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Planning economic integration among developing countries
REGIONAL AND URBAN E?ONOMICS - VoL3, No. 2 (1973) 217-220
BOOK REVIEW L.B.M. Mennes, !iPhtig Economic LntegraYonamong Developing Countries (Univerdtaire Pers, Rotterdam, t973) pp. 1%.
International rnd inter-regional trade, so theorists have long post&ted, can arise out of differences in factor endowments or in technology. Recently a new reason for speciaj.&tion i.. production has been advanced - econombs of scale. Like technology, economies of scale seem to be specific to an industry; like factor endowments, to be stable over time. EIK@I~S into the effects of economies of scale on location and trade have proceeded along both general and particularlines: Max Corden and MurrayKemp have made attempts to extend international t&e theory to accommodate economies of scale; and David Kendrick (in his study of the regional allocation of investment in the Brazilian steel industry), Camoy and Crunwdd (in theirs of Latin kriraricsuh economic integration), Belassa,Meerus and Stoutjesdijk (investment in fertilizer in Kenya, Tanzania and Uganda), Alan Manne et al. (nwWeve1 planning in Medico), and H.C. Bos et al., (investment packages in Southeast *Asia)have and are invest@ating ~y?scurceallocation in tk contexts of- particualaaindusbies and regions of the world. What M~MW has done in the book under review is to unite the two lines of enquiry, taking the glenerai-equik~brium model so beloved of international trade theorists and inserting into it two industries with characteristics similar to those encountered by the practitioners. Mennes’ model is 8p1extension to two countries of Westphal’s exercise in planning investment under economies of scale in South Korea. The existing ecoiqsmies of each of Mennes” two countries are descrrtid by aggregated inpub-output tables (with activities covering production, capital formation and international trade) of four sectors each. The table for one country (Court&y 1) describes the South Korean economy; the table for the other Country 2) descriis an in& nary ecalnomy of similar size and stage of development, but with somewhat hig?rerrate of investment. AU e:xMhg activities exhibit constant returns to scale, and capital is the only scarce factor of production. it is the potential sectors of Mennas’ model that exhibit economies rBfscale: then are two in number, one whkh would produce a product formerly imported (petrochemicals) and the other Cwhich would produce both an imported product (iron and steel fabrications) a3 well as a product already produced domestically (basic iron and steel). The countries are ass~wned10 be capable of utilizing the same technology, so the input-output structures of t&-2potential sectors are identi& The problem PAennesselects is how to allocate scarce capital within the two count&%so aa to minimize the amount needed to achieve specified increases in gross domestic product over the planning period. As formulated, this is a mixed-integer programming proble I$, which. Mennes was able to solve on a computer by comp$te eaumerazion of ti possible ~~~~.. The table below summarizes Mennes’ results, which were derived for different hrvestment packages and different institutional arrangements.AU but the second and last packa@ assume a limited customs union between the two countries with no impediments (tariffj nr $uotas) to the two members’ trade iit petrochemicals and iron and steel.
Book review
218
Mennes discovered that the begt aLlocation was the on3 which assigned to Country 2 the iron and steel complex and to Country 1 nothing: it rec@red speciabzation by one country and abstinence by the other, to their mutual advantage. The next best allocation was onC which avoided investment in either new industry in either country, leaving all capital free for traditional activities. Comparing the best and the second best allocations and using the language of international trade theory we would say that within the market formed by the two countries, Country 2 has a compuative advantage in iron and steel and Country J1 in neither of the two industries co&&red. Under a regime of perfect competition and free trade among the partners, an iron and steel complex would be built :.! Country 2; Country 1 would @port iron and steel fkom Country 2; both wuntries would import petrochemitz from the rest of the world, imposing on them their customary tariffs tsad both would continue their traditional exports to the rest of the world. In comparing all the packages that Mennes analyzed one sees several implications for the theory and practice of economic integration. The first is that independent development of prestigious industries is economically a very unattractive strategy: the table of results places Table 1 Differences in total capital costs of meeting GNP targets under different project a2locations.a Contents of package
--A One industry (with greater economies of scale) only
Assignment of projects Iron and steel
Petrochemicals
COUntry1
Country1
country2
caulk tay 2
Excess capital cost (above best padcage) (mill. $1 Coun&Y 1
0
country 2
4.9
0 q --b-J
16.7
-8.0
One industry (tit11 lesser economies of 3zale) only
16.4
-0.8
One industry ( with llesser economies of scale) only
4.8
10.8
13.2
7.1
21.6
8.9
0
35.5
54.8
-8.0
52.6
39.2
No industry in either country One in$ustry (with greater economies of scale) only
-
Both industries shared -_
Both industries shared -
Both industries in one c:ountry Both industries in other country
-
Both industries in both countries (autarky) a Data drawn from Mennti,? text and tables.
