The Elixir of Growth
Trade and Development

At a London lunchtime meeting on 19 October, Patrick Minford suggested that recent and fashionable theories of endogenous growth ignore the most important element in the growth process: the role played by international trade and comparative advantage. He found this neglect of trade puzzling, arguing that it is in the traded sector of developing countries that growth tends first to manifest itself, and where technology is transferred and economic convergence takes place. Minford is Edward Gonner Professor of Economics at the University of Liverpool, Visiting Professor at Cardiff Business School, and a Research Fellow in the CEPR International Macroeconomics programme. He is also one of the Panel of Independent Forecasters who advise the UK Treasury. His talk was based on research reported in his CEPR Discussion Paper No. 1165, `The Elixir of Growth: Trade, Non-traded Goods and Development', written with Jonathan Riley and Eric Nowell.
Minford drew attention to the evidence that there is an elixir for growth, and that it works for a country regardless of history, culture, ethnicity and religion. Recent research by Parente and Prescott (1993), for example, has provided a formal framework in which what they call `business capital' (their name for the elixir) is the key input into the growth process. Minford argued that the elixir that can suddenly turn previously torpid or declining economies into growth miracles could also be described as `open economy capitalism', in particular, the adoption of secure property rights, not merely for nationals but also for foreigners. These are a vital component because of the role played by foreign investment and technology transmission in the traded sector.
Minford outlined a model which allows trade and technology transfer to play a role in the growth process. The model comprises two linked open economies, `North' and `South', and is based on the Heckscher-Ohlin- Samuelson (HOS) theory of international trade. This theory focuses on the production function and its factor inputs. Its key assumptions are constant returns to scale (plausible within a study of long-run growth), and that factors of production can be divided into mobile and immobile factors. Only immobile factors play a role in determining comparative advantage: if, for example, capital is mobile at a price set internationally, a country's capital stock will not help to determine its comparative advantage. In addition to the basic HOS assumptions, the model features: a division of factors of production into mobile and immobile, based mainly on the degree of international market integration – capital is mobile and there are endogenous supplies of immobile factors, including land and skilled and unskilled labour; a non-traded goods sector; and a number of hypotheses about the supply of factors and the transfer of technology, which provide the dynamics of the model.
The resulting model implies that differences in relative income per capita are determined by differences in the relative technology of a country's traded sector and by the accumulation of savings and skills. In addition, the model assumes that the speed of foreign investment and technology transmission is determined by the property rights environment as well as by the sheer physical power of communications and transport technology itself. According to Minford, recent empirical work on the role of `openness' confirms the importance of property rights in the growth process.
The model is complex and highly non-linear and simulations are needed in order to reveal the properties of the growth process. In order to carry out the simulations, the model is first `calibrated', by imposing a set of assumed coefficients on the equations of the model. It is then used to simulate the transfer of technology to the manufacturing sector of the South, by assuming a growth rate of productivity in the Southern sector of 2.3% annually, a figure consistent with the annual increase in wages in manufacturing observed for newly industrializing countries (NICs) over the period 1975–92.
The model simulations are consistent with the HOS theory. The rise in Southern manufacturing productivity raises the relative reward to the (immobile) factor in which manufacturing is intensive: unskilled labour. The supply of this factor rises in the South, and, via the Rybczynski theorem, the expansion of manufacturing is accompanied by a contraction in the Southern supply of traded services and agriculture. The additional income in the South is spent broadly across all traded goods, as against the additional Southern supply of manufacturing and contraction in that of services and agriculture. This raises world prices of services and agriculture, improving the terms of trade of the North and hence its welfare. The fall in manufacturing's relative price, however, causes, via the Stolper-Samuelson theorem, a fall in the real wages of the factor in which manufacturing is intensive (unskilled labour), and a rise in the rewards of the factors in which it is not intensive (skill and land). Overall, both North and South gain from the rise in the South's productivity by more than the crude addition to world disposable income that this represents: there are gains from trade.
In quantitative terms, the simulations reveal that in the North rewards to skilled labour and to land grow respectively by 2.6% and 2.8% per annum, and unskilled wages fall by 1% relative to manufacturing prices (the numéraire). The fall in unskilled wages is even more dramatic in real terms: 2% per annum, relative to the consumer price deflator which rises by 1% per annum. As a result, the supply of unskilled labour contracts in the North by 0.5% per annum, or by 11% overall over 23 years, while both human capital and land in use rise by 50% over the same period. Real disposable income rises in the North by 1.9% per annum over the period of the simulations.
The simulations suggest that the transfer of technology to emerging markets enhances world welfare – &nbspimproving the terms of trade of the North, while raising productivity and so living standards in the South – but that it dramatically reduces the living standards of unskilled workers in the North. Minford warned that this poses severe challenges both for social policy and for the maintenance of popular allegiance to free trade in the North.
This aspect of the simulation results was likely to prove controversial, according to Minford, since it contradicts a number of studies, based on US data, which find no link between the growth in manufacturing in the NICs and the fall in US unskilled wages. Some of the studies – by Katz and Murphy (1992) and Bound and Johnson (1992) – are flawed, according to Minford, because they take only a partial equilibrium view, examining only the labour market. Other studies, such as that by Lawrence and Slaughter (1993), do adopt the correct general equilibrium approach, but are flawed in other respects. Lawrence and Slaughter use the ratio of non-production workers in order to rank US industries by their skill intensity: this may have yielded the wrong ranking, according to Minford. In addition, the relationship between changes in relative wages and factor intensities are very sensitive to the level of aggregation employed, suggesting that the apparent increase in skill content may merely be due to the process of outsourcing, whereby the US abandons production of low-skill items. Lastly, their terms of trade calculation, which severely contradict the international data, may be biased by a shifting definition of goods – &nbspfor example, `shoes' would seem to rise in price as Gucci shoes replace sneakers.