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Meddling with Comparative Advantage?

Meddling with Comparative Advantage?

International Competitiveness and Knowledge- based Industries in India (2007) edited by Nagesh Kumar and K J Joseph;

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Meddling with Comparative Advantage?

C Veeramani

I
nternational competitiveness has become a dominant buzzword of our times. The concern with competitiveness is laden with both fear and hope. The fear is associated with the possibility that import competition would put at risk the very survival of domestic industry, leading to what is termed “de-industrialisation”. Being internationally competitive, therefore, is a matter of life and death. On the side of hope, rapid export expansion, parti cularly of high technology goods, has been considered a way of improving the standard of living of a country’s citizens. It is also hoped that the countries that make inroads into world markets for high technology goods acquire higher status and power in the international economic and political arena. The volume edited by Nagesh Kumar and K J Joseph, like most others in its genre, shares these concerns.

The book empirically analyses the nonprice factors behind the export success of firms in India’s knowledge-based industries. It uses a large data set relating to Indian companies. Detailed and careful case studies of five important knowledgeintensive industries (electronics, pharmaceuticals, chemicals, automotive and nonelectrical machinery) have been attempted using primary and secondary data. Overall, the analysis provides interesting insights into the role of corporate strategy

International Competitiveness and Knowledgebased Industries in India (2007) edited by Nagesh Kumar and K J Joseph; Oxford University Press, New Delhi; pp xviii + 349, Rs 675.

in determining the export success of firms. In particular, the critical importance of factors such as scale of operations, technological effort, affiliation with multinational enterprises (MNEs), outward investment, etc, have been clearly established in different chapters. The book appropriately focuses on the non-price aspects of competition, rather than price competition, since what matters mostly in knowledge-based industries is the former.

While an analysis of the micro determinants of exports is a worthwhile project on its own merit, the normative side of the book – that is, the supposedly superior policy framework the authors put forth based on their empirical findings – loses sight of some important perspectives. The “obsession” with international competitiveness compels the authors to project an extremely one-sided vision of policy choices. In an influential article, Paul Krugman warned that the obsession with competitiveness is “dangerous” because it leads “to bad economic policies on a wide range of issues, domestic and foreign, whether it be in healthcare or trade” [Krugman 1994: 30]. The book, however, has many distinct strengths. Before commenting on them, I shall discuss certain issues where a broader perspective would have been more appropriate.

How Diversified?

A major motivation for the book is that

despite the reforms since 1991,

India’s export structure is still dominated by relatively simple, undifferentiated, and slow-moving products such as textiles, clothing, leather goods, agricultural commodities and raw materials…India has little presence in the world markets for high technology goods…the challenge for India is to upgrade the technology profile of her exports… this…calls for a clear understanding of the factors that have bearing on export competitiveness in the knowledge-based industries (pp 2-3, 87).

Does India fall behind other countries with respect to the export of high technology products? In this respect, the relevant countries for comparison are those at a similar level of development. Using disaggregated trade data (six-digit), a recent study notes a high level of sophistication in India’s export basket relative to her per capita GDP [Hausman et al 2007]. This study also notes that India is not as spectacular as China is, “but this is in large part because our measure is based on commodity exports and does not capture the explosion in India’s software exports” (ibid: 15). Nonetheless, in terms of export sophistication, India ranks higher than Argentina (a country that is about four times richer in purchasing power parity terms) and Chile (about three times richer) (ibid).

The World Bank’s world development indicators provide data for a large number of countries on the share of high

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techno logy exports in the total manufactured exports (hereafter denoted as SHARE). Among the 133 countries in 2003 (the year for which SHARE is available for the largest number of countries), India ranks 107 in terms of per capita income (constant, US dollar) while its rank in terms of SHARE is 69. Among the 64 countries whose SHARE is lower than that of India, the large majority (i e, 44) have their per capita incomes higher than that of India, including the countries such as Turkey, Poland, Chile, Peru, Romania, Sri Lanka, etc. It may also be noted that some of the poorest counties of the world (Burundi, Rwanda, Burkina Faso, Uganda and Senegal) have higher values of SHARE than that of India. The bottomline is that export sophistication does not by itself guarantee prosperity. What is important is specialisation according to comparative advantage.

More often than not, export sophistication is an effect rather than the cause of economic prosperity.1 Accumulation of productive factors, such as human and physical capital, that characterises economic development, brings in its wake a dynamic process of changing comparative advantage. For example, the road to the export success of the newly industrialised countries (NICs) of Asia started with labour-intensive and low technology manufactures. However, as investments in physical and human capital rose and as labour costs increased with the accumulation of skills, relatively more sophisticated manufacturing activity expanded in these countries at the expense of labour-intensive manufactures. China too started its export expansion by specialising in labour-intensive manufacturing. Even today, China accounts for about 23 per cent of the world exports of garments; about 22 per cent of the world exports of fabrics and about 11 per cent of the world exports of leather. In comparison, India’s shares in these products are abysmally low at about 4 per cent, 2 per cent, and 3 per cent respectively [Srinivasan 2008].

