CHAPTER 1: The transformation of world industry: an introduction and summary
The last thirty years have brought many fundamental changes in world industry. Two of the more important of these—the internationalization of markets, and the growing opportunities for firms to specialize—establish the themes around which this book is built. This chapter begins with a brief discussion of these two developments and some of their implications. The concluding section describes approaches and objectives of the book and summarizes the major findings.
The internationalization of industry
For nearly two centuries, manufacturers operated in a spatial context that was predominantly local. The search for inputs, materials and buyers seldom extended beyond regional markets, and it was rarer still that such activities were national in scope. This provincial character no longer applies. Whatever their country of origin, most large firms now tend to operate in an environment that is international, if not global, in scope. Crude evidence to support such a view of industry is found in the rapid growth of international trade, the development of international capital markets, the continued spread of foreign investment, and the accelerated transmission of technologies across national boundaries.
Greater internationalization has brought more opportunities for collaboration, but it has also created new types of rivalries. The traditional agent of competition in any market has always been the firm. Today, however, governments are intimately involved in the process. National policy-makers have always been concerned with their country’s position in industrial hierarchies; but the potential rewards and losses of competition have risen as markets have become more integrated.
The degree of interdependence between countries has accentuated national rivalries. The expansion of an industry in one country (whether developed or developing) will often result in the contraction of the same industry elsewhere. Relative changes in any industrial hierarchy are therefore likely to induce policy responses in several countries. Such rivalries are found in both newly emerging industries and mature ones and have repercussions for producers throughout the world.
The integration of markets for manufactures has also changed the micro-economic environment. Foreign buyers of products or suppliers of raw materials and other inputs now constitute a significant part of any large firm’s network for the exchange of factors and goods. The international dimension is equally evident in other types of inter-firm relationships. Manufacturers buy and sell process or product technologies from foreign counterparts. They embark on collaborative forms of R and D, share out production facilities and distribution systems, and engage in many other forms of cross-border cooperation.
Increased opportunities for inter-firm collaboration also have a competitive dimension. Foreign firms will unexpectedly challenge complacent suppliers in the latter’s home or export markets. They sometimes go to great lengths to acquire vital technologies and secrets of their international competitors. Domestic firms, in turn, are often reluctant to provide the same proprietory knowledge to foreign firms that they share with their domestic collaborators. The steadily expanding network of inter-firm collaboration and competition has spilled across national boundaries. It has changed the ways firms operate, the types of strategies they adopt, and the very nature of business—government relations.
Greater market integration has brought more opportunities for specialization in particular products or product lines. The potential buyers in today’s market represent a wider range of incomes, tastes and preferences. This diversity affords more opportunities to compete on the basis of non-price attributes. Buyers also become more demanding and discriminating as their incomes grow and as they become more experienced. These are but a few of the observable changes in demand patterns which have occurred as the incomes of households and firms have grown.
At the microeconomic level, the motives for specialization are known. Most firms choose to specialize because they accept the premise that low prices and high volumes are essential to the achievement of competitive superiority. According to conventional wisdom, firms that enlarge their market share will realize the benefits of economies of scale. Attempts to compete on the basis of other attributes such as timeliness, quality or variety have, in the past, been regarded with some scepticism. The reason for scepticism was the suspicion that in many industries the costs of achieving these goals will grow faster than the benefits they provide.
The alternative routes to specialization are contradictory in the sense that individual firms are forced to choose between them. They may compete on the basis of price (and therefore seek greater economies of scale), or they may choose non-price forms of product differentiation. That decision is a firm-specific one which lies outside the scope of this book. In another sense, however, the two views are not contradictory since both stress the importance of specialization, albeit of different types. The internationalization of markets is increasing the scope for specialization by offering firms in developing and developed countries more choice in the ways they compete.
Orientation and approach
Interest in the determinants of specialization and trade has a long tradition, but the changes that have taken place in the last thirty years have led to new theories and to revisions of existing ones. In an effort to explain the forces behind today’s trading system, some trade specialists have gone outside their field by drawing on the work of analysts in the field of industrial organization. This approach is welcome: a compartmental relationship between the two broad lines of research serves no purpose in today’s world.
But while some barriers have been torn down, others still exist. One division is between trade theoreticians and empiricists. Theoreticians have struggled to keep abreast of changes in the real world by constructing more realistic models of the trading system. Empiricists have launched increasingly sophisticated studies in order to identify and measure the determinants of trade. All this work has led to numerous refinements, both theoretical and empirical. However, the theoretician’s task of modelling a world populated by a multiplicity of buyers and suppliers of commodities and factors of production is daunting. Progress has been achieved at the cost of much greater complexity. Empiricists, on the other hand, now have access to more powerful econometric methods and a growing volume of data. Yet their task is made no easier when they must utilize these tools within the confines of today’s multi-dimensional models.
