Theory

lnternational Economics, 1 5th Edition 139

fhapter 7 ( irrnl.'tl'' rrirri Tr''tiLl

Develcping a new exportable natural resource can {a'Jst prokllems. One. discussed iater in this chaptel is the prcblem of "immiserieing growth"; lf you are already exporting and- ycur

J*pott expansion lowers the wcrld price of your

exports, ycu could end up worse off' A second is

the apparent problem called the l":r:ii' ':iii'rj''i:';'r' in which new production of a natural resour{e results in a decline in production of manuf*c- tured products (deindustria lization)'

For the Netheriands. ihe origin of the disease

was the development of new natural gas fields under the North Sea. li leemed that the mole the

Netlrerlands developed its natural gas production'

the mcre depreii'ed its manufaeturers of traded gcods became' Even the windfaii price increases

inut tf,. two oil shocks offered the Netherlands (all fuei prices skyrocketed, including that for naturai gas) seented to adci to indusiry's slump' The Dutth disease has been thought to have spread to Britain. Norway. Australia, Mexico' ancl cther countries that have newiy devek:ped

natural resourceg' The main premise o{ this fear is corre'ct: Under

many'realistic conditions, the windfall of a ner"'r natural resource does indeed erode pro{its and production in the manufactured goods se'tor' Deinclustrialization cccurs for the same reason that underiies the Rybczynski theorem intro- duced in this chapter: The new s€ctor draws resources away from the manufacturing secto!-' Specifically" to develop proriuction of the naturai resource, the sector must hire labor away from

the manufacturing sector, and it must obtain capital that otherwise would have been invested

in the manufacturing sector' Thus, the rnanuiat-

turing sector contracts. lournalistic coverage of the link beturee*

natural resource development and deindustii-

"f i=rtion tends to discover the ba:ic Rybczynsl*i

effect in a different way' The press tends i*

""tli* that the develcpment of the expcrta*ie

natural regource causes the nation's {$tl*l}{}{ to rise in value on foreign exchangc r**rk*t't because of the increased demand far li:e tc$?t"

iryt .uttunry as fareign buyers pay f*r ii: r*:' pu,:rf,rt*u. A higher vaiue of the natio*'s cur' ienry makes it harder for its indurlriai firn:si* .o*p*t" against foreign products whose pr*'{e is now relativeiy lowe*r. lo the manufactxr*'tag' sector this feels like a drop irr demand' a** '€*e. ,*.io, .ontracts. The foreign exchang* r**rk#" in gravitating back toward the origin*l bsi'Bt3{*

cf irade. is pioducing the same result w* s'r#i*s

get from a barter trade model: lf you eryryp i'rore o* a good, You'll end uP either *;x$sq.€1 ing l*r, af

-another good er impo*ir'g ry'

Sorietfring has to give so that tiade wril'rctilrff to the same balance as before'

Even though the Dutch disease does lead to some cleindustrialization. it is not clear that this is really a national problem' Merely shifting

resources away from the manufacturing sector into the producticn of natural resources is not

necessarily bad, despite a rich foiklcre assufi- ing that industria! expansion is sornehow key r* prlsperity. The country usually gains fr**r C*vel- oping production o{ itr natuta! test:urtee, *s lang

.i tnlt'gto*th does not tip into the realn'r af the immiserizing'

Changes ip a country's p,iiiingness to tfade catt aitel lhe countryi tc't'llrs r:l iraiie it

the country i,r large enough for its tlade to have att inipact on tli* itrt"'t'na1ii:r:tie1 rqili-

libriuni. ln tunr^ any charile in tire cou.ir)."s ternls of irade all'ects the srtet:l;''t r.ii-ri;it

thr country 'oenefits fiom its growth.d', s.

*;i* S,i

S:,'' g':'.

