Export Diversification in Ukraine. Intensive and Extensive Margins
EXPORT DIVERSIFICATION IN UKRAINE. INTENSIVE AND EXTENSIVE MARGINS
by
Mykhailo Syrotenko
A thesis submitted in partial fulfillment of the requirements for the degree of
MA in Economics
KyivSchool of Economics
2009
Approved by ______
KSE Program Director
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______
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Date ______
KyivSchool of Economics
Abstract
EXPORT DIVERSIFICATION IN UKRAINE. INTENSIVE AND EXTENSIVE MARGINS.
by Mykhailo Syrotenko
KSE Program Director: Tom Coupé
Export diversification is very essential for transition countries. External economy of Ukraine is an issue of high interest of economists because Ukraine takes one of the first places in the world regarding the rate of ration of foreign-trade to GNP. The reasons for diversification of Ukrainian trade are quite clear. Ukraine will be less sensitive to the shocks on the world markets of products in case of more diversified trade. So export diversification decreases the risks from the unstable demand of the trade partners. This paper uses the recent developments in the international trade theory that considers the fact that some firms export, some do not to investigate the pattern of export diversification. Using a gravity model the highly disaggregated trade data in the period from 2001 to 2007 was analyzed. It was found that intensive margin is the most important share of the trade growth. As for extensive margin we can conclude that geographical extensive margin is more important than product extensive for the growth of export. Signing free trade agreement increases the probability to diversify.
TableofContents
INTRODUCTION
LITERATURE REVIEW
METHODOLOGY
DATA DISCRIPTION
ESTIMATION RESULTS
BIBLIOGRAPHY
APPENDIX
LIST OFFIGURES
Number Page
Table 4.1. Descriptive statistic of the variables……………………………….16
Table 5.1. The quantity of zero-export from Ukraine to the 20 lаrgest import partners……………………………………………………………………....20
Table 5.2. Overall growth of export, extensive vs. intensive margins. ………..21
Table 5.3. Tobit estimation -- Marginal Effect on intensive margin, by
industry. ……………………………………………………………………..22
Table 5.4. Tobit estimation n Marginal Effect on extensive margin, by
exporter. …………………………………………………………………….23
Table A1: Total level export in Ukraine vs. export of metal in Ukraine……...30
Table A2: Variables, definitions, and sources………………………………….33
Table A3:List of importers of Ukrainian export………………………………34
Table A4 Correlation matrix…………………………………………………..35
Table A5: Classification of products to industries……………………………...36
Table A6: Probit model……………………………………………………….38
Table A7 : Tobit model. Marginal Effects: Latent Variable………………….....39
Figure 3.1. Margins, Amurgo-Pacheco (2007). ………………………………10
Figure 3.2. The trade pattern, Baldwin, Richard (2005b) …………………….12
Figure 5.1 The evolution of the total level of Ukrainian export………………18
Figure 5.2. Counties distribution of the level of aggregated import from Ukraine (2001-2007)………………………………………………………………….18
Figure 5.3. The Evolution of the quantities of zeros in trading matrix (2001-2007). ……………………………………………………………………….21
Figure A1: The distribution of Ukrainian exports among industries………….31
Figure A2: Intensive vs. Extensive margins…………………………………..32
Acknowledgments
The author wishes to express thankfulness to his advisor LarysaKrasnikovafor hergreat support andinvaluable comments. Special words of thanks are devoted to Oleksandr Shepotylofor providing the dataset for research and help with a topic selection. The author would like to thank Tom Coupe for his advices and useful suggestions during the whole academic year.
GlossarY
Intensive margin means that increase of trade export happens due to increase the quantity of exported goods that have been exported before.
Extensive margin means that increase of trade export is due to the growth in new class of goods.
1
Chapter 1
INTRODUCTION
Export diversification is very essential for developing countries. If a country concentrates its trading efforts on some certain products and (or) on the trade with some group of countries, as a result such a country can have a very unstable income from trade. Russiahas been a major buyer of Ukrainian goods. It imports about 22 percent of the total Ukrainian exports. Countries that have contiguity frequently sign free trade agreements. The advantages of such agreements are liquidation of customs barriers; raise in the level of trade between countries; reduction in price of imported products; efficient usage of the resources. Ukrainian authorities have signed the free trade agreement with Russian Federation in 1993. According to the existing agreement the countries can exclude products from free trade. But for this purpose country-partner has to show a well-grounded reason for this action. The quantity of such exclusions has increased significantly of late. Russian authorities try to influence on domestic policy in Ukraine. There are a lot of reasons for these actions. There are a lot of unsolved problems, e.g.: future location and withdrawal of the Black Sea Fleet, common border, particularly in Sea of Azov. Russian authorities don’t wish to solve these problems and hold them as a way of pressure on Ukraine in future. In addition, Russian authorities are waiting for possible political conjuncture in Ukraine to solve all problems in own interests. The problems of gas supply and “trade war” become a continuation of political opposition between Ukraine and Russian Federation. So, Russian authorities use these questions to destabilize the political situation in Ukraine. Russia had imposed special duty on Ukrainian caramel in November of 2005, quotas on glow lamp and forbidden to import all animal products in January of 2006. These restrictions had negativelyinfluence on Ukrainian exports. The official explanation for all these restrictions was that Ukrainian products did not meet the veterinary and sanitary standards of Russian Federation. But Ukrainian veterinaries, Customs Service and producers of the products deny claim.