A large and growing share of international trade consists of intermediate and unfinished goods shipped from one country to another to combine manufacturing or services [Feenstra 1998]. In 2006, China

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accounted for about 12 per cent of the world exports of high techno logy products (pharmaceuticals, electrical machinery and non-electrical machinery) but China is also a major importer of these products accounting for about 10 per cent of the world imports (estimated using the COMTRADE database, United Nations). In general, the major exporters of high techno logy products are also the major importers of such products. The grand idea of building a “self-sufficient industry” is meaningless in the current landscape of international commerce, where countries engage in trade by specialising at the level of distinct product lines and processes within industries on the basis of their comparative advantages. What is important is the creation of an environment that encourages entrepreneurs to search and identify opportunities in the global supply chains of various industries.

Strategy of Getting Prices Wrong

Authors in this volume strongly argue in favour of strategic industrial policy as if unanimity of opinion existed with regard to its beneficial role. It has been claimed that the “governments in a number of south-east Asian countries provide substantial incentives to promote pioneer industries that did not exist in the country. Such policies promoted rapid techno logical upgradation of the industrial and export structure of these countries.” Industrial policy or what Amsden (1989) has called the strategy of deliberately “getting prices wrong”, however, is highly controversial. Supporters claim that industrial policy is necessary to address market failures. Critics argue that the danger of government failure is often higher and that industrial policy is an invitation to rent seeking.

Bhagwati (1996) and Little (1996), among others, have argued that industrial policy has little to do with east Asia’s growth and may have even harmed it! Krugman (1996) notes that “although the strategist draws on the work of the economic theorists who during the 1980s put together what came to be known as the ‘new trade theory’, surprisingly few of the new trade theorists themselves are strategists. Instead, however excited they may have been about the intellectual contribution of the new trade theory, they have become increasingly sceptical about the extent to which this theory can justify government activism in practice”.2 A recent survey by Pack and Saggi (2006) concludes that “although there are cases where government intervention coexists with success, there are many instances where industrial policy has failed to yield any gains”.

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The industries that show relatively high export orientation in India (textile, clothing, leather, food, tobacco, gems and jewellery, other manufacturing, etc) are not the ones that benefited the most from government interventions during the heydays of import substitution. India’s export composition, for the most part, reflects its comparative advantage in labour-intensive goods, even though government policies have been favourable for capital-intensive industries. India’s software industry is purely a private initiative. “Governments at various levels became involved only after the success of the sector was evident, ratifying the success rather than catalysing it. The industry expanded on the basis of comparative advantage and never needed any protection” (ibid: 23).

Financing of higher education by the government (a critical precondition for the development of India’s software industry) is a generic intervention and not part of a strategy to selectively promote any particular industry. Government interventions to improve the overall investment climate (for example, investments in social and physical infrastructure) should not be equated with the selective interventions that attempt to alter the structure of production in favour of certain industries.

Obsession with Competitiveness

Krugman (1994) reminds us the simple but often overlooked fact that nations do not compete with each other in the same way that corporations do. He argues that “the obsession with competitiveness is not only wrong but dangerous...in both theory and practice, a trade surplus may be a sign of national weakness, a deficit a sign of strength”. Thinking in terms of competitiveness, argues Krugman, could lead to distortions and misallocation of resources: for example, it could result in the wasteful spending of government money supposedly to enhance competitiveness. The concern with competitiveness justifies the use of protectionist and distortionary policies. For example, anti-dumping has been used today, more often than not, as a pure protection than as a remedy against dumping. Thus, one author in the present volume remarks that the “use of anti-dumping is a good start to protect the industry…India should also actively use non-tariff barriers where relevant”.

It is important to realise that the notions of comparative advantage and domestic productivity, rather than international competitiveness, should guide the discourse on development strategy. National living standards are overwhelmingly determined by the growth rate of domestic productivity, and not by the productivity relative to competitors [Krugman 1994]. For ex ample, the share of exports of goods and services in GDP in two of the richest countries of the world – US and Japan – is significantly lower than that of India: 10 per cent for US, 13 per cent for Japan and 18 per cent for India.

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For India, the most important but often neglected issue is the creation of productive employment in rural and urban areas to absorb the surplus labour engaged in the country’s agriculture. While the contribution of agriculture to India’s GDP is about 18 per cent, the large majority of the labour force (about 60 per cent) still depends on agriculture. The onus to absorb the surplus labour rests primarily on the low skilled labour-intensive industries and services. It is well known that the knowledge-based manufacturing and service sectors mainly employ the educated urban youth.

That the national living standards are primarily determined by domestic factors and not by some competition for world markets should not be taken as an argument against an outward-looking strategy. It is a misconception to say that exports at any cost are an integral part of the outward-looking strategy. An outwardlooking strategy is neutral which favours neither the domestic nor the export market [Bhagwati 1978].

