3.4 Technological Change, the Location of Production, and International Trade

The H-O theory highlights differences in resource endowments as the basis for comparative advantage. In our discussion of that theory, we assumed that technology was the same across countries. Another basis for comparative advantage is differences in production technologies. That is, production will be biased in favour of the product in which the country has the more advanced technology. Technological change occurs at different rates in different countries, which means that shifts in technology-induced comparative advantage can occur over time. Technology-driven comparative advantage, therefore, is likely to be transitory. This idea of shifting comparative advantage due to technological change is reflected in the product life cycle theory.

Most technological change results from concerted research and development (R&D) efforts by governments as well as firms. Taking the world as a whole, research and development activity is concentrated in developed countries where there is an abundance of financial capital and skilled labour. In this regard, we can see a connection to the H-O theory – countries with an abundance of financial and human capital generate R&D, which uses these resources intensively. The relative abundance of these two factors provides the basis for the technological advantage that developed countries have had regarding many manufactured products.

However, while it makes sense that the national location of the development of new technologies will be in developed countries, the location where the new technologies are applied can shift across countries as the embodied spreads. Firms in other countries will have an incentive to obtain new technologies to become more competitive. In addition, the developers of new technologies will seek to profit by applying them in foreign markets. Therefore, while the new technologies will most often be initially applied in the same countries where the R&D was done, we are likely to see production of new products shift to other countries.

According to the life cycle theory, there is a predictable cycle in which the home country initially exports a product, then loses its comparative advantage to other countries, and eventually becomes an importer (Carbaugh, 2015; Pugel, 2020). When a product is first introduced, its price is likely to be high and demand limited. In addition, it may be necessary to conduct further R&D to modify the product to better fit with consumer preferences. Therefore, initial production of the new product is likely to be in the home country. Over time, however, as production technology becomes more standardized, the requirement for skilled labour for R&D will diminish. Thus, the technology spreads and the location of production shifts to countries with plentiful supplies of less skilled labour. The pattern of trade, therefore, changes in line with shifts in comparative advantage. The innovating country is at first the exporter but eventually becomes the importer of the product.

Unlike the static H-O theory, the life cycle theory is dynamic in that it addresses changes in comparative advantage over time. Still, if we consider the life cycle theory through its stages, we see that production shifts because of comparative advantage. Therefore, the life cycle theory is largely consistent with its H-O counterpart. The electronics industry is one that appears to fit the product life cycle theory well.

References

Carbaugh, R.J. (2015). International economics, (15th ed.). Cengage Learning.

Pugel, T. A. (2020). International economics, (17th ed.). McGraw-Hill.