Skip to main content
SpringerLink
Log in

RCA indices, multinational production and the Ricardian trade model

  • Original Paper
  • Published:
International Economics and Economic Policy Aims and scope Submit manuscript

Abstract

The practice of using Revealed Comparative Advantage (RCA) Indices to determine the flow of goods trade among countries is well established. But an important issue that demands attention is whether the RCA indices reflect the essentials of comparative advantage theory. Deb and Basu Foreign Trade Rev 46(3):3–28, (2011) examined the consistency of alternative RCA indices with the Heckscher-Ohlin theory of comparative advantage, leaving scope for re-examination of the indices in the context of the Ricardian comparative advantage theory, which insists on relative factor productivity differences among countries contrary to Heckscher-Ohlin’s relative factor endowment differences. The other issue which has been overlooked in much of the existing literature is the importance of value-added trade. With the growing importance of global production chains, RCA indices based on gross export values may not portray an accurate picture of the underlying comparative advantage of countries. In this context, adjusting the RCA indices to incorporate domestic value-added in exports seems to be quite relevant. This paper explores the consistency of RCA indices based on domestic value-added in exports with the Ricardian theory of comparative advantage using a panel data approach. A brief review on the structures of alternative RCA indices is also provided. The Log-of-Balassa index is found to be the best performer in this empirical examination, although the deficiencies of the index for cross-country or cross-commodity comparison must be acknowledged. The index of Yu et al. Ann Reg Sci 43(1):267–282, (2009) does possess the latter feature but in our study its performance is quite poor and hence its consistency with the Ricardian theory of comparative advantage is questionable.

This is a preview of subscription content, log in via an institution to check access.

Access this article

Log in via an institution

Price excludes VAT (USA)
Tax calculation will be finalised during checkout.

Instant access to the full article PDF.

Institutional subscriptions

Similar content being viewed by others

Notes

  1. In a theoretical study, Hillman (1980) explored the relation between Balassa’s RCA index values and comparative advantage as indicated by the pre-trade relative prices and failed to establish their one to one correspondence under all circumstances. His idea has been extended by Bebek (2011) in the context of other export based RCA indices.

  2. An earlier version of this article looked at the possibility of incorporating imports and exports into our RCA indices. Theoretically, using net exports rather than gross exports as the basis of a measure of comparative advantage might be desirable in sectors with large amounts of intra-industry trade and re-exports. However, converting all of our indices was difficult given that some of our indices are in ratio form, while others are in deviation form, forcing us to adopt the approach of Vollrath (1991) regarding the incorporation of imports in the indices. Furthermore, our studies in this area yielded little real impact on our primary results.

  3. This move was primarily aimed at ensuring the reliability of the corresponding regression estimates.

  4. The concept of Galtonian regression was first adopted by Hart and Prais (1956) from Galton’s (1889) methodology while studying the heights of fathers and sons and analyzing size wise concentration. Since then, the Galtonian regression method has been extensively employed in the literature to examine technological specialization patterns (Cantwell 1989), convergence of productivity levels over time (Hart 1995) and changes in the structure of trade specialization using RCA indices (Dalum et al. 1998; Laursen 1998; Frantzen 2008; Sharma and Dietrich 2007; Sanidas and Shin 2010, 2011).

  5. A distribution with an unstable mean across sectors with respect to a country, has two consequences for comparability – (1) If a country gains a comparative advantage in one sector, it is impossible to say for certain that it has lost a comparative advantage in some other sector. Hence cross-sectoral comparison becomes difficult. (2) The same sectoral value of the index may have a different meaning for different countries, which leads to difficulty in comparing country index values for that particular sector. Hence, ranking countries by RCA for a sector would not be reliable. Similar problems would exist in case of a distribution with an unstable mean across countries with respect to a sector.

  6. End use categorization classifies goods as intermediate goods, final consumption goods and capital goods.

  7. The recent change in global merchandise trade could be explained by several factors. The first explanation is, a higher rate of reduction in tariffs and other trade costs on intermediate products compared to final products over the last 20 years, has contributed to greater movement of parts and components all over the world (Miroudot et al. 2009). Second, the growth of foreign direct investment (FDI) boosted the trade in intermediate products (Miroudot et al. 2009). Third, induced by the first and second factors, intra-firm trade has increased and has contributed to increased intermediate goods trade (Yi 2003). Finally, domestic market oriented reforms by countries like China have enabled other countries and multinational enterprises to involve China in their global production network (Meng et al. 2012, 4).

