Download Retheorising geography, trade and regional development

Retheorisinggeography,tradeandregionaldevelopment
Michael Dunford¹² Godfrey Yeung3 Liu Weidong² and Liu Zhigao² 1 School of Global Studies University of Sussex, Falmer, Brighton BN1 9QN 2 Institute of Geographical Sciences and Natural Resources Research Chinese Academy of Sciences (CAS), 100101, Beijing, China 3 National University of Singapore Abstract Existing theories of geographical specialization and trade can be classified into four categories: supply‐side, demand‐side, endogenous growth, and institutional models. In the recent past economic geographers concentrated for the most part on detailed examination of production structures, the chains linking upstream and downstream activities into production and value networks, clusters, institutions and more recently evolutionary mechanisms. As a result existing economic geography is ill‐equipped to deal with aspects of the evolution of trade, exchange rates, capital flows and regional development. Geographical economics does include an underlying theory of trade yet its supply‐side approach neglects the role of financial and demand‐side factors. The aim of this paper is to present a more comprehensive theoretical framework for examining relationships between institutions, regional development, and international trade. Accordingly some of the insights of regional economics concerning the roles of resource endowments, demand‐side conditions and endogenous growth are reintroduced but significantly re‐interpreted. Additionally some of the reciprocal impact of supply and demand conditions, trade and development and the formal and informal institutional rules and constraints are examined. Introduction
The economic crisis of the 1970s saw major changes in the trajectories of national and regional economies. Up until that point in time, in developed countries, the growth of domestic markets played a major role in driving economic growth and development. In the case of the United States (US) exports stood at just 5.2% of Gross Domestic Product (GDP) in 1960 and 5.8% in 1970, while in the EURO zone it stood at 18.6% in 1960 and 19.8% in 1970. The 1970s crisis and neo‐liberal globalization saw a significant reorientation of growth and development towards external markets: in the case of developed countries, increased wage costs and social conflict saw significant outward flows of investment to lower cost countries, while imports and exports increased as shares of 1 regional and national output and employment. In the case of the US and the EURO zone, exports reached 12.7% and 41.1% respectively in 2007 (OECD, various years). At the root of these transformations were a number of factors. In the case of the EURO zone economic integration was an important factor. Of more general importance however were gaping global disparities in wealth and income, that permitted large reductions in efficiency wage costs (at international exchange rates). A large‐scale geographical redistribution of economic activities could also not have taken place without significant investments in improved communications and other general conditions of production and exchange, and increased global economic and political integration. Complementary shifts accordingly occurred in less developed countries. In the 1950s and 1960s many developing countries had pursued strategies of import substitution designed to replace imports with domestically‐produced goods and services. At the end of the 1950s and in the 1960s the small East Asian Tiger economies adopted export‐oriented growth strategies. Their subsequent achievement of high and sustained growth rates saw a more general move away from import substitution and towards export promotion. The 1997 Asian crisis led initially to a certain degree of skepticism about the real strengths of Asian growth. Indeed a number of economists concluded from growth accounting exercises that Asian growth reflected perspiration rather than inspiration, and that their rise would fade much as the rise of the Soviet bloc faded after the 1970s (Krugman, 1998; see also Young, 1992). The Asian crisis and its sequels in Russia, Brazil and Argentina helped change emerging‐developed country relationships and the course of global development. The Asian economies responded strongly to the dangers of financial liberalization and dollar debts, altering their model of development and emerging as countries with budget surpluses and as creditors of the United States and other developed capitalist economies. Asian domestic markets declined in importance, as Asian manufacturers reduced prices and increased export volumes: excess capacities of production, compressed margins and currency depreciation made these countries formidable trade competitors and drove down world prices. The arrival of cheap imported goods put strong downward pressure on profitability in developed countries and encouraged recourse to financially‐driven growth. In 1998‐2000 a speculative financial boom associated with over‐optimistic projections of internet‐led growth encouraged household consumption and firm investment in new projects, generating serious problems of overproduction. Surprisingly the Anglo‐American economies responded quickly to the dotcom crisis: the monetary policy of the authorities drove down interest rates, credit markets were liberalized and a large inflow of savings from Asian and oil producing economies with large trade surpluses saw an explosion in the supply of credit, underpinned by house price increases to which credit expansion contributed. The consequence was an extraordinary polarization of trade surpluses and deficits (globally and inside of trading blocs such as the European Union) and dramatic increases in the foreign exchange holdings of emerging economies such as China enabling them to embark on processes of internationalization (Figure 1). 2 Figure 1: Current account balance in different regions, 1980‐2008. Elaborated from International Monetary Fund (IMF), 2010 1500000
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These imbalances have led to intense arguments about the exchange rate of surplus economies such as China and to sovereign debt crises in deficit countries such as Greece in the Euro zone. China strongly resists Western pressure to increase its exchange rate in part in the light of the Japanese experience. After the 1985 Plaza Accord a sharp appreciation of the Yen caused a recession (Figure 2). A macroeconomic programme to stimulate growth resulted in credit growth and soaring asset values. In 1990 the financial bubble burst opening the way to two lost decades marked by dismal economic performance. As far as Euroland is concerned, current Mediterranean sovereign debt crises are connected with the inability of their currencies to continue fall in value to restore competitiveness after adoption of the Euro (Figure 2). 3 Figure 2 Evolution of US$ exchange rates (Index numbers, 1960=100) Source: elaborated from OECD, 2011. 450
