The conventional approach to modelling the exports of the newly industrializing economies (NIEs), as a demand equation, depending on relative home and world prices and on world income, has been criticized on account of the low price elasticities and very high income elasticities of demand commonly obtained. According to Riedel, NIEs' export growth is supply-determined, world income is largely irrelevant, and the price elasticities of export demand are high.

Conventional empirical studies obtain low price and large income elasticities because demand and supply are not modelled simultaneously, but the extraordinarily rapid growth of NIEs' exports has not led to a massive deterioration in their terms of trade. Riedel rejects the conventional `explanation' that the NIEs export goods for which the world income elasticity of demand happens to be high as implausible, and he argues that price elasticities of demand for NIE exports must be high. This debate is vital to the policy issue of the relative usefulness of export- promotion and import-substitution strategies.

In Discussion Paper No. 426, Anton Muscatelli, T G Srinivasan and Research Fellow David Vines, conduct a detailed econometric evaluation of both explanations, and they comment on the theoretical insights and policy implications of their results. They use a data set of total exports from Hong Kong, South Korea and Taiwan to assess the possibility that the exports of a group of NIEs are strongly influenced by demand, and they specify a full demand and supply system and investigate the issue of `normalization' in some depth (following the work of Nguyen and Riedel).

Their results confirm the low price elasticity of demand and the large and significant income effects found by the `conventional' studies, and they are not unduly affected by the choice of estimation method or by normalization. They do not conclude, however, that an import-substitution strategy is preferable, since in certain circumstances (following Krugman's technology- transfer model) this will not lead to a deterioration in the terms of trade. Hence, in the presence of market imperfections, for a country facing a less-than-perfectly-elastic demand for its exports, export subsidies may well represent the best strategy.

Muscatelli, Srinivasan and Vines argue that for an NIE embarking on a policy of export promotion in these circumstances, the extra supply will create its own demand. These supply-side influences on demand suggest the need for caution in interpreting the high income growth elasticities, and they also indicate that an inward-oriented development strategy is not necessarily suitable for all LDCs.

The Empirical Modelling of NIE Exports: An Evaluation of Different Approaches
V A Muscatelli, T G Srinivasan and David Vines

Discussion Paper No. 426, July 1990 (IM/IT)