Silk vs. Automobile – Why Countries Need to Defy Comparative Advantage In Order to Develop Comments Off on Silk vs. Automobile – Why Countries Need to Defy Comparative Advantage In Order to Develop 1156

Once upon a time, the leading car-maker of a developing country exported its first passenger cars to the US. Unfortunately, the product was a total failure. Most US consumers thought the little car looked lousy and were reluctant to spend serious money on a car that came from a place where only shoddy products were made. The car was such a failure that it had to be officially withdrawn from the US market.


This disaster led to a major debate in the country. Many argued that the industry should be shut down. Here was an industry, they said, whose best company could not penetrate even the lowest of the low end of the US market. And that was after the country’s government had given it 25 years of high tariff protection and banned foreign direct investment for 20 years.

The critics argued that the country should forget about industries like automobile, ship building and steel, which its government had been promoting – these industries were too capital-intensive for a country with very little capital and a lot of labour. The country should instead, they argued, concentrate on industries that intensively use its abundant labour force. After all, silk was the biggest export item of the country at the time.

They pointed out that the received economic theory supports their argument. The theory of comparative advantage, the most widely accepted trade theory, tells us that given its resource endowment, the country should specialise in labour-intensive products in which it has comparative advantage, rather than capital-intensive products in which it does not have comparative advantage.

The reader will be shockd to learn that the year was 1958, the country was Japan and the company was Toyota, and the car was called Toyopet. Japan’s automobile industry had been protected with high tariffs since its inception in 1933. Since it kicked out General Motors and Ford in 1939, in the run up to the Pacific War, the Japanese government had not allow any foreign company to produce automobiles in Japan. We may add that Toyota was doing so badly that in 1949 the Japanese government had to inject public money through the Bank of Japan, the Central Bank, to bail it out.

By: Prof. Ha-Joon Chang, University of Cambridge South Korean institutioal economist, specialising in development economies Consultant at World Bank, the Asian Development Bank, the European Investment Bank

Today, Japanese cars are considered as ‘natural’ as Scottish salmon or French wine, but only two generations ago most people including many Japanese, thought that the Japanese car industry simply should not exist. Indeed, at the time, the Japanese car industry was, to put it bluntly, a joke. In 1955, all the Japanese car companies combined (there were around a dozen of them) produced 70,000 cars (with Toyota, the biggest company producing 35,000 cars) compared to 3.5 million cars that was produced by General Motors alone and 7 million cars by the US automobile industry as a whole.

Starting from this stark reality and going against one of the most widely accepted theories in economics (that is, the theory of comparative advantage), Japan persisted with the promotion of the automobile industry. By the late 1970s, it conquered the smaller car market, prompting the US and the European countries to impose quotas on Japanese car imports – euphemistically called ‘voluntary export restraints’. Even so, when the Japanese companies announced in the late 1980s that they are going to enter the luxury car market with new brands (Toyota’s Lexus, Nissan’s Infiniti, and Honda’s Accura), most people sniggered, muttering, “Japanese luxury car, that is an oxymoron, isn’t it?”. By 2008, however, Toyota became the biggest car-making company in the world beating General Motors, and the Japanese luxury car brands are neck-and-neck with BMW and Mercedes-Benz.

Do a little thought experiment to see how monumental the progress of the Japanese automobile industry has been. Suppose that you went back to 1958 and told people that there is this totally unknown third-rate car company called Toyota in Japan but that the company will in 50 years beat General Motors, you would be lucky if people thought you were writing a science fiction. More likely, they would have put you in a mental hospital.

The car industry is not alone. Japan developed its other key industries – such as steel, shipbuilding, electronics, and so on – by using similar mixtures of tariff protection, ban on foreign direct investment, subsidised loans from government-regulated banks, subsidies for R&D, special treatment for domestic firms in government procurement programmes (especially important for the development of the main frame computer industry), and many other internvetionist measures.

Moreover, Japan is not alone in this. It is well known that countries like Korea and Taiwan and more recently China, have used similar policies to industrialise and develop their economies. Less well known is the fact that virtually all other rich countries – the UK (in the 18th and the early 19th century), the US (throughout the 19th century and the early 20th century), Germany and Sweden (in the late 19th and the early 20th century), and others – also promoted their economic developments in similar ways.

Thus, given that virtually all countries have developed their economies by defying their comparative advantages and ‘artificially’ developed industries in which they do not have comparative advantage, we need to seriously re-examine the theory of comparative advange as the guideline for a country’s trade, industrial, and even development policies.

