Download Paradigms of exports and imports

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PRAGUE SOCIAL SCIENCE STUDIES
PRAŽSKÉ SOCIÁLNĚ VĚDNÍ STUDIE
DETERMINING FACTORS OF EXPORTS AND IMPORTS:
A SYNTHESIS OF EXPLANATORY PARADIGMS
2006
Vladimír Benáček
Public policy and forward studies series - xxx
V
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Faculty of Social Sciences, Charles University / Fakulta sociálních věd UK
Faculty of Arts, Charles University / Filozofická fakulta UK
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This study was commissioned as part of Research Objective MSM0021620841
Development of Czech Society within the EU: Challenges and Risks.
Copyright  Vladimír Benáček
ISSN 1801-5999
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Vladimír Benáček
Determinimg Factors of Exports and Imports:
A Synthesis of Explanatory Paradigms
VLADIMÍR BENÁČEK, FACULTY OF SOCIAL SCIENCES, CHARLES
UNIVERSITY
ABSTRACT
The basic objective of this paper is to design an appropriate structural model
based on economic behavioural foundations, whose explanatory variables would
represent the determining factors of trade specialization and growth in given
country. The analysis of policy instruments relevant to trade is also a part of the
study. The list of core explanatory variables discussed in the model of exports and
imports is based on macroeconomic theories of income, the real exchange rate and
the monetary policy. The remaining explanatory variables have both the time and
the industrial dimension.
A specific role is assigned to three price variables: the index of price
changes in industries and the unit prices of exports and imports. According to the
alternative theories of comparative advantage by Heckscher, Ohlin and Ricardo the
variables of capital per labour and the productivities of labour were introduced and
complemented with the variable of foreign direct investment stocks. Finally the
material inputs and the policy variable of tariff rates were considered important for
determining the trade intensities. The models are proposed for both the explanatory
purposes and the empirical testing by means of econometric methods.
ABSTRAKT
Účelem článku je navrhnout vhodný strukturální (odvětvový) model
vycházející ze syntézy ekonomických teorií obchodu, který by umožňoval testování
různých determinant vývoje obchodní specializace, růstu a efektivnosti dané země.
Analýza nástrojů ekonomické politiky je také součástí teoretických úvah.
Identifikace základních vysvětlujících proměnných modelu exportu a importu
vychází z makroekonomických teorií důchodu, reálného kursu a monetární politiky.
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Vladimír Benáček
Zvláštní role je v modelech přisouzena cenovým determinantám: indexu
cenových zeměn v odvětví a jednotkovým cenám exportu a importu. V souladu s
alternativními pojetími komparativních výhod podle Heckschera, Ohlina a Ricarda
v článku se diskutují role takových proměnných, jakými jsou zásoby fyzického
kapitálu na pracovníka, produktivita práce a přítomnost zahraničních investic v
odvětví. Posledními zvažovanými determinantami intenzity obchodu jsou
materiálové vstupy do odvětví a výše celních sazeb. Navrhované modely mohou
sloužit jak explanatorním (teoretickým) úvahám, tak testování pomocí
ekonometrických metod.
Keywords: International trade; sectoral trade balance; production factor intensities;
export and import specialization; panel data estimation.
Reference citations to this paper
AUTHOR’S ACKNOWLEDGEMENS AND CREDITS
Contact address for comments and correspondence: [email protected]
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Determinimg Factors of Exports and Imports:
A Synthesis of Explanatory Paradigms
1. INTRODUCTION
Since the time of Adam Smith economics has been searching for the causes
and effects of the growth of income and wealth and for the explanation of the
structure of international trade. Notwithstanding the enormous progress in those
matters, Joan Robinson (1978, p. 213) came with a sweeping criticism nearly 200
years after the Wealth of Nations: „There is not a branch in economics in which
there is a wider gap between orthodox doctrine and actual problems then in the
theory of international trade“. It is true, while there are fascinating pure theories
running parallel to each other, their synthesis is seldom proposed. In addition, the
analysis of the structure of specialisation is methodologically very different from
the quantitative assessments of total trade developments. While the former is
subject to microeconomic analysis in a commodity breakdown, the latter is
explained generally by macroeconomic aggregates. The schism is also evident from
the textbooks of international economics where former problems are discussed in
the part of international trade, while the latter are explained in the part of
international finance. There is hardly any methodological bridge between these
two.
There has been proceeding a significant change in this respect in the last 20
years. Aggregate production functions estimated by using macroeconomic
identities have been subjected to harsh criticism (see Felipe and McCombie, 2002
and 2003). The theory of endogenous growth (Grossman and Helpman, 1991,
Rivera-Batiz and Romer, 1991 or Aghion and Howitt, 1998) came with a
systematic inclusion of factors covering comparative advantages into their
explanatory variables. Therefore changing trading patterns, structure of production
and institutional factors of an integrated world, conceived as endogenous factors
closing the object and idea gaps, became ever more used not only in theoretical
explanations but also in empirical studies. Lutz (2002) has also argued that the
traditional chasm between “economic” and “institutional” factors in explaining
international trade has been narrowing in the last ten years.
The objective of this paper is to outline a model that, in its explanatory
functions, would be compatible with the major alternative economic theories of
trade and, at the same time, that would be subject to empirical testing of its
hypotheses. Such a model should include macroeconomic factors (e.g. the
international transmission of growth), microeconomic impacts of changing
economic factor endowments, diffusion of technologies via foreign direct
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investment and various policy factors.