  8. Goods with similar factor intensity are characterized by excellent substitution possibilities. Moreover, as inherent in the intra-industry trade literature, with number of goods being substantially large relative to the number of factors, it is possible to expand the production of some goods at the expense of others without raising the marginal opportunity costs. Both these characteristics of intra-industry trade underline the essence of Ricardian determinants of trade such that with linear transformation curves, trade could take place on the basis of technical differences (Davis 1995).

  9. This formulation however differs to some extent from the domestic value-added concept of Koopman et al. (2012) represented by expression (8). They basically enquire about how much of the domestic content from various sectors could be found in a country’s final exports of a product. But in order to determine the comparative advantage of a country in a sector, one should enquire about that sector’s domestic content in exports of various products from a country.

  10. In principle, what matters for the determination of comparative advantage is the marginal product of labour (MPL), rather than the APL. However, data limitations prevent us from directly observing the marginal product, even though the APL and MPL will not generally be the same. However, for our purposes, it is sufficient that these measures should be highly correlated with each other. We believe this to be a reasonable assumption if comparative advantage is driven primarily by differences in factor productivity across countries (as in the Ricardian model) rather than factor accumulation (as in the traditional Heckscher-Ohlin model, which does not perform well empirically unless augmented by differences in factor productivity). We note in the conclusion below that creating a better MPL measurement would be a desirable area for future research.

  11. Country fixed effects take care of the fact that different countries may have different time invariant features which need to be estimated separately, so that we could factor out the effects that these country specific characteristics may have on the relationship between RCA index and productivity ratio. Similarly, year fixed effects factor out the variations across years for reasons such as technological changes, wars, conflicts etc., and country-year fixed effects to take care of country specific characteristics varying over time. In addition, the random effects component allows for the fact that for each sector in any particular country, the residual term would be correlated across years (country-sector is defined to be the cross sectional unit for the panel).

  12. ISIC stands for International Standard for Industrial Classification of all Economic Activities

  13. This had to be done because the input–output matrices are based on GTAP database. Due to the difficulty in matching the commodity classification of GTAP with the ISIC codes, Nicita and Olarreaga (2007) could provide a rough classification of sectors on the basis of ISIC codes in the input–output tables of Trade Production and Protection database. We use the 17 sectors from their classification and simultaneously adjust the data on exports, value added and number of employees to match those 17 sectors. While more finely disaggregated data on imports and exports are available (for example at the HS 4-digit or 8-digit levels), we cannot easily match these data to the “domestic” data on production, value added, and input–output matrices. The study is thus constrained by the non-availability of detailed disaggregated data on the relevant variables. The input–output coefficient matrices required for the adjustment of gross exports figures for the domestic value-added in export figures are provided by the TPP database only for 3 digit ISIC codes. Other sources of such data e.g., World Input Output Database, IDE-JETRO, and GTAP report data at highly aggregated sectoral classifications and matching their commodity classification into more disaggregated international sectoral classifications might not be feasible. However, at higher levels of industry aggregation, intra-industry trade might be observed while inter-industry trade is occurring. A country might be exporting a product classified under one 4 digit ISIC code while importing another product classified under a different 4 digit ISIC code, but under the same 3 digit sectoral classification. It would appear to be engaged in inter-industry trade when considering the 4 digit classifications but intra-industry trade when considering the corresponding 3 digit classification. Hence, the finer the sectoral classification, the more likely that inter-industry trade would be observed and would perhaps provide a more relevant framework for analyzing the Ricardian model of inter-industry trade. The non-availability of required input–output matrices on the basis of more disaggregated sectoral classifications is thus a major constraint in analyzing the Ricardian model.

  14. We do not report the estimated coefficients of fixed effects due to space constraints. However, these results are available on request.

  15. In practice, this means that we no longer subscript our variables with sectors, as a variables in a given regression are from the same sector. Also, we no longer use country-year fixed effects, but rather just year fixed effects.

References

  • Ando M (2006) Fragmentation and vertical intra-industry trade in East Asia. N Am J Econ Financ 17(3):257–281

    Article  Google Scholar 

  • Arndt SW (1997) Globalization and the open economy. N Am J Econ Financ 81(1):71–79

    Article  Google Scholar 

  • Balassa B (1965) Trade liberalisation and ‘revealed’ comparative advantage. Manch Sch 33(2):99–123

    Article  Google Scholar 

  • Balassa B, Bauwens L (1988) Changing trade patterns in manufactured goods: An econometric approach. Elsevier, New York

    Google Scholar 

  • Bebek UG (2011) Monotonicity of additive indices revealed comparative advantage. Econ Bull 31(2):1894–1901

    Google Scholar 

  • Bowen H, Leamer E, Sveikauskas L (1987) Multicountry, multifactor tests of the factor abundance theory. Am Econ Rev 77(5):791–809

