Trade, Globalization and Development

Kalyan K. Sanyal (1951–2012)

Rajat Acharyya • Sugata MarjitEditors

Trade, Globalizationand Development

Essays in Honour of Kalyan K. Sanyal

123

EditorsRajat AcharyyaDepartment of EconomicsJadavpur UniversityKolkata, West BengalIndia

Sugata MarjitCentre for Studies in Social Sciences

CalcuttaKolkata, West BengalIndia

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Preface

Kalyan K. Sanyal (1951–2012) was an excellent teacher and a renowned scholarof economics. He made original contributions both in mainstream neoclassicaleconomic theory in his early days of research at the University of Rochester, NewYork, and in Marxian and development economics later. His Theory of MiddleProducts, co-authored with Ronald Jones and published in the American Eco-nomic Review in the year 1982, which was based on his Ph.D. dissertation at theUniversity of Rochester, was a seminal work in the field of international tradetheory. This work has been a precursor of many subsequent significant works byresearchers across the globe on trade in intermediate goods. After returning fromRochester he joined the Department of Economics, Calcutta University, and taughtinternational trade theory and policy for almost three decades. He also held visitingteaching positions at various Universities in Europe and USA. His insights,articulation, and brilliance in teaching international economics have influencedand shaped intellectual development of many of his students including one of theeditors of this volume.

After his sudden demise in February 2012, his students and colleagues orga-nized a symposium in his honour at the Department of Economics, JadavpurUniversity during April 19–20, 2012. This symposium was sponsored by theCentre for Advanced Studies in Economics, Jadavpur University, and the IndianCouncil for Social Science Research, Eastern Region, and was attendedby scholars and experts in the field of International Trade Theory and Policyfrom different parts of India. Some of the papers published in this volume werepresented at this symposium.

Kalyan K. Sanyal’s untimely demise at the age of 61 years is a personal andprofessional loss for his students, friends, and colleagues. This volume, a collec-tive effort of many people, is a small tribute to his intellect. First of all, we thankall the authors who encouraged us to undertake this endeavor and readily agreed tomake their contributions. Without their valuable support it would not have beenpossible for us to bring out this volume. Second, we gratefully remember thecontributions of the reviewers. Their support has been as valuable as the authors.Special mention must be made of Swapnendu Bandyopadhyay (Jadavpur Uni-versity, Kolkata), Brati Shankar Chakraborty (Indian Statistical Institute, Kolkata),

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Indrani Chakraborty (Institute of Development Studies, Kolkata), Pranab K. Das(Centre for Studies in Social Sciences, Kolkata), Tarun Kabiraj (Indian StatisticalInstitute, Kolkata), Biswajit Mandal (Visva Bharati University, Santiniketan), andAjitava Raychaudhuri (Jadavpur University, Kolkata).

We also thank Sagarika Ghosh of Springer (India) for providing us excellentand high quality publishing support. In this context, we acknowledge theencouragement that we received from Martina Bihn (Springer-Verlag, Heidel-berg), when an informal proposal for this volume was placed before her while shewas visiting Jadavpur University.

Last but not the least, we thank the family members of Kalyan K. Sanyal, hiswife Saswatee and two sons Arani and Avik for their emotional support. At thesame time, we take this opportunity to express our deep sorrow for the loss theyhave suffered and share their grief as we all have lost a wonderful mind.

vi Preface

Contents

Part I Globalization, Input Trade and Sanyal’s Contributionto Trade Theory

1 Middle Products Revisited . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3Ronald W. Jones

2 ‘‘Antitrust Policy’’ Versus ‘‘Industrial Policy’’ . . . . . . . . . . . . . . . 15Makoto Yano, Takakazu Honryo and Fumio Dei

Part II Trade, Technology and Increasing Returns

3 Protectionism and Increasing Returns . . . . . . . . . . . . . . . . . . . . . 33Roy Ruffin and Wilfred J. Ethier

4 Transaction Cost, Technology Transfer, and Modeof Organization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 51Biswajit Mandal and Sugata Marjit

