Dear Professor Shiozawa, it is fantastic nhow you justify your question. I learn a lot from you. Thank you so much, indeed!

I do not have the elements to rightly answer your question. However, please allow me an indirect take, thus: much of how the world is being run happens without a theory. Furthermore, a large part of scince takes place without a solid theory, just as it it the case you mention. (I am personally working on a parallel domain, namely: the trublke about a general theory for the living beings. And yet, sciences such as biology or medicne exist. It is a serious mistery to me!).

I have the hunch that some scientists are ahead of their times, when questioning the abscence of a theory that supports the actions and explanations of a number of fields. I firmly believe that our world cannot go too far without the "construction" of theories like the one you mention. That, probably, is part of the crises we are going into...

Respected Yoshinori Sir,

I do not 'have any good explanation'. Many may not have. 

However, if one goes back to mercantilism and thinks over the balance of trade concept kept dear by the early mercantilist pamphleteers she will find processing trade absolutely a non-desirable because it might diminish the balance of treasure. The later mercantilists or mercantilists proper, though, had learnt to admit of the value of processable inputs if they could be turned into commodities commanding more exchange value and hence greater balance of treasure.

I would rather say that input trade was discussed by the mercantilists, but it was ignored or omitted by the classical and neoclassical thinkers probably on account of the inclusion of the intermediate inputs in the theories of international trade based on comparative cost advantage.

The European empires were major traders of natural resources and basic raw materials. They could not ignore such a valuable item to go unnoticed. I think it is because the empires and their intellectuals put their eyes more on their cost advantages, say the profits. So to them it was more important to find out the cheapest source and the degree of cheapness. The input imports were as good as final goods for the purpose of profiteering analyses. Traded inputs might have been a concern of the macroeconomy. But for trade theory, it was not such a big thing to disturb the BoP. They might not be discussed separately, therefore. 

Sir, in the theory of tariffs the processing-and-retraded-inputs have conventionally attracted lower rates of tariffs in most of the countries.

Sir, the post-Washington-Consensus international trade scenario is fundamentally different from the earlier times and, now, the inter_MNC and intra-MNC trade has become a major trade component. This is a major boost to thinking on processing business in international commodity movements. As you know well, the theories in economics are ex-post-facto descriptions of reality rather than being ex-ante contemplations.

Sir, please forgive me for anything unsubstantial.

With sincere regards

Israr

Dear Yoshinori,

In considering a 'theory' to describe the conditions for processing industry which is able to give insight into the factors it is affected by and the affects its operations have on other factors there are, at least, two requirements.

First, one needs data and good reason to analyse it. 

Israr is probably quite correct to say that the prevailing view is set in mercantilist approach in which how things are made is unimportant to the question of how best to profit from their trade. Consequently it is only with the recent focus on international fragmentation of processes under the control of globalised corporations that the industry has attracted attention.  The lack of accountability and seemingly autonomous power wielded by globalised corporations has made them the subject of study.  Process industry is a large part of what they do.  The rest of this 'essay' expands on that thought.  I hope you find it at least a little interesting!  If not, then you have my apologies..  :-))

At first glance it seems likely that 'early period' processing industries were characterised by inflows of primary resources towards centres of technological advantage in processing skills, both within countries and between them.  During the third quarter of the 20th century this process peaked and began to change, perhaps for the prima facie reason that real wage rates in the manufacturing centres of Europe and North America had peaked at the same time as inter-modal transportation efficiencies had significantly reduced the cost of transportation at a global scale.

These two factors created the conditions whereby the lower wage rates of distant countries might be accessed by moving processing technology to them.  The decision as to where to locate could be optimised on a total-factor basis that allowed the minimisation of the basket of volumetric-mass transportation charges of bulk primary input materials and at the same time optimised delivery charges in the final costs of finished goods.

This possibility, once contemplated, was clearly going to be extensible throughout the value-chains that produce the intermediate goods leading to finished products.  Global vertically-integrated conglomerate corporate structures would be the institutional technology best able to profit from this opportunity.  Countries with the companies 'first to market' with this technology of total factor cost minimisation on a global scale would always be able to avail themselves of the 'comparative advantage' of all other nations entering the industry at a later stage.

During '4Q19th C' this opportunity was realised, MNC's were born.  This development lead to the invention and co-option of a range of other institutional technologies amongst the nations hosting those early MNC's, each of which whilst facilitating the mechanics of the now burgeoning international trade also served to consolidate the comparative advantage gained into the hands of those 'first to market' host nations.

It has only been over the past two decades that MNC's (multinational corporations?) have grown in size and complexity such that many of the nations not in the 'early bird club', have realised that these corporations command greater resources and economic power than the countries that they seek to operate within.  Much like a small local retailer competing with the local branch of a distant supermarket, they no longer have very much control or influence within their own neighbourhood.  Comparative advantages which they do invest in and develop, once they become significantly effective, become the easy target any MNC whose local interests it may threaten.  They may 'take over' the new development or simply 'compete it into oblivion' or employ any number of alternative tactics, that may be technically legal and sometimes may be illegal.  

The smaller nations also seek to have some control over their own destiny in relation to other nations.  The ability of governments to do this effectively has now increasingly been seen to be under threat when they find that they need foreign MNC's to work with them in developing their own long-term national interests.  The attempt to exercise this 'natural right', which is generally accepted to exist amongst societies, has exposed a systemic structurally integrated conflict of interest to have been built into the very fabric of the institutions of foreign trade and development which tends to strengthen the hand of the already strong and which tends towards a maintenance of the status quo as regards the pattern and nature of the distribution of instances of comparative advantage across the globe.

This has given rise to great concern since the 1990's.  Data, both panel and time-series, has now been gathered.  The analyses of this data are now beginning to appear and their rate of publication is accelerating.  It will now be possible to start deconstruction and simplifications that will indicate whether or not new theories are required, including changing to those already existing.  Or if, miraculously in my opinion, it is only required to adjust and amend the current body of knowledge.

The second requirement for a 'theory' which has scientific merit, as opposed to merely having great historical interest, is for it to have 'predictive power'.  It is this ability to predict future events from the conditions of the present which makes science potential useful.  Repeated demonstrations of the same claimed predictive power is the process by which theories, laws and so-called axioms are validated and established within our body of knowledge. A status which is not eternally assured for even the most dearly held principals... some of which move on to becoming unsupported beliefs and dogmas wherever their adherents see continuing profit by promoting them.

It follows that economics is, although it is able to share with science a tool box of mathematical skills that overlap in many areas of application through a certain shared commonality of problem types, not yet, nor is it ever likely to become a science in th accepted sense.  By mistaking it to have those qualities we give rise to a plethora of misinformed mathematicians who, in seeking solid ground for their mathematical skills, validate their work by raising the more popular results of the musings of natural philosophers such as Adam Smith and Ricardo to the status of 'Axioms'.

Economics is about what people do.  It studies what they do and have done, through socially acceptable individual and cooperative means and in every situation, to provide themselves with the requirements and pleasures of life.

This behavioural study of human beings, as it has developed over the past 200 years, can go no further than being a mathematically supported analytical approach to the observations delivered by a particular branch of comparative history.  In practice it has been, as most histories are, a story that has been largely written under and within the hegemony of the victors.  And it is consequently appropriately biased, doctrinaire and dogmatic in many aspects which are often present only by implication rather than by explicit exposition.  They consequently remain hidden and unsuspected by many trusting souls who devote their lives to it.

For economics to be useful to policy formulation in all societies it has to build upon a deconstructed view of humanity, of societies and our processes of response to the challenges of our circumstances that determine our behaviours in meeting our most basic goals and how we then build upon them.  We need to be self-consciously aware of the metaphysical basis of 'acceptable behaviours' both in the face of local challenges and on the wider geographic platforms where societies interact and seek to develop behaviours that are acceptable and productive towards goals that have species relevance and are apposite to safeguarding our position across the global environment.

These goals, at the level of the human individual or that of the species, have no foundational, behavioural place in the current body of economic theory.  They have been 'accommodated' within certain 'result sets and policy proposals' but play no part in the development of those results and proposals.  They cannot because 'science' builds upon stable foundational truths. 

The stuff of economics is individual people and groups and how they create economic behaviours amongst themselves in response to challenges and needs.  They do so self-consciously.  Consequently they learn from what they do.  That causes them to further adapt and change their economic behaviour. 

Human behaviour is thus always undergoing change through time.  This happens in different places, to different degrees and amongst different numbers of individuals.  To a certain extent these processes might be simplified as being driven by individuals and groups following a path of rational decision making in their perceived self-interest, as Adam Smith characterised us.

What this produces is not a single, universally applicable economic system and institutional structure fit-for-purpose through eternity.  It is a myriad of local systemic implementations of unique approaches which have independently of, and also to differing degrees been developed through interaction with, other local societies who had their own challenges in their own different environments according to their own social mores and beliefs.

The challenge of economics, as a branch of Behavioural Studies, is to assist people in the adaptation and development of their future behaviours such that their personal, societal and species level goals may best be met within the determinants of our species identity and our drive to survive by continual behavioural adaptation whilst developing a trait we choose to call 'our humanity'.   

This is not a mission that can be undertaken with tools and theoretical approaches which refuse to be adaptive or considerate of people as the centre of the study of their various economic behaviours.  It is a mission which would rather study the behaviour of various people in the face of a 'given' system of economic relations and cadestral principles.  One which imposes a specific unique societal and institutional template on all data before interpreting it. 

Unsurprisingly the approach then encourages policy decisions at local and global scale that seek to alter the circumstances of the economic lives of people to the conditions required by the 'given' template so that the desired policy outcomes may be realised by the policies it recommends.  This is done on the metaphysical assumption that the chosen system is both the most effective in the face of all challenges and that it is the most effective in delivering on the life goals of each and every individual and that this unique system omnisciently knows better than each individual what these are.  In a consistent fashion its adherents thus have no ethical problems with also seeking to alter the the wants, needs and life goals desired of all individuals such that they can be met by consumption of the outputs of the economic system and its institutions the adoption of which the economists have encouraged the policy implementers to achieve amongst all societies that have not yet come to the same belief.

As Carlos Maldonado has recognised, there are large areas of economic behaviour which have not yet been studied although they still do happen.   Some of these do not happen because their study is unnecessary to the development of further validation of the neoclassical model or because they might weaken its authority.   Deep study of process industry will reveal it to be the primary engine not just of international trade.  It will also show the necessary and sufficient conditions for the perpetuation of a relatively stable paradigm of economic imperialism is the easy and flexible movement of process technology to the repatriated profit optimal locii of all factors of full-cost pricing as the total cost mix for any production process changes through time, provided that all exposed components of that technology can be protected in the hands of those that control or own it.  Thus you will see that any model of process industry must also include the arrangements by which intellectual property is internationally protected and the processes by which relative foreign currency valuations can be altered through short-term speculative transactions to synchronise with large funds transfers generated by the process industries with the context of MNC involvements.

Almost every aspect of a macroeconomic study of the international factors pertaining to the establishment, residency periods, protection, supply, ownership, funds transfer and intellectual property rights process industries are potentially significant would be seen as serving a dual purpose to the benefit of the host and the client nations. 

The 'inconvenient truth' it will show might account for some of the delay in any serious attempt to address the subject.  It might also suggest ways for client countries to take the benefits of hosting international process industry while totally eliminating the detrimental affects of long-term extraction of labour-time value via low wage structures, and through price manipulation of fiat exchange media through speculative transactions on forex markets.

Dear All

I do agree with what Sir Robin has said about the state of economics and economic behavior, here. 

With regards

Israr

If I may say so, the very core of any economical study consists en checking out/reviewing/critizising/re-evaluating/ etc. - the production function. That, I have the impression, is the most sensitive aspect - especially in the world we currently live...

I made a grave mistake when I posed my question. I did not give a definition of "processing trade." Robin Edward Jarvis have given a full essay in "processing industry" and it deserves its own consideration. I would like to discuss this point in later post.

My present interest is not "processing industry" or "processing manufacturing," but "processing trade."

"Processing trade" is defined in a document "Processing trade in China" by EU SME Centre as follows:

• Processing trade refers to the business activity of importing all, or part of, the raw and auxiliary materials, parts and components, accessories, and packaging materials from abroad in bond, and re-exporting the finished products after processing or assembly by enterprises within mainland China.

 A paper in HKTDC Research paper, defines processing trade practically in the same phrase. This my be an official definition by China's trade authority. This definition is too narrow as a definition of  "processing trade" because it supposes that the processing is made in a bonded zone (or in an equivalent status). 

Some papers refer to "processing trade" as an activity based on subcontract. This is a modern form of putting out system. This concept is also too narrow, because in this notion "processing trade" is restricted to a form of outsourcing organized mainly by firms in an advanced country and employ low waged workers in a less developed country.

Japanese concept of "processing trade" (a standard translation of a Japanese word 加工貿易(kakō bōeki, barred vowels are pronounced longer)) is much wider than the present notion of "bonded processing trade" or "subcontracted processing." It can be an activity made by an initiative of a country which burdens processing part.  Imports, processing and exports can be operated by different firms. A classical form of Kakō bōeki is the export of cotton textile while cotton flower was imported from abroad. In this case, import and export were a business of general trade company called Shōsha　(simply meaning trading company) and the processing (i.e. spinning and weaving) was operated by independent textile firms.

If I give a definition of "processing trade" of my own, it is a series of industrial activities that consist of importing major part of materials and parts, processing and assembling them into a manufactured product and exporting it. By this definition, majority of Japanese exports are a result of processing  trade. If I search exceptions, silk products until 1930's and  some agricultural products such as apples may be counted as genuine exports (meaning not depending on "processing trade"). The well known Japanese beef (Wagiu) is not a genuine export, because major part of feed grain is imported from abroad.         

Once we observe the interconnected character of international trade and manufacturing, all most all products are produced by Kakō bōeki. In this wider concept, we can say that majority of developing (and even developed) countries are facing problems of "processing trade" promotion. Foreign initiative in some cases of processing trade are essential characteristics of Kakō bōeki.    

I am not sticking to the term "processing trade." If some have an idea of an English word that can express Japanese concept of  Kakō bōeki, I will be willing to use that term. I am asking why this kind of conceptual lacuna emerged in the international trade theory.  

Dear Yoshinori,  Thank you for clearing up the semantic problem, in your usual clear and complete style. You teach very well!  It would appear that Kako boeki (apologies for character simplification.. my keyboard is not set up for a wide UTF character set!) is a special case within the general set of 'processing industry'.   The two key phrases, taken together, in the definition are "importing major part[s] ... [all physical inputs].." and "assembling them into a manufactured product and exporting it". 

The general case would be 'the manufacturing industry" in the context of global economic activity.  The production of almost any finished product involves multiple direct inputs each of which are likely to be the 'finished product' of a 'preliminary' manufacturing process which itself consists of manufacture from multiple inputs of which many in turn may be the 'finished' product of several 'preliminary' manufacturing processes.  This is to say that all manufacturing, in general, exhibits a fractal-like structure.  The spectrum of different arrangements and composition of 'sub-processes' can vary from a 'primitive sculpture' that is manufactured by a single sculptor who creates his own tools and obtains his own material from his immediate environment by his own skill prior to producing and selling his own art, and will extend to the most complex globally dispersed network of intermediary processing involving many companies and countries before the finished product emerges.