    Google Scholar 

  • Cantwell J (1989) Technological Innovation and Multinational Corporations. Basil Blackwell, Oxford

    Google Scholar 

  • Dalum B, Laursen K, Villumsen G (1998) Structural change in OECD export specialisation patterns: despecialisation and ‘stickiness’. Int Rev Appl Econ 12(3):423–443

    Article  Google Scholar 

  • Daudin G, Rifflart C, Schweisguth D (2011) Who produces for whom in the world economy? Can J Econ 44(4):1403–1437

    Article  Google Scholar 

  • Davis DR (1995) Intra-industry trade: a Heckscher-Ohlin-Ricardo approach. J Int Econ 39(1995):201–226

    Article  Google Scholar 

  • Deardorff AV (2001) Fragmentation in simple trade models. N Am J Econ Financ 12(2):121–137

    Article  Google Scholar 

  • Deb K, Basu P (2011) Indices of revealed comparative advantage and their consistency with the Heckscher-Ohlin theory. Foreign Trade Rev 46(3):3–28

    Article  Google Scholar 

  • Eaton J, Kierzkowski H (1984) Oligopolistic Competition, Product Variety and International Trade. In: Kierzkowski H (ed) Monopolistic Competition and International Trade. Oxford University Press, Oxford, pp 69–83

    Google Scholar 

  • Falvey RE (1981) Commercial policy and intra-industry trade. J Int Econ 11(1981):495–511

    Article  Google Scholar 

  • Falvey RE, Kierzkowski H (1987) Product Quality, Intra-Industry Trade and (Im)Perfect competition. In: Kierzkowski H (ed) Protection and Competition in International Trade. Basil Blackwell, New York, pp 143–161

    Google Scholar 

  • Feenstra, RC (1998) Integration of trade and disintegration of production in the global economy. J Econ Perspectives 12(4):31–50

  • Feenstra RC, Hanson GH (1997) Foreign direct investment and relative wages: evidence from Mexico’s maquiladoras. J Int Econ 42(3–4):371–439

    Article  Google Scholar 

  • Frantzen D (2008) Technology, competitiveness and specialisation in OECD manufacturing. J Econ Stud 35:44–68

    Article  Google Scholar 

  • Galton F (1889) Natural Inheritance. Macmillan, London

    Book  Google Scholar 

  • Grubel H, Lloyd PJ (1975) Intra-Industry Trade: The Theory and Measurement of International Trade in Differentiated Product. Macmillan, London

    Google Scholar 

  • Hart PE (1995) The convergence of labour productivity in British and German industries. Int J Econ Bus 2:453–464

    Article  Google Scholar 

  • Hart PE, Prais SJ (1956) The analysis of business concentration: a statistical approach. J R Stat Soc Ser A (Gen) 119:150–191

    Article  Google Scholar 

  • Helpman E (1981) International trade in the presence of product differentiation, economies of scale and monopolistic competition: a Chamberlin-Heckscher-Ohlin approach. J Int Econ 11(1981):305–340

    Article  Google Scholar 

  • Helpman E (1985) Multinational corporations and trade structure. Rev Econ Stud 52(3):443–457

    Article  Google Scholar 

  • Hillman AL (1980) Observations on the relation between “revealed comparative advantage” and comparative advantage as indicated by pre-trade relative prices. Weltwirtschaftliches Arch 116:315–321

    Article  Google Scholar 

  • Hoen A, Oosterhaven J (2006) On the measurement of comparative advantage. Ann Reg Sci 40(3):677–691

    Article  Google Scholar 

  • Hummels D, Rapoport D, Yi K (1998) Vertical specialisation and the changing nature of world trade. Fed Reserv Bank N Y Econ Policy Rev 4(2):79–99

    Google Scholar 

  • Hummels D, Ishii J, Yi K (2001) The nature and growth of vertical specialization in world trade. J Int Econ 54(2001):75–96

    Article  Google Scholar 

  • Johnson R, Noguera G (2012) Accounting for intermediates: production sharing and trade in value-added. J Int Econ 86(2012):224–236

    Article  Google Scholar 

  • Jones RW, Kierzkowski H (2001) A Framework for Fragmentation. In: Arndt SW, Kierzkowski H (eds) Fragmentation. New Production Patterns in the World Economy. Oxford University Press, Oxford, pp 17–34

    Google Scholar 

  • Jones RW, Kierzkowski H, Leonard G (2002) Fragmentation and Intra-Industry Trade. In: Lloyd PJ, Lee HH (eds) Frontiers of Research in Intra-Industry Trade. Palgrave McMillan, New York, pp 67–86

