The Factor Endowment Theory: Application To Trinidad And Tobago

Title: Select a country and examine its actual exports and imports. Explain how these fit with the theory of factor endowments

Julianna Vanessa Baptiste

University of the West Indies

2007

International Business Management MGMT (3037)

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Abstract This paper intends to examine whether factor proportions determine the structure of trade in Trinidad and Tobago. It examines the major imports and exports of the country and determines whether or not factor endowments are a major indicator of Trade. It also looks at the implications of the structure of trade in the country of Trinidad and gives some recommendations as to what could be done to further the level and consistency of exports and imports to Trinidad and Tobago.

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Table of Contents

List of Illustrations……………………………………………………………………………...4 Introduction……………………………………………………………………………………..5 The Theory of Factor Endowments………………………………….......................................7 Heckscher-Ohlin Model Assumptions – Market Structure……………………………...8 Heckscher-Ohlin Model Assumptions – Production………………………………….…9 Heckscher-Ohlin Model Assumptions – Fixed Versus Variable Proportions………….12 Literature Review........................................ ………………………………………………….14 Case Study: Trinidad and Tobago The Importance of Trade in Trinidad and Tobago……………………………………..16 Merchandise Trade…………………………………………………………..…………17 Recent Trends…………………………………………………………………..17 Exports………………………………………………………………………….18 Imports……………………………………………………………………….…23 Services Trade……………………….. ……..................................................................25 Recent Trends………………………………………………………….………..25 Travel Sector: Tourism, Education, Health……………………………………..25 Transportation Sector: Air and Maritime…………………………………….…27 Commercial Sector: Communication, Financial and Insurance services…….....28 Implications/Recommendations/Conclusion……………………………………………...….29

Bibliography………………………………….……………………………………………..….32

Appendices..................................................................................................................................33

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List of Illustrations Figure

Title

Page

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Merchandise Trade 1990-2004……………………………………..17

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Sector Composition of Exports 1990-2003………………………...18

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Services Exports by Area 1990-2003………………………………26

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Travel and Tourism Exports (Cumulative Real Growth, %)…….…27

Table 1

Top 20 Exports to the World and CARICOM, 2001-2003………....19

Appendix 1

Trinidad and Tobago: Structure of the Energy Sector, 2003……..…33

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Trinidad and Tobago: Sources and Uses of Energy Resources……...34

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Introduction

The twin-island State of Trinidad and Tobago can be viewed as the economic giant of the Caribbean. In the 1980s, Trinidad and Tobago was an upper-middle-income, oil-exporting country that was highly dependent on the world price of oil for its economic growth. The nation displayed the largest gross domestic product (GDP--see Glossary) of the Commonwealth Caribbean, one of the highest per capita GDPs among the nations of the Western Hemisphere, and one of the highest standards of living in the developing world. The country's GDP in 1985 stood at roughly US$7.7 billion at current prices, or about US$6,000 per capita.

The major sectors of the economy were petroleum and petrochemicals, construction, services, and agriculture. Petroleum had fueled the economy since the early twentieth century and in 1985 still represented roughly 24 percent of GDP and 80 percent of exports. Oil reserves at the current rate of extraction were expected to last approximately ten years, but the islands enjoyed large reserves of natural gas. New petrochemical plants, utilizing the country's natural gas resources, came on-stream in the early 1980s and included ammonia, urea, and methanol. These large industrial projects were located at the newly built Point Lisas industrial park, which, along with the park's new iron and steel plant, provided Trinidad and Tobago with an industrial base that was unmatched throughout the Caribbean.

In the postwar era, the economy experienced two great boom decades, both of which were followed by decades of slow or negative growth. Growth in import substitution manufacturing and the economy as a whole waned in the late 1960s, exacerbating the social unrest at the end of the decade. The quadrupling of oil prices in 1973 revived the economy and created a 9.6-percent real annual growth rate from 1974 to 1979. Trinidadians and Tobagonians, nicknamed the "Arabs of the Caribbean," were known throughout the region in the 1970s for the carnival of consumption that they participated in with their instant oil wealth. The downturn in oil prices in 1982, however, plummeted the economy into a deep depression in 1983 from which the country had not emerged by 1987. Negative growth peaked in 1984, when the economy contracted by nearly 11 percent.

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Trinidad and Tobago was a very open economy, dependent on the export of oil to purchase large amounts of imported food, consumer goods, and capital goods. Oil represented approximately 80 percent of exports, whereas food accounted for as much as 20 percent of imports in the late 1980s. Unlike virtually every other Caribbean country, Trinidad and Tobago generally enjoyed yearly trade and balance of payments surpluses. The country depended on the United States for roughly 50 percent of its trade, but the islands also maintained important trade relations with the European Economic Community (EEC) and the Caribbean Community and Common Market. Once a donor nation that aided its poorer Caribbean neighbors, Trinidad and Tobago in the late 1980s was increasingly in need of external financing to weather its economic adjustment period.

Despite the recession of the 80s the country has been able to revive itself and improve its trade performance. The energy sector continues to play a central in the economy. In 2003, it accounted for nearly 40 percent of GDP, 83 percent of exports of goods, 41 percent of central government revenues. Also, since the late 1970s, the energy production structure in Trinidad and Tobago has shifted from primarily oil-based to natural and gas-based petrochemical production. Natural gas production increased from 346 million cubic feet per day (mmcf/d) in 1975 to 2,594 mmcf/d in 2003. The expansion of the gas sector received a major boost in 1999, when the Atlantic Liquefied Natural Gas Company (ALNG) began operations. Trinidad and Tobago has developed its petrochemical and liquid natural gas (LNG) mainly for exports. However, can Trinidad and Tobago’s export and import performance be related to the theory of factor endowments? This theory essentially says a country should export its abundant resources and import scare ones. Several papers have explored the relationship between country specialization and factor endowment1. However existing tests of the framework find scant evidence in favor of endowment-driven trade (e.g. Bowen et al 1987, Trefler 1995)

Therefore, this paper looks at the theory of factor endowments and attempts to examine its fit with the major exports and imports of Trinidad and Tobago. Firstly, it describes the theory of factor endowments and looks at example of the model itself. It then looks at the existing literature regarding the theory of factor endowments and its relation to the exports and imports of a country. The second part of the paper examines the major exports and imports of Trinidad and 1

For a survey, see Harrigan (2003).