On this understanding of the position of 'processing trade' as that it is the result of having establishing a comparative advantage in the design of the systems and the application of the skills required to produce finished products for which there may be little demand locally but which are in great demand as exports,   This capability, when considered in its totality, constitutes a 'technology'.  One which some countries, such as Japan, are notable for having successfully developed and applied.  To their great profit. 

This great benefit was only realised because it is a technology that few other countries have been able to emulate... in particular those that have not been able to do so include those that spend the most money on university Schools of Economics and operate in the de facto 'lingua franca' of English!   It follows that an understanding of 'processing trade' as an independent and unique concept is not widespread.  It is largely confined to those countries that have made a success of this mode of economic activity.  Countries from which little knowledge emerges in English.

You do of course realise that you have now revealed the 'secret' of the 'miraculous' success of Far Eastern countries over the past 50 years, and may now face much more severe competition as a result!! :-))     Perhaps the USPTO will accept, and grant, a patent application from the Japanese Minister of Industry and Trade?

Dear Robin, 

you are right to say that "the general case [of processing trade/industry] would be the manufacturing industry." Processing trade (in my concept and the one in East Asian tradition: See P.S.) today is nothing other than manufacturing except that the former has a strong drive for export and a connotation that major or essential ingredients of the product are imported from abroad. 

This generality proves the importance of the concept of processing trade. Almost all countries (except for some oil rich countries and others) are endeavoring to promote “processing trade.” This is not simply to promote its manufacturing, because the industry thus enhanced must be competitive in the world market. Inevitably, this leads to Export-oriented industrialization (EOI). It is also evident that (pure) Import-substitution industrialization (ISI) without an effort to promote export is doomed to fail.

If we had a firm concept of “processing trade,” the arguments concerning ISI and EOI would have been very different.

Yoshinori

P.S.. Processing trade in three East Asian languages:

• 加工貿易　Kakō bōeki in Japanese
• 가공 무역　gagong muyeog in Korean
• 加工贸易　　jiā gōng mào　yì　in Chinese

What an excellent discussion between two learned scholars! For the benefit of the learners like us. 

Thanks, Sirs.

Dear Yoshinori,

Another, rather more directly cynical, explanation in answer to your question is suggested by the evidence that a fairly good understanding developed throughout the latter half of the 20th century amongst 'advanced nations' of the advantages for themselves of the international 'process trade', and also perhaps that the general global application of the model had certain prerequisite institutions if they were to gain maximal profit from it.

By the nature of human behaviour, well illustrated by the machinations to which corporations and local businessmen will both go to ensure that they are able to take  advantage of every opportunity that presents itself or which they can bring into existence, much of the potential benefit to those countries of a generalisation internationally of the 'process trade' might be lost to them.  The setting up of the prerequisite institutions had to take place in a necessarily global forum under a certain amount of public scrutiny, under the auspices of the UN.  If a large proportion of the populations of each of the developing and under-developed nations were fully conscious and aware of the likely long-term outcomes to them, both individually and collectively during their lifetimes, of the various negotiations and agreements that their governments would be called upon to enter into then their peaceable acquiescence might not be easily assured and the negotiations might become even more protracted and the final terms may not provide institutions of a design that is 'optimal' to those advanced nations initiating the process.

This paper by Jones in 2003 shows that by that time, across the fields of economic geography, economic fragmentation and of globalisation the issues, the opportunities, the structural consequences and likely distributed outcomes were already well understood:

http://www.econ.rochester.edu/people/jones/International Fragmentation and the New Economic Geography[2].pdf

The paper expresses everything in suitably 'objective' economically rigorous phraseology.  It could just as well have been written using the synonyms in more common use in the news media and in public debates.    But to have done so would have been seen as inviting 'normative' debates beyond the sterile positivist confines of modern economic study and practice.

The paper observes the global network of B-to-B trade which has grown greatly in volume as inter-business process fragmentation has proceeded along with MNC's globalising fragments of their own operations.   Despite the past 50 years having been billed by the neoclassicists and monetarist theorists as the opportunity for creating a wealthier and happier world through opening international trade to all countries, the details of the 'evidence' of the success of this process having occurred read, when translated into the words of the 'common man', like a catalogue of the sins of modern business which the world's green, ecological and humanitarian lobbies have made so familiar to us all and which now populate the majority of popular political rhetoric as the targets of necessary corrective action if we, as a species, are not going to be the cause of our own demise!

Low wage exploitation in rapidly expanded, utility deficient, urban concentrations of business concentrated around each developing nation's appropriate communication and transportation gateways through which all other input factors arrive and leave largely through highly profitable services owned and operated by MNC's of advanced nations;   the expectation that broadly speaking, this arrangement of technological and product advances originating in 'advanced' nations in which new products arise moving outwards to areas of cheap labour as processing technology is optimised and simplified (robotised?) so that fragmentation of product production through separating manufacturing processes from services allows dynamic optimisation of the overall profitability of each final product.  These are simply the scaling up of the factoring structure of the textile trades of Britain which date back to Medieval times over 500 years ago!  The Agricultural, Industrial, Technological and Information 'Revolutions' have each followed the same broad evolutionary process of adaptive fragmentation and optimisation of the dominant productive processes under the influence of changing technologies. 

It is not suggestive of a body of knowledge and techniques that is convergent upon also producing a world of universally wealthier and happier people.  Quite the opposite.

So the answer to your question, Yoshinori, might be that the clear identification and dissemination of the 'processing trade' model from the 1970's onwards would have quickly led to clear expositions and wide understanding of the 'mechanics' of international trade which would have undermined the very foundations of global institutions that had been in development since Bretton-Woods.  At least in so far as the hopes and expectations of their 'founding father's and governments' were concerned.  The UN, the World Bank and IMF to name a few.

To change any of this for the better economics cannot be practised without proceeding from some common adherence to a single 'Theory of Moral Sentiments'.  The basis of which must be a global understanding and acceptance of the particular system of ethical philosophy and its logically inferred principles upon which that morality proceeds.  Even that utopian dream is insufficient. 

Much of our economic understanding of ourselves is correct.  We often are selfish, greedy and too ready to take advantage of any power over others that we can exercise or manufacture or trick them into yielding to.  Economic processes and outcomes are suffused with the evidence of this.  It is common sense and we all know of it.  Yet.  We persist throughout economics as though morality is a given, or that all systemic wrong doings go unpunished by any exogenous factors imposed by the institutions of societies and communities.in which an economy operates.  Everybody is absolved by the inevitability of the power of the market to punish all wrong doings and can therefore be assumed away.  What sort of adult theorising is that?  It is a childish kow-tow to the interests of the politically powerful and commercially powerful who see them themselves as 'providers' of our individual incomes because the infrastructure in which we live has been constructed in such a manner that it would appear to be true.   But 'truth' is not the same as 'right'.  Economics may describe a truth, but that truth does not necessarily describe a 'right' thing.  Economics, without ethics, not only does not care it is systemically incapable of being concerned what the answer may be let alone to pose the question in the first place.

This is the problem.   You might just as well ask 'Why did the formulation of neoclassical economics come before a green/eco/humanitarian/universal economics?' as ask 'Why did the notion of "processing trade" not become a major concept before fragmentation and global supply chain? '.

The answers are very similar...   a lack of basic morality benevolent towards all members of mankind and the environments in which we live.

Very Respectfully,  Robin

Robin Edward Jarvis raises at once so points of discussion that are all important, I cannot follow him promptly. I want to answer to his second post (post number 7). In his third post (post number 10), he makes a point that economics cannot and should not go without ethics. He is fundamentally right, but I am not prepared to discuss this question yet and do not enter to this question in this question page. Mohammad Israr Khan posed a question: How do the economists define self-interest and rationality?

https://www.researchgate.net/post/How_do_the_economists_define_self-interest_and_rationality

In order to answer to his question in depth, I believe we cannot go without asking the elation between economics and ethics. I only started to learn one or two basic books to consider on this question. I will try to challenge answering in the near future (I hope). 

Another fascinating wonderful question, totally new to me, was raised by Carlos Eduardo Maldonado (post number 1) and Robin Edward Jarvis (post number 3, at the end of his post) mentioned on it:

• There exist large areas of economics which have not yet been studied or recognized although they still do happen  

I will come back to this question after I will have discussed Robins’ two points. 

Robin Edward Jarvis (post number 7) raises many points here also, but I want to discuss following two points in the coming two posts :

• (1) Technology in economics.
• (2) Fractal-like structure of the world production network.

Wonderful analysis by Yoshinori Shiozawa. I think I support Carlos answer to some extent. What I know is that theory is a reflection of reality. But can we say that this processing trade is embedded in the theory of comparative advantage or should we sieve it from it.   Comparative advantage tells us that all thing being equal, if I could produce cotton with high cost compared to other countries, I should IMPORT it. Now if I have comparative advance in the technology to produce textile compared to other countries then I can use the imported cotton to produce the textile which I will then export.  I think what can be done is to extend this comparative advantage theory to explicitly capture the processing trade. Meanwhile thank you for the knowledge provoking issue.

Prof. Michael Haynes, a colleague of Ebenezer, has written of the obligation for responsibility for people's lives that economists carry: 

https://www.researchgate.net/profile/Michael_Haynes/publications?sorting=newest&page=2  . 

This and much of his work touches, or directly confronts, the issues of morality and ethics with regard to the economic endeavours of man.  Mostly, but not exclusively, from an Eastern European historical perspective in the global context.  For those concerned to explore these questions the bibliographies of his publications would be a good starting point.

Dear Ebenezer, please allow me a tiny remark. Of course I get your point. Hwever, I'd like to go a tiny bit farther. I do not think that a tehory is (just) of reflection of reality. Moreover, in many senses, it illuminates reality as well as it does shape reality. Without a theory reality is,, at it s best, just an X.

Nonetheless, I do not pretend to subsume reality in a theory - though that is a much worthy dream of humanity. Reality adopts a form and a dynamics thanks to ouir capacity to explain it...

...which is to say, paraphrasing Carlos, that our present real predicament is in large part due to our failure over the past 150 years to update the basic theory of man and society that is embedded in our modern economic theory.  Our problem now is to do so, so that we might reshape the realities of our economic and social relationships in line with our modern more humanitarian and universalistic theory of man and society.

I could not agree more with you, dear Robin. Smack to the point!

Dear Carlos

Are you definite a trade theory cannot honour the man and the society? Are you, as your tone goes in your reply to Sir Robin, comfortable with an economic analysis sans any concern of the humanitarian values as raised by Sir Robin?

I do not think so. Sir Robin is very near to the reality. He is saying what economists, anyhow, avoid discussing.

With kind regards

Israr

(1) Technology in economics 

What is discussed as technology in economics is quite different from technology in industry or that understood by engineers. Robin Edward Jarvis surely have a good knowledge of the second kind, as he is a most honorable Fellow of the Royal Society for the encouragement of Arts, Manufactures and Commerce (RSA) and he must have discussed on this themes with his colleagues. 

Technology is first of all ignored from many economists. More often, technology is not a subject matter of economics of its own. Some economists emphasize that technology matters but they barely explain how it matters. We have not many papers and books that considered technology in depth. Major exceptions may be the following three books: 

• K. Marx Capital (1867)
• N. Rosenberg Inside the Black Box: technology and economics (1982)
• B. Arthur The nature of Technology: what it is and how it evolves (2009)

 Rosenberg was a historian of technology (he died this year) and his book has been influential, as it engendered the now flourishing idea of National Innovation Systems. Rosenberg is however more interested in the speed of technical progress (Rosenberg's terminology) than in the nature of technology.

 Many books and papers (about 100) appear in The historiography of technical progress, the 1st chapter of his book, but there are very few books which appear in the textbooks of microeconomics, macroeconomics or international economics. Notable exceptions would be two books of Schumpeter (Business Cycles and Capitalism, Socialism and Democracy), two works of Kuznets and a paper of Robert Solow (Technical Change and the Aggregate Production Function, 1957). Hicks' book (The Theory of Wage) may be cited by chance in a book but surely from a totally different interest than technical progress. Solow's paper is very often cited in macroeconomics and development economics textbooks (and I will come back to this paper soon). 

Technology is most often treated in economics as exogenous conditions. However, many textbooks including economic classics do not even mention technology. For example, we find no "technology" or "technique" in Smith's Wealth of Nations, Ricardo and Mill's Principles of Political Economy. Alfred Marshall's voluminous Principles of Economics does not contain the word "technology." The word "technique" appears only 5 times in the book which counts more than seven hundred pages. We cannot blame contemporary textbook writers who do not choose technology as an independent topic in their textbooks. 

This apparent neglect of technology does not mean that majority of economists are innocent with regard to technology. On the contrary, without being aware of what they are doing, they hold a extremely odd idea about production techniques or production processes. In any macroeconomic textbook, we find aggregate production functions. Remember this was the core of Solow's "seminal" paper. 

Solow is the very person who has succeeded to persuade majority of economists that technology is important. In this sense, Solow made an invaluable contribution to economics in redressing understanding of the role of technology in economy. However, his reasoning (or the model he relied on) is build upon a complete misunderstanding of production technique (at least in modern industry). 

Solow starts his reasoning from the aggregate production function in the following form: 

　　　Q = A(t) f(K, L).                              (1) 

Here, Q is the aggregate product (total sum of products in value), K and L are the capital and labor inputted in the production. Variables Q, K, L are functions of time t. Technology is expressed by A(t) f, where function f describes the substitution relation between K and L and A(t) expresses the technical change. This means that the production technique progresses in such a way that substitution relation f remains invariant. In the following, we simply write A instead of A(t). 

Differentiate equation (1) with respect to time t and dividing Q, we have 

　　　dQ/Q = dA/A + A(∂f/∂K)(dK/Q) + A(∂f/∂L)(dL/Q),  　　(2) 

where dQ, dA, dK, dL stand for derivatives with respect to t. If we note r and w the rate of return and the wage rate respectively, we have then 

　　　r = ∂Q/∂K = A (∂f/∂K) and

　　　 w  = ∂Q/∂L = A (∂f/∂L). 

Substituting these equations in to (2), we finally have

 　　　dQ/Q = dA/A + r (dK/K) + w (dL/L).                 (3) 

Based on this relation and American data over the period from 1909 to 1949, Solow determined the contribution to the growth of each factors technology, capital and labor. The result was summed up as follows: 

• Gross output per man (Q/L) doubled over the interval, where 87½ per cent of the increase is attributed for technical change and 12½ per cent to the increase of capital.

 This result was astonishing for majority of economists at the time, because it was the custom to think that growth is a result of increasing inputs. Many studies followed after Solow. The estimation changes according to data and period, but contribution of the technical change was always considerable.

 To estimate each contribution of equation (3) became a standard routine and named growth accounting. This growth accounting is used not only in growth analysis of advanced countries but also in the discussion of economic development of less developed countries.