Another reason for concentrating on a synthetic empirically testable model
of trade is the study of the economic transition in post-communist countries. Many
of them were stricken by the following paradox in their development: while their
total growth declined or stagnated, their exports and imports regularly expanded by
a two-digit growth rate. The majority of their analyses were macroeconomic,
putting in parallel the development in the aggregate inflation, exchange rate,
employment, growth abroad and external equilibrium. Unfortunately that by-passed
the real causes of economic development that were hidden behind the
macroeconomic aggregates. Dealing quantitatively with the global growth or global
external or internal equilibrium, when the country is subject to a profound industrydependent restructuring, may be therefore spurious. The analysis should address
microeconomic causes of growth that concern industries, enterprises, changes in
factor endowments, product specialization, shifts in quality and gains in
competitiveness. For example, macroeconomic aggregates can give a false picture
of real changes if there are perfect trade-offs between enterprises (or industries) in
the sense that an expansion of some of them is countervailed by the demise of
others.
The estimation of the factors behind structural changes, especially in the
manufacturing sector, is therefore an issue highly relevant to monetary and fiscal
policy-making. The depth of the problem can be illustrated on such fundamental
policy instrument like exchange rate. The exchange rate is an economic parameter
that is closely related both to the sustainability of the current account balance and
to the direction of net flows on the capital account. Many economists make the
mistake of relying on macroeconomic analysis alone when talking about exchange
rate regime options, nominal convergence and the trade balance. In the transition
economies, the exchange rate level is neither just a function of relative price level
changes (between countries or between the traded and non-traded sectors at home)
nor an outcome of changes in average productivities of labour. 1
The sustainability of the real exchange rates in transition countries is related
to qualitative changes in products and technology that are not uniform throughout
all industries. For example, there may be gains in output growth in one particular
industry due to its export expansion accompanied by gains in the terms of trade
caused by product quality and marketing strategy upgrades. At the same time there
may proceed a contraction of other, less efficient export industries and a
restructuring of imports. The new structure of trade thus reflects a higher level of
competitiveness of the national economy. The external balance can be in
equilibrium only if the real exchange rate appreciates.
1
For example, in the recent study in that train of macroeconomic thought, Egert (2002)
could explain only 5–20% of the real appreciation in countries such as Poland, Hungary,
Czechia and Slovakia by the Balassa-Samuelson effect. Unfortunately, the standard
macroeconomic models used for such purposes are too simplified if compared with the
excessive structural non-stationarity of transition economies, so that their results may give
an incomplete picture of reality.
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Our approach to modelling of export and import flows concentrates on the
dynamics of competitiveness that is inter-linked by its causes and effects with the
whole national economy. Such models must be strictly structural – open to the
world competition and based on asymmetric industrial trends. These asymmetries
are explained by three theories of specialization: Ricardian, neo-classical
(Heckscher–Ohlin) and the “new theory”. The models have three functions: (1)
explanatory – by stating the theoretical relationships between the variables; (2)
analytical – by estimating the quantitative dependency between variables in the
concrete past structure of trade; (3) predictive – by extrapolating past behavioural
patterns in accordance with certain assumptions included in scenarios.
2. TRADE, GROWTH, COMPETITIVENESS AND MODELLING
The problem addressed in this paper centres on growth and on the evolution
of the competitiveness of domestic production vis-à-vis competition with producers
from abroad. A large part of such change is reflected in exchange rate pressures.
The opening up of the post-communist economies and the process of their
integration into the European Union (EU) had a big positive impact on the structure
of specialization and on growth throughout Europe (Pelkmans, 2002).
However, the need to divert trade from the East to the West and to
restructure supply had high costs, too. On the part of the transition countries, there
were large terms-of-trade and transformation losses. The competitiveness of their
domestic economies initially decreased sharply, what was accompanied by real
exchange rate depreciation and profound decreases in unit labour costs. After
stabilization and economic recovery the real exchange rate began to appreciate,
wages rose and exports increased exponentially – reflecting gains in
competitiveness (Campos and Coricelli, 2002).
In all transition economies, the highest rates of trade growth were achieved
in trade with the EU. For example, during 1993–2001, Czech exports to the EU
rose from EUR 6.3 billion to EUR 25.6 billion, while Czech exports to the rest of
the world grew at a normal nominal rate of 4%. Therefore the trade creation with
OECD partners was accompanied by a large trade diversion from the former
partners grouped in COMECON. Trade liberalization concessions on the Czech and
the EU sides have therefore opened an unprecedented window of opportunity.
Their particular structural development was country specific – determined by
particular characteristics such as factor endowments, location, policies and other
economic factors.
The liberalization of trade had major repercussions on the transition
countries’ domestic economies by offering new strategic incentives for growth and
restructuring. This impact of the openness was often so strong that it dominated the
economic growth. It is the purpose of this study to deal more closely with the
theoretical, quantitative and technical aspects of such changes.
The developments in international trade in small open economies determine
the allocation and efficiency of the majority of domestic resources. Here one should
abandon the macroeconomic illusion that international trade influences the GDP by
the mere size of its trade balance (X-M), that is seldom higher than 10% and often
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negative, while the remaining 90% or more of GDP is somehow assumed to be the
domain of purely internal factors. Actually the share of traded commodities (i.e.
those produced for exports and domestic import replacements) in GDP is very high
– in some small economies it is even above 70% of GDP. Hence, export and import
functions for small open economies overlap methodologically to a large extent with
empirical models proposed for the explanation of GDP dynamics, for example in
Barro, 1991, Levine and Renelt, 1992, Sala-i-Martin, 1996, Badinger and Tondl,
2002 or Crespo-Cuaresma et al., 2002.
