Trade data are usually classified by product characteristics in the trade, technology and development literature. Such classifications are important in empirical economics as well as development analysis. As technology-intensive products are growing swiftly because of its development benefits to exporting countries, developing countries are now getting interested to enter production networks to raise exports and transfer new skills and technology. Since activities differ in the extent to which they can fragment, it becomes extremely useful to look at product characteristics.
Problems with existing taxonomies
Technology classifications of trade yield a handful of methodological problems. The most significant dilemma is the large difference in the level of detail of data between industry and trade levels – trade data are available at disaggregated levels. Also, technological characteristics of activities can change rapidly over time as innovations transform technologies. The said problems may be addressed by using qualitative information or expert judgment. But since such activities rely on the differing assessment of researchers and on expensive information, qualitative judgment might be an even more daunting task.
There is another problem in using industry-based taxonomies in trade performance analysis: the core technical characteristics of products may not reflect the technologies used in their manufacture in a particular location. Data by process rather than product are required to assess the real technological content of national exports, but such data are not available.
Kaplinsky and Santos Paulino (2004) attempted to overcome the lack of industry data at the necessary level of detail. They measured product innovativeness by unit price changes over time, and hypothesized that innovative products have rising prices while non-innovative ones have declining prices. This measure, however, assumes away cost-reducing process innovation and does not take into account the impact of different degrees of fragmentation between products.
Export ‘sophistication’: rationale and methodology
One way to classify traded products without industry data is by export sophistication. This classification infers product characteristics from the characteristics of the exporter rather than from parent industry data on factor content. An export is deemed more sophisticated as the average income of its exporter increases. If trade interventions are disregarded, products exported by richer countries will have characteristics that allow high wage producers to compete in world markets.
The sophistication index is a combination of these factors. Technology is clearly a major feature in the index, but its role cannot be separated from that of other factors. The main factors affecting export location are:
· Technology. Technology is the main source of competitiveness. It includes R&D-based innovation, production capabilities, minor innovation, scale and agglomeration economies, supplier organization, and efficient supply chains. High sophistication will tend to reflect technological complexity as products that require advanced technologies will tend to be exported by countries that possess the necessary technological capabilities.
· Marketing. This includes advanced design and packaging, strong product branding, customization of products to demands of customers, control over distribution channels. If production is not technology- intensive it will be relocated in lower wage areas while design and marketing will remain in rich ones.
· Logistics and proximity. The location of production can reflect proximity advantages since rich countries are the main markets for most exports
· Fragmentability. When production processes are divisible, the location of export production can reflect the technical possibilities of separating segments and placing them in low wage countries. High sophistication scores thus reflect the low fragmentability of particular products.
· Information and familiarity. The location of product sourcing may reflect information on the production capabilities of particular countries, familiarity with their business systems and procedures, etc.
· Natural resources. It is expected that high wage economies will be significant exporters of resource-based products for which they have ample resources, or where they are more efficient in using new technologies.
· Infrastructure. Only countries that are able to provide and operate advanced infrastructure can be competitive.
· Value chain organization. As global trade becomes organized in tight value chains, the origin and organization of particular chains may influence geographical sourcing patterns.
Products that rank high or low in both technology and sophistication agree with trade theory. Rich countries have a comparative advantage in products using advanced technologies, while poor ones have comparative advantage in products using simple or mature technologies. Products with high technology and low sophistication have fragmented production processes. Those of low technology with high sophistication, on the other hand, suggest that the products have specific natural resource, logistical or other needs that are out of reach of poorer countries. By allowing changes in exporter incomes to be traced over time, analysts are able to track how different factors are interacting in the trade arena. Sophistication analysis also helps competitiveness policy by pointing where to provide policy support.
The sophistication index[1] was obtained for each product by taking the weighted average[2] of exporter incomes. The scores are normalized to produce an index ranging from zero to 100. Scores can be calculated at any level of detail and are unique to each product. It is now possible to distinguish products without having to use detailed industry data or qualitative criteria.
Sophistication scores were calculated for 1990 and 2000 for 237 products at the 3-digit level (of SITC Revision 2), and for 766 products at the 4-digit level. Export sophistication patterns were shown for the main developing regions and leading developing and industrialized countries; it was also analyzed in a few selected industries.
Country and regional sophistication scores are useful in studying national performance over time and benchmarking against other countries and regions. Although the interpretation of sophistication scores is not straightforward, the presumption that higher sophistication is desirable is strong within product groups where growth rates are not an issue.