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These and other related trends in exchange rates, investment, trade and growth have played a profound role in reshaping world economic geography. It is therefore surprising that much of the recent economic geography literature has addressed these trade and payments issues in a very limited way (essentially in the new geographical economics) if at all (in economic geography itself). A fundamental reason why is that, with the exception of value chain research, much of this literature embodies real, supply‐side approaches to the study of economic development. The new geographical economics does deepen understanding of the geography of economic development in particular as a result of recent analyses of the dynamic effects on specialization and trade of endogenous growth mechanisms. In economic geography the more sociologically‐oriented studies of untraded interdependencies and externalities (Storper, 1995), institutional thickness and embeddedness (Amin and Thrift, 1995), industrial districts (Beccatini, 1994) and clusters (Scott, 1988; Storper and Walker, 1989), buzz and pipelines (Bathelt et al., 2004), networks and chains (Coe et al, 2004), regional competitiveness, externalities, economic evolution and regional resilience (Martin, 2011; Martin and Simmie, 2010) all help explain the dynamism of particular local economies. Both approaches have prompted a renewed interest in concepts of cumulative causation refining some of the original concepts in the shape of ideas about path dependence. And yet these theories have little to say about the reshaping of global economic geography and the geography of the recent financial and debt crises. The problems with these recent theoretical developments is that there is a significant absence: an examination of monetary and, other than in the recent interest in economic evolution and resilience, real adjustment issues that are in fact vital elements even of the original Ricardian framework. Only through an integration into theories of trade and regional development of international (and regional) payments issues and of impacts on income, expenditure and demand, considered in Keynesian demand‐side approaches to trade, can an adequate theoretical framework be developed (Figure 3). In accordance with recent insights, this synthesis must itself also examine the ways in which trade and growth are not simply a result but also a cause of conditions of production and exchange and recognize the significance of the structures and national and international governance. 4 5 Figure 3 Geography, cumulative causation, trade and international payments. Source: Aglietta (1984) and extended In the rest of this paper we elaborate on aspects of this framework. In the first section we consider the relationships between the institutional and geographical context and trade and regional development. In the second we insist on an interpretation of the principle of comparative advantage that recognizes the significance of exchange rates and monetary adjustment mechanisms. The feedback effects from trade and growth to resource endowments is considered in discussions of the principle of cumulative causation and of input‐output relationships embodied in a wider syatem of economic accounts for regional economies. The conclusion examines the importance of some of these insights for an understanding of post‐financial and debt crisis economic geography. Institutions,geographyandtrade
International trade theories rest on a conception of the world as a constellation of national/regional institutional configurations and interests that shape economic trends (Figure 3). International movements of capital and people do lead to the creation of global, trans‐national organizations, chains and networks. These global activities are however geographically situated in national economies with different degrees of autonomy. Trade along with international investments and movements of people are some of the (asymmetric) ways in which varying national models of development are integrated with one another. These asymmetries reflect the ever changing hierarchical relationships between nation states and economic blocs and the rise and decline of hegemonic powers, countries subject to different degrees of domination and contender states (van der Pijl, 2006). Integration, interaction and interdependence modify the internal structure and dynamics of national configurations and generate international/global disequilibria (Figure 3). In some cases economic integration is accompanied by closer political integration and a decline in the degrees of national autonomy. The division of the world into national and regional institutional configuration remains however a fundamental foundation of the international economic order: any analysis of trade and development must therefore examine its underlying institutional conditions and social relations. 6 A variety of approaches to the study of the institutional foundation of economic life exist: traditional and new institutional economics (see Hodgson, 1998); regulation theory (Dunford, 1990); new economic sociology (Granovetter, 1973; 1985); and varieties of capitalism (Peck and Theodore, 2007). In this section we shall concentrate on the former due to its relation to recent literature on geography, trade and development. In economics traditional institutionalism developed by Thorstein Veblen saw the market as one of several possible mechanisms for economic interaction. The new institutional economics is methodologically individualist in character. It examines the way in which rational choices and market institutions and governance interact to minimize transaction costs and shape economic activities (Hodgson, 1998),1 is built upon the idea of transaction costs (Coase, 1937), and was further developed in seminal works of Williamson (1975, 1979, 1989) on the governance of contracts (as transaction cost economics), and North (1990, 2005) on institutional environment (as institutional economics). North (1990, 2005) highlighted the role of the institutional environment – the formal rules (such as laws and regulations, especially with regard to property rights and incentive mechanisms) and informal constraints (such as behavioural norms), and their enforcement – as factors that could account for regional development. Williamson’s and North’s conceptions on institutions differ in three significant ways (Richter, 2005; Rafiqui, 2009). First, Williamson (1985) argues that institutions are efficient ways of reducing transaction costs, but North suggests that inefficient institutions could exist for a prolonged period of time. Second, Williamson examines the transaction costs of different organizational forms within a given institutional framework, while North investigates the processes of institutional change and its impacts on transaction costs. Third, Williamson defines transaction costs economics as a theory of contracts under the assumptions of imperfect enforcement and bounded rationality, while North (1993, 2005) deploys the theory of choice which rejects the neo‐classical assumption of rationality (so individuals do not make choices in isolation). Institutions, either in form of Williamson’s transaction cost reducing organizational forms or North’s formal rules and informal constraints, is crucial to explain the disparity in regional development. For Williamson, high transaction costs, resulting from bounded rationality and/or imperfect enforcement of contracts by agents, contribute to the regional inequality. For North, regional inequality exists when market institutions are either non‐existent or unable to function effectively, due to specific sets of formal rules and informal constraints in developing countries without functional market economies. Geography,tradeandregionaldevelopment
