BEYOND COMPARATIVE ADVANTAGE: NEW TRADE THEORIES

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

2. What we have learned…. • Ricardian Model • Heckscher Ohlin Model refer to trade pattern Why does Colombia export coffee? China with apparel/textile, Brazil with steel? Japan with digital cameras?

3. HOM: Rybczynski Theorem an increase in a country's factor endowment will cause an increase in output of the good which uses that factor intensively, and a decrease in the output of the other good.

4. HOM: Stolper-Samuelson theorem An increase in the price of a good will cause an increase in the price of the factor used intensively in that industry and a decrease in the price of the other factor.

5. HOM: factor specific model • Trade will have an ambiguous effect on the nation’s mobile factor (L) • benefit the immobile factor specific (K) to nation’s export commodities or sectors • harm the immobile factor specific (K) to the nation’s import competing commodities or sector

6. LEARNING OUTCOME • The end of lesson student should get the following: • Differentiate the contribution from classical trade theory and New Trade theory • Calculate the intra industry trade index • Explain type of intra industry trade

7. From Classical Trade Theory to New Trade Theory

8. New Trade Theory

9. New Trade Theory

10. Why country do trade • In the absence of resistances to trade (such as ignorance of trading opportunities, distance, transport costs, and tariffs), countries trade because of differences in prices at home and abroad. reflect economies of scale, by which a country has a lower cost of production simply because its domestic market is larger than that of its trading partners.

11. also reflect differences in the opportunity costs of production, and a country is said to have a comparative advantage in the production --- if its lower opportunity costs of production than trading partners

12. INTER INDUSTRY TRADE

13. EXAMPLE: BRUNEI • example of a country with large natural endowments of oil • exports in such quantities that she needs • import only a few commodities and has a comparative advantage in only one of the nine priority sectors, textiles.

14. ANOTHER REASON TO TRADE demand for different varieties (models) of the same commodity (say cars) in their consumption patterns.

15. Intra-Industry Trade • However economies of scale do not allow them all to produce something of each variety: • they specialize in producing different varieties, and this causes them to have a high level of trade in different varieties or models of the same commodity. • given country exports one variety or model and imports another variety or model of what is essentially the same commodity.

16. Intra industry vs inter industry inter-industry trade occurs when a country exports and imports goods produced in quite different industries such as exporting machines and importing textiles. • Intra-industry trade occurs when a country exports and imports goods within the same industry or product group such as exporting autos and importing autos.

18. Intra-industry trade index • Where • X = value of exports • M = value of imports

19. Example: Intra-industry Trade Index • Example: US imports $150,000 of cloth and exports no cloth • IIT Index = 0 • no intra-industry trade in cloth.

20. Example: Intra-industry Trade Index • US imports $150,000 of computers and exports $150,000 computers . • IIT = 1 • all trade in computers is intra-industry trade or alternatively exports of computers = imports of computers.

21. Intra Industry Trade vs Inter Industry Trade • IIT ranges from 0 (no intraindustry trade) to 1 (100 percent intraindustry trade). • The closer to 0, the less intraindustry trade relative to interindustry trade. • The closer to 1, the more intraindustry trade relative to interindustry trade.

22. Example: Intra-Industry Trade

23. Example: Intra-Industry Trade

24. Rubbers, tires and tube (Code 615) Wood manufacturers (code 635) Textiles articles (code 658)

25. FACTS ABOUT IIT • Calculating the IIT for a country’s overall trade allows comparison across countries of the degree of intra- industry trade • Intra- industry trade, represents a growing share of total trade, especially among the high income industrial economies • the more narrowly defined the industry classifications used, the lower the resulting estimates of intra-industry trade.

27. Intraindustry Trade Homogeneous Products Vertically Differentiated Products Horizontally Differentiated Products Same Price Identical Products (Wheat, Concrete, Petroleum) Similar Prices Slightly Different Product Characteristics (Gasoline, Chocolate, Perfume) Varying Prices Widely Different Product Characteristics (Automobiles, Watches) Associated Processes Associated Processes Reduction of Transportation Costs Economies of Scale Product Cycle Overlapping Demands Provision of Homogeneous Services (Insurance, Shipping, Financing Associated with International Trade) Provision of Uninterrupted Flow of Seasonal Products (Tomatoes) Types of Intraindustry Trade Figure 4.5: Types of Intraindustry Trade and Associated Processes

28. IIT in homogenous versus Differentiated Goods • The basic trade model assumes that goods are homogeneous • perfectly competitive markets. • Homogeneity implies (in the presence of transportation costs) that a single good typically cannot be both imported and exported by the same country. • Rather than import the good from abroad, a country would simply choose to consume more of its domestic production and reduce its exports.

29. Explanations of Intra-industry Trade in Homogeneous Products • Homogeneous goods • One product is identical to every other product produced within an industry. • Homogeneous goods most likely to be involved in the intra industry trade include items that are heavy or for some other reason expensive to transport. • Why might there be intra-industry trade in these goods?

