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Technology, Trade and Development

by Prof Jan Kregel*

Bogota, Nov—It is difficult to consider trade and external finance independently of each other, and the two need to be viewed together. It is equally important to integrate technology with the role of trade in development financing. In fact, the theories that are used to justify the introduction of free multilateral trade for all countries, irrespective of their level of development, also have direct implications for the level of technology that different countries use to produce the goods that enter into trade.

According to the Ricardian theory of comparative advantage, a country is better off concentrating on the production of goods in which it has the lower relative labour costs, or higher relative labour productivity. Here the comparison is relative to other goods produced by the country. Thus a country that has 10% higher labour costs per unit of output in one product compared to those abroad, and 20% higher costs compared to those for foreign suppliers in a second product is at an absolute disadvantage relative to foreign producers in all the goods it produces, but still has a “relative” or “comparative advantage” in producing the first commodity rather than the second commodity because its disadvantage is lower.

Ricardo cited the example of England and Portugal, with Portugal being more productive in both corn and wine, but whose outputs in both could be increased if England produced corn and left the production of wine to Portugal.

Ricardo’s theory was based on labour values and was criticized because it ignored other factors of production such as natural resources of the land and capital. The Hecksher-Ohlin-Samuelson theory aimed to remedy this deficiency by explaining trade in terms of relative factor intensities. The basic idea of the theory was that while countries would have different endowments of factors of production these difference could be offset by trade, thereby making the international mobility of factors unnecessary to economic development.

Instead of trying to attract the factors of production in which it was deficient in international markets, countries could specialise in the production of those goods using the abundant factor more intensively and trade these goods for foreign produced goods that used the scarce factor more intensively (which was abundant in the foreign country). Since exports would increase the demand for the products using the abundant factor its price would be driven up, while imports would increase the supply of goods using the scarce factor and drive its price down.

Thus, trade would offset relative scarcity of factors and produce an equalisation of the prices of factors. Thus the implication for a country like St. Lucia was that it need not worry about a scarcity of capital since concentration on the production and trade of bananas would allow it to import capital intensive goods that it could not produce because of the scarcity of domestic capital.

Both of these theories imply that the gains from trade accrue as the result of specialization in production of goods that are traded at improving terms of trade. However, actual trading patterns observed in industrialized countries do not show this predicted specialization.

Instead, economists have been surprised to observe that “intra-industry” trade predominates, that is, all countries trading together simultaneously import and export the same goods. For example, both Italy and Germany produce wine and automobiles and import both products from each other (note that, pace Ricardo, England also produces wine).

On the other hand, specialization seems to be the predominant case in developing countries who continue to be dependent on primary commodities and commodity processing for their exports. Thus the specialization predicted by the theories appears to be in terms of developed countries producing a wide range of manufactured goods, which they trade among themselves, and developing countries who produce primary products which they trade for the manufactured goods of the developed countries.

Unfortunately the benefits of this kind of specialization seem to be greater for the countries that engage in intra-industry trade in manufactured goods than they do for countries that specialize in primary commodities.

This is one of the main reasons that Raul Prebisch called on developing countries to build their manufacturing sectors in order to participate in intra-industry trade and liberate themselves from the primary commodity dependence specialization.

What is usually not noticed is that these theories not only imply specialization in the production of goods, they also have implications for the techniques of production used in different countries. In Ricardo’s theory a country that specialises in the good in which it has a comparative advantage will not be using the global best practice technology. A country that has an absolute disadvantage in all goods will be specializing in the production of goods that use an inferior technology to that used in the country with an absolute advantage.

The theory of factor price equalisation assumes that the same technical knowledge (in the form of a common “production function”) is available to all countries, but since countries have different relative availability of factors and thus relative prices, each will be on a different position of the function and thus using different techniques.

But, even if factor price equalisation takes place countries will not be able to change their production techniques, since the actual supplies of factors do not alter. Thus, the theory also leads to the conclusion that there will be specialization in techniques of production as well as in outputs.