Geography is another fundamental foundation of the international economic order. Geography is the study of areal differentiation including the (trade and other) relationships among places. At any point in time trade and development are shaped by each area’s resources endowments and assets (Figure 3). These varying resources and assets comprise natural assets and created assets. In the recent past economists have emphasized the role of physical geography in driving trade and regional development, partly due to the strong correlation in cross‐country regressions between per capita income and physical geographical explanatory variables such as latitude or physical location 1
Methodologically, the traditional institutionalism (developed by Thorstein Veblen to examine the relationships between embodied technological change and cultural rigidities) is evolutionary in nature, as the resultant economy is determined by individuals interacting in institutions and the underlying socio‐economic circumstances (Hodgson, 1998). 7 (Hall and Jones, 1999; Acemoglu et al., 2001), climate zone, disease ecology, and distance from the coast (Sachs, 2005). Sachs argument re‐asserts the importance of physical resource endowments. Institutional economists argue that geography has weak effects on income levels once institutions are controlled for. Acemoglu et al. (2001) argued that institutions account for three‐quarter of the income gap between the top and bottom of the world income distribution. Acemoglu et al. (2003) divided the requirements for effective property rights into two components – the traditional Northian general provision of secure property rights, and the extension of such rights to society at large – and attributed the economic growth of Botswana to good institutions (of private property). Rodrik et al. (2004) compared three sets of determinants of economic growth: geographical factors comprising climate, natural resources, disease burden and transportation costs; economic openness and international trade; and institutions comprising property rights, the rule of law and social infrastructure and argued that trade and economic integration have no direct effect on income levels once institutional quality is controlled for. Following a similar line of argument, Evans (2008:76‐77) demonstrated that the high economic growth rates experienced in Botswana were partly due to the strategic negotiations between the state and a transnational diamond mining company, which gave half of all export revenues to the government. In other words, the economic success of Botswana is more due to a combination of effective state‐building and political constraints in harnessing the country’s resource endowment than providing incentives to local private investors. McArthur and Sachs (2001) argued that Acemoglu et al.’s (2001) cross‐country regression finding is geographically limited by the selection of a small sample of ex‐colonies. To counter Rodrik et al.’s (2004) ‘institution rule’ argument, Sachs (2003) further demonstrated that both institutions and geography, proxied by malaria transmission, have direct impacts on per capita income after controlling for the quality of institutions. In 2001 partly as a result of these debates the United Nations General Assembly decided to establish the Office of the High Representative for the Least Developed Countries, Landlocked Developing Countries and the Small Island Developing States (UN‐
OHRLLS) to examine the impact of physical geography on economic development (Chowdhury and Erdenebileg, 2006). Mainstream economists employ a remarkably narrow definition of geography. A landlocked state for example is simply measured in terms of physical distance to the coast (Acemoglu et al., 2001, 2003; Rodrik et al., 2004). In reality, governance is spatially sticky in the Northian sense as informal norms are spatially embedded in places and the enforcement of (private) property rights is also partially determined by local socio‐economic and legal institutions. Precisely because of the potential stickiness of governance, some regions could be locked in the circular and cumulative trap of limited resource endowments, lower levels of trade and capital inflow. In examining the institutions and geography, economic geographers have drawn on the new economic sociology. In this case economic relations are seen as deriving not from the rational economic decision‐making but as embedded in social networks (Granovetter, 1973; 1985). In other words, economic relations are dependent upon norms, institutions and sets of assumptions shared by groups of actors. The embeddedness of economic action and its outcomes are a result neither of idealised market conditions nor of pure bureaucratic hierarchies (Granovetter 1985). 8 In geography this work has revealed how certain institutional forms produce particular industrial practices and thus influence regional development (Amin and Thrift 1994; Gertler 2004, 2010; see also Markusen 1996). Economic geographers apply the inherently non‐spatial concept of embeddedness to unpack ‘institutional thickness’ (regional cultures and local institutional fabrics) that is seen as a driver of regional economic development (see Ash and Thrift 1994, 1995; Thrift and Olds 1996; Hess 2004). These institutional geographies – spatial variations in the range, density and functions of the formal organizations, rules and practices, and informal customs, norms and networks that underpin (or even undermine) economic activities – play a part in shaping regional development. Thick regional institutions are considered as the significant facilitators for regional economies, partly due to the geographically‐bounded ‘untraded interdependencies’, including technological externalities, technical know‐how and learning (Storper, 1995; 1997). These interdependencies are developed through the learning and cooperation of actors involving face‐to face exchanges, embedded routines, habits and norms, local conventions, reciprocity and trust. This type of tacit knowledge is not easily substitutable. All these factors can facilitate collective efficiency (Schmitz, 1999), develop ‘learning regions’ (Storper, 1993; Mackinnon, 2002) and help local firms to ‘catch up’ with lead firms or economies (Coe et al., 2004). Subsequently, different regions develop their own specific networks of inter‐firm traded and untraded interdependencies, institutional forms, and socio‐economic and political practices that affect regional development. Therefore, ‘[p]ath dependence does not just ‘produce’ geography …; places produce path dependence’ (Martin, 1999:80). Following North (1990, 1991, 2005), Gertler (2004, 2010) argues that institutions with formal regulations and informal norms shape the attitudes, values, and expectations of individual economic actors through governing the workings of labour markets, education and training systems, industrial relations regimes, corporate governance, and capital markets. A region’s locally embedded formal and informal rules shape decision‐making processes and are reproduced over time generating distinctive national models. At the same time economic geography has refined the concept of resource endowment and assets. Many of the assets and resources on which development depends are a result of development (reflected in the circular and cumulative feed‐back loops in Figure 3). The value of these resources and assets depends not just on their quantity and quality but also on a whole range of untraded interdependencies and externalities (Storper, 1995), on the management and use of these resources and on the networks and chains (Coe et al, 2004) that shape the evolution of these resources and assets and their resilience.2 At present however a number of core economic mechanisms are frequently overlooked. In the next section therefore we shall consider the nature and effect of several of these vital mechanisms. Mainstreamsupply‐sidetheories
