Anne O. Krueger

English

Research Papers in Economics

This PDF is a selection from an out-of-print volume from the National Bureau
of Economic Research
Volume Title: Trade and Employment in Developing Countries, vol. 2: Factor
Supply and Substitution
Volume Author/Editor: Anne O. Krueger, editor
Volume Publisher: University of Chicago Press
Volume ISBN: 0-226-45493-2
Volume URL: http://www.nber.org/books/krue82-1
Publication Date: 1982
Chapter Title: Editorâ€™s Preface
Chapter Author: Anne O. Krueger
Chapter URL: http://www.nber.org/chapters/c8264
Chapter pages in book: (p. -7 - -1)Editor’s Preface 
This is the second of three volumes emanating from the National Bureau 
of  Economic Research project on alternative trade strategies and em- 
ployment. It contains a series of papers focusing on important aspects of 
the analysis of  the trade strategies-employment relationship. 
The entire project has been devoted to analyzing the extent to which 
employment and income distribution are affected by the choice of trade 
strategies and by the interaction of  trade policies with domestic policies 
and market distortions. The trade strategies in question are, of  course, 
import substitution and export promotion  as alternative means of  en- 
couraging the growth of  domestic industry.  Although earlier studies, 
including the NBER project on foreign trade regimes and economic 
development (see Bhagwati 1978 and Krueger 1978  for details), provided 
considerable  evidence that the economic growth performance  of  de- 
veloping countries pursuing export-oriented trade strategies was substan- 
tially superior to that of  countries under import substitution, little atten- 
tion was given to the relationship between the choice of  trade strategy 
and conditions in the domestic labor market before this project. 
Trade theory, especially the Heckscher-Ohlin-Samuelson model, pre- 
dicts that poor countries will generally have a comparative advantage in 
the production of relatively labor-intensive commodities. In light of this, 
failure to investigate the possible links between different rates of growth 
of  employment and real wages with alternative trade strategies consti- 
tuted a significant hiatus in our understanding of  the trade strategies- 
growth relationship. 
A first task in the research project on alternative trade strategies and 
employment was to provide an analytical framework within which the 
links between trade strategies and employment could be identified. This 
was  done in  Krueger (1977). A next  step was to secure a group of 
ix x  Editor’s Preface 
researchers to investigate the empirical dimensions of the relationship. 
Many of  the project  participants  undertook empirical  and analytical 
studies of  individual country experiences. The studies for ten countries 
were presented in the first volume in this series, Krueger, et al. (1981), 
which  also  contains  a  chapter describing  the common  concepts and 
methods employed in all the country studies. 
It was clear from the outset that the country studies would provide a 
great deal of  insight into the trade strategies-employment  relation, but 
that there were some interesting questions where comparative analysis, 
or focus upon a single aspect of  the relationship, would yield fruitful 
results. In addition to the country studies, research on these questions 
was considered an integral part of  the project. This volume presents the 
results of those endeavors. A final volume will analyze the findings from 
the entire project, based upon the results reported in both this volume 
and the individual country studies. 
A statement of the theory underlying the links between factor markets, 
substitution possibilities, and supply responses covered in this volume is 
not possible here and has been given in Krueger (1977). It suffices to 
point out that the net result of a change in real exchange rates or other 
incentives provided through  trade regimes is a function of  supply re- 
sponse and of  underlying conditions within domestic markets. In particu- 
lar, conditions and regulations  covering real wages,  social  insurance 
taxes, and the like can affect the sorts of industries that find it profitable to 
respond to altered incentives. Credit rationing, artificially low costs of 
capital goods, and other inducements to employ capital-intensive tech- 
niques can also affect both the output mix and the factor proportions that 
will result from any particular set of trade policy instruments. The scope 
for substitution between factors of  production is crucial in determining to 
what degree factor proportions are affected by domestic factor market 
distortions.  Likewise,  the extent to which  the industry mix  alters in 
response  to changed  incentives  is  a function of  the extent of  supply 
responses. Finally, there is an interaction term between prevailing factor 
market conditions  and the mix  of  outputs that will  result  from  any 
particular set of  incentives conveyed by the trade regime. 
Each country  author attempted to assess the importance  of  these 
phenomena for his country, and the results are highly revealing.  The 
results of  the individual country studies point to significant supply re- 
sponses and to a fairly large scope for altering overall factor proportions 
within the industrial sector both by altering the mix of  output and by 
altering factor proportions. 
There is no substitute for in-depth analysis of  individual countries’ 
economies and particular situations. There is, however, scope for com- 
plementary analysis. That is what this volume provides. The first study, 
by  James M. Henderson, contains  an optimizing  model  that  uses  a xi  Editor’s Preface 
nodinear programming framework to investigate what individual coun- 
tries’ optimal export and import vectors might be if  they maximized the 
international value added of  a fixed bundle of  available domestic re- 
sources subject to production functions that permit substitution between 
labor and capital. Much of the data base for Henderson’s study originated 
