Market Size in Globalisation(former title: Industrial Development in the Middle-sized Country)

Hayato Kato1

Toshihiro Okubo2

1 Keio University, JSPS
2 Keio University

ARSC @ Kobe U.
Nov. 2016

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Globalisation and industrial development

I

During the globalisation, economic performance differs fromcountry to country.

IIndustrialisation process is difficult for middle-income countries
as well as low-income ones.

I

Some middle countries have performed well, but others have not.

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I

The impact of economic integration is not uniform across middle
countries, e.g. East Asia vs. Latin America.

GDP per capita relative to the US (%)
Source: Penn World Table.

Q1. What brought the divergence of middle countries?
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De-industrialisation of large countries
From the viewpoint of developed countries...
I The expansion of middle-sized economies intensifies competition
for industry.
II

Growing fear of losing manufacturing jobs in the US, Europe andJapan.

Q2. Are these concerns justified?
Q3. If so, how does the large country prevent industry relocation?

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What we doI

Key factors are market size and wage rate.

IThree-country footloose capital (FC) model withexogenous wages:
Forslid (2011BookChap).

I

Two-country FC model with endogenous wages:
Takatsuka and Zeng (2012CJE).

→ Our model combines the two.
I

Unlike Zeng and Uchikawa (2014JMathE), we highlight the
middle-sized country, corner solutions and policy analysis.
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The modelI

Three countries: 1, 2 and 3.

I

Two sectors:

 Outside sectorperfect competition + non-traded.
 Manufacturing sectormonopolistic competition + trade costs.
I

Two factors: Internationally mobile capital K and immobile
labour L.

 Endowments: (Ki , Li ) = (si K , si L),

s1 + s2 + s3 = 1.

 Assume (market) size asymmetry: s1 > s2 > s3 .
 Capital is specific to the M-sector.

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Endogenous wage
IThe wage rate is determined to clear the labour market:
L1 = (L. demand in M-sector) + (L. demand in non-tradeable sector).

IThis givess3 [(1 − µ)s1 + (σ − 1)n1 ]w1= w1 =.
w3
s1 [(1 − µ)s3 + (σ − 1)n3 ]• µ ∈ (0, 1): expenditure share on M-goods; σ > 1: elasticity of substitution.
• Ni = ni K : Number of firms in Country i.
• Normalisation: w3 = 1.

I

The wage rate is proportional to the firm share: n1 ⇑→ w1 ⇑.
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Location equilibrium

I

Under free movement of capital,
the equilibrium number of firms in Country i, Ni = ni K , isdetermined by profit equalisation:I

π1 = π2 = π3 = π (in interior equilibria).

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In a two-country world• Agglomeration force (large market) vs. dispersion force (high wages).

(s1 , s2 ) = (0.6, 0.4).

• What about the middle country?
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Industry evolution in the middle country

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Three patterns of industry evolution in Cntry. 2

Market size triangle.
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Patterns of industry evolution in Country 2.

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Loss of industry/welfare in the large country

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Agglomeration in Country 1• If s1 >> s2 and σ is low, all firms may locate in 1 at intermediate trade
freeness.

Two-country agglomeration (left): (s1 , s2 , s3 ) = (0.45, 0.33, 0.22).
Full agglomeration (right): (s1 , s2 , s3 ) = (0.56, 0.3, 0.14).
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Agglomeration patterns in the market size triangle.

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• Country 1 may be worse off when relocation starts.
→ The fear of losing manufacturing jobs comes true.

(s1 , s2 , s3 ) = (0.56, 0.3, 0.14).

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Welfare decomposition
I

Real income per capita:
U1 =I

Labour and capital incomes
w1 + π= µ 1−µPrice index
P1 p01

When relocation from 1 to 2 starts,
Good:
Price of non-tradeable good: p0i ⇓.
Bad:
Wage: w1 ⇓. (*)
Ambiguous: Price index of M-goods: P1 ⇑⇓.
Good: Reduced cost & import price → P1 ⇓,Bad: Decreased variety → P1 ⇑. (**)

No change:
I

Capital income: π.

The damages from decreased wages (*) and variety (**) exceed
the benefits
when σ is low and s1 is not extremely large.
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Industry/welfare keeping policy in the large
country

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Asymmetric trade costs reductions

I

Country 1 reduces bilateral trade costs asymmetrically, e.g.
investment on infrastructure; FTA.

I

When Country 1 enhances trade with Country 2:
φ12 = φ21 = αφ, α > 1; φ13 = φ31 = φ23 = φ32 = φ.

IWhen Country 1 enhances trade with Country 3:
φ13 = φ31 = αφ, α > 1; φ12 = φ21 = φ23 = φ32 = φ.

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• Focus on the range of full agglomeration.
21 / 23• At, U112 (=FTA w/ 2) < U1 (=no FTA) < U113 (=FTA w/ 3).

• Trade enhancing policy with Country 2 accelerates relocation,
but the policy with Country 3 slows it down!
cf. “the U.S. has put too much effort on low risk, low reward negotiations
with small countries around the globe” by Schott (2004).

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Summary of findings

I

Relative market size matters for industrial development in themiddle country.

I

The large country that starts losing industry may be worseoff.

I

To prevent industry/welfare loss, the large country enhances
trade with the small country, rather than the middle country.

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