A couple of examples: 10 months ago Russiastopped buying the milk solids and cheese from Ukraine. As a result Ukraine lost the benefits that had before from this trade. The level of trade export of Ukraine decreased in August, 2008 by 895 million of dollars in comparison with July, about 700 million of dollars due to decreasing in export of metal[1]. A similar problem Ukraine has with the chemical industry, there is a significant decrease in the level of exports for chemical products that was produced. The trade exports of Ukraine have decreased even more during last three months of 2008. As a result Ukrainecan have negative balance of foreign trade and the devaluation pressure on national currency (foreign currency from export comes each month less and less). The question is: whether it is possible to decrease the negative consequences of unstable demand from trade partners? Definitely it is possible in case of a higher export diversification—trade different products with many trade partners. Has Ukraine got high level of export diversification? Probably the level of export diversification of Ukraine is quite low. Such expectations make sense because the level of trade export in Ukraine increased significantly mainly due to export of metal and chemical products from the beginning of 2000 year[2]. The total level of metal exports from the first half of 2008 year was about 45.8% of the total export of Ukraine. As a result it is very sensitive to shocks to the world markets of products. The need for diversification of Ukrainian trade is quite clear. Thus the balance of payments will be less volatile and macroeconomic stability will be obtained. One more aspect of international trade for transition economy is to have diversified internal production that depends on success of macroeconomic policy of the country.So export diversification decreases the risks from the unstable demand from the trade partners. As a result it creates more stable income from trade. There are some recent studies that had shown the positive relationship between the level of export diversification and economic growth (Lederman and Maloney, 2007, Imb and Wacziarg 2003). There is a research for transition economies with similar results (Funke M. and Ruhwedel R. 2003). Thus export diversification leads to higher predictable growth. Moreover foreignpolicy of Ukraine attracts to itself big interest of economists because Ukraine takes one of the first places in the world on the rate of ration on foreign-trade to GNP.
The objective of this paper is to investigate how Ukraine differs at the intensive (an increase of trade export which happens due in increase the quantity of exported goods that have been exported before) and extensive (an increase of trade export which is due to the growth in new classes of goods) margins and the importance of each margin for the growth of trade and stability of economy as well. This is essential question because it helps to understand the causes of growth in trade of Ukraine with other countries in the world. This work will help to understand the possible ways of increasing the level of export diversification for Ukraine. In turn Ukrainian authorities can also consider decreasing export volatility as essential additional economic purpose because of export instability can influence income instability.
Using a gravity model we will estimate the influence of explanatory variables on extensive and intensive margins for Ukraine. In this work we will use the recent developments in the international trade theory that consider the fact that some firms export, some do not. Our gravity model will be based on Melitz (2003) theory model which will help us to explain zero trade value in trading matrix (a matrix with the levels of trade between partners in certain category of goods). Concerning to the theory of Melitz model, firms attempt to have profit enough for covering the sunk cost of incoming the distant market. If the trading is not beneficial, we see a censored data point (0 export). We focus our attention on the trade that changes the value of trade from zero value to positive for each county-partner and look how it changes the present trade flows. For this purpose we use Tobit estimation technique, which considers zero-trade flows as censored data. For this estimation it was used the highly disaggregated trade level data for Ukraine that is available (6-digit level of the Harmonized System, that is 5132 products and time horizon from 2001 to 2007 year) fromUnited Nations Commodity Trade Statistics Database. So a large dataset was analyzed (6.107 080 million observations).
Chapter 2
LITERATURE REVIEW
The gravity model is very popular for studying a large variety of trade questions.This attractiveness is due partially to its actually good representing of trade flows and partially to strong theoretical foundation provided for it. We will consider existing theoretical and empirical works for deeper understanding of trade flows. First we look and describe the theoretical works that help to explain the trade flows in the world. Then we describe in some details the Melitz (2003) model as the base for our further research in explanation of trade flows. After that we show the findings of recent papers that used the gravity model for estimation the role of extensive and intensive margins in the growth of trade.
There exist a lot of theoretical works that help to explain the trade flows in the world. Tinbergen (1962) beganto usethe gravity equations for explanation trade flows in the world. He considered the relationship between the bilateral trade flows among two countries and the product of an index of their economic sizeand“trade resistance” of the trade partners. As the measures of “trade resistance”, he incorporated geographical remoteness, a dummy for common borders, and dummies for Common wealth and Beneluxmembership.Helpman, Melitz, Rubinstein (2006) have mentioned: “Tinbergen’s specification has been widely used, simply because it provides a good fit to most data sets of regional and international trade flows”. The gravity equation is useful empirical instrumentfor investigationthe questions of international trade; it has been used to determine the influence of international borders, money unions, special trading blocs, membership in trading organizations and the size of home market effects on trade flows.
