Mode of technology transfer and North-South trade and welfare: Revisiting Kojima – Ozawa propositions

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Is the Ricardian growth theory passé – or still relevant?

The Ricardian growth theory is the very first macroeconomic theory of stagnation due to profit squeeze. Ricardo pointed out how the irremovable scarcity of arable land (on which agricultural output is subjected to the law of diminishing marginal returns) and the Malthusian population growth phenomenon would increase food prices and money wages and eventually erode the entrepreneur’s profit (reinvestable capital). The net outcome is the complete evaporation of investable funds and the arrival of a stagnated economy (Ozawa, 2005).
Ricardo emphasized that economic growth depends on capital accumulation, which in turn relies on profits. He pessimistically saw the inevitability of the stationary state. Can the economy escape from stagnation? Ricardo pointed out that the day of reckoning could be postponed if free trade was pursued. He argued that North -South trade provided a growth-sustaining escape mechanism by enabling two regions to specialise The South, a land abundant economy, had a comparative advantage in producing agricultural goods. The North removes capital stock from its own agricultural production and reallocates it in the production of manufactured goods. Through its import of wage goods from the South more cheaply, it maintains a higher rate of profit and sustains capital accumulation (Ricardo, [1817] 1951; Molana and Vines, 1989). However, Fiaschi and Signorino, (2003, p.12) added that “if the importation of cheaper agricultural commodities from abroad is unable to counteract the action of diminishing returns in domestic [North] agriculture, the process of economic growth inevitably comes to a halt”. According to Findlay’s (1980) interpretation of the Ricardian growth model, the world economy must tend toward a stationary state. Trade can thus postpone, but not stop, the cessation of growth because of diminishing returns. According to Ozawa (2005, pp.158-159), Ricardo did not focus on another important solution-which is FDI- as a means of transplanting industrial activities to new locations abroad where arable land is still abundant and wages are still low28. All the three possible escape responses to Ricardo’s bottlenecks – Trade liberalization, technological progress and offshore productions – are conducted by the advanced mature economies.
Ozawa (1979a, p.85) added that “the Ricardian model applied to a closed economy without trade (cheap food imports and other imported wage goods would certainly stem rising labour costs);and the irremovable scarcity of key input factors emphasized by Hicks (1974) is expected, under normal circumstances, to occur only in the long run when the economy matures”. However, many economies best typified by Japan, in the earlier seventies, and more recently Singapore, Hong Kong, South Korea and Taiwan, despite their openness to trade, reached these growth barriers experiencing acute land and labour shortages and rising wage rates (see Wu and Chen, 2001). For these countries, direct investment was an escape from industrial stagnation brought about by increasing scarcities of natural resource, land and labour. As economic growth was restricted by a shortage of resources, necessary adjustments to the industrial structure meant that mature technologies and industries needed to be transferred abroad.
We focus on the generalized Ricardian growth theory; called the “Ricardo-Hicksian bottlenecks theory of industrialization”. Ricardo’s theory of growth stagnation was strongly supported by Hicks (1973, 1974, 1981). Hicks applied it to a fast-growing economy and stated that irremovable scarcity of labour and land would in the end, constrain the pace of economic growth. Hicks’s growth model can be combined with Ricardo’s theory of stagnation into what may be called the “Ricardo-Hicksian trap of industrial development” (Ozawa, 1979a, b, 1993, 2005). According to this Ricardo-Hicksian theory of growth bottlenecks, an industrial economy cannot expand indefinitely, as sooner or later it must encounter “irremovable scarcities” of key productive factors such as land (for industrial sites ), natural resources and labour- the Ricardo- Hicksian shortage of key productive factors. Hicks (1973, pp. 218-219).

FDI from natural resource scarce industrialized economies: a vibrant research topic

The leitmotif of this sub-section is that any fast growing country that goes for a resource-intensive heavy industrialization searches aggressively for resources abroad by investing in resource rich countries. We focus on the resources-based FDI from resources-scarce but industrialized economies-the “Ricardian economies” – best typified by Japan in the 1970s. We explain the push effect of natural resource shortage for OFDI from industrialized countries (for example, China and India) feeling the pressure of the Ricardian bottlenecks on their industrial development and seeking to secure stable long-term supplies of raw materials and natural resources.
We examine the implications for FDI aiming at overcoming natural resource-scarcity bottlenecks to economic growth. When any resource-scarce country reaches a stage of growth based on resource-intensive heavy industries, it is pushed to seek out resources abroad via FDI which contributes to efficiency by breaking industrial supply bottlenecks. In general, the early forms of a country’s OFDI are primarily resource seeking. This type of FDI integrates  30Ozawa notes that FDI has served as a house-cleaning-and-renovating vehicle for Japan as it has steadily upgraded its domestic production facilities and repeatedly metamorphosed from one phase of industrialisation to another.
backwardly into the search for raw materials which either do not exist in the home investing country or are only available in amounts inadequate for industrial development. Several of the resources seeking FDI from developing countries follow the earlier resource seeking FDI from the UK, the USA and more recently, Japan, which are largely dependent on foreign natural resources for their domestic industrial requirements.