The overlap can be explained using the macro identities for production (Y)
and absorption (A), where the indices d and m indicate the “domestic” and
“imported” origin of domestic consumption. The most common identities are:
Y = C + I + G + (X – M )
A=C+I+G
and
Y–A = X–M.
For more insight we have to decompose the expressions using the following
definitions:
C = Cd + Cm
I = I d + Im
G = Gd + G m
X = Xd + X m
where Xd is the domestic value added contained in exports and
Xm is the import contents of exports.
M = Cm + Im + Gm + Xm i.e. imports required for the production of C, I, G, X.
Cd + Id + Gd = Dd
i.e. the domestic production for domestic
consumption.
GDP is therefore composed of the following segments:
Y = Cd + Cm + Id + Im + Gd + Gm + (Xd + Xm) – (Cm + Im + Gm + Xm)
Therefore:
Y = C d + I d + Gd + X d
i.e. Y = Dd + Xd
Thus getting: Y = Dd + X – Xm
and
A = Dd + M – Xm
Export and import functions are relevant not only for explaining the intensity
of trade flows in their industrial specialisation, but also for those parts of domestic
production that are earmarked for domestic consumption either as a tradable
product or as non-tradables that are inputs to traded production.2 In addition, there
are those domestic goods that have been out-competed and eliminated from
production by imports.
In the Czech case export and import functions are relevant not only for
explaining the intensity of trade flows in their industrial specialisation (i.e. X, M –
both 70% of GDP), but also for those parts of domestic production that are
earmarked for domestic consumption (i.e. Dd) either as a tradable product or as
non-tradables that are inputs to traded production.3 In addition, there are those
2
There is a wide discussion in the economic literature whether trade is a fundamental and
primary factor of growth. The studies motivated by the endogenous growth found that,
considering all countries of the world, trade openness has a large positive effect on GDP
(Frankel and Romer, 1999). However, there may be significant differences between
countries, whose trade could be impeded by imperfect market environment and the public
governance. Trade can also lead to immiserization (Bhagwati, 1967) or to structural
frictions known as „Dutch disease“ where the expansion of some industries is
accompanied by a parallel contraction of other industries (Gylfason et al., 1999).
3
There is a wide discussion in the economic literature whether trade is a fundamental and
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domestic goods that have been out-competed and eliminated from production by
imports. If we estimate that at least 50% of the Czech value added is in the traded
sector (i. e. X-Xm plus approximately 45% of the Dd segment), then the location,
redistribution and demise of at least 65% of domestic resources for the production
of Czech GDP may be subject to the evolution of comparative advantages and
competitive advantages4 estimated by the export or import functions. A similar
consideration pays for the relevance of such functions for the GDP growth.
The general relevance of structured export and import functions for general
growth in transition economies can be strengthened by technical arguments for the
estimation that can benefit from the additional information contained in the sectoral
and country dimension of data. Moreover, the export and import functions are
superior to closed economy growth models because they can deal more naturally
with dynamics entering the domestic economy from the outside world. The
intrinsically asymmetric evolution of sectors lies at the core of growth. This has
little meaning in closed economies, where the factors determining the output
structure are completely exogenous to the economy.
Although “competitiveness” is a word very often used by business leaders
and government officials, it is seldom to be found in economic textbooks, which
prefer the term “comparative advantage” – a narrowly defined formula for
describing the causes of producers’ success or failure on world markets. However,
as one gets through to the substance of comparative advantage, as explained by
either the Ricardian or the Heckscher–Ohlin theories, it is not difficult to
understand that “comparative advantage” and “competitiveness” need not
necessarily overlap, because competitiveness is a much wider and more
heterogeneous concept.
In the Ricardian sense, “comparative advantage” means a favourable starting
position in the physical labour content (intensities, requirements) of a physical unit
of production of one producer relative to the labour content of the production of its
competitors. In the Heckscher–Ohlin context, it is the ability of firms to adjust the
structure of production to the relative factor endowments of that particular country.
Here, “comparative advantage” and “competitiveness” can be taken for synonyms
(see Krugman, 1994).
primary factor of growth. The studies motivated by the endogenous growth found that,
considering all countries of the world, trade openness has a large positive effect on GDP
(Frankel and Romer, 1999). However, there may be significant differences between
countries, whose trade could be impeded by imperfect market environment and the public
governance. Trade can also lead to immiserization (Bhagwati, 1967) or to structural
frictions known as „Dutch disease“ where the expansion of some industries is
accompanied by a parallel contraction of other industries (Gylfason et al., 1999).
4
In difference to comparative advantages (given exogenously by relative factor
endowments, relative productivities or increasing returns to scale), the competitive
advantages are policy-induced. For example, they can be achieved by taking advantage of
competitive devaluation, pricing and marketing policies, tariffs, product differentiation
(Helpman, Krugman, 1985), market power (Krugman, Obstfeld, 2003, pp. 120-159),
aggressive psychological trade policies (Bayard, Elliott, 1992), government interventions
(Pelkmans, 1997, pp. 168–171) or various monetary policy instruments (Dornbusch,
1973), among others.
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On the other hand, the term “competitiveness” as defined in the business
literature has a strictly pragmatic meaning: as the capacity of firms to sustain their
market share, or even as their ability to increase their market share (WCY, 2003).
Market structure changes are often in the background of competitiveness in this
sense. Hardly anything is said in such literature about relative labour content or
about factor requirements matching endowments, even though implicitly they may
be important. Competitiveness can be also achieved by taking advantage of
economies of scale, product differentiation, consumer taste and market power (see
Helpman and Krugman, 1985 or Krugman and Obstfeld, 2003, pp. 120-159. The
argument may still remain within the tenets of the new trade theories, although its
causes have shifted far away from the classical theories of comparative advantage.