In this world of relatively independent political and economic jurisdictions, national specialization, the international division of labour and international trade were traditionally seen as driven by 2
Global Value Chains and Global Production Networks interpret shifts in production conditions as industrial upgrading/downgrading where the former is defined as ‘the process by which economic actors—nations, firms, and workers— move from low‐value to relatively high‐value activities in global production networks’ (Gereffi, 2005: 171, see also Sturgeon et al., 2008; Coe et al., 2004). These approaches have the further advantage of examining the role of multinational corporations and foreign direct investment in shaping the geographies of comparative advantage. 9 comparative advantage (Ricardo, 1817) and by underlying production factor or resource endowments (Heckscher; Ohlin, 1933). According to the Heckscher‐Ohlin theorem, a capital‐
abundant country exports capital‐intensive goods to labour‐abundant countries, while importing labour‐intensive commodities in return. Assuming that the production factors (labour and capital) are mobile within countries but immobile between countries, Samuelson’s (1949) factor price equalization theorem predicts that in a perfectly competitive world the prices of all factors along with those of traded goods will converge. Of these arguments the idea that trade is driven by comparative advantage is widely accepted. The neoclassical trade theory prediction of regional income convergence has however not materialized. The existing literature has also established that there is a positive relationship between trade and growth (normally measured by the trade to GDP ratio), while growth itself is seen as driven by the investment of capital (traditionally considered subject to diminishing returns), the mobilization of human resources and exogenous time‐varying technologies (Solow, 1956) and as a regional convergence mechanism.3 These neoclassical models of trade and growth raised a number of difficulties. Trade and growth theory predictions of convergence were not observed empirically. Trade also occurred between similarly endowed countries in goods produced with similar factor intensities. To deal with some of these difficulties new theories of growth and trade were developed. Krugman (1979; 1991) attributed international trade between similar countries and the geographical concentration of wealth to economies of scale and consumer preferences for diverse goods and services and also identified the potential significance of the size of the domestic market. In growth theory Romer (1986) and Lucas (1988) incorporated increasing returns to capital arising from the accumulation of knowledge into new (endogenous) growth models. Romer (1986) argued that private investments generate knowledge spillovers that could offset diminishing returns to capital, and therefore lead to increasing marginal social returns to capital in the economy as a whole, while Lucas (1998) developed models in which a positive externality determined by the average level of human capital was an economy‐wide phenomenon. By highlighting technological changes through learning by doing, education and human capital formation, these models could explain the polarization of income that resulted when developed countries grew faster than developing countries (Romer, 1994; Sala‐i‐Martin, 1996). These models have a number of implications. First there is a feedback from trade and growth to the evolution of factor endowments making the development of industrial activities and of zones of industrial development path dependent and cumulative. Second, increasing returns (which should be conceived more widely than in the aforementioned models) and network externalities give rise to monopolistic competition and oligopolistic markets. Third, increasing returns open the way to a case for strategic industrial policies (which mainstream economists generally oppose but which are widely used by nations that catch‐up with more developed economies; see Amsden, 1985; 1989) and infant‐industry protection: industrial development is path dependent in ways that judicious tariff 3
The Solow model predicts conditional ß‐convergence (ß‐convergence in the presence of control variables removing the effect of structural heterogeneity in technology, savings and population growth rates) of per capita income to the long‐
run levels at about 2 percent per annum (Barro et al., 1995) or convergence of an individual country’s income toward its own long‐run steady‐state level determined by its structural characteristics rather than the convergence between countries (Darity and Davis, 2005). 10 and quota protection, knowledge transfer, active industrial policies and state development planning might assist (see Frank, 1969). These measures are especially relevant in the case of agricultural based economies whose newly established industries are, in the absence of state intervention, vulnerable to international competition. Initial protection and support allows local industries to achieve a sufficient level of technical and human capability and scale of production. Obviously, the contentious issues relate to when and how the state should withdraw support and require these industries to compete internationally. These neoclassical theoretical developments imply that an examination of trade and development requires an examination of the dynamic evolution of comparative advantage and specialization. This conclusion was however far from new: it was anticipated in earlier studies of cumulative causation (Myrdal, 1956) and examined in the flying geese paradigm which drew on a dynamic version of trade theory to argue that the emerging economies in East Asia pursued one after another a sequence of industrial evolutions (Akamatsu, 1962). 4 Specialisationandtheinternationaldivisionoflabour:theprincipleof
comparativecostsreinterpreted Although they draw on ides of comparative or competitive advantage, the models and explanations considered in the last section are deficient in that they pay no attention to monetary mechanisms.5 At present the values of goods and services and the conditions governing the reproduction of the wage earning class are formed at a national level. National structures and processes of regulation are characterised by important degrees of long‐term autonomy. As a result national contrasts in the development of the wage‐earning class, the process of wage determination and the production of the conditions of production and exchange are constantly renewed. The factor price equalization theorem is therefore wrong in positing that market mechanisms lead to an international equilibrium in which the prices of all goods and factors of production are equalised. 4
Initially developed by Akamatsu (1962) to describe an industrial life‐cycle sequence involving successively the import of modern manufactures, domestic production, export and finally re‐imports once production was moved offshore during the pre‐World War II industrial evolution of Japan, the paradigm was also used to explain a movement from lower to higher value added activities and a the development of a succession of industries (textiles, chemicals, iron and steel, motor vehicles and electronic products). The ‘wide‐geese‐flying pattern’ was formulated to analyze the industrial restructuring in specific countries and the relocation of products and industries from counties that were more advanced to countries occupying lower positions in the hierarchy (Yamazawa, 1990: 28). This model is also called a ‘catching‐up product cycle model’ by Kojima (1973) (Yamazawa, Hirata and Yokota, 1991:222) 5