This book is mainly, though not exclusively, concerned with subjects of interest to theoreticians, industrial economists and trade analysts. It is empirical in approach, but is not intended to be merely a documentary account of long-term trends or recent developments. The compilation and analysis of quantitative material is closely linked to particular aspects of economic theory. In this sense, the book attempts to bridge the gap between the work of the theoretician and that of the empiricist.
The selection of themes had several implications. First, the emphasis placed on the internationalization of markets meant that the book should be designed as a global study and not as a treatise rooted in a single economy, however important. Issues relating to patterns of specialization and trade are just as vital for small, open economies as for large ones, and appear to have applicability whether the countries are rich or poor. Second, many of the questions arising in the book cannot be properly examined when the subject of analysis is the manufacturing sector in its entirety. Thus an industry-specific framework is adopted, and much of the subsequent discussion proceeds along that line. The following section considers some of the approaches and methods employed in the study in more detail.
The framework for analysis
The literature on international specialization can be interpreted in different ways. This book follows the practice of trade theorists who use the term to refer to production-related developments. That usage is in contrast to the work of empiricists, who often refer to specialization as a trade-related phenomenon, by which they usually mean changes in the composition of a country’s exports and imports or other types of shifts in trading patterns.
Although theoretical discussions of specialization may be confined to shifts in production, supporting evidence can still be drawn from trade. In doing so, economists regard international trade as consisting of two distinct components. One of these components, inter-industry trade, figures prominently in studies of the international division of labour. The other is often referred to as two-way or intra-industry trade (IIT). It can be defined as the simultaneous import and export of products that are close substitutes, in terms of either their factor inputs or their final uses. That definition is operational in the sense that the intra-industry component of trade can be measured and distinguished from the inter-industry component.
Inter-industry trade is dependent on comparative advantage, and the structure of production is determined by a country’s factor endowments. IIT, however, depends on economies of scale and perhaps other determinants not recognized by models based on comparative advantage (Krugman, 1983, p. 344). The same applies to the domestic equivalent of IIT in production, which is referred to here as intra-industrial specialization. Each industry will have a wide range of potential products, some of which will be produced under conditions of increasing returns. But the existence of scale economies implies that each country produces only a subset of the potential products available to it. Little can be said about expected patterns of intra-industrial specialization on the basis of such theories.
The distinction between inter-industry and intra-industry patterns of trade is clearly related to the issue of specialization but cannot be carried over easily to studies of the latter. Both types of trade are considered in this book, but no attempt is made to investigate intra-industrial specialization. There are several reasons for this. First, it is virtually impossible to assess the patterns of such specialization in production. The data requirements would be massive, including information on production technologies, product characteristics and inter-firm exchanges. Second, it is not possible to formulate a workable definition of an industry which would be equally applicable to a large number of countries. An unambiguous definition—even for a single country—is rarely possible, since industries consist of shifting groups of competitors which are clustered around specific products or processes. Nor are there objective criteria for such a definition. The assignment of products and/or activities to a particular industry depends instead on the researcher’s subjective judgement of the extent of substitutability. Third, the usefulness of attempting any distinction between inter-industrial and intra-industrial specialization is questionable once it is recognized that the choice of products to be produced by each country is essentially arbitrary.
Trade analysts have addressed this problem in a pragmatic manner, often defining each ‘industry’ as the equivalent of a three-digit category in the Standard International Trade Classification (SITC). The method has not escaped criticism, but it is now a generally accepted part of the literature. This book follows the same practice, and the discussion of inter-industry and intra-industry trade patterns proceeds accordingly. The definitional problems are more serious when the subject of discussion is domestic production. The International Standard Industrial Classification (ISIC) offers the most comprehensive source of international data on production. However, each ISIC category is a heterogeneous mixture of products and activities which does not really approximate even the loosest definition of an industry. The ISIC serves as a basis for defining industries in the early parts of the book but in later stages more detailed industry descriptions are employed.
The conceptual basis for the distinction between international trade and inter-industrial specialization can be made clearer by drawing upon the tools used in the exposition of trade theory. Theoreticians, for example, usually begin their study of trade by assuming a state of autarky (that is, a hypothetical situation where the country engages in no trade whatsoever). They demonstrate the effects of trade by comparing a country’s post-trade patterns of production and consumption with those that prevailed in autarky. The transition from autarky to trade is depicted as a two-step process. With no trade, patterns of production and consumption depend solely on domestic forces. Once the possibility of external demand and supply is acknowledged, patterns of consumption will change, giving rise to what is described as ‘gains from international exchange’. The second step in the adjustment process involves a shift in patterns of production. After trade occurs, there is an incentive to specialize, which gives rise to ‘gains from specialization’. Together, the two effects represent the ‘gains from trade’ and are part of the theoretician’s toolkit to demonstrate the superiority of free trade rather than no trade. This book makes no attempt to measure the welfare effects of trade. Nor is it concerned with the identification of gains from specialization or international exchange. However, the theoretician’s use of an imaginary two-step process is retained, since it provides a useful device to distinguish between the production and trade-related effects of specialization.