Book xview
213 L1
autarky at the bottoxn, the most expensive of all. In studies where constant returns to s&e are assumed, such as, e.g., F.B. C:~k’s of investment planning in Nigeria, prestigious projects are advised against on the rrounds of their highly capital-intensive nalure; Mennes offers the same advice, but on the narrFwer grounds of the high cost likely to be incurred at the small scab of national sufficiency. i’l The second implicati~ c. Menn:es’enquiry is that the combination of capital-intensity and t%OnOKlkS of SC& Iave dl signif%zantinfluence on the selection of industry. The optimal solution to Mennes’ model containid just one investment project (the iron and a&e1complex allotted to Country 2), that with the greater economies of scale. The solution which a&gned the same project to the other country was slightly more expensive. The sohtion which assigned :‘5?(r project with lesser economies of scale (petrochemicals) to the country better suited fu)rit (Country I) was worse still. Given thase results one cannot state that, for countries coopentmng in their deuelopment, projects exhiWing economies of scale are generally more attractive tin those exhibiting constant returns to scale, nor that projects highly capital-intensive (as, in Mennes” model both iron and steel and petrochemicals were, relative to the existing activities) are generally leersattractive. The only conclusion can be that if economies of scale outwleigh capital-intensity in one c~ountrywhere capital is scarce they are likely tu outweigh it in another country. In a partial customs union the choice of industry appears to be more important ,than the choice of location. Moreover, from MeMes’ ranking of alternatives one observes that the total capital coat of sharing two projects is less than abetting both to one country and none to the other. For c ountries at roughly equal stages of development and determined to industrialize 8~sharing of projects seems to be economically efficient as well as being politically equitable. The impo&inn of political constraints may not reduce the economic advantagesof integration. Thirdly, we are encouraged by Menncs’ work to evaitiate large-scale projects within tn explicitly-stat+& general-equiliiriun’rcontext. It is not only that the /optimalallocation derived from the solution of a partialsq,uiliirium model may be different from the sohltion to a general-equiliiium model, but that the distribution of benefits may be different. When alllowante is made for indirect, as well ap direct effects, the rewards to integration seem to become more evenly shared. The best alkation (&hefirst case in the tabulation) offers an exarnpk: superkially it would appear that Country 2, which is assigned the iron and steel comlplex, benefits much more than its partner, which is assigned nothing. Yet when the capital czosts incurred by each country separately are compared with those incurred in the non-cooperutivt case (the second in the tabulation), the result is just the opposite. Country 1, which is not assigned the project, meets its CD&growth target with a saving of 54.8 milBon;whereasCoun= try 2, which is assigned the project,’spends $0.8 million more. Country 1’s savhrgs ad beam it does not have to invest so much in transportation facilities; Country 2’s tota! investment ri*s because of the highly capital-intens#venature of the iron and steel complex. Economic inte@ation canters on the partner allotted the project the benefits of production, and seems to confer on the pmner not allotted the praiject the benefits of trade. Economic interchange thus l:ds to distribute the gains from speciali$ation. Stemming from tht desirability ;of the general-equilibriumapproach is the tipliatifll that our analytical tools are not up to our current needs. Although generakquilibri’um modelk are pmferable, the practice is to we +ia~uilibrium models with some ad hoc adjustment to factor prices (a la Little-?&&es),. because these can be sotied. Before Var&Pted PadrnePsof of scab CJUI investment projects - many indust.fies in many countries - exhibiting emnOdeS be evahrated, better solution algorithms tc mixed-integer programmingproblems mu@ be invented: the branch-and&ok-ndprocedure currently availablehas not proved sufficiently power* ful to solve any df the problems mentioned at the beginning of this review. Superior methods are required if project evaluation Q to be improved and the benefits of economic inWPti>n to be quantifii.
