Structural Adjustment in Developed Open Economies

The theory of international trade has been extended in recent years to deal with intra-industry trade.² These extensions aim to explain certain facts about existing trade patterns, which cannot be explained by the traditional comparative costs theory (Ricardo) and the traditional relative factor abundance theory (Heckscher-Ohlin). They are based on the existence of product differentiation, economies of scale and monopolistic competition. They provide an explanation of trade which is complementary to the traditional views and it has, indeed, been shown by several authors that both explanations can coexist in extended models of international trade (see Helpman, 1984, for a review of this literature).

One of the most important trends in the world economy in recent decades has been the gradual erosion of the technological superiority of the industrial nations in general, and of the USA in particular. To this ‘closing of the gap’ may be attributed the decline of some traditional industries in the advanced countries; the increasing relative importance of high-technology products in the advanced countries’ exports; and the secular decline in US relative wages and the US real exchange rate. These effects on trade of technology and technological change are at the heart of the debate on international economic policy. Furthermore, there is widespread agreement on certain ways of looking at this issue — such as the common image of a ‘ladder’ of countries whose exports can be ranked on a ‘scale’ of goods — which suggest an implicit model shared by many observers. Yet this model has not been formalised. To a remarkable extent the treatment of technology in formal trade theory has failed to connect with policy concerns.

The recent volatility of international trade and mounting pressures for protection have stimulated new interest in the role of adjustment in trade theory. An excellent cross-section of current research is provided by an NBER volume on import competition and adjustment (Bhagwati, 1982). These essays show that adjustment may be, or may appear to be, costly for several reasons. First, real resources may be required to switch factors of production from one activity to another, as in retraining or retooling.¹ Second, adjustment may induce unemployment because of imperfections in factor markets.² Third, adjustment may be made costly by policy; for example, subsidies to declining industries may raise costs above competitive levels for expanding industries.³

In this paper, I forego the temptation to produce a formal model. Instead, I choose to raise some pertinent theoretical and policy issues that relate to the interaction between trade in goods and international factor mobility in so far as it has bearing on the major theme of this conference: namely the question of ‘structural adjustment’ in developed, open economies.

In the contemporary world, a national economy is closely integrated with the rest of the world through international trade and investment, to such an extent that it is continually exposed to changing conditions in foreign markets. It could be affected in many ways by disturbances in both the level and the structure of foreign prices. For instance, a decline in the foreign price level is likely to bring about a fall in the domestic price level, causing a reduction in the domestic employment and a deficit on the current account of the balance of payments at least in the short run. Furthermore, if this also involves a change in the foreign price structure, the national economy is forced to undergo structural adjustment processes, both in the short and the medium term. These will impose additional social costs unless resources can be smoothly reallocated from contracting to expanding sectors.

There is an evident incompatibility between the necessity to open small centrally planned economies to trade and the rigidity of their structure of production and exports. In order to eliminate this rigidity and facilitate the processes of structural adjustment to the changing external conditions, small centrally planned economies must reform their system of planning and management. The paper deals with the question how to change this system and what are the problems encountered.

This paper presents the results of an experiment in using a general equilibrium model to investigate the implications of protectionism in a world with rigidities. It reflects two aspects of policy-making today. One is the strong resistance of broad groups of the population to reductions in per capita incomes. The other is the efforts of pressure groups to use protection (and other means) to manipulate the distribution of incomes in their favour. To the extent that they are successful, these efforts extract rents from the economy and reduce its efficiency, making it more difficult to satisfy the per capita income objectives of the rest of the population.

In this paper we examine adjustment to trade policy changes in the context of a recently-formulated seven-region numerical general-equilibrium model of world trade, due to Whalley (1982). We evaluate possible short-run adjustment costs in response to trade policy changes using an approach similar to that adopted by Cline et al. (1978) in their analysis of the ‘Tokyo Round’ of trade negotiations. We examine different formulations in which the required long-run price and/or quantity adjustments are prevented from occurring because of adjustment rigidities. We also relate our calculations to welfare and adjustment-cost estimates for the USA from a study of multilateral tariff reductions by Baldwin et. al. (1980).