 Nobel Prize in economic sciences in 1987 was given to Solow by his contribution to this theory of economic growth. His influence did not remained in the "classical" growth theory but the new theory called Endogenous Growth Theory in 1980's and after, Real Business Cycle (RBS) theory and Dynamical Statistical General Equilibrium (DSGE) theory are deeply inspired on Solow's model and adopt production function of the same form. 

There was a strong objection made by Herbert A. Simon, pointing that Solow's growth accounting is in fact a different expression of accounting identities. His paper Parsimonious Explanations of Production Relations was published in The Scandinavian Journal of Economics at the time when Simon received in 1978 (before Solow) his Nobel Prize in Economic Science. This coincidence was intended one but ignored by the majority of economists including Solow. 

Production function of form (1) or more general ft(K, L) is widely used in macroeconomics and in microeconomics. It is hard to find in the mainstream economics any textbooks which do not employ this kind of production function. 

Economists do not consider deeply what this production function means. Capital and labor are measured in physical units (Solow, 1957, p.312). Unless capital is highly malleable steel or so, capital goods take concrete forms of various things: ingredients and parts if they are circulating capital, and tools, machines and installations if they are fixed capital. Then K is a set of miscellaneous goods. The production function f(K, L) expresses that some amount of a product is obtained at the end of production process, if we input K and L whatever the composition of K. In a word, the production function expresses production activity in a primitive society, where "bricolage" (Claude Lévi-Strauss) is the standard principle of making necessary things. Modern industry is based on totally different principles. Can you imagine that 10 wheels and 3 sets of wire harnesses, 2 bodies and no engine make something similar to a car? 

In the case of aggregate production functions, various arguments may be possible, but many economists believe that production function that is continuously differentiable is a good description of  the production possibility relations for a production in a factory. A short reflection on how the products are produced will easily reveal how production function formulation is ridiculous idea for an industrial production.   

At the very basis of neoclassical economics (micro or macro) lies a serious flaw if it is examined from a production technology point of view. This proves (I think) that mainstream economists have never considered how the industrial products are made.  

Before and after 2000 difference may be partly due to China's accession to the WTO in 2001.  China's external trade, which had already included significant processing trade, increased sharply starting around 2003, with processing trade increasing at least as fast if not faster.  This tremendous growth in China's processing trade generated considerable interest among academic economists and policymakers.  Now the emphasis has moved towards measuring trade on a value added basis.

Dear Robert E. Yuskavage,

please note that value added trade, global value chain, offshoring and fragmentation are all varieties of processing trade in my definition (and in East Asian traditional concept). See my post (post number 6). The processing trade you are referring to seems to me bonded processing trade.  Do I  misunderstand you?

I think labor-abundant economies can solve problems of employment and earning

foreign exchange through the 'processing' of imported goods for export. This was true when Flanders used British wool to export throughout West Europe. It remains true as Mauritius exports woolen gloves and mittens without keeping any sheep.

Such activities become alternative to let local labor working abroad. With reduced transportation/communication cost, task trading blossoms along the supply chain.

In China, imported inputs for export is tariff-free, and that type of activity is separated in statistics under the term kakō bōeki, but pronounced in the Chinese way. This is what made China into the World's Workshop. Technological progress leads to production fragmentation, and the size of the Chinese population makes Chinese trade significant. Both of these factors make 'processing trade' an often used term today, I think.

Not necessarily just bonded processing trade.  China distinguishes between processing with assembly and processing with imported materials.  The former excludes the purchase of intermediate inputs (assembly only with no import duties) while the latter includes the purchase of imported inputs on which import duties must be paid.  These import duties are rebated if the finished product is exported but not if sold in China.

Both types have increased sharply since China's WTO accession.  My point is that the sharp growth in China's processing trade and its implications for trade imbalances may be what generated the increase in articles that you cite.  This growth was also partly responsible for the IMF Balance of Payments Manual (2009) new recommendation that "goods for processing" be excluded from merchandise trade and only the manufacturing service be included as trade in service.

(2) Fractal-like Structure of World Production 

The second point of discussion that Robin Edward Jarvis raised in his second post (post number 7) is the fractal-like structure of world production. As he noted, 

• The production of almost any finished product involves multiple direct inputs each of which are likely to be the 'finished product' of a 'preliminary' manufacturing process which itself consists of manufacture from multiple inputs of which many in turn may be the 'finished' product of several 'preliminary' manufacturing processes.  This is to say that all manufacturing, in general, exhibits a fractal-like structure. 

Indeed, all manufacturing product is a fractal itself. Of course, it is not a geometrical fractal on a plain, but if we consider the composition of each component a product can be seen as a fractal. 

Imagine a product Π(a) that is produced in country A. Suppose it is manufactured using a part Π(ab) manufactured in country B and a part Π(ac) manufactured in country C. As Robin described it, part Π(ab) may be made using a part Π(aba) from country A and a part Π(abc). In this way, if we go upstream the series of productions, we get a chart like this: 

                           Π(a)

               Π(ab)              Π(ac)

       Π(...)    Π(...)    　Π(...)      Π(...)

     Π　　　Π　Π　　　Π　 Π　　 Π　　Π　　  Π

 　.　.     . . 　  . .       . .     . .      ..       ..         ..

This chart can be extended infinitely. This kind of illustration is possible when the number of parts is limited up to 2. When there are parts imported from 3 or more countries, illustration becomes much more complicated and messy but it is true that the production has more complicated fractal structure. 

There are two types of thinking on the structure of production. In Austrian school tradition, products can be classified by orders. Raw materials before mining and smelting form products of order 0. Products produced using only raw materials are order 1. By induction, we define the order of a product as follows. A product is order N when it is produced using products of order less than or equal to N-1 and using at least one product of order N-1. Thus Austrian school of economics thought that products are produced from products of lower orders and most elaborated products have higher order than lower order more primitive products.

 The second type of thinking observes that products are produced by products but it is impossible to arrange them in a linear order, because they make a circular structure.  Piero Sraffa referred to this production structure as Production of Commodities by means of Commodities and used it as the title of his famous thin book. 

In the first type of thinking, the above chart ends at a finite rank whereas in the second type of thinking the above chart continues infinitely and this makes a true infinite fractal. 

This fractal structure of world production was the main reason why trade theory which admits input trade was difficult. The production cost of a product is decomposed into a sum of different countries' wages. Thus a production cost depends not only on the wage rate of production countries but also on wage rates of other countries which are providers of different parts. 

On the other hand, each firm compares the prices of a part and procures the cheapest one, if there are several countries which can produce the same product of the same quality. Therefore, when international values are concerned, we need a theory of systems of simultaneous inequalities. 

Let a(τ) = (0, ... , α, ... , 0; a1, ... , aN) be input coefficient vector of a production technique τ in country i. (Distinguish Greek tau τ  and italic upper case T) Here the first part is the labor input but posed on the i-th coordinate because workers of different country are considered as different labor. Each country is endowed with a set of production techniques for each product (including the case of prohibitively inefficient technique). One country may have several production techniques for a product. Let T be the number of all production techniques. T is equal to or greater than M・N. Arrange all these production techniques in column and we gets a T×(M+N) matrix A. 

Let v = (w, p) = (w1, ... , wM; p1, ... , pN) be a international value vector composed of wage rates and prices. Then the production cost by technique τ can be expressed by a bilinear form 

   =  wc(τ)α(τ)c(τ) + ∑j aj(τ)pj.

 If we assume that markup rate is 0 (the case of positive markup rate can be treated in the similar way), the firm which operated technique τ will price its product . A value vector v = (w, p) is admissible when 

     A v ≧ p.

 Now, let c(τ) and g(τ) be the country of production and the good produced respectively of technique τ. If v is admissible, we define index pair (i,j) competitive when 

       = pc(τ)　for some τ which satisfies i=c(τ), j =g(τ).

 Given input coefficient matrix A, the competitive type T is defined as a set of all competitive index pairs. Then T is a subgraph of the complete bipartite graph KM,N. An admissible value v with this competitive type has a nice property when T is spanning and connected, for example the value is uniqueness up to scalar multiplication. A production that is composed of productions belonging to type T is defined as production belonging to T.

 A type T is by definition spanning and connected tree when following three conditions are satisfied.

N.B. Many mathematically interesting questions exists around this concept. See for example

https://www.researchgate.net/post/Do_you_know_an_algorithm_that_gives_an_admissible_tree_in_a_complete_bipartite_graph_which_has_a_given_right_degrees

https://www.researchgate.net/post/Do_you_know_the_number_of_all_spanning_trees_of_a_given_class?_tpcectx=profile_questions

 If there exists a positive vector v = (w, p), then it is easy to show that a value vector is unique up to scalar multiplication. This is what I called regular international value. Existence of a regular international value requires deeper analysis but we can analyze many properties that we observe in classical value theory. For example, the value does not change even if demand (and therefore production) changes as far as production belongs to the same competitive type. In this way, Ricardo's trade theory can be generalized to a very wide economy of many countries and many goods which admits choice of production techniques and input trade. 

It is important to note that core tool is the theory of systems of linear inequalities. Schumpeter once pointed that Ricardo tried to solve impossible question because it needed "to deal with systems of simultaneous equations" but he lacked that capability which Alfred Marshall and Léon Walras were equipped with (Schumpeter, History of Economics Analysis, p.543). As far as trade theory is concerned, Schumpeter should say that Ricardo lacked the necessary tool which is the theory of systems of linear inequalities. The latter developed in the 20th century and this explains why trade theory with input trade was not developed in the 19th century. In fact this trade theory was not constructed until the 21st century.

 Dear Henry Wan and Robert E. Yuskavage,

thank you for clarification. I (and readers of this page) have understood the details of classification and how duties are treated. I have to thank Henry Wan, because this is the first and unique answer he made in RG. This is a great honor for the question and for me. Robert E. Yuskavage has worked and is working (I suppose) on the design problem of statistics. It is a great job. All economists owe much to this spadework behind the scenes.

As Henry Wan remarked on English wool export to Flanders, "processing trade" played a extremely important role in shaping the economic power balance between countries. The Netherlands exported woolen cloth to other countries and this was one of the source of wealth accumulation.

As Wan emphasized, processing trade can contribute to solve problems of employment and earning foreign currency. In this sense, processing trade has been one of nation's important policies. It did exist since before the modern capitalism. Now, what was the reason that this important key policy lacked the general concept until around the beginning of the 21st century? How do you think on it?

Dear Yoshinori, Although my linear algebra is by now so rusty that I cannot critically assess what you have written down, it does certainly appear to describe very well a quite reasonable model for trade which is vastly superior to those which the mainstream papers are still struggling with. 

The graphical representation of models in 'hyperspace' tends to be a mental exercise! However, a paper by Shian-Loong Bernard Lew at Taylor's in Malaysia dealing with the application of game theory to the modelling of economic behaviour may be helpful. In it he links to works in which gaming tree structures and linkages have been graphically represented in 3-D space.  This may be helpful.  His short paper, at a philosophical level is also very impressive, although I think he intends it to be more of a call for more people to explore and use the gaming approach...  many elements of which I think I see in the model you have described here.

A concern that I have with all trade models arises when one puts data into them.  There then exists a 'tautological' construct, a circularity as regards value and price.  This arises because of the 'un-modelled' existence of foreign exchange 'casinos' in which exchange values of the currencies involved in valuing the product are subject to strong extraneous influences chief amongst which is the sentiment created by central banks, politicians and influencers of media content amongst currency traders.  This form of market power at the level of nation state (or currency region) is analogous to that of monopoly (on a dollar standard) or oligopoly (on an OECD basket of values).  It enables strong nations to devalue the labour component of manufactures they import from weaker countries while over-valuing their own labour value.  Intellectual property rights and biases built into bilateral agreements between trading states and more generic WTO agreements also contribute to this phenomenon.  These institutions are analogous in their effect upon perceptions of value to those intra-country institutions whereby labour forced to be exchanged for wages is structurally devalued through the operation of the relationships between private or state ownership of everything that can be defined as a 'property',  the right to expect a rental income from that ownership and the over-valuation of the labour expended in 'management services' applied to the economic application of that owned property.

It is for this reason that I see the most useful application of 'heterodox' economic theory to be that of contributing to the building a paradigm of theory that is based upon a model of 'economic man' which has as 'his' goal his own, 'properly defined' well-being which is in the context of desiring it to be consistent with the perceptions of well-being held by everybody else.  This would be a labour value based body of knowledge claiming not to represent 'life as it is' so that institutions might be developed and modified so as to support the imagined status quo such that it becomes our reality, as happened in the past, but one that claims to represent 'life as it is desired to be' so that institutions might be developed and modified so as to support a desired dynamic state of being. 

'Economics' is supposed to be synonymous with it being 'The Philosophy of Political Economy'.  The use of the word 'political' reflects the belief at the time of the primacy of the nation state and its 'macro' interests.  Interests which just happened to be totally convergent with those of a small social class which already owned just about everything.  'Political Economy' is by definition about furthering those interests, through policy, which are aligned to those of 'the body politic' and not coincidentally those of the persons of which it is comprised.   It might be far more appropriate for the current times to commence with a field of 'The Philosophy of Human Economy' which begins with its own  'Theory of Moral Sentiments' before moving on to build the analogues of the classic works.  Perhaps entitled'.. Regarding the Wealth of Persons' and 'A 21st Century Restatement of the Ricardian Theories of Value'.  As you have shown through Evolutionary Economics, we have many of the tools that might be needed, and Bernard Lew has suggested a perfectly valid path already exists for further fruitful developments.

This work, if it is to emerge from 'All the Other Doctrines' aka. Heterodoxy it must be able to present a degree of coherence across its many aspects so that it can be recognised as having its own powerful identity able to challenge and supplant the neoclassical view that is now an artefact of the past, a mere dogma.

I hope I have not upset anybody, or disgraced myself.  I am as you can see somewhat passionate about people.  Economics kills... it should be handled carefully and it has to be reformed.  Before more people die.

Kind regards,  Robin

I would like to suggest a couple of additional points:

1. In PRC, they have 3 or 4 types of processing trade, but only one seems to weigh most heavily. The practical issue is businessmen prefer tariff exemption than tariff rebate as far as possible. Dealing with bureaucrats anywhere raises blood pressure, causes nightmare. 'When can I get my money back?'

This is true in Taiwan, too. Some former Texas Instrument executive told me so.

2. Actual importance of processing trade is: China has run huge, continuous payment deficit in non-processing trade.

See Thorbecke, Willem (2015), Measuring the Competitiveness of China’s Processing Exports, China and World Economy 23:1, 78-100.

The implication: Chinese growth might have slowed down way earlier like India did, after India's 1st 5 year plan, when trade deficit forced the country to focus on import substitution.

3. At the same time, tasks-trading is not free. The fragmentation model of Jones and Kierzkowski includes a 'fixed cost' for linking production up across countries.