with  the individual  country  authors, and there is  significant  overlap 
between the countries covered by his study and those covered in the first 
volume in this series. Henderson’s paper makes a twofold contribution: 
on one hand, his model provides an additional tool that economists can 
use to estimate the direction of  likely changes from a shifting of  trade 
strategies or a removal of factor market distortions, or both; on the other 
hand, his substantive findings tend to reinforce those of  the individual 
country authors. In particular, his results suggest that countries that have 
followed export-oriented trade strategies appear to have an output mix 
fairly close to one the model indicates to be optimal, while some of the 
countries known to have had fairly severe distortions in the domestic 
wagehental ratio and large deviations between domestic and internation- 
al prices show fairly large scope for gains through resource reallocation 
and altered factor  proportions.  Henderson’s  comparisons with  some 
developed countries further reinforce this finding. By employing capacity 
constraints he is able to use the shadow prices derived from the optimal 
program  to infer  a considerable amount about the direction of  likely 
resource pulls in the event of an alteration in trade strategies, and this 
should prove a useful tool in future research. 
The second chapter by T. Paul Schultz, focuses on the income distribu- 
tion implications of protecting domestic industry. Using data from Co- 
lombia, Schultz estimates earnings functions for workers of various skill 
categories. He finds a strong and significant relationship between the 
protection  afforded an industry and earnings, even after allowance is 
made for such factors as schooling and experience. This finding holds for 
both employers and employees, thus strongly suggesting that protection 
does protect the incomes of those within  the industry. Although  it is 
possible that this might reflect the attraction of  more able persons within 
each schooling and experience category to more highly protected indus- 
tries, it is more likely that protection has served to shelter the incomes of 
those in the protected sectors. Particularly in light of the findings in most 
of the country studies, that import substitution industries tend to employ 
a relatively larger proportion of  skilled workers than do  export industries, 
Schultz’s results strongly suggest that the income distribution effects of 
import substitution regimes, or at least the regime in Colombia, have 
been to increase the incomes of those already earning more than average. 
Schultz’s effort is the first empirically oriented demonstration of the ways 
effective protection affects incomes of  domestic owners of the factors of 
production. While the Colombian situation may not be representative, it xii  Editor’s Preface 
is a significant first step in documenting the direct effects of  effective 
protection on income distribution. 
In chapter 3, JosC Carvalho and Clfiudio Haddad, who also wrote the 
Brazilian country study in volume 1, provide estimates of  the extent to 
which Brazilian exports responded to changes in incentives. One of  the 
frequently heard arguments against shifting from an inner-oriented im- 
port substitution trade strategy to export promotion is that there is little 
export potential within the domestic economy. “Export pessimism’’  has, 
in  one form  or another, discouraged  a shift in  strategy.  There  was 
considerable pessimism in Brazil before its shift in trade strategy, so the 
Carvalho-Haddad findings are of particular interest. They conclude that 
Brazil’s exports, especially exports of manufactured products, were very 
responsive to the altered incentives to export. Their estimates suggest 
that the overvaluation of  the real exchange rate that characterized the 
Brazilian trade regime during the late 1950s and early 1960s explained a 
large part of  the lagging export performance in those years, and that 
alteration of those policies after 1964 significantly affected performance. 
To  be sure, other incentives to export appear to have been influential too, 
though Carvalho and Haddad find that an export subsidy led to a some- 
what smaller export response than did an equal increase in incentives by 
means of the exchange rate. While many unanswered questions remain- 
such as the role of the increased certainty exporters felt after the adoption 
of a sliding-peg exchange rate-the  Carvalho-Haddad estimates contrib- 
ute significantly to knowledge about the responsiveness of  exports to 
altered incentives and the empirical orders of  magnitude of  those re- 
sponses. 
The next two chapters, by Jere R. Behrman and by Vittorio Corbo and 
Patricio Meller, directly address the question of  scope for substitution 
between labor and capital. Behrman’s approach is to use cross-sectional 
data for seventy countries and as many as twenty-seven two-digit indus- 
tries for the period  1967 to 1973. This is probably the richest cross- 
sectional data set to be used in many estimates of substitution possibili- 
ties. Using average observed inputs and outputs (to reduce problems 
associated with year-to-year fluctuations owing to strikes, recessions, and 
so forth), he estimates that elasticities of  substitution are close to the 
Cobb-Douglas value of  unity. His results are robust under alternative 
specifications of the model, though inclusion of a real per capita income 
variable yields some puzzling results. 
Behrman provides strong evidence in support of the view that policies 
that  affect the payments made for capital services and workers may 
significantly alter the factor mix in developing countries. They reinforce 
the notion that some of  the capital intensity observed in  developing 
countries may  be  a function  of  the distortions  in  wagehental ratios xiii  Editor’s Preface 
occurring in those countries and thus significant in affecting the employ- 
ment implications of any trade strategy. His estimates are used as a basis 
