JACQUES R. ARTUS and SUSANA C. SOSA *
This paper explores the effects of changes in export price competitiveness at a disaggregated level. A case study is considered—namely, the effects of relative price changes among the three main exporters of nonelectrical machinery–the Federal Republic of Germany, the United States, and the United Kingdom–on their relative export performances. All direct and cross-price elasticities of demand in a number of foreign markets are estimated in a consistent fashion. These markets are the European Economic Community (EEC), the rest of the Organization for Economic Cooperation and Development (OECD) countries (RO), and the developing countries (DC).1
The study has two major focuses: (i) it attempts to test the validity of the new “elasticity pessimism” that has arisen following the apparent failure of the large exchange rate changes and relative price changes of 1969–73 to affect trade balances significantly; 2 and (ii) it attempts to eliminate certain methodological flaws that reduce the usefulness of many existing empirical studies on foreign trade price elasticities. Concern with the methodological aspects has led to the present consideration of relative price effects in the world market for a specific group of products rather than to a broad study of countries’ total import and export flows. This choice, of course, limits the implications that can be drawn from the study as to the validity of the new elasticity pessimism; nevertheless, the results are relevant to this issue because of the importance of nonelectrical machinery in world trade 3 and because of the large relative price changes experienced by the three dominant suppliers of these products in recent years.4
On a methodological level, the present study incorporates several characteristics that are not often combined in empirical studies on foreign trade price elasticities:5
(1) The international demand functions are explicitly derived from a specific theory of demand, namely, the theory of demand for products distinguished by place of production developed by Armington (1969). This approach has the advantage of making clear what kinds of structural parameters are being estimated and what assumptions and constraints underlie the empirical model.
(2) Aggregation biases that plague most empirical studies have been limited through the choice of a specific group of products, the individual consideration of various foreign markets, and the recognition that, even at this level of disaggregation, countries’ exports are differentiated as far as product mixes are concerned. 6 This differentiation is taken into account in deriving the weighting schemes used in the calculation of the relative price terms.
(3) Lags between changes in relative prices and their effects on market shares are taken into account without the imposition of either uniform lag patterns on all of the variables in the equation, or of continuously declining weights. Account is also taken of the fact that unit values reflect prices negotiated at the time goods are contracted for, rather than current prices.
(4) Further, a country’s competitiveness depends not only on the prices it is able to offer but, to a large extent, also on nonprice factors such as delivery time, credit terms, reliability of the goods, and existence of technological dependence. In the present study, such factors are proxied by variables measuring relative delivery delays and by time trends. The delivery delay variable picks up both the effects of additional costs to buyers arising from delayed deliveries and the effects of other nonprice rationing variables that move together with delivery delays over the cycle.7
(5) Unit value indices are used only for the United Kingdom. Price series for the Federal Republic of Germany and for the United States are based on more reliable contract price series.8 There is no doubt, however, that the likelihood of significant observation errors in the price indices remains a serious potential source of bias.
(6) An attempt is made to take into account the elasticity of supply for exports and to reduce simultaneous-equation bias in the estimation of the price elasticities of demand.
The first section of the paper discusses the theoretical framework and the specification of the export equations. The second section presents and discusses the results of the estimation. Some conclusions suggested by the results follow.
Armington, Paul S., “A Theory of Demand for Products Distinguished by Place of Production,” Staff Papers, Vol. 16 (March 1969), pp. 159–78.
Artus, Jacques R. (1970), “The Short-Run Effects of Domestic Demand Pressure on British Export Performance,” Staff Papers, Vol. 17 (July 1970), pp. 247–76.
Artus, Jacques R. (1973), “The Short-Run Effects of Domestic Demand Pressure on Export Delivery Delays for Machinery,” Journal of International Economics, Vol. 3 (February 1973), pp. 21–36.
Ball, R.J., and others, “The Relationship Between United Kingdom Export Performance in Manufactures and the Internal Pressure of Demand,” Economic Journal, Vol. 76 (September 1966), pp. 501–518.
Barker, Terence S., “Aggregation Error and Estimates of the U. K. Import Demand Function,” in The Econometric Study of the United Kingdom, ed. by Kenneth, Hilton and David F. Heathfield(London, 1970), pp. 115–45.
Goldstein, Morris, and Mohsin S. Khan, “The Supply and Demand for Exports: A Simultaneous Approach” (unpublished, International Monetary Fund, March 23, 1976), forthcoming in the May 1978 issue of the Review of Economics and Statistics.
Isard, Peter, “Dock Strike Adjustment Factors for Major Categories of U. S. Imports and Exports, 1958–1974,” International Finance Discussion Paper No. 60, Board of Governors of the Federal Reserve System (February 7, 1975).
Kravis, Irving B., and Robert E. Lipsey, Price Competitiveness in World Trade, National Bureau of Economic Research (Columbia University Press, 1971).
Magee, Stephen P., “Prices, Incomes, and Foreign Trade,” in International Trade and Finance: Frontiers for Research, ed. by Peter B., Kenen, (Cambridge University Press, 1975), pp. 175–252.
Steuer, M.D., and others, “The Effect of Waiting Times on Foreign Orders for Machine Tools,” Economica, Vol. 33 (November 1966), pp. 387–403.
White, William H., “Bias in Export Substitution Elasticities Derived Through Use of Cross-Section (Sub-Market) Data” (unpublished, International Monetary Fund, March 4, 1970).
Whitman, Marina v. N., “The Payments Adjustment Process and the Exchange Rate Regime: What Have We Learned?” American Economic Review—Papers and Proceedings, Vol. 65 (May 1975), pp. 133–46.