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Tobago2 and examines whether or not the theory of factor endowments fits with the flow of exports and imports. The paper then identifies measures which would improve the level and consistency of Trade in Trinidad and Tobago.

The Theory of Factor Endowments The factor proportions model was originally developed by two Swedish economists, Eli Heckscher and his student Bertil Ohlin in the 1920s. Many elaborations of the model were provided by Paul Samuelson after the 1930s and thus sometimes the model is referred to as the Heckscher-Ohlin-Samuelson (or HOS) model. In the 1950s and 60s some noteworthy extensions to the model were made by Jaroslav Vanek and so occasionally the model is called the Heckscher-Ohlin-Vanek model. All versions of the model can be simply called the “HeckscherOhlin (or H-O) theory,” the Factor Endowment Theory, or simply the more generic “Factor Proportions theory.” The H-O model incorporates a number of realistic characteristics of production that are left out of the simple Ricardian model. In the simple Ricardian model only one factor of production, labor, is needed to produce goods and services. The productivity of labor is assumed to vary across countries, which implies a difference in technology between nations. It was the difference in technology that motivated advantageous international trade in the model. The standard H-O model3 however, begins by expanding the number of factors of production from one to two. The Model incorporates four main theorems: the Heckscher-Ohlin theorem, the Stolper-Samuelson Theorem, the Rybczynski theorem, and the factor-price equalization theorem. The Stolper-Samuelson and Rybczynski theorems describe relationships between variables in the model while the H-O and factor-price equalization theorems present some of the key results of the model. The Theory makes a number of assumptions these are described below:

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Data presented would only be up to the year 2003, since actual data is only available up to this year. The subsequent years are only estimates and as such assessments may not be necessarily accurate. 3 The “standard” H-O model refers to the case of two countries, two goods and two factors of production. The H-O model has been extended to a many country, many goods and many factors case but in this paper, and by economists in general, reference is made to the standard model.

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Heckscher-Ohlin Model Assumptions – Market Structure Perfect Competition prevails in all markets. Two countries: The case of two countries is used to simplify the model analysis. For example, let one country be Trinidad, the other China*. Note: anything related exclusively to China* will be marked with an asterisk. Two goods: Two goods are produced by both countries. A barter economy is assumed4. As such, for trade to occur, goods must be traded for other goods. Thus at least two goods are needed in the model. Let the two produced goods be steel and clothing. Two factors: Two factors of production, labor and capital, are used to produce clothing and steel. Both labor and capital are homogeneous. Thus there is only one type of labor and one type of capital. The laborers and capital equipment in different industries are exactly the same. It is also assumed that labor and capital are freely mobile across industries within the country but immobile across countries. Free mobility makes the H-O model a long-run model (Suranovic 2006). Factor Constraints: Additionally it is assumed that the total amount of labor and capital used in production is limited to the endowment of the country. The Labor Constraint is,

Where

and

are the quantities of labor used in clothing and steel production, respectively. L

represents the labor endowment of the country. Full employment of labor implies the expression would hold with equality. The Capital Constraint is,

Where

and

are the quantities of capital used in clothing and steel production, respectively.

K represents the capital endowment of the country. Full employment of capital implies the expression would hold with equality.

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This means that there is no money used to make transactions.

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Endowments: The only difference between countries assumed in the model is differences in endowments of capital and labor5. Thus in this case, Trinidad is capital-abundant relative to China if:

Where K is the capital endowment, L the labor endowment in the Trinidad. K* is the capital endowment, L* the labor endowment in China. Therefore if Trinidad is capital-abundant then China is labor-abundant since the above inequality can be rewritten to get:

This means that China has more labor per unit of capital for use in production than the Trinidad. General Equilibrium: The H-O model is a general equilibrium model. The income earned by the factors is used to purchase the two goods. The industries' revenue in turn is used to pay for the factor services. The prices of outputs and factors in equilibrium are those which equalize supply and demand in all markets simultaneously (Suranovic 2006).

Heckscher-Ohlin Model Assumptions - Production The production functions below represent industry production not firm production. The industry consists of many small firms in light of the assumption of perfect competition. Production of Clothing Trinidad

China

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A country is capital-abundant relative to another country if it has more capital endowment per labor endowment than the other country.

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where QC = quantity of clothing produced in Trinidad measured in racks. LC = amount of labor applied to clothing production in Trinidad measured in labor-hours. KC = amount of capital applied to clothing production in Trinidad measured in capital-hours. f( ) = the clothing production function which transforms labor and capital inputs into clothing output. and where all starred variables are defined in the same way but refer to the production process in China. Production of Steel Trinidad

China

Where QS = quantity of steel produced in Trinidad measured in tons. LS = amount of labor applied to steel production in Trinidad measured in labor-hours. KS = amount of capital applied to steel production in Trinidad measured in capital-hours. g( ) = the steel production function which transforms labor and capital inputs into steel output. and where all starred variables are defined in the same way but refer to the production process in China. Production functions are assumed to be identical across countries within an industry. Thus both Trinidad and China share the same production function f(.) for clothing and g(.) for steel. This means that the countries share the same technologies. Neither country has a technological advantage over the other. This is different from the Ricardian model which assumed that technologies were different across countries. A simple formulation of the production process is possible by defining the unit-factor requirements. Let, 10

represent the unit-labor requirement in clothing production. It is the number of labor-hours needed to produce a rack of clothing. Let,

represent the unit-capital requirement in clothing production. It is the number of capital-hours needed to produce a rack of clothing. Similarly,

is the unit-labor requirement in steel production. It is the number of labor-hours needed to produce a ton of steel.