Institutions also matter. In China, central government grants local governments in southern China a higher level of autonomy and allows them to implement policies that overcome planned economy legacies. Foreign joint ventures (and partially privatised enterprises) were permitted as were flexible and piece‐rate remuneration. Chinese labour productivity increased, and the abundant supply of migrant workers kept the real wage low. The early success of the industry allowed entrepreneurs to accumulate capital and develop entrepreneurial and management skills, encouraging local government to provide further institutional support for the industry, including financial incentives and technical assistance in moving up of value chain. Local governments are learning and competing with each other further enhancing the competitiveness of labour‐intensive industry in southern China. Rodrik (2006) argued that the technological content of China’s exports (for its income level) is high and is due to industrial policies supporting the growth of consumer electronics industries rather than the usual factor endowment of a low‐income country with abundant unskilled labour. In addition to ‘priority industries’ that are identified by the central government for special financial and technological support, the state insisted on the transfer of technology through the formation of joint ventures and the establishment of local content requirements (the procurement of parts and components locally) with tangible impacts on the transfer of technology and the further development of manufacturing industries in China. 11 As a result of the varying national histories of investment, national systems of production differ, as do comparative costs. Suppose, as did Ricardo, that the costs of production in two countries are the ones set out in Table 1. But let us interpret these costs as quantities of direct and indirect labour commanded by the wage weighted by a rate of profit which itself reflects the difficulty of producing wage goods in the country concerned. In this situation multiplying them by the money wage yields the prices of production. It is important to note that these comparative costs and prices of production (around which market prices oscillate) depend on indirect as well as direct production costs. Suppose that aij is the quantity of good i normally required to produce one unit of good j, and that A is the corresponding matrix of input‐output coefficients where A is (1) non‐negative and indecomposable and (2) non‐singular. If is the vector of quantities of abstract labour newly added to units of these goods in the period of reproduction, r is the general rate of profit, w is the wage share of value added (real social wage cost or wage cost per unit of value produced), the vector of prices of production is given by (see Lipietz, 1982:76‐8): 1
1
or 1
1
These comparative costs and prices of production therefore summarise the impacts of a range of underlying drivers including wages, profit rates, value added and input‐output relationships. Table 1. The Ricardian Tableau for England and Portugal (in hours of work per yard of cloth or gallon of wine). England Portugal Cloth 100 hours 90 hours Wine 120 hours 80 hours Source: Ricardo (1817). In the situation depicted in Table 1 Portuguese producers can produce both wine and cloth more cheaply than their English counterparts: the Portuguese have an absolute advantage in the production of both commodities. But in Portugal wine is comparatively cheap, as
, whereas in England cloth is comparatively cheap. Alternatively Portuguese producers have a comparatively greater advantage over their English counterparts in the production of wine, as , whereas English producers have a comparatively smaller disadvantage in the production of cloth. The value of commodities bought and sold on the international market is not formed in the same way as values on the national market. In Ricardo's example where the terms of trade were assumed 12 to be 100:100 England ends up exchanging the produce of 100 hours of work for that of 80 hours. For Ricardo this inequality of exchange occurs largely because of the international immobility of capital. International values are formed as a result of the establishment of a rate of exchange that establishes a correspondence between the price systems of relatively autonomous national economies. International exchange can only be sustained if prices expressed in a common currency lie within certain limits, and the international monetary constraint is respected. This constraint requires, that in the absence of net overseas earnings and net international credit, exports should equal imports. Suppose that and are the international prices of wine and cloth, and and are the money wages in Portugal and England respectively, with all quantities being expressed in a common currency. International exchange will only occur if and , with . In other words it will only occur if the ratio of money wages expressed in a common currency satisfies the constraint .6 Suppose that the rate of exchange is equal to 1 unit (escudo) of the Portuguese currency per unit (£) of the English currency, or . Suppose also that the money wage in each country is £0.01. If the price of cloth in England is £1 the average price of cloth in Portugal expressed in units of the English currency is £
£0.90. Similarly the prices of wine are £1.20 and £0.80 respectively (see the opening tableaus in Tables 2). In these circumstances the Portuguese economy has an advantage not only in the production of wine but also in the production of cloth. If trade were to occur the English economy would have a large trade deficit and the Portuguese economy a large surplus. What is required is a mechanism which will raise the international prices of all Portuguese products and lower the international prices of all English products until (1) English producers can undersell the Portuguese in one of the two commodities, and England's comparative advantage has been translated into a competitive advantage, (2) resources have been transferred to the activities in which each country has a comparative advantage, and (3) the values of each country's exports and imports have been altered and the balance of payments of the two countries brought into equilibrium. In the absence of these adjustments protectionism, exchange controls and capital transfers would be the only way of avoiding international trade conflicts and national economic crises. Adjustment can occur in a number of ways. In the first place wages in Portugal could rise, pushing up prices, while those in England fell, until , and the prices of cloth expressed in English 7
currency were equal. As is indicated in Table 2, the desired result could be achieved by a 5.26 per cent fall in English prices and an equivalent rise in Portuguese prices. In these circumstances England 6
The inverses of total costs can be interpreted as indices of the productivity of labour employed to produce one unit of each type of commodity in the conditions of production prevailing in each country. It follows that each economy has a tendency to export those goods where its productivity relative to that of its competitors is greater than the ratio of money wages expressed in a common currency. 7