As a crucial alternative, competitiveness can be explained by institutional
and policy factors, such as the use (or abuse) of public resources in the hands of the
government and by various protectionist measures (Bayard and Elliott, 1992).
There, the most notorious case is the subsidization of agricultural products in the
EU. This may lead to EU agriculture turning from goods out-competed by imports
to “successful” export commodities (Pelkmans, 1997, pp. 168–171). The rising
social costs of such gains in competitiveness are often disregarded.
Higher competitiveness in international trading can be also achieved by
exchange rate depreciation or by directly lowering wage rates. The theories behind
various definitions of real exchange rates are important theoretical contributions to
the explanation of “competitiveness”. In its less orthodox version, appreciation of
the real exchange rate, defined as higher growth in the price level of non-traded
goods over growth in the price level of traded goods (well structured in line with
comparative advantage), could become a serious threat undermining the
competitiveness of internationally traded production in a large segment of the
economy.
Furthermore, imbalances on the domestic monetary side have links to
problems on the external side of the real economy, as was first analyzed by Salter,
1959. Various monetary policy instruments can therefore influence competitiveness
beyond the objectively determined comparative advantages (Dornbusch, 1973).
Although the traditional theory of the real exchange rate can tell us a lot about
competitiveness in stabilized economies, it can offer only a small part of the story
in cases of transition economies, as the paper by Egert, 2002, has shown.
Theoretical terms like comparative advantages, factor endowments and
factor productivities are treated as objectively given national economic
fundamentals that directly influence competitiveness in trade on international
markets. However, “competitiveness” can be significantly influenced by subjective
factors, among which economic policies are the most important. Different policies
can have different real outcomes, thus influencing the development of
fundamentals. The effects of policies can have a polar direction: they can either
enhance the role of fundamentals (e.g., improved education promoting efficiency)
or turn against them (e.g., by subsidising inefficient firms).
Observed empirically, competitiveness in foreign trade is therefore revealed
as differences in the growth rate that lead to a change in the composition of exports
or imports over time, which can be related to two structural aspects: the
geographical (territorial) breakdown and the commodity breakdown. The variables,
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whose evolution should be explained, can be depicted by a matrix of trade growth
indices πijt, taken separately for annual changes in exports (ΔX) and imports (ΔM):
πijt(X) = ΔXijt / Xijt-1
πijt(M) = ΔMijt / Mijt-1
i = 1, 2, 3, …, m are the trading partners of the analysed “home”
country;
j = 1, 2, 3, …, n are the commodities traded; and
t = 2, 3, …, T are years.
The empirical estimation of the whole problem can be simplified by taking
natural logarithms of the trade flows Xijt and Mijt and all relevant explanatory
variables. However, the dynamics of “why and where we are headed” can have a
meaning only if we understand “where we are now”, which requires the study of
those factors that actually determined the present structural dimension of Xijt and
Mijt.
The methodological roots of this approach are present in the principles of
economic policy modelling (Tinbergen, 1952 and 1956) where present, future and
past are intertwined in the following predictive model: Xijt+1 = φ (Xijt-1, ΔXijt),
where the structure of past Xijt-1 and the dynamics of present ΔXijt need not be
subject to identical determining forces. For example, the former could have
developed in the environment of central planning and early stages of transition,
while the present and the future evolve in a globalised market environment.
Therefore the dynamic analysis open to the future (Xijt+1) must be
supplemented by a static (structural) analysis of the past (Xijt-1), reflecting the fact
that the past of transition economies was moulded by different factors than the
current changes (ΔXijt). At the same time the current “flows” (ΔXijt) cannot be
completely independent of the particular state of accumulated “stocks” embedded
in Xijt-1.
The aim of this study is thus two-pronged: to provide a theoretical
framework for explaining what determining factors could be behind these changes
in trade flows in the past and what forces may potentially drive them into the
future. Such models can be then tested by econometric methods. The policy
implications and predictions could be also a part of their applications. The
transition countries are specifically targeted as objects of our analysis. The schism
between their not so remote past and their presence has hardly any parallel in the
history of economic development. The intensity of changes that happened to their
trade during the last 12 years vindicates such statement.
where
3. STRUCTURAL CHANGES AND RESTRUCTURING IN THE PROCESS OF OPENING
UP
The international trade among Communist countries under the institutional
backing of COMECON was relatively intensive. However, it lacked the support of
a market mechanism for determining the structure of specialization at the level of
standard economic agents such as producers, exporters and importers. The
structural microeconomic problem of specialization was therefore determined at the
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Vladimír Benáček
level of bureaucratic decision-making – to a large extent outside of enterprises and
without market signals. It was thus highly probable that the resultant specialization
pattern would miss some of the absolutely crucial economic criteria, such as
comparative advantages, efficiency and competitiveness.
Most surprisingly, however, the commodity breakdown of trade among the
COMECON partners (but not with other trading partners) revealed characteristics
compatible with the Heckscher–Ohlin criteria. This means that in the majority of
cases, the trade structure was compatible with endowments and scarcities in the
basic productive factors (labour, capital, human capital and natural resources) – see
Benáček (1988a, 1988b, and 1989).
Once the COMECON institutions collapsed and price and trade
liberalization became a standard policy among its former member states, intensive
trade diversion subject to economic gravity (Hamilton and Winters, 1992) was the
natural process that followed as an aftermath. As early as 1991, negotiations began
on the preferential trading arrangements offered by the European Commission to
some of the post-communist countries. The Association Agreements of these
economies with the EU countries, aimed at creating a free trade area, were
concluded during 1992–1994. The trend of channelling the majority of trade
through free trade arrangements led to the creation of the Central European Free
Trade Agreement (CEFTA) in 1993. Its impact was visible in intensive trade
creation among its members, often at the expense of trade diversion from countries
outside the EU and the CEFTA alliance. In that sense CEFTA behaved like a
typical customs union (Pelkmans, 1997).