And,

is the unit-capital requirement in steel production. It is the number of

capital-hours needed to produce a ton of steel. By taking the ratios of the unit-factor requirements in each industry a capital-labor (or laborcapital) ratio can be defined. These ratios, one for each industry, represent the proportions in which factors are used in the production process. They are also the basis for the model's name.

First,

is the capital-labor ratio in clothing production. It is the proportion in which capital

and labor are used to produce clothing.

Similarly

is the capital-labor ratio in steel production. It is the proportion in which capital

and labor are used to produce steel. It is said that steel production is capital-intensive relative to clothing production if:

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This means steel production requires more capital per labor-hour than is required in clothing production. Clearly, if steel is capital-intensive, clothing must be labor-intensive. Clothing production is labor-intensive relative to steel production if:

This means clothing production requires more labor per capital-hour than steel production Heckscher-Ohlin Model Assumptions - Fixed versus Variable Proportions Two different assumptions can be applied in a Heckscher-Ohlin model: fixed and variable proportions. A fixed proportions assumption means that the capital-labor ratio in each production process is fixed. A variable proportions assumption means that the capital-labor ratio can adjust to changes in the wage rate for labor and rental rate for capital. Fixed proportions is a more simplistic and also less realistic assumption. However, many of the primary results of the H-O model can be demonstrated within the context of fixed proportions. Thus the fixed proportions assumption is useful in deriving the fundamental theorems of the H-O model. The variable proportions assumption6 is more realistic but makes solving the model significantly more difficult analytically7 Fixed Factor Proportions Fixed factor proportions means that aKC, aLC, aKS, and aLS are exogenous to the model and are

fixed. Since the capital-output and labor-output ratios are fixed, the capital-labor ratios,

and

, are also fixed. Thus, clothing production must use capital to labor in a particular proportion

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Under variable proportions the capital-labor ratio used in the production process is endogenous. The ratio will vary with changes in the factor prices. Thus if there were a large increase in wage rates paid to labor, producers would reduce their demand for labor and substitute relatively cheaper capital in the production process. This means aKC and aLC are variable rather than fixed. So as the wage and rental rates change, the capital output ratio and the labor output ratio are also going to change. 7 Steven M. Suranovic (2006) “International Trade Theory and Policy”

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regardless of the quantity of clothing produced. The ratio of capital to labor used in steel production is also fixed but is assumed different from the proportion used in clothing production. Therefore, based on these assumptions, The Factor Endowment theory predicts the pattern of trade between countries based on the characteristics of the countries. It says that a capitalabundant country will export the capital-intensive good while the labor-abundant country will export the labor-intensive good. This is because, a capital-abundant country is one that is well endowed with capital relative to the other country. This gives the country a propensity for producing the good which uses relatively more capital in the production process, i.e., the capital-intensive good. As a result, if these two countries were not trading initially, i.e., they were in autarky, the price of the capitalintensive good in the capital-abundant country would be bid down (due to its extra supply) relative to the price of the good in the other country. Similarly, in the labor-abundant country the price of the labor-intensive good would be bid down relative to the price of that good in the capital-abundant country. Once trade is allowed, profit-seeking firms will move their products to the markets that temporarily have the higher price. Thus the capital-abundant country will export the capitalintensive good since the price will be temporarily higher in the other country. Likewise the laborabundant country will export the labor-intensive good. Trade flows will rise until the price of both goods are equalized in the two markets. The Factor endowment theory thus demonstrates that differences in resource endowments as defined by national abundancies is one reason that international trade may occur

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Literature Review This review will look at some of the existing literature on the fit of theory of Factor endowments with the trade performance of a coutry. Much of the traditional empirical studies on the location of production are based on the Heckscher-Ohlin theory. This theory can be seen as a combination of the Rybczynski theorem with the assumption of identical preferences. 

The Rybczynski theorem shows that as endowment of a given factor increases, the country will increase production of the good that uses that factor intensively. For example, suppose that China is relatively abundant in labour. An increase in labour endowment will then have the effect of increasing the production of labour-intensive goods such as textiles. Combining the results of the Rybcyznski theorem with identical preferences across countries gives us the conclusion that countries will export goods whose production are intensive in the factors that are relatively abundant in that countries.

Traditionally, empirical work on the Heckscher-Ohlin theory has been carried out using trade data. However, recently, there have been a number of papers that explored the implications of the Heckscher-Ohlin model from the production side. Harrigan (1995) uses data from a group of OECD countries to examine the importance of factor endowments to manufacturing. He finds that endowments of capital are a source of comparative advantage for most industries while the effects of endowments of skilled and unskilled labour on comparative advantage are ambiguous. Part of the reason for the ambiguity of the results of skilled labour may be due to the fact that the services sector is more skill-intensive than manufacturing. As a result, an increase in the endowment of skilled labour will lead to larger services sector and relative contraction of manufacturing. Harrigan (1997) expands on this result and shows that technological differences are important in explaining the variation of output in a panel of OECD countries. Using a dataset containing a mixture of both OECD and non-OECD countries, Harrigan and Zakrajsek (2001) also find an important role for factor endowments in determining the location of production.