The concept of comparative advantage was first developed by the 19th century British economist David Ricardo. It is actually a very counter-intuitive idea. Before Ricardo, everyone believed that a country should trade with another only when it can produce something more cheaper than the other. This is known as the idea of absolute advantage. However, using the concept of comparative advantage, Ricardo argued that even a country with no absolute international cost advantage in any industry (that is, even if it cannot produce anything more cheaper than other countries can), the country will still be better off if it specialised in industries in which it is least bad at and traded with other nations. Conversely, even if a country can produce everything more cheaply than other countries can, it will still pay for that country to specialise in industries in which it is particularly good at and engage in international trade, rather than trying to produce everything itself.
The theory of comparative advantage is often misunderstood. I have heard professional economists saying things like “such-and-such poor country does not have comparative advantage in anything”. This is a logical impossibility. All countries, however inefficient they may be compared to other countries, have comparative advantage in something. To put it more starkly, even if you are rubbish at everything, there must be something at which you are the least rubbish at, and that is where your comparative advantage lies and that is therefore what you should specialise in.

From this concept, a whole body of theoretical edifice has been constructed to argue that free trade will naturally make countries specialise in industries in which they have comparative advantage, thereby making them better off. From there, it is but a small step to argue that following comparative advantage is the best development strategy.

The theory of comparative advantage is absolutely correct – in so far as the assumptions that underlie the theory are met. However, there are many assumptions that underlie the theory that do not hold in reality. The theory assumes that there is perfect competition, when the real world economy is dominated by monopolies and oligopolies. It assumes that there is no slack in the economy, when in the real world you have under-utilised resources and unemployed workers. And the theory does not work without the assumption that capital and labour can easily be re-deployed across sectors if changes in trade flows demand so. However, in reality machines and worker skills are very specific to the industry they are deployed in and cannot be used elsewhere.

There is nothing unusual about the fact that the theory of comparative advantage make all these assumptions that do not hold in reality. All theories, not just this theory, are constructed on the bases of certain assumptions and therefore do not hold if those assumptions are not met. What is special about the theory of comparative advantage, however, is that it has been used as a guide to economic development despite making assumptions that assume away the very core issues of economic development – that is, the nature of technology and the development of technological capabilities.

The currently dominant version of the theory of comparative advantage, known as the Heckscher-Ohlin-Samuelson model (after Eli Heckscher, Bertil Ohlin, and Paul Samuelson, who constructed the theory in the mid-20th century), assumes that there is only one best technology for producing a particular product and more importantly, that all countries have the same ability to use that technology. The only difference between countries in this model is the relative amounts of capital and labour they have – richer countries have more capital than labour and poorer countries have more labour than capital. So, in the Heckscher-Ohlin-Samuelson model (henceforth the HOS model), if Sri Lanka should not be producing things like BMWs, it is not because it cannot do it, but because doing that has too high an opportunity cost, as producing BMWs will use too much of its scarce factor of production, capital.

Thus seen, the main problem with the theory of comparative advantage is that it is not a theory that is useful in understanding the process of economic development. It is largely true that in the short run, a country will benefit the most by specialising in products in which it has comparative advantage in (I say ‘largely’ because the theory has assumptions that are often not met in reality even for this to be true). However, in the longer run, a country’s development success depends on how it finds a way to defy its comparative advantage and get into industries with dynamic demand growth, faster technological progress, and greater impacts on other sectors of the economy.

In doing so, the theory of comparative advantage can act as the ‘compass’ that tells a country’s policy-makers where their country stands and how much of the static gains from trade they are going to forego if they protected industries in which their country does not have comparative advantage. However, in the same way in which a compass cannot tell us where to go and, even less, how to get there, the theory of comparative advantage cannot tell the policy-makers which path of development path of their country should take and how to navigate the country through that path.

For far too long, developing countries, including Sri Lanka, have been told that sticking to their comparative advantages by following free-trade, free-market policies is the best development strategy. It is time that developing countries realise that the theory of comparative advantage is not a theory about economic development. It is only like a compass, helping us figure out where we are, but is of little use unless they have a clear destination, a good detailed map, and a knowledge of how to navigate the terrain that is full of physical obstacles, dangerous animals, and unpredictable weather conditions.

The Price We Pay For Not Understanding The ‘Price’ 0 1113

In the book titled ‘Marx’s ‘Theory of price and its Modern Rivals’, Sri Lankan born and educated Prof. Howard Nicholas exposes the flaws in the many theoretical debates in money, price and inflation. This he does by revealing the inconsistencies and contradictions in economic theories submitted to explain price. This is nothing new in Sri Lanka and many developed countries attributable to the fact the certain economists, due to a false understanding, are misled on what price is all about. Therefore, let us examine this false interpretation and try to understand the real parts that from PRICE which we play in commerce.