XL F.l {t::

1 4A ; lnternational Economics - Vol' 1

Part One The Therry of Intertrttriorut[Trat{t

i':'

t' f". iii:

5r l*j

fi

In this section we first exatnine the case of a Sn:ali {*#r}?fy" one whose trade

does not affect the international price ratio. We then examine the case of a i'r*'l-t*r

e**r;try. one whose trade can have an impact on the telative international price ratio {that is, an effect on ihe price the country receives for its expofis, the price it pays for its imports. or both). Note that the definitions of smull colt,lttn and letrge'(:o;tnfi1v

are based ol the ability of the countly to have a noticeable efTect on one of more international prices. Even a country that rve think of as having a small economy can be a larye counffy. For instance. Ghana (r,vhich is a relatively srnali country, overall) is a major exporter of cocoa. A reasonable change in its export supply{say, an increase in its export suppbr by l0 percent due to an improvernent ln^faiming practices) would affect worid cocoa prices. On the other hancl, even a

colrntfy thai rve think of as having a large economy (for instance. Japan) can be a small country for some products (examples wouid be rnilk and cheese), in the sense

that reasonable changes in its orvn production or demand have no discernible efYect

on the world Price of the Product.

Small CountrY If a country is small {that is, a price-taker in world markets),

then its ffade has ncr

impact on the inr.rnutionui price ratio (the country's terms ol trade)' The graphs

shown in Figure ?.1 ;;;;;.;t rhe tull anaiysis of growth.by the sma1l countr;'. In

each of these cases tfre'lountr' gains fromits growth in the sense that it reaches a

higher comrnunitv inditTerence curve (at point c, c,, or cu. depending on the type

of growth).

Large CountrY If a counffy is large. a change in its willingless to irade affects

the equilibrium inter-

national price ratio. bonrii", first the case in which growth reduces the country's

rviilingness to tracie at any given price. as shown in Figure 7'3 lwhich reproduces the

ppc shift of Figure l.iei. dr. reiuction in the country's dema'd ftir imports red*ces

the relative price of the iruport good (or the reduciio[ in the country's supply of

exports increases ti,. ,.iu,io*'pricJof the export goocl)' This change in the equilibriun't

international price is an improvement in the co'[6y's ternts of tratle' 11 this case' the

country gets two benefits from growtil:

" The procluction benefit from growth as the ppc shifts out' - The benefit from improved terms of trade as it receives a better price for its

exports

relative to the price ihat it has to pay for its imports"

ln Figure 7.3 theimproved terms of trade are shown in a t'latter price line (a lower

relative price of "rotrr.

it "

i*por, ggodl. In response, the country shifts its production

point to So o' the ,,; dr uni^6".-id.. to constlme ai a point C6' lMith this ppc grorvth

and no change in the tlims of trade, the country wauld 1ea1h ie level of well-being

associated with the conrmunitv indifference cu**e through c, (48 wheat and 72 cloth)

in Figure 7.1B. The improvetnent in the terms of trade permiti tne country to reach the

higher level of **1-f.1ng ussociated *ltt, iire .o**unity indifference curve tlrrough

CrtS+ wheat and 82 clothlin Flgure 7'3'

trr.rrec*ati{F*d S€s*6&tr5" i :th Edition

ihapter l ,,,t, l,: ,rtl,i ltt,t.ltl

141

iii:: ii;t.: ., :j {ir.:ri't1.t

3;*sr-j ton'ard ,E:*piecing

!:i:Jiilrh i11 a i.*:g* i luntrv

Wheat

91

80+ .\ I Ji r

\CT-,{- 4Ai----:

1r I

Price=213 V{lC

ppjqs = 1 WICll Cloth

,t l,.tSt .","*y cao gain in tr'vo rva-vs from an expanding

orr i n,-":,,, p*uu.* ttr. imp'r t-compeli:s sood ;. h:'