However, there is as yet limited consensus on the appropriate empirical proxy for measuring resource abundance. Leamer (1984) argues that standard Heckscher-Ohlin trade theory dictates that the appropriate measure is net exports of resources per worker. Though this measure has 14

been the basis for extensive research on the determinants of trade patterns (e.g., Trefler 1995, Antweiler and Trefler 2002, Estevadeordal and Taylor 2002) to date there has been essentially no empirical work testing its impact on growth.8 Also, the Heckscher-Ohlin framework is essentially static in that the classical world is characterized by a fixed level of technology for each country (though it may be differential across countries). Hence the theory does not deal with the dynamics of the creation of comparative advantage and the question of how comparative advantage may change over time (Özçelik and Taymaz 2002). Additionally, facts casually and not so casually collected seem to be adding up a convincing case against the HO model. The first was Leontief’s (1953) troubling discovery that U.S imports in 1947 were more capital intensive than U.S exports. For several decades this blow to the HO model was thought to have knock-out power but Learner (1980) showed that it missed the mark because of a misreading of the theory. Bowen, Leamer and Sveikauskus (1987) did not intend to attack the HO model but, although doing the correct calculation, found what seems to be disappointingly small association across countries between factors embodied in traded and factor supplies. Another critique was provided by the Grubel and Lloyd (1975), who cataloged the surprising amount of two-way trade in even finely disaggregated trade data. Furthermore, trade among the industrial countries has apparently become more similar in their factor endowments9

Despite these criticisms, there is still some support of the theory. Recent research (Wood, 1994; Aldaz-Carroll, 2002) shows that H-O theory has a lot of explanatory power if its domain is restricted to broad product categories (rather than specific goods, for which scale economies are often the main determinant of trade) and if capital – physical and financial – is excluded from the list of production factors, because of its international mobility. Keesing (1966) calculated simple correlations of US export performance with skill intensities. The largest positive correlations occurred at the highest skill levels, while export performance was negatively correlated with the unskilled labor share.

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It is worth mentioning that the cited references show that the H-O model of factor endowments performs relatively well for natural resources net exports, but it performs less well for manufactures. 9 Leamer (1995) “the Heckscher-Ohlin Model in Theory and Practice”

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Case Study Trinidad and Tobago Importance of Trade In Trinidad and Tobago To begin our analysis, we outline the importance of trade to the twin island of Trinidad and Tobago. In this dual economy, external trade plays a dominant role. One way of illustrating this is by looking at the value of Trinidad and Tobago’s external transactions relative to its total output, a measure referred to as trade openness. Trinidad and Tobago displays a high degree of openness10 Another way of illustrating the importance of trade in the national economy is by looking at how trade flows affect the country’s balance of payments. Trade surpluses recorded for the period 2001-2005 had an immediate and positive effect on the current account.11 This has also resulted in considerable increases in the official reserves of the country. It is clearly evident therefore that Trinidad and Tobago has maintained a healthy export performance so that exports exceed imports consistently. It is important to establish from the outset, that Trinidad and Tobago is endowed with vast amounts of energy resources (See Appendix 1). As discussed below, the petroleum sector, which emerged based on these resources, constitute a significant part of the country’s exports. However, energy prices are very volatile in the world market and, as a result, a downward trend in these prices affect the country’s main export commodities, oil and gas, and could easily wipe out the existing trade surplus, pushing the current account into a deficit. Over the period 20012005 however, oil prices have manifested an upward trend.11 In 2005, the external current account strengthened to the equivalent of 18.5 percent of GDP, reflecting higher export volumes and record prices for oil and petrochemicals.

10

Its Trade/GDP Ratio (exports plus imports of Goods and Services divided by GDP) is close to 100 percent one of the highest in the Western Hemisphere. Calculation are based on IMF-DOTS and IMS, and World Bank-WDI 11 See Balance of Payments 2005 in Appendix

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Merchandise Trade12 Recent Trends Over the past decade, Trinidad and Tobago’s merchandise trade has been characterized by strong growth and volatility. Between 1990 and 2004, exports grew by an average of 10.6 percent a year, faster than the 7.2 percent growth in world trade. Export growth, while significant in overall terms, fluctuated wildly over the period (from –18 percent in 1996 to +73 percent in 2003). Import growth averaged 10.9 percent a year, and fluctuated almost as strongly (from +62 percent in 1995 to –14 percent in 2000). Such volatility is mainly related to variations in international fuel prices. Figure 1 illustrates the country’s vulnerability to such price shocks. Figure 1: Merchandise Trade 1990 - 2004

Source: IDB Integration and Regional Programs Department using IMF-DOTS.Note: 2003–2004 are IMF estimates.

Trinidad and Tobago relies heavily on the United States as a destination for its merchandise exports. Between 2000 and 2004, nearly 60 percent of its exports went to the U.S. As regards other export destinations, there is a clear trend toward a growing concentration on regional markets. Over the past decade, the country has more than doubled its exports to the Caribbean Community (CARICOM), taking advantage of opportunities offered by preferential access to that market. Since 2000, exports to CARICOM have averaged 19 percent of total exports, up from 12 percent in 1990. Today, Trinidad and Tobago exports more than twice as much to CARICOM as to the European Union (EU) and more than 10 times what it sends to Canada. 12

Despite recent growth in its services trade, Trinidad and Tobago differs from most other Caribbean Islands in that goods still account for the bulk of its external trade (85 percent of total trade and an equal share of its exports) as such, these would be discussed in great detail

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Latin American countries absorb about 9 percent, while sales to the rest of the world have declined in both absolute and relative terms. Import sources are more diversified, with about 31 percent from the U.S., 24 percent from Latin America, 21 percent from the EU, and 19 percent from the rest of the world. CARICOM and Canada each supply less than 3 percent of Trinidad and Tobago imports13

Exports Product and Sector Composition Despite recent attempts at export diversification, oil and gas account for about 60 percent of Trinidad and Tobago’s total exports (average for the 2000–03 period) (Figure 2)14 Over the last decade, that share has not declined appreciably; trends in international fuel prices, to a great extent, have explained annual variations. Manufactured goods increased their share in total exports from 30 percent in 1990–93 to 34 percent in 2000–03. Most of these exports are naturalgas-based products (ammonia, methyl alcohol and urea). Sector diversification has remained limited; in 2003, for example, only six products accounted for 66 percent of the value of total manufactured exports. Food products, accounting for 5 percent of total exports, grew by only 2 percent in 2000–03. The share of agricultural raw materials and ores and metals in total exports was negligible Figure 2: Sector Composition of Exports 1990-2003

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Source: IDB Integration and Regional Programs Department Throughout the analysis period averages were mostly used since, in the context of strong year-to-year fluctuations in fuel prices and thus export income, they represent trends more accurately than do single years. 14

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Fuels dominate sales to all of Trinidad and Tobago’s major export destinations, accounting for nearly 66 percent of exports to the U.S. and 50-60 percent of exports to CARICOM, Latin America, and the EU.15 There are, however, notable variations in the sectoral composition of exports to each of these markets. Food exports, for example, account for a larger share of exports to CARICOM (17 percent) and the EU (8 percent) than to the U.S. (1 percent). Conversely, manufactured goods account for a larger share of sales to the U.S. and EU (35 percent) than to CARICOM (25 percent).