    Chapter  Google Scholar 

  • Kinoshita Y, Campos NF (2006) Determinants and effects of foreign direct investment in transition economies. In: Nakagawa J (ed) Managing Development: Globalisation, Economic Restructuring and Social Policy. Routledge, England, pp 261–285

    Google Scholar 

  • Koopman R, Wang Z, Wei S (2012) Estimating domestic content in exports when processing trade is pervasive. J Dev Econ 99(2012):178–189

    Article  Google Scholar 

  • Koopman R, Wang Z, Wei S (2014) Tracing value-added and double counting in gross exports. Am Econ Rev 104(2):459–494

    Article  Google Scholar 

  • Krugman P (1979) Increasing returns, monopolistic competition and international trade. J Int Econ 9(1979):469–479

    Article  Google Scholar 

  • Krugman P (1980) Scale economies, product differentiation and the pattern of trade. Am Econ Rev 70(5):950–959

    Google Scholar 

  • Lancaster K (1980) Intra-industry trade under perfect monopolistic competition. J Int Econ 10(2):151–170

    Article  Google Scholar 

  • Laursen K (1998) Revealed Comparative Advantage and the Alternatives as Measures of International Specialisation. DRUID Working Papers, 1998–30

  • Meng B, Fang Y, Yamano N (2012) Measuring Global Value Chains and Regional Economic Integration: An International Input–output Approach. IDE Discussion Paper No. 362

  • Miroudot S, Lanz R, Ragoussis A (2009) Trade in Intermediate Goods and Services. OECD Trade Policy Working Paper No. 93

  • Nicita A, Olarreaga M (2007) Trade, production and protection. World Bank Econ Rev 21(1):165–171

    Article  Google Scholar 

  • NRC (2006) Analyzing the U.S. content of imports and the foreign content of exports. In: National Research Council. The National Academies Press, Washington DC

    Google Scholar 

  • Pittiglio R (2014) An essay on intra-industry trade in intermediate goods. Mod Econ 5:468–488

    Article  Google Scholar 

  • Sanidas E, Shin Y (2010) Comparison of Revealed Comparative Advantage Indices with Application to Trade Tendencies of East Asian Countries. Paper Presented at the 9th Korea and the World Economy Conference, Incheon, 2010

  • Sanidas E, Shin Y (2011) Convergence towards the revealed comparative advantage neutral point for East Asia: similarities and differences between the three countries. Seoul J Econ 24:21–50

    Google Scholar 

  • Sharma A, Dietrich M (2007) The structure and composition of India’s exports and industrial transformation (1980–2000). Int Econ J 21:207–231

    Article  Google Scholar 

  • Trefler D (1995) The case of missing trade and other mysteries. Am Econ Rev 85(5):1029–1046

    Google Scholar 

  • Türkcan K (2011) Vertical intra-industry trade and product fragmentation in the auto-parts industry. J Ind Compet Trade 11(2):149–186

    Article  Google Scholar 

  • Türkcan K, Ates A (2011) Vertical intra-industry trade and fragmentation: an empirical examination of the U.S. auto-parts industry. World Econ 34(1):154–172

    Article  Google Scholar 

  • Vollrath T (1991) A theoretical evaluation of alternative trade intensity measures of revealed comparative advantage. Rev World Econ 127(2):265–280

    Google Scholar 

  • Yi K (2003) Can vertical specialization explain the growth of world trade? J Polit Econ 111(1):52–102

    Article  Google Scholar 

  • Yu R, Cai J, Leung P (2009) The normalized revealed comparative advantage index. Ann Reg Sci 43(1):267–282

    Article  Google Scholar 

Download references

Author information

Authors and Affiliations

  1. Department of Humanities and Social Sciences, Indian Institute of Technology Guwahati, Guwahati, 781039, Assam, India

    Kaveri Deb

  2. Department of Economics, Moore School of Business, University of South Carolina, 1014 Greene Street, Columbia, SC, 29208, USA

    William R. Hauk Jr.

Authors
  1. Kaveri Deb
    View author publications

    You can also search for this author in PubMed Google Scholar

  2. William R. Hauk Jr.
    View author publications

    You can also search for this author in PubMed Google Scholar

Corresponding author

Correspondence to William R. Hauk Jr..

Rights and permissions

Reprints and permissions

About this article

Check for updates. Verify currency and authenticity via CrossMark

Cite this article

Deb, K., Hauk, W.R. RCA indices, multinational production and the Ricardian trade model. Int Econ Econ Policy 14, 1–25 (2017). https://doi.org/10.1007/s10368-015-0317-z

Download citation

  • Published:

  • Issue Date:

  • DOI: https://doi.org/10.1007/s10368-015-0317-z

Keywords

JEL Classification

Search

Navigation