The popular notion that Europe has t base it's industrial future on 'hi-tech' products could be wrong, argued research fellow Victor Norman at a CEPR lunchtime meeting on May 9. Norman eported the results of simulations which suggested that over the long run, Europe should modernize and expand production in capital-intensive industries such as metals, chemicals and sea and air transportation. This, he argued, could allow Europe to exploit more fully its comparitive advantages over the next twenty years. Trade and industrial policies had effects over a period of twenty or thiry years, yet these policies were oftenformulated as responses to very short-run problems. A longer term perspective was needed.

Victor Norman is Professor of International Economics at the Norwegian School of Economics and Business Administration and visiting Professional Fellow at the School of European Studies at Sussex University. He is also a Research Fellow in the Centre's International Trade programme. Professor Norman has written extensively on many aspects of world trade including trade policy, labour supply, technological change and competitiveness. The lunchtime meeting at which he spoke was one of a series at which CEPR Research Fellows discuss research relevant to economic policy; the opinions expressed are their own and not those of CEPR, which does not itself take policy positions.

Professor Norman based his talk on simulations using the VEMOD model, developed by a group of economists at the Norwegian School of Economics. The model is designed to predict the future pattern of world production and trade by isolating the most important long-term influences on the pattern of comparative advantages and the worldwode division of labour. VEMOD divides the world economy into six major regions - Western Europe, North America, Japan, OPEC, newly industrializing countries (NICs) and non-oil-exporting developing countries (NODCs). The pattern of comparative advantages across regions is influenced by saving rates, labour force trends, the educational composition of the labour force, the supply of oil and raw materials, the rate of technical progress and diffusion of new technology across regions, trade policies and capital flows.

Norman noted that VEMOD combines the features of a number of theoretical trade models. The 'Ricardian' features in VEMOD are found in the important role played by technological differences between regions in the model simulations. Productivity parameters are specified in the model for all regions and sectors. Technological differences are important for the pattern of production and trade, and the way technology changes over time is of great importance for the final structure of comparative advantages between the major regions of the world. In one scenario discussed by Norman, technological progress is assumed to take place at the same rate in all regions; hence, the effects on comparative advantages are neutral. Other alternative scenarios allowed technological differences to diminish over time, to reflect increased international mobility and diffusion of technology.

The Heckscher-Ohlin theory of trade emphasizes that the relative abundance of factors of production in an economy plays an important role in determining its comparative advantage. VEMOD also reflects this emphasis in its treatment of savings, investment, and trends in the size and education of the labour force.

Norman discussed one scenario explored in the VEMOD simulations, which he called 'Prolonged Trends'. In this scenario the model's parameters were chosen partly on the basis of recent historical experience and partly on the team's calculations based on 'stylized facts'. The benchmark year for the simulations was taken as 1979, and the time horizon extended to the year 2000. Hence the structural changes and adjustments reported by Norman take place over a twenty-year period.

Even though Norman cautioned against drawing conclusions from a single scenario, a number of the results carry through on a wide range of 'reasonable' underlying assumptions. A comparative advantage for North America in high-technology production and for less developed countries (NICs and NODCs) in labour-intensive production are among these robust results. Rapid population growth and low savings in the LDCs meant rising labour-capital ratios and a relatively unskilled labour force. This gave them a comparative advantage in labour-intensive but low-technology goods. In North America population growth and low savings also led to a rising labour-capital ratio, but in this case the labour force was highly educated. The result was a comparative advantage in high-technology goods.

The simulations confirmed this North American comparative advantage in high-technology production. It was so strong that over the simulation period North American production of all other traded goods fell substantially, even in absolute terms. The developing countries (the NICs and NODCs) have a comparative advantage in labour-intensive production, and output of these goods in LDCs increases significantly in order to realize the potential gains from international trade. For both regions, the simulations suggested that their current comparative advantage will be reinforced by the likely development of capital stocks and labour supplies, and the strength of these comparative advantages made it unlikely that Europe or Japan would capture the markets for labour-intensive or for high-technology goods.
The simulations suggested that Japan had a comparative advantage in the production of capital-intensive goods, but this result was sensitive to the behaviour of their net savings ratio. For Western Europe the results were less dramatic. The production of skill-intensive goods remained fairly constant in absolute terms and fell as a share of GDP. Growth in European output came in the labour-intensive and capital-intensive sectors. The Western European position as a 'Jack of all trades' was confirmed by alternative scenarios, which did not reveal any marked comparative advantage for Europe. Western Europe kept a diversified pattern of production in most simulations; the variations in this diversified pattern in particular simulations seemed to be dictated by the strength of the comparative advantages in the other regions. Because Europe has a relatively balanced set of factor endowments, its production is not biased in favour of any particular good, according to the VEMOD simulations. Europe appeared in the simulations to fill the gaps left by the other regions.

The model simulations suggest that Europe and Japan will have to share the remaining demand for skill- and labour-intensive products, and that they will supply the bulk of world demand for capital-intensive goods. Thus, European and Japanese producers are likely to remain the principal competitors in international markets for manufactured goods.

If Japanese capital accumulation were to regain the levels reached in the 1960s and 70s, its capital stock would grow so rapidly that the likely outcome would be Japanese dominance in capital-intensive products. Europe would then become a 'residual supplier' with balanced production in all product areas. Norman thought this unlikely, however: a more plausible scenario involved a permanent decline in the rate of capital growth in Japan. In this case, the Japanese would seem to have a competitive edge over Europe in high-technology goods, so Europe will (or should) possess a comparative advantage in capital- intensive goods.

Norman argued that the surprises in the simulation results underlined the sometimes paradoxical nature of comparative advantage, as well as the importance of simulations which took full account of interactions between regions. Even if, for example, the developing countries were assumed to 'catch up' technologically, this merely reinforced their comparative advantage in labour-intensive products and led them to produce more of these goods. European policy-makers were preoccupied, according to Norman, with the question of what Europe must do in order to compete in high-technology goods. Norman suggested that Europe might instead make a virtue of its adaptability and do what the rest of the world was not doing.

The discussion which followed was lively, and focussed on the nature of comparative advantage and of European 'adaptability'. Norman drew attention to the 'Leontief paradox', the discovery that the United States did not export goods which were capital- intensive in nature. This was not a paradox, argued Norman. The United States was not a relatively capital-abundant country; it was instead a resource-abundant and will-educated country! Could Europe catch up in high-technology goods? Norman noted that the European labour force was a distant third, behind the United States and Japan, in terms of education. Was it realistic to imagine achieving Japanese levels of education over a fifteen- year period? The investment necessary would be huge and, Norman argued, the chances of success were slight.