According to Prof. Nicholas, Orthodox economists starting with David Ricardo have not quite understood the concept of ‘price’ and how it is computed. He argues that the explanation of price by Marx, who had a deep understanding of the capitalist system, is more logical and clear. To understand Price we have to first understand how commodities bearing a price tag are produced and marketed. Prof. Nicholas who refers to this process as the- Production Cycle’ explains that present day economists go astray since at the outset they focus only on the process of exchange, assuming individuals are naturally endowed with commodities. This mistake causes them to ignore cost of production and focus on individuals and their choices when explaining prices.

A second important point made by Prof. Nicholas in his book is that when explaining price, from the outset we need to bring money into the picture. This is, to explain prices as money- prices. When products calculate the values of their commodities, they do so in terms of money thereby setting money prices. Buyers of goods in markets make payment in accordance with these money- prices. According to economic orthodoxy, the prices that matters are relative prices. That is, the price of one product in terms of another and not in terms of money. In fact, although this may not be so apparent when reading standard economics text books, money has no role to play in the basic explanation of prices. It only makes its appearance when macro-economic phenomena, in particular the aggregate level of prices are considered.

The third major argument prof. Nicholas advances is that the basis for explanation of cost of production of the commodity as its money cost of production, needs to be seen as the labour time spent in production. This is what Marx referred to as the value of commodity. Labour time spent in production amounts to money costs, when money represents labour time by itself. This happens when money is used by producers, to depict the value of the product. The importance of explaining prices is perhaps best been by producers, to depict the value of the product. The importance of explaining prices is perhaps best seen by the present downward pressure on global prices, resulting from the massive technological change across the globe. Despite unprecedented levels of printing of currency by Central Bank of major countries, world inflation rate has continued to fall down. This underlines the importance of labour productivity in explaining price, and the incorrect explanation of money and price by economists. It may also be the clearest practical support for Marx’s price theory as seen by Prf. Nicholas

By : Dr Kenneth De Zilwa

“Made in Sri Lanka” 0 1495

Ever watch the movie, Rocky? I mean, any of those would suffice. But mainly, the original. In fact, if you know anything about Stallone’s life itself, you’ll know that he’s probably one of the biggest success stories in history. Now, there are plenty of famous people who failed but never gave up on their dreams. You can find them all throughout history. There sagas are powerful enough to make you second guess ever giving up in life.

Does the common idea of geniuses having an eccentric ideas and behaviors bear any truth? Here is a story of eccentric entrepreneur for you to decide.

People waste searching endlessly for magic, whereas to Lawrence Perera life itself is a magic. “I didn’t grow up around incredible cars or at a time where there was luxury. Few of my earliest and fondest memories involve automobiles. My story begins as kid who broke every toy car received just so that I could see how it was made. My mother noticed my passion for cars and decided that I should get into automobile engineering field and made me enter the German tech without waiting to go to the university, she was keen to see me making a career in the automobile industry’’ says Dr. Lawrence with a sense of gratitude, by starting his conversation with BiZnomics. “Just as we have moments in time crystallized by places, music or movies that imprint upon us, the automobile left an indelible impression on my experience and who I became”.

Now an Automobile Engineer by profession with over 40 years’ experience in the Automobile Engineering Industry both locally and overseas, Dr.Perera is a diploma holder in Automobile Engineering at the CGTTI, and Institute of Motor Industry of UK. He is also a certified automobile engineer in the Institute of Motor Industry and a fellow member of the Institute of Motor Industry – UK (FIMI).

‘’I know from very hard won experience that start-ups are enormously difficult and risky and chances are you might not succeed” says Dr. Lawrence Perera, Leading entrepreneur, Chairman and CEO of Micro Holdings and Micro Cars Ltd. Dr. Lawrence’s “ hard won experience’’ is based on manufacturing the car “Micro” the first designed , developed and manufactured car in Sri Lanka.

He has received extensive training with BMW, Volkswagen – Germany and Peugeot – France. Dr. Perera described his daily sightings of stranded people on the roads due to the chaotic situation of public transport and realized the crying need for a reliable alternative. ‘’I thought that if people had a reliable, economical, decent, comfortable and affordable car that would take them to the place they want to go, the problem would be solved and many man-hours would be saved. I then set to design and develop a small car with every household in mind – and that’s where MICRO started’’ he said.

