| inframarginal economics |
|
Pattern of Trade and Economic Development in the Model of Monopolistic Competition Jeffrey Sachs Xiaokai Yang and Dingsheng Zhang
JEL code: D30, F10, O10. DE# 9184 REVIEW OF DEVELOPMENT ECONOMICS Contact author: Xiaokai Yang, JEL code: D30, F10, O10. Key words: Income distribution, division of labor, dual structure, economic development, trade pattern, monopolistic competition, economies of scale, inframarginal analysis
The paper introduces differences in production
and transaction conditions between countries into the model of monopolistic
competition. It applies inframarginal analysis to show that as transaction
conditions are improved, the general equilibrium may discontinuously
jump across different patterns of trade and economic development.
It shows that a country may export a good in which it has exogenous
comparative disadvantage if its endogenous comparative advantage dominates
this disadvantage. Countries will choose a trade and development pattern
to utilize their net exogenous and endogenous comparative advantages
in production as well as in transactions. The purpose of this paper is twofold. First
we introduce differences in transaction and production conditions
between countries into a model of monopolistic competition to investigate
trade pattern in this model. Second, we use the model with both final
and intermediate goods to investigate the interplay between trade
patterns and development strategies. Let us motivate the two tasks
one by one. In most of the models, symmetry is assumed
(production and transaction conditions are the same for all agents)
and therefore which country exports which goods is indeterminate.
The current paper shall introduce asymmetric transaction and production
conditions into the model of endogenous number of goods and economies
of scale to investigate trade pattern. This research follows a tradition in trade
theory represented by Bhagwati and Dehejia (1994), who suggested that
the models with the CES production function and economies of scale
may predict trade patterns that cannot be explained by the Heckscher-Ohlin
(HO) theorem, the Stolper-Samuelson (SS) theorem, and factor equalization
(FPE) theorem. These core trade theorems are at odds with empirical
observations (Trefler, 1995, Grossman and Levinsohn, 1989). The current
paper shall substantiate Bhagwati and Dehejia's suggestion (1994,
p. 44). In the face of a sufficiently large shift in relative factor
prices, goods could switch over from being intensive in one factor
to being intensive in the other (factor reversal). Scale economies
could generate endogenous (ex post) differences in technology and,
in particular, could invalidate the SS theorem, causing both factors
real wages to rise as scale efficiencies from trade swamp adverse
effects on the scarce factor. In addition the current paper shall synthesize
two research lines of trade pattern. In the Ricardo model of exogenous
comparative advantage (see Cheng, Sachs, and Yang, 2000), trade pattern
is explained by exogenous comparative advantage in technologies. Here,
exogenous comparative advantages come from ex ante differences between
agents before they have made decisions. In the literature of endogenous
specialization (see Yang and Ng, 1998 for a recent survey of this
literature and references there), trade pattern is explained by endogenous
comparative advantage, which is generated by increasing returns and
may exist between ex ante identical agents. As Yang (1991) shows,
individuals trade those goods which have greater economies of specialization,
better transaction condition, and/or are more desirable if not all
goods are traded. But who sells which good is indeterminate in the
models of endogenous specialization because of the assumption that
all individuals are ex ante identical. The current paper shall investigate
the implications of coexistence of endogenous and exogenous comparative
advantage and transaction costs for economic development and trade.
As the difference in transaction and production conditions between
countries (which generates exogenous comparative advantage) is introduced
into the model with economies of scale (which generate endogenous
comparative advantage), marginal analysis is not enough for managing
the model. We will develop inframarginal analysis (total cost-benefit
analysis across different patterns of trade and development in addition
to marginal analysis of each pattern) of the model of monopolistic
competition. The inframarginal analysis will generate much richer
stories on patterns of trade and economic development than in other
models of monopolistic competition and in the HO model. We shall show that as relevant concepts change
in response to changes in analytical framework, relevant empirical
evidences may be changed too. As Albert Einstein stated (quoted in
Heisenberg, 1971, p. 31), "It is quite wrong to try founding
a theory on observable magnitudes alone. … It is the theory which
decides what we can observe." For instance, many economists take
the notion of capital as granted. But its meaning in the model of
endogenous number of intermediate (capital) goods is totally different
from that in a neoclassical HO model. As the number of capital goods
that are employed to produce a final good increases in response to
improvements in transaction conditions, the equilibrium input level
of capital and capital intensity increase even if production conditions,
tastes, and endowment of primary resources are not changed. Hence,
in a model of monopolistic competition, outsourcing trade, disintegration,
and variety of goods might be better concepts than the notion of capital
for capturing the essence of comparative statics of equilibrium. Hence,
data sets that are designed according to the new concepts might be
more appropriate for testing the new theory. Many new models of monopolistic competition
with transaction costs are used to analyze trade and development phenomena.
For instance Krugman and Venables (1995) analyze industrialization
and income distribution, Fujita and Krugman (1995) analyze urbanization
by introducing difference of transaction conditions between industrial
and agricultural sectors into the model of monopolistic competition.
Puga and Venables (1998) analyze import substitution and geographical
concentration of industrial production. As the essence of comparative
statics of equilibrium in this kind of models is increasingly more
appreciated, we can see that many conventional notions, such as import
substitution, become out-of-date. Rethinking of the relationship between
trade pattern and economic development pattern is needed. Hence, the second purpose of the current paper
is to investigate the interplay between trade pattern and development
pattern in a model of monopolistic competition. Feenstra (1998) reviews
empirical evidences for the relationship between increases in trade
of intermediate inputs and economic development. He points out that
the distinction between effects of trade and effects of technological
changes on income distribution becomes suspect if we consider equilibrium
comparative statics in a model of endogenous number of intermediate
goods. As transaction conditions are improved (due to new communication
and transacting technology) the number of intermediate goods increases,
final goods become more "capital intensive," and outsourcing
trade increases. Our general equilibrium comparative statics in the
framework of monopolistic competition will assist clarifying the discussion
in which vague logic and inaccurate terms are sometimes used. As we introduce exogenous comparative advantage
in production and exogenous comparative advantage in transactions
into the model with monopolistic competition and endogenous comparative
advantage, we can show that a country may export goods in which it
has exogenous comparative disadvantage in production if its endogenous
comparative advantages in production and exogenous comparative advantage
in transactions dominate its exogenous comparative disadvantage. Also,
final manufactured goods may become increasingly more capital intensive,
as the number of capital goods increases in response to parameter
changes. A country can export capital intensive goods even if it has
exogenous comparative disadvantage in producing this good. Our model will show that a country will trade
goods in which it has net comprehensive exogenous and endogenous comparative
advantage in production as well as in transactions. It will exploit
substitution between trades of different types of goods to avoid trade
that involves high transaction costs. Various possible substitutions
between endogenous and exogenous comparative advantages and between
comparative advantages in production and in transactions generate
much more colorful picture of equilibrium trade and development patterns
than in neoclassical trade models. Section 2 specifies the model, identifies
possible trade patterns, and solves for local equilibrium in each
trade pattern. Section 3 conducts inframarginal analysis across different
trade patterns and identifies parameter subspaces within each of which
a local equilibrium is the general equilibrium. In section 4, our
results are compared with the neoclassical theories of trade and economic
development based on the models with constant returns to scale technology.
Final section concludes the paper. Inframarginal Economics Society www.inframarginal.com
|