Henry

A large part of that 'fixed' cost can be laid at the feet of the cost of the 'energy of transportation', less formally called 'oil'.  The facts regarding the advantages to dominant producers of fragmented processing reduce to those of labour wage-exploitation but this is compromised by high raw fuel costs, high fuel transport costs and long sea and air routes.  Hence the world's flash points all involve the military power, or threat thereof, of the fragmented-process industry's dominant players as these areas all host or contribute in one way or another to the management of the costs of these factors and hence of the profit derived from the fragmented-processing industry.  This qualifies them as those countries' so-called 'vital interests'.  From this perspective one can see that the international petroleum industry as well as the ownership or significant shareholding by firms of these countries in local fragmented-processing industry companies are a manifestation of vertical-integration by them in this industry.  A natural business phenomenon which further maximises their opportunity for repatriating value that is actually produced by labour in those local countries.  It is all a very integrated and complex example of system engineering in the international corporate context.  It is not susceptible to simplistic models of free markets and free competition conceived 150 years ago.  That is just a convenient myth.

PRC jealously guarded and developed the labour value available to them and they tried to use it optimally for their own benefit as they developed their basic infrastructures, their business and their industrial communities with local and public ownership before engaging in large scale Kakō bōeki.  After 1945 Japan's industrial and business infrastructure was largely intact and they were able to move into this area, on their own account, much earlier than PRC.  On the other hand ROC appears to have been much more exposed to foreign initiatives in the founding of their Kakō bōeki sector, as perhaps were most other 'Asian Tigers' of the time.

Yoshinori asks "Now, what was the reason that this important key policy lacked the general concept until around the beginning of the 21st century?" Taking as an example the 'wool trade' between England and Flanders this processing trade is taught in Economic History, and in schools in the mid-20th century, as being a 'factor trade'.  This did not refer to to an 'economic factor' but to the people who 'ran the trade'.  They were called 'factors'.  In England they would deliver and collect the wool through a series of skilled specialist cottage (home industry) workmen (and their families), paying the workmen at each stage for the service that had been rendered, until at last the finished cloth could be sold on to the Flemish merchants.  The wool was produced in England, and made the aristocracy rich and paid for nearly all the village churches scattered across England.  The skills originally arrived from Flanders, in East of England at the village of Worstead, as a consequence of refugees from the French and Spanish occupation of the 'Low Countries' and from religious intolerance.  They also brought with them continental business connections and market knowledge.  The early Industrial Revolution brought these scattered 'independent' clients of the 'factors' to points where economies of scale could be realised, near to water power, clean water, Fuller's Earth and newly invented machinery.  These places were therefore called 'factories'.  This concentration of labour, under the discipline of wage employment with no alternative access to means of self-sustenance, culminated in the invention of steam power.  By this time the 'Flanders' trade was a dim memory and empire trade was the focus.  It was at this time that Smith and Ricardo began formulating their ideas. The Dutch East India Company in the 17th and 18th Century were secretive and a power to themselves.  They were also not English, and were imperial rivals.  If they developed a strong process trade in the East, it would not have been well appreciated by these thinkers at that time but merely would be seen as 'trade'.  The same is true of British companies operating out into the new empire. 'Trade was king', not processing.  It was upper most in everyone's thinking and those who promoted 'trade' were self-consciously called 'Mercantilists'.  They were not called 'Foreign-land Factors' or something similar.  Their perception of reality remained the dominant one to recent times, even though reality for those countries practising 'process industry' has been perceived differently since much earlier.

Just another perspective on arriving at a possible answer to your question.

Regards,  Robin

Robin

The following is an excerpt from a paper titled Firms in International Trade in Journal of Economic Perspectives, 21: 105-130, 2007.

• A large share of international trade, however, takes place between relatively similar trading partners, apparently within industries (Grubel and Lloyd, 1975). Germany and the United States, for example, exchange automobiles. This fact and others led to the creation of “new” trade models by Paul Krugman (1980), Elhanan Helpman (1981) and William Ethier (1982). (Bernard et al., 2007)

In the case of intra-industry trade, only a few years passed after the recognition of its heavy weight until an arrival of a new theory (so-called New Trade Theory) that explains the existence of intra-industry trade. Importance of processing trade or input trade was obvious since the time of the Industrial Revolution. McKenzie and Jones emphasized, already around 1960, the necessity of constructing a theory that incorporate trade of intermediate products, and yet a general theory was not constructed until the 21 century.

One of the reasons of this delay can be explained by Jones's (1963) misleading comment. In fact, Jones wrote that he explored "the case in which intermediate products are freely traded" (Jones, 1961, p.161), but in reality he had only succeeded to treat the case where all material input coefficients are the same for all trading countries (symmetric case in Jones's expression). We can find an evidence that illustrates an atmosphere carried on from Jones's time:

• Jones supplied the crowning achievement of his area of trade theory, answering a question that had been outstanding since the time of Ricardo. The contribution was so definitive that the Ricardian model has since been used almost entirely as a tool for other purposes and not as a subject of research in its own right. (Ethier, 1999, p.764)

This misunderstanding which prevailed after Jones (1961) may have prohibited sincere effort for constructing a general theory. Why many economists were satisfied can be explained by my assumption that economists in international trade theory are not really interested in theory. On this account, see my another question:

https://www.researchgate.net/post/Why_are_researchers_working_on_international_trade_not_interested_in_theory_questions

If we examine the case of New Trade Theory more deeply, we may find some hints. The results obtained by Paul Krugman (1980) and others are quite restricted, because the models suppose an extremely high symmetry (thus a very special situation) either on demand function (through utility function) and on production function. It is quite strange that no trials were made in order to set those examples in a more general framework. Are they all thinking that the general theory is provided by general equilibrium theory such as Arrow and Debreu? They should have known that increasing returns are excluded from this general theory by the convexity assumption on production possibility sets. I do not understand why they were satisfied by this unsatisfactory state of the theory?

Why do economists in trade theory satisfy themselves only by discovering an example that illustrate the phenomenon? This proves again my assumption or doubt that researchers working on international trade are not interested in theory questions. How do you think of it?

Reference:

Bernard, Andrew B., J. Bradford Jensen, Stephen J. Redding, and Peter K. Schott (2007) Firms in International Trade, Journal of Economic Perspectives, 21: 105-130.

Ethier, W.J. 1999 Jones and Trade Theory, Review of International Economics 7(4): 764-768.

Jones, R. 1961 Comparative Advantage and the Theory of Tariffs: A Multi-Country, Multi-Commodity Model, Review of Economic Studies 28(3): 161-175.

"Why do economists in trade theory satisfy themselves only by discovering an example that illustrate the phenomenon?"

Tentatively, might I suggest that it is because they are human?  Perhaps 'rationally following their own (short-term) self-interests? After all they are also economists!

Rob

Dear Robin,

of course, you are right! We are all human and have a lot of defects. All researchers have their freedom to pursuit objectives at their choice. And this is the reason that we should always reflect on our general tendency of our pursuit and ask if we are going "right" way.

I am still reflecting on Carlos Eduardo Maldonado 's comment (post number 1). As he put it,

• much of how the world is being run happens without a theory.
• a large part of science takes place without a solid theory.

Of course, Carlos is fully right! As an old prayer says, we must have serenity to accept what we cannot theorize, but also we should have the wisdom to distinguish what we can theorize and what we cannot, and we should have courage to challenge theorizing when we can.

I wonder if the subject of processing trade was something that was difficult to know and ponder on it as a theory problem.

Dear Yoshinori,

I think your last proposition is probably true.  The problem, I think, might lie in the question of prices ( accepting that they have little to do with 'value' in any absolute sense during the course of daily business transactions ) and the granularity of trade transactions combined with the long term contractual nature of many more.

If you go back to Ricardo's simple model.  Then reconsider it, not as a proxy for an equilibrium 'market clearing' data point, but as the aggregation of a series of transactions occurring over time within a closed economic group.  Expand the matrix to 4x4, with the production of four different products requiring different content of labour-hours (1, 1.5, 2, 2.5 per unit) at equal 'time' capacity (8 hours each) of 4 individual's allocated in the rows across the production quantities accepted by each in turn from each other for their 'consumption', including the retained own production for own use, down the columns. Then 'randomly' allocate a consumption pattern for each producer down each of their columns such that each has a different total consumption of units produced.

If one then re-writes the matrix obtained, converting all of the 'units consumed' elements of the matrix to the labour-hours they each represent, and normalise the matrix.   What you now have is not 'shadow prices' in the normal sense but the agreed rates of exchange applicable to each of 12 transactions between the particiapnats in the 'economy'.

This reveals that in the real world, as we well know, prices are in general individaully negotiated when the circumstances of the 'trade' permits i.e. when the prices are not administered and there exists sufficient discretion on the parts of both parties for each transaction to result in a different price.

In international trade this is the situation, for the majority of the volumes concerned, and can be said to characterise the nature of the trade.

Thus Ricardo's simple approach is totally inappropriate as a basis for scaling up anything from and to still expect a valid model to result.  Just as it is invalid in anything except the artificial 'instantaneous market clearing of multi-lateral trading frenzy' into which it tries to reduce our reality.

It also reveals that their is unlikely to be any reductionist approach to theorising about international trade due to the multiple and various types of 'exchange value' negotiating styles involved and the many contractual periods varying from one-time trades to long-term contractual arrangements, with and without links into prevailing currency exchange rates, rates of interest, prices of oil or coal and so on. Not to mention significance of each of these factors being also likely to be dependent upon the contract periods that might be involved and the rates of delivery that they call for.

But we also have to remember that the granularity of these operations tend to immediately call into question the validity of any assumptions regarding the 'freedom of the market' we imagine it represents by reason of the likely lack of sufficiently fine grained competition in large parts of it.  Again, long-term contracts tend to mitigate the uncertainties, and therefore the equilibria inducing influence, of competition and market forces.  The 'free information' requirement is even more obviously unlikely to be met in these circumstances.

High granularity of participants and transactions, at first glance, suggests that international trade has more to do with the simultaneous playing of multiple games of strategy in which certain outcomes of certain of these games, the mix being specific to each 'trade' or strategy game, are input factors into each one of the games being played.   Even when I buy an item on EBay sourced from another country I might strategically time the transaction according to currency fluctuatioin expectations based upon many other factors, I might be concerned about freight rates, seasonal congestion.. and hence fuel pricing.. with transportation options, duties and taxes, my won cash flow and costs of money...  and I am not even negotiating price! For me and my small requirement prices are administered and I am not competing with anybody for a limited supply... demand will bring that forth.  Yet there are millions of others like me 'polluting' the trade figures... perhaps creating data leakages!

But theory is important, even if modelling with real data cannot be done.  It is the perceived potential value of credible models credibly derived from credible theory which brings forth the 'governmental' actions that cause the data sets that are needed to create real and useful models to be collected from the trade processes and transactions which are taking place.

And... as you have said... THAT does require wisdom.  Theorists do need to know where to put their limited time and effort.  We only live once (I think!) and if reward and recognition in this life is one's aim from applying what personal skills and resources one has then long-term projects are not good choices.  Long-term complex projects with no assurance of valuable results are even less likely to be undertaken.

For most academics they are young enough to be looking always for 'good career choices'.   Therefore, International Trade Theory probably does not qualify, in their minds, as being worthy of any attention.

Then there is the question "Who is it that will gain value from an effective theory and the modelling with predictive value that it may provide?".  I suspect that the main beneficiaries will be the least powerful, and therefore least wealthy, countries.  The powerful trade participants gain value from the exercise of their economic power which is facilitated by the promotion amongst less powerful nations of the myth that 'barrier free trade' will benefit them in their dealings with the larger players and that in some way, supported by neoclassical justifications appealing to authors such as Ricardo,  'barrier free trade' is in some way the same thing as a 'free market' and that it implements the pre-requisite conditions for a 'free market' and is therefore 'fair' also.

The last thing the large economies need is truth, or even a little.  It has nasty habit of exposing cynicism for what it is.... the practice of deceit and lies.  An ancient component of the most rewarding trade negotiations and of almost every market trade from the pavement pedlar to the boards of global corporations and the offices of government Ministers of Trade.

As I have said already, first you need a credible Theory of Moral Sentiment, a new essay 'On the Wealth of Individuals and Communities' and then some very good PR. And a large amount of cash and personal independence of action!  I am still working on the first two items on the list....   then comes faith!

Much Respect and Regards,

Robin

Respected Yoshinori Sir,

You have got a right hunch that the "researchers working on international trade are not interested in theory questions". The reasons for this phenomenon to  happen may be numerous. To me comes this one:

Any theory worth a valid recognition and satisfactory explanation, in the contemporary circumstances, needs a lot of explanatory variables but most of them may not be convenient enough to be included in the proposed theorems because of the ideological, computational, control or any other reasons.

With best regards

Israr

Fascinating question, indeed.

Some argue that processing trade as part of global value chains is nothing new and has been going on for centuries (the "Old Wine in New Bottle" side of the story: this is just a new facet of MNEs exploiting developing countries). Others (and my own opinion) that this is an entirely new ball game which started taking place from both a theoretical and a practical point of view in 1985: Michael Porter for the theory of value chain optimization and Japan for her strategy of outsourcing/offshoring to foreign countries the part of production that had became too expensive after the Yen revaluation. 

But this new model (further developed from an international trade perspective by e.g., Baldwin, Richard (2006) "Globalisation: the great unbundling(s)" Economic Council of Finland, or  Grossman, Gene and Esteban Rossi-Hansberg (2006) "The rise of offshoring: it's not wine for cloth anymore") was still looking for appropriate data.

On the empirical side, D. Hummels provided a measure for vertical specialization based on input-output and trade data (2001? not sure of the date);  following this lead, Daudin, Gillaume, Paola Monperrus-Veroni, Christine Rifflart and Danielle Schweisguth offered in 2006 the first global measure based on GTAP (but the paper was in French, too bad for them ("Le commerce extérieur en valeur ajoutée"). 

Then the statisticians came-in: a communication by WTO to the French Association of National Accounts  in 2008 on new ways of measuring trade when global value chains are prevalent, a WTO-IDE-JETRO measure of trade in tasks in East Asia (2011) then the OECD-WTO Trade in Value Added database.  

So, this is a classic (and success) story of a new model walking on both legs: models and data; the journey is just beginning. As you mentioned, the literature is booming and the statisticians are busy expanding data coverage and designing new value-chain indicators.

This said, economists should be modest: supply chain management has been in the program of business and engineering schools at least a decade before mainstream economists start realizing that something new was happening in international trade.

And Merry Christmas to all

Hubert 

Professor Shiozawa,

I have learned a lot from the discussion.

I would like to suggest that over time, certain new elements come into play that at once make the issues more complex, but also more important.

There is a time dimension in processing trade which looms large nowadays as processing firms compete not just in cost, but also in the time-to-market dimension, not usually mentioned in the literature.

In David Morawetz (1981) Why the Emperor's New Clothes are not made in Colombia, one can see the importance of this factor. In Michael Borrus (1997) Left for Dead collected in Barry Naughton ed. the China Circle made the claim that American electronics industry survived the competition from Japan only by seeking Asian subcontractors who can deliver goods fast. If trade patterns (or survival of national industries hanging on a thread on the characteristics (such punctuality) of the subcontractors in the processing trade, naturally sooner or later, attention of economists have to gravitate to the topic of processing trade. It is unlike the days Tudor  rulers in England took generations to erode the power of Bruges as a center of processing wool textile.zzz

In Tung and Wan (2013), Chinese electronics export, Taiwanese subcontracting, World Economy, we mentioned a little bit how the time dimension matters in today's competitive environment. This is the situation that the trade pattern is decided by detailed characteristics of the processing trade.