Armington’s (1969) theoretical works tries to explain and clarify the worldwide trade flows based on a theoretical basis in which countries can only increase their exports by decreasing their prices relative to those charged by other countries. Unfortunately, this model does not explain international trade quite well because of using very restrictive assumptions (model considers only one mentioned above way of increasing the level of export). The new trade Krugman`s theory(1980) model avoidedmentioned problems by assuming that at least some of the country manufactures differentiated goods, and the customers have “a love of variety” based on the preference structure that was suggested by Dixit and Stiglitz (1977). However, this model has some characteristics that are broadly seen as incompatible with the facts. In particular, they are unrealistic in determining customers as preferring all goods without any limit. More importantly, they mean that all goods will be exported to all markets in the world, when actuality most possible trade flows have zero value.
Anderson and van Wincoop (2003) theoretical model assumes that homogenous firms within each country and consumer love of variety ensures that all goods are traded everywhere. But the weakness of this model is that the growth of export is possible only due to expansion of trade of goods that have already been exported before. There is no extensive margin in this model and all changes in trade should therefore occur in the intensive margin. Moreover this model does not explain the asymmetries between the volumes of exports (the level of export from country A to country B can not be equal the level of export from B to A).
Hummels and Klenow (2005) have recently considered Armington`s and Krugman`s models and have showedthat both models can not clarify trade flows adequately. The amount of exported products increases less quickly than was forecasted by the Krugman`s model, but more quickly than forecasted by the Armington`s model. Based on Feenstra’s classic study (1994), Hummels and Klenow provided a quantitative framework for separating trade growth into an extensive margin relating increase in the number of goods exported and an intensive margin relating growth in the quantity of each export goods that has already been exported before.The econometric analysis of Hummels and Klenow showed that extensive margin increase was a large fraction of total increase in exports for a large sample of countries. They have detected that the extensive margin accounts for 60 percent of the larger exports of larger economies. The intensive margin can be distinguished into price and quantity size and is prevailed by higher quantities rather than higher prices. Richer economies export higher quality goods, while economies with more workers export higher quantities but not at higher prices.
All the above-mentioned theoretical works help to explain the international trade flows that have only positive values. Moreover standard specifications of these models impose symmetry of the trade flows between countries which is inconsistent with the data. An empirical works for estimating trading flows that are based on Armington’s, Krugman`s, Anderson and van Wincoop models produce biased estimates as a result. These trade theories are not appropriate for exploring the diversification of export because they don’t explain zero trade export and do not take into account the censored structure of the data,while this information is very essential for explaining trade flows. These trade theories do not consider the fixed cost of incoming the market for local potential exporter. The empirical works that use the gravity equation based on the mentioned theoretical studies as the best decision to this problem, considers canceling out zero trade observation or plugging some positive value to zero trade observation (e.g. Wаng, Winters (1992)). Thus we can not study the extensive margin in such a way. As will be explained below, zero-trade is very important piece of information for us that we can not ignore or drop.
To avoid these biases we use the recent developments in the international trade theory that consider the fact that some firms export, some do not. Such idea helps to explore the diversification of export by permitting us to deal with zero-trade export in the trading matrix.Melitz (2003) develops a microeconomic model with producer heterogeneity and fixed export costs that can clarify the present of zero trade export in trading matrix. Melitz’smodel improves the Anderson and van Wincoop model in two ways. From the one hand it accounts heterogeneity for firm and fixed trade costs and thus predicts an extensive margin for trade flows. From the other hand it accounts asymmetries between the volumes of exports. This modelconsiders heterogeneous producers who manufacture differentiated goods and must pay a fixed cost in order to export and whose exports areissue to a trade barrier, usually a tariff. The firms are heterogeneous in their efficiency; low efficient firmscould not make enough earnings from export to cover the fixed cost (they do notexport); high efficient firms can make enough export profits to cover the fixed cost (they do export).Sobecause of fixed trade charges, only the more productive producers get it profitable to sell products abroad.Theproducers that do not export are producing non-traded products. As tradebarriers go down, the potential earnings of non-exporting producers raise and, for some firms, theseprofits raise enough to cover the fixed export cost, stimulating these firms to beginexporting.So it will lead to change in extensive and intensive margins of the total trade level. In this respect Anderson and van Wincoop (2003) presume that all producers have the same productivity level. The lack of this model is that it predicts that all changes in level of export can be only due to intensive margin. Thereby changing in the level of fixed cost influences only the intensive margin but not the extensive margin. Nevertheless Melitz model helps to explain intensive margin and extensive as well and the influence of different factors on both margins. According to this model fixed and variable costs have negative effect on extensive margin but can have as positive as negative influence on the intensive margin.