«Published Annually Vol. 6, No. 1 ISBN 978-0-979-7593-3-8 CONFERENCE PROCEEDINGS Sawyer School of Business, Suffolk University, Boston, Massachusetts ...»
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Conference papers © Knowledge Globalization Institute, Pune, India, 2012 Consistency of the Revealed Comparative Advantage Indices with the Heckscher-Ohlin Theory
The issue of comparative advantage constitutes an important feature of the theory of international trade. Comparative advantage of countries has been measured in the literature by various alternative indices of ‘revealed comparative advantage’. Balassa first coined the term ‘revealed comparative advantage’ and the index that he devised in the process, has been later modified by various authors in many ways to address one or more of the shortcomings of Balassa’s index. However, the existing literature have not tried to determine empirically, the extent to which the different indices are consistent with the idea of comparative advantage as identified particularly by Eli Heckscher and Bertil Ohlin. The present paper makes an attempt in this regard. In the process, another index has been derived by considering the logarithmic transformation of the Balassa’s index, and its consistency with the theory has been empirically tested in a similar manner to determine whether it performs better than the other indices. A theoretical review of the alternative indices and empirical findings exhibit, the modified index certainly has an edge over other indices.
Keywords: Revealed comparative advantage, Heckscher-Ohlin theory, labour intensive commodities, capital intensive commodities.
1 Introduction Comparative advantage as a determinant of international trade, was developed and conceptualised by David Ricardo in 1817.
In the Ricardian model, comparative advantage was the outcome of differences in technology or factor productivity between the countries. Later in 1930s, Eli Heckscher and Bertil Ohlin identified comparative advantage as the outcome of differences in relative factor endowments of two countries. With capital and labour as the two factors of production, the Heckscher-Ohlin theory propounded, a relatively labour abundant country will have comparative advantage in labour intensive goods and will export the same. A relatively capital abundant country on the other hand, will have comparative advantage in capital intensive goods, which it will export.
The orthodox trade theories on comparative advantage formed the basis of inter-industry trade or trade in dissimilar products.
With the development of new trade theories, the validity of the orthodox trade theories had been questioned. It had been argued that the recent splurge of intra-industry trade or trade in similar products can be explained by new trade theories only.
However, this idea had been challenged by many theorists and they have demonstrated that even the orthodox trade theories can account for intra-industry trade (Falvey 1981; Davis 1995). Hence, the idea of comparative advantage and theories encompassing it, still remain an important strand of international trade theory.
While comparative advantage has been conceptualised theoretically to explain the pattern of international trade, the quantification of comparative advantage for empirical analysis is obviously not an easy task. This is because, economic theory is based upon certain restrictive assumptions which are difficult to quantify in the real world. The first problem relates to the fact that unlike as required by the theory, data available for measuring comparative advantage pertain to the post-trade situation.
Moreover, the data are subjected to distortionary impacts of government intervention and imperfect information (Vollrath 1991, 266-267). The second problem encountered during the empirical measurement of comparative advantage, arises out of commodity aggregation. It is possible for a country to have comparative disadvantage in a composite commodity and comparative advantage for a disaggregated commodity within the same composite group (Vollrath 1991, 267).
Despite such shortcomings, several attempts have been made in the past to quantify comparative advantage and are still being actively pursued. Typically, comparative advantages of countries have been measured in the literature by various alternative indices of ‘revealed comparative advantage’ (RCA), using post-trade data. Balassa (1965) coined the term ‘revealed comparative advantage’. However, over the years Balassa’s RCA index has been criticized from various perspectives and alternative RCA indices have been suggested in the literature. Though each of these latter indices have tried to address one or
Conference papers © Knowledge Globalization Institute, Pune, India, 2012
more shortcomings of the Balassa’s RCA index, the existing literature have not tried to determine empirically, how various alternative RCA indices are consistent with the idea of comparative advantage, as identified by Heckscher-Ohlin. Section 2 of this paper, reviews the RCA indices of Balassa and subsequent authors. Eventually it introduces another index, by considering suitable modification of the index of Balassa, such that the new index has structural features superior to other existing indices.
Section 3 attempts to examine empirically, using cross sectional data, how far the RCA indices considered in section 2, are consistent with the Heckscher-Ohlin theory and thereby permits a comparative study. Section 4 concludes that the suggested modified index could be used to determine the comparative advantage of countries as it has good structural features and in addition is empirically consistent with the theory.
2 Indices of RCA
Although the idea of ‘revealed comparative advantage’ is attributed to Balassa, prior to that, Liesner (1958) actually made a preliminary attempt at quantifying comparative advantage, using post-trade data. Liesner used relative export performance in order to assess bilateral comparative advantage between Britain and one of its European competitors, for a single commodity, while exporting to Europe. However, the index that he devised in the process, was limited in its coverage as it considered only a single commodity, and attempted to identify comparative advantage of a country, on the basis of its performance in exporting that commodity, relative to other countries (Vollrath 1991, 269).
Eventually, by adjusting Liesner’s index, Balassa (1965) developed his index and named it as ‘revealed comparative advantage index’. In his view, comparative advantage can be ‘revealed’ through real life patterns of country or commodity trade, because actual exchange reflects differences in costs as well as non-price factors (Vollrath 1991, 266). The original RCA index of Balassa
was defined in the following form:
i c i c (X a / X a) / (X m / X m) Here, X stands for exports, m denotes all manufactured goods and a to any one of the manufactured goods. i and c denote any one of the 11 industrial countries that he considered and all the 11 countries together respectively. The index is thus expressed as the ratio of a country’s share in 11 countries’ exports of a particular product, to its share in the 11 countries’ exports of all manufactured goods. A value of the index greater (less) than unity signifies revealed comparative advantage (disadvantage) in product a by country i.
Identifying the fact that Balassa’s index is restricted in terms of both commodity and country coverage, it was later modified to
include all countries and all traded commodities. Hence, the RCA index of Balassa takes the following form:
Here a refers to any specific commodity (not necessarily manufactures); t refers to all traded commodities (both manufactures and non manufactures); i and w to any country and the world respectively. In the following analysis, while referring to the Balassa’s RCA index, this version of the original index would be considered.
2.1 Problems with the RCA index of Balassa