Ideas that may or may not matter: Population, the home market effect and manufacturing

This is sort of in the vein of the intermittent series (1, 2), its adopted sibling and an older post on “hollowing out”. But it’s also much less thought out.

Earlier today, following the announcement that Ford would shut its Geelong plant,  Scott Steel tweeted

Although the following conversation indicated he may have been concerned largely with products designed for Australian consumers rather than domestic production and certainly not exports, it did remind me of something very interesting, but possibly unimportant – the home markets effect, a product (partly) of the equally fascinating and possibly unimportant New Trade Theory and New Economic Geography.

In short, companies that produce for a market in their own country have an advantage when exporting. If we have increasing returns to scale, that is it keeps getting cheaper to produce more once you’re already producing, then the efficient, cheap producers are those who are already producing. This might simply be because the factories are already built, the workers trained, the know how known etc so there are no start up costs.

If so, then when it comes to trade, the countries who were producing widgets for their own market are those that provide it cheapest to everyone else. The home market has become part of the country’s comparative advantage.

The trivial example might be in your cupboard. If you have a tin of tomatoes, unless it is SPC, its almost certainly from Italy. The most expensive part of a tin of tomatoes is the canning. Italian plants already produces heaps of tins for Italians, so they can provide them for just 79 cents to us.

Its obvious though that a bigger population has a bigger home market. So if the hypothesis is true, population size becomes comparative advantage. Immigration could then become industry policy that works.

There’s a great deal of problems though.

Most importantly there aren’t too many cases I can think of where this advantage has been maintained without government props. Other elements of comparative advantage, like wages levels or training, seem to outweigh lingering home market effects – the massive amounts of computer hardware out of South East Asia isn’t due to their love of PCs, nor do Chinese consumers exhibit a love for…everything manufactured. The most valuable thing seems to be know how, and that is the most mobile of production factors.

The other is hat it makes the most sense when countries have been operating as autarchies and then BAM, international trade. That possibly made sense in the world of 1985 following five odd decades of global protectionism, but not now. Any developing industry will start with many countries as potential locations, regardless of where the consumer lies. The home market effect would only hold if transport costs are high so manufacturing close to customers is cheaper, but then that the lowering of costs once things get going are so great they more than offset the cost of transport.

This is probably a reason why its so hard to think of Australian examples.  Mining equipment for certain, given there is such a large industry here that can’t go elsewhere that also has to produce with a high productivity labour force [1]. Lamb meat? English language tertiary education…

Anyway, I haven’t thought about it deeply, but it’s interesting and possibly useless. But if it leads to an acceptance of higher immigration I might take to trumpeting it.

[fn1] Or high wage if you will, they’re obviously the same thing if unemployment isn’t sky high

About Richard Tsukamasa Green

Richard Tsukamasa Green is an economist. Public employment means he can't post on policy much anymore. Also found at @RHTGreen on twitter.
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17 Responses to Ideas that may or may not matter: Population, the home market effect and manufacturing

  1. john r walker says:

    When it comes to making things like cars, airplanes and the like, its all very automated, very computer robot stuff these days. The costs of building the factory needed would be much the same anywhere and the costs of the skilled labor needed to run it should also be much the same every where.

    I would guess that the increasing costs of upgrading existing production lines would have been a factor. (As well as uncertainty as to what sort of car to build: for example small efficient petrol or electric)

    In general it seems that US manufacturers have for whatever reason been particularly slow to invest in new technology/production facilities, for example they have been very slow at tooling up to make things like small turbo+super charged engines, most of their cars are still big V6s or V8s.

    • Patrick says:

      I am pretty sure that those comments are completely wrong?!

      For example: I think that the cost, as well as availability, of skilled labour is one of the greatest differences from country to country.

      Also, I don’t think that American car companies judging that there was no market for straight 4 matchboxes has anything to do with investment in factories, for example. I’m pretty sure that GM, Ford and Chrysler all went through periods in which they didn’t invest in factories because they were too busy investing in pensions, but overall, in the car industry as elsewhere, America is continuing to invest and innovate on a very healthy scale.

      • john r walker says:

        Skilled labor is mobile.
        As for the US car industry it is starting to come out of the problems… their is a long lead time between , the decision to invest in a new plant , construction, and full production

        • Patrick says:

          Right. That’s why all the Chinese engineers are still in China, it’s because of their freely-exercised choice not be mobilise themselves to the US or elsewhere.

  2. desipis says:

    But if it leads to an acceptance of higher immigration I might take to trumpeting it.

    I’m not sure higher immigration is a feasible way to change the population to an extent that it would matter. The effects you’re talking about would only have significance after we double or triple our population. I doubt we’re going to achieve that in the short term. It’s also debatable whether it’s possible to do so in the relative sense (i.e grow a lot more/faster than the rest of the world) in the long term.

    The most valuable thing seems to be know how, and that is the most mobile of production factors.