220
Book reud:w
FmalJy, Menses’ results show that institutional arrangements between countries have a significant effect upon the optimal allocation of resources: variations
BOOK REVIEW L.B.M. Mennes, !iPhtig Economic LntegraYonamong Developing Countries (Univerdtaire Pers, Rotterdam, t973) pp. 1%.
International rnd inter-regional trade, so theorists have long post&ted, can arise out of differences in factor endowments or in technology. Recently a new reason for speciaj.&tion i.. production has been advanced - econombs of scale. Like technology, economies of scale seem to be specific to an industry; like factor endowments, to be stable over time. EIK@I~S into the effects of economies of scale on location and trade have proceeded along both general and particularlines: Max Corden and MurrayKemp have made attempts to extend international t&e theory to accommodate economies of scale; and David Kendrick (in his study of the regional allocation of investment in the Brazilian steel industry), Camoy and Crunwdd (in theirs of Latin kriraricsuh economic integration), Belassa,Meerus and Stoutjesdijk (investment in fertilizer in Kenya, Tanzania and Uganda), Alan Manne et al. (nwWeve1 planning in Medico), and H.C. Bos et al., (investment packages in Southeast *Asia)have and are invest@ating ~y?scurceallocation in tk contexts of- particualaaindusbies and regions of the world. What M~MW has done in the book under review is to unite the two lines of enquiry, taking the glenerai-equik~brium model so beloved of international trade theorists and inserting into it two industries with characteristics similar to those encountered by the practitioners. Mennes’ model is 8p1extension to two countries of Westphal’s exercise in planning investment under economies of scale in South Korea. The existing ecoiqsmies of each of Mennes” two countries are descrrtid by aggregated inpub-output tables (with activities covering production, capital formation and international trade) of four sectors each. The table for one country (Court&y 1) describes the South Korean economy; the table for the other Country 2) descriis an in& nary ecalnomy of similar size and stage of development, but with somewhat hig?rerrate of investment. AU e:xMhg activities exhibit constant returns to scale, and capital is the only scarce factor of production. it is the potential sectors of Mennas’ model that exhibit economies rBfscale: then are two in number, one whkh would produce a product formerly imported (petrochemicals) and the other Cwhich would produce both an imported product (iron and steel fabrications) a3 well as a product already produced domestically (basic iron and steel). The countries are ass~wned10 be capable of utilizing the same technology, so the input-output structures of t&-2potential sectors are identi& The problem PAennesselects is how to allocate scarce capital within the two count&%so aa to minimize the amount needed to achieve specified increases in gross domestic product over the planning period. As formulated, this is a mixed-integer programming proble I$, which. Mennes was able to solve on a computer by comp$te eaumerazion of ti possible ~~~~.. The table below summarizes Mennes’ results, which were derived for different hrvestment packages and different institutional arrangements.AU but the second and last packa@ assume a limited customs union between the two countries with no impediments (tariffj nr $uotas) to the two members’ trade iit petrochemicals and iron and steel.
Book review
218
Mennes discovered that the begt aLlocation was the on3 which assigned to Country 2 the iron and steel complex and to Country 1 nothing: it rec@red speciabzation by one country and abstinence by the other, to their mutual advantage. The next best allocation was onC which avoided investment in either new industry in either country, leaving all capital free for traditional activities. Comparing the best and the second best allocations and using the language of international trade theory we would say that within the market formed by the two countries, Country 2 has a compuative advantage in iron and steel and Country J1 in neither of the two industries co&&red. Under a regime of perfect competition and free trade among the partners, an iron and steel complex would be built :.! Country 2; Country 1 would @port iron and steel fkom Country 2; both wuntries would import petrochemitz from the rest of the world, imposing on them their customary tariffs tsad both would continue their traditional exports to the rest of the world. In comparing all the packages that Mennes analyzed one sees several implications for the theory and practice of economic integration. The first is that independent development of prestigious industries is economically a very unattractive strategy: the table of results places Table 1 Differences in total capital costs of meeting GNP targets under different project a2locations.a Contents of package
--A One industry (with greater economies of scale) only
Assignment of projects Iron and steel
Petrochemicals
COUntry1
Country1
country2
caulk tay 2
Excess capital cost (above best padcage) (mill. $1 Coun&Y 1
0
country 2
4.9
0 q --b-J
16.7
-8.0
One industry (tit11 lesser economies of 3zale) only
16.4
-0.8
One industry ( with llesser economies of scale) only
4.8
10.8
13.2
7.1
21.6
8.9
0
35.5
54.8
-8.0
52.6
39.2
No industry in either country One in$ustry (with greater economies of scale) only
-
Both industries shared -_
Both industries shared -
Both industries in one c:ountry Both industries in other country
-
Both industries in both countries (autarky) a Data drawn from Mennti,? text and tables.