Mention should also be made of certain statistical and classificational issues. Because the volume of data included in the study is substantial, various summary measures must be used. These types of data aggregation are derived from the underlying theoretical and empirical literature. The arrangement of industry data according to factor intensity, or the categorization of trade in manufactures as resource-based, Heckscher-Ohlin and product-cycle goods, is common practice. The same applies to the distinction between intra-industry trade and inter-industry trade as well as other commonly used statistical and economic conventions.
Of more significance perhaps is the arrangement of country data used here. Information on a large number of countries is included in the book, and space constraints dictated that various country groupings be used. The most familiar of these groupings is the developed market economies (DMEs). These economies are a fairly homogeneous group, being similar in terms of relative factor endowments, structure of manufacturing production, composition of trade and other attributes. The same degree of homogeneity does not apply to the developing countries. A certain amount of country-specific data is presented in the following chapters, but, more often, the developing countries are arranged in different subgroups: newly industrializing economies (NIEs), second-generation NIEs, and other developing countries. These types of country groupings are familiar to most readers, although economic theory provides no clear criteria to determine group membership (see e.g. Bradford and Branson, 1987; Cline, 1982; Michaely, 1985).
No generally accepted definition of group membership is available. Instead, the selection of first—and second-generation NIEs has merely drawn upon the work of others. In the case of the first-generation NIEs, the group is pictured as consisting of countries that are ‘super competitors’ in many international markets for manufactures and are likely to embody production and trading attributes that distinguish them from most other developing countries. The same claims do not necessarily apply to second-generation NIEs, though their involvement in world exports would still seem to distinguish them from other developing countries.
Other elements of the book’s framework are conceptual in nature and are drawn from the theoretical literature. The choice of theoretical tools is determined partly by the types of broad issues mentioned above. For example, the book’s emphasis on empirical issues requires that theoretical tools be operational in the sense that data requirements are realistic and attainable. Propositions that can be closely linked with underlying theory are also favoured over those that can be stated only intuitively. Finally, because the study is international in scope, there is also a preference for theoretical material that is of general applicability rather than valid only for specific cases.
Based on these considerations, the H–O model (also described as the factor proportions, factor endowments or factor abundance approach) provides much of the theoretical framework for analysis. The factor abundance approach operates reasonably well when inter-industry aspects of trade and specialization are the subject of investigation and the scope of study is international or global. But the model is not intended to suggest that factor abundance is the only source of trade or specialization. Once attention turns to intra-industry aspects, it faces a strong challenge. A theoretical counter-culture has emerged which Krugman describes as being represented by ‘a set of informal arguments stressing sources of trade other than those in formal models’ (1987, p. 132)
The conceptual basis for analysis
The two approaches mentioned above are distinct in several ways, but they are also complementary in the sense that the H–O model is concerned with interindustry characteristics while the alternative approaches referred to by Krugman are especially useful for an analysis of intra-industry forms of specialization and trade. Both lines of argument are utilized in the following account. Because several characteristic assumptions are the subject of empirical inquiry in later chapters, it is helpful to summarize them here.
The distinguishing assumptions of the H–O model as outlined in Chipman (1988) can be most easily described for the simple case involving only two countries which produce two goods and make use of two factors of production. The factors are assumed to be qualitatively identical between countries. They are completely mobile between industries but are immobile between countries. Goods, however, move freely between countries. The production functions for each good are the same in both countries and are subject to constant returns to scale. A further assumption is that factor requirements (intensities) will never be reversed between the two goods, no matter how factor prices change.
The H–O model goes on to assume perfect competition in markets for both goods and factors. This postulate, together with the insistence on constant returns to scale, enables the analyst to construct the general equilibrium framework for trade which the H–O model represents. In order to highlight the role of factor abundance, the possible impact of demand on trade patterns is excluded by the assumption that consumption patterns are identical between countries at any given set of goods’ prices. Finally, it is assumed that trade in goods is balanced.
Differences in factor proportions—with respect to both country endowments and input requirements—are necessary for international trade to arise. Differences in factor endowments relate to factor abundance, while input requirements are represented by factor intensities. On the basis of these assumptions, factor abundance will determine the pattern of int...
