A Story of Trade-induced Industrialization

Abstract

We offer a simple variant of the standard Heckscher-Ohlin Model that explains how a developing country, by opening up to trade with a large capital-abundant economy, can be induced to shift resources into more capital-intensive production than that which it was producing in autarky. As a result, it experiences a rise in its return to capital and, if capital is internationally mobile, both an increase in its capital stock and an increase in trade. These results arise in a model in which both a traditional and a modern sector can produce final goods that are perfect substitutes. The modern sector uses intermediate inputs that differ in their relative capital intensities, while being both more capital intensive than the traditional sector. The results of this model accord well with the experience of the Asian Tiger economies during the early decades of their export-oriented industrialization.

Keywords:

• Industrialization
• trade
• intermediate inputs
• Heckscher-Ohlin Model
• Asian Tiger economies

Acknowledgements

We have benefited from discussions of this paper with Gene Grossman, Samuel Kortum, and Andrei Levchenko. We are also grateful to conference and seminar participants at the Hitotsubashi University, Kyoto University, University of Michigan, Nagoya University, Princeton University, and Waseda University. Park would like to express his gratitude to the hospitality of the Department of Economics and International Economics Section at Princeton University and the Institute of Economic Research at Hitotsubashi University, where he has worked on this paper as a visiting fellow.

Notes

¹We assume that one unit of the modern good is a perfect substitute for one unit of the traditional good, but it could just as easily be a perfect substitute for more than one unit of the latter, to reflect difference in quality. The assumption of perfect substitution, however, is needed to keep the exposition of the model simple.

²Alternatively, the developing country may also, or instead, import the modern final good in exchange for exporting the labor-intensive intermediate input. Regardless of these different forms of trade that may arise between the countries, in terms of the factor content of trade, the developing country ends up importing the services of capital from the developed country in exchange for exporting the services of labor embodied in the labor-intensive intermediate input.

³ Section 4 provides a detailed discussion of these characteristics of trade-induced industrialization of developing countries that have pursued the export-oriented industrialization strategy.

⁴One may model good Y of the modern sector to be a superior substitute for the traditional good X, consumers having the utility function, u(x, y)=x+λ y with λ>1 and lower-case letters representing the amounts of consumption of the corresponding goods. 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, we assume that λ=1.

⁵This could be justified by the introduction of an infinitesimally small iceberg transportation cost.

⁶This indeterminacy in our model, however, has an important implication for the effect of having high tariffs on the final consumption goods (good Y) but zero or low tariffs on the capital-intensive intermediate inputs (good N), a typical trade policy of the countries that have pursued the export-oriented industrialization strategy, such as Korea. As long as a developing country imposes no tariff on good N, a high tariff on good Y would not cause any distortional losses to the economy. Such asymmetric tariffs simply play the role of narrowing down the pattern of production and trade by inducing the developing country to import N in exchange for exporting either M or Y, thus effectively avoiding any tariff being paid.

⁷There is one more way of obtaining good N for the production of good Y at the same lower cost: they can produce extra units of good X beyond what is necessary for their domestic consumption and exchange it for good N (first by exporting good X in exchange with good Y, then exchanging good Y for good N). Producing one unit of good Y using the imported good N obtained by exporting good X will require a combination of labor and capital that is in the middle of the X and M isoquants in Figure 3 and on the tangent line common to these two isoquants. Denote such a combination of labor and capital by (L _XN , K _XN ). Note that it is a more labor-intensive way to produce one unit of good Y than exporting good M in exchange for good N. While exporting good X in exchange for good N may replace exporting good M in exchange for good N, the latter form of trade should occur (at least be a part of trade) if k>K _XN /L _XN in order to satisfy the full employment condition. We thank Gene Grossman for mentioning this alternative way to obtain good N for the developing countries.

⁸See Deardorff (1994).

⁹The size of the modern sector in the small country represents the amount of its resources employed for the (eventual) production of good Y. With no domestic production of good N in the small country, the size of its modern sector is equal to the amount of resources employed to produce good M (for eventual production of good Y), having its capital and labor employed at the ratio of k′ _M , in the absence of exporting good X in exchange for good N considered in Note 7. Even when the small country exports good X in exchange for good N, we can continue to apply the same definition in determining the size of the modern sector: it employs its capital and labor at the ratio of K _XN /L _XN in its modern sector (for the eventual production of good Y) instead of employing its resources at the ratio of k′ _M . An increase in k in the small country requires its resources to move from the traditional sector (for the domestic consumption of good X), which hires resources at the ratio of k′ _X , to the modern sector (for the eventual production of good Y), which hires resources either at the ratio of k′ _M or at the ratio of K _XN /L _XN . Note that only the modern sector is involved in trade (importing good N in exchange for its output).

¹⁰These figures come from Table 36 of Krueger (1979).

¹¹These figures come from Tables 28, 36, and 37 of Krueger (1979).

¹²These numbers come from the first Essay of Balassa (1980).

¹³These numbers were calculated based on Korean GDP and investment data from the Penn World Table Version 6.1.

¹⁴See Table 1 of Kim (2007).