30. Explanations of Intra-industry Trade in Homogeneous Products 1. A foreign supplier is closer than a domestic supplier of goods with high transportation costs. Example: Cement 2. Services are produced jointly with another traded product. Example: Insurance on shipments • Countries engage in substantial entrepot and re-export trade. • Entrepot Trade – Goods are imported into a country and sometime later the same goods are exported to another country. • Re-Export Trade – Goods are imported into a country, and sometime later the same goods are subjected to a small transformation and exported to another country. • Transportation cost and Seasonal

31. Location can cause IIT in homogenous product • Firm A in country A (FA) and FB • Consumer A(CA) and CB buy the product • Because of the firm and consumer location, it may be the case that consumer CA buys from firm FBand vice versa. • To minimum the transportation cost and location of industry Country B Country A FA CB FB CA

32. seasonal can cause IIT in homogenous product • Seasonal considerations also can cause intra- industry trade in homogeneous goods. • Agricultural growing seasons provide a clear example. • A country in the Northern Hemisphere might export agricultural products during the summer and import the same goods from a Southern Hemisphere trading partner during the winter.

33. We have discussed • Classical trade theory to New Trade theory • Differentiate intra industry trade and inter industry trade • How to calculate IIT • Type of IIT 1. Homogenous products (√) 2. Differentiated products

34. Intra-industry Trade in Differentiated Products/Goods Most intra-industry trade is in differentiated products • These goods have features that make them appear different from competing goods in the same market or industry such as computers with different components or specifications.

35. Suppose that most Japanese are content to drive Toyotas and Hondas, while most Germans are happy with their Volkswagen and BMWs. • Nonetheless a few Japanese want BMWs, and a few German want Hondas. • because consumer don’t view the various types of cars as perfect substitutes. Why don’t Japanese auto producers just make a few close BMW substitutes and German a few good Honda substitutes?

36. IIT in productdifferentiation • To explain trade in many manufactured goods we must take into account such productdifferentiation in IIT

37. Competition and Intra-industry Trade in Differentiated Products • Differentiated goods are usually offered in imperfectly competitive markets. • Imperfect competition occurs whenever firms can affect their prices by changing output. • Imperfect competition occurs in markets characterized as monopolistic competition, oligopoly, and monopoly

38. TYPE OF DIFFERENTIATED GOODS

39. Horizontally Differentiated goods • Intra- industry trade in finished products, on the other hand, involves trade in goods in the same industry and produced using smaller factor intensities. • Therefore, the changes in factor demands and relative factor prices from such trade tend to be smaller.

40. Vertically Differentiated goods : (Breaking Up the Production Chain) • Most industrialized economies both import and export finished automobiles • so that domestic consumer can buy their preferred varieties. • vertical specialization, more important in complex manufacturing industries such as automobile production. • Increasingly, the various components of cars are produced in different locations around the world and then brought together for final assembly.

41. Vertically Differentiated goods • This type of IIT is very much in the spirit of Heckscher and Ohlin. • the factor intensities of making floor mats, tires, transmission subassemblies, airbags, and computerized controllers for antilock braking systems differ widely • so we should expect countries to have comparative advantages in different aspects of car production.

42. example • Car Production: Honda makes transmissions in Indonesia, engine parts in china, and assembles its City subcompact in Thailand. • Household appliances:Maytag dishwashers contain Chinese motors and Mexican wiring harnesses, and are assembled in the United States. • Low transportation and communications costs make it feasible for firms to perform each task in the most efficient location.

43. vertical specialization • Low transportation costs are essential to vertical specialization • which can involve multiple ocean crossing for each partially assembled unit. • Cheap communication technologies such as faxes and e-mail are also important because vertical specialization requires that managers maintain close contact with plants around the world to keep the production process coordinated and on schedule.

44. Why Does Intra- Industry Trade Matter?-summary • Unlike trade based on comparative advantage, IIT in finished products occurs in greatest volume between developed industrial economies with a. similar factor endowment, b. skill levels, and c. stages of development. • The industries most likely to report high IIT in finished products include: • sophisticated manufactured goods that exhibit product differentiation and whose production processes are characterized by economies of scale.

45. Why Does Intra- Industry Trade Matter?-summary • Intra- industry trade in finished products based on transportation costs, seasonal trade, or product differentiation often presents fewer pressures for protection and less political controversy than does inter- industry trade or intra- industry vertical specialization based on comparative advantage. • Recall that the redistribution of income caused by inter- industry trade or vertical specialization occurs because the different factor intensities of industry imply that opening trade alters relative demands for different factors and thereby changes their relative prices.

46. IIT: summary • Differentiate the contribution from classical trade theory and New Trade theory a. Ricardian and HOM b. Intra Industry Trade • Calculate the intra industry trade index • Explain type of intra industry trade a. Homogenous Products b. Differentiated Products (Horizontal and Vertical)