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International Trade Patterns Theories

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1. Introduction

In the course of globalization, highly-developed countries should have increasingly specialized in human capital-intensive manufactured goods and, in return, should have sourced labor-intensive manufactured products from low-wage countries. For this reason, especially the opening up of Eastern Europe, but also the international integration of the Newly Industrializing East Asian Economies is often considered a significant cause of labor demand shifts detrimental for the lower-qualified in Western European countries, since international trade should favor the high-skilled in these countries (e.g. Freeman 1995, Wood 1995). This paper addresses this question by analyzing the skill content of bilateral intra-European trade flows of selected EU Member States, allowing inferences to be made about the impact of these trade relations on factor demand patterns in those countries. Previous studies on the factor content of trade have shown that, even in trade between highly developed countries, the results depend largely on whether or not international differences in technology are considered. Unlike previous studies, this paper takes up this issue by analyzing the high-, mediumand low-skill content of bilateral trade between Western European and, for comparison, also between Western and Eastern European countries. The skill content of trade is analyzed for identical, but also for different technologies by using country specific input-output and factor input data. According to theory, different factor intensities in production are a prerequisite for vertical product differentiation, which has become more and more important in recent decades (Falvey and Kierzkowski 1987, Helpman 1981).

2. Review of the Literature

One of the main theoretical foundations for explaining international trade patterns and their consequences for factor demand and income distribution in trading partner countries is the neo-classical Heckscher-Ohlin (HO) model of trade. According to this model, each country will specialize in and export commodities utilizing its abundant and thus comparatively cheap factors of production and will import goods using its scarce factors of production. An empirical test of the HO-theorem for the United States performed by Leontief (1953) seemed to disprove the hypothesis that countries' patterns of specialization are determined by factor proportions. In a model with two production factors (capital and labor), Leontief disaggregated the US economy into 50 industries, 38 of which produced tradable goods. He showed that in 1947, US imports were 30% more capital-intensive than US exports, although at the time the US was considered to be one of the most capital-abundant countries in the world. Today it is widely accepted that, besides trade barriers, differences in labor force qualifications is the main reason for this Leontief paradox (Baldwin 1971, Kravis 1956, Trefler 1993).

So far, analyses investigating the factor content of trade for different countries exist (e.g. Dasgupta et al. (2009) for India, Engelbrecht (1996) for Germany, Webster (1993) for the UK and Widell (2005) for Sweden), as well as studies testing traditional trade theories (e.g. Bowen et al. 1987, Davis and Weinstein 2001, Maskus 1985, Staiger 1988, Trefler 1995). However, in many of these last mentioned studies the empirical results of these tests are quite inconclusive. A critical concern is that the bulk of these studies assume identical production technologies and factor inputs across countries for calculating the factor content of countries' trade. As a consequence, the factor content of exports and imports hardly deviates one from the other. However, according to New Trade Theories, identical production technologies would imply only horizontal product differentiation, resulting in horizontal intra-industry trade. In this case, imports would differ from domestically manufactured export goods only with respect to product characteristics, but would be of the same quality. But these days, product differentiation is largely vertical, which means that goods are manufactured with different factor proportions or technologies and differ with respect to quality and prices (Falvey and Kierzkowski 1987, Flam and Helpman 1987). By implication, this means that producing a perfect import substitute would require exactly the same factor inputs and production technology that are applied when producing the considered product abroad. If not, the domestically manufactured import substitute and the imported product would not be homogeneous. Against this background, quantifying domestic job losses induced by imports for different skill groups requires calculating the factor content of imports by using technology as well as factor input matrices of trading partner countries.

Although empirical analyses investigating the factor content of trade on a bilateral level have more recently used technology matrices of both the exporting and the importing country (e.g. Choi and Krishna 2004, Davis and Weinstein 2003, Harrigan 1997, Lundberg and Wiker 1997, Nishioka 2006 and Torstensson 1992), many of these analyses are restricted to highly developed OECD countries, which probably share quite similar production technologies and factor endowments. Although Hakura (1999) found that theoretical hypotheses are empirically supported for EU Member States if different technology matrices are used for the countries considered, only bilateral trade relations between the high income Western European countries of Belgium, Germany, France, Italy and the Netherlands were considered. For EU member states, only Cabral et al. (2006 and 2009) focused on trade between high-income countries (the UK and others, respectively) and middle-income countries. However, for the former, only the United Kingdom's, and for the latter, only the Portuguese technology matrix was used and considered as representative.