Although the trade with the EU has been dominant and steadily growing in
all European transition countries, their regional trade balances will remain open to
large changes even after the EU accession and subject to expected fluctuations in
the enormous capital account surpluses with market economies. Trade readjustments due to trade diversion and the diversified intensity of trade creation
with alternative trading partners (associated also with asymmetric patterns of
restructuring in industries), will long remain a sensitive issue in all transition
economies. The balance of trade can be brought to equilibrium by various
mechanisms and policies, and we should be aware which factors act potentially
behind the dynamics of exports and imports.
The intensity of changes in the geographical structure of trade that was
initiated by transition can be illustrated on Czech trade. Figure 1 depicts how the
shares of Czech exports changed over the period 1989–2001 with respect to six
major regions. We can see that trade with the EU countries had the fastest positive
dynamics. The share of trade with CEFTA and with developing countries declined
only marginally, while Russia and Ukraine were the main losers. We can also
observe that the bulk of the changes occurred during 1990–1994.
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Vladimír Benáček
01
02
20
20
00
20
98
97
99
19
19
19
95
94
96
19
19
19
93
19
91
92
19
19
90
Developing c.
Russia+Ukraine
CEFTA
Other advanced c.
Other EU
Germany
19
19
89
100
90
80
70
60
50
40
30
20
10
0
Figure 1: Share of Czech exports to economic regions in 1989–2002 (in %)
Source: Czech Statistical Office trade statistics adjusted for changes in
methodology.
The period after 1999 is characterized by geographical stabilization. The
growth rates of Czech exports (in constant EUR) were 11.2% annually during
1993-2002 (of which exports to the EU grew at 14.3%). That is in a sharp contrast
with the Czech GDP growth of 2.2% in the same period. In parallel, there were
profound changes in the industrial structure of trade (Tomšík et al., 2002 and
2003). There is an inconsistency problem when we work with time series in an
environment that is subject to intensive systemic (qualitative) changes, such as an
economic transition. A priori we cannot exclude a case that during the studied
period the nature of economic agents (especially firms) changed to such a degree
that the underlying trade was subject to different behavioural patterns. An artificial
amalgamation of disparate time periods and disparate groups of industries (or
enterprises within industries) could then result in a weak statistical significance of
the estimated general behavioural characteristics.
4. SPECIFICATION OF MODELS FOR EMPIRICAL TESTING
It is of a paramount importance in econometric hypothesis testing that the
specification of the model involves a full set of real causal influences – that is, that
there is not a single substantial variable left out that would be non-random. The
current state of the art of economic theory helps us approach this objective. The
present microeconomic theories of trade are able to “explain” the specialization
pattern quite well, but unfortunately they are not so good at explaining trade
intensities. Combining them with macroeconomic theories (open economy
absorption, real exchange rates and the elasticities approach to the balance of trade)
is unavoidable.
Econometric studies dealing with the estimation of factors influencing the
commodity structure of international trade have had to tackle this problem by
combining a number of exogenous variables that do not come from just one
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theoretical school of trade specialization (see Pain and Wakelin, 1997, Aturupane,
Djankov and Hoekman, 1997 or Greenaway et al. 2002). Luckily, the parallel
paradigms seem to concentrate on alternative aspects of the causal forces leading to
trade, so that they can be assumed autonomous and non-collinear.
The economic background of this paper has been discussed also in Benáček,
Prokop and Víšek, 2003, and its theoretical principles are illustrated and explained
in the appendix. It is assumed that the studied economy has certain initial structure
and intensity of exports, imports and domestic production that reflect the past
conditions for specialisation (e.g. the pre-transition and the early stages of
transition). Then the economy is subjected to new market and institutional
shocks, both internal and external, what wield a new pressure on the structure and
the dynamics of trade. For example, according to economic theory (Krugman,
Obstfeld, 2003) the changes of trade flows can be induced by the following
changes in exogenous variables (considered as “determining factors of trade”):
 endowments of factors (that also includes a change in relative factor prices),
 internal producer prices reflecting costs or productivity improvements,
 prices of exports and imports (at f.o.b. parity),
 quality /image, goodwill/ of traded products,
 real exchange rate,
 aggregate demand,
 tariffs,
 economies to scale and intra-industry patterns of specialisation.
By estimating the coefficients of such determining variables we can study
how they may influence the evolution of exports, imports and the trade balance.
4.1. GDP, Exchange Rate, Prices and Quality
For imports, we can posit the following hypothesis for empirical testing:
which factors were active in determining the value of imported commodities of
country C (for example, Czechia) in industries i = 1, 2, …, m from a group of
territories j = 1, 2, …, n during the years t = 1, 2, …, τ, as expressed in nominal
values (in CZK). In accordance with Keynesian theory, the current values of Czech
imports (Mit) are considered to be a function of Czech gross domestic product
(GDPt) in real terms (constant CZK) and the variable of industrial price changes
(PCit). The combination of these two variables reflects the potential purchasing
absorption of aggregate domestic demand in nominal terms.
The coefficient of the variable of price changes has an additional
interpretation: if it is statistically significant and negative, then (under the
assumption of one market price) we can treat it as a standard demand factor. An
autonomous price increase in an industry discourages its consumers from
purchasing the given product, irrespective of its origin. If the sign is positive, then
we should look more at the supply side: the products were either improving in
quality or the industry was subject to evolving oligopolistic pricing. In that case it
is also a measure of nominal convergence in given industries.