Product Sophistication Scores
The sophistication scores for 181 manufactured exports in 1990 and 2000 shows a general decline over time as developing countries raise their share of world exports. This does not have technological connotations; it only reflects the growth of industrial capabilities in low-income countries. Meanwhile, as export production is shifting to lower income sites, not all developing low-wage countries are gaining.
Although the predictions of trade theories are valid, many products did not conform to a priori expectations. For example, manufactured tobacco is regarded sophisticated because it is exported mainly by rich countries due to its continuous and capital-intensive processes, the importance of marketing, and perhaps trade barriers. Some resource-based products like paper, salted fish, animal fats or cheese have high sophistication because their raw materials are located in rich countries, or because these countries are exceptionally efficient at producing them. Goods like milk or butter signal distortions caused by government subsidies and protection of the agricultural sector. Among low technology products, the ‘fashion cluster’ segment starts low in the index but covers a wide range. Meanwhile, high technology electronics products like semiconductors, office machines, automatic data processing machines and telecom equipment move rapidly down the sophistication scale due to production fragmentation. Other engineering industries like automobiles, industrial capital goods or aircraft also have discrete processes that can be separated economically, but are not fragmenting as much as electronics[3].
Despite the shifts in product sophistication ranks, there is considerable stability in sophistication scores between 1990 and 2000. The correlation coefficient is 0.88, suggesting that export location has considerable inactivity. There is, however, no statistically relationship between export growth rates and sophistication. When considered across products, there is no effect of a rise in sophistication on export growth.
Regional and country sophistication performance
North America and Western Europe take the lead in regional sophistication although both see a decrease in levels. For 2000, Latin America had the highest sophistication[4]. On the other hand, the sophistication levels of all developing regions declined; the most marked decline was observed in parts of South Asia: Pakistan, Bangladesh and Sri Lanka.
The sophistication of Latin America depended on the weight of automotive products in exports and also on aircraft exports by Brazil. It is also heavily influenced by the performance of Mexico. This goes hand in hand with low rates of growth and with little progress in the main generator of recent export growth. Meanwhile, South Asia’s very low sophistication and the stagnation in its export structure can be attributed to the stagnation of the rest of its export structure.
For the world market shares (WMS) of manufactured exports, East Asia (including China) projected a significant global presence in all sophistication categories. At the country level, the US has the highest score in 2000, exchanging places with Japan who formerly had the position in ten years ago. Germany is on third place both in 1990 and 2000. For developing countries, Singapore took the lead, overtaking Mexico which has a significant share of low technology textiles and apparel.
Although the general result was expected, some interesting deviations appeared in the analysis. This was addressed by a linear regression between income levels (per capita gross national income) and export sophistication levels for the two years. The 1990 regression produced a better fit than in 2000, showing that fragmentation and local capability development led to greater divergence over the decade between income levels and export patterns.
The export sophistication performance of leading newly-industrializing countries was analyzed using their world market shares (WMS). Results show that:
· The three mature Tiger economies with strong industrial sectors (Singapore, Republic of Korea and Taiwan, China) hold the highest WMS in relatively high sophistication products.
· Korea made the largest improvement among the mature Tigers in highly sophisticated products, while Taiwan made the least improvement. Hong Kong loses ground in all segments.
· China has a sophistication profile matching its low income However, its largest percentage gains are driven not just by electronics products but also a vast range of other engineering products that denote high industrial capabilities.
· Malaysia and the Philippines show a profile similar to the three mature Tigers, but both retain relatively large low sophistication exports.
· Indonesia, which is the most resource-rich but poorest economy in East Asia, is concentrated in low levels of sophistication.
· Mexico has the largest percentage increases in WMS over the decade. Its WMS structure is evenly spread over all sophistication levels and sees large rises in all levels. Unlike the mature Tigers, it has a large increase in the lowest sophistication level.
· India and Brazil concentrate in the lowest sophistication level. India specializes in this level mainly in textile and apparel products, while Brazil specializes in iron ore, footwear and food products.
As for industrialized countries Japan lost its overall market share while USA took the lead. Germany suffered a large decline in total WMS. Meanwhile, Finland lost overall WMS by one percentage point, but the structure of its shares changed significantly.
Sophistication at the four-digit level
The scores for all the 766 products at the four-digit level indicate that leading products are a mix of technologically complex items and resource-based products exported by rich countries. At the four-digit level, sophistication scores are now calculated separately for each category (or industry). They are not comparable across categories (or industries) but they are comparable across countries and regions. This set of scores does not match the scores for all the products together, though the order of activities according to sophistication within each category (or industry) is of course identical to that in the general score. The sophistication index can be very useful to assess how products at fine levels of disaggregation perform within technological categories or industries.
