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Public policy and forward studies series - xxx 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 u Faculty of Social Sciences, Charles University / Fakulta sociálních věd UK Faculty of Arts, Charles University / Filozofická fakulta UK Factors of Exports 2 Vladimír Benáček This text has passed reviewers’ comments. 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 Factors of Exports 3 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. Factors of Exports 4 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] Factors of Exports 5 Vladimír Benáček 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 Factors of Exports 6 Vladimír Benáček 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. Factors of Exports 7 Vladimír Benáček 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 Factors of Exports 8 Vladimír Benáček 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 Factors of Exports 9 Vladimír Benáček 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. Factors of Exports 10 Vladimír Benáček 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, Factors of Exports 11 Vladimír Benáček 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 Factors of Exports 12 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. Factors of Exports 13 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 Factors of Exports 14 Vladimír Benáček 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 15 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. Factors of Exports 17 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. Factors of Exports 18 Vladimír Benáček 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. 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Factors of Exports 25 Vladimír Benáček PRAGUE SOCIAL SCIENCE STUDIES / PRAŽSKÉ SOCIÁLNĚ VĚDNÍ STUDIE Public policy and forward studies 2003 – 2006 (CESES) xxx yyy zzz Factors of Exports 26 Vladimír Benáček DETERMINING FACTORS OF EXPORTS AND IMPORTS: A SYNTHESIS OF EXPLANATORY PARADIGMS Vladimír Benáček PSSS Edition Public policy and forward studies series - xxx Editorial Board Vladimír Benáček Petr Just Miloš Balabán Copy Proofreader Published by Faculty of Social Sciences, Charles University, Smetanovo nábřeží 6, Prague 1 Contact address [email protected]