Again, actual experience does not confirm this result for the case of industrialized countries who use diverse techniques both within and across national boundaries for the production of industrial goods. Indeed, technology is one of the basic means of competition and reasons for trade among these countries. On the other hand, developing countries specialization in primary commodities does seem to be accompanied by specialization in technology, and when these countries produce industrial goods they often use technologies that are less efficient than those used in developed countries.

Those who have followed the debate over the new Information Technology revolution will know that “networking” (close to what Alfred Marshall had in mind with his theory of industrial districts) is an important element of the process of externalizing the research that produces technologies and their applications which lead to the creation of new goods. Developed country intra-industry trade might be thought of as representing a network which produces positive externalities and the continual creation of product innovation that produces competitive advantages for the goods embodying the new technology relative to existing goods embodying the existing technology. Thus, while all countries may produce nearly all goods, they will be produced by firms using different technologies.

Increasingly, transnational corporations provide the vehicle for much of this intra-industry trade since their trade is not organized by country boundaries, but by technological considerations. The “slicing” of different phases of production increases the trade in semi-finished goods, as various phases of the production process are located in different countries according to relative cost and marketing considerations. Nonetheless, as long as there is competition amongst transnational firms intra-industry trade on a country basis should be observed.

However, since few developing countries produce transnational corporations, they do not enter these intra-industry trading networks. Rather, they are chosen as locations of production because of relative costs, usually labour costs. Thus, they do not gain the networking advantages and the environment for developing new technology.

Indeed, in the cases where transnational corporations acquire firms in developing countries these firms are integrated into the networks of the parent, and cut off from other domestic firms, making more difficult for developing countries to develop local networks or disrupting local networks where they already exist.

The pattern of intra-industry trade amongst developed countries also seems to prevail in capital flows which are predominantly intra-industry flows amongst developed countries. This is especially the case for FDI flows. Again, developing countries seem to be excluded from this network.

It is probable that the two intra-industry flows of goods and direct investment are interdependent, first because of the dominance of technological advance in the developed country networks which requires investment, and second because much of the FDI represents mergers and acquisitions which are part of the competitive process implicit in intra-industry trade as firms attempt to acquire their foreign competitors in similar fields in order to gain competitive technological advantage.

As long as developing countries remain specialized, capital flows and direct investments will tend to be for development of primary natural resources, or for competitive advantage of transnational firms competing in developed country networks.

The means that diversification of production into manufactured goods will not be enough to allow developing countries to exploit trade as a source of development finance. They will also have to develop the networks that promote the production of new technologies which can generate product innovations that will allow them to compete on an equal basis in the intra-industry trading networks of developed countries. It also suggests that if they are unable to do so, it is unlikely that the magnitude of FDI flows from developed to developing countries will ever reach that of the flows among the developed countries or the level required to produce convergence to the technological levels practices in developed countries.

It is not sufficient for developing countries to produce using best practice technology in production units of transnational firms, since the value added from the technology accrues to the home country of the firm, not to the country of location of production.

This means that developing countries will never be able to catch up with developed countries simply on the basis of domestic resource mobilization or increasing the share of exports in output. Nor will increased net resource flows be sufficient in the absence of the ability to appropriate the competitive gains from the domestic generation of new technologies and new products. With the advent of knowledge-based goods generated by new IT technology, the risk is that the technology gap will widen as developing countries are reduced to the production of manufactured goods whose prices increasingly behave as those of primary commodities, with declining terms of trade relative to knowledge based goods of the advanced countries.

Current trends in the regulation of trade in intellectual property do not favour the equitable distribution of technology and thus serve to reinforce the specialization of developing countries in primary commodities and low-technology goods with low value added and low growth in per capita incomes.

Thus, in any discussion of trade as a source development finance, it is impossible to ignore technology, since it is difficult to separate the goods from the technologies they embody.

[* Prof. Jan Kregel is a senior economist and financial expert at the UN Conference on Trade and Development. He presented these views at a panel session on ‘The Decisive Role of Trade in Development Financing’ in Bogota, Colombia, last week during the Latin American and Caribbean Regional Consultation on Financing for Development. An presentation by Prof Kregel on Trade and External Finance was in SUNS #4784] .

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