l k l k respetively apital (k) required to produe one unit of lothing () respetively anufatures (). Let L and K denote the physial aount of labor respetively apital, and r and denote the pries of apital (rent) respetively labor (ages). If, say, in ountry i-1 the rent-age ratio is higher than in ountry i, the forer ountry is labor-abundant relative to the latter and vie-versa. Thus if: r 1 > r 2 >. r i 1 > r i > > the n ountries are in a sequene of dereasing labor-intensiveness. If ountry i-1 is labor-abundant relative to ountry i, its prodution ratio (lothing over anufatures) ust be higher than in ountry i (i = 2 n). This eans that if: Q 1 > Q 2 > > Q i 1 > Q i r n > Q ountry i-1 has oparative advantage in the lothing prodution relative, not only to ountry i but to all the ountries ranking beteen i and n. If ountries endoents ith resoures are fixed and fators are iobile internationally, hanges in the struture of international trade ill ost likely our as a result of other types of influenes suh as trade poliy easures or regional integration trends. Let s onsider the folloing ase: ountries i, i+1 n deide to establish a trade union, hih does not inlude ountries 1, 2 i-1. As a rule, nely-reated trade unions ill disantle inside trade barriers but raise higher ones against third ountries iports, espeially in eonoi setors here opetition fro outside the union is ost intense. Sine labor-intensive industries generally fall under this ategory, in our exaple, an interindustry shift in oparative advantage ill ost likely result fro a fall in the rentage ratio in ountry i, due to the lopsided trade protetion at the union s frontier: uh higher in the lothing setor than in the anufatures setor. 5 Geoetrially, the effets are illustrated in figure 1. Under free trade, ountry i s prodution is loated in point A, on its prodution possibility frontier (ii). The doesti relative prie of goods is equal to the orld relative prie, as indiated by the slope of the p line. Consuption is loated in point C, on the I 0 indifferene urve. One an notie that ountry i is a net exporter of anufatures (prodution is greater than onsuption) and a net iporter of lothing (onsuption exeeds prodution). The iposition by the trade union of a quota on iports of lothing fro third ountries ill ause the orld relative prie of lothing to deline (fro p to p ) 6. The rise in the orld relative prie of anufatures ill stiulate produers in the Y setor to inrease prodution. The prodution ix ill be transferred in point A, here ountry i produes a larger quantity of anufatures and a loer quantity of lothing than before. 7 Hoever, on the internal arket, the relative prie of lothing ill rise folloing the iposition of the iport quota (as shon by the slope of the p i line). This ill deterine, aording to Stolper and Sauelson (1941), a rise in the inoe of the n (2) (3) Studies in Business and Eonois

5 Studies in Business and Eonois fator the lothing setor uses intensively, hih is labor, and onoitantly, a deline in the inoe of apital, the fator the anufatures setor uses ith relative intensity. Further on, the fall in the relative prie of apital ill ipliitly generate a rise in the deand for this fator, hih beoes ore sought after relative to labor. Y I 1 i A I 0 F A H G C E p p i p Figure 1 O i X 4. Alternative soures of oparative advantage Due to its foridable preditive poer, the Riardian theory ontinues to underlie orld ountries long-ter trade poliy strategies. Reality has nevertheless shon that, if based on oparative advantage in labor-intensive goods, international speialization is onduive to a sorry eonoi state haraterized by deteriorating ters of trade, a draati deline in export revenues and enhaned vulnerability to external arkets his. Aepting the idea that suh an international division of labor is indelible ould ean aditting that ertain ountries are eternally ondened to poverty. And the truth is, any less developed eonoies are in dire straights for being unable to iprove their position in international trade. Briefly, oparative advantage assoiated ith heap labor turns out to be inherently volatile 8 the ore so as labor osts as a perentage of the total osts of a fir have delined onstantly. Globalization has rendered it even ore volatile beause labor-intensive industries exhibit pronouned obility toard the periphery. 9 Textiles and lothing are an illustrative exaple, as ephasized by Young and Zhong (1998): beause lothing is ore labor-intensive than textiles, the Asian tigers lost oparative advantage in lothing ore rapidly than in textiles and hene a large part of their lothing prodution ativities has oved overseas, espeially to China and other Asian ountries Studies in Business and Eonois