A replication of the Japanese Ricardian-trap stage of transnationalism

Since chemical and heavy industries are highly resource and energy intensive, the Ricardian trap of industrial production is ineluctable and explains the forces resulting in outward reach of the industrialized resource-scarce countries – the “Ricardian economies”-for foreign resources. Securing resource supplies from abroad becomes of vital importance for these countries. Early on, many industrialised countries best typified by Japan relied on trade for importing natural resources but soon began to secure the supply sources by FDI (Ozawa, 1993, 1996). According to the stylized facts on FDI trends in Asian region (see the survey of Tolentino, 1993, 2000), the industrial development of heavy and chemical industries in Taiwan in the 1960s and 1970s led to the dominant role of OFDI to relocate abroad some of the more resource intensive and often pollution prone industries in the 1970s and 1980s to escape from the Ricardo-Hicksian trap of industrialisation and economic growth. Similarly, the industrial development of heavy and chemical industries in South Korea in the 1970s and 1980s led to the emergence of its OFDI in natural resource extraction and heavy and chemical industries in those decades. To the extent that South Korean and Taiwanese FDI could be compared with the pattern of Japanese FDI since the second World War, the phase of Japanese FDI in heavy and chemical industries during the Ricardo-Hicksian trap stage of Japanese FDI has been transposed in the case of the history of South Korean MNFs and in the case of Taiwanese MNFs. It seems that we can substitute the words “Korean” and “Korea”, “Taiwan” and “Taiwanese” for “Japanese” and “Japan”, respectively, in the explanation of OFDI, and that the “Ricardian bottlenecks” approach still holds. In addition, outward resources-based investments from the Philippines in the 1980s seem to follow some features of the Japanese experience (see Tolentino, 1993, 2000; Dent, 1996; Randerson and Dent, 1996; Kimura and Lee, 1998).

Fuelling the industrial development and economic growth of “Asian Drivers”38-China and India

As emphasized above, natural resource scarcity acts as bottleneck to economic growth. Any economy, but especially resource scarce one, that goes through growth based on natural resource intensive industries struggles to secure stable supplies of resources abroad. The motivation to secure access to natural resources is becoming more and more important, reflecting a rise in demand from emerging developing countries to support their economic growth. OFDI might seek natural resources to acquire and secure a continual supply for the investing country. The growing demand for various natural resources has been a key driver in the recent expansion abroad of State-owned MNFs from Asia.
China and India’s great appetite for energy and metal has boosted international prices. The recent energy crunch gave way to stories about China’s and India’s efforts to invest in oil projects and companies in the world, in particular in Russia, Canada, Australia, Latin America, Central Asia, and Africa. China and India are hungry for energy39. With a combined population that accounts for one third of humanity, the two “Asian Drivers” are now going through a phase of rapid industrialization, creating a huge demand for energy consumption. Neither country produces enough energy to satisfy its own needs. Their fast-growing imports of oil, natural gas, and other materials have put substantial pressure on the global energy and resource markets (Kant, 2008; Buckley et al., 2008). Given many reports of billion dollar deals in 2006 and 2007 involving resource rich countries in Africa, central Asia and elsewhere, resource grabbing was a key driving force behind China’s and India’s OFDI (International Energy Agency, 2007; Buckley, 2007; Buckley et al.,2007; Buckley et al.,2008;Goldstein et al.,2006;UNCTAD, 2007,2008b). The share of mining activities in Chinese OFDI stock increased from 13.29% in 2004, to 15.12% in 2005, to 19.75% in 2006. The share of mining activities in Chinese OFDI stock increased from 13.29% in 2004, to 15.12% in 2005, to 19.75% in 2006 (Ministry of Commerce of the People’s Republic of China, 2006). The share of extractive activities in Indian OFDI stock increased from 1.47% in 2000, to 11.44% in 2004 (Kumar and Chadha, 2008).

