The Effects of a Booming Export Industry on the Rest of the Economy*

NGO VAN LONG Australian National University,

Canberra, ACT 2600

It is argued that the roles of relative factor intensity and of the degree of factor mobility have been neglected in models of booming export industries. This paper shows that. contrary to populiir beliefs. the mineral export boom may result in (a) an expansign of all industries, ( b ) an increase in the proftability of the tladitional tradeablessector, and(c) a fall in the relative price of non-tradeables.

I Introduction The recent growth of the mining industry has led

economists to develop models to study the impact of a booming exports industry on the rest of the economy. Most theoretical analyses seemed to agree on the predictions that the price of non- traded goods will rise relative to the price of non- mining traded goods, and that the output of the latter category of goods will decline.’

The purpose of the present paper is to contribute a further analysis of the incidence of an exports boom. Our main contention is that earlier analyses did not pay enough attention to import elements such as relative factor intensities and the degree of factor mobility. Using a simple model incorporating these elements, we are able to show that:

(i) the price of non-traded goods may fall relative to the price of non-mining traded goods,

(ii) the non-mining traded goods industry may expand even when its price falls relative to the price of non-traded goods, and

Research support by the Sonderforschungsbcreich 5 programme (Mannheim University) is gratefully acknowledged. This paper is based on a more technical paper presentcd by the author at the Tenth Conference of Economists (Canberra, August 1981). I would like to thank Hans-Werner Sinn and two refems for helpful comments.

* See, for example, Gregory (1976). Snap (1977). and Corden and Neary (1980).

(iii) the expansion described in (ii) above may be accompanied by a contraction of the output of the ‘booming’ mining industry, relative to its pre-boom equilibrium output.

Our three ‘paradoxical’ results rely on the Rybczynski effect wh ch gives rise to supply-side complementarity. While the same paradoxical possibilities can be obtained in more general models, we choose to derive our results from the simplest model in order to highlight the basic factors a t work.

I I The Model Our simple economy consists of three industries:

a non-traded goods industry, a booming exports industry, and a n industry producing ‘other traded goods’. Their outputs are denoted by QN, Q ~ a n d Q o respectively, and the corresponding prices are PN. P B and Pa The relative price P B l P O is exogenously given, while the relative price PN/ PO is endogenously determined.

There are three factors of production: a globally mobile factor, a factor which is specific to the non- traded goods industry, and a factor which is mobile only within the two traded goods industries. These factors of production are denoted by G, S and R respectively. (To aid memory, one may think that G stands for ‘global mob:lity’, S for ‘specificity’ and R for ‘restricted mobility’.) The production functions are:

Q~ = wB(cB RA. (1)

5 8 THE ECONOMIC RECORD MARCH

where 8 is a shift parameter representing 'technical progress'. The usual assumptions of constant returns to scale, positive and diminishing marginal products, and diminishing marginal rates of substitution are adopted.

The mining boom is represented either by an increase in 8 or in P5 The factors of production G. Sand R are assumed to be in fixed supplies, so that

G e + G o + G N = C ; , (4) R B + Ro = 1, ( 5 ) s N = s. (6) Defining the aggregate output of all traded

Q r = Q o + ( P B / P o ) Q ~ (7)

P T = PO, (8)

goods as

and the price of traded goods as

we can draw the economy's production possibility curve in the ( Q N , Q T ) space. It is clear from (4) and (1) that a shift in 8 has the same effect on the production possibility curve as a shift in P g . As the production possibility curve has the usual concave shape, the economy's supply curve for non-traded goodsz is upward sloping, as illustrated in Figure 1, where the non-mining traded goods serve as the numeraire goods, and X N denotes the price ratio

In Figure 1, the pre-boom output and relative price of non-traded goods are denoted by Q N and ;N respectively. The demand curve DD is the pre- boom compensated demand curve. Our first task is to establish the direction of shifts in the demand and supply curves as a result of the export boom.

As we assume there are no domestic distortions and that at the new equilibrium (as well as at the old equilibrium) the economy operates at full employment with expenditure equal income, the exports boom gives rise to a higher level of utility. As a result, the new demand curve, D'D', is to the right of DD, provided that goods are gross substitutes in consumption.

The effect of the boom on the supply curve of non-traded goods is more complicated. The supply

P N / p O .

A referee suggested the use of Figure 1, which is perhaps a better exposition device than the use of transformation curves originally used in Long (1981).

D'

FIGURE 1

curve SS in Figure 1 depicts the marginal cost of non-traded goods, which is MC = WG/ M P g (9)

where WG is the 'wage' (in terms of the numeraire goods) of the globally mobile factor and MPgis its marginal physical product in the non-traded goods industry. At any given level of non-traded goods output, the Stolper-Samuelson theorem (applied to the two traded goods industries) predicts that a rise in PB(or equivalently a rise in 0) will cause WG (the 'wage' of the globally mobile factor) to rise if the booming industry uses it more intensively' than the other traded goods industry, and to fall if the reverse is true.