Of the more than 2,000 products Trinidad and Tobago exported during 2001–03, the top 20 Accounted for 84 percent of total exports (in value terms); 10 of them were fuel products (Table 1). Aside from the effects of fluctuating commodity prices, the share and composition of the top 20 in total exports has remained constant over the years. The share is somewhat lower (72 percent) in exports to CARICOM, where the top-20 list includes a number of food and manufactured items that are not among the main products exported to the world

15

According to the Balance of Payments 2005 the energy sector comprising exploration and production, refining and the production of petrochemicals, account for a significant 85.9% of merchandise export receipts and 42.9 and 46.1 % of GDP and government revenues respectively in that said year.

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Table 1: Top 20 Exports to the World and Caricom, 2001-2003

Source: IDB Integration and Regional Programs Department, Using UN-Commodity Trade Statistics Database

As a result of the large share of energy reserves, the island has attracted significant amounts of foreign direct investment in the sector from multinational companies.16 The Petroleum Company of Trinidad and Tobago Limited (PETROTRIN), a wholly state-owned integrated oil company, is involved in a large range of petroleum-related activities17, Its refinery in Point-a-Pierre processes 160,000 barrels of oil per day (bopd), sourcing additional crude from Venezuela, Brazil and other suppliers. The company exports 85% of its refined products with the balance being used up locally.18 On the matter of natural gas, Trinidad and Tobago has benefited significantly from these natural mineral reserves, with benefits being passed on to the local companies and the export market. In 2005, natural gas production averaged 3,219 million cubic feet per day (mmcf/d). The LNG industry accounted for 49.2 percent of total usage, followed by the ammonia industry (16.5 percent), the methanol industry (12.4 percent) and power generation (7.6 percent). The remainder 16

These include British Petroleum (BP), British Gas (BG), Repsol, Petro Canada and Atlantic LNG Including: exploration, development and production; transportation from the oilfields to its refinery; purchase of crude oil on the international markets; manufacturing; and services including third-party crude oil processing 18 Petro Connect Corporate News at a glance, Pg 52, December 21 st 2005. 17

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was absorbed by the iron and steel industry and other small consumers. The United States market claimed the largest share of LNG exports (89.6 percent), with a further 4.6 percent going to Puerto Rico, 3.6 percent to Spain and 1.6 percent to the Dominican Republic. The market for Trinidad and Tobago’s LNG exports expanded during the year to include Belgium which received its first shipment of LNG from this country.

Existing data indicates that approximately 99 percent of natural gas liquids produced each year is exported with the remaining 1 percent being utilized locally. Clearly, we see the factor endowment theory holding true in the case of this twin island thus far, as evidence has shown thus far that our major exports (fuels) are goods from existing resources that are abundant.19

As was noted previously, manufactured goods account for a growing share in the nation’s export market. In the 1980s, the manufacturing sector was supposed to have contributed towards the structural transformation of the country away from petroleum and sugar. Today however, statistics reveal that the greater proportion of these exports are still linked to the petroleum sector in the form of natural gas-based products namely, nitrogenous fertilizers, ammonia, methyl alcohol and urea. The industries which correspond to this list of activities will be considered as manufacturing industries, and when taken all together, will be called the manufacturing sector. They are enlisted as follows:

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

Food, Beverages and Tobacco



Textiles, Garments and Footwear



Printing, Publishing etc



Wood and Related Products



Chemicals and Non-Metallic Materials



Assembly type and Related Industries



Miscellaneous Manufacturing

Appendix 2 shows this clearly

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Returning to the theory which forms the basis of our study; the factor proportions theory states that countries produce and export goods that require resources (factors) that are abundant. Considering that the cost of any resource is simply the result of supply and demand, ceteris paribus, then the factors in great supply relative to demand will be less costly than factors in short supply relative to demand. This simple analysis forms the foundation for the rapid growth of the manufacturing sector in the country. The abundance of natural gas in the country has resulted in this energy resource being regarded as relatively cheaper or less costly for manufacturers in this country as compared to manufacturers in other Caribbean islands. Consequently, the number of manufacturing plants seeking to take advantage of this reduced-input-cost advantage is great and is expected to increase in years to come.20 The latest development in this area has been marked by government’s initiative to allow the setting up of 2 Aluminum Smelter Plants (Alcoa and Alutrin) in the southern part of the island, near the major energy resources. The process of processing the chemical alumina into aluminum requires significant amounts of energy and so, locating these plants where energy sources are abundant reduces cost and will in effect, increase exports for the country. In 2005, production and exports of methanol increased significantly, reflecting the coming-onstream of two of the largest methanol plants in the world. The first of these plants, Atlas methanol facility came on stream in 2004 with the second, M5000 starting operations in 2005. The addition of these two plants pushed domestic production up to a capacity of 6.4 million tonnes per year, cementing our position as the number one exporter of methanol. Ammonia production is also very considerable to the economy and to export performance, with the operation of nine ammonia plants in the country. In the case of exports of nitrogenous fertilizers and urea, these average 92 percent and 98 percent of production respectively. With regards to the production of iron and steel products, exports over the period 2001-2005 constitute an average of 60 percent of production, with the balance of production used in local consumption.