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An empirical follow-up on Ozawa’s macroeconomic theory of outward FDI: new evidence from catching-up countries

There is a plethora of studies on the developing countries (especially China) as recipient of FDI. However, the role of the developing and transition countries as investing economies has received little attention. In this sub-section, we examine the determinants of OFDI from the emerging countries and transition economies and we focus on the role of home country ‘push’ factors in explaining the rise of MNFs (from these countries). Why do these countries invest and send their capital abroad? What are the home country’s characteristics and forces that push for OFDI? Is Ozawa’s macroeconomic (Japanese) theory for OFDI (based on “Ricardo-Hicksian bottlenecks theory of industrialization”) passé – or still relevant? Answers to these questions depend on the emerging multinationals’ motives and need careful econometric study.
Countries, in the resource-intensive heavy and chemical industrialisation phase, become more dependent on foreign resources, especially if it concerns a resource-poor nation. If prices of these resources increase and profit squeeze occurs, natural resource-seeking FDI takes place to secure a stable supply. Profit squeeze may also occur because of increased international competition. Ozawa labels the threat that such subsequent profit squeeze leads to stagnation at the macroeconomic level as “Ricardian bottlenecks” which, according to the author, can be solved by OFDI. Pollution and increasing environmental costs may also encourage ‘house cleaning’ investments in other less strict countries.
We have reconsidered Ozawa’s view of the Japanese OFDI and have showed that his arguments still hold. We show that the generalized Ricardian growth framework remains an appealing framework to understand the macroeconomic push factors for OFDI. OFDI should be considered as a means of removing the uncertainties of foreign supplies of industrial resources. In addition, OFDI allows firms to cope with land (for industrial sites) and labour shortages. To test empirically these Ricardian predictions, a dataset is prepared to examine the relationships between the home country macroeconomic factors and the level of its OFDI.
The aim of this section is to analyse the home country determinants (the push factors) that instigate the developing country’s firms to become MNF. We examine the effect of the energy consumption, labour force, population density, GDP per unit of energy use, fuel imports and pollution on OFDI. The above predictions of the theory will be tested on the basis of a sample of emerging countries and transition economies over 1990-2006 period using new advanced techniques50 for (slightly) incomplete and balanced panel. Our empirical specification takes the following form:
log(OFDIit ) = ∂ + α i + α t + ∂1 log(Energy)it + ∂ 2 log(labour)it + ∂ 3GDPper energy useit + ∂ 4 pop densityit + ∂ 5Trade Balanceit + ∂ 6 Pollutionit + ∂ 7 fuelit +ν it (1).

Econometric methodology and estimation results from an incomplete panel

First, we use an incomplete (slightly) panel data because of the lack of some observations. We start our econometric estimation with a fixed effects model, controlling for country and time-specific effects. We have to take into account heteroscedasticity and serial correlation potential problems in the residuals. Since a modified Wald test for groupwise heteroskedasticity rejects the null hypothesis of homoscedasticity, we rely on robust standard errors. We test our models for autocorrelation of residuals with Wooldridge’s (2002) test for serial correlation; the statistics obtained indicate that there is serial correlation of the residuals. A serial correlation of residuals implies estimators which are less efficient as their standard errors may be underestimated and therefore their statistical significance overstated. Therefore, we use an estimator, which is robust with respect to heteroscedasticity and autocorrelation in the residuals53. We utilize heteroscedasticity and autocorrelation consistent (HAC) kernel estimator and Newey-West54 correction on standard errors (see Cameron and Trivedi, 2009; Zimmerman, 2009; Ahlquist and Prakash, 2008; Schaffer, 2007; Peterson, 2009; Baltagi et al., 2008; Colacelli, 2010). We also re-run our regressions using Driscoll-Kraay correction on standard errors. We do so by employing a version of the variance-covariance matrix estimator for spatially and/or serially correlated data following Driscoll and Kraay (1998) (see Hoechle, 2007; Egger and Raff, 2010).
As recommended by Peterson (2009), Egger and Raff (2010), Baltagi et al. (2008) and Hericourt & Poncet (2009), we apply various estimation techniques to our data in order to assess robustness of the key variables’ significance to multiple corrections on standard errors. Following Du and Hayes (2009), Hutzschenreuter and Gröne (2009), Zimmerman (2009), Martínez-Zarzoso et al. (2009), Kendix and Walls (2010) and Fleisher et al.(2010), we provide (see the notes below our tables of regressions) the details on the Stata packages used for testing our regressions. We report the results from OFDI regressions in Tables 1.2 and 1.3. It is interesting to note that the estimated coefficients on energy consumption, energy dependency, labour force, employment to population ratio, total employment, fuel imports (% total imports ) (and electricity production from natural gas (% total electricity production) ), GDP per energy use and population density are statistically significant in all fixed effect regressions. Our findings show strong conclusive evidence supporting our approach on the push effect of the “Ricardian bottlenecks” for OFDI.