6 Studies in Business and Eonois By ontrast, the opposite vie, aording to hih speialization ould be suessful and lead to sustained groth only if based on the developent of tehnologial knoledge and skills, has been gaining ground in the last deades. Still, one ust take aount, as Dollar (1993) ephasized, of the fat that ere flos of inforation or one-off or sparse tehnologial developents are not a soure of longter oparative advantage. This an only be ahieved by institutions that generate ne tehnology on an ongoing basis and train opleentary tehnial labor. The botto line is that, beause investent in plant and equipent is highly orrelated ith groth and so are eduation and huan apital upgrading, hanging international speialization requires the ipleentation of a developent strategy based on the novel onept of dynai oparative advantage (Cypher, Dietz, 1999) Globalization has ade it possible that oparative advantage should be derived fro alternative soures. Sine anufaturing segents ithin the value-hain are generally populated by sall and ediu-sized firs, sithing fro unskilledlabor to skilled-labor intensive ativities ight result fro a shift in oparative advantage deterined, beside tehnologial progress, by arket organization, finanial iperfetions or ealth in general. Wynne (2005) Furtherore, as Lall (2001) argues, oparative advantage hanges ith auulation, i.e. ountries use to invest ore in eduation as they get riher. This last point gives better insight into hy oparative advantage in labor intensive industries shifted to South-East Asian ountries during the 1950s and 1960s that is earlier than in other regions of the orld. 5.The oneptual fraeork, adjusted to hanges indued by globalization During the last deades, the prodution of labor-intensive goods has expanded over a vast area of the developing orld, inluding ountries hih, though systeatially by-passed by foreign investors beause of their poorly opetitive eonoies, ontrol large and often untapped pools of unskilled labor. As a result, ne jobs are still being reated in droves in poor ountries but they do not see to be ontributing to their long-ter eonoi developent. Instead, the overheling supply of lo-ost, unskilled labor on the global arkets is fuelling a rae to the botto aong developing ountries, leading to a ontinuous deline in ages and orking onditions throughout the developing orld. (It is alays possible to find another ould-be subontrator, loated in an even poorer ountry, illing to arry out the sae task for a fe pennies less.) On the other hand, globalization has rendered the prodution of goods heavily dependant on outsouring: in order to stay prieopetitive, leading firs fro estern ountries, oning state-of-the-art tehnologies, valuable brands and solid positions on international arkets ill transfer anual laborbased ativities to developing ountries, trying to apitalize on the latter s heaper labor fore. Studies in Business and Eonois

7 Studies in Business and Eonois What relevane does the oparative advantage onept have under the ne onditions? In the ontext desribed above, the lai that lo ages are a soure of oparative advantage is a fallay. A terinologial differentiation is therefore neessary: the oparative advantage onept needs to be distinguished fro the absolute advantage in anufaturing operations (ostly requiring unskilled labor), resulting fro age rate differentials aong ountries. On the ontrary, oparative advantage ust be assoiated ith firs apaity to aquire the knoledge and tehnial and anagerial abilities that should enable the to arry out all of the skilledlabor intensive ativities involved by the prodution and arketing of a good, not just the unskilled-labor intensive ones required in final assebly. This akes it easier to understand hy labor-intensive industries are highly obile both geographially and soially and hy sholars onsider the oparative advantage in labor-intensive industries volatile. Countries that have oparative advantage in the prodution of labor-intensive goods ill be tepted to forego the absolute advantage in the anufaturing of the respetive goods in favor of other poorer ountries, here ages are even loer and unskilled labor is in plenty. Notes 1 The groth in developing ountries share in international trade ith labor-intensive goods put heavy pressure on opeting industries in the West, hih inurred signifiant job losses during the 1980s and 1990s. Hoever, aording to ertain sholars, e.g. Revenga (1992), a solid orrelation beteen international trade and the fall in estern ountries anufaturing eployent has not been onviningly deonstrated. 2 Aording to Feenstra and Hanson (1996), outsouring refers to all interediate or final goods that are iported by a ultinational enterprise fro a less developed ountry, to be used in the prodution of, or sold under the brand nae of the forer. In this broader sense, the ter iplies a transfer of ativities fro the ultinational to the less developed ountry, thus ating as an endogenous tehnial hange. 3 These are generi ters, designating to different lasses of goods depending on fator intensity: lothing designates labor-intensive goods, hile anufatures refers to a ide range of goods, ith various degrees of proessing, hih use other fators than labor (apital, in our ase) ith relative intensiveness. 4 This assuption, although soehat unrealisti is iportant beause it aintains the analysis ithin the fraeork of the Heksher-Ohlin-Sauelson theore, on hih the first part of the odel is based. These restritions ill be relaxed in the seond part. 5 These assuptions are realisti enough. For exaple, the establishent of the European Eonoi Counity (EEC) in 1957 led to the reoval of ustos frontiers aong the eber ountries. But afterards, the adoption of the Multi Fibre Arrangeent in 1973 translated into high trade barriers (ainly quotas) against iports of textiles and lothing fro developing ountries. This aused, as I going to Studies in Business and Eonois