5 A Simple Model of Foreign Brand Penetrationwith Multi-Product Firms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 63Toru Kikuchi and Ngo Van Long

Part III Agricultural Trade, Uncertainty and the Emerging Issues

6 Agricultural Trade with Production Uncertainty . . . . . . . . . . . . . 83Debasmita Basu and Abhirup Sarkar

7 Safeguards and Investigations . . . . . . . . . . . . . . . . . . . . . . . . . . . 103Mostafa Beshkar and Eric W. Bond

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Part IV Trade Diversity, Quality and the Developing Countries

8 Infrastructure Development, Comparative Advantageand Missing Trade . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 117Rajat Acharyya

9 Catching Up in Terms of Product Quality . . . . . . . . . . . . . . . . . . 133Ranajoy Bhattacharyya and Munmun Mukherjee

Part V Dynamic Issues

10 Convergence in a Three-Factor Dynamic Model:Finite Versus Infinite Lives . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 145Partha Sen

Part VI Trade, Finance and Exchange Rate

11 Some Reflections on the Recent Financial Crisis . . . . . . . . . . . . . 161Gary Gorton

12 Mundell-Fleming with Stock Market and EndogenousRisk Premium . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 185Soumyen Sikdar

13 Reforms, Exchange Rate Pass-Through and India’sExport Prices . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 195Saikat Sinha Roy and Pradyut Kumar Pyne

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Contributors

Rajat Acharyya Department of Economics, Jadavpur University, Kolkata, WestBengal, India

Debasmita Basu Indian Statistical Institute, Kolkata, West Bengal, India

Mostafa Beshkar Department of Economics, University of New Hampshire,Durham, NH, USA

Ranajoy Bhattacharyya Indian Institute of Foreign Trade, Kolkata, West Bengal,India

Eric W. Bond Department of Economics, Vanderbilt University, Nashville, TN,USA

Fumio Dei Department of Economics, Kobe University, Kobe, Japan

Wilfred Ethier Department of Economics, University of Pennsylvania, Phila-delphia, PA, USA

Gary Gorton Yale School of Management, Yale University, New Haven, CT,USA

Takakazu Honryo Department of Economics, University of Manheim, Mannheim,Germany

Ronald W. Jones Department of Economics, Rochester University, Rochester,NY, USA

Toru Kikuchi Graduate School of Economics, Kobe University, Kobe, Japan

Sugata Marjit WBSCHE and Centre for Studies in Social Sciences, Kolkata,West Bengal, India

Biswajit Mandal Department of Economics, Visva Bharati University, Bolpur,West Bengal, India

Munmun Mukherjee Department of Economics, Calcutta University, Kolkata,West Bengal, India

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Pradyut Pyne Indian Institute of Foreign Trade, Kolkata, West Bengal, India

Roy Ruffin Department of Economics, University of Houston, Houston, TX,USA

Abhirup Sarkar Economic Research Unit, Indian Statistical Institute, Kolkata,West Bengal, India

Partha Sen Centre for Development Economics, Delhi School of Economics,Delhi University, New Delhi, India

Soumyen Sikdar Indian Institute of Management Calcutta, Kolkata, WestBengal, India

Saikat Sinha Roy Department of Economics, Jadavpur University, Kolkata, WestBengal, India

Ngo van Long Department of Economics, McGill University, Montreal, QC,USA

Makoto Yano Institute of Economic Research, Kyoto University, Kyoto, Japan

x Contributors

Editors’ Biosketch

Rajat Acharyya is a Professor of Economics at Jadavpur University, and cur-rently teaches Microeconomic Theory and International Economics. He was astudent of Prof. Kalyan K. Sanyal at Calcutta University from 1987 to 1989. Hecompleted his Ph.D. at Jadavpur University and subsequently held a Ford Foun-dation Fellowship at the University of Rochester, USA (1997–1998). He washonored with the EXIM Bank International Trade Research Award in 1997 and theMahalanobis Memorial Medal Award in 2006. Professor Acharyya was a VisitingFellow at the University of Kent at Canterbury, UK (2008–2010) and VisitingProfessor at Utrecht School of Economics, The Netherlands (2010). He is theEditor of Trade and Development Review (www.tdrju.net). His research areasinclude economic theory, international economics, TRIPS and health innovations,development economics.