:-. :].1'n ir., -aOirl;i., ro rhe gains fr.orn be ing able

t. p'oduce 'llors

iutr"oOo shorvu in Figure 7'iB)' it can itlprove its terms of

ir^,f .. L]:' rlemanding f'er'r'er itnpot'ls ( a decr*ased *'i llit rgness

io ffadei. it ruakes cloth cheapel' ot't 'nvorld nrarkets Aiier

gt"tt;Jt. if.r- r'elative price olcloth declines to 2r'-1 ltr'r{- in the

lrnna,t- sllowtl.'fhe country! reiriaining.inrports cost less

Ihus. rhe couiltrY gains more firx'rr grnwth' a! collsunlpttoll

.r',in.. ,iorr, c', t,i{. because thc price line becomes tlatter'

{lonsider next the case in whicli grorvth itrcreases lhe ctlttntrY's willingtress to

ffade. Tlre increase itl the cot-ttttl-v.S del]land tb, in.,po1.,, itrcreases rire reiative

piicc ol

rhc impor:t good (or rhe increase in the cor:nt.y"t tupplu olexpot'ts i'e'luces the relative

price of rhe export g*ii.:ifrit change in tne equitibriut.''' intet:naLitnal price ra1lo:s

a dcterioration in the countr)i's terils of "oOt' it-r this case the overail efl'ect ou the

countr),''s \\'ell-being is not ciear' Cirorvth brings u p:"d.Y:1t-t"lbenefit' L:ut the coulltry

is hr-rrt 6y the subsequent 4ecline iil irs tenils ,irtro,i.. (lt receives a lor'r'er pr"ice tbr:

its

export prodr:cts ..torol.i to the irrice that it pays for its irnport prodtlcts')

if the terms of tracle,Jo ttot clecline by tooinrtclr' then the countr'v gains o'e.tal1fiottt

gr.wtli. but n't u:,' ,.lJ".rrls it *oura'ii tire ternrs of trade did not ch'l'ge' l{orvever'

if trre adverse inovement is rarge. a surpdsing outcome is possitrlc'

lmmiserizing Growth Wlrat lrapperrs if the tet.rns of trarie declinf a gleai

de al irr lesp0ltse to gror,vth in tlre

country"s abiliry to pro,i** its export goori'.' Jiii'u tu"'tt t''f trarltt rieclinc substantially'

the country's well-Lreing could fall. {or. jn tl'ie !i}-be$'eel} casc' lhe conntrv's u'ei.l-

being could be Lrnchanged') The possibiliii' i-rl a rieclill"l in u'*11-beittg is shorvn tn

Figure 7.4. in rvhich a lirge improver;r'r:r i:i *l:e*t-pri:ili.i*iioii technology resilits

in I

shitl in the ppc that is ,tringry'rr,*\\,l.d t*$*rll 'llpandi:tg t'heat pr'dtlclion'

142 lnternational Economics - Vol, I

: l:r Part One Thc Thtrirr of ittnr.:;:lririi Trr'ai:

:'-ii-"jijfit;j.$ Imuriserizing Gror,vth in a Large CountrY

Wheat

A large counfry actually couid be made worse offby an

improvement in its ability to produce the products it exports'

Such a perverse case of immisetizing growth is show'n here'

By expanding its ability to produce wheat. its export good'

the laige cotntry increases its supply ofexports (expands its

willingness to trade).This drives down the relatlve price of

rvlreat in worlcl narkets. Looked at the other way' this causes

an increase {here a tripliirg) of the relative price that it must

pay for its imports of cloth. The decline in the couutry's

teims of ti"ade is so bad in this case, that it outweighs the

benefits of the extra ability to produce. Consumer enjolment

is lolver at C, than at the initial consumption point C,'

For a relatively steep price line (.showing a 1alge decline in the country's ten]ls 01'

trade), the countiyl procluction is at point '9, on the-ne' ppc and its consumption at

pomt,r-ffre 1evel oiwe11-being for C' is-1ess than that for point tl-0"t"91t g:"^T.'::.,'- Thir'porribiliry is a remarkable result, first analyzed carefully_by Jagdtsh lJhag$'atr' It is calfed the possibility of irxirn*s*'rleinqg {}r{:k:/{:i'ni lrowltr that expands

the c*un-

try,s rvillingness to trade can result in such ; large decline in the country's terms of trade that the coulltry is worse of-f'

Three condiiions seem crttcial fbr immiserizing grou'th to occur:

1. The countl,],"5 gronth must be strongly biaseci toward expanding the countty's srtp-

p11, of exporrs {increasing its willingness to trade), and the increase in export supply

mlst be iurg* *n*,,gh to have a noticeable impact on world prices.