    Which is why high quality (not just mass produced) education & research are so important to our economy. We need to keep producing new know-how to ensure we have innovative and higher quality products/services produced locally. We can’t compete on economic efficiency; we need to compete in different ways.

    • Tel says:

      Who gets to decide what constitutes “high quality” education?

      Teachers? Students? Parents? Government committees? Employers? Political parties?

  3. john r walker says:

    sorry Richard I meant to post my comments in Vale Ford… though they may have some relevance here :-)

  4. Paul Frijters says:

    One has to be careful about the economies of scales argument (and this is the kind of debate in which an affinity with maths and thus ability to read the theory literature on it really goes a long way). Economies of scale with regard to a single product or fairly small industries do not translate into economies of scale at the national level: bigger countries then merely dominate more products and small industries but would not be richer per capita than small countries.

    To get economies at scale at the national level one not only needs economies of scale that transcends individual products (and involves public goods), but it would need to be in industries big enough to exhaust the productive capacity of that country. And one would need some barrier between countries such that one cant simply be part of a larger zone that shares the economies of scale across borders (such as the EU or the US).

    Empirically, there may be something to the economies of scale argument for manufacturing as a whole.

    I recommend you take a good macro/trade course on this one.

  5. Richard Tsukamasa Green says:

    Paul – I’m intrigued by this proverbial “good macro/trade course”. In my brief survey of what the Laputans are teaching in post grad I did find a great deal about how I could learn about the trade between single people economies with constant returns to scale and single tradable goods. I was assured it was rigourous though

  6. Tel says:

    The trivial example might be in your cupboard. If you have a tin of tomatoes, unless it is SPC, its almost certainly from Italy. The most expensive part of a tin of tomatoes is the canning. Italian plants already produces heaps of tins for Italians, so they can provide them for just 79 cents to us.

    Hmmm, Leggos claim to do their packing in Australia, possibly from imported ingredients (but they don’t say where). The other tin does appear to have been canned in Italy.

    What you are essentially saying is that mercantilism works, because positive feedback is real. Sounds like The Death of Economics by that Ormerod character. That said, if positive feedback is real then chaos theory is real, and all economic theory is bunk (even central planning, which presumably is also subject to positive feedback in the form of self interest and corruption).

    • Richard Tsukamasa Green says:

      Although Krugman was associated with the New Trade Theory (and technically it was behind is Riksbank prize) he spent the early part of his career as a pop economics writer trying to portray Democrats who used the mechanisms described to justify mercantilist policy as a symmetrical equivalent of Republican Supply Siders in dangerous dodginess. Unlike the SSers, the “strategic traders” who wanted to build up infant industries never really had much influence, and are long forgotten.

      But yes, the bloke most associated with the idea thought it was ripe for abuse by the dodgy, and saw no policy implications.

  7. Tel says:

    The lesson that shan’t speak it’s name – if we’d like to keep making stuff in Australia, we need more people in Australia

    I don’t quite get that. The USA has ten times the population we do, so if this guy is talking about local consumer markets is he saying we should increase our population tenfold in order to compete with the USA? In a short space of time… how exactly? Tenfold!?!

    Different government positions on immigration might make a difference of a few percent (John Howard was enthusiastic in upping the total immigration quota) but seriously we will still be significantly behind our trading partners in terms of population regardless of who we vote for. So what exactly is this “need more people in Australia” all about?

  8. murph the surf. says:

    Tel- immigration can be thought of as a way to obtain demand without having to work at improving productivity?

  9. derrida derider says:

    GDP is a measure of the volume of market transactions. Naturally if you crowd more people together there will be more transactions between them. So yes, immigration (or any other source of population increase) increases GDP per capita.

    But this surely just says that GDP per capita is a very imperfect measure of human welfare. Covering the earth in a huge number of Hong Kongs (assuming that is sustainable – a dubious proposition in itself) may make us rich in material goods, but doesn’t say anything either way about whether we’ll be happy.

  10. Crocodile Chuck says:

    The idea of boosting immigration is silly. We don’t have enough water now (see our spanking new fleet of desal plants in 3 capital cities), arable land is reducing through faster rates of desertification/erosion and, in Sydney at least, new infrastructure is just an idea we read about in the newspapers.

    Read ‘The Future Eaters’?

  11. john r walker says:

    A friend has been involved in manufacturing for 40+years. For about 7 years he has been operating in and out of china. He reckons that there is something a bit mysterious about the costs of manufactures in china ; They are much cheaper than they should be, these days.
    Labor cost are lower (but rising), the artificial exchange rate goes part of the way… but plant and equipment (which these days tends to be brand new in china) and raw materials cost much the same and they are a big component of higher end manufacturing.. he thinks that there must be some other factor, what do you think?

    • john r walker says:

      Forgot to add that my friend suspects that the low unit costs reflect a level of production that is well above demand ,domestic and OS combined , except that is, in itself, a sort of mysterious , walking on air explanation of a mystery.

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