OCOB Ann Rep 07-08 - Orfalea College of Business - Cal Poly San ...

FACULTY REPORTSExplaining World TradeBY KATHRYN G. MARSHALLASSISTANT PROFESSOR OF ECONOMICSThe growth of global trade in the last several decades offersan exciting area of research for economists. Nocountry better illustrates the potential for trade thanChina, which is now one of the largest trading countries inthe world. Since coming to Cal Poly in 2007, my researchin collaboration with Cal Poly Professor Eric Fisher hasfocused on theoretical and empirical methods to betterunderstand the driving forces of world trade, and I have appliedthese new ideas to help explain China’s remarkabletrade growth. In this article, I will sketch the main featuresof this research and highlight some significant findings.Input Output AnalysisTo understand the pattern of international trade, onemust first look carefully at the structure of productionwithin each country. Economist Wassily Leontief pioneeredthe use of the input output table in the 1940s tomodel the intricate linkages between different industries ina modern economy. Each industry or sector in an economyproduces goods which are in turn used as intermediate inputsin the production of other products. When we measuregross domestic product (GDP), we capture only the finalstage in that complex production process. For example, inthe U.S. economy, the production of one dollar’s worth ofoutput in the automotive sector requires about $0.03 worthof products produced in the rubber and plastics sector andabout $0.05 worth of iron and steel products. In total, about$0.76 per dollar of intermediate inputs from all sectors ofthe U.S. economy goes into the production of automobiles.The remaining $0.24 per dollar of automobile productionmeasures the most important component in any productionprocess: value-added. To a business professional,value-added is better known as profits (paid to the ownersof capital) and wages (paid to workers). Economists callthese two special inputs, capital and labor, factors of production.In the automotive example, the $0.76 worth of intermediateinputs is itself produced by workers and capitalin other sectors, sectors which in turn use intermediateinputs combined with the services of workers and capitalto produce output. While this may seem like an infiniteregression, a simple mathematical technique converts thedollar value of any final product into payments to capitaland labor used directly to produce that product and indirectlyto produce all the intermediate inputs that went intothe product. For the U.S. automotive industry, when thisfull accounting is undertaken, each dollar’s worth of automobileproduction amounts to a payment of $0.31 to ownersof capital and a payment of $0.69 to workers throughoutthe economy. Labor intensive industries are defined as industrieswith a higher payment share to labor.Two different economies can be readily compared usinginput output tables. Thanks to the efforts of the Organizationof Economic Cooperation and Development(OECD), detailed and consistent input output accounts areavailable for many countries of the world. To compare theU.S. and Chinese economy, Table 1 summarizes these detailedaccounts into four major sectors – agriculture, mining,manufacturing, and services. I have also added data onemployment in each broad sector taken from the InternationalLabor Office.The most notable feature of the Chinese economy isthe huge labor force of around 721 million workers, equalto about five times the size of the U.S. labor force. But noticealso the disparity in wages across sectors. Overall, theU.S. average wage is about 19 times higher than the Chineseaverage wage. This is a clear indication that the productivityof labor is different in these two economies. U.S. workersTable 1: A Comparison of the U.S. and Chinese economies in 2000USAAgriculture Mining Manufacturing Services TotalPayments to Capital ($ billions) 71 71 496 2,985 3,624Payments to Labor ($ billions) 32 38 948 5,176 6,193Employment (millions) 3 1 20 111 135Average Wage $ 9,223 $72,204 $ 47,558 $46,505 $ 45,806ChinaAgriculture Mining Manufacturing Services TotalPayments to Capital ($ billions) 44 83 496 446 1,069Payments to Labor ($ billions) 416 59 561 737 1,773Employment (millions) 334 6 80 301 721Average Wage $ 1,248 $ 9,811 $ 6,978 $ 2,448 $ 2,459ORFALEA COLLEGE OF BUSINESS ❚ 21