Primary and processed primary products still account for nearly half the South's total merchandise exports to the North, and for many developing countries remain the sole source of foreign exchange earnings. Moreover, both casual observation and serious research (Whalley & Colleen, 1996) suggest that trade in primary products is shaped by differences in natural resource endowments, in accordance with the general principles of H-O theory (Whalley & Colleen, 1996).
However, land is of much less concern in the narrower context of this thesis. Of course, all manufactures contain some primary products (and what are called here 'processed primary products are classified as manufactures in production and employment data). Possession of a particular natural resource may therefore give a country a comparative advantage in manufactured goods embodying the primary product concerned. But this is not necessarily or generally the case, even for processed primary products, since most raw materials are internationally traded with low transport costs (Agosin, et al. 2007). Only where bulk or perishability are serious problems is the location of manufacturing governed by that of the natural resource.
On average, the South probably has fewer natural resources per person than the North, and most of the developing countries which depend heavily on primary exports do so not because they have absolutely abundant natural resources, but because they have few other resources. In some respects, then, the most illuminating way to introduce land into the simple model sketched above would be not as a third factor, but as a third country, which supplied primary intermediate inputs to the manufacturing sectors of both the North and the South.
This formulation would be misleading for some purposes, because natural resources can affect comparative advantage in manufacturing (in general, not only in resource-processing activities). Countries with more natural resources tend to export fewer manufactures, since they can produce (and export) primary commodities relatively more cheaply than other countries. However, natural resource abundance need not affect a country's comparative advantage within manufacturing. Whether a country exports skill-intensive or labor-intensive manufactures depends simply on the ratio of skilled to unskilled workers in its labor force, regardless of the extent of its natural resources (Agosin, et al. 2007).
The omission of (physical) capital from the initial model may seem even more curious than the omission of land. Not only is capital one of the two factors in most textbook presentations of H-O theory, but it is also usually seen as one of the fundamental bases of North-South trade in manufactures. The North is said to be well endowed with capital and thus an exporter of capital-intensive manufactures to the South, which, because it is poorly endowed with capital, has a comparative advantage in labor-intensive (meaning non-capital-intensive) production.
But this capital-based view of North-South trade is misleading. Machines and financial capital are internationally mobile, most buildings can be put up anywhere in a year or two, and rates of interest and profit are much the same in the South as in the North. In these circumstances, theory tells us (as does common sense) that capital cannot be a basic source of comparative advantage, though the capital-based view of North-South trade contains one important element of truth, which concerns infrastructure. There is thus actually little reason to bring capital into the present model (Backus, et al. 2010).
Nature of capital
Implicit in the capital-based view of North-South trade is a simplified treatment of capital, which is common to most expositions and applications of the H-O version of 'old' trade theory. The simplification is to regard capital as an exogenously given aggregate, analogous to land, of which some countries have relatively larger endowments than others, giving them a comparative advantage in relatively capital-intensive products. This approach has been subjected to two quite different sorts of criticism (Ho, 2006).
The first criticism is that capital goods are reproducible. 9 Given some time, machines and buildings can be multiplied without physical limit, and are thus not at all like land. On the contrary, it is more helpful to think of capital goods as a special class of intermediate goods: made to be used up in production, albeit over a longer period than other intermediate goods. It is also helpful to think of both intermediate goods and capital goods as forms of indirect labor: work done at earlier stages of the process of production, as contrasted with the direct labor of current production (Baxter & Kouparitsas, 2000).
This way of thinking is helpful because it reminds one constantly that capital goods are not an independent primary factor of production, but a reflection of the phasing or time-pattern of the input of labor. It also helps in explaining how the prices of capital goods are determined, and hence makes it easier to interpret value aggregates of capital, which in practice are usually based on the purchase prices of the capital goods concerned. In particular, this view of capital goods makes it clear that their prices must depend on the cost of producing them, which in turn must depend largely on the amount of labor (directly and indirectly) used in their creation, and on the wages of the labor concerned.
Of course, the cost of a capital good also includes an element of profit or interest on the part of the labor that was contributed in earlier periods, as well as some rent on natural resource inputs. But the bulk of the cost of most capital goods consists of (direct and indirect) wages. This wage element can be decomposed into (a) the number of hours of labor involved and (b) the average hourly wage. The latter clearly depends on the ratio of skilled to unskilled labor used in producing particular capital goods. It also depends on where these goods were produced. So if wages are lower in the South than in the North, the price of a capital good will tend to be lower if it is produced in the South than if it is produced in the North.
The second criticism of the 'given-endowment-of-capital' version of H-O theory is that many capital goods are internationally trade able. Capital goods can be divided into two categories, traded and non-traded. These will be referred to as 'machines' and 'buildings' respectively, although in reality some machines are too bulky to transport, and some buildings are erected by internationally mobile construction firms. There are of course transport costs on machines, and tariffs and other artificial barriers to trading them. But in theory, if machines are traded, it is natural to assume that their prices will be similar in all countries. 10 it is also an empirical fact that the average price of machines is much the same in poor countries as in rich countries (Baxter & Kouparitsas, 2000).
Moreover, if machines are traded, it is reasonable to suppose that any country can buy any machine, in unlimited amounts, provided it is able and willing to pay the going price. (Some exceptions will be discussed below.) if this is so, then possession of particular types or amounts of machinery cannot give a country an enduring comparative advantage in the production of particular goods, any more than a comparative advantage in cotton spinning can be obtained simply by purchasing a lot of ginned cotton on the international market. Thus whether machines are labeled a 'middle good' or a 'footloose factor', all theorists would agree that this type of input cannot in itself affect the pattern of trade (OECD, 2003).
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Whalley, John, ed. Developing Countries and the Global Trading System, Vol.…