Table of contents :

Chapter 1. Generalized Ricardian growth bottlenecks and outward FDI : New evidence on the emerging multinationals
1.1 Introduction
1.2 On the Ricardian growth approach toward FDI
1.2.1 Is the Ricardian growth theory passé – or still relevant?
1.2.2 FDI from natural resource scarce industrialized economies: a vibrant research topic Natural resource scarcity and growth Resource seeking FDI: a Ricardian approach A replication of the Japanese Ricardian-trap stage of transnationalism Fuelling the industrial development and economic growth of “Asian Drivers”– China and India
1.2.3 Push effect of land and labour shortages Push effect of land (housing market bottleneck) and industrial site shortages… Push effect of labour shortage
1.3 An empirical follow-up on Ozawa’s macroeconomic theory of outward FDI: new evidence from catching-up countries
1.3.1 Econometric methodology and estimation’ results from an incomplete panel …
1.3.2 Additional tests and robustness checks…
1.3.3 Estimations and results from a balanced panel…
1.A Conclusion
Appendix for chapter 1
Chapter 2. North-South trade and reformulated Kojima’s «correspondence principle»: A Ricardian trade approach
2.1 Introduction
2.2 Ricardian trade approaches toward FDI : a review of literature
2.2.1 Direct investment as a capital flow
2.2.2 FDI, technology transfer, product-cycle and trade
2.2.3 FDI and unit labour costs
2.3 Macroeconomic approach to FDI
2.3.1 Kojima’s model of comparative investment profitabilities Heckscher – Ohlin setting Correspondence between comparative advantages and comparative profit rates
2.3.2 Pro-trade FDI and the flying geese model The flying geese model: theory and evidence FDI-cum-trade approach Transferability of the flying geese model
2.4 North – South FDI and reformulated “correspondence principle”: a Ricardian approach
2.4.1 FDI and comparative advantage: a brief review of literature Theoretical aspects Some empirical aspects
2.4.2 Reformulating Kojima “correspondence principle”: a Ricardian setting Conditions for North-South FDI Technological superiority Industry-specificity of capital The reformulated correspondence principle and the technology-trade-welfare link Closing the model The reformulated “correspondence principle” and the welfare analysis
2.5 Conclusion
Chapter 3. Technology transfer and North-South trade : a theoretical and empirical assessment
3.1 Introduction
3.2 Technology transfer, consumer preferences and welfare in a Ricardian model
3.2.1 The structure of consumer preferences and the terms of trade in the Ricardian model Immiserizing specialization of developing countries Introducing technology transfer in the Ricardian Model with CES utility function
3.2.2 Technology transfer, specialization and developing country’ welfare A two-good setting Extension of the model to n commodities
3.3 Mode of technology transfer and North-South trade and welfare: Revisiting Kojima – Ozawa propositions
3.3.1 Kojima and Ozawa macroeconomic approach to FDI and technology transfer Kojima – Ozawa propositions on technology transfer Free technology transfer
3.3.2 Northern exploitation of technological superiority through licensing and FDI: are Kojima and Ozawa right? Technology transfer via licensing Licensing Welfare effect of technology transfer via licensing Technology transfer via FDI FDI and quasi-rents Welfare effect of technology transfer via FDI
3.3.3 The effect of licensing and inward FDI on the developing country terms of trade: an empirical analysis Measure of terms of trade Model, estimation and results Robustness check: alternative measures of real royalties Estimations and results from a large incomplete panel
Chapter 4. Export sophistication of developing countries: an empirical follow-up on an extended DFS (1977) framework
4.1 Introduction
4.2 The link between openness and technological progress
4.2.1 Foreign presence, productivity and technological progress
4.2.2 Openness and technology diffusion Technology diffusion through imports Technology diffusion through exports
4.3 An extended continuum Ricardian setting
4.3.1 Goods and technology
4.3.2 Importing superior technology, technological inflow and diffusion
4.3.3 Technology gap within a comparative advantage framework
4.4 Linking theory to empirics
4.4.1 Measure of export sophistication The North-South trade cut-off (z ~ ) Construction of the HHR export sophistication measure
4.4.2 Export sophistication: Testable estimation, data and econometric analysis Model 1 Estimation and results Model 2 Estimation and results Additional tests using relative export sophistication Estimation’ results from a large incomplete panel
4.4.3 Putting back the terms of trade deterioration at the forefront of the analysis Is there a trap for the developing countries? Testable estimation, data and econometric analysis Instrumental variable estimation and exogeneity checks
Appendix for chapter 4


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