Describing his product further he states: ‘’It was the tuk-tuk that influenced me to create a small car. The Morris Minor was the smallest at the time and the dimensions of my drawing were smaller. My product which was patented in 1999 was an 80% local manufacture. As far the brand name, I decided on micro mini and finally named it MICRO’’.

Dr. Lawrence Perera had been skeptical of the success of his product at the time it was launched at the price of LKR 300,000. ‘’ At that time local products were thought to be inferior but MICRO turned out to be acceptable and most bought it because it was economically priced’’. Marketing local brands had been very competitive as it was difficult to challenge and compete with international giants in the market.

The Micro was fitted with safety standards such as air bags and seat belts. Yet, Lawrence had to stop production mainly due to complicated manufacturing process and cost of production increasing.

The garment industry in Sri Lanka has made a big contribution to change people’s mentality in buying ‘made in Sri Lanka goods’. Garments sewn in Sri Lanka have earned in international reputation and Sri Lankan consumers are well aware of this fact. The government should encourage local products, and especially an industry such as automobile requires a certain tax relief for composite material used for making cars. Adding to this, He criticizes the industrial policy and taxation systems prevailing as not being friendly and conducive to local industrialist and manufactures. The Micro brand of which Sri Lanka could be proud of became well known the world over, even in countries such as Germany, China and Korea. But I could not develop Micro because support for the automobile industry is almost zero. For one thing vehicle importers were against local manufacture since their imports business would take a downward turn. And next, the industrial policy of the country and the taxation system does not provide any impetus at all. Although a normal car is not a luxury, but a necessity”. He claims that during the last four years, the company run with losses, and that the financing aspect has been terrible. The bank loan interest rate has shot up from 6.5% to 14.5%. p.a. “Business has been thrown into a quagmire”, he says and adds, “We have to pay much more than we earn”

Dr. Lawrence opines, that Sri Lanka has been in a miasma of uncertainty for a while, and that the combined effects of numerous policy changes have thrown many enterprises including the motor vehicle industry into turmoil, insists that the country should have strong decision-taking and unwavering leaders who will dispel personal gains and crack the whip to drive away corruption while instilling discipline in all sectors, in order that the country could emerge from one of its lowest phases in recent history with a record decline in business.

Dr. Lawrence Perera’s view is that gasoline engines will gradually go out of the market. He states that with the introduction of hybrid vehicles, gasoline engines changed, but that hybrids will survive only with combustion engines. ‘’whereas Japan went for the hybrid, China jumped into electric engines which will last for another 100 years. We should also adopt the electric car. With sunshine around all throughout the year, car solar batteries fitted to electric engines can be charged at no cost and what a saving on fuel that will be! Anyway, gasoline engines will gradually make its way out of the market, in not too distant future.

With the influx of hybrid and electronic cars an eco-environment challenge will be the lack of adequate provisions to dispose of used bittern such vehicles in the future. The lack of regulators for strict recycling and safe disposal of batteries will lead to them ending in garbage dumps. Another area that needs attention to curb pollution and improve and conserve of quantity is to adopt a long-term vision or polices of emission standards. The lack of the stable policy outlook may associate Sri Lanka with volatility and high risk.

Adding to his many innovative ‘firsts’, Dr. Lawrence Perera was the first to design an economical rail solution for the Sri Lanka Railway, in 2004, the first in Sri Lanka to assemble 4×4 SUVs under the technology transfer agreement with the Korean Ssang Yong motor company, with Mercedes technology in 2006, and the first to manufacture a luxury double decker bus with the latest technology complete with fully aluminium low floor monocaqne design for public transport in 2007. Commenting on his economical rail solution Dr. Perera says: “In 2004 I designed an economical rail solution termed ‘Lanka Econo Rail’ for mass transport to replace the car in the megapolis. My proposal was to build carriages using scrapped steel, with automatic doors, good seating and all comfort. My proposal envisaged buses at relevant stations to transport the passengers to their destination like the monorail or metro in foreign countries. It was a light-rail concept place of the heavy locomotive system which has been in operation for the past 164 years. However, this was blocked by railway officers who want the steel to be sold at dirt price by the kilo, as obsolete.

Dr.Perera attributes his success to his family – wife and two daughters who had been very supportive, without their support he wouldn’t have achieved so much. Dr.Perera is determined to showcase Sri Lanka’s potential in the international car industry.

By : T V Perera

Image Curtsey : Eranga Pilimatalawwe