Competitive Edges: What the New Wave Of Trade Theory Can Teach New Zealand.

Listener: 1 November, 2003.

Keywords: Globalisation & Trade;

Does it strike you as odd that we drink wine and eat cheeses from Europe and yet New Zealand exports them there? Or that Germans drive Renaults and the French drive Volkswagens? The phenomenon puzzled economists, too. Renaults and Volkswagens are different cars, but they are not that different. Neither the German nor French economies would collapse if they could not import cars: perhaps local manufacturers would make the foreign models, although substantial economies of scale keep the costs of this specialisation down (and diminishing costs of distance make the inter-regional trade possible). Consumers would be only marginally worse off.

For 200 years, international trade theory was based on David Ricardo’s theory of comparative advantage of “inter-industry trade” in which unlike was traded for unlike – cloth from England for wine from Portugal. Nowadays there is “intra-industry trade” of like with almost like, which totals roughly a quarter of world trade, up from zero 50 years ago. (The other roughly equal parts are oil for anything, commodities for manufacture and inter-industry trade.)

There are other strange un-Ricardian phenomena. The components from foreign sources are combined into a complex product, some of which is exported back to the component suppliers. So Italians export suits back to us made from our wool. It is even unclear sometimes which country makes some products. Robert Reich reports in his 1991 The Work of Nations that there was more US content in the Hondas sold in the US than in the Fords. The balance may have changed, such is the kaleidoscope of trading linkages at the firm level.

Odder still is the existence of international firms located in non-obvious countries. Why is mobile-phone maker Nokia located in Finland? Why should we have a successful whiteware exporter such as Fisher & Paykel?

Over the last three decades economists have been rebuilding trade theory. Some of its components have been mentioned: economies of scale, product differentiation, the death of distance. (Paul Krugman is its best-known theorist.) Another crucial factor, summarised in the term “competitive advantage”, in contrast to “comparative advantage”, is ongoing innovativeness. Nokia, Fisher & Paykel, or whoever, survive because they are creative at staying ahead of their international competitors.

The precise policy implications are not clear. But first we need to recognise the phenomenon. Successful businesses already do. Otherwise, they would have long gone to the wall. Our public policy seems less aware of these new trading patterns. Its focus remains on comparative advantage, not least because of our strength in primary-product industries based on natural resources that are cruelly restricted in the markets of those who talk free trade, walk protection, and dump their surpluses into New Zealand’s third markets. There is absolutely nothing in the New Trade Theory that says comparative advantage is wrong. It just says it is incomplete – increasingly incomplete given the higher growth rate of intra-industry trade. Some of the primary-product exporters participate in intra-industry trade. Organs from cows and sheep are the base for pharmaceutical exports.

The standard case against commodity exporting is that its relative prices tend to fall in the long run. But firms with high rates of productivity gains can compensate for weakening prices, as the computer industry demonstrates. That is why the New Zealand dairy industry managed to survive in the postwar era. Its productivity gains kept farmers facing falling relative prices in business, even though the main beneficiaries were foreign consumers. Recently, and fortunately, it seems the trend of relative prices (the terms of trade) for our primary products has been stable or even rising – wool excepted. The Uruguay trade-negotiations round (which preceded the current Doha round) may have limited some of the price depressing protectionism.

We need not be too pessimistic about public policy. The keystone of the government’s economic strategy, “growth and innovation framework” (GIF), gives some attention to competitive advantage. Over time, we will better incorporate the new economic-theory developments as the practices they describe impinge. However, only with Australia do we have an effective intra-industry trade relationship. With other OECD economies, we have markedly lower intra-industry trade, so much so that we are at the bottom of the rankings of those countries for which we have measures. Yet, as the GIF framework recognises, intra-industry trade can drive growth in New Zealand. We need to factor this analysis into both our international trade strategy and our industrial assistance.

Brian Easton is on the Growth and Innovation Board that provides a private-sector perspective to the Prime Minister and Cabinet on the GIF. The column is, however, Brian’s personal analysis.