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Industrial heterogeneity and international product cycles

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Abstract

This paper proposes a model of quality ladder in the context of North–South trade to examine the emergence of product cycles in industries of different research and development (R&D) intensity levels. To acquire the dominant advantage, firms as a whole can strategically undertake either quality upgrades through R&D or cost saving through the channels of market penetration—foreign direct investment (FDI) or offshoring. In an infinite-horizon game, the uses of mixing moving-up and moving-out strategies in high-tech and medium-tech industries generate product cycles. Furthermore, in low-tech industries, FDI is a strongly dominant strategy for the industry leaders and followers. Under certain conditions, firms leapfrog over each other and product cycles thus emerge.

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Notes

  1. See, also, Hu and Jefferson (2002), Feenstra and Hanson (2005), Liu (2010) and Fu (2011).

  2. According to “Statistics Sweden” (http://www.scb.se/en), China is now the 10th-largest trading partner of Sweden with 3.1% share of its total exports of goods. Compared to other nine major trading partners with Sweden, China is the one whose gross domestic product (at purchasing power parity) per capita is less than 15,000 international dollars (Int$). See, World Bank 2015 data source: http://data.worldbank.org/indicator/.

  3. Krugman’s work has been extended by Dollar (1986) and Jensen and Thursby (1986). Dollar maintained Krugman’s assumption of an exogenous rate of product innovation, but related the rate of technology transfer to the North–South terms of trade, albeit in an entirely ad hoc manner. Jensen and Thursby assumed that all innovation is carried out by a single entrepreneur in the North, and that the allocation of resources in the South is performed by a social planner.

  4. In addition to the variety-based model and the quality ladder model, other frameworks can be used to analyze product cycles. For instance, Zhu (2004) extended the Dornbusch–Fischer–Samuelson (DFS) model with Northern product innovation and product-cycle-driven technology transfers. Antràs (2005) incorporated the model of incomplete contracts into the product cycle issue.

  5. In contrast to the strong scale effects in the earlier literature, economic growth in their model is characterized by weak scale effects. See, also, Gustafsson and Segerstrom (2010).

  6. See, also, Segerstrom (1991), Mukoyama (2003) and Horii and Iwaisako (2007).

  7. Specifically, Lu’s (2007, p. 326) Figure 1 in her introduction utilized the measurement and data of product-cycle trade from Zhu (2005), and then illustrated the product-cycle trade intensity and the R&D intensity across industries. The figure evidently showed that product cycle emerges in industries in almost all levels. Notice that, in her figure, industries are arranged along the axis according to their R&D intensities with the most R&D-intensive industry located at the far right.

  8. As the second trand we have shown above, R&D in this paper is to upgrade quality for the existing varieties of products.

  9. See, e.g., Grossman and Helpman (1991a, b, c) for details.

  10. Although the wages might be endogenously influenced by the results of strategic choices between R&D and FDI/outsourcing, we assume that the wage rates are exogenously fixed as traditional trade theories for solving outcomes in the present fairly complicated model.

  11. This is equivalent to the Schumpeterian “process of creative destruction.” In each period, a firm enjoys its temporary monopoly power until a more inventive challenger appears. See, e.g., Reinganum (1985).

  12. In Lu (2007), she considered only the production of final goods. Thereby, a multinational firm’s instantaneous profit in her model is \(\pi _{F}=pX-X\) with the wage rate in the South being 1. See, also, Suzuki (2015). In the present paper, we specifically separate the production line by two divisions respectively on intermediate and final goods. It follows that a multinational firm’s cost in its instantaneous profit function is 2X. Notice that each intermediate good is variety-specific by assumptions.

  13. See, also, Grossman and Helpman (1991b), Glass and Saggi (2002) and Lu (2007).

  14. Slightly different from Lu (2007) and Suzuki (2015) as we shown in the former footnote, the present paper considers two divisions of upstream and downstream production processes. It follows that the production cost in a Northern firm’s instantaneous profit function is \(w_{N}(1+\gamma )X\).

  15. This cost can be seen as a training cost equivalently. To undertake R&D, a firm requires skilled labors, and then pays for upgrading workers’ skills.

  16. We simply assume that the follower after the first period t learns and uses the same development path as the leader did, that is, move up, then move out, then move up, then move out, and so on. However, if the follower insists on undertaking R&D, then there is no chance for the leader to seek possible cost advantages via FDI or offshoring. Otherwise, the leader may lose the market at some point.

  17. Recall that \(a_{F}^{*}(z,y,j)\) denotes the unit Southern labor requirement per unit of FDI intensity for the version j of product (z, y), and \(a_{R}\) denotes the number of skilled labors working for R&D. One can see also the Sects. 3.3 and 2.3.3 in detail.

  18. For instance, if \(\frac{1+w_{N}\tau }{\lambda }>2\) and J always undertakes offshoring and never engages in R&D, then J earns zero profit at the end.

  19. In low-tech industries, a dominant firm considers FDI as its strategy until it no longer earns profit, and then invests in R&D. The game mentions the rotation of the undertaking of FDI and R&D.

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Acknowledgements

We are indebted to the editor-in-chief, two referees, Haitao Mao, Wenshou Yan, Xiaopeng Yin and Qi Zhang for constructive comments and helpful suggestions. Also, we are grateful for many useful comments and discussions by conference participants at 2016 Asia Meeting of Econometric Society in Japan and 2017 Annual Meeting of Chinese Society of International Trade.

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  1. School of Economics, Zhongnan University of Economics and Law, Wuhan, 430073, Hubei, China

    Yuxiang Zou

  2. Wenlan School of Business, Zhongnan University of Economics and Law, Wuhan, 430073, Hubei, China

    Tai-Liang Chen

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Zou, Y., Chen, TL. Industrial heterogeneity and international product cycles. J Econ 125, 1–25 (2018). https://doi.org/10.1007/s00712-017-0586-9

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