Consider first the case in which the booming exports industry uses the globally mobile factor more intensively. In this case, the boom shifts SS upwards, causing P N / PO to rise (a non- paradoxical result). The new equilibrium point is at 2 or 3 in Figure 1. The output of non-traded goods

'The booming industry is said to be more G-intensive if Ge/ R B > G o / R o . We note that this standard u x of the adjective 'intensive' in trade theory does not correspond to its normal meaning. Professor Fritz Machlup argued that trade theorists should replace the word 'intensive' by the word 'extensive'. For example, it would make more sense to say that Australia uses land more extensively (rather than more intensively) than Japan.

1983 EFFECTS OF EXPORT BOOM 59

may rise or fall, a result first stated by S n a p ( 1 977). If the boom takes the form of a Hicks-neutral technical progress or if the goods produced by the booming industry are not consumed in the home country, the demand for traded goods must rise (as iong as they are not inferior goods), and therefore the aggregate value of the output of traded goods must rise. However, two paradoxical possibilities emerge: the output of 'other' traded goods may rise and the value of output of the booming industry may fall.

In order to see this, it isconvenient to decompose the effects of the boom on the outputs of the two traded goods industries into two parts. Firstly. a t the initial level of non-traded goods production, the booming industry expands while the 'other' traded goods industry contracts. Secondly, the expansion (or contraction) of the non-traded goods industry will increase (or decrease) the supply of the globalky mobile factor to the traded goods sector. At a point such as point 2 in Figure 1, the expansion of the non-traded goods industry means that less of the globally mobile factor is available to the traded goods sector, causing the contraction of the output of the industry that uses this factor more intensively-the mining industry in this case-and the expansion of the 'other' traded goods industry. Thus the primary effect and the secondary effect (which is predicted by the Rybczynski theorem) work in opposite directions. The secondary effect is stronger the higher is the income elasticity of demand for non-traded goods and the more elastic is their supply.

Let us turn our attention to the case in which the 'other' traded goods industry uses the globally mobile factor more intensively. In this case the boom (represented by a rise in PBor in 0) will cause WG to fall (by virtue of the Stolper-Samuelson theorem). This fall shifts thc supply curve for non- traded goods downwards, and the new equilibrium will be at a point such as points 4 or 5 in Figure 1. At point 5 we have a 'paradoxical' result: the price ratio PN fak4 At both points 4 and 5, the non- traded goods industry expands relative to the initial equilibrium. As a consequence less of the globally

mobile factor is available to the two traded goods industries, causing a contraction in the output of the industry that uses this factor more intensively and a n expansion of the output of the industry that uses it less intensively (the boomingexport industry in this case).

111 Final Remarks The 'paradoxical' rtsults reported in this paper

were not obtainable i i earlier models by Gregory (1970), Snape (1977) and Corden and Neary (1980). because Gregory essentially assumed that the booming industyi is a supply enclave while Snape and Corden and Neary assumed that all but one factors of production are industry-specific. In terms of Figure 1. point 1 is Gregory's point (no shift in the supply curve of non-traded goods), points 2 and 3 are Snape's points (the supply curve can only shift up-without the paradoxical possibilities of the expansion of 'other' traded goods industry and t:ontraction of the booming industry because thr. Rybczynski effect is not present in Snape's model).

Our model exhibits supply-side complementarity which is possible only in models with at least two mobile factors of production.

Finally, it should br: noted that in this paper no attempt has been made to tackle the problem in an intertemporal context. The optimal intertemporal behaviour of mining firms would make the paper too complicated.'

REFERENCES Corden, W. M. and Neary, S. P. (1980). 'Booming Sector

and De-Industrialisation in a Small Open Economy', Australian National University, Canberra, mimco.

Gregory, R. (1976). 'Sonic Implications of the Growth of the Mineral Sector, The Australian Journal of Agricultural Econ0mrt.s. 20. August, 7 1-91.

Kemp. M. C. and Long, N V. (1979). 'International Trade with an Exhautible Resource: A Theorem of Rybczynski Type'. Incernational Economic Review. 20, October. 671-7.

If the government pursues a policy of maintaining full employment. external and internal equilibrium. and a constant nominal price for non-rraded goods. the fall in PN/ PO is feasible only by a deprcciarion of the exchange rate. The rix in nominal national income implied by this policy must be accommodated by a rise in nominal money supply.

For some analyses cf interrcmporal optimization In the context of international trade with an exhaustible resource. set Kemp and Long (1979, 1980. 1982).

60 THE ECONOMIC RECORD MARCH

- (1980). Exhaustible Resources, Optimnliry and Industry on the Rest of the Economy: A Theoretical Approach', paper presented at the Tenth Conference

- (1982). 'The Role of Natural Resources in Trade of Australia and New Zealand's Economists, Canberra.

Snapc. R. H. (1977), 'Effects of Mineral Development on the Economy', The Australian Journal of Agricultural

Trade, North-Holland, Amsterdam.

Models', Chapter 8 in R. W. J o n a and P. Kenen (eds), Norrh-Holland Hmdbook of Intcmfionul &OMmiU, Volume I: International Trade 73eory. North-Holland, Amsterdam. Economics, 21, December. 147-56.

Long. N. V. (1981). 'The Effects of a Booming Exports