20

See Table 4 for a list of existing gas-based plants for the year 2005.

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In addition to the manufacture and export of chemicals and other natural gas-based products, the production and export of beverages and tobacco play a major part in the attainment of trade surpluses in the economy over extended periods in previous years. Exported products such as juices and soft drinks manufactured by SM Jaleel and Co.; beers such as Carib and Stag manufactured by Carib Brewery Ltd.; and alcoholic beverages (including the renowned Angostura’s Bitters) made by Angostura Ltd. are just a few of the manufactured items that can be seen on the shelves of stores outside of Trinidad and Tobago. Exports in this category of manufacturing activity exceed import demand by approximately four times, thereby creating a favourable trade balance in this area.21 The Sugar Industry could also be used as an example of the relationship between a country’s exports and imports and its factor endowments. In the 70’s, an examination of the island would prove that Trinidad had the potential to be one of the most economically viable of all West Indian Islands. Its size, fertility and geographical location were all in its favour.22 Exports of sugar to the United States, Europe and other external markets generated additional revenue to the economy for years and thus served as a complement to the rich oil sector. For the year 2000, exports reportedly brought in foreign exchange earnings equivalent of TT$243.6 million. However, the decline of the sugar industry was eminent.23 Attributing to the demise of the sugar industry were factors such as the high cost of operations, the erosion of protection in the European Union (EU) which has resulted in reductions in preferential prices. Clearly Trinidad and Tobago could not compete with countries whose factor endowments consisted of land and Capital (machinery) as such could produce sugar much cheaper. And applying the factor endowment theory here, we began to import sugar because the endowments necessary for low cost manufacture, and supply was not available.

Imports Trinidad and Tobago’s factor endowment would relate to the amount of resources that this country possesses and can exploit. Our imports are based on the need for goods and services which we cannot supply due to the lack of technology, machinery, and merely because of

21

One Possible reason for the success of this aspect of manufacturing activity is the availability sugar and subsidized fuel prices to operate machinery. 22 Note: most Caribbean Islands including Trinidad and Tobago were given preferential treatment 23 The Annual Economic 2002 reported the sugar industry as being uncompetitive and unviable.

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sociological factors which affect customers such as changes in individuals’ income and lifestyles and subsequent changes in demand.

The United States accounts for significant percentage of imports to Trinidad and Tobago. Existing data24 shows that 27.2% of total imports came from the US during the period January to February 2006. 11.4% or TT$615 million came from Brazil, 8.6% or TT$464 million came from Colombia and 6.8% or TT$367 million came from Gabon. But what exactly does this country import?

According to the World Fact Book (2005), the major imports to Trinidad and Tobago include machinery, transportation equipment, manufactured goods, food and live animals

It is important to note that motor vehicle imports and imports of oil and gas equipment have contributed towards a major portion of Trinidad and Tobago’s import bill for the period 2003 to 2005. During this period the total import bill of automotive parts and service equipment increased by 10 percent. Trinidad and Tobago also imports a significant amount of Crude Oil; the Leontief Paradox may appear to have some weight here this is because, Trinidad and Tobago is significantly endowed with mineral resources yet it imports crude oil, mineral fuel and lubricants. Upon further investigation we see that Trinidad and Tobago is actually utilizes imported crude oil along with domestic supplies in the production process so as to create refined petroleum this is exported25 The petrochemical sector is the greatest contributor to Trinidad and Tobago’s Gross Domestic Product. US investors have sought to capitalize on this area by exporting line pipe used for oil or gas, drill pipe, casings and tubing for drilling, parts for gas turbines, pumps and parts for filling station pumps. Machinery for liquefying air or other gases and filtering or purifying machinery are also in great demand in Trinidad and Tobago.

The expansion of the Telecommunications Services of Trinidad and Tobago, together with the additional six Internet providers, the already existing competition in the cable service provision, 24 25

The Central Statistical Office (CSO) Trade Bullent Vol. 12 No. 363 See Appendix 2

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radio broadcasting and satellite services, has created the increase in the need for telecommunications equipment. There are now two cellular operators in business in this country. Imports to this sector were valued at US$16m in 2003 and more than doubled to US$38m in 2004. 2005 saw and increase to US$40.1m.

Businesses in Trinidad and Tobago have recognized the need to automate their operations hence the increase in computer and peripheral purchases. Computers are also used by individuals in their homes, in schools and in libraries. Many financial institutions have provided special loans to facilitate such purchases.

Computer and peripheral imports rose from US$47.7m to

US$51.1m during the period 2003 to 2005.

There is a major construction boom in Trinidad and Tobago. Residential homes, industrial buildings, and new office buildings are being erected during this major thrust. Imports of construction equipment have risen from US$36m to US$38.1m from 2003 to 2005. The food import bill for Trinidad and Tobago is very significant. In 2003 for example, Trinidad and Tobago’s total agricultural imports were $352m of which consumer oriented fish and seafood products comprised roughly 57. Moreover, this country only supplies 30 percent of rice domestically; the other 70 percent is imported.

Services Trade In Trinidad and Tobago, unlike other Caribbean islands, services still account for a relatively small share of total exports (12 percent) and GDP (7 percent).26 These shares have fluctuated considerably over the years, with no apparent upward trend. Despite moderate growth in the past, services constitute an important source of export revenue and jobs, with significant potential.27

Recent Trends During the 1990–2003 periods, services exports grew at an average annual rate of 5.8 percent in value terms, just below the world’s average rate of 6.5 percent.28 Over the period, annual growth 26

This estimate is based on data from the IDB Regional Programming Paper of CARICOM and the U.S. Trade Representative’s Fourth Report on the CBI (for exports to the U.S) 27 Unfortunately, scarcity of reliable services data-resulting from a system deficient in data collection and dissemination, severely limits the scope of analysis on services trade. 28 Derived from WTO databases

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rates fluctuated significantly. The importance of certain sectors within the country’s services portfolio has changed over time. From 1990–95 to 2000–03, the share of transportation earnings in total services exports declined from 50 to 35 percent. The cause was not a drop in earnings, but strong growth in travel services, which increased their participation in services exports from 24 to 37 percent. Over the period, commercial and government services maintained their respective shares of approximately 25 and 4 percent (Figure 3).

