Trade-induced Industrialization and Economic Growth

Abstract

Based on a modified Heckscher-Ohlin model of Deardorff and Park (2010), this paper develops a dynamic model of trade-induced industrialization and economic growth. It shows that a developing country may grow out of its autarky steady state with no industrialization into a new steady state with full industrialization by opening to trade with a large industrialized country, exporting the labor-intensive intermediate input in exchange for the capital-intensive intermediate input for the modern good. Even when the developing country is on its path toward complete industrialization under autarky, free trade may induce it to grow faster with its return to capital being raised and sustained at a level that is higher than its autarky level during its industrialization process. Once it completes its industrialization process by having all of its resources in the modern sector, then diminishing returns to capital come back to accompany further capital accumulation, slowing down the growth of the economy. This trade-induced industrialization and economic growth, having an expansion of international trade both in its absolute value and in its ratio to the size of the developing country, correspond well with the dynamic profiles of East Asian Miracle countries’ economic growth based on their export-oriented industrialization strategy.

Keywords:

• Industrialization
• economic growth
• export-oriented industrialization

JEL CLASSIFICATIONS :

• F11
• Q14
• Q24
• Q41

Acknowledgements

For constructive comments, I would like to thank Alan Deardorff, Keun Lee and Keunkwan Ryu and seminar participants at Seoul National University. I am also thankful to the editor and an anonymous referee for their helpful comments. I would like to gratefully acknowledge financial support from the Department of Economics at the Seoul National University for the grant provided by the Seoul National University Foundation.

Notes

¹World Bank (1993) compares average tariff rates of several groups of developing countries, showing that these East Asian countries have been less protectionist than others. However, they have not employed trade policies that are anything close to free trade, with their average rate of protection being 24% in 1985. Discussing such data, for example, Krugman and Obstfeld (2006) present the following skepticism: ‘while there is a correlation between rapid growth in exports and rapid overall economic growth, the correlation does not necessarily demonstrate that free trade policy has been the main reason for the high growth’.

²Deardorff and Park (2010) provide a detailed discussion of these characteristics of trade-induced industrialization.

³Because there exist more goods than production factors in the static trade model of Deardorff and Park (2010), the trade pattern is indeterminate. This indeterminacy in trade patterns enables the small country to bypath any tariff on the modern final good via importing the capital-intensive intermediate input that is required to produce the final good. See Note 18 for a more detailed discussion on indeterminacy in trade patterns.

⁴As discussed in Section 3 of Krueger (1979), the Korean government provided ‘tariff exemptions on imports of raw materials and spare parts’ and ‘tariff and tax exemptions granted to domestic suppliers of exporting firms’ as well as other types of export promotion schemes.

⁵As acknowledged by Young (1995), there exist similar studies on these East Asian countries done prior to his study, such as Lau and Kim (1994) and Pyo and Kwon (1991).

⁶A slowdown in the growth rate after 20–30 years of rapid industrialization has been a common phenomenon in East Asian countries. As a potential explanation for such slowdowns, Acemoglu and Ventura (2002) emphasize that specialization and trade introduce de facto diminishing returns for countries that accumulate capital faster than average as they experience declining prices of export products. In contrast with their model, the diminishing returns occur in this paper's model in the absence of declining prices of export products: once all the resources are moved away from the traditional sector into the production of the labor-intensive-intermediate input production for the modern good under free trade, the usual diminishing returns in production technology come into play without any change in the price of the intermediate input.

⁷The results of this paper continue to hold under a wide range of production technologies, such as any production function that is homogeneous of degree 1, as long as the production functions have the same factor-intensity ordering as those in equation (1) without any factor intensity reversal. The use of Cobb-Douglas functions is mainly for expositional simplicity and the numerical analysis in the following section.

⁸Thus, we normalize the labor supply at time 0 at unity.

⁹One may model good Y of the modern sector to be a superior substitute for the traditional good X, consumers having the instantaneous utility function at time t, u(x _t , y _t )=x _t +λ y _t with λ>1, and lower case letters representing the amounts of consumption of the corresponding goods at time t. Assuming λ>1 (or even λ<1) instead of λ=1, however, does not affect the qualitative results of the following analysis. For simplicity of exposition, I assume that λ=1.

¹⁰The following analysis using the Lerner Diagram in Figure 1 directly comes from Deardorff and Park (2010).

¹¹Recall that the prices of good X and good Y are set to be 1, thus rk+w is the real income per capita.

¹²For example, see Section 2.5 of Barro and Sala-i-Martin (1995) for a derivation of this result.

¹³See Section 2.6 of Barro and Sala-i-Martin (1995) for such an argument.

¹⁴In contrast with the original Rybczynski Theorem, in which the relative prices are fixed due to the small open economy assumption, note that the relative price of good Y (in terms of X) is fixed because X and Y are perfect substitutes in this paper.

¹⁵The following analysis using the Lerner Diagram in Figure 4 is largely a replication of the corresponding static analysis of Deardorff and Park (2010).

¹⁶Note that ω=w/r when the small country produces both M and X, with which cost-minimizing firms will produce M and X, satisfying k _m ^/=K _m /L _m =[α _m /(1−α _m )](w/r) and k _x ^/=K _x /L _x =[α _x /(1−α _x )](w/r). See the Appendix for the derivation of equation (13).

¹⁷This could be justified by the introduction of an infinitesimally small iceberg transport cost.

¹⁸It can also export good Y in exchange for good N because it can combine imported input N with domestically made input M to produce and export good Y. The exact pattern of production and trade is here indeterminate, as is often the case when there exist more goods than factors. Whichever pattern of production and trade that the small country ends up taking, in essence, it obtains the capital-intensive intermediate input N necessary for the production of good Y at the lower cost by producing extra units of good M and exchanging it for good N (or indirectly conducting such an exchange of intermediate inputs in terms of factor content of trade) in the world market.

¹⁹While some of these parameter values, such as α _y =να _m +(1−ν)α _n =0.3, are from the previous studies on economic growth (for example, see Section 2.6.5 of Barro & Sala-i-Martin, 1995), other parameter values are chosen to ease the view of phase diagrams in Figure 7(a). For a wide range of parameter values, however, the qualitative nature of the numerical analysis remains the same as the one shown in Figure 7.

²⁰The current model implies that the real return to capital would rise but the real return to labor would fall in a developing country as a result of trade-induced industrialization, with those returns staying at the changed levels throughout its industrialization process. By interpreting human capital embodied in skilled labor as a part of broadly-defined capital, one can draw an implication from the model that the return to skilled labor would increase more rapidly than the return to unskilled labor as a result of trade-induced industrialization. According to the 1976 Occupational Wage Survey of the Ministry of Labor of Korea, which started in 1970, the real wage of unskilled workers in the modern manufacturing sector rose at the annual rate of 5.5% from 1971 to 1976, a much lower rate than the corresponding growth rate for skilled workers and professionals, 11%.

²¹As emphasized by many studies on endogenous growth, such as Grossman and Helpman (1991), the technological progress in an integrated world economy can be faster than the technological progress of a closed economy. If technological progress of the modern manufacturing sector in a developing country is faster under free trade than under autarky as the endogenous growth literature implies, then such an extension of the current model may no longer relapse into the dynamic curse of free trade even with an identical discount rate across countries. The faster technological progress of the modern manufacturing sector under free trade can raise the return to capital beyond the level that is attainable under autarky throughout the industrialization process, generating a stronger incentive for a developing country to industrialize under free trade than under autarky.