Sugata Marjit is the Reserve Bank of India Professor of Industrial Economics atthe Centre for Studies in Social Sciences, Kolkata and Chairman of the WestBengal State Council of Higher Education. His research interests include Inter-national Economics, Industrial Organization, Development Economics, Macro-economics, and Public Economics. He has held professorial positions at the IndianStatistical Institute, Jawaharlal Nehru University, at the Universities of Bonn,Cornell, Penn State, Rochester, Erasmus, Copenhagen, Queensland, and at the CityUniversity of Hong Kong. He received the Mahalanobis Memorial Medal Awardfrom the Indian Econometric Society in 2002 and the VKRV Rao National Prizefor young Social Scientists in 2003. He serves on the Editorial Boards of variousnational and international journals and is the Editor of The South Asian Journal ofMacroeconomics and Public Finance.

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Editors’ Note

International commodity trade and factor flows have become more complex innature as well as dimension with the increasing order of integration of nationalmarkets, both real and financial, in the present era of globalization. Trade policyrules are also playing larger roles than ever before. The theoretical as well asempirical analyses in the chapters included in this volume are largely contextu-alized in these perspectives of globalization and commodity trade liberalization,increased international financial flows, and the policy implications thereof. The 13chapters are divided into 6 broad themes ranging from manufacturing trade underincreasing returns to scale and transport cost, agricultural trade under uncertaintyto dynamic and financial issues.

The volume begins with discussions of input trade, which was the central themeof Sanyal’s early theoretical work in the field of neoclassical internationaleconomics. In Middle Products Revisited, the first chapter of the volume, RonaldJones recasts the Theory of Middle Products, which he and Kalyan Sanyaldeveloped in their AER paper, with a single middle product produced in the InputTier. As is demonstrated quite lucidly, this one dimensionality in the Input Tiercaptures the basic idea of the original model in a more simple way without goinginto the analysis of demand behavior when more than a single commodity isconsumed. The other variant of the original model discussed here uses the SpecificFactors Model in the Input Tier, which creates scope for allowing many middleproducts being produced in that Tier.

The chapter titled ‘‘Antitrust Policy’’ Versus ‘‘Industrial Policy’’ by MakotoYano, Takakazu Honryo, and Fumio Dei (Chap. 2) is based on the Sanyal–Jonespaper on middle products. This chapter constructs a two country partial equilib-rium trade model and focuses on the policy interaction of the respective govern-ments regarding the choice of degree of competition in different sectors. The homecountry produces both intermediate and final goods, whereas the other countryproduces only final goods. So trade occurs only in intermediate or middle products.In a Nash equilibrium in the repeated game, one country restricts competitionwhereas the other country maintains perfect competition. In particular, it is shownthat the home or exporting country will always follow perfect competition in itsfinal good industry. Then suppressing competition by the importing country in thefinal good producing sector can be purely retaliatory in effect against the policy of

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the exporting country that suppresses competition in the intermediate good pro-ducing industry. If the exporting country follows perfect competition in the middlegood producing industry, the importing country has no incentive to adopt an anti-competitive policy in the final good sector. Despite that this state is not Paretooptimal, it is difficult for the countries to get out of the state even if they play thesame policy game repeatedly.

Increasing returns to scale in production and trade in differentiated productsunder monopolistically competitive market structure alter many of the well-knownresults in international trade theory. This is the main theme in Part II. Roy Ruffinand Wilfred Ethier discuss in their chapter Protectionism and Increasing Returns(Chap. 3) various types of external economies that can affect the cost conditions inan industry and its implications for pattern of trade and trade policy. Marshallianadjustment mechanism is utilized to derive equilibrium outcomes. A major findingof the chapter, apart from other results, is that the conventional wisdom recom-mending protection of an industry characterized by increasing returns to scale(IRS) fails to hold in the presence of substantial comparative cost advantage. Acountry will be better off by not producing a good in which it has a comparativedisadvantage in spite of the fact that it is a sector characterized by IRS.