Book xview
213 L1
autarky at the bottoxn, the most expensive of all. In studies where constant returns to s&e are assumed, such as, e.g., F.B. C:~k’s of investment planning in Nigeria, prestigious projects are advised against on the rrounds of their highly capital-intensive nalure; Mennes offers the same advice, but on the narrFwer grounds of the high cost likely to be incurred at the small scab of national sufficiency. i’l The second implicati~ c. Menn:es’enquiry is that the combination of capital-intensity and t%OnOKlkS of SC& Iave dl signif%zantinfluence on the selection of industry. The optimal solution to Mennes’ model containid just one investment project (the iron and a&e1complex allotted to Country 2), that with the greater economies of scale. The solution which a&gned the same project to the other country was slightly more expensive. The sohtion which assigned :‘5?(r project with lesser economies of scale (petrochemicals) to the country better suited fu)rit (Country I) was worse still. Given thase results one cannot state that, for countries coopentmng in their deuelopment, projects exhiWing economies of scale are generally more attractive tin those exhibiting constant returns to scale, nor that projects highly capital-intensive (as, in Mennes” model both iron and steel and petrochemicals were, relative to the existing activities) are generally leersattractive. The only conclusion can be that if economies of scale outwleigh capital-intensity in one c~ountrywhere capital is scarce they are likely tu outweigh it in another country. In a partial customs union the choice of industry appears to be more important ,than the choice of location. Moreover, from MeMes’ ranking of alternatives one observes that the total capital coat of sharing two projects is less than abetting both to one country and none to the other. For c ountries at roughly equal stages of development and determined to industrialize 8~sharing of projects seems to be economically efficient as well as being politically equitable. The impo&inn of political constraints may not reduce the economic advantagesof integration. Thirdly, we are encouraged by Menncs’ work to evaitiate large-scale projects within tn explicitly-stat+& general-equiliiriun’rcontext. It is not only that the /optimalallocation derived from the solution of a partialsq,uiliirium model may be different from the sohltion to a general-equiliiium model, but that the distribution of benefits may be different. When alllowante is made for indirect, as well ap direct effects, the rewards to integration seem to become more evenly shared. The best alkation (&hefirst case in the tabulation) offers an exarnpk: superkially it would appear that Country 2, which is assigned the iron and steel comlplex, benefits much more than its partner, which is assigned nothing. Yet when the capital czosts incurred by each country separately are compared with those incurred in the non-cooperutivt case (the second in the tabulation), the result is just the opposite. Country 1, which is not assigned the project, meets its CD&growth target with a saving of 54.8 milBon;whereasCoun= try 2, which is assigned the project,’spends $0.8 million more. Country 1’s savhrgs ad beam it does not have to invest so much in transportation facilities; Country 2’s tota! investment ri*s because of the highly capital-intens#venature of the iron and steel complex. Economic inte@ation canters on the partner allotted the project the benefits of production, and seems to confer on the pmner not allotted the praiject the benefits of trade. Economic interchange thus l:ds to distribute the gains from speciali$ation. Stemming from tht desirability ;of the general-equilibriumapproach is the tipliatifll that our analytical tools are not up to our current needs. Although generakquilibri’um modelk are pmferable, the practice is to we +ia~uilibrium models with some ad hoc adjustment to factor prices (a la Little-?&&es),. because these can be sotied. Before Var&Pted PadrnePsof of scab CJUI investment projects - many indust.fies in many countries - exhibiting emnOdeS be evahrated, better solution algorithms tc mixed-integer programmingproblems mu@ be invented: the branch-and&ok-ndprocedure currently availablehas not proved sufficiently power* ful to solve any df the problems mentioned at the beginning of this review. Superior methods are required if project evaluation Q to be improved and the benefits of economic inWPti>n to be quantifii.
220
Book reud:w
FmalJy, Menses’ results show that institutional arrangements between countries have a significant effect upon the optimal allocation of resources: variations