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Increasing Returns to Scale in Thailand s Manufacturing Industry By Nat Tharnpanich 23

Thailand's spatial inequality. Manufacturing establishments tend to be in a large scale and concentrated in the same area (Arayah 2006).Population growth rate in Bangkok metropolitan area is three times as high as those in other mega-cities in developed countries (World Bank 2009) and has produced

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Increasing Returns to Scale in Thailand s Manufacturing Industry By Nat Tharnpanich 23

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    1. Increasing Returns to Scale in Thailand’s Manufacturing Industry By Nat Tharnpanich 23/09/09

    2. Thailand’s spatial inequality Manufacturing establishments tend to be in a large scale and concentrated in the same area (Arayah 2006). Population growth rate in Bangkok metropolitan area is three times as high as those in other mega-cities in developed countries (World Bank 2009) and has produced around one-half of the nation’s GDP (Wisaweisuan 2009). Evidence of catch-up behaviour is found in the Central plain and the East with thriving industrial activities while other regions are still stagnated (Wisaweisuan 2009).

    3. Increasing Returns to Scale (IRS) Static and internal or firm-level - reduction in average cost Dynamic - learning by doing as a function of cumulative output External - agglomeration economies which explains why cities exist “Backyard Capitalism” (Krugman, 1991)

    4. Objectives of this presentation To measure the degree of returns to scale in Thailand’s manufacturing industry To discuss the role of the degree of returns to scale in economic growth

    5. History of IRS Adam Smith (1776) the Wealth of Nations Division of labour depends on the extent of the market Marshall (1920) Within-industry Allyn Young (1928) Between-industry

    6. Why were IRS ignored? Lack of mathematical tools to model IRS CRS and diminishing returns to factors of production became increasingly popular in mid 19th century. Perfect competition and convexity are needed to prove the uniqueness of Walasian general equilibrium It has increasingly received more attention in economics literature such as New Urban Economics and New Economic Geography

    7. Neoclassical growth model Assumptions CRS in production Perfect competition Perfect factor substitutability, K/L is determined solely by wage-rental ratio. Well-behaved aggregate production function Diminishing marginal productivity wrt capital and labour Growth accounting by Denison (1962) also relies on these assumptions. Supply-side model Predicts convergence

    8. Shortcomings of Neoclassical growth model Unsatisfactory empirical support Ignoring contribution of demand factors No explanation as to how supply-side factors are different Closed economy Very sectorally neutral

    9. IRS in neoclassical theory Limited to the context of theory of cost Firm-level Static and internal

    10. Production Function Approach Cobb-Douglas or CES production function Qt = Ae?tLaKß qt = c + alt + ßkt Usually CRS or small IRS are found with a very good fit.

    11. Weaknesses of the Production Function Approach When using time-series monetary data, it merely captures the income identity (Felipe et al. 2004). Qt = wtLt + rtKt qt = afwt + (1-a)frt + alt + (1-a)kt qt = c + alt + ßkt Thus, the a and ß will always equal factor shares which add up to unity which indicates the existence of CRS.

    12. Cumulative Causation Theory Growth is demand-determined. Factors of production are endogenous. Capital accumulation (technique of production or K/L ratio) is determined primarily by the scale of production rather than by wage-rental ratio, causing circular and cumulative growth process. IRS as a lynchpin of cumulative growth process Manufacturing as an engine of growth Surplus labour

    13. Export-led growth model What determines growth of demand in the first place? It is export demand. qt = ?(xt) pt = a + ?qt rdt = wt – pt - tt xt = ? (rdt - rft) + ezt

    14. Export-led growth model This is an equilibrium model. Predicts sustained or widening regional disparities

    15. Verdoorn’s law pt = a + ?qt where ? ˜ 0.5 Measures IRS broadly defined It is a source of regional disparities when other parameters are the same between regions. Also serves to amplify the existing regional disparities.

    16. Data Industrial Census 1997 and 2007 from NSO Cross-region within a country 23,677 and 34,625 establishments throughout the kingdom with 10 and 11 persons or more engaged respectively

    17. Verdoorn’s law specifications

    18. Results: et = a1 + b1qt

    19. Results: et = a2 + b2qt+ c2kt

    20. Results: tfit = a3 + b3qt

    21. Augmented Verdoorn’s law

    22. Augmented Verdoorn’s law

    23. Verdoorn’s law controversies Simultaneous equation bias Static-dynamic Verdoorn law paradox

    24. Simultaneous equation bias Supply-side specification qt = a4+b4tfit or tfpt = a5+b5tfit b4 > 1 or b5 > 0 CRS or DRS are usually found The use of cross-regional data makes it possible to assume away the supply-side constraint.

    25. Results: tfpt = a4+b4tfit

    26. The static-dynamic Verdoorn law paradox Dynamic version (tfi = a + bq) ? strong IRS are found Static or log-level version (lnTFI = a + blnQ) ? CRS or small IRS are found The biased result is caused by Spatial Aggregation Bias (McCombie and Roberts, 2007)

    27. Spatial Aggregation Bias The ideal spatial production unit is Functional Economic Area (FEA) At FEA-level, Verdoorn’s law is a power relationship. TFI = cQ0.5. However, values of each FEA are summed arithmetically.

    28. Spatial Aggregation Bias, TFI = cQ0.5

    29. Spatial aggregation bias

    30. Cross-sectional static VL Cross sectional ?lnTFIi = a+ßlnQi + ei Cross sectional with time dummy ?lnTFIi = a+ßlnQi +?Dt+ ei Time fixed effects ?lnTFIit = at+ ßlnQit + eit All yield biased Verdoorn relationship

    31. Time series static VL Time-series ? lnTFIt = a + ßlnQt + et Regional fixed effects ? lnTFIit = ai+ ßlnQit + eit Both yield unbiased Verdoorn relationship. However, it merely captures Okun’s law. Nothing is related to IRS. Data should be cross-regional in dynamic version VL.

    32. Fixed effects static VL

    33. Random effects static VL Time random effects As N is larger and T is smaller, f ? 0. It is, therefore, equivalent to time fixed effects model. Regional random effects As N is larger and T is smaller, f ? 8. It is, therefore, equivalent to between estimator which, in turn, is cross-sectional.

    34. Panel-data static VL

    36. Conclusion The existence of IRS, broadly defined, is indisputable. With IRS, virtuous circle of growth is possible, causing regional disparities. Growth is supply- as well as demand-determined. Policies that can effectively manage both demand- and supply-side factors are needed to eliminate regional disparities.

    37. Suggested Further Reading Thirlwall, A. P. (2002). The Nature of Economic Growth: An Alternative Framework for Understanding the Performance of Nations. Cheltenham : Edwards Elgar. McCombie, J. S. L., Pugno, M., and Soro, B. (2002). Productivity Growth and Economic Performance : Essays on Verdoorn’s Law. Basingstroke, Palgrave Macmillan. McCombie, J. S. L. and Thirlwall, A. P. (1994). Economic growth and Balance-of-Payments Constraint. Basingstroke, Macmillan.

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