2. Th* foreign demand for the counry's expotts must_ be price inelastic. so that an

expansi*n in tr,e "o.rntry,s

export supply ieads to a large drop in the international

pric* *f tlle *xP** Product.

lnternaiis, al Economics, 1 5th Edition r43

Chapter 7 (lrorth 'rnLJ

1i'url* i i i

3,t]eforethegrowtlr'thecountrynustbeheal'il-velgagedintrade'sothatther'velfare loss fi"om the decline in the terms cl'trade is great

enough to ottset ttre gains from

being able to Produce tnore'

Llor.rntries that export a diversifieil selection of export ploducts rlo no1 seem to be at

rr-,u.t', *rt* of eiperiencing i;iserlzing gror'vth' A developing coulltry that reiies on

one or a fbrv primary p,ortu.i, logri"ufiriul or mineral proclucts) is more at |isk' For

example. consider a corurtry iike fanrbia that relits otl a mitterai ore (e'g'. copper) lbr

most ol its expolt feveilues. e o,*ou.ty that leacls to the opening of severai tterv large

mines woulcl increase its ore expofis and greatly reduce the international price of tiris

ore. As a result of the decline in ttie price. Ihe cotill1'y coulcl be worse off' For iustance'

ttre rnoriey; vu-r* oizutnbiak expoits of copper orl coLrld ciecline (ii the price falls

more than the export cluantlt; i*creases). and'Zambiathen coulcl rtot afford to inport

as much as before the grorvth'

ft nif, ,*.; foolisiitbr a nation to undergo atr expansion that makes itself worse

oij. B,t remember that *re .*junrion rvorrldle uncler.taketr. botli in the model and in

tt e ,eai ,";;ld. t), indiviciual eompetitive firms.. each of rvhich mrght prot'ii individu-

;i;tt'*,, its .u,n'expansiorr. tndividual rationality can solnetimes add up to collective

irrationalitY. -fire possibiliry of immiserizing growth ofTers large counlries a

policy lesson that

transcencls the cases in rvhich it actuall-v occlrrs. B.tiitseltl the case of imrniseriziug

gror,r,th is pr.babiy irrst a coiio,ru ,arity Even lorlarge countries the rtecessary condi-

tions listed above are not lifreiy io t . *.r very often-. Yct a larger pt'rint etnerges tt'om

Figures l'3 andT '4. lrr.r,eflbct of growth in tiie nationai economy on the

terms of trade aftects the national

gains f1onr encouragitrg ,ftui gt,nt'trt. Supqo.le that the government is debating rvhich

- indLlstfies to favc.,r rvith tax bieaks 0r subsidies, and has to choose befil'een etlcoufag-

ingitnpcrt.replacingindustriesanclencouragingexport-exparrdingones.Itt'lq.:']:"1.1 rve tbunrl that the colnltq/ reaped greatef benefits if its expansion of

import-competlng

.npurriiitl** causes a c1.op inii* pii.. of imporrs. By confl'ast, in Figure 7'4" expanding

export inclustries is less beneficial because it lowers the relative price o1'exports' This

is rrue whether or not the bad terrns-ot'-trarle etl-ect is Lrig enough to outiveigh the gains

tiorn being rnore productive. So a laige country has reason t0 favor import-replaeing

indusffies over export industlies: {l othir things are truly equal, rvhy not favor iildustries

that tr-rrn rvorlci prices ln your:a.,oi rather thariagainst you'/j We return to this point r'vhen

c.liscussing rrade policy for developin-q countries in Chapter 14'