for inferring some of  those costs in the final volume in this series. 
Whereas Behrman’s estimates are based upon data for many countries, 
Corbo and Meller, who also undertook the Chilean country study, base 
their estimated production relations upon data for 11,468  establishments 
in eighty-five four-digit Chilean industries, though only forty-four indus- 
tries provide more than ten degrees of  freedom and form the basis for 
their estimates. Using the general translog model,  they test  first for 
constant returns to scale, then for the validity of  the Cobb-Douglas 
specification. For  thirty-five of  the forty-four  sectors, Cobb-Douglas 
technology could not be rejected, tending to reinforce Behrman’s conclu- 
sion. Corbo and Meller proceeded to investigate the substitution rela- 
tionships between unskilled labor, skilled labor, and capital. As they 
explain, the nature of  this relationship-whether  human  capital and 
unskilled labor are relatively good substitutes while complementary with 
physical capital, or whether human capital is more appropriately aggre- 
gated with physical capital-is  of  considerable importance for under- 
standing many aspects of labor market behavior and the determinants of 
the pattern of wage differentials in developing countries. They find that, 
for Chile  at least,  there is more  econometric  support for  regarding 
unskilled and skilled labor as substitutes and aggregating them than there 
is for aggregating human and physical capital. In view of the fact that the 
evidence from the country studies (and from Henderson’s model) all 
suggests that there are strong differences in  skill coefficients between 
exportable and import competing industries, this finding is important. 
For, if import substitution industries are skill-intensive  relative to export 
industries, a shift in trade strategy would tend to increase the demand for 
unskilled labor in exportable industries, while releasing skilled labor (or 
failing to absorb the growth in supply of skilled labor) in import substitu- 
tion industries. If  skilled and unskilled labor tend to be substitutes, as 
Corbo and Meller’s findings suggest, the adjustment process within the 
labor  market  would be relatively straightforward,  as skilled workers 
could be absorbed in exportable industries. 
The final chapter in this volume, by Robert E. Lipsey, Irving B. Kravis, 
and Romualdo A. Roldan, focuses upon multinational firms and their 
adaptation, or nonadaptation, to altered relative factor prices in develop- 
ing countries. Using data on the behavior of American firms and Swedish 
firms, they investigated factor proportions (by a variety of yardsticks) in 
the multinationals’ home countries, in other developed countries, and in 
developing countries. They found that capital intensity of  the multina- 
tionals was higher at home than in other developed countries, which in 
turn was higher than that in developing countries. In general, a higher xiv  Editor’s Preface 
price of labor implied the use of  less labor-intensive techniques, thereby 
providing strong evidence of  adaptation by multinationals. In addition, 
more labor-intensive operations tend to be in lower-wage countries, so 
that there is adaptation by multinationals both in their choice of  tech- 
nique and in the choice of which activities to locate in which countries. 
These findings are of  interest not only because of the light they shed on 
the behavior of  multinationals, but also because they suggest that the 
costs of  factor market distortions, and especially labor market distor- 
tions, in developing labor-abundant countries may be greater than can be 
inferred by inspection of  the behavior of domestic industry. For develop- 
ing  countries that rely  upon  multinational  firms to contribute to the 
growth of  their domestic industry, distortions in the wage structure may 
either scare off multinationals or induce them to choose more capital- 
intensive products or techniques than would be optimal given the abun- 
dance of  labor. 
Taken as a whole, the studies included in  this volume represent  a 
significant contribution to knowledge about scope for alteration of prod- 
uct mix and factor proportions. In addition, they tend to reinforce the 
conclusions of the individual country studies and to provide evidence that 
trade strategy, and its interaction with domestic policies affecting the 
relative costs of  labor and capital services, may significantly affect em- 
ployment opportunities and their growth. 
The authors of  the studies included here were all financed in  their 
research by the National Bureau of Economic Research, which in turn 
received  funding  for the project  from the United  States Agency for 
International Development. Other sources of  funding for the individual 
studies have been noted by the authors. All the authors, as well as the 
project director, owe Hal B. Lary a considerable debt of gratitude for his 
careful reading and comments on earlier drafts of the manuscript. Delma 
Burns capably retyped many of the manuscripts and handled the numer- 
ous details of  manuscript preparation necessary to ready the studies for 
press. 
References 
Bhagwati, Jagdish N. 1978. Foreign trade regimes and economic develop- 
ment: Anatomy and consequences of  exchange control regimes. Cam- 
bridge: Ballinger. 
Krueger, Anne 0.  1977. Growth, distortions andpatterns of  trade among 
many countries. Princeton Studies in International Finance, no. 40. 
Princeton: Princeton University Press. xv  Editor’s Preface 
. 1978. Foreign trade regimes and economic development: Liber- 
alization attempts and consequences. Cambridge: Ballinger. 
Krueger, Anne 0.;  Lary, Hal B.; Monson,  Terry; and  Akrasanee, 
Narongchai, eds. 1981. Trade and employment in developing countries. 
Vol. 1. Individual studies. Chicago: University of  Chicago Press for 
National Bureau of  Economic Research. 

Trade and Employment in Developing Countries, vol. 2: Factor Supply and Substitution

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