Dynamics, Economic Growth, and International Trade

4. Endogenous Growth, Trade, and Specialization under Variable Returns to Scale: The Case of a Small Open Economy

CHAPTER 4 Endogenous Growth, Trade, and Specialization under Variable Returns to Scale: The Case of a Small Open Economy Ngo Van Long, Kazuo Nishimura, and Koji Shimomura 1. Introduction The spectacular success of several East and South East Asian economies has sparked a great deal of interest in the search for a better understanding of mechanisms that propel growth. According to the World Bank, the GNP per capita of Hong Kong, adjusted for purchasing power parity, have overtaken that of Canada and Japan. On the other hand, many countries remain unindustrialized and poor. What is it that prevents some countries from industrialization? Is there a poverty trap from which it is difficult to escape? What can national governments and international organizations do to accelerate the growth process of less developed countries? There are many theories that claim to provide partial answers to the above questions. They range from the culture-based explanations of Harrison (1997) and Lee Kwan Yew to the socio-economic based theory of Murphy, Shleifer, and Vishny (1991), among others. In the book entitled "The Pan-American Dream: Do Latin America's Cultural Values Discourage True Partnership with the United States and Canada?" Harrison argues that Latin America's chronic failure to achieve lasting prosperity is due to an "Ibero-Catholic" culture. Lee Kwan Yew is well known for his view that "Confucian values" constitute the main driving force behind the East and South East Asian miracles. Eisuke Saka):dbara 's book (1993), "Beyond Capitalism", advances the view that values other than capitalistic profit-seeking ones contribute much to economic growth in East Asia. Murphy, Shleifer, and Vishny (1991, p. 505) argue that "the allocation of talents to the rent-seeking sectors might be the reason for stagnation in much of Africa and Latin America, for slow growth in the United States, and for success of newly industrializing countries where these sectors are smaller." According to this view, bribes, taxes, and fees in a rent-seeking society constitute a tax on the profit of the productive 127 128 Dynamics, Economic Growth, and International Trade sector; the higher the tax, the lower the incentive to invest. These authors suggest that a measure of this "tax rate" might be the size of government consumption, thus providing a plausible explanation of Barro's (1991) finding that countries with smaller government consumption relative GDP grow faster. The recent empirical work of Mauro (1995) lends support to this socio-economic approach. Using a newly assembled data set consisting of indices of corruption, red tape, and efficiency of the judicial system for about 70 countries, Mauro finds that countries with higher corruption tend to have a lower ratio of investment to GNP, and therefore slower growth. Another stream of thoughts relates economic performance to more traditional concepts in economics such as returns to scale, externalities, and complementarity in demands and supplies. If there are impediments to world trade, small countries cannot take advantage of increasing returns to scale. For large economies, such as India, complementarity is a key factor for potential development. As an example of complementarity , it is often stated that the industrialization of one sector enlarges the size of market of other sectors. This process can be self-reinforcing, due to spillover effects, and backward and forward linkages. The idea of coordinated investments is at the heart of the theory of the "big push" associated with Rosenstein-Rodan (1943) and others. This line of arguments has been further developed by economists such as Nurkse (1953), Scitovsky (1954), and Flemming (1955). Their theories can be interpreted in terms of the concept of multiple equilibria in general equilibrium theory. This interpretive effort is most evident in another paper by Murphy, Shleifer, and Vishny (1989), where a set of models are presented , in all of which the central role is given to pecuniary externalities generated by imperfect competition with large fixed costs. An economy may remain settled in a low income equilibrium due to coordination failure. Active government intervention might be needed to move the economy to a high income equilibrium. However, by restricting attention to a two-period framework, these models, while offering a great deal of insight, lack much in dynamics. To talk about poverty traps, it is essential to address the issue of stability of equilibria. This has been formalized by Durlauf (1993) in a stochastic growth with many heterogeneous industries employing non-convex technologies that incorporate spillover effects from the history of production decisions to the productivity of the economy...