In addition, we must extend this set of explanatory variables by adding the
real exchange rate (RERt based on the CPI), since the individual industry-based
inflators (PCit) are not correlated with real exchange rate changes that are universal
Factors of Exports
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Vladimír Benáček
for the whole economy. Real exchange rate appreciation (i.e., higher values of the
RER) should be associated with globally rising imports.
Similar approach can be taken for the basic specification of exports. They
can be tested as a function of GDP in the partner countries (in nominal EUR) and
the real exchange rate, which transfers aggregate demand abroad into the part of
Czech effective aggregate demand related to potential exports. The variable of
Czech price changes in industries (PCit) can be also retained here. It is assumed that
the differences in the indices of sectoral price changes reflect a narrowing of the
gap between world prices and the former prices under central planning. If this
parameter is positive it is a measure of nominal convergence related to the intensity
of trading.
The sufficiently long time series of indices PCit reflect how domestic
relative prices changed after the economy was opened up to the West. We might
expect that in sectors open to trade, the nominal (price) convergence will proceed
faster until all domestic prices of tradables are equal to the prices abroad. This is
also closely related to improvements in the terms of trade, which “pass through”
from exports into a higher domestic price level. The higher the rate of “imported
inflation” is in such industry, the higher the growth in its exports should be. The
Ricardo, Stolper–Samuelson and Haberler theorems (Kenen, 1994) are consistent
with this hypothesis. They explain why after the transition from protectionism
export sectors have higher “inflation” than sectors without comparative advantages.
We should thus expect a positive coefficient for this variable.
In accordance with the classical theory of trade, imports are considered to be
a function of relative unit prices based on costs; namely, we should relate domestic
and foreign unit prices. But this raises a question about which particular prices
should be compared. One option is to take internal prices at home relative to
internal prices abroad, as is done in the literature describing the evolution of trade
from autarchy. Such statistics are practically unavailable. Alternatively, we could
compare domestic export prices with the export prices of our foreign competitors.
This is again a problem, since we have too many competitors all over the world and
we are not sure which of them the relevant ones are.
As a pragmatic second-best solution, because we are dealing with tradable
commodities in highly open and competing economies, we could compare domestic
export prices with the prices of domestic imports, which was the option finally
selected for this study. It is assumed that these two prices represent competing
products. A similar option was taken, for example, in the seminal papers by
MacDougall, 1951 and 1952.
If the model is nonlinear (e.g., a power function of Cobb-Douglas type),5
then its coefficient represents the “elasticity of substitution” of world consumers
(importers) of the given product between our country’s exports and the production
Taken specifically, we could “explain” the intensity of Czech exports to the EU using the
model:
XitEU = A*(PXit(EU) / PMit(EU))B, where A is the constant term and B is the coefficient of the
elasticity of substitution between purchases of an identical commodity i produced both in
Czechia and in the EU. PX and PM are the price indices of Czech exports to the EU and
Czech imports from the EU, respectively.
5
Factors of Exports
16
Vladimír Benáček
of our competitors. A review of the problem is provided in Harberger, 1957. Here,
we were challenged by methodological problems concerning both the numerator
and the denominator:
a) Since neither the unit prices for the aggregated NACE groups of products nor
even the time series of their inflators are available, analysts are obliged to resort to
substitutes, what has only a pragmatic justification. In our case we used the values
of exports and imports per tonne of the given products as proxy variables for unit
prices. The values should be in foreign (contract) currency in order to eliminate
exchange rate changes that have been already considered in the RER variable.
b) Unit prices based on values per tonne can have an ambiguous interpretation,
since they reflect both the cost (i.e., the price competitiveness of two otherwise
identical products) and the quality. In the latter case, if the prices differ, the
products are differentiated. In the case of vertical differentiation the products only
appear to be similar, because they belong to “vertically” different consumer baskets
due to their different levels of quality (e.g., up-market and down-market products).
According to various studies, vertical differentiation dominates the trade among
industrial countries (Fontagné et al., 1998). If our indicator of relative prices
changes over time, we may interpret that in two ways: first, we may assume that
there was a “vertical” shift in relative quality and not in relative costs. The reason
for it may be that the law of one world price allows only such price differentials.
But the law of one price has its clear limits. Thus we may make a second
assumption where competition is based only on changed prices without any
recourse to shifts in quality. Both of these important alternative aspects should be
estimated in the empirical analysis.
c) The problem of relative price competitiveness can be even better revealed if the
differentiation is horizontal. In such a case, the products belong to a similar quality
category but may be different in both their prices and in their costs.
The condition of export product homogeneity and its perfect substitutability
by imports is untenable in empirical testing because we have to work with product
groups subject to an unpredictable degree of variety. Thus we have to limit
ourselves to price comparisons PXit/PMit with heterogeneous composition of
commodity bundles coming from the same industry i. Although such relative prices
have hardly any meaning in the given year, we can at least interpret their changes
over time. Our relative price index actually becomes an index of the terms of trade.
Indices PX/PM can reflect two features of competitiveness – price and
quality competition. Unfortunately they may run in parallel, and we cannot be
certain if they complement or compete with each other. We offer some logical
clues for getting out of the tangle by accepting some simplifications that have a
high degree of credibility, relying on the annual changes of indices over time. In
addition, after taking natural logarithms, we can separate the data and get ln(PXit)
and ln(PMit) and simplify the matter to a problem of rates of change.