Actually there was a news report that HP has a plant in West China shipping outputs to Europe. Ocean transportation is cheaper than taking the transcontinental trains, but HP choose the latter, since it deliver the goods faster, and HP can act on that  earlier information, say, stop producing the unsalable. This does not directly deal with processing trade, but highlights the importance of time, which can affect the choice of the supply network and who will be the winners on the competition.

Thanks for allowing to participate in the discussion.

Henry

Hubert says "

Michael Porter for the theory of value chain optimization and Japan for her strategy of outsourcing/offshoring to foreign countries the part of production that had became too expensive after the Yen revaluation.

Why did the notion of "processing trade" not become a major concept before fragmentation and global supply chain? - ResearchGate. Available from: https://www.researchgate.net/post/Why_did_the_notion_of_processing_trade_not_become_a_major_concept_before_fragmentation_and_global_supply_chain#view=5679591360614bb3818b4576 [accessed Dec 23, 2015]."

I am sorry.  Perhaps I do no longer understand the rules of what constitutes a behavioural theory, and what constitutes a new behavioural theory.  Specialisation is an optimisation of available resources, better specialisation than the next person provides competitive advantage to those consciously or inadvertently following that strategy.

Value chains existed and were optimised by medieval wool factors to get the most and fastest conversion of raw wool to exported cloth.  Those Bruges factors with their own agents operating as factors and facilitating the work of villagers washing, carding, spinning, weaving and finishing cloth and of the carriers who transported the consolidated loads in the areas beyond Worsted in East Anglia were clearly engaged  in off-shoring and vertical specialisation which was in no basic way any  different from what MNE's do today, amid a fanfare of new semantics,  

I do not understand how the updating of models and the development of new data recording capabilities and the development of new data sets to cater for the inevitably changing details of human trading behaviour under the impact of the passage of time, new products, new technologies and new geographies can be represented as a new theory.

I suddenly feel like a visitor from an alien planet.  Perhaps it is a matter of my disadvantaged cultural background that tells me 'If sits like a cat, moves like a cat, eats like a cat and sounds like a cat... then it is a cat."

Or is it simply that I cannot see the Emperor's New Clothes?  I certainly do now feel like a little boy pointing a finger.

I hope that someone can explain what subtle point I have missed? 

I hope that point is not that the 'old' theory exposes too well to public view the extension of the exploitative model of cheap labour from the factories of 18th and 19th century England to global scale and now desperately needs to be obfuscated with the only means available..  semantic confusion and a new set of clothes for the Emperor.

Thank you and, really, very respectfully...

Robin E Jarvis

Dear Robin,

Interesting debate indeed…

On the “new paradigm vs. old wine in new bottle” issue, one may criticise the importance given to the new type of trading arrangements (a large share of trade is still done under 19th and 20th century type of comparative advantages), but you should not discard it entirely as old capitalist wine into new disguise. Previous inter-industrial complementarities that existed along the Silk Road, in Medieval Europe or between colonial empires and their colonies were based on difference in natural or technological endowments. And the models used to analyse them were based on the non-mobility of these resources.  

Outsourcing is new in the sense that it is founded on micro-economic decisions of the type “make or buy”.  The decision of Apple to buy its micro-chip from arch rival Samsung, or Daimler to subcontract the design and production of its Smart car to Renault are based on complex industrial strategies that could not be explained by previous models. So, a new “new” trade theory had to be created to provide an explanation.  

The profession tends to concur (but you may disagree) that this new “new” theory was born in 2003. So, 2003 is pretty new wine, at least for me.

As I said, you may disagree: debating is the main force behind scientific developments. Where I have more doubts, is when you discard as useless the contribution of new data to the debate (if it moves like a cat…). Many animals may move like a cat, and it is only by accumulating more data on cats or pseudo-cats that we are able to make the difference between a cat, a tiger or a lion. And being able to learn the difference may save your life. So, long life to statistics.

Best regards, Hubert

Thank you Shiozawa sensei in raising this question. Although he raised the issue of processing trade in case of China but the concept is equally useful to other economies, especially developing economies. The global value chain analysis gives a good explanation how the factor inputs in processing trade is linked with distributional impacts of trade. Likewise, input-output relationship is at the core of backward and forward linkages in industrial activities, thus, has the potential answer of unequal growth of tradable and non-tradable sectors. In case of the former, traditional trade theories of Heckscher-Ohlin or Heckscher-Ohlin-Samuelson definitely give a basic explanation to the concern raised in this question.

Opinions are divided between Robin and Hubert. There are at least two misunderstandings that make Robin and Hubert have different opinions. These misunderstandings are common not only for Robin and Hubert, but for most of us, because they are based on established (mis-)understandings that is rooted in the history of trade theory. The two are in fact connected, but it would be easier to grasp the point when discussed separately.

 (1) Nature of Ricardo's theory on international trade

In his post (post number 31), Robin started to re-examine "Ricardo's simple model" and showed how complex the problem is once we leave the most simple case of two-country, two-commodity case. As he stated, 

• Thus Ricardo's simple approach is totally inappropriate as a basis for scaling up anything from and to still expect a valid model to result. 

The basic reason lies in the fact that many analyzed the question in real terms (in the name of Ricardo's trade theory). There was a famous debate in 1930's between Viner, Herberler and Ohlin. One of major points of discussion was whether we can get a trade theory based on real terms. Here “real terms” means physical input coefficients, for example. This was the traditional position and Viner supported it and this continues even today. Ohlin argued that trade can only be analyzed in value terms. In this case, comparison should be made in money prices.

 As Ohlin presented a now famous Heckscher-Ohlin model, a misunderstanding emerged: Ricardo argued in real terms and this is the essence of Ricardo's theory of comparative advantage. However, if we confine ourselves to analyze comparative advantage in real terms, we cannot go much far more than 2-country 2-good case. Moreover, if we want to examine the situation where we trade intermediate good (or input trade), no plausible criterion was discovered for comparative advantage.

See for example, A. Deardorff (2005) . You can download the Discussion Paper version from Deardorff's web page. 

However, it is a misunderstanding that Ricardo and Ricardian method should be based on the real term analysis. The numerical example that Samuelson called Ricardo's four magic numbers is given only as an illustration and his argument in the first part of his Chapter on Foreign Trade is done assuming an existence of an international (exchange) value. (See e.g. Maneschi’s paper 2004 although “the true meaning” has been made clear in Japanese by Yukizawa already in 1974). In the latter part of his Principles, he also stated 

• The motive which determines us to import a commodity, is the discovery of its relative cheapness abroad: it is the comparison of its price abroad with its price at home. If a country exports hats, and imports cloth, it does so because it can obtain more cloth by making hats, and exchanging them for cloth, than if it made the cloth itself. (Ricardo, 1951 Ed. by Sraffa, p.170)

Although Ricardo himself did not succeeded in construction a general theory on the extension of classical value theory, it is possible to do it, as I have argued elsewhere. It is important to note that my theory is constructed on the base of money price comparisons of those goods made in different countries. This point is related to the second misunderstanding. 

(2) Macro-view versus micro-view

As Robin (post umber 31) put it, "prices are in general individually negotiated when the circumstances of the 'trade' permits." This is also the criterion that determines which country exports which product. 

One of persisting misunderstanding with regard to the Ricardian trade theory is the traditional interpretation of "comparative advantage." Many economists believe and teach their students that comparison should be made in real terms. From this point of view, it is inevitable that we should have a macro-view or know all relevant conditions. This may be possible for an administrator who knows everything, but we and mangers in industry know a few things: our cost of production and prices offered by competitors. If the quality and delivery are the same, it is the price that determines competitiveness. Trade merchants and firm's managers was adopted micro-view since the beginning of history, because they cannot take other view. Traditional interpretation is totally misleading in this sense.   

Professor Fujimoto and I discussed long on this question in our paper below. 

Now, the point that Huber is misunderstanding is that he thinks that trade was conducted as the "standard" trade theory analyses. It is true that "macro interpretation" was dominant before 1985, but it does not prove that mangers and traders in old days reasoned as the traditional economic theory explained. 

Huber is right when he says 

• supply chain management has been in the program of business and engineering schools at least a decade before mainstream economists start realizing that something new was happening in international trade.

However, the trade has been conducted in the similar way since late medieval ages when Bruges merchants engaged in processing trade. Although their calculation was not as fine as present day supply chain managers, they did the same kind of comparison: Which is the best way: to process whole work under the direct control in Bruges, or to subcontract the some parts of processing in East Anglia and so on.

Hubert referred to Baldwin's report (2006). I discussed how this phenomenon can be explained in the generalized Ricardian framework in my still unfinished paper: Economics of Great Unbundling. There is no essential difference between old processing trade and modern unbundling (the general term Baldwin coined for outsourcing, processing trade, value added trade between high wage countries and low waged countries), except that recent unbundling is mainly organized by multi-national enterprises.

End of point (2). 

If we correct above two misunderstandings, I believe that Hubert will change his opinion to the "Old Wine in New Bottle" story. Hubert (post number 36) referred to “the non-mobility” of resources. He may be thinking of capital movements (which comprise parts, materials and machines), because there are no big human migrations now, for example between the US and China or the US and India. What are moving around are “capital goods” or more plausibly input goods. This is the very point of our discussion. In any processing trade, input goods or intermediate goods were traded as main ingredients to be processed. It was only the theory that could not treat this and people did not recognize the importance of input trade before 1985 except in some countries (mainly in East Asia) that depended heavily on processing trade.

Hubert also mentioned “the classic (and success) story of a new model walking on both legs: models and data.” Our case seems to indicate that it was the retarded theory that prevented our recognition of the existence and importance of processing trade.  

Reference:

Deardorff, A. (2005) Ricardian Comparative Advantage with Intermediates Inputs, North American Journal of Economics and Finance 16: 39-71. 

Fujimoto and Shiozawa 2011-2012 Inter and Intra Company Competition in the Age of Global Competition: A Micro and Macro Interpretation of Ricardian Trade Theory, Evolutionary and Institutional Economics Review 8(1): 1-37 and 8(2): 193-231. You can download this from RG. See below. 

Maneschi, A. 2004 The True Meaning of David Ricardo’s Four Magic Papers, Journal of International Economics 62(2): 433-443. 

Shiozawa, Y. (2015) The Economics of the Great Unbundling, a paper read in Tohoku Forum for Creativity Pre-Program 2014 Annual Wrap-up Seminar, At Tohoku University, Sendai, Japan. You can download this from RG. See below.

Article Inter and Intra Company Competition in the Age of Global Com...

Conference Paper The Economics of the Great Unbundling

This is an addendum to my previous post (post number 37).

 I have read Hubert's paper calling for "Closing the gaps between trade theories, trade policies and global production statistics: a practitioner's perspective."

At the point 2 of his Introduction, he points two trends that require reformulation of trade statistics: 

• (1) the emergence of the "firm" as the main focus for analyzing international trade, as opposed  to the ‘Nation-State’ which  was  the explicit  or  implicit  reference of  both  trade theories  and  official  statistics.
•  (2) the  globalization  of  production  networks, giving  raise  to  global  value  chains  (GVCs) that closely  knit  firms  from  many  different countries,  blurring  not  only national borders,  but  also  the  frontier  between goods and services, as most of the business to business trade along GVCs is in activities or "tasks". 

Based on these two new trends, Hubert calls to close "the gaps between trade theories, trade policies and global production statistics." I totally agree with him at this point. All three items i.e. theory, policies and statistics are not catching up recent big changes. 

As he put it in point 5, 

• The value-added generated by each differentiated task along GVCs is embodied in a buoyant intra-industry exchange of intermediate goods, such as "parts and components" and other "goods for processing". Indeed, trade in intermediate goods amounts to more than half of world trade, excluding oil (WTO and IDE-JETRO, 2011).

It is true that theory or theories was retarded with respect to this development. For example, the new trade theory à la Krugman (partly) explains horizontal intra-industry trade but cannot explain vertical trade, because it has no theory of input trade. Input trade has been discussed since 2000.

The above comment shows eloquently the vital necessity for theory to incorporate trade of intermediate goods. Of course, we have many trials. A notable example is Jones (2000). Jones (and many others) examined the cases where the trade pattern is predetermined. This is a big defect as a theory, because Global Optimum Sourcing changes the pattern of trade and specialization. Jones's model is too ad hoc. A general theory id needed. It requires a deep theoretical analysis, because of its complex fractal-like structure. See my post (post number 23) with the title (2) Fractal-like Structure of World Production. My reconstruction of Ricardian trade theory answers these requirements, although it is highly mathematical. See my 2007 paper and a few explaining papers, for example a conference paper (2012). 

N.B. Firms and Nation-state point of view in (2) corresponds to micro- and macro views respectively in the previous post. 

Literature:

Jones, R. 2000 Globalization and the Theory of Input Trade, MIT press.

Shiozawa, Y. 2007 A New Construction of Ricardian Trade Theory--A Many-country, Many-commodity Case with Intermediate Goods and Choice of Production Techniques, Evolutionary and Institutional Economics Review 3(2): 141-187.

Shiozawa, Y. 2012 Final Resolution of the Ricardian Problem on International Values. See below. 

Article A New Construction of Ricardian Trade Theory--A Many-country...

Conference Paper Final Resolution of the Ricardian Problem on International Values

Dear Sanjaya Acharya,

Thank you for your comment. You are right. Processing trade is useful to economies other than China and India, especially developing economies. It is also closely related to policies. The lack of theory that incorporate processing trade retarded the recognition of this important set of policies.

Dear Henry Wan Jr.,

I have read your paper on Contract Manufacturing in Late Industrialization. Late-industrialization is a research subject that is extremely valuable for all developing countries and I hope many participants in this question page will consult his paper. (Unfortunately the pdf in RG is a bit too heavy. )

Late comers are handicapped in many aspects, but they have one powerful arm that is the low wage rate. Akamatsu's Flying Geese theory (Model I) is based mainly on this wage discrepancies. I have explained Akamtus's three models elsewhere and I ask participants to read my answer (post number 31) to Silburn Clarke's question:

Do economies whose industries are dominated by services sectors exhibit less robustness & sustainability than those dominated by the goods sectors? (see below)

Of course, low wage rate is not what we pursue. We have to use this situation in order to bring up general wage level. This requires delicate combined policies on the how to enhance the productivity and the technology. This is the policy problem we have to solve.

Yoshinori

https://www.researchgate.net/post/Do_economies_whose_industries_are_dominated_by_services_sectors_exhibit_less_robustness_sustainability_than_those_dominated_by_the_goods_sectors

Sorry, I am jumping in the debate -- even before I found time to read all the posts of this fascinating discussion. So, what I am going to say may have been developed by someone else already. To make my point short, I think there is an inherent difference between importing raw materials like cotton, produce a shirt, like England did in the 19th century and then reexport it somewhere else and what is happening nowadays. Now, we have an import of many goods that have already been processed and come from several countries, they are assembled say, in China (which is less and les the case) and then reexported. It needs a global strategy, with a complex coordination -- and generally with contracts that links the different entities. This is why Michael Porter is of great value to explain this phenomenon, as well as Gereffi, etc. It changed the nature of international trade, and this started to occur in the 1980s. The movement acceledated in the 1990s with the growth of China -- and so the volume of literature devoted to the phenomenon. See also the good book of Hobday (1995) on the different strategies of the 4 dragons -- with the revisiting of Akamatsu's flying geese model. Hobday clearly linked production and marketing and analyse their common evolution (like in the original model of Akamatsu).

