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Expanding the scope of the export sector

by Michael Spence and Sandile Hlatshwayo

NEW YORK — Since the end of World War II, the global economy’s trade and financial openness has increased, thanks to institutions like the International Monetary Fund and successive rounds of liberalization, starting with the General Agreement on Tariffs and Trade in 1947.

In parallel, colonialism collapsed, and we are now slightly more than halfway through a century-long process of modernization for the many developing countries that emerged. But where has that process led, where is it taking us now, and, perhaps most importantly, how can we influence its course?

With formal barriers to trade and capital flows lowered, several trends combined to accelerate growth and structural change in postcolonial and other developing economies. These included advances in technology (especially transportation and communications), management innovation in multinational companies, and integration of their supply chains.

Thus, in the early postwar period, developing countries, whose exports had previously consisted mainly of natural resources and agricultural products, expanded into labor-intensive manufacturing. Textiles and apparel came first, followed by luggage, dishes, toys, etc. Supply chains also dispersed geographically, with lower value-added components and processes allocated to low-income countries.

In consumer electronics, for example, low-income countries became a natural location for labor-intensive assembly processes, while semiconductors, circuit boards and other components were designed and manufactured in high middle-income countries like South Korea.

After more than 30 years of rapid growth, China is entering a “middle-income transition.” Over time, labor-intensive components of value-added chains will move away from China’s higher-income areas. Helped by massive public investment in infrastructure and logistical capabilities, some of this work will move inland, where incomes are lower. Eventually, though, labor-intensive activities will move to countries at earlier stages of development.

This middle-income transition is sometimes deemed a trap. Indeed, most countries entering middle-income transitions see their growth slow, even stall. Of the 13 postwar cases of sustained high growth (soon to be 15, with the addition of India and Vietnam), only five economies — Japan, South Korea, Taiwan, Hong Kong and Singapore — have maintained high growth rates through the middle-income transition and proceeded toward advanced-country income levels of $20,000 per capita or above.

Early high-growth economies — Japan, South Korea, Taiwan — initially exported labor-intensive products, then graduated to more capital-intensive goods like motor vehicles, and then to human-capital- intensive activities like design and technology development. As wages rose, Japan’s labor-intensive activities migrated to later arrivals in the global economy.

China accelerated to a high-growth pattern in the late 1970s and early ’80s, owing to the benefits of its low-cost labor and a major change in economic policy. No one anticipated its abrupt shift away from a closed, centrally planned economy to a more open, market-oriented one with expanded economic freedom for individuals and enterprises alike.

As emerging-market economies shift to higher value-added components in global supply chains, their physical, human and institutional capital deepens. This brings their structure closer to that of the advanced countries, introducing greater competition in what was once the advanced countries’ sole territory.

The aggregate size of developing countries, their rising incomes and their movement up the value chain increasingly affect advanced-country economies, particularly the tradable sectors.

What is the impact on a large advanced country like the United States? Some 98 percent of the 27.3 million net new jobs created in the U.S. since 1990 have been in the nontradable sector — dominated by government, health care, retail, hospitality and real estate. Given long-term constraints on both fiscal and household spending in the wake of the financial crisis and downward pressure on asset prices, the sustainability of such an employment trend is questionable.

Indeed, the postcrisis shortfall in domestic demand is causing stubbornly high unemployment, even as the economy recovers some of its growth momentum.

In principle, foreign demand, especially in high-growth emerging markets, could make up some of the difference, but that hasn’t happened yet. Although the U.S. trade deficit fell to $375 billion in 2009, from $702 billion in 2007, the adjustment came entirely from a sharp decline in imports, from $2.35 trillion to $1.95 trillion (exports actually fell slightly from $1.65 trillion to $1.57 trillion).

Growth in exports could come with further expansion in parts of the value-added chains where the U.S. is already competitive (finance, insurance and computer systems design, for example). But the scope of the export sector itself will have to expand in order to generate sufficient employment and reduce the external deficit.

That will require restoring and creating competitiveness in an expanded set of value-added components in the tradable sector. There isn’t an easy and reasonably certain way to accomplish that. Protectionism is certainly not the answer.

Michael Spence, a Nobel laureate in economics, is professor of economics, Stern School of Business, New York University. Sandile Hlatshwayo is a researcher at the Stern School. © 2011 Project Syndicate