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Article Excerpt
Abstract We analyze the role of vertical innovation in trade patterns for developing economies trading with technologically advanced countries. A model is presented where the international diffusion of knowledge, promoted by economic integration, is the source of a technological catching up and leads to a convergence in the quality of traded goods, with a positive effect on exports. We then turn our attention on the evolution of trade between the Central and Eastern European countries (CEECs-5) and their European Union partner countries, assessing whether economic integration has increase the quality of the goods produced. For the period 1995-2005, we find evidence of the increasing role of intra-industry trade and vertical differentiation and a process of specialization in higher quality products, especially in the medium-and high-skill sectors.
Keywords Vertical innovation. Technological catching up Quality upgrading and trade Economic integration
JEL F01. F10. 040. 052. 057
Introduction
The recent development of technological change theories has given rise to a new perspective in analyzing the relationship among trade, growth, and technological change in open economies. (1) Theoretical contributions within the new-Schumpeterian approach to growth have stressed goods manufactured in a given country are characterized by a quality content which reflects the stock of knowledge capital available in that country at a given time. (2) It follows that economies lagging behind due to a lower rate of innovation produce lower quality goods. Yet, technologically inferior countries may benefit from the advanced countries' higher knowledge level because of technology's public good characteristics. In fact, there is wide empirical evidence the international diffusion of knowledge is promoted, by trade in goods and services, foreign direct investment, migration, and business contacts, among other channels. (3) With the integration of markets, both the spread of general scientific knowledge and the diffusion of more product-specific information occur faster and more frequently.
In a previous paper (Cavallaro and Mulino (2007)), we addressed the issue of external imbalances and competitiveness for a technologically inferior country, when traded goods vary in quality. We derived export and import demand functions, where the relative quality content of goods matters, and showed a technological catching up driven by international knowledge spillovers, may lead to a reduction of the quality gap, with positive effects on trade. In fact, the model shows that the export performance of the follower country depends, to a large extent, on its ability to absorb foreign technology and to master and improve upon technologies conceived abroad. It turns out, if the lagging countries are more open to the rest of the world, their ability to benefit from the higher stock of leader countries' knowledge capital increases.
In the present paper, we focus on the new EU members, the Central and Eastern European Countries (CEECs-5: the Czech Republic, Hungary, Poland, Slovakia and Slovenia); this is a group of countries having undergone a process of intense economic integration and we investigate whether the evolution of their trade is consistent with the predictions of the model that economic integration favors rising quality standards. As early as the first half of the nineties, most contributions point to these countries shifts in exports from low to high-tech industries, decreasing the weight of one-way trade and the predominant role of intra-industry trade (IIT), trade in vertically differentiated products in particular. (4) In this paper, we first perform a descriptive analysis where we study the evolution of the structure of trade from 1995 to 2005 and find evidence for an increasing role of IIT in the economic relationship between CECCs-5 and EU-13; the process of trade reorientation has occurred with a specialization in the up-market with high quality products, in medium and high-skill sectors, in particular. We then test the assumption of the theoretical model outlined earlier that the quality upgrading of the goods produced positively impacts the performance of exports. By so doing, we provide empirical support to the assumption of successful quality competition, a concept now familiar in modern trade theory.
The Theoretical Model
In this section, we briefly recall the previously developed model and derive some of the results to use as the basis of the empirical investigation of next sections. The analytical framework considered is a semi-small open economy, where imported goods are purchased at given world prices and exported goods are perceived to be imperfect substitutes for the tradable goods of other countries resulting in the country facing a downward sloping demand schedule for its exports. The number of goods produced in the country is fixed; over time, research and development (R & D) activity takes place, leading to an increase in the quality of goods. Due to the lower rate of innovation, the goods manufactured in the country are of lower quality when compared with goods manufactured in the rest of the world. (5) Households have a preference for diversity and therefore derive utility from the consumption of n goods from the follower country and m goods from the advanced nation. Representative consumer preferences between domestic and foreign goods are given by the following utility function:
U = [([q.sup.H][n.summation over (i = 1)][C.sub.i.sup.[[[theta]-1]/[theta]]] + [q.sup.F][m.summation over (j = 1)][C.sub.j.sup.[[[theta]-1]/[theta]]]).sup.[[theta]/[[theta]-1]]] (1)
where the subscripts H and F refer to the home and foreign countries, respectively. Domestic and foreign goods enter consumer preferences based on their quality content, [q.sup.H] and [q.sup.F], respectively. It is assumed all consumption goods manufactured in a given country have identical quality content, since they embody the same country-specific technology, and therefore enter symmetrically in Eq. 1. The parameter [theta] > 1 is the constant elasticity of substitution among all goods. The representative consumer maximizes his utility obtaining the following demand functions:
[C.sub.i] = [([P.sub.i]/P).sup.-[theta]][[delta].sup.[theta]][E/P] (2)
[C.sub.j] = [([r[P.sub.j]/P]).sup.-[theta]][(1 - [delta]).sup.[theta]][E/P] (3)
where E is the consumer's expenditure, [P.sub.i] and [P.sub.j] represent the...
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