Travel Sector: Tourism, Education, and Health Figure 3 also shows, the importance of travel in total services exports is growing. In 1995–2003, travel earnings increased by an average of 16 percent a year, compared to about 3 percent for transportation and commercial and government services. Receipts from personal travel tripled, reaching US$ 200 million in 2003; business travel grew at a slower rate. Over the period, 50 percent of all tourist arrivals were from the U.S. and Canada, 22 percent from the Caribbean, and 20 percent from Europe.

Figure 3: Services Exports by Area (1990-2003)

Such strong growth in travel receipts is partly a result of concerted efforts to develop the country’s tourism industry. Additionally, in relation to factor endowments, as a tourism destination, Trinidad and Tobago has much to offer. The small country boasts a wealth of natural and cultural resources, with Trinidad serving as an internationally renowned centre for music and 26

dance, and Tobago offering some of the Caribbean’s most pristine beaches and some of the best diving locations. More than 430 species of birds can be found on the two islands and Tobago is home to the oldest protected rainforest in the Western Hemisphere. The island is also internationally recognized for its drift dives- its seas are home to 300 species of South Atlantic coral and a variety of multicolored fish.

In 2005, Travel and Tourism services and merchandise exports for Trinidad and Tobago totaled approximately TT$9.7 billion, or US$1.5 billion (34 percent by visitors, 66 percent by exported consumer and capital goods). The World Travel and Tourism Council (WTTC) reported that over the past 15 years, the gains for Travel and Tourism Visitor Exports in Trinidad and Tobago have been impressive. The report continues by acknowledging that over the total 16 year period, (1988-2004), Trinidad and Tobago’s Visitor Exports have grown by 86 percent in real terms. Over the next nine years, these exports are expected to grow by a strong 7.2 percent per annum, Travel and Tourism Merchandise Exports (non-visitor exports) are also expected to show healthy growth at 5.1 percent per annum. This can be shown in Figure 4 below.

Figure 4: Travel and Tourism Exports (Cumulative Real Growth, %)

Source: World Tourism Council 2004

Trinidad and Tobago’s travel sector also has growth potential in education and health-related services. The St. Augustine campus of the University of the West Indies attracts many student visitors to Trinidad. While earnings from student travel have been marginal in recent years, there is potential to attract additional regional and extra-regional tertiary-level students. The health-

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services industry also has growth potential, given the country’s proximity to North American markets, favorable climate, educated work force, well-developed domestic health infrastructure, and well-trained health practitioners (World Bank 2005).

Transportation Sector: Air and Maritime Between 1990 and 2003, transportation services exports grew moderately, at 3 percent a year. Passenger fares were the largest contributor to earnings, representing an average of 80 percent of transportation and 33 percent of total services exports. A major player in the regional airline market at the time was Trinidad and Tobago’s national carrier, British West Indian Airways (BWIA).29 The maritime transport sector is also important, given Trinidad and Tobago’s large export-oriented energy and chemical industries and its geographical location as a trans-shipment point.

Commercial Sector: Communications, Financial, and Insurance Services Trinidad and Tobago’s commercial-services export has proven vulnerable in recent years. A healthy 12-percent annual growth rate in 1990–99 gave way to stagnant growth over the next five-year period. This weak performance is primarily attributed to the communications sector, particularly to adjustments in the accounting rate used for incoming telephone calls. Exports of communications services increased by 10 percent a year, reaching US$ 110 million in the late 1990s; subsequently, they dropped significantly, now accounting for about US$ 35 million in annual earnings.

The prospects for financial and insurance services are better. In Trinidad and Tobago, although data on the country’s trade in financial services is not readily available, there are indications that this sector is an important player in both domestic and regional markets. Insurance is an increasingly important segment of the country’s services-sector portfolio. Among the services sectors, exports of insurance services performed best, growing fivefold over the last decade. In 2000–03 alone, earnings from insurance services accounted for over half of all commercialservices exports, growing by an average of 33 percent per year.

29

Note: This Airline went out of Operation in January 2007 and was replaced by Caribbean Airlines.

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Implications, Conclusions and Recommendations

The concept of comparative advantage hinges on the endowments of factor inputs available in a given country: labor, capital, and natural resources. Many countries and businesses have tried to compete by undercutting each other’s labor costs or exploiting and creating vulnerable reliance on commodities and natural endowments. In an increasingly global economy, factor inputs have become less important as sources of productivity and sustained growth. Countries are no longer constrained by their factor inheritance in creating competitive firms and environments; thus, competitive advantage no longer rests on a country’s natural endowments but on its ability to create a business environment, along with supporting institutions that allow the nation’s inputs to be used and upgraded in the most productive manner (Porter 1990).

Trinidad and Tobago lacks successful firms that innovate, upgrade, and export complex products by staying abreast of customers’ needs. Such competitive firms can charge premium prices for their products, which they can then invest in workers’ skills. They can, in turn, pay workers higher salaries, leading to a virtuous cycle of national prosperity. Like the energy industry itself, Trinidad and Tobago’s manufacturers have used their comparative advantage to generate income. But they have not built the types of products and brands that can lead to wealth in the absence of comparative advantage.