, , . i: , ' ": i t"''',:t,'" * t'-"

';

This chapter's ciiscussion of biased growth can be iinked to the gener:ri discussion

of the basis lbr comparative aclvantase presentecl in chapter 4' As we noted there'

:Renrernber, however, that thr: rryircjs ie;:cl j,:l i;o:r,n! rrrpcr-t repiacement.here relates to tr:rttinq

ini'.:rnational prices lll this naliolr,s {a.,.or. i:ll.ite,.!:i.]:.:: a';i:cle, tne[e c.n be no such gi:itl anrl trcl

iilmiseriziirg gro"{h. clne countrys -lails i!csi=:r itlrr" i"rirtlss ii llre'ielins ol lrade equal anotlrer

r uu'rlry'5 lussc's (rta;nst.

1M lnternational Economics - Vol. 1

Part One The Theurr rf lntrririrrionti 'lr;g-lr

comparative advantage ske\A/s collntries' capabilities'fbr proclucirlg vadous products.

ln presenting the Heckscher-Ohlin theory we spent much time discussing dilferelces

in factor endowments as ihe basis for comparative advantage' Another basis for comparative advantage is differences in production tech-

nologies available in the r.,arious countdes. Technology di1l-erences tend to skew production ip each country toward producing the product(s) in which the counfi:y has

ihe reiatively better technology {that is, the techlology of greatest advzuitage or least

disadvantage). Teclnol-ogy-based comparative aclvantage cail arise over time as technological

change occ.irs at different rates in different sectors atrd countiies. For instance, in otLr

e*uropl* from Chapters 4 and 5, improvements in the produclion technology used in

the wheat industry in the United States over time would skerv U.S. production capabili-

ties toward producing larger amounts of wheat. The U.S. ppc would shift out in a way

biased towarcl wheat production (as in Figure 7.lC). These technology improvements

could include improved farming practices or better seed varieties. lf the technology for whear prosusiisn is not improving rn a aomparable mannff in the rcst 0l'lhg w8fld, then the United States can develop a comparative advantage in rvheat based on its rela-

tive technology advantage in wheat. In some r,vays this technology-based explanation is an alternative that competes

with the H-O theory. Technology differences can become an important cause (some-

times the dominant cause) of the pattern of trade in specific products. For instance, the

fact that the United States became a net importer of steel products in the early 1960s can be explained in part by the adoption of newer production technologie s ior steel in Japan and other countries.

In other r,vays technology differences can be consistent witli an H-O view 0f the world, at least one using an extended aqd d,vnarnic H.-O approach. To see this, we nlust

consider the question of rvhere the technological improvements come from. Some technotrogical improvement happens by chance or through the unusual efforts

of individuals. However, most industrially useful new technology norv conres from organized efTorts that we call r*s*ar*h *ne* dev*t*p*'l**{ tRe*}. This R&D is done largely by businesses and focuses on improvements in production techitologies for existing products and on new production technologies for new or improved prod-

ucts. Products or industries in which R&D is relatively itnportant-such as aircraft, semicondnctors, and pharmaceuticals-are usually called high technologl'. Ongoing (and costly) R&D within these high-tech industries can create an ongoing stream of nerv and improved technology over time.

The most obvious link to the H-O theory is the natiottal location of R&D itself, R&D is a production activity that is intensive in highly skilled labor--scientists and engineers in palticular. Most of the world's R&D is done in the industrialized coun- tries that hat'e an abundance of this lvpe of labor. Another factor of importance is capital willing to take fhe substantial risks involved in financing R&D investn-ients. The relative abundance af t,entw'e capitul (ontsiders' purchase of orvnership in nelv businessesi in th* United States is the basis for a u.S. advantage, while other colttttries

like Japaa depend more on internal funding of R&D within their latge corporations. The nati**al l*cation of production using the nerv technology, rvhich is what is

shown e.xpiicitll.' in c*r ppc graph, is not so clear-cul. lt seems reasonable that the first