Mr. Artus, a staff member of the External Adjustment Division of the Research Department, holds degrees from the Faculty of Law and Economics in Paris and from the University of California at Berkeley.
Mrs. Sosa, a staff member in the External Adjustment Division, is a graduate of the Universidad de la República, Uruguay and received her masters degree from American University. She has earned certificates of graduate studies from the University of Chile and from the Latin American Institute for Economic and Social Planning in Santiago.
The study is concerned only with relative price effects in third markets, so that the EEC market is defined as excluding the Federal Republic of Germany and the United Kingdom, while the market formed by the “rest of the OECD countries” excludes the United States, the United Kingdom, and the Federal Republic of Germany, and includes South Africa (which is not an OECD member).
This elasticity pessimism was particularly widespread among economists and policymakers in the United States in 1972–73; see Whitman (1975).
Nonelectrical machinery accounted in 1974 for 21 per cent of the Federal Republic of Germany’s exports, 17 per cent of U. S. exports, and 19 per cent of U. K. exports. It accounted for 13 per cent of OECD countries’ exports to the OECD area, and for 17 per cent of their exports to the non-OECD area.
On the basis of the price indices used in the present study, the Federal Republic of Germany’s nonelectrical machinery export prices in dollar terms increased between 1969 and 1974 by close to 60 per cent relative to U. S. prices and by about 30 per cent with respect to British prices.
A number of excellent surveys of econometric work on foreign trade price elasticities and their weaknesses are available; for example, see Magee (1975), Leamer and Stern (1970), and Stern and others (1976).
The importance of allowing for the existence of differences in substitution elasticities between markets has been pointed out by White (1970), while the need to take into account the pattern of the various countries’ exports across markets has also been demonstrated by White (1970). Biases caused by improper aggregation of commodities have been analyzed by Leamer and Stern (1970, Appendix to Ch. 2, pp. 41–50) and Magee (1975). Barker (1970) has attempted to quantify aggregation biases involved in the estimation of the import price elasticities of U. K. imports.
The role played by delivery delays and other cyclical nonprice rationing variables in export equations has been explored by Ball and others (1966), Steuer and others (1966), and Artus (1970 and 1973).
The case against the use of unit value indices in econometric work on foreign trade price elasticities and the argument in favor of contract prices have been forcefully presented by Kravis and Lipsey (1971).
The deflator P is calculated from the formula
where sl is the share of country l in total demand (in nominal terms).
This condition is often referred to as the independence assumption.
The list of subgroups is given in the Appendix.
This weighting scheme is to some extent equivalent to assuming that the substitution elasticity σ is the same for all subgroups of products in the market considered. However, the equations (4) for the subgroups cannot be easily aggregated because they are expressed in logs, so that the aggregate equation used here has to be considered as an approximation.
The price equation can be seen as an implicit supply equation. The parameter fj in equation (7) is the inverse of the supply price elasticity.
The EEC market used here includes the founding members except for the Federal Republic of Germany—that is, Belgium-Luxembourg, France, Italy, and the Netherlands. The countries included in the two other markets considered are listed in the Appendix.
An attempt at estimating relative price effects in the Sino-Soviet market failed because exports to that market are strongly influenced by governmental regulations and political factors.
These three major exporting countries account for 63 per cent of total exports of nonelectrical machinery by OECD countries to the rest of the world (excluding the three countries considered).
The empirical relation between U. K. export contract prices and unit values has been investigated by Artus (1974).
White (1970) has shown that the existence of such price discrimination may lead to biased estimates of the price elasticities.
Longer lags could not be obtained on the basis of the limited sample data used here. It is, in any case, difficult, if not impossible, to disentangle very long lags from the structural changes that are imperfectly proxied in time-series studies by simple time trends.
The fraction of the last quarter that is required to work off the amount of unfilled orders is calculated by dividing the remaining unfilled orders by the total amount of orders delivered during that quarter.
Thus, the calculation of WT for the United States rests on the further assumption that foreign orders keep their places in the total (home plus foreign) order queue.
Introducing all three countries into the equation may lead to some interdependence among the error terms, since the shares of the three countries must sum to one. The variables, however, are used in log form, so that the constraint that the sum of the shares must equal one does not introduce a strict linear dependence among the error terms.
The point estimates for the long-run elasticities are obtained by summing the values of σt→4 and σ5→12 presented in Table 1; their standard errors are calculated as the square root of the sum of the variances of the estimates of and σ5→12 plus twice the covariance between these estimates. The notation σ1→4, for example, refers to the elasticity with respect to the period t-1 through t-4.
Parentheses enclose standard errors of coefficients.
For example, this belief was recently expressed by Mr. Hans Apel, the [then] Minister of Finance of the Federal Republic of Germany. Asked to explain why German exports have not suffered much from the more than 30 per cent effective appreciation of the deutsche mark (DM) between early 1973 and March 1977, Mr. Apel answered:
The fact that this [appreciation of the DM] has been possible without endangering German exports, can be explained like this: obviously the variety and the quality of German goods fits almost exactly what the customer wants. Also, customers can rely on the dates of delivery promised by German suppliers being met. This is, to a large extent, due to good labour relations in our country. These points—for the buyer of German products—apparently are so important that the high price of the German currency unit has not had much influence on our exports. See “Apel Answers Back,” The Banker, Vol. 127 (April 1977), p. 40.
This is a recurring theme in empirical studies of foreign trade price elasticities, but one that cannot be overemphasized.
Finland is an associate member of the EFTA.