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Vladimír Benáček
Table 1: Relationship between unit prices (P), quality (Q) and export intensities
Case
Characteristics
Export
intensity
Sign of
coefficient
Implication
Q
less proportional
Q
less proportional
Q
more proportional
Q
more proportional
1a
P

minus
1b
P

minus
2a
P

plus
2b
P

plus
3a
P & Q

minus
3b
P & Q

minus
4a
P & Q

plus
irrational case
4b
P & Q

plus
irrational case
paradox of P
paradox of P
Type of
competition
in prices
in prices
in quality
in quality
in prices (Q ignored)
in prices (Q ignored)
false inference about
Q competitiveness
false inference about
Q competitiveness
Let us now illustrate the interpretation of coefficients in Table 1 in a case of
Czech exports. If the sign of the export variable is statistically significant and
negative, then export price decreases over time are compatible with more intensive
exports. The case that higher exports would be compatible with decreases in export
quality can be refuted as logically incorrect. Therefore, we can judge that it must
have been the price (cost) competitiveness in exports that was the dominant feature
of their penetration on the EU markets. This case is described in rows 1a and 1b.
On the other hand, if the coefficient had a positive sign for PX that would
indicate the dominance of Czech quality competition (see cases 2a and 2b). Higher
exports are compatible only with improvements in quality, which are reflected in
price increases. The complication is if at the same time the coefficient of PM
(representing foreign products competing with ours) is also significant and positive.
Then we can say that, with high probability, the Czech “average” export growth
happened in spite of the EU’s rising quality. Thus both competitions in quality
were successful, thanks, for example, to well-chosen differentiation of products.
Problems may arise, however, in some of the paradox situations illustrated
in the last four rows of Table 1. In case 3a, a price increase is implicitly associated
with a quality decrease, which naturally leads to a loss of exports. Though our
inference about price competition is correct, we fail to recognize the parallel
existence of competition in quality. In cases 4a and 4b, we even may come to false
conclusions, in which we ascribe the gains in exports to improved quality, while in
reality the quality decreased. Even though we would fail in cases 3a through 4b
(partially or fully), we can assume that the probability of such occurrences must be
very low, and thus the impact of their bias can be disregarded.
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4.2. Factor Requirements, FDI and Tariffs
The economic interpretation of our model expands as we introduce additional
explanatory variables in industrial breakdown. The whole economic problem can
be explained by Lerner–Pearce unit-value diagram in the domestic currency.6 It is
based on monitoring how the isoquants of production and isocost („budget“) lines
move in time and in production space, and how their position reflecting scarcities
and efficiency is related to the pattern and the intensity of trade. The distribution of
the isoquants is caused by different factor requirements in industries. Their shifts
are caused by technical change and/or by the presence of FDIit,7 exchange rate
fluctuation and domestic price level changes. The isocost unit-value lines of
industries are shifted by changes in their sectoral prices of labour and capital. From
the demand side there come the effects of aggregate demand absorption, tariffs and
the pricing policies of exporters and their competitors (PEit and PMit).
Taken from these purely theoretical (behavioural) aspects, we test various
cost-benefit conditions in industries and their impact on exports and imports. The
most rudimentary indicators of costs are factor requirements per unit of traded
output. Relative factor requirements of production, measured by capital-per-labour
(Kit/Lit) ratios, have gained a particular importance. They are the exclusive
determining factors in the Heckscher–Ohlin models of trade specialization based on
supply-side characteristics. If a country is relatively better endowed with labour,
then, according to Rybczynski and Stolper–Samuelson theorems, it is assumed that
the domestic labour cost/capital cost ratio (so called wage/rental ratio) is lower than
abroad and the country has comparative advantage in labour-intensive products.
It is traditionally assumed that Czechia is such a country (Drabek, 1984,
Benáček, 1989 or Stolze, 1997), if the international comparison of K/L endowments
is made as a trade-weighted average usage of factors. Relative to the EU, it is
expected that Czech exports should be biased towards labour-intensive products.
We cannot be as certain about the sign with Czech exports to the rest of world. Our
test is therefore also a test of the relevance how the Kit/Lit ratios of specific factor
requirements of individual industries are important for determining trade patterns.
The previous variable of K/L requirements will not give complete
information on the position of isoquants of the production functions in the
production space if we do not know how the individual isoquants may shift over
time (along the radiants of the same Ki/Li requirements) due to changing total
factor productivities (TFPit) of the unit-value isoquants. This variable can be
6
This is a standard approach used in the multi-industrial analysis of specialisation and
trade in small open economies, as introduced by Jones (1974) and Leamer (1995) and also
described in Caves et al. (1999, p. 125-130). The axes depict the usage of capital and
labour, identically like the production function methodology. The combination of unitvalue isoquants of production and unit-value isocost (budget) lines allows to analyse the
efficiency and the factor intensity of all traded products and the potential for
specialisation.
7
The effect of both can be quantified by the total factor productivity indices. FDI can be
interpreted as the human capital that improves technical efficiency – shifting the isoquants
closer to the origin. In addition, FDI can be interpreted as “network capital” acting on the
demand side by opening markets to both export and import penetration.
Factors of Exports
19
Vladimír Benáček
interpreted as the Ricardian parameter of specialization based on different gaps in
productivities. Alternatively, the variable of net output per labour (Yit/Lit) can be
taken as a second-best proxy. Thus the relative lags in productivity decide about
exports and imports. This is different from the Heckscher-Ohlin assumptions where
the technology is common for all countries.