Whether gains from trade occur depends on assumptions of constant returns to scale in all production processes and full employment. In the presence of diminishing or increasing returns costs would be affected by changes in the level of output, while the existence of unemployed resources would mean that the opportunity cost of producing the imported good domestically is zero, except as and in so far as production could only occur if materials and capital goods were imported. In addition inflexibility in factor markets must be ruled out along with the existence of costs of adjustment. 13 would be able to export cloth and to earn foreign currency with which it could pay for imports of wine. Table 2 International prices with fixed exchange rates and wage flexibility where and . England Portugal England Portugal England Portugal Cloth £1.00 £0.90 £0.95 £0.95 £0.80 £1.08 Wine £1.20 £0.80 £1.14 £0.84 £0.96 £0.96 The prices set out in the middle section of Table 2 are the lower limit at which the balance of payments of the two trading countries can be equilibrated. The upper limit occurs at the point at which the prices of wine expressed in the English currency are equal. At this point . One way in which this wage ratio could be established is through a 20 per cent fall in English wages and a corresponding increase in money wages in Portugal. A second way in which adjustment could occur and the international flows of money corresponding to international commodity exchange could be equalised is through movements in the rate of exchange. Starting from the same initial position the rate of exchange would have to move in favour of the Portuguese until it reached at least 1 escudo=£1.11 (
) and the prices of cloth were equalised. But an upper limit to the depreciation of the pound also exists. In this case it is set by a rate of exchange of 1 escudo=£1.50 (
) at which the prices of English and Portuguese wine would be equal (see Table 3). Table 3 International prices with flexible exchange rates and wage inflexibility with and . , England Portugal England Portugal England Portugal Cloth £1.00 £0.90 £1.00 £1.00 £1.00 £1.35 Wine £1.20 £0.80 £1.20 £0.89 £1.20 £1.20 This argument makes it clear that the establishment of a comparative advantage requires the existence of separate currencies (or regional wage variations). Within a single monetary space principles of absolute advantage prevail. The argument also requires imperfect mobility lest all investment occurs in the area with the lowest comparative costs (assuming that costs are constant). Of course a third possibility is for surplus areas to transfer financial resources to deficit areas to permit them to consume more than they produce. Movements in relative money wages or in the rate of exchange, caused by changes in the process of money income formation and the operation of an international monetary constraint, always occur, however, in conjunction with changes in specialisation. Each economy is normally capable of producing a range of commodities, and the constraint on the money wage ratio should be written 14 . In other words for a given money wage ratio and rate of exchange there exists an international division of social production with England exporting a quantity of each of the internationally traded goods to the left of , which can be represented by a vector , in exchange for imports from Portugal of the other goods, represented by a vector . Suppose that England has a trade deficit, so that the international monetary constraint is not respected. In other words , where and are vectors denoting the prices of production prevailing in Portugal and England respectively. In these conditions wages, or the exchange rate, or both must fall in England and rise in Portugal. The wage ratio expressed in a common currency which links the two national price systems would accordingly be altered moving to the right through the ranked array of comparative costs. As a result the schema of specialisation should change with commodities that were formerly exported by the Portuguese now being exported by the English. This analysis must however be qualified in several ways. In the first place any reduction in capacity and development of new spheres of activity involve a scrapping of existing equipment, investment in new activities, and a redeployment of workers. As a result shifts in specialisation are neither smooth nor automatic. What is more only if the English industrial system is highly diversified and integrated can exports be increased and imports diminished without very large variations in the wage ratio or in the exchange rate, and only if a country is capable of remodelling its industrial system and is not dependent on narrow market niches can shifts in specialisation occur without serious dislocation. Another difficulty concerns the effects and efficiency of monetary mechanisms. In the view of Ricardo the mechanism through which adjustment would occur was the one posited in the classical quantity theory of money (see Shaikh, 1979:281‐302 and 1980:27‐57). On this account net transfers of gold, at first from England to Portugal, would be translated into movements in money price levels in the two nations (relative prices are deemed to be determined by real factors, and money is only introduced in order to determine the general price level). Whether or not monetary expansion and contraction have a direct effect on the price level has been a subject of dispute in economics. According to Marx and Keynes, for example, changes in the supply of money have a direct effect only on the rate of interest: a fall in the supply of money results in an increase in the rate of interest raising, incidentally, the costs of borrowing and impeding the new investment necessary for adjustment, and vice‐versa. Under monopolistic regulation wages and other costs are characterised by a certain inflexibility. In the face of, say, a fall in the rate of exchange employers may choose not to adjust prices expressed in a foreign currency downwards. As a result the competitiveness of the enterprise's output would remain the same, while its profit margins on export markets would increase. In these and other circumstances adjustment may well fall on output instead of on prices (see, for example, Edwards, 1985:123‐37). Adjustment is neither automatic nor self‐equilibrating at full‐employment levels of resource use. So far the argument has simply focused on sectoral specialisation. Much contemporary trade occurs within particular industries. Any particular pair of countries may therefore import and export similar products. The processes of production of many goods are segmented and spread over national and international networks of production sites, with intermediate and semi‐finished goods transferred 15 from one place to another for further processing. Different places can specialise in different stages of production whose capital, knowledge and skill intensities can differ. Exports embody the skills and technologies incorporated in imported inputs, impacts on income depend on variations in net value added and trade is associated with occupational specialisation. In all industries there is a variety of functional and occupational roles: research and development, product design and engineering, manufacture, marketing, sales, inbound and outbound logistics and administration. The specialisation of different places in different functions and occupations within industries is another driver of trade and differential development. The method of theoretical analysis outlined in this section nonetheless remains pertinent as activities are allocated to different places according to comparative cost, alongside other, considerations, and as the impacts on value added and income influence development paths. In this section we have identified a number of vital mechanisms of international adjustment: exchange rates, wage rates and international monetary constraints. In addition a method of theoretical analysis was used in order to identify and describe the interaction of some of the major determinants or factors (summarised in Figure 3) on which the evolution of the rate of exchange and of the international division of labour depend. The historical process itself can however only be explained if this theory is elaborated further to consider amongst other things intra‐commodity trade and is supplemented by empirical analysis. Thetheoryofcircularandcumulativecausation
