Monday, April 30, 2012

Globalization's Second Rebundling

When Old Trade Theory turned New, New Trade Theory turned Old, and Future Trade Theory may turn New again.

What will the production technology of the future look like?  A recent Economist essay on 3D printing hypothesizes a third industrial revolution, in which small parts could be “printed” on an individualized basis.  This would be a departure from the economies of scale that characterize capital intensive industries, as one would no longer need to submit orders for thousands of a specialized part; one prototype would get the job done.

But how will this transformation affect patterns of international trade?  Before arriving at a conclusive claim on the effects on trade, it’s important to get some perspective on the development of trade theory over the past few decades.  Old trade circa Ricardo and Heckscher-Ohlin-Samuelson was founded upon comparative advantage and natural factor endowments.  Countries scarce in labor would import labor intensive products, whereas countries scarce in capital would import capital intensive products.  This theory of trade then failed to explain the fact that many capital rich countries tended to import capital intensive products!  In a large scale test, HO predicted the direction of trade across multiple industries with 49.8% accuracy – lower than that of chance.

New Trade arose to explain these empirical irregularities by incorporating monopolistic competition, internal scale economies, and transportation costs.   Now that firms were monopolistically competitive, intra-industry trade began to play a much larger role.  Because the various firms in the capital intensive core could trade more cheaply with other core firms for intermediate inputs, firms would aggregate in the core.  This dynamic would also create home-market effects, in which an increase for the goods of an industry in the core would create a proportionately higher increase of the production of that good.  Part of the new production goes to feeding domestic industries, while the other part goes out to export as a result of a more competitive industry.

However, recent innovations with respect to transportation costs and communications technologies have reversed this trend.  In the original model, transportation costs functioned as a key reason for why intra-industry trade in the core happened.  Without transportation costs, the firms in the core could trade with the firms in the periphery for intermediate goods; there would be no home market effect. Such reversal of the predictions of New Trade became readily more apparent as new data rolled in.  Even when Krugman was giving his Nobel Prize acceptance speech for his work in trade theory, he noted that New Trade theory was getting old.  One of the canonical examples of New Trade was the development of auto industries.  Within the United States, “home market effects” tended to aggregate auto production in the Midwest (Mitten State represent!).  A Chicago Fed map of auto parts suppliers clearly illustrates this phenomenon:

Yet, in more recent times, a substantial amount of auto production shifted to the south, where labor was cheaper.  In effect, scale economies were overwhelmed by factor endowment advantages; new trade theory was becoming old.

This trend on the international level has been called by Baldwin as “globalization’s second unbundling”.  The reduction of transportation costs and communication costs allows supply chains to be more spread out over a larger region.  Intermediate goods don’t all need to be produced by one country.  Rather, they can be produced by smaller firms distributed over a larger region.  While Japan might be the home of Honda, the Thailand does much of the assembly, and has prospered much more as a part of a new “factory Asia.”  On the other hand, Malaysia tried the old method of building the entire supply chain, and is doing substantially worse.  This new regionalism allows for a greater diffusion of industry and, as a result, is more sensitive to initial factor endowments, much like old trade.

It is in this light that we can analyze the prospects for 3D printing on transforming the face of international trade.  What will happen will depend crucially on whether 3D printing will be generalized or specialized.  If 3D printing uses very general materials, then one firm could create key goods in a wide variety of industries.  There would not be an auto parts supplier and a tablet chip supplier; there would just be one 3D printing factory that could produce all of the small components as needed.  On one hand, the versatility of 3D printing would allow one firm to There would be less monopolistic competition as firms would not be as differentiated.  Taking away this key source of internal economies of scale may accelerate the second unbundling as there would be fewer reasons for firms to aggregate in one region.

On the other hand, if 3D printing is highly specialized, then new firms would quickly proliferate to fill the various market niches.  Monopolistic competition would actually heighten, creating more incentives for industries to agglomerate together.  Along with the increase in oil and transportation costs, transportation from distant factories may make it increasingly difficult for foreign factories to create the specialized components that 3D printing would support.  3D printing would allow such a high level of intra-industry trade.  Especially if the parts become highly specialized, it’s not that unreasonable to imagine that certain 3D printing firms may create the critical components for other 3D printers to continue their operations.  The result would be that we may return again to the world of New Trade Theory, in which initial geographic distributions can have a large effect on the movement and agglomeration of firms.   And as the original Economist article argues, this may result in a return of companies to rich countries as firms try to capitalize on the larger markets there.

With this possible transformation on the horizon, trade policy becomes increasingly important as industrial organization now may become even more fixed in the future.  Yet the fixed nature of trade may be an even stronger argument for higher labor mobility.  If factor mobility and free trade are substitutes, global welfare will be best served by allowing the citizens of poor countries to move to rich countries.  If the firms don’t move, the people will.

Increasing agglomeration of firms will also have an effect on currency unions and exchange rate pegging.  This was a key issue in the debate for the Eurozone:
As the EU moves towards a monetary union, it can be expected that the geographic concentration of industries will increase further, in line with developments so far, and paralleling United States experience (Krugman, 1991b). This, in turn, would raise the likelihood of asymmetric shocks affecting EMU member countries, thereby raising difficulties of adjustment in the absence of nominal exchange-rate instruments
If countries become increasingly heterogeneous and labor mobility is still limited by de facto issues such as language and culture, national sovereignty over monetary policy will be vital for each country’s stability.

With the technological revolution of 3D printing, New Trade Theory may become relevant again.  Globalization unbundled itself with the initial decrease in transportation costs that facilitated international trade.  It then rebundled itself as monopolistic competition and intra-industry trade caused firms to agglomerate in a global core, away from the periphery.  In recent times, the world has unbundled again with decreases in coordination costs allowing more regional supply chains.  The future may hold a second rebundling, in which 3D printing causes firms to return to countries and retreat from deep global integration.  This will have massive implications for globalization and trade policy as we watch these trends unfold in the coming decades.

No comments:

Post a Comment