Essay on the Technical Progress of a Country and International Trade

The modern world is a highly mechanised world. It is shaped by technical progress. The rapid progress of modern economic societies has become possible due to changes caused by technological and scientific progress.

It must, however, be recognised that, technical progress can affect the volume and mode of international trade to a great extent. As technical progress influences the composition of production function, relative cost-price structure, demand pattern use of resources, so on and so forth, its effect on foreign trade is also bound to be very significant.

2. Forms of Technical Progress :

(i) Natural Technical Progress :

It refers to a neutral innovation – a new process of production. As Hicks put it, in a two-factor production function (say, labour and capital inputs). The effect of neutral innovation is to raise the marginal productivity of both the factors – labour and capital – in the same proportion. Thus, neutral technical progress keeps the relationship between labour and capital unaffected.

(ii) Labour-saving Technical Progress :

Using Hicksian criterion, labour-saving technical progress may be defined as that kind of technical improvement and change in the process of production which increases the marginal productivity of labour relatively to that of capital. Under labour-saving innovation, the production function is modified with an increasing quantity of capital and reduced input of labour.

(iii) Capital-saving Technical Progress :

It refers to that new process which tends to increase the marginal productivity of c relatively to that of labour. The effect of capital-saving innovation on the production function is to reduce the input of capital and increase the quantum of labour.

3. Technical Progress and Terms of Trades

Technical progress can affect the terms of trade of a country by influencing the productivity factory inputs. How it reacts we shall analyse below.

Different forms of technical progress will affect the terms of trade and foreign trade of country in different ways.

Effect of Neutral Technical Progress

A general hypothesis may be laid down that, if neutral technical progress takes place in export sector of a country, the country’s terms of trade may deteriorate, while technological pro in the import substitutions of the country will help the country to improve its terms of trade.

To explain this phenomenon, let us assume a two-factor, two-good, two-country model, say countries A and B have factors labour (L) and capital (K), and produce goods X and Y. Assume the product X is labour-intensive and F capital-intensive.

When neutral technical progress takes place in Y industry, the isoquant downward, its slope renaming unchanged. This implies that, due to a proportional rise in the productivities of labour and capital, less input of both these factors will be needed to produce the same outputs of Y. If factor prices are unchanged: P1 /IP0, the same factor proportions

Used in the production function as before. But if the same commodity prices are to be maintained,

Factor prices will have to be changed. The new factor-price ratio is obtained by drawing a

New factor-price line p₂ tangent to the new y’y’ isoquant the old xx isoquant. This is reflected in a rise in the relative prices of capital in the Y industry. This is due to the fact that as producers find increased productivity of capital and want to produce of Y the demand for capital tend to increase leading to a rise in the price of capital. But when capital becomes costly, the producers will resort to

Labour-intensive techniques in both the industries X and Y. The new ratio of factor-proportions

In the production function is, thus, shown by OZ’ in Y and OM’ in X. Induced by technical progress in the Y industry, when the country produces more of Y with labour-intensive method, the labour input in X decreases, so the output of X contracts. At the constant commodity price, therefore, there will be an excess demand for X Consequently, the price of X will rise and that of Y will tend to fall (caused by its increased supply).

Now, if Y happens to be the country’s exportable goods and X its importable goods, the terms of trade of the country will be settled unfavourably on account of the rising domestic price of Y (exportable), leading to contraction in its foreign demand and increasing domestic demand for X, resulting in its high import demand. In this event, the offer curve of the country will shift towards the exportable axis offering more amount of exportable for a given unit of importable.

If, however, Y is an import substitute, technical progress in this line will improve the bargaining position of the country so its terms of trade will also improve.

However, the direction in the charge of the terms of trade caused by neutral innovation depends more on elasticities of demand for exports and imports, along with other factors. If the income elasticity of demand for importable goods is less than unity, the deterioration in terms of trade will be less in the unfavorable case and improvement in terms of trade will be more in the favourable case.