One noteworthy example is Hydro Aluminum, a local smelter that produces alumina from bauxite extracted from nearby Guyana. In this case, the comparative advantages are location and cheap energy. Yet the smelter’s production is exported before any downstream products are made. Many such products could be re-sold to locally operating energy companies, creating a competitive advantage. Applying the factor endowment theory here, yes the country is exporting its abundant resources but, it is not developing the resources so as to maximize returns. Upgrading the competiveness of a nation’s export competitiveness requires a shared understanding of competitiveness within the nation. Competitiveness is not simply a favorable exchange rate, a positive trade balance, or low inflation. Rather, competitiveness is determined by the productivity with which resources are deployed: human, capital, and physical assets. Since competitiveness relies on the productive deployment of resources, industry sectors and their 29

firms, not nations, compete. More accurately, clusters of related and supporting firms constitute the building blocks of a competitive economy (Fairbanks and Lindsay 1997). Ironically, the scale of Trinidad and Tobago’s comparative advantage may have stunted development of its potential competitive advantage. Trinidad and Tobago’s non-energy manufacturers, which contribute seven percent of the country’s GDP,30 have succeeded in exporting to their less efficient Caribbean neighbors. While the country’s per-capita income has grown beyond that of its larger neighbors, its other cost advantages, including low energy prices and import duties used to safeguard the manufacturing sector, have allowed Trinidad and Tobago manufacturers to export basic goods at well below the cost of production. The national business model is simple: import raw materials, manufacture low value-added goods far less expensively than neighboring countries, and export those goods to substitute for equally low value-added goods locally produced.

While depletion of oil or gas is not an imminent threat, it is understood that even the largest reserves will eventually dry up. In fact, the interim sense of economic security derived from this oil and gas windfall has created complacency at the expense of physical and social capital depletion; in fact, Trinidad and Tobago has been decapitalizing the country by converting natural resources to currency. Still more troublesome, fluctuating energy prices and substitutes make Trinidad and Tobago’s much enjoyed stability largely dependent on external conditions. Indeed, the nation’s increased dependence on energy resources through recently discovered natural gas means that any price shock would be disastrous to the economy. It took the country more than a decade to recover from the last shocks. At present projections, energy reserves will be exhausted in 20 years. In this pressing context, it is in the nation’s best interest to act swiftly to transform its economy by channeling oil and gas rents into sustainable endeavors that will ultimately insulate the country against future swings of fortune. Trinidad and Tobago’s biggest trade challenge is to maintain high export growth. Given that most of the country’s exports are now based on its endowment of finite energy reserves, the only way to achieve sustainable export growth into the future is through export diversification into 30

International Financial Statistics (IFS)

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non-fuel activities. Diversification efforts should mainly target products and services that face growing worldwide demand. This goes against Factor endowment theory which says to export resources that are in abundant. However, Trinidad and Tobago’s abundant resources are finite and as such, this country must seek to develop other sectors of the economy so as to insulate itself from in changes in internal or external conditions.

Diversifying into products embedded with insight requires building superior industry structures and product traits that cater to sophisticated customers. Superior industries are characterized by low rivalry and high demand, while weak ones have the opposite traits. At the same time, attractive products embody customer needs; they usually weigh less and are well branded and they are attractive to price insensitive customers. Insight, brand, and focus are the building blocks of world-class strategies Porter (1990)

In this context, Trinidad and Tobago has a long road ahead to fully achieve its competitive advantages. Economic growth and prosperity have centered on natural-resource extraction. Business development has focused on oil and gas extraction and exploitation of readily available resources, without any effort to upgrade inputs or reach more sophisticated consumers. The few industries that have developed outside the oil and gas sector remain largely entrenched in the same pattern: reliance on low labor costs, production of commodity products, and dependence on the lingering artificial advantages from an import-substitution model that the Government followed years ago. In many cases, domestic producers assume that advantages in natural resources and cheap labor will win them leading positions in export markets. However, today’s successful nations create wealth by exporting products and services that embody insight into customer needs, technologies and processes, distribution channels, and relative competitive positions and not necessarily on abundant resources as put forth by the factor endowment theory.

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Bibliography Antweiler, Werner and Daniel Trefler. 2002. “ Increasing Returns and All That: A View from Trade.” American Economic Review. 92(1):93-119 Bowen, Harry P, Edward E. Leamer and Leo Sveikauskas. 1987. Multicountry, Multifactor Tests of the Factor Abundance Theory. American Economic Review 77(5):791-809. Estevadeordal, Antoni and Alan M. Taylor. 2002. “ A Century of Missing Trade?”. American Economic Review Vol 92(1):383-393 Fairbanks, M., and S. Lindsay. 1997. Plowing the Sea: Nurturing the Hidden Sources of Growth in the Developing World. Boston: Harvard Business School Press. Grubel, Herbert G., and Peter J. Lloyd, Intra-Industry Trade: the Theory and Measurement of International Trade in Differentiated Products, New York, Macimillan. 1975. Harrigan, James. 2003. “Specialization and The Volume Of Trade: Do theData Obey the Laws?,” in Handbook of International Trade, Kwan Choi and James Harrigan (Eds). London: Basil Blackwell. Harrigan, J. (1995), “Factor Endowments and the International Location of Production: Econometric Evidence for the OECD, 1970-86,” Journal of International Economics, 39, 123-41. Harrigan, J. and E. Zakrajsek (1999), “ Factor Supplies and Specialization in the World Economy,” NBER Working Paper, No. 7848. Keesing D. (1966), “Labor Skills and Comparative Advantage”, American Economic Review, 56(2), pp.249-258. Leaner, Edward E., “The Leontief Paradox Reconsidered.” Journal of Political Economy, 88 (June 1980), pp. 495-503 ______Sources of Comparative Advantage: Theory and Evidence: Cambridge Massachusetts: MIT Press, 1984 Leontief. Wassily W., “Domestic Production and Foreign Trade: The American Capital Position Re-examined,” Proceedigns of the American Philosophical Society, 94 (September 1953). Pp. 332-349. Porter, M. 1990. The Competitiveness of Nations. New York: McMillan. Trefler, Daniel. 1995. “The Case of the Missing Trade and Other Mysteries.” American Economic Review 85(5): 1029-46

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Appendix 1: Trinidad and Tobago: Structure of the Energy Sector 2003

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Appendix 2: Trinidad and Tobago: Sources and Uses of Energy Resources

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