Sugata Marjit and Biswajit Mandal develop a monopolistically competitivemodel without contract incompleteness for a closed economy producing hori-zontally differentiated products in their chapter Transaction Cost, TechnologyTransfer, and Mode of Organization (Chap. 4). They show that if superior tech-nology is not allowed to be transferred, integration would be the best mode oforganization given that the transaction cost of an intermediate input is not suffi-ciently small. However, transferability of technology calls for adding the dimen-sion of factor intensity of input. In such a case, integration could be the betteroption only when input production technology is capital-intensive. This resultvalidates the empirical findings in a context even without incomplete contract.

The chapter titled A Simple Model of Foreign Brand Penetration with Multi-Product Firms by Toru Kikuchi and Ngo Van Long (Chap. 5) develops a model ofmonopolistic competition to look at the choice of domestic entrepreneurs overoffering domestic brands or foreign (imported) brands, and over the range ofvarieties within each brand in the context of a fall in trade cost. In the short run, adecrease in trade costs may lead to expansion of range of varieties of foreign brandand contraction of range of varieties of domestic brand. But in the long-run, moredomestic entrepreneurs would prefer to be the providers of foreign brands thoughthe range of each brand must shrink.

Part III is devoted to agricultural trade liberalization and the related policyissues. The typical element in the discussion of agricultural trade is uncertainties inproduction. The gain from trade in such a context is analyzed in the chapterAgricultural Trade with Production Uncertainty by Debasmita Basu and AbhirupSarkar (Chap. 6). The interesting result they derive is that even when comparativeadvantage effects are not strong enough such that free trade is worse than autarky,there exists a tax-subsidy scheme which with trade always makes the country

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better off than autarky in the absence of an insurance market. Countries with strongcomparative advantage for agricultural goods have reasons for governmentintervention which provides insurance. Overall, for all countries, some trade (freeor restricted) is better than no trade.

The chapter Safeguards and Investigations by Mostafa Bheskar and Eric Bond(Chap. 7) addresses the relevant problem of providing safeguards through tariffs todomestic producers when their (unobservable) income and the (observable) worldprice are both stochastic. They characterize the optimal safeguard policy for thegovernment of a small country, which uses a weighted social welfare function toevaluate policies, under two types of safeguard mechanisms that correspond to theWTO’s special safeguard mechanism for agricultural and the WTO’s safeguardagreement, respectively.

The new growth theories imply that faster growth of exports of manufacturinggoods per se does not matter for augmenting growth of countries. Rather acountry’s ability to produce newer varieties and improve quality of its exportproducts is an important factor behind faster growth. These two dimensions arediscussed in the two chapters in Part IV. Rajat Acharyya in InfrastructureDevelopment, Comparative Advantage and Missing Trade (Chap. 8) examineswhether infrastructure development facilitates trade by establishing comparativeadvantage in a wider set of goods. Infrastructure development lowers transport costby increasing port efficiency or improving road quality. Thus, relative infra-structure development itself can be a source of comparative cost advantage ofcountries. But, at the same time, in an economy with fully employed resources,infrastructure development may generate forces of comparative cost disadvantageby drawing resources from production and thereby raising their prices. In anextended continuum of goods Ricardian model it is shown that when infrastructuredevelopment is financed through income tax collection, more goods are traded andthe export basket of at least one country becomes more diversified. But if it isfinanced by tariff proceeds, increased volume of trade and diversified exportbaskets are not certain outcomes.

In the chapter Catching Up in Terms of Product Quality (Chap. 9), RanajoyBhattacharyya and Munmun Mukherjee address the catching up possibility by adeveloping country through product innovation and product quality improvement.In a two-stage vertically differentiated duopoly model with unserved consumerswhere consumers are distributed in a continuum, it is shown that catching up bythe developing country firm results in enhanced welfare for its country as well asaggregate world welfare even though the welfare of the developed country falls.