Effect of Capital-saving Technical Progress

The basic hypothesis is that capital-saving technological progress will lead to unfavourable terms of trade in a country if its exportables belong to the capital-intensive line of production. If technical progress relates to the import substitution industry (which belongs to the capital-intensive sector), the terms of trade will improve on account of the capital-saving innovation.

To explain this phenomenon, in our illustration model, when capital-saving innovation occurs, the marginal productivity of labour improves; so at unchanged factor prices, the method of production will tend to be more labour-intensive.

If commodity prices are to be kept constant, factor prices must change in favour of capital, so capital has become more dear, producers will resort to labour-intensive techniques in both the lines of production. Since income expands due to increased productivity caused by technological progress, demand for X and Y will tend to increase.

At a constant price therefore, demand for X will be in excess in relation to its supply, assist supply decreases in the process of transferring more labour to Y industry. The price of X will thus rise. Thus, if Y is exportable, the terms of trade will go against the country. If Y is an import substitute, then the country’s terms of trade will tend to improve.

Effect of Labour-saving Innovation

In the case of a labour-saving technological progress in a capital-intensive industry, we cannot visualise any determinate effect on the terms of trade, as the relative price of the innovating good might increase or decrease, so on precise theoretical inference is possible.

In the geometric model, when labour-saving technical progress occurs in the case of Y industry, the new isoquant will be y’y’ with a changed slope along with, the shift towards origin.

Then, the price of capital (PK) must rise. Because, when technological innovation occurs in the Y (capital-intensive) sector, producers will be inclined to produce more of Y, as such the demand for AT will rise. Further, in a labour-saving innovation capital productivity rises, so also the demand for capital rises, which causes PK to rise. The new factor price line P is derived thus. New

Equilibrium points are Z’ and M. It appears that ~ ratio falls in A” industry, though, there is no technical progress (but on account of the high price of capital, labour-intensive method is adopted). However, the marginal productivity of capital improves because of labour-saving technical progress, so the producers may be induced to adopt capital-intensive technique of production. The stronger this tendency, the greater will be the use made of the capital-intensive method, despite its high cost.

But if innovation were to lower the costs still further, as is seen from y “y” isoquant, the story would be different. Then, the new factor price line will be p₂, which means a very high cost of capital relative to labour. In the X industry, then, labour-intensive method will be adopted (see equilibrium point M”). Similarly, the equilibrium point Z” indicates that in Y industry also, more labour-intensive technique will be used, despite the improved marginal productivity of capital.

In short, labour-saving technical progress in the capital-intensive sector will cause an increase

In the relative price of capital to that of labour and ratio will fall in the labour-intensive production
sector. A high ratio in capital-intensive industry will mean a decrease in Y product; but a low

Ratio in labour-intensive industry will mean an increase in the production of X at constant prices. Thus, there will be excess demand for 7(caused by rising income and contracting output), the price of Y- (Py) will rise in relation to the price of X- (Px). If, however, reduction in costs cause by innovation is high the reverse will happen. So, we cannot arrive at a determinate conclusion this regard.

To recapitulate, technical progress affects the marginal productivities of factors of production. When the r productivity of a factor rises on account of innovation, a greater proportion of this factor will be employed in the innovating industry than in a non-innovating industry. Hence, reallocation of factors depends on the change in t absolute value of the marginal productivities.

As Bo Sodersten concludes: “When technological progress increases the marginal productivities of both the factors (in a. two-factoral production function), the effects on output and relative prices, and terms of trade are clearly determinate. But if the marginal productivity of one of the factors or both the factors falls, then the resulting phenomenon about terms of trade cannot be firmly determined.

Bo Sodersten also states that technical progress in the import substitution field will always have a positive effect on the real income of the country. If it is so in the case of the export sector, and the marginal productivities of factors are decreased by innovation, then only will it have a positive effect on the national income. But an increased marginal productivity caused by the export-oriented innovation produces a negative effect on real income.