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Competing
in
Capabilities
…some stories about growth:
1. All you need is Capital
…some stories about growth:
1. All you need is Capital
2. All you need is Free Trade
…some stories about growth:
1. All you need is Capital
2. All you need is Free Trade
3. All you need is Human Capital
…some stories about growth:
1. All you need is Capital
2. All you need is Free Trade
3. All you need is Human Capital
4. All you need is Good Institutions
I want to look at the PROXIMATE causes of differences in income per capita…
I want to look at the PROXIMATE causes of differences in income per capita…
… not the ultimate causes.
Globalisation and History
• Three Great Phases
• 1 Late nineteenth century
• 2 The Post-WWII era
• 3 The Current Phase
History and Theory
• From nineteenth century globalization yo the Hecksher-Ohlin model
• The empirical success of Hecksher-Ohlin
• The O’Rourke-Williamson anaysis
History and Theory continued
• Balassa’s evidence
• The Intra-Industry Trade debate
• The rise of the Dixit-Stiglitz-Krugman model
History and Theory continued
• So what’s going on now?
Quality and Trade : the new literature
Motivation
• 1 Firms’ concerns
• 2 Empirical patterns in new firm level data sets
Capabilitiesd
dc
u c = ‘productivity’
u = ‘quality’
Capability is a pair (c, u) for each technical trajectory (submarket)
1)( zuxU
Key feature:
The consumers choose products offering the best u/p
Implication: if u>v, the market share of a firm offering u cannot be eroded to zero by any number of firms offering v
Proposition 1
- given any configuration of capabilities
(c1,u1), (c2,u2) . . (cn,un)
there is a lower bound in (c,u) space below which a firm cannot achieve positive sales at equilibrium
(ex. Cournot equilibrium)
xu
(Quality)
1/c (Productivity)
x
u/c = bu/c = ax
Competing in Capabilities
Fixed /Sunk costs
• Iso-elastic response of quality(beta)
• Isoelastic response of labour productivity (gamma)
• Unit variable cost = labour cost + materials cost
Proposition 2
Suppose one element in building capability is the expenditure of fixed outlays (“sunk costs”)
- Then competition in ‘capability building’ will lead to a bound on the number of firms ‘in the window’.
X
X
X
X
X
X
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X
X
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X
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So what’s new?
• The model has been chosen so that prices and qualities, and therefore productivity and quality enter in a completely symmetric fashion
• The key point is that unit materials cost sets a floor to price, thus limiting the degree to which changes in wages and productivity can offset changes in quality
Quality vs. productivity
• Once raw materials at international prices are an input….
• Wage adjustment can rescue poor productivity…
• But not poor quality
Capability Threshold
Quality
uB
1/cBProductivity
uB
WB 0
WB >>0
A Digression ….
• An extension of the model adds a second parameter (horizontal differentiation)
• This can be further generalized to “linkages between sub-markets”
• This extension is important in providing an explanation for cross-industry differences in market structure
σ Linkages Across Submarkets
The Dixit/Stiglitz/Krugman
LineThe Hotelling
Line
Perfect Competition
β
Effectiveness of Capability
Building
A Multi-Country Model
• m industries ; Cobb-Douglas consumers
• r of these are commodity type, many firms
• m-r have n firms in each of countries A,B
• Country C supplies raw material
• Labour supply same in all
• Capability of B firms < A firms
Capabilities, Quality and WagesFirst r goods: qualities =1, Prod. 1/c=1
Remaining goods: qualities u in A, v in B
(Prod. Differs also)
W
L
Ls
Country A
W
L
Ls
Country B
A third country produces (only) an intermediate good, a fixed number of units of which enter into the production of all three final goods
Modelling Pre-Globalisation
• The aim is to exclude competition in “quality” goods, while allowing A and B to source materials from C.
• Two routes:
• (i) Partition country C
• (ii) Unify C but inhabitants are insensitive to quality differences
Three Phases
• Phase I: Impact phase…Capabilities given
• Phase II: Transfer phase
• Phase III: Re-investment (escalation) phase
Phase I : Impact
• There are three regimes, depending on the size of the gap in capability
• Regime I….gap ~ 0
• Regime II…..moderate gap
• Regime III….wide gap
Relative Wages
1Relative Quality
wB
v
u
I
II
III
wA
Free Trade
II
III
Free Trade
III
BU
v/u
b (i) b (ii)
v/u
Case (a) Case (b)
II
Main substantive argument
• The case for globalisation should rest primarily on the transfer and growth of capabilities it induces
• A fundamental set of mechanisms are driven by the coexistence of high capabilities and low wages
• These mechanisms include, inter alia, • ---self help driven by new incentives• ---Transfers via FDI/ Supply chains, etc.