This stream of posts is getting really fascinating for its epistemology content. Thanks Pr Shiozawa to start the discussion.

So, after all controversies on old vs new wine, even if I am wrong, we are still back to the initial question: "If it is old stuff, why (trade) theory was retarded with respect to this development? " 

My practical answer is that even if the practice existed, it did not take much importance before the 1980s, for a number of technical (transport and communication costs) and institutional reasons (Cold War, hight tariff duties, inadequate business models privileging vertical integration and cartels).

Now, and just to push the ball a bit further: Does the new "new" trade theory that emerged in the early 2000s to cope with this gap is actually a theory or just a conceptualisation of business practices? I am personally frustrated by the low-level of theoretical debate about this "theory": most papers I have dealt with are simply sophisticated econometrics applied to micro-data. It is more data-mining than modelling to me (not that I have anything against data-mining, but perhaps economists have better things to do than invading the statisticians'field of work).   

 There is a conceptual framework which may be interesting to reinstall the "new" new trade discussion into a macro-reference: the post-Marxist school of regulation. Processing trade breaks the "Fordian and Post-Fordian" models, in reference to Henri Ford who proved Mark wrong by raising the wages of his workers in order to sell ("realise" as the Marxist say) the production of his highly productive plants, and the post WW2 Keynesian regulation of effective demand.

Global manufacturing breaks the geographical tie between income generation and consumption. The iPhone is made in China but is expected to be purchased by US consumers. Increasing Chinese wages does not work for Apple exactly as it was expected to do in the Fordian model. Keynesian regulation fails also when the producers and the consumers are dissociated. This probably explain why the G-20 identified in 2012 GVCs as a priority topic for global coordination.

A. Emmanuel  was probably right when he concluded that the unequal exchange between North and South would end the day MNEs transfer to developing countries' workers their most advanced Northern technology. In the process, the "rent" collected by workers in industrialised countries disappears and the Post-Fordist regulation is no more sustainable (unless you increase public debt to maintain the welfare state).

By the way, A. Emmanuel was almost kicked out of the French Communist Party for having put into question the Leninist dogma of proletarian solidarity between developed and developing countries. So he was probably right :-)

Dear Louis,

you are welcome. I have just argued that the logic (not the appearance) of the world trade did not changed a bit. See my post (post number 38, in the previous page). Hubert Escaith (post number 33) has once proposed a view that "entirely new ball game which started taking place from both a theoretical and a practical point of view in 1985" and mentioned Michael Porter.

You compared 19th century England and present Global Economy saying that in the former case, England (or English firms) imported cotton and exported processed product whereas we now import many goods that have already been processed and come from several countries, assemble them and reexport. Does plurality or "manyness" of imported items make a qualitative difference to the management? Of course, logistic management becomes much more difficult than ever, but old time managers and adventure capitalists made a decision that might be more difficult than that of present-day managers.

Yoshinori

Dear Shiozawa-sensei,

I think it does make a difference, for several reasons. First, as you said, the complexity of the process; second, it is not only a problem of importing raw materials, processing them and the sell in the domestic market (or even re-export them), but it involves the assembly of intermediate goods. Someone mentioned the example of iPhones "made in China". But in fact, these iphones are NOT made in China, just the assembly is done in China, and the value added that is captured by firms in China is really small (I think it is about 5 percent, if my memory is good). And third, at the difference of import of cotton and reexports of shirts, the relations between firms in the case of processing trade needs to be relatively stable. It means, it needs specific arrangements and contracts (OEM, OBM types, for example). I may even happen that the original company is producing NOTHING, beside design and marketing. For example, sport shoes; again, the profits are made by Nike or Adidas and the share which remains in the producing country (China, Thailand etc) is very small. Interestingly, it may be the SAME factory that is producing for Nike, Puma, Adidas, etc. To go back with specific arrangements (Ok, my post is not very organized, but this is not an academic article), companies (eg. Acer) can work for different subcontractors (Texas Instrument, Toshiba...) in the first stage, and then start to improve the design, and then produce their own design and finally market them under their own brands -- while still producing as a subcontractor (again, Acer). The most difficult for companies that enter that cycle is the last stage (marketing and brand promotion). I know, this last part may look a bit different from the original question, but I think it demonstrates the difference between the "old type" "processing trade" and the current one (we should also include as a new type intra-firm trade). I don't know if you noticed, but this debate looks like the one on "globalization" -- is globalization a new phenomenon, or something that already existed? This is normal, since the way international trade has been transformed is, of course, part of this debate on the definition of globalization.

Dear Professor Shiozawa,

For answer at your question we should look the history of multilateral agreements the free trade development.

The world economy started on the path to a more free trade after World War II.

            In 1948 under the auspices of the United Nations was created the General Agreement on Tariffs and Trade (GATT), whose mission was to put into question the issues of world trade, and to contribute to the reduction of customs taxes.  In 1995 GATT is reformed and transformed into the WTO, the latter serving as the basis for all other multilateral agreements concluded under the GATT as well as modern FTA agreements corresponding to WTO + framework.

But WTO creation is not excluded interaction between two contradictory tendencies in the foreign trade: protectionism and liberalism.  For example, the tendency to protectionism becomes especially acute during the period of national economic crisis. It is permanent lobby subject for low competitive domestic business in developing countries. And currently SMEs in developing countries are presented in low income Global Value Chains.

 In plus after creation of framework of free trade, a time was need for the elaboration a strategy by multinational companies of placement their business in the world, the determination the countries with more profit activities in the net, as well as the valorification of potential of offshore zone for tax evasion.

... In short Marica i saying that the GATT/WTO's work was to set up a framework that would make it easier for large economically developed countries to freely access the export resources, goods markets, labour rates and tax regimes of liberalised small developing economies across all sectors of their economies whilst selectively protecting their own domestic producers and markets overlayed, wherever this is not the default position, by a myriad of subsequent bi-laterally negotiated 'mutual agreements' and through the specific wording of of multiple qualifying clauses embedded in the forever changing regional components of the almost continuously renegotiated basic framework.

This process is not an economic behaviour and therefore susceptible to the development of economic theory to explain it.   You just have to read the ancient texts on politics and state craft... start with Machiavelli. 

Would somebody like to tackle the development of  "The Unified Field Theory of Politics AND Economy"? 

Happy New Year (UTC) to all!

Robin

I wish you A Happy and Peaceful New Year to all!

Dear Louis,

thank you for various information on recent processing trade (or global value chain). Of course, there are many spectacular changes. I only emphasized  that the logic is not changed.

All you have described did once happen inside of a country. National brand merchandisers designed, ordered parts and materials, processed and assembled and transported finished goods to the markets where they can sell. One day most of these happened inside of a country (mainly in the country of final market). Now they are happening world-wide across countries. In old days, national brand maker  tried to make their product by nationally optimal procurement. Now they are making their products by globally optimal procurement. A change of  procuring range occurred, but the logic remains as before.

The same kind of transition occurred around the time of  Interstate Commerce Law (1887) in the United States of America. In the early 19th century, most procurement occurred inside of a state, but in the last quarter of the 19th century,  a new law became required because interstate transaction and procurement increased. With the decrease of transport costs and information costs, producers began to connect products at far more distant places.  Now we are observing that products are crossing the national borders.

The nature of procurement policy did not changed much but economics could not follow this rapid change, because it continued to assume that only final products are traded internationally. This is odd because Lancashire imported cotton (agricultural product) from abroad. Before that, Flemish merchants imported wool from England before process it into woolen products and export them for various countries. International trade included "processing trade" from very old days.

International trade theories were deeply entrenched in the idea that trade is an exchange of  production factors. The typical theory is Heckscher-Ohlin-Vanek model. This is not an old model. Vanek's paper was published in 1968, but  empirical works were mainly made in  1990's. At that time, cross-border subcontracting, outsourcing, procurement are starting to flourish. This gap between the theory and what is happening in the real economy must be revealing something important.   

Yoshinori

(call me simply Yoshinori)

Dear Marica,

welcome again. I am happy that you have found a time to contribute to our discussion. Political or legal framework is one of the crucial conditions that formed present day global chain economy. Collapse of communist regime and opening of China were another important political change that transformed world economy.

In relation to WTO/GATT, we Japanese had a nation-dividing hard arguments for these 3 or four years concerning the TPP (trans-pacific partnership treaty), which include 12 countries around the Pacific Ocean. 

I heard that Moldova belongs to a country that showed a good economic performance among the new-market economies. Can you explain why? As Moldova is rather a small country, I wonder if you had a specific policy in promoting processing trade.

Yoshinori

Dear Yoshinori,

You said it is not a big change,  but to me it is a fundamental change -- of course, it is a question or appreciation. For one reason, not, the "processing trade" does not only involve raw materials, but "semi-finished products". there is a difference between the import of wool and the import of main board of a computer... Second, the process is getting much more complex because the import/export does not only concerns two countries, but a great diversity. For example, iPhones are not "made in China", but in 5 or 6 countries, and the value added for China is really small.

Second, a substantial part of this trade occurs within the same company (which makes the interpretation of international trade statistics difficult btw).

Third, the fact that the trade occurs in different countries implies that companies are playing with different "competitive advantages" -- including law systems, taxes, labour costs and so on. 

Of course, you can say it is the continuation of previous trends, or you can say it is entirely new, or you can say there is no fundamental differences with before. This is a question of interpretation.

Dear Robin, 

The Unified Field Theory of Politics AND Economy?  What a magnificent idea! Even inside of economics, we have hardly Unified Theory.

Neoclassical economists based on general equilibrium theory must believe that they have a Unified Theory of Economics, but they are paying a great cost in ignoring all details that emerge during a process.

The typical example is financial economics. Most of important phenomena occur outside of equilibrium. That is why financial economics or modern macro-economics cannot predict nor analyze financial crisis. This is a vital problem for economics. Before attempting to unify economics and political science, it would be necessary to construct a unified theory inside of economics.

Yoshinori

Dear Louis,

theory is mainly concerned in the logic of phenomena. What is the essential difference between trade within a country and trade between countries? Of course, we have formalities, duties, and restrictions or quotas. Beside this apparent difference, we have another rather hidden conditions that are the differences of wage rates.

International trade theory has been ignoring this crucial factor. A typical theorem of Heckscher-Ohlin theory (HO theory) is the factor price equalization theorem. It means that wage rates of all countries are the same. What a fantastic theorem! Of course, the theorem requires some sufficient conditions to hold, but this remained and discussed as a standard case theory. 

Louis must be thinking from management science side. Management science assumes all conditions outside of a firm as given. Wage differentials may be one of them. For trade theory, it has to explain how this wage difference occur and how it is determined. The formulation of this simple fact remained a difficult task for trade theory especially when inputs were traded across countries. Good prices (and the real wage rate of a country) depend on wage rates of other countries through the importation of parts and materials. Wage rates and product prices have to be determined at the same time. Here is one of the most difficult point for the theory building that incorporates input trade.

In face of this difficulty, the mainstream trade theory adopted a strategy to approach this question in two steps. First, it assumes the existence of a system of wages and prices on the basis of general equilibrium framework. The theory provides an existence of a set of wages and prices. Then it assumes a specific trade pattern or pattern of specialization and sets out to analyze phenomena such as outsourcing, offshoring, fragmentation and global value chains and so on. However, the first step means that there is no unemployment in any nation. This is equivalent to assume that there are no trade conflicts, because major trade conflicts occur when some industry in a country is placed in a difficult situation because of trade liberalization and workers in the industry are menaced of　unemployment.

I am wondering if there are some connections between this state of theory and our world conception. International trade theory ignored for a long time input trade and this may forced the absence of processing trade concept.

Now we are all aware of the fact that processing trade has been important since long time. However, the absence of processing trade concept may have impeded making of plausible trade policy for many countries for a long time. I am wondering if this state of mind (lack of processing trade concept) still prevails and is orienting our imagination in misdirected policies.

The theory I rely on has nothing to see with management. It relies on several theoretical bodies. The first one is the value chain theory, as developed by economists such as Gereffi and Kaplinsky. The second is on world system, which was first elaborated by Wallenstein. These theories have been -- of course -- criticized and amended since they were first elaborated (see McMichael, for example), but I think they help to ask the right questions. Which are: 1. international trade was quite developed at the end of the 19th century, much less after WW 2 and pick up again in the late 20th century. Then, is there a difference in nature between the trade of the late 19th century and nowadays? For these people, a major difference is just in the nature of processing trade... 2. What the increase of international trade really means for developing countries? Again, part of the answer lies in the way the processing trade (and processing production) is organized. 

Again, I think there is major differences between a company that is imported cotton to make in-house shirts, and a company that is producing nothing but design and marketing and outsources all the production to companies located in several countries; or a company which is producing different parts in different countries before it assembles the whole stuff in another different place. Unless you consider the world is flat, to me these have very different conceptual and theoretical consequences.

Dear Yoshinori,

As we know WTO follows and promotes multilateral trade liberalization with the objective of collaboration within the international system to reduce trade barriers and expand trade between countries.  An exception from this primordial principle of WTO is allowed only on the basis of the GATT XXIV, under which countries may conclude preferential agreements among themselves, but with the condition that they do not create barriers to trade in non-signatory countries of these agreements.                            

  Increasing the number of FTA is a predominant tendency over the last twenty years in the sphere of international trade.  Basically, any country member of the WTO is a signatory of at least one such agreement. Moldova isn’t exception.

Recent generation of FTA makes emphasis on promoting economic policies pertinent to functioning market economies as well as their formulation and implementation. It also relies on deepening cooperation within the Free Trade Zone, which corresponds to the WTO – plus framework. It means that WTO provisions constitute bases that underpin additional commitments in the new regional agreement and finally the FTA adds to WTO rights and obligations.

Again regarding to Moldova, country had the image of success story of EU till the end 2014. At present it is clear for all that 2015 was the year without reforms. Beginning with Parliament elections end 2014 country is permanent political, governmental and economic crisis.  

Although global value chains (GVCs) are often associated with current wave of globalisation,  they are not studied sufficiently. There are no statistical data on them, especially about developing countries participation. The main source of information (or analytic unit) should be enterprise engaged in external economic activity.   I think that based on finding data analysis it should be elaborate set of economic and trade policies for including the SME and developing countries in the high income Global Value Chains.  Sector of SME is dominating in the most countries, at least in the developing ones. In Moldova it consists about 98% of all enterprises. I try to analyze very scant information from BTDIxE about Moldova. To find an information gap the questioner of entrepreneurs may be a solution.

