An advancement of the Ricardian trade model sees countries producing semi finished goods and exporting it to another country to continue the chain of production until the goods becomes finished goods for consumption. Example of this is a situation where Mexico import raw steel from Japan, and stamp and pressed them to be exported to United States where the steels are used for manufacturing tractors and other farm implements. According to Hummels et al (1999), the vertical specialization involved in the trade of semi-finished goods among nations has the key feature of which is that imported inputs are used to produce a country’s export goods.
“Our concept emphasizes the twin notions that the production sequence of a good involves at least two countries, and that during this sequence, the good-in-process crosses at least two international borders. This latter notion highlights the sequential production, the multiple-border crossing, and the back-and-forth aspect of an increasing amount of international trade” (ibid). This notion further goes to amplify the interconnectivity effect of wage differentiation between workers in the same industry in the international arena.
The workers in developing countries that mainly deal in the exploration of raw materials as their means for foreign exchange usually are not in anyway comparable with workers in advance countries with higher pay structure for their workers. Even the fact that workers in developing or under developed countries perform the same function in the same industry and specialized function, this difference is still obvious. One significant fact leading to this wage differences is because of the price attached to the produced goods from the developed countries and those from developing or underdeveloped countries.
It is a known fact that raw materials in the international trade are valued far less than the transformed finished products from advance countries. The involvement in international has mostly favored developed economy countries, in the detriment of small and underdeveloped countries. As aforementioned, small economy, countries primary goods based on exploration of natural resources are poorly priced compared to the finished product produced by developed countries.
The fear of small countries is on how their international trade would lead to the stiffing of their economy, through lost of labor as result of brain drain, and a non-comparative basis for ensuring thriving of their economy, when terms of trade is not much favorable to them. According to Davis (1996), “Small countries have long feared economic dominance by their larger neighbors. One element of this is concern that increased economic integration would lead important segments of national industry to abandon the smaller for the larger market.
Insofar as these fears are based on market size, they find no foundation in traditional theories of trade due to comparative advantage. While such trade may restructure national industry, the direction of the change will depend not at all on relative market size”. Market size of a country’s economy goes a long in determining the industrial strength of companies operating in such economy. In the case of small economy, their involvement in international trade has not favored the development of their industry, in terms of vibrant development resulting from maximization of the best output for labor.
The differences in wage payment to labor between a developed economy and those for less developed countries sometimes affect the motivating force that spurs workers to put in their best in ensuring high productive results for the organization they work for. The operational cost for organization operating in a small and underdeveloped economy leaves little room for them to engage in adequate wage payment compared to what is obtainable in advanced countries.
Thus, based on the international trade concept of Ricardian theory the comparative advantage derived from product differentiation is favorable to developed and advanced economy. This is mostly, adduced to the pricing system in the international trade arena, as aforementioned where primary resource goods are under priced compared to prices for goods such as machineries, electronics, automobiles. This scenario has made workers in small economy to be worse off and those leaving little room for development to the economy of less developed economy countries.
In this view Hummels et al (1999), based on their findings, purported that “Decompositions reveal that the sectors where most export growth has taken place (chemicals and machinery) are also the sectors where most VS (measurement for the value of imported inputs embodied in goods that are exported) growth has occurred. Also, reliance on imported inputs has grown faster for exported goods than for domestically consumed goods. Finally, vertical specialization in the OECD primarily involves other OECD countries – inputs from developed nations are transformed and exported to other developed nations.
A notable exception to this pattern is the US, which has become more oriented toward developing countries at the same time that vertical specialization has grown rapidly”. In a fragmentation process of production, where different stages of the production process is handled by different organization, according to the Ricardian model the small country cannot lose from fragmentation so long as prices of final goods remain fixed. In addition, fixity of prices has certain plausibility if the rest-of-world is integrated, as noted above.
However, a large country can surely not take prices as given, and the problems that arise for a large country are those that arise for a non-integrated rest-of-world (Deardorff, 1998) Source: Deardorff, 1998 In the diagram above, in the upper left corner is drawn the production possibility frontier (PPF) for the country of interest, Country A, which is assumed again to have a comparative advantage in good X. Its customary Ricardian transformation curve is TATA’ in the X-Y plane, showing the maximum amounts of goods X and Y that it can produce without fragmentation.
Fragmentation expands its production possibilities into a third dimension, with the Z axis measuring its net output of intermediate good Z, positive if it produces it, negative if it is a net user of Z in production of X. Point ZA shows the maximum amount that can be produced if all labor is devoted to production of good Z. Production possibilities include the triangular plane through ZA, TA, and TA’. Based on the diagram above, the small country thus indicating that the assumptions made there were appropriate, where for instance at point I Country A does not lose from fragmentation.
Conclusively, the bases of international being unfavorable to workers with low income wage, this is directly adduced to the differentiated pricing of goods in the international trade arena. In this case less developed countries that deals in primary goods, as in case of raw materials , have low prices for their goods compare to developed countries with high price for their automobiles, tractors, machineries, electronics etc. this unbalanced pricing system, less developed countries to page lower wage package top their workers.
This leads to brain drain in most instances where labors migrate to developed economy to seek for greener pastures, making the less and underdeveloped countries worse off.
- Chilcote Ronald H. (2000), Theories of Comparative Political Economy. Boulder, CO: Westview Press. p. 6
- Davis, Donald R. (1996), “The Home Market, Trade, and Industrial Structure” http://www. newyorkfed. org/research/staff_reports/sr35. pdf (27/01/07)
- Deardorff Alan V. (1998), “Fragmentation in Simple Trade Models” RESEARCH SEMINAR IN INTERNATIONAL ECONOMICS Discussion Paper No. 422 http://www.fordschool.umich.edu/rsie/workingpapers/Papers401-425/r422.pdf