Firm-Specific Advantages

The book is primarily concerned with an empirical investigation into firm-specific competitive advantages as opposed to industry level comparative advantages. Traditional trade theory-based on perfect competition considers industry as the unit of analysis while firms within an industry are assumed to be identical. A consequence of introducing imperfect compe tition (as in the new trade theories) is the need to consider individual firms. This, however, does not mean that an imperfect competition framework must be disconnected from the very notion of national comparative advantages. Abedel-Rahman (1991) makes the following analytical distinction. First, even in a situation of comparative advantage at the industry level, some firms in the country will be “under-competitive” in comparison with the industrial norm. Second, even in a situation of comparative disadvantage at the industry level, some firms in the country will be “over-competitive” in relation to the industrial norm.

The empirical analysis in the book is essentially an attempt to understand how a set of firms in India’s knowledge-based

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industries (where India has a comparative disadvantage) becomes “over-competitive” in the above sense. This is an interesting question by itself. Analysis based on a more general sample of firms (chapter 2) and detailed case studies of five knowledge-based industries establish the importance of certain firm-specific factors in explaining export success. In general, the empirical results highlight a positive impact of firm size, in house research and development, capital goods imports, affiliation with MNEs and outward investment by domestic firms. The relative importance of these factors, however, does vary depending upon the industry and technology sub-samples.

The relative performance of multinational affiliates and their local counterparts is a long-standing question for empirical research in India. Previous studies relating to the pre-liberalisation period find no significant difference in the export orientation of foreign and local enterprises. The results reported in this book, however, suggest a relatively higher export orientation of the foreign enterprises. Another new and interesting result reported in the book is the positive impact of outward investments by Indian firms on their export orientation. The book argues that, in general, the liberalised policy regime since 1991 had a favourable impact on the export orientation of firms. In particular, the positive impacts of various fiscal incentives and tax concessions have been highlighted in different chapters (this, however, does not mean that they are socially desirable). The case studies of different industries, using primary data, throw light on the constraints being faced by firms engaged in exporting.

The strength of the book lies in its rigorous analysis of firm level data collected from secondary and primary sources. Its focus on the role of corporate strategies in shaping the export behaviour of firms in India’s knowledge-based industries is both novel and timely. The book fills an important gap in our understanding of certain important but under-researched, questions: Why do some firms in an industry export, while others in the same industry persistently serve the domestic market only? What are the determinants behind these different patterns within industries? Some of its unpersuasive policy arguments notwithstanding, the book does a commendable job of achieving its main purpose, namely, to analyse the micro factors behind the export performance of firms in India’s knowledgebased industries. It should be of immense value to researchers and students of applied international trade and industrial economics.

Email: veeramani@igidr.ac.in

Notes

1 Those who support strategic trade policy, including Hausman et al (2007), however, hold an opposite view.

2 See also Srinivasan (1989) who argues that the new trade theory does “not provide unequivocal analytical support for the exercise of an interventionist trade policy by developing countries” (p 20).

References

Abed-el-Rahman, K (1991): ‘Firms’ Competitive and National Comparative Advantages as Joint Determinants of Trade Composition’, Weltwirtschaftliches Archiv, Vol 127, pp 83-97.

Amsden, Alice (1989): Asia’s Next Giant, Oxford University Press, New York.

Bhagwati, Jagdish N (1978): ‘Anatomy and Consequences of Exchange Control Regimes’, Studies in International Economic Relations, National Bureau of Economic Research, Vol 1, No 10.

– (1996): ‘The Miracle that Did Happen: Understanding East Asia in Comparative Perspective’, keynote speech, conference on Government and Market: The Relevance of the Taiwanese Performance to Development Theory and Policy in honour of professors Liu and Tsiang, Cornell University, May 3, 1996, available at http:// www. columbia. edu/~jb38/East_asian_miracle.pdf.

Feenstra, Robert C (1998): ‘Integration of Trade and Disintegration of Production in the Global Economy’, Journal of Economic Perspectives, Vol 12, No 4, pp 31-50.

Hausman, Ricardo, Jason Hwang and Dani Rodrik (2007): ‘What You Export Matters’, Journal of Economic Growth, Vol 12, No 1, pp 1-25.

Krugman, Paul (1994): ‘Competitiveness: A Dangerous Obsession’, Foreign Affairs, Vol 73, No 2, pp 28-44.

– (1996): ‘Making Sense of the Competitiveness Debate’, Oxford Review of Economic Policy, Vol 12, No 3, pp 17-25.

Little, Ian (1996): ‘Picking Winners: The East Asian Experience’, Social Market Foundation Occasional Paper, London.

Pack, Howard and Kamal Saggi (2006): ‘Is there a Case for Industrial Policy? A Critical Survey’, The World Bank Research Observer, Vol 21, No 2, pp 267-97.

Srinivasan, T N (1989): ‘Recent Theories of Imperfect Competition and International Trade: Any Implications for Development Strategy?’, The Indian Economic Review, Vol 24, No 1, pp 1-23.

– (2008): ‘Development Strategy, the State and Agriculture since Independence’, valedictory address, conference on Money and Finance, January 18-19, 2008, Indira Gandhi Institute of Development Research, Mumbai, available at http:// www. igidr. ac.in/~money/MFC_ 2008Program.html.

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