I can only agree with most of the points and remarks of both of you, Louis and Yoshinori.  There is an almost complete lack of theory that tackles the fundamentals of economic activity that is any more advanced than the initial observations of Smith and Ricardo.  What has come since then has largely dealt with embellishments in various areas of interest, and in each case the important fundamentals processes which are key to a full understanding in these areas is hidden under the umbrella of ceteris parirbus.  Unfortunately this 'catch all', while reducing a complex reality to a set of elements that is small enough to facilitate manipulation and exploration, hides from our view those as yet undeclared elements which were not explored by the early thinkers in a way which made them integral to the development of all the future work which was to follow.  WE have thus become habituated to a convention through which we have become complicit in our own blindness and that of the politicians and working people that we ultimately serve.

It is in the internationalisation of economic processes that all of these elements have been exposed, both those that our thinking has considered and revealed as well as all those elements which may have been occasionally considered but which have never been fully integrated into our fundamental understanding.  To build an analogy for a moment.  We are still constrained in our problem solving ability in the same way that the physicists reaching out to understand the universe from a basis in Newtonian Mechanics into the microscopic and macroscopic dimensions were limited by not having fully considered and developed those elements which are now developed within the Relativity and Quantum Theories.  Smith and Ricardo are our 'Newtons' but unlike the physicists we have been unable to progress very much at all beyond their conceptions.

Perhaps here another analogy is in order.   The old institutions of traditional power, in the early days of natural science, actively and also subtly exercised their powers through their very many 'actors' and agents throughout the societies within their domains to inhibit and prevent the development of concepts and theories which were perceived to be antagonistic to the preservation their own supremacy within those societies.  Their hegemony was only challenged successfully, and mostly overcome, by the development of demonstrably useful but the inevitably complex bodies of theory that I have mentioned.  The economic power, influence and position which they once enjoyed has been inherited by those sections of society who, since then, have been positioned to become the main beneficiaries of the application of those theories to the manufacture of the products and systems which characterise our current economic activities of manufacture and service.  The 'Ancien Regime' of a hegemony based upon religious and feudal traditions was replaced by a 'techno-economic' hegemony during which the feudal elements of the traditional hegemony abandoned their alliance of power with religion, as the provider of the main praxis through which their access to power was maintained, and they embraced the institutions of technocratic economies to provide that function, experimenting along the way with a variety of political institutions to provide the necessary elements of governance.  These have ranged from arrangements bearing a range of labels.  Amongst them Totalitarian, Autocratic and Democratic, but all remaining firmly Plutocratic.

The fundamental elements of 'political economy' which have hitherto failed to be integrated into our most basic concepts of economic activity are precisely those which describe the manner, nature and motivations by which the current 'techno-economic' hegemony is also maintained.  We ourselves represent an 'anointed' priesthood' within that institutional area of this hegemony.  One which is relied upon to anticipate the economic challenges of the future and to chart a 'safe passage' for it, through appropriate observation, conceptualisation and policy recommendation.   Those of us in the mainstream are seen to be active and useful contributors to the perpetuation of the hegemony and are lauded and rewarded accordingly.  Those of us in the Heterodoxy must rely upon scribbled notes, thought experiments and mutual encouragement and discussion, and always with little funding.   An overt, pragmatic, tolerance is practised towards the Heterodox which enables its focus to be encouraged towards the pursuit of esoteric derivative matters out of which new insight might 'enrich' the mainstream.  It is also a tolerance which makes it that much easier to discourage and frustrate any serious debate and pursuit of those additional economic fundamentals which have not been incorporated into the mainstream. Fundamentals which would represent a heresy to the belief system upon which our new 'ancien regime' is based. A tolerance whose purpose and motivations have been well described nearly a century ago by Orwell and Huxley.  And by Machiavelli centuries before them.

The route to this heresy is the expansive consideration of the production and exchange of goods, in the microcosm employed by Smith and Ricardo, to include those social vectors of power which are themselves introduced by those simple models if one does not immediately surround their expansion by limiting assumptions.  Our observations regarding the macrocosm exposed by international trade gives valuable insight into what aspects of production and exchange it should be that are first included in the expansion of the, properly labelled, simplest micro-economic model.  By doing so we would be able to better understand and integrate these effects, which although disappearing to zero in the microcosm, just as gravity effects do, they are known by us to expand to great significance when the model's scope and scale is expanded.  This is entirely analogous to what we have seen in our endeavours to model the systems of natural science.  Behavioural Science requires the same approach if it is to advance in a similarly remarkable fashion.

If have sent to Yoshinori, or placed into an Answer - I am not sure which, a small expansion and variation upon Ricardo's 'Matrix'.  I did not discuss it fully in the attached notes.  However, it demonstrates how at even the most fundamental modelling of a closed system of specialised production and mutual exchange across a package of goods that might be required to sustainably provide for the society it encompasses the basic requirements for the development for economic inequality will develop within the very first period of exchange.  The immediate consequence of this eventuality is that social relations of power will also be established differentially and that these will then inevitably feed back into the economic processes of production and then on back into the circumstances of exchange in the 'second' iteration.

This complex of creation and feedback of power that has significant economic consequences is thus inherent in everything that we do.  It would be to demonstrate a deliberate lapse of academic integrity on the part of anybody to continue in the vigorous support and further development of the unsubstantiated belief system that we have so far constructed once they have become aware of this irrefutable reality concerning the natural consequence of economic specialisation operating within the sphere of unconstrained human behaviours.   Except, that is, in so far as those pursuits serve to actively inform the very difficult work required by the development of a more General Theory.   ....of Politics AND Economy?  :-))    Rob

.

Dear Marica,

thank you for various useful information. At any rate , Moldova is a remote country for Japan (Equivalently, Japan is remote from Moldova) and we know little about it. I am curious why Modova succeeded in EU, even if it is the　story before 2014.

Yoshinori

Dear Robin,

• Those of us in the Heterodoxy must rely upon scribbled notes, thought experiments and mutual encouragement and discussion, and always with little funding. An overt, pragmatic, tolerance is practised towards the Heterodox which enables its focus to be encouraged towards the pursuit of esoteric derivative matters out of which new insight might 'enrich' the mainstream.

This is a passage form your last post. It is true that academic tolerance contribut much to enrich the mainstream. I agree with you but you may be too pessimistic. Tolerance may be its weak point, or a kind of dilemma. The mainstream have to be telerant to remain productive but at the same time it may undermine their prestige and authority. New truth always starts from minority. We have to believe in the power of truth, reason and discussion.

Yoshinori

Dear Louis,

I now see your mode of reasoning. You rely on value chain theory developed by Gereffi and Kaplinsky. You receive inspirations from the world systems theory.

I have read a paper Kaplinsky (2000):

• Kaplinsky, R. 2000. Globalisation and Unequalisation: What Can be Learned from Value Chain Analysis. Journal of Development Studies 73(2):117-146.

I have two minor remarks to make before I enter to the contents of this paper.

The first remark: It seems that Gereffi and Kaplinsky are inspired by world systems theory. Then most of your arguments flow out from Wallerstein. I highly respect Braudel, but not Wallerstein as much. Anyway, this is not our theme of our discussion.

The second remark is the origin of the term "value chain." As it is written in Wikipedia (Value Chain), this concept comes from business management and was popularized by Michael Porter in his 1985 best-seller, Competitive Advantage: Creating and Sustaining Superior Performance. I could not see the difference between your arguments and arguments of Porter and others.

Now, let me enter in the main argument. World systems theory relies much upon dependency theory. Kaplinsky's paper  (2000) has one common subject-matter as the dependency theory, that is the terms of trade. Do you know that "terms of trade" came out from the John Stuart Mill's examination of Ricardo's famous chapter on foreign trade. Ricardo left in his Principles a problem of constructing international value theory as an extension of the domestic (or national) value theory (Be careful. Ricardo's theory is not labor theory of value, but cost-of-production theory of value.). John Stuart Mill transformed this problem into a different problem, i.e. the determination of terms of trade. His theory was adopted by A. Marshall and F. Y. Edgworth and developed as "classical theory of trade" (in fact neocalssical theory) and continues to dominate international trade theory even today, for example Heckscher-Ohlin-Samuelson theory. (The latter may not be a topical theme now but it continues to be taught in schools as standard theory.) In my opinion, this was one of the internal determinants of the neoclassical revolution around 1870's and after. (See my first paper cited below.)

The trouble I feel with dependency and world systems theories is that their arguments are based on Mill's (and therefore neoclassical) tradition. They examine competitive relations (monopoly power, institutional rent) but they have no theory how the wage rates of different countries are determined. Without this theory, the analysis is deemed to be superficial and symptomatic. 

Kaplinsky know this weakness and put it as follows: 

• Consiedered in this way, the value chain analysis is merely a descriptive construct, at most providing a heuristic framework for the generation of data. (Kaplinsky 2000 p.122)

 Although Kaplinsky contends that

•  However, recent developments of the value chain framework have begun to provide an analytical structure which ... provides important insights into our twin concerns with the determinants of global income distribution and the identification of effective policy levers to ameliorate trends towards unequalization. (ibid.),

 he presents no theory how the global income distribution is determined. Rent division between members of transnational firms or those governed as a part of global value chains may explain something, but it does not change the general wage level of workers. 

HOS theory has no such theory. It only predicts in a standard case that wage rates will become equal (in the long run?). Marxian theorists in global affairs are forgetting that they have no proper theory which is comparative as the labor theory of value in the case of a national economy. However, the theory that determines the wage rates between countries already exists. See my second paper below. This is a abstract version of my book in Japanese.

 Two of my posts on

•  (1) Technology in economics (post number 18) 
• (2) Fractal-like Structure of World Production (post number 23)

 may be useful to understand what kind of problems are concerned.

 When I say "technology" of a country, it is a set of all (potential) production techniques and represented by their input coefficients. These coefficients reflect the technology level of a country as a whole but also influenced by infrastructures such as road, port and communication systems.

Conference Paper On Ricardo's Two Rectification Problems

Conference Paper Final Resolution of the Ricardian Problem on International Values

Dear Yoshinori,

Thank you for interest for my country.   Pro European Parties came to power declared course towards integration into the EU. Republic of Moldova was considered a successful story of EU because it negotiated and signed the DCFTA agreement with EU in comparison with Ukraine, which in the last hundred meters refused to do this.  You know about political crisis in Ukraine regarding to this event.   By this Moldova took obligations to implement reforms in all domains.  In fact the legislation of country has been adjusted at the EU norms. It is ongoing process.  But it is not implemented because of high level of corruption in country.

Moldova has received a visa-free regime with EU. It is the big success of Moldova’s diplomats. The principle applied for Moldova by EU was “more for more”

Currently political and economic situation is difficult in Moldova:  http://jurnal.md/en/social/2016/1/14/citizens-protest-against-plahotniuc-s-advancement-at-leadership-of-govern-jurnal-md-broadcasts-live-the-event/

Dear Yoshinori,

 I would like to ask you regarding the evolution the notion of "processing trade" in contemporary works in comparison with 20 century works.   Did you analyze the notion, defined by you under this aspect?  I mean for example from traditional approach of economical manual regarding the capture of share of market to place in Global Value Chains.

With respect,

Marica

Dear Marica,

No, I did not. Sorry.

Is the political rally is going on now? It is astonishing that the President of the Republic is  compared to Ceauşescu. It is very difficult that democracy works well. We have to learn much from history. 

Yoshinori

Dear Yoshinori,

Yes. It is. Please see the Mr President position: http://www.moldpres.md/en/news/2016/01/13/16000256

Perhaps Mr. Prime Minister designate needs a little bit of control exercised with the check and balances built into the office of President by the Moldovian constitution?  This article from 2013 suggests that the Parliamentary Majority of the Prime Minister was not acquired on a level-playing field... given his credentials:

     http://blogs.ucl.ac.uk/ssees/2013/06/05/moldova-an-unravelling-success-story/

Robin

I have posted a new question on the comparative advantage principle. Ten odd years ago, a new interpretation of Ricardo's four magic numbers was discovered (re-discovered if I say more correctly). Many discussion were made since then and new interpretation of the Ricardo's theory of international trade changed substantially. It inevitably requires the change of what you teach in your classroom.

Please post your answer how you are doing and how you think about it. For those who are not well versed in the new interpretation, I have given there a suggested reading, which is a concise and precise paper written by Faccarello. 

https://www.researchgate.net/post/Comparative_advantage_is_what_you_teach_every_year_in_your_classroom_Are_you_sure_that_you_are_updating_your_knowledge_and_teaching?_tpcectx=profile_questions

Dear Professor Shiozawa,

I learned a lot from your question.

So I would like to add some information of mine.

Two pieces of information seems to indicate, in the present era, processing trade has considerable global impact. I would like to know whether same type of impact was there at

time past, and your original question can be approached from that angle.

1) Source A:

Willem Thorbecke, 2015. "Measuring the Competitiveness of China's Processed Exports," China & World Economy, Institute of World Economics and Politics, Chinese Academy of Social Sciences, vol. 23(1), pages 78-100, 01.

The data there showed, without processing trade, there might be such huge payment

deficit for China during the Great Recession in the last few years, such that it is possible

(my interpretation) Chinese growth would be 'OVER', whatever that means.

2) Source B:

Duhigg and Bradsher , NYT, Jan. 21, 2012,

In 2007, Apple redesigned the first iPhone at the last minute, forcing an assembly line overhaul to make the screen with unscratchable ‘gorilla glass’ “Jobs said, ‘I want a glass screen, and I want it perfect in six weeks.’ . . . [O]ne executive left that meeting, he booked a flight to Shenzhen, China. If Mr. Jobs wants perfect, there is nowhere else to go (emphasis added)”.

So, the world's most valuable firm - that Apple Corporation of America - would not be what it is without the operation of Foxconn at Shenzhen, China, which is part of 'processing trade' of China.

Of course, the above evaluation of the processing trade in China may be over-exaggerated.

Still, it seems to be a hig oint of influence of such trade within the most recent days.

This may or may not be the first time such trade has this degree of world-wide impact.

I would like to know your opinion.

Sincerely,

Henry Wan, Jr.

Dear Henry Wan

thank you for teaching me two sources. I will study those two papers.

The question of processing trade is closely connected to outsourcing, contract manufacturing, fabless manufacturing and so on. As you have put it at the top of your paper "Contract manufacturing in late industrialization" (2012), they a re the catalysts that are shaping the world economy.

You story on Foxconn at Shenzhen is very interesting. I am wondering if these examples would go without great hindrance forever or if the bias made and structured by these processes causes in the future a brake for a balanced development of the economy. This is the reason why my conference paper "The Economics of the Great Unbundling" still lacks later sections. Late industrialization was one of my research fields when I was still a young scholar. I am still wondering how to think about it.

Late industrialization is also the reason why I tried for long years to develop a new trade theory different from Hechscher-Ohlin theory. Production techniques are different for each country and for each firm. Heckscher-Ohlin type factor endowment ratio and factor intensity theory does not work at all in considering industrialization. The new theory of international values is a product of this effort. I have recently written a paper in a guise of a comment on an encyclopedic article “Comparative Advantage.”

The New Interpretation of Ricardo's Four Magic Numbers and the New Theory of International Values / A Comment on Faccarello's " Comparative advantage

I think that it is readable for a wider class of people who are not specialists in trade theory.

Your criticism (in your paper "Comparative Advantages and Possible Coordination Failure: An Explanatory Note," p.281) on Arrow-Debreu-McKenzie model is quite right. It is not designed to analyze the economy that is imbedded in sequentially opened markets.