" ..i:g$ '. !;

lnte$latitfial tror${?t*p 1 5th Edition . 145

{h+pter 7 (}i'nr''rh lrd TrsJr 1:i}

useinpfoductioncouldbeinthesamec0llntryinrvhrchtheR&Dwasdone,However, rechnology can spread ini**utiooutly' This iJtrinu'ionol

spread or "tratle" in technol-

ogy is called *lffxsa*n New tech'oiogy is difficult ro keep secret, and other countries

have an incentive to obtain the technoiogy i*prou.tent;' Indeed" the creator of the

new rech'oiogy l.ras ;;;;;;"* to uppl"/ it in prodrction in the national location(s)

in which the nerv technology is rnost slrlt;b; (and therefore most profitablel' H-O

theory suggests that the suiiable location *aicttes the factor proportions 6f productiort

using the new technoffiio ti.,* ru.tot eildowments of the national location.

lndividual Products and the Product Cycle

One efforr to find a pattern in these technologt activities is the pr*dtl{t {Vel*

?iyp*tlre:i*, flrst advlircrJ uy nuy*ond venrJri. When a product is first i*vented

(born), it still must be il;f*ft niditional n*n ir needed ancl production is olten

in sma1l amounts ry sritteo workers. tn oJ.t;iion, the major demand is mostly in the

high-income countries. since most nerv protlucts are luxrries in the economisth seRse'

Close communirutioiii, n.edecl between trte-ngn. production' anel marketing people

in the producing fir*.,{11 this suggeto tttuinotft R&n and initial procluction are iikely

to be in an advanced developed country'

overtinre,theproductanditsproductiontechnologybeconremolestandardized a'd tamiliar (mafure). Factor intensitv i" ito4uttlon

tJnds to shift away from skilled

labor and tor,vard t..r-ri.itt.o labor. Tire teitrnology difTuses. and production locations

shift into other courrtries, evenfually into developing countries that are abundant in

'tt;:*l-;|ll*1-?ri .n",'*e in a manner consisrenr with shifting productionlocatir:ns'

The innovating cor.lrtry is initiaily the exporter of the new product' but if eventua]ly

becomes un irnport.r.'ait1,org1, it is aynamic and empltasiz"t additional consider-

ations like demand and commJrnication, mu"y orp..ts of this pr"oduct cycle hypothesis

arr'consistent with H-o theory. The procluct c,vcle fr:rp"tfr-iit does fit the experience of products

in many indus-

tr.ies in the past centurv. Laptop compulers afe an example. computer firms in the

Unired States and ;rptuiU-gi'' nAn to design small,.portable,cornputers in the 1970s

anrl eariy 1980s. The finns planned t9 *9ii9*.nected demard^by businesspeople and

researchers in the Unitecl States ancl other high-incr:me countries' Several eariy models

were produced in the urited srates and Japln, and R&D continued. In the late 1980s

and early 1990s, iBN{,lbshiba. Texas lnstruments. and other u's' and Japanese firms

introduced befier rnodcls, wirh proiluction in the united states and Japan. and some

ol this prod'ctior was exported to buyers in ott't"t counffies' As the conponents of

the laptops became standaidized, and as cornpetition.u*gng selJers inte'sifleci through

the 1990s, finns shitted much of the urr.*fly production of laptop:,.f.irlt.to Ti:y"11

and later to China, to reduce prod*ction cosis'-ln the process' tlie initial innovatttrg

countries became imPofiers' Nonetheless, the risefulness of the product cycie hypothesis

is limited tbr several

reasons.,rhese ha'e to jo witrr tire unpredictable tengilx or progression of the

phases

of tlie cycle. ln *unf inOurtiies*-especially high+eih jndustnr"s--*prod.ct and pro-

rluctio,fecinologres 'ari

i'orrtinually ivolviilg beZause of.onggirig R&D' I(eluvenatjort

or replenishecl vouthtulness is important' Iir addition, internatitluai di{hrsion often

.;{

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rl

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