Emerging comparative institutional advantages

Beyond a classification of countries into respective baskets of LME or CME, VoC goes further to argue that the institutional configurations based on institutional complementarities can serve to explain economic structures. Although in their basic introduction into the concept (Hall and Soskice 2001) the authors merely tentatively touch on that topic, the underlying thought is far-reaching for internal economic structures, foreign direct investment and trade: the sectoral distributions should be highest in those economic activities in which countries have a comparative institutional advantage. Hence, one should be able to observe

specific trade patterns according to comparative institutional advantages of nations. More recently, due to ongoing liberalization of capital flows institutional configurations may lead to an “institutional arbitrage” in the sense that companies shift production to those countries which serve their institutional needs better, particularly regarding modes of innovation: “…

companies may locate […] activities in coordinated market economies in order to secure access to the quality control, skill levels, and capacities for incremental innovation that their institutional frameworks offer.” (Hall and Soskice 2001: 57). The reverse is true for activities which rely on radical innovations: here firms use greater openness on a global scale to move activities to liberal market economies. A clear-cut empirical investigation into the issue of comparative institutional advantages is still to come (cf. Taylor 2004).

In the present case of Estonia and Slovenia a first examination of trade patterns and foreign direct investment according to the identified economic systems will shed light on comparative institutional advantages.

2.1 Sectoral contributions to the trade balance

The contribution of specific sectors to the trade of nations is a first measure to identify possible comparative advantages. Freudenberg and Lemoine (1999) use trade data for Central and Eastern Europe for the period from 1993 to 1996. They apply an index developed by Lafay (1992) for the sectoral contribution to the trade balance. The index takes a negative value for comparative disadvantage and a positive for an advantage in a specific sector¹⁰. Their overall assessment of the specialization of transition economies in their trade with the EU reveals that comparative advantages can be predominantly found in resource- and/or labour-intensive industries as wood or textiles. This is mostly due to huge wage differentials to western economies. However, at the same time the authors identify a beginning trend of

‘despecialization’ in these very sectors. A detailed analysis of Estonia and Slovenia in this period reveals the following patterns: Estonia shows comparative advantages in areas such as wood, coke and textiles. Furthermore, comparative disadvantages in manufacturing sectors such as optics, motor vehicles or machinery and equipment increased in the period from 1993-1996. Slovenia also shows comparative advantages in similar sectors, such as wearing

10. The Lafay-indicator is defined as: , whereby subscript I

denotes specific industries under study and T refers to total trade volumes, for exports X and imports M. Y stands for the country’s GDP. The first term of the indicator measures the trade balance for a single industry weighted with GDP. The second term attempts to eliminate variations caused by business cycles. It expresses a theoretical trade balance for the case that all industries contribute according to their share in total trade. Thus, a positive L for a given industry indicates that this industry contributes comparatively more than the ‘expected’ share. This is also the case for a trade deficit, which is smaller than the expected. For LI> 0 a given industry therefore exhibits a comparative advantage, and for LI < 0 an industry reveals a comparative disadvantage (Lafay 1992).

apparel and wood. Apart from that, it proves to have a comparatively large contribution to the trade balance in electrical machinery. In more advanced manufacturing sectors such as motor vehicles and chemicals the comparative disadvantage in the beginning of the period significantly decreased, especially in the motor vehicles sector. Also, a shift towards specialization, i.e. a move from a negative value of the index in 1993 to a positive one in 1996 occurred in the field of machineries.

To get further insights into the development of comparative advantages in both countries over the course of transition the Lafay-Index has been calculated for a subsequent period, from 2000-2003 using SITC Rev. 3 data from the UN COMTRADE database¹¹. It can be assumed that this reveals a clearer picture of comparative advantages in both countries as the catch-up process has carried on. To obtain a first impression in Figure 4 a selection of those sectors will be shown where both countries reveal a contrasting picture of one country showing a comparative advantage in those manufacturing sectors where the other enjoys a comparative disadvantage, and vice versa. What interests us most are manufacturing sectors to asses the shift from labour- and resource-intensive to more advanced industries.

Figure 3.4: Contributions to the trade balance (Lafay-Index) in Estonia and Slovenia. Average 2000-2003, Source: UN COMTRADE Database, on SITC Rev. 3, two-digit levels.

11. Freudenberg and Lemoine (1999) use data according to the NACE classification system.

The analysis of trade patterns of both countries according to trade figures in the SITC classification has potential drawbacks. As this kind of trade data does not account for services potential comparative institutional advantages of LMEs will not be unearthed through them.

In fact, the analysis seems to be suited best to analyze CMEs, which reveal comparative institutional advantage in manufacturing sectors captured by international trade data.

However, some conclusion still can be drawn from the analysis of Lafay-Indexes of Estonia and Slovenia. First of all, from Figure 3.4 it follows that Slovenian trade figures reveal a comparative advantage in typical CME-sectors, such as road vehicles, electric machinery and rubber manufacturing. In these very sectors Estonia has a comparative disadvantage. Second, the trend predicted by Freudenberg and Lemoine (1999) in Slovenia can be confirmed. The top category of chemicals (SITC Nr. 5) reveals a positive index in 2003. The case of motor vehicles is most revealing in this respect. Until 1996 this figure was negative, since 2000 at least it shows positive figures. This points to a deep structural change in the economy. The third observation refers to the Estonian case: the telecommunications sector reveals a strong comparative advantage in Estonia.

Not only contributions to the trade balance can point to comparative institutional advantage of countries, but also movements of foreign direct investments. As argued above, firms should locate their activities, or parts of them, in those institutional settings, which fit them best. At the same time, activities in trade and foreign direct investments are interrelated as large sectoral inflows of foreign direct investment impact on trade performances.

Consequently, in a next step patterns of FDI in Estonia and Slovenia will be analyzed.