Following the advent of floating rates in 1973, there have been some sizeable swings in exchange rates involving the US dollar and other major currencies. Most recently, the dollar has appreciated sharply with respect to many other currencies. This appreciation has been a cause for concern to US policy-makers because, coming at a time of recession, it might aggravate the already painful process of adjusting domestically to the changing pattern of comparative advantage in both import-competing and export industries.

ORANI is a multisectoral model of the Australian economy. (Fully documented in P. B. Dixon, B. R. Parmenter, J. Sutton and D. Vincent (1982), hereafter cited as DPSV (1982).) It has been applied in studies of the effects on industries, regions and occupational groups of changes in tariffs, in the exchange rate, in wages and in aggregate demand, as well as of the adoption of home-price schemes for exported products, the exploitation of mineral resources, the adoption of equal pay for women, changes in domestic oil pricing policies, changes in world commodity prices and changes in the provision of subsidies to ailing industries. In all these applications, a feature of the results has been the sensitivity of the export-oriented industries to increases in the costs of labour and other inputs. In ORANI simulations, it is normally assumed that exporters face elastic foreign-demand schedules for their products, so that they cannot pass on cost increases to foreign customers without suffering significant sales reductions.

When the average rate of growth of an economy is high, considerable changes in the relative sizes of different sectors can often be accommodated without great cost. However, in an environment of sluggish overall growth, such as has characterised most of the world in the past eight years, structural adjustment may be extremely painful, even though it results from a boom elsewhere in the economy. The problems are likely to be particularly acute if the boom takes the form of a rapid and unanticipated expansion of a small number of sectors, as typically follows the exploitation of natural resource discoveries.

This paper constitutes an initial attempt to sort out and assess, within a neo-classical general-equilibrium framework, the relative and absolute importance of three separate potential influences on domestic sectoral-prices within a country: (1) external prices, (2) capital movements, and (3) technological change. Monthly data for West Germany and Sweden are used, since these are among the few countries for which price-index series exist for imports and exports, classified consistently with the price-index series for commodities sold on the domestic market.²

The general nature of the competitive position of the United States in world trade is well known. Analyses of world market shares of manufacturing exports have been made on a regular basis for the past 35 years, and reports over the past few years by the GATT, OECD and various individual scholars have clearly chronicled the deterioration in the competitive position of the USA. However, most studies have dealt with manufacturing as a whole or else divided manufactures into only a few broad product groups. Few have analysed the manufacturing sector in terms of detailed SIC or input-output sectors, or tried to relate detailed competitive shifts to changes in the employment of different types of labour. The result has been that while policy officials are well aware of the competitive problems of such industries as footwear, clothing, steel, colour TV and automobiles as well as the competitive gains by such sectors as computers and aircraft, they do not have a good picture of competitive trends in the many other industries making up the US manufacturing sector.

Textile and clothing industries comprise a group of industries which have exhibited trends common to many industrialised countries. Increasing competition from the Newly-industrialised Countries (NICs) in particular has raised the share of the market held by imported supplies. Changes in technological processes and in fashion have forced other major adjustments upon producers in the group. Governments have responded to these pressures by increasing the level of government assistance to the industries. (See Keesing and Wolf, 1980.) Thus the group provides an example of industries which have been subject to higher-than-average competitive pressures for structural adjustments and of the government response to these pressures.

Changes in the structure of production and employment are nothing but a normal feature of any economic development. Indeed, the process of economic growth is little more than a sequence of structural changes. The famous Schumpeterian notion on the ‘process of creative destruction’ in capitalist development may somewhat overstate the point, but it is certainly correct in focusing attention on the relevant issues. During periods of economic prosperity, and this is the case by definition, structural change is not accompanied by major frictions in the adjustment process. Expanding firms and industries rapidly absorb available resources. The withdrawal of resources from stagnating or declining firms and industries takes place more or less smoothly and is encouraged by the existence of ample employment opportunities in other economic activities. Up to the first oil crisis of 1973–4, this happy conjuncture seems to have prevailed in the Western industrial countries. Since then, however, structural adjustment in almost all countries has been accompanied by extensive friction and by waste of resources through unemployment. Low investment activity and slow economic growth performance (measured in relation to earlier standards) have characterised the recent period of economic malaise.