8 Studies in Business and Eonois deonstrate, oparative advantage to shift fro eber-ountries like, say, Greee and Portugal, to outside ountries like Yugoslavia, Bulgaria, Roania, Hungary, Poland and others. 6 Had the easure been iposed by a sall ountry, the effets upon the orld prie ould have been null; it ould only have deterined a rise in the doesti prie of lothing (as shon by the slope of the p i line). On the ontrary, the iposition of an iport quota by a large ountry (in our ase, the trade union) ill depress the orld deand and deterine a fall in the orld prie of the good; the prodution ix oves to A. 7 By oparing the trade triangles AGC and A FE, one an notie that ountry i s ters of trade iproved: the inrease in exports (fro AG to A F) as aopanied by a ore than proportional inrease in iports (the segent FE is uh longer than GC). The onsuption point, E is loated on a higher indifferene urve (I 1 ). And another interesting aspet: the ountry s exports of anufatures (A F) are exhanged for FH iports of lothing (in doesti pries), hih is equivalent to FE iports of lothing (in orld pries). 8 Volatility of oparative advantage is a ter oined by Bhagati (2002), ho used it to explain the loss of oparative advantage by estern eonoies beginning ith the 1980s, in a nuber of industries, in favor of their rivals fro eerging eonoies, ainly fro South-East Asia. 9 The ters ore and periphery are oonly used in literature to denote the soial status of orkers irrespetive of here their ativity is loated geographially. In general, high-value added ativities belong to the ore hile the lo-value added ones belong to the periphery. (UNIDO 2000) 10 A ountry, say Taian an have oparative advantage in the prodution of a good, say, oputer hardare, ithout produing any physial unit of it; the entire prodution (assebly) ill be subontrated to opanies loated in a less-advaned neighboring ountry, say Vietna. 6. Referenes Bhagati J. (1964) The Pure Theory of International Trade: A Survey, The Eonoi Journal, vol.74, Nr.293, pp Bhagati J. (2002) Free Trade Today, Prineton University Press, pp Crook C. (2006) Grinding the Poor in Eonois, Making Sense of the Modern Eonoy edited by Cox S. et al., 2 nd ed., Profile Books Ltd., pp Cypher J. M., Dietz J. L. (1999) Stati and Dynai Coparative Advantage: A Multi-Period Analysis ith Delining Ters of Trade, Journal of Eonoi Issues, Volue: 32. Issue: 2, pp Deardorff A. (1980) The General Validity of the La of Coparative Advantage, The Journal of Politial Eonoy, Vol. 88, No. 5, pp Dollar D. (1993). Tehnologial Differenes as a Soure of Coparative Advantage, The Aerian Eonoi Revie, Vol. 83, No. 2, pp Studies in Business and Eonois

9 Studies in Business and Eonois Feenstra R.C., Hanson G. (1996) Foreign Investent, Outsouring and Relative Wages in The Politial Eonoy of Trade Poliy: Papers in Honor of Jagdish Bhagati, edited by R.C. Feenstra, G.M. Grossan and D.A. Irin, MIT Press: Cabridge, MA, pp Jones R.W., Marjit S. (1957) The Role of International Fragentation in the Developent Proess, The Aerian Eonoi Revie, Vol. 91, No. 2, pp Krugan P., Cooper R.N., Srinivasan T.N. (1995) Groing World Trade: Causes and Consequenes, Brookings Papers on Eonoi Ativity, vol.1995, Nr.1, p.334 Lall S. (2001) World Trade and Developent in Global Eonois edited by R. Beynon, Routledge, Taylor & Franis Group, pp Revenga A. (1992) Exporting Jobs?: The Ipat of Iport Copetition on Eployent and Wages in the U.S. Manufaturing, The Quarterly Journal of Eonois, vol.107, No.1, pp Riardo D. (1996). Priniples of Politial Eonoy and Taxation, Proetheus Books, pp.65-75, Sauelson P.A. (1948) International Trade and the Equalisation of Fator Pries, The Eonoi Journal, Vol. 58, No. 230, pp Stolper, Wolfgang F., Sauelson, Paul A. (1941) Protetion and Real Wages, The Revie of Eonoi Studies, Vol. 9, No. 1, pp UNIDO (2000) Industry and Trade in a Global Eonoy ith Speial Referene to Sub-Saharan Afria, pp.6-7 Vernon R. (1966) International Trade and International Investent in the Produt-Cyle, The Quarterly Journal of Eonois, Vol. 80, No. 2, pp Wynne J. (2005) Wealth as a Deterinant of Coparative Advantage, The Aerian Eonoi Revie, Vol. 95, No. 1, pp Young Y., Zhong C. (1998) China s Textile and Clothing Exports in a Changing World Eonoy, The Developing Eonoies XXXVI-1, pp Studies in Business and Eonois