The argument set out in the last section can be developed in a variety of ways. In particular it can be extended to include an account of the dynamic interaction of the schema of specialisation represented by the vectors xe and xp and the conditions A, l, w and r, and of what Myrdal and Kaldor have called processes of circular and cumulative causation (see Myrdal, 1957:11‐22 and Kaldor, 1970:340‐4 and 1972:1244‐5). Models of circular and cumulative causation along with an analysis of the underlying mechanisms of value formation supply in fact one of the main explanations of uneven development. In them inequality is seen as a product of the way in which growth itself creates the material and social conditions on which further growth depends: fast growth is self‐reinforcing, as is slow growth. According to the formulation of Kaldor, for example, natural resource endowments are only relevant in explaining the location of raw material dependent and land‐based activities (see Kaldor, 1970:337‐
40). In the case of processing activities resource endowments and markets themselves are endogenous elements and not exogenous and naturally determined: as manufacturing activity expands in a particular locality the infrastructural and other conditions necessary for the success of new rounds of investment are supplied and at intervals renewed. As a result initial differences in the levels and rates of growth of activity are likely to be perpetuated in a cumulative spiral movement in which new investment, factor movements, markets, and trade interact dynamically with one another. One of the key factors in Kaldor's explanation of the growth of a national or regional economy is the demand for the area's exports: in his view increases in this particular component of demand play an especially important role in inducing new investment. The movement of exports in turn depends on 16 the growth in demand for the products produced in the region, and on the efficiency wage relative to that in other producing areas. The efficiency wage is equal to the money wage divided by the productivity of labour. Within a country differences in money wages are comparatively small. Productivity on the other hand varies according to the rate of growth of output (Verdoorn's Law) and employment (Kaldor's Law). The dependence of productivity on output growth, summarised by Verdoorn's Law, is said to stem from several factors. First, increases in an economy's resource endowment are largely endogenous being determined by the rate at which technical progress is embodied in new equipment and consequently by the rate of output growth. In the presence of increasing returns international and interregional trade can increase the original competitive advantage of one economy relative to another. And excess demand for labour in an area can cause international or interregional factor movements which can themselves generate increasing returns. (Similar mechanisms underlay the relationship between productivity and employment growth that has been called Kaldor's Law). As a result, therefore, of initial shifts in demand, which result in increases in regional output and factor movements, efficiency wages fall in the nations or regions that are prospering, stimulating further export demand, and so on. As in the case of Myrdal's model the existence of a variety of 'spread effects' is also recognised. Included are the diffusion of innovations, the stimulation of demand for complementary products from poor economies, diseconomies of congestion, spread effects associated with the mobility of workers which counteract the more frequently mentioned 'backwash effects', and, within a nation, built‐in fiscal stabilisers.8 A formal representation of this model (Dixon and Thirlwall, 1973) is as follows: 8
where rate of productivity growth, coefficient, money wages, of exports, rate of productivity growth, rate of growth of rate of autonomous productivity growth, rate of domestic inflation, rate of growth of world income, prices and a constant. 17 rate of growth income elasticity of demand for exports, cross‐elasticity of demand for exports, rate of growth of per cent mark‐up on unit labour costs, price elasticity of demand for exports, Verdoorn rate of growth of world The mechanisms highlighted in this model are concerned only with the movement of economic aggregates and with very broad sectors of activity identified in standard national and regional social accounts. Yet transactions within sectors and especially within the industrial sector/account are particularly important. Information on inter‐industry transactions indicates the structure of production within an economy from the point of view of the dependence of any industry on other industries either as a supplier of inputs or as a purchaser of outputs. Suppose that every industry is given a production account and that the appropriation, accumulation, and external accounts of a region are consolidated. In these conditions the matrix for a closed regional economy assumes the following form: Production account industries All other accounts Totals Production accounts All other accounts Totals O In the column for each industry is recorded the value of its inputs divided between intermediate, or produced, inputs, represented by elements of the matrix , and the total value of factor, or non‐
produced, inputs represented by elements of the vector (which must include depreciation). In the row for each industry is recorded the value of its sales divided into sales of intermediate products to other industries and sales of final products. The main model associated with this display of accounts is the input‐output model. It can be thought of as a means of calculating all the intermediate product flows required to support a given set of outputs of final goods. Once these outputs are known, the outputs and levels of income generated in the various industries can be calculated. The model is , where is a matrix of coefficients, , denoting the quantity of good required to produce one unit of good , such that , where is a column vector the elements of which are units, and where is a diagonal matrix whose diagonal elements are the elements of the vector of outputs of final goods. The solution of the model is: 18 The inverse , a sufficient condition for whose existence is that , is known as the matrix multiplier. The solution for income, , can be found by multiplying the elements of the vector by the proportions which factor incomes bear to total output in each industry, or by the complements of the proportions represented by total intermediate inputs. Interregional linkages have important implications for the effects of an expansion of demand on a regional economy. Suppose that two regions have the following matrix multipliers: Suppose also that the demand for the products of industry 1 in region 1 increases by £100 million. The multiplier attached to industry 1 in region 1 is equal to the sum of the column elements, or 1.3, so that output in region 1 expands by (1.3)(£100 million) = £130 million. Assume, however, that industry 1 in region 1 always buys 50 per cent of its inputs from activity 1 in region 2. In these conditions the demand for region 2's exports increases by £50 million. As the multiplier for activity 1 in region 2 is 2.6, output in region 2 will expand by (2.6)(£50 million) = £130 million. Additional feedbacks are likely to occur from region 2 to region 1, while a complete interregional input‐output table would be more useful than tables for closed regions and import coefficients (see also Thirlwall, 1974:5‐10). Anewgeographyoftradeandregionaldevelopment