Against this background, in this study trade flows between not only selected Western, but also between Western and new Eastern European EU member states will be taken into account. The countries considered are Austria, Denmark, France, Germany, the Netherlands and Sweden and, as Eastern European trading partners, the Czech Republic, Hungary, Poland and Slovakia. Thereby, those Western European countries with the most intensive trade relations with Eastern Europe, measured by the share of the four Eastern European countries in total exports and imports, are considered. With respect to Eastern European countries, the country selection was limited by data availability. Detailed data on labor input by industry are only available for the four countries mentioned above. However, these four countries are the most important Eastern European trading partners of the Western European countries considered in this study. Since data on capital input are only available for the Czech Republic and Hungary, capital was not taken into account.2 Unlike many other studies dealing with factor content in bilateral trade (e.g. Davis and Weinstein 2001, Harrigan 1997, Lai and Zhu 2007), in this study the total labor force will be subdivided into human capital and lower-qualified labor in order to deduce factor demand patterns arising from international trade between EU Member States. This will be done by identifying the high-, medium- and low-skill content of intra-European trade flows. In this way, the calculations will be performed in the case of identical as well as of different technologies across countries by using national factor input and input-output matrices. This allows for a consideration of country specific factor inputs resulting from endowment differences.

"EUROPE needs to import to export." That is the slogan of the European Commission's new strategy for securing its economic place in the world, unveiled this week by Peter Mandelson, the European Union's commissioner for trade. The soundbite, of course, gets the economics precisely backwards: exports are the price a country must pay for its imports; Europeans toil away making stuff for others to consume only so they can in turn get their hands on the fruits of foreign labours.

But the slogan does capture two awkward truths European exporters must now confront. First, only by offering to open its own markets can the EU hope to persuade foreign countries to open theirs. But with the collapse of the Doha round of trade talks, it is not obvious to whom the Europeans should make their offers. Second, European companies are now part of elaborate global supply chains. Clumsy efforts to protect some of them from foreign competition deprive others of the cheap inputs they need to thrive in world markets.

The new trade strategy looks at both of these dilemmas, among others. Though Mr Mandelson insists that he remains wedded to multilateral negotiations at the World Trade Organisation, he also fancies pursuing a bit on the side with other willing trade partners. The EU will pick its partners according to three criteria: do they offer a big, growing market? Are they cutting deals with America or Japan? And are they guilty of deterring European companies, either repelling them at the border with high tariffs, or bogging them down in cumbersome rules and regulations? The strategy names ASEAN, South Korea, India and Russia as priorities, as well as two regional blocks, Mercosur and the Gulf Co-operation Council, that it is already courting. The EU will reveal its plans for China at the end of the month.

The strategy also proposes to look again at how the EU protects its own borders, because its favoured weapons are prone to backfire. For example, EU ministers decided this week to slap anti-dumping duties on leather shoes from Vietnam and China, which threaten shoemakers in Italy, Portugal and Spain. But the duties are opposed by Europe's own retailers and some of its sportswear makers. Letting Asian workers stitch and glue sports shoes makes it possible for such firms to employ Europeans to design and market them.

Mr Mandelson presented his strategy as a way to help the EU become more competitive. Opening up to foreign rivals is, of course, an excellent way to foster competition in cloistered domestic industries. A pity then that most of his concrete proposals were about conquering markets abroad, and that the EU is still so ready to raise its defences at home.

In the wake of globalization, Western European high-wage countries have experienced rising unemployment among the lower-qualified, which is often ascribed to the integration of the Central and Eastern European as well as the Newly Industrializing Asian Economies into the international division of labor. In this context, human capitalabundant countries are expected to specialize in capital- and high-skill-intensively manufactured goods. As the analyses have shown, imports of selected Western European countries from Eastern European trading partners require higher inputs of workers of all skill-levels than the corresponding exports, but especially of mediumskilled workers. Seemingly, East-West trade in Europe is not primarily harmful for the low-skilled in Western European high-wage countries. This suggests some policy implications. For instance, in Western European countries, selective policies towards different skill groups, not only limited to the low-qualified, are required. Moreover, the outcomes of European East-West trade do probably differ from industry to industry. Of course, in some industries, East-West trade might be harmful primarily to the lowskilled in Western European countries. Thus, one aim should focus on increasing interindustrial worker mobility and/or a sufficient flexibility of wages. The empirical results comply with the fact that unemployment of the low-skilled is not only a problem in Western, but also in Eastern Europe. Since high unemployment of the low-skilled is probably largely due to skill-biased technological change, policy should also aim at increasing labor force qualification. This is especially the case for the Western European countries, where the share of the low-skilled in total population is, at least according to EUROSTAT data, even larger than in most of the Eastern European countries. Finally, in view of the fact that unemployment of the low-skilled in the context of European integration is not limited to Western European countries, the temporary arrangements introduced in order to impede the free movement of workers between new Eastern European and Western European EU member states should be scrutinized.

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