Of the developing regions or countries, only Korea comes close to the average sophistication scores of developed countries. The country showed particular strength in its low technology sectors indicating technological upgrading in these areas. Meanwhile, China still had a relatively unsophisticated export structure despite its rapid export growth.
Some resource-based manufactured exports are location specific due to the availability of natural resources. This may explain the relatively low sophistication scores for resource-based manufactures from Latin America. On the other hand, the scores take no account of export volume in each category. This can be attributed to the narrower range of products exported by smaller players and to little specialization in labour-intensive segments because global networks have by-passed them, leading to little specialization in labour-intensive segments. The small volumes of exports tend to be similar to goods from developed economies. China, on the other hand, has lower scores in these categories precisely because of its success in goods not exported by developed economies.
Change in sophistication scores over time describe shifts in the location of export production between different income groups and the impact of changes in production fragmentation, local capabilities, transportability, trade arrangements, etc. Location was observed to be stable for textiles/yarn and telecom equipment because most shifts in export location took place before 1990. Meanwhile, there is more relocation in electrical machinery, office machinery and clothing & apparel. In terms of the relation between overall sophistication scores (in 1990) and export growth (over 1990-2000) at the four-digit level, the correlation coefficient is low. As at the three-digit level, there is no significant relationship between the initial share of rich countries and subsequent growth.
Among the following four industries: 1) textiles and clothing, 2) automotive, 3) electronics and 4) industrial chemicals industries, the textiles and clothing industry has the largest number of items, while the auto industry has the smallest. In technological terms, the most advanced industry is electronics, followed by industrial chemicals, automotive products, and textiles and clothing. Developed countries have higher scores than developing ones in all four industries, although the sophistication level declines in all four. The highest average scores are in automotive products, while the lowest score is in textiles and clothing. The electronics industry shifted despite its high R&D intensity, while industrial chemical is somewhere in between it and the auto industry. East Asia has highest level of sophistication in textile and clothing exports due to the upgrading of exports in the advanced newly industrializing economies like the Republic of Korea and China.
If countries show a rise in their outlier status, so that the difference between their actual index score and that predicted for their income level widens, this shows an upgrade within the industry category concerned. It was noticed that China moved from a sophistication score for electronics over 20% below that predicted in 1990 to one lying in the regression line for its income level. India had a sophistication index above that predicted. Korea and Argentina upgraded in the textiles and clothing industry. On the other hand, Sri Lanka and India registered scores that are below predicted. In automotive products, evidence of upgrading for both China and Taiwan are observed as they both move from situations of negative to positive outlier status between 1990 and 2000 while the reverse is found in Korea. For chemicals, there is evidence indicating the downgrade in Korea. India, on the other hand, had a higher than predicted score in both years, although the strength of its positive outlier status has diminished over time.
Conclusions
Sophistication provides a new way of analyzing trade and location patterns as well as tracking competitiveness. What is good about it is that it can be calculated quickly at any level of detail and for any period of time. However, it is not a specific technology measure as it captures many other factors affecting export location.
The sophistication technique can be useful in several ways. First, the scores have practical and information that facilitates analysis. Second, the scores are product-specific and can be as detailed as needed. Third, the data can be used to analyze fragmentation and location inertia. Fourth, sophistication can be used for country competitiveness analysis. This can map the location shifts in exports of interest. Within product segments, it could also locate the country in terms of the skill and technology level of its exports. Moreover, it can determine if a country’s sophistication structure is in line with its income level.
Source:
Lall, Sanjaya, John Weiss and Jinkang Zhang, “The ‘Sophistication’ Of Exports: A New Measure of Product Characteristics” QEH Working Paper Series, Working Paper Number 123, Queen Elizabeth House, University of Oxford.
[1] SI (i) = 100*(US (i)-US (min))/(US (max)-US (min))
Where:
SI is the normalized sophistication index of product (i)
US is the unique sophistication score as a dollar value for product (i)
US (max) is the maximum unique sophistication dollar value for all products
US (min) is the minimum unique sophistication score dollar value for all products.
[2] Each country’s shares of world exports serve as weights
[3] The performance of electronics is of particular interest because export values are very large and their growth very rapid.
[4] However, when Mexico is excluded, the region falls behind East Asia.
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