In this paper we have emphasized the continuing importance of models and concepts developed in regional economics and earlier geographical traditions. We also argued for a synthesis of these ideas recognizing the significance of monetary mechanisms, demand side factors and the structure of production. The new research on institutionally shaped and mediated resource endowments and regional competitive advantage should include consideration of these causal mechanisms and their institutional contexts, as at present the relationships between institutions, trade and regional development are not fully theorized, while trade, exchange rates and development are rarely examined. A more comprehensive theoretical framework for examining relationships between institutional conditions, geography, trade and regional development requires an analysis of real and monetary factors and mechanisms (Figure 3). It also requires new conceptualizations of already identified causal mechanisms that pay more attention to financial and demand‐side factors. Adjustment mechanisms in shape of currency exchange rates and capital mobility are crucial for the understanding of relationships between international trade, regional resources and assets (which also depend on the mobility of labour and capital), regional competitiveness and regional development. The geographical evolution of markets and underlying trends in income and credit play major roles in the growth, contraction and relative development of regional economies. In each case development is path‐dependent and cumulative with cases of ‘lock‐in’ and sustained growth though the relevant mechanisms include decisions about exchange rates and currency unions. 19 The institutional environment interacts with both of the supply and demand sides of international trade and regional development, and these interactions shape economic and institutional evolutions. The translation of resource endowments into comparative or absolute advantage depends upon the impact of local formal rules and informal customs. Geographers must however also examine the translation of these conditions into efficiency wages, values and flows of money and capital: only in this way can one fully understand geographies of competitiveness of and international trade patterns and the way they change. Again it is vital to examine real outcomes in the shape of changing inflows (or outflows) of labour and/or capital, imports/exports of types of commodities and services. Monetary outcomes and imbalances associated with changes in trade surplus and deficits, movements in exchange rates, capital flows and associated changes in income are also however capable of generating imbalances and can have real effects through their feedback effects on real and institutional development. A further consequence is the need to examine real and monetary adjustment mechanisms in determining the ability of regional economies to enhance their capacities and capabilities and to move up the value‐chain as a response to demand‐side, supply‐side and monetary factors. References
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(1985) The Economic Institutions of Capitalism. New York: Free Press. Williamson, O. E. (1989) ‘Transaction cost economics’, in Schmalensee, R.and Willig, R. (eds.) Handbook of Industrial Organization, Vol. 1, Amsterdam: Elsevier Science Publishers. Young, Alwyn. (1992) “A Tale of Two Cities: Factor Accumulation and Technical Change in Hong Kong and Singapore.” in Blanchard, Oliver Jean. & Fischer, Stanley. (eds.) NBER Macroeconomics Annual 1992. Cambridge: The MIT Press. pp. 13‐61 The contrasting fortunes of labour‐intensive manufacturing sectors (especially textiles and clothing, and shoe making) in China and Romania are illustrative examples for the proposed new geography of trade and regional development. Interviews conducted in both countries in 2010 and 2011 indicated that both countries have inherited the legacies of planned economies but differences in the relationship between the institutional environment and supply‐side endowments at least partially contributed to the growth of Chinese and the rapid shrinking of Romanian labour‐intensive manufacturing industries. In Romania, the informal constraints of socialist era mentalities are still reflected in national, sectoral wage negotiation between the entrepreneurs in privatized firms and union representatives. The fixed minimum wages result in a vicious circle of lower productivity and profitability, lower value‐added and the lack of technological upgrading in the industry. A massive relocation of orders to Asian countries (especially China) further limits the production capacities of remaining Romanian firms and made them rely on the last advantage of geographical proximity to 24 western European customers placing small volume orders for niche products (or restocking specific products). With diminishing taxation revenues and employment, the institutional environment in Romania weakens diminishing the competitiveness of labour‐intensive manufacturing industries. In China, central government grants local governments in southern China a higher level of autonomy and allows them to implement policies that overcome planned economy legacies. Foreign joint ventures (and partially privatized enterprises) were permitted as were flexible and piece‐rate remuneration. Chinese labour productivity increased, and the abundant supply of migrant workers kept the real wage low. The early success of the industry allowed entrepreneurs to accumulate capital and develop entrepreneurial and management skills, encouraging local government to provide further institutional support for the industry, including financial incentives and technical assistance in moving up of value chain. Local governments are learning and competing with each other further enhancing the competitiveness of labour‐intensive industry in southern China. Rodrik (2006) argued that the technological content of China’s exports (for its income level) is high and is due to industrial policies supporting the growth of consumer electronics industries rather than the usual factor endowment of a low‐income country with abundant unskilled labour. In addition to ‘priority industries’ that are identified by the central government for special financial and technological support, the state insisted on the transfer of technology through the formation of joint ventures and the establishment of local content requirements (the procurement of parts and components locally) with tangible impacts on the transfer of technology and the further development of manufacturing industries in China. 25