Part V focuses on dynamic issues in international trade. Partha Sen in hischapter Convergence in a Three-Factor Dynamic Model: Finite Versus InfiniteLives (Chap. 10) extends the convergence literature in the context of the openeconomies in terms of a dynamic specific factor model. Main conclusions seem tobe that even if factor prices are equalized in the infinite horizon case, per capitaincomes do not necessarily converge and in the uncertain lifetime case factorprices are not even equalized. The conclusions are interesting because in the

Editors’ Note xv

standard Solow type neoclassical model convergence is a necessity. In the staticspecific factor model, factor prices are usually not equalized. Hence, the issue ofconvergence does not arise. On the other hand, in this dynamic model factor pricesdo get equalized and yet convergence does not occur.

Finally, the three chapters in Part VI discuss the financial aspects of trade andglobalization. In his chapter Some Reflections on the Recent Financial Crisis(Chap. 11), Gary Gorton addresses some of the issues pertaining to recent financialcrisis in general that often economists and policy makers give inadequate attentionto. In general, people were unaware of the crisis that was impending and finally hitthe globe in 2007–2008. The author highlights many of the ‘‘do not know’’ side ofthe crisis. The financial crisis of 2007–2008 provides the opportunity to reassessour understanding of crises. All financial crises are at root bank runs, because bankdebt—of all forms—is vulnerable to sudden exit by bank debt holders. The currentcrisis raises issues for crisis theory. And, empirically, studying crises is chal-lenging because of small samples and incomplete data.

The chapter Mundell-Flemming with Stock Market and Endogenous RiskPremium (Chap. 12) by Soumyen Sikdar extends the standard Mundell-Fleming(M-F) model, incorporating a stock market, an endogenous risk premium, andsubsequently an endogenous capital gain in the stock price. The model discussesthe implication of an endogenous risk premium for domestic bonds which isbought by investors in the foreign country. This is somewhat similar to uncoveredinterest parity type modeling except that the difference between foreign anddomestic interest rate is in terms of the country risk premium and not an unan-ticipated change in the exchange rates. The risk premium is made endogenous anda typical IS-LM model for an open economy is shown to produce the standardresults. Investment is made a function of Tobin’s q. Under flexible exchange rates,a rise in domestic money supply is shown to raise aggregate output and income,but has an ambiguous effect on the exchange rate and net exports (unlike a M-Fmodel with flexible exchange rate). Finally, capital gain in the stock market isendogenized through a modified adaptive expectation.

In the final chapter of the volume Reforms, Exchange Rate Pass-Through andIndia’s Export Prices ( Chap. 13), Saikat Sinha Roy and Pradyut Kumar Pyneestimate exchange rate pass-through to India’s export prices during 1960–1961 to1999–2000, using a simultaneous demand–supply model. Applying panel estimationtechnique, the study comes to the conclusion that exchange rate pass-through toIndia’s aggregate export prices is high but incomplete. At the disaggregate level, thepaper finds that exchange rate pass-through varies across product groups. Thefindings of this study are, therefore, in contrast with the earlier existing studies whichfind that pass-through to export prices is complete during the post-reform period.

The volume in a nutshell speaks of intermediation of various kinds with signifi-cant implications for market integration through trade and finance. Formal literatureon international trade till the first half of the last century was mainly concentrating ontrade in final goods. Trade theory started accommodating intermediate goods informal discussion later. However, the idea that so far as physical trade is concerned

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conceptually there can never be a pure traded good, was born out of the middleproduct paper. That trade can generate many nontraded service sector links hasemerged as a topic of growing concern and can claim its lineage with the idea ofmiddle product. These ideas suggest that trade-related policies can have remarkableimpact on the nontraded segments and vise versa. Recent literature on trade andfragmentation is also an eye opener in this context. Larger impact of a paper, beyondnumber of citations, lies in terms of the derived passion it creates among youngerresearchers to pursue new questions. Undoubtedly by this yardstick Sanyal’s con-tribution in trade theory will be regarded as historic.

Editors’ Note xvii