New goods, new methods, and new production locations all emerge through the Schumpeterian evolutionary process which comprises change and selection. They must be proved in the existing market and its price structure. Simply stating, a new product must be better than old ones, or it must be more price competitive. A new specialization pattern emerges through evolutionary process. This is the reason why I support evolutionary economics rather than orthodox neoclassical economics.

Dear Professor Shiozawa,

Thanks for your kind reply.

It seems when one thinks a new good can have many different characteristics in relation to existing ones, some complementary, some substituting, etc. then what Paul Romer or Paul Krugman considered that the varieties of goods are expanded ('by the numbers') is not entirely sound because by focusing on mathematical modeling, one tends to simplify calculation, one makes certain specific assumptions, may be unconsciously, say, considering they are all substitutes to each other, while in fact, this may be so.

In more general terms, when fragmentation, task trading, etc. enlarged the range of actions individual business can take, the only thing one can say is, in view of the particular situation on the ground, more possibility of action (because of outsourcing) one ought not saying things in general.

Natural scientist are less likely to say since the possibilities are enlarged, this must mean one way or another, without getting more information from the field.

One thing about 'new' and 'old' is in machine tools trade, sometimes the new producer of lower capability products would tell buyers, that if you want to set up a new machine shop, by all means buy those producers selling products of higher capability, but also buy ours, it will stretch your money further, so you can get a larger work shop, some their ones (sophisticated, but higher priced) but also our elementary ones.

This example shows it not all rivalry, but there is also alliance (though one cannot be naive, as competition is there at least to certain degree),

The salad dressing uses egg yolk as component to substitute all yolk as dressing, but if more people eat salad because dressing become cheaper, in the end may be more eggs will be used

Hope what I suggsted makes sense.

But one thing, one can say is, when the possibility of subcontracting has changed the R & D process itself, meaning in the made off between R&D and fabrication is affected, one ought think in terms of world-wide co-evolution, not The East Pacific taking all the lead, The West Pacific playing the 2nd fiddle, even if at the present stage, there is less research, design in the West Pacific than the East Pacific, yet.

Henry

Dear Henry, 

call me Yoshinori, please. 

In the previous post, you wrote:

• Paul Krugman considered that the varieties of goods are expanded ('by the numbers') is not entirely sound because by focusing on mathematical modeling, one tends to simplify calculation, one makes certain specific assumptions, may be unconsciously, say, considering they are all substitutes to each other, while in fact, this may be so.

It is certainly too simplistic to assume that numbers of varieties increases. Of course, the number of varieties increases but each variety cannot be treated as interchangeable or symmetric. Krugman's model depends too much on symmetry of varieties.  

Some varieties may have a big demand and some others may have a small demand. Firms cannot be indifferent In which ones to specialize, because it will determine the success of an enterprise or the future growth rate.  Krugman's model of intra-industry trade is completely neglecting these aspects.

The problem is that we do not know a firm empirical law about the distribution of demand. I once supposed that the demands obey a power law. Order the varieties in the decreasing order of demand and number them by x. I wonder if we may suppose that the demand D(x) of the variety number x is expressed

        D(x) = A x－ρ,                                                                                   (1)

where A and ρ are positive constants.

It is plausible that this kind of phenomenon occurs If we suppose that products are all services that should be consumed within a city. If there is a restriction that the minimum units of production must exceed the volume M. Then the maximum number of varieties must be bounded from above:

       x  ≦　(A／M)1/ρ.                                                                             (2)

This is an extremely rough estimation, but it gives us a hint that the knowledge like (1) would have a great importance.

I wonder if there are anyone who have already made this kind of research using sales data for a company such as Amazon and others.

Yoshinori

Dear Yoshinori,

Thank you to share with me the idea of applying power law. It may have profound effect, but I am not so sure. My understanding of cultural impact on development is very limited. I understand in Japan, one can buy utensils with far greater variety than in the West (This is hearsay for me). Does that contribute the efficacy of Toyota performance, while Americans do not have that much cultural tie with their past, they cook up brands to entice customers, rather than trying to respect the existing product varieties, I am not sure.

On the other hand, sometimes product differentiation has strategic aspect on the market. For example, Samsung is both a supplier in intermediate goods and a competitor of final goods to Apple. The example I mentioned last time about machine tools came from the information a former Taiwanese student supplied me, how Taiwanese machine tool suppliers employ to get into a market Japanese firms excel (like playing 'go' chess). Again another example is described in a joint paper by a former student, Dr. Han of Korea and me, 'The Irony in Steel', that Shin Nippon Steel worked so sincerely and hard in the founding of POSCØ, not concerned about assisting a potential rival (POSCO was very small anyway) but to let upstream Japanese suppliers of steel-making equipment (that supplied both forms) to have scale economy. Professor Okada also explained how Japanese semiconductor sector used to operate with the Korean and Taiwanese firms who buy upstream equipment from Japan, but supply downstream goods similar to Japanese firms selling better grade of goods. The American book 'No Hand' also discuss the bicycle industry where Chinese and Taiwanese firms get into complex relationships with American firms, especially, Schwinn, which failed, but Shimano of Japan quietly became a global power, selling core components of bicycles.

When teaching my Industrial Policy course, such facts convinced me that game theory has a big role to play too.

Henry

Dear Henry,

power law may be useful for consumer goods, but may not be applicable to industrial goods.

It is true that one can buy in Japan utensils with far greater variety than in the West. This may be partly explained by the professional people's culture. For example, Chinese cook (I mean Chinese cooking cook) can make almost all his cooking by a single kitchen knife but Japanese cook prefers to use many kinds of knives. Also, Japanese cook prefers to use varieties of dishes.  However, the question if this culture  contribute to the efficacy of Toyota and other Japanese companies' performance is quite doubtful. As you say it, industrial production is something different from workman's production. 

I could not find your paper "The Irony in Steel," but I can guess what happened between POSCO and Nippon Steel Corporation. I once visited POSCO in late 1980's and heard how cooperation was made between them.

I think this kind of "irony" is rather universal. From Meiji Revolution to Prewar years, many Japanese companies were helped by European and American companies. Even Toyota learned much from automobile  companies  in the US, such as Ford and General Motors.  Mitsubishi Electric  was helped by Westinghouse in its foundation period. At the period of computer development, Toshiba was helped by GE by technology cooperation contract.    

What is enigmatic for me is the strength of Shimano. How can it be still so powerful and how long does this state continue?

If I return to your main interest, fragmentation surely  helps the processing country when the production is operated by an independent firm. When the production is made by a 100% ancillary firm, does it still help the processing country? Workers and  engineers would accumulate experience and it may help for a third person to establish a new firm in similar products.  If everything works well, fragmentation is a wonderful way to stimulate industrial development  for a certain kind of developing countries. 

Your paper with Ai-Ting Goh "Fragmentation, Engel’s Law, and Learning" was very interesting. It gave me many hints for me.

Yoshinori 

I have written a new paper (yet at a draft stage): New Theory of International Values: A General Introduction.

If you are interested in processing trade, input trade ,outsourcing, fragmentation, global network  and global optimum supply chain management. The new paper provides a general theory to deal with these phenomena. 

Working Paper The New Theory of International Values: An Overview

I was reading a book by Morihiro Yomogida yesterday. It is a small book written in Japanese published in 2006. The title is "Theory of Vertical International Division of Labor." It represents a standard understanding of the state-of-the art economics, because it is not a very original and creative book. 

On reading this small book, I remarked two things. (1) how the mainstream trade theorists explain the sudden emergence of vertical division of labor between countries, and (2) how they explain the rapid spread of vertical division of labor.

First point. How do the mainstream trade theorists explain the sudden emergence of vertical division of labor between countries? Yomogida explains this uniquely by the change of economic situations. Until 1980's economists remarked the wider spread of horizontal division of labor. Grubel and Lloyd (1977) Intra-Industry Trade attracted  both empirical and theoretical studies and Krugman and others succeeded to presents New Trade Theory. International economy witnessed a big change of economic environmental and the vertical division of labor became conspicuous.

From this explanation, it seems that no attention was made on vertical division of labor and trade of input goods, including materials and parts. This is a pure imagination in defense of their profession. As I have argued above, McKenzie realized clearly in late 1950's that the impossibility to treat intermediate goods (equivalents to input goods) was the biggest limit of the trade theory.

Second point. Yomigida boasts that he has succeeded in presenting a theory of vertical division of labor based on the idea of Davis (1995) Intra-Industry Trade: Hechscher-Ohlin-Ricardo Approach. if it is true, he should have noted that his theory assumes many supplementary  assumptions and is far from a general theory that explains vertical di\vision of labor.

When the first and second points were combined, this presentation of  vertical division of labor covers all the theoretical problems concerning the construction of vertical and horizontal international division of labor.

The most disguising effect of this story is that the main forces of vertical division of labor derives from the differential endowments of factors of  productions. Of course, Davis adds differences of technologies between countries but it does not rectify that factor endowments still play a primordial role in international trade. this may work for a defense of HO tradition but camouflages the difference between what is important and what is subsidiary. 

We have a famous story. There is a jar with half filled water. One says: Oh, there is still a half of water. The other says: There is only a half of water.

The history of international trade theory looks like this. In textbooks it is explained that there are four generations of trade theories:

(1) (textbook) Ricardian theory

(2) Heckscer-Ohlin(-Samuelson) theory

(3) New trade theory (Krugman)

(4) New new trade theory (Melitz)

It is true that trade theory has developed and is developing if we see how a new phenomenon came to be explored. However, if we see what is achieved in input trade, we have to say that all four generations have been missing to incorporate it.

Interesting debate, indeed.

As for myself, I started studying input trade by reading the Supply Chain Management textbooks of my eldest daughter, who was studying engineering...

So, in term of economics, it is more A. Smith rather than D. Ricardo, I'd say. Kind of microeconomics with additional costs due to borders.

This said, can we actually oppose Ricardo to Smith? But this is another issue.

Best regards.

@Hubert Escaith

Very interesting question. Have you any concrete text in Adam Smith in which he mentioned input trade?

I made a brief search in the Wealth of Nations by two key words: export and import. Except terms "carrying trade" and "round-about foreign trade," I could find only two examples that he may have thought about input trade:

II.5.17 Import of flax and hemp

The capitals of the British manufacturers who work up the flax and hemp annually imported from the coasts of the Baltic are surely very useful to the countries which produce them.

IV.1.31 Import of lean cattle

To any country which was highly improved throughout, it would be more advantageous to import its lean cattle than to breed them.

Numbers are paragraph reference in Wealth of Nations that we find in the Library of Economics and Liberty.

@Yoshinori Shiozawa

Sorry for the confusion. I wasn't referring to my (limited) understanding of what A. Smith may have written on international trade (e.g., absolute advantage, vs. Ricardo's comparative advantages), but --more modestly-- on the fact that today's GVC trade is probably better understood following Smith's pin factory example rather than Ricardo's comparative advantages.

Ricardo was interested in understanding trade on the basis of comparative advantages (a static analysis, at least in Ricardo's terms); Smith was looking at efficiency and competitiveness through specialization (a more dynamic approach as specialization in tasks can be understood as an innovation/ technological change).

This is why I mentioned that, when we look a GVC trade, we may better source our inspiration in Smith than in Ricardo. The specificity of GVC is that production takes place in different countries: the pin factory is spread across different countries. So we must add "border effects" to the microeconomic analysis (resources endowments, trade costs, exchange rate uncertainty, trade policy and protectionism).

You provide an example in you book chapter: how trade costs may "protect" ineffective domestic production as long as the inefficiency margin of the domestic firm is lower than the trade costs.

This said, and returning to A. Smith, it is true that, seen from a microeconomic perspective, GVC trade is governed by Smith's absolute advantages: if a firm isn't cost effective even after factoring-in the trade costs that protects it from international competition (e.g., if it cannot cover its production costs plus a mark-up to cover fixed capital costs), it has to exit the market.

This rule is relaxed when the firm is large enough to behave like a country: redeploying resources across different departments and investing in R&D to enter new markets. But even in this case, it is not Ricardo's approach of mutually advantageous trade even when one side is inefficient in all products, just plain Schumpeterian survival: to remain in business, the firm must be cost effective in its new activity.

Best,

Hubert

You must be right when you say that GVC trade is better understood by Smith's pin factory example.

I have written the following point somewhere, but I have forgotten where. So let me repeat again the same story. The opposition between absolute and comparative advantage is not a good way to understand international trade. There are two reasons: historical and theoretical. Of course, theoretical reason is much more important.

(1) Historically this opposition is an invention probably of the 20th century. At least the story that Smith preached absolute advantage theory and Ricardo comparative advantage is a pure fiction which became famous in the latter half of the 20th century. Many textbooks teach in this way but it is not literally founded. A mistaken formula is transmitted from one writer to another.

(2) Theoretically, comparative advantage has no firm definition. Comparison of two ratios of input coefficients like aPC/aEC and aPW/aEW can be extended only for cases when (a) either number of countries or commodities is two and (b) there is no input trade. In other cases, there is no good formula that gives which commodity of which country is comparatively advantageous than the same commodity of other countries.

Ricardo, Mill and Marshall considered 2-country, 2-commodity case. Viner and Dornbusch, Fischer and Samuelson considered 2-coutnry, many-commodity case. Jones examined the N-country, N-commodity case. Except these cases, general many-country, many-commodity case is not examined and no formula was found. In my opinion, to define comparative advantage is a wrong and failed research program.

According to Marian Bowley who wrote a book on Nassau Senior in 1937, Bertil Ohlin was the only economist who avowedly adopted the approach to analyze the whole question in value terms. Although I do not adopt Ohlin's famous theory on trade (or Heckscher-Ohlin-Samuelson theory), Ohlin was right in believing that whole problems should be approached in value terms and not in "real" terms as for example Viner did.

My theory of international value is constructed in value terms. In this theory, the most important part is the determination of relative wages of different countries. If once wages are determined, all other analyses are the comparison of the production cost. A country which can produce the same commodity with least cost is competitive with regard to the commodity.

In the new theory, international trade is a competition with wages as handicaps. Advanced country with high wage rate is handicapped by its high wage. However, let me add that my theory is more loyal to what Ricardo developed in his Principles than what is usually called Ricardian theory of international trade which is an invention of John Stuart Mill (Please see my paper: An Origin of the Neoclassical Revolution). Ricardo's theory was cost-of-production theory of value. It worked well in a closed economy, but he could not present a theory when there are more than two countries, because he could not determine the wages of different countries. John Stuart Mill changed the Ricardo's question into a pure exchange problem and opened a way to the neoclassical economics. My theory stands in the Ricardian tradition, because it is still a cost-of-production theory of value. In this point also, the opposition between absolute and comparative advantage theory is misleading.

Let us come back to the initial Smith's pin factory. GVCs are a value side of GSCs. As you put it, this is indeed a pin factory extended over state borders. The manager of this pin factory must try to implement the world optimal procurement. This is the state that the new theory of international values describes. Difficulty in this situation is that you should determine wage rates and goods prices and see if all firms are operating with the global optimal procurement rule. The new theory shows that there is such a value (wages and prices) and we can work out some uniqueness and constancy theorems.