Except for capital and labour there are other important factors – namely the
human capital. If the variable directly measuring human capital in industries is not
available, we had to find a proxy that would be highly correlated with it. We found
that proxy in the inflows of FDI, namely in the FDI industrial stock (Benáček,
Gronicki et al., 2000) 8. The stocks of FDI, complemented with K/L requirements
and productivities in industries, are thus able to provide all the relevant supply-side
characteristics of production necessary for the determination of comparative
advantages and their impacts on exports. The same variables can be retained in the
import function, even though there were some controversies about the role of FDI it
there (see Benáček, Prokop and Víšek, 2003, p. 18).
The rising importance of economies to scale in explaining the intensity of
trade (Krugman and Obstfeld, 2003, pp. 120-159) should be a part of our tests. We
can test if the growth in the “size of industry” is positively correlated with the
growth in its exports and if their elasticity is greater than unity. This variable can be
represented by material inputs (MATit). Another reason why this variable is
selected (and not total output) is that exports contain not only the value added of
given industry i but they also depend on inputs. The sources of export expansion or
import substitution need not always rest in the given industry.
At the end we will deal with policy variables. The most traditional trade
policy instruments are tariffs. Those we levied on imports (TMit) or the foreign one
levied on our exports (TXit). Their coefficient should have a negative sign. The last
variable we considered is the monetary policy (MPt) of the national bank. It can be
represented by the stock of real M2 in given years or by interest rate (such as
PRIBOR). The effect of this variable is described by Mundell-Fleming model. But
here we must distinguish between its alternative impacts on nominal exchange rates
that are partially present in the variable of RER. The interaction between imports
and exports (and the effects of substitution versus complementarity between them)
may also differ among countries. Thus the expected impact of monetary expansion
on exports need not be always positive.
8
FDI can reflect the qualitative aspects of managerial skills, the ability to penetrate world
markets, and the quality of the physical capital. In the export function, the presence of a
large FDI stock in an industry should boost its exports, since FDI location is attracted by
comparative advantages and by the potential for growth they offer.
Factors of Exports
20
Vladimír Benáček
5. The Final Specification of Import and Export Functions
The basic models for empirical testing of the Czech trade flows can be
therefore defined as follows:
Mitw = ΦMw (GDPt, RERtw, PCit, PMitw, PXitw, Kit /Lit, FDIit, TMitw, itw)
Xitw = ΦXw (GDPtw, RERtw, PCit, PXitw, PMitw, Kit /Lit,FDIit, TXitw, itw)
where:
i ...
t ...
w ...
are commodity groups (e.g., at NACE classification);
the years (e.g., 1993 through 2002);
regions from where the imports originated or to where the exports were
directed;
Mitw ... Czech imports from w (in current CZK);
Xitw ... Czech exports to w (in current CZK);
GDPt ... Czech GDP in CZK at constant prices, measuring the real aggregate
demand absorption capacity;
GDPtw ... aggregated GDP in EUR for countries w importing Czech products,
measuring their aggregate demand absorption capacity;
w
RERt ... the effective real exchange rate index based on the CPI and related to the
currencies of the given trade partners (increase means appreciation);
PCit ... Czech price changes in industries i (as price deflators, where the base year
has index 1.00), measuring the intensity of nominal convergence;
w
PMit ... unit prices in EUR per tonne, measuring the type of competition (in prices
or in quality);
PXitw ... unit prices in EUR per tonne, measuring the type of competition; 9
Kit/Lit ... capital (at constant prices) per unit of labour, characterising the domestic
technologies and their relative factor requirements;
Yit /Lit … productivity of labour (at constant prices);
FDIit ... foreign direct investment stocks (in CZK), serving as a proxy variable for
human
capital;
MATit ... material input adjusted to price changes;
TMitw ... tariff rates levied on Czech imports from w (at home);
TXitw ... tariff rates levied on exports to w (abroad);
itw ... random term.
The proposed models are constructed primarily for empirical testing as
explanatory models. They attempt to capture the logically closed set of behavioural
factors on both the supply and the demand sides determining the intensities of
exports and imports in their structural alternatives for specialization. There will be
two aspects of our analysis: structural (industrial, static) and time-driven
(dynamic). The reason for this is that it is a characteristic of a small open economy
that its dynamics of trade are constrained not only by the global evolution in the
aggregate supply or aggregate demand, but also by structural constraints and
industrial trade-offs of efficient specialization, where some industries grow while
9
In the export equation it is the strategy used by Czech exporters abroad. In the import
equation it is a proxy variable for Czech domestic competition to foreign imports.
Factors of Exports
21
Vladimír Benáček
some others have to be downsized. The data are structured as panels having the
time and the industrial dimensions.
Therefore an even very healthy evolution, as a sead of future booming
growth, can mature hidden in low macroeconomic dynamics. We can also estimate
these models either as time series of individual industries (usually as dynamically
estimated models) or as factors of cross-section trade-offs in the evolution of
industries in the breakdown by years.
With the exception of aggregate demand, all our remaining variables
describe factors underlying the changes in prices and in costs on the supply side.
The hidden objective function of trade and specialization is the significantly
enlarged potential for profit maximization on open world markets. But as this
potential is subject to changes in time, the trade flows, the labour and the capital
must adjust quickly by a reallocatation among industries. Such is the mixed
blessing of higher competition. Future gains in growth and profits must be
redeemed by preceding restructuring costs.
The econometric testing of proposed import and export functions need not
“explain” the behaviour of absolute intensities of trade in the space of industries,
countries and time only. The same explanatory variables may be used for a
combination of exports and imports, such as net balance of trade (Xitw – Mitw) or
various indices of revealed comparative advantages (RCAitw), as defined by
Vollrath, 1991.
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