Apr 24 2008

Dominican Republic struggles to find its “comparative advantage” as it faces new competition from Asia

FT.com / World / Americas – US economy threatens Dominican Republic

Trade based on comparative advantage… the theory originally articulated by Adam Smith, later fine-tuned by David Ricardo, the theory that suggests that if each nation specializes its economic activity on the products for which it faces the lowest opportunity cost, then trades with its neighbors, total world output and efficiency can be maximized: today this theory represents the philosophical underpinning of all free trade agreements signed between and among the nations of the world.

Through trade, countries can exchange their extra output with other nations for the goods specialized in by others, enabling all nations to enjoy a level of consumption beyond what they’d be able to achieve if they tried to produce all goods domestically.

For many developing countries, with their abundance of either land or labor, comparative advantages tend to lie in either agricultural goods or low-skilled manufactured goods. Since global prices for food are highly unstable and dependency on healthy harvests, good weather, and stable rainfall are all highly risky endeavors for a poor country, developing nations prefer to foster the growth of manufacturing sectors in their path towards economic development.

Strategies for economic growth available to developing nations include export-oriented and inward-oriented growth. A country like the Dominican Republic, the largest economy in the Caribbean, has pursued a predominantly export-oriented growth strategy, promoting through “free zones” the growth of a textile industry aimed at producing goods for consumers in developed countries, primarily the US.

To the Domincans, producing textiles for export to America has successfully given the people of this poor nation a grip on a rung of the ladder towards economic development. The import of capital has taken previously unproductive workers out of agriculture and put them into an industry where productivity, thus income, has risen, leading to improvements in living standards. Export-led growth, however, runs some serious risks of its own, as is being realized by the people of the Dominican Republic today.

It had been clear for some time that Luis Caraballo’s textile factory, in one of the Dominican Republic’s largest “free zones”, was struggling.

Finally, last December, he closed the factory gates for the last time: cut-throat competition from China and Vietnam, a weakening US dollar and unsustainable costs had become too much.

Once a hot destination for American companies looking for a cheap place to “off-shore” production of labor intensive textiles, the Dominican Republic today faces new competition, and is finding its comparative advantage slip slowly away from textiles…

The Dominican Republic depends heavily on the US, which is the destination of more than 85 per cent of exports. But textile exports – these days accounting for less than a third of total exports – fell by 32 per cent over 2007.

Although other countries in the Caribbean are also suffering from Asian competition – with Chinese textile exports to the US tripling between 2000 and 2005, while Vietnam’s multiplied almost 117 times – the Dominican Republic has been worst hit.

Here’s the thing: a nation’s comparative advantage may shift over time (from land to labor to capital intensive goods) as the structure of the global economy evolves. Once an economy like the Dominican Republic’s has undergone a period of structural adjustment, away from agriculture and towards industry, the flow of low wage workers from farm to factory begins to slow to a trickle, leading to rising wages and increased competition from countries with more abundant supplies of cheap labor.

The challenge for policy makers is to manage the structural changes as they come, minimizing the deleterious impact such global shifts of productive resources has on the citizens of a country like the D.R. Clearly, it is in the country’s interest to prepare its citizens for a “new economy”, one in which skilled labor will play a larger role. The problem is, this requires a solid education system, which the D.R., it turns out, does not yet have:

There is widespread acceptance of the need to develop a better-educated workforce, but so far education spending has been inadequate.

“The government simply doesn’t have enough resources,” said Mr Montás. About 40 per cent of its budget goes on debt obligations and another 15 per cent is dished out through subsidies. Just 1.5 per cent goes towards education.

It also turns out that this is a balance of payments story:

Mr Montás calculated that for every percentage point the US economy contracted, the Dominican Republic’s GDP would shrink by 0.4 per cent.

Not only will exporters be hit, but also the huge tourism sector and remittance flows…

One possible result of the decline in exports and flows of remittances from the US will be a depreciation of the D.R. peso, as demand for pesos by Americans falls. A weaker peso might make the country’s exports attractive once again, assuming the exchange rate is allowed to adjust on foreign exchange markets. A weaker peso should help slow the decline in the D.R.’s exports to the US, at least until new competition emerges, perhaps elsewhere in Asia, maybe even from Africa or other Latin American countries.

In all likelihood, given the increased competition from Asian textile manufacturers, continued economic growth in the Dominican Republic will depend on the country’s ability to educate and train its workforce to adapt to a more capital, technology and information-based economy, which, if successful, will eventually lead to rising incomes and higher standards of living for the people of the this rising Caribbean nation.

Comparative advantages evolve with the emergence of new competition among developing and developed countries. The negative impacts this evolution has on a particular economy can be managed if wise policy actions are taken to assure a country’s workforce is educated and trained to participate in tomorrow’s economy, rather than yesterday’s or today’s.

About the author:  Jason Welker teaches International Baccalaureate and Advanced Placement Economics at Zurich International School in Switzerland. In addition to publishing various online resources for economics students and teachers, Jason developed the online version of the Economics course for the IB and is has authored two Economics textbooks: Pearson Baccalaureate’s Economics for the IB Diploma and REA’s AP Macroeconomics Crash Course. Jason is a native of the Pacific Northwest of the United States, and is a passionate adventurer, who considers himself a skier / mountain biker who teaches Economics in his free time. He and his wife keep a ski chalet in the mountains of Northern Idaho, which now that they live in the Swiss Alps gets far too little use. Read more posts by this author

30 responses so far

30 Responses to “Dominican Republic struggles to find its “comparative advantage” as it faces new competition from Asia”

  1. Tim Chuon 25 Apr 2008 at 12:09 am

    In the case of the DR, it seems like the only thing that people can do is reeducation but I wonder if the incentives are high enough. In a country that is still developing, I'd expect more people to worry about getting enough money to survive the next year than going to school where you get no pay to support your family and no food, so that there is a small chance you could get a better job. But then again, that's just my assumption. And i guess it's kinda bad that the US is just dumping it's factories in other countries and developing a dependency on the US and just ripping that away to run off to a cheaper place. What do you guys think?

  2. kevinhuangon 27 Apr 2008 at 4:56 pm

    Well although it is bad that the US is doing this kind of activity, it's only natural since the US lots of money and no where else to turn to for the primary and secondary production. America has become a place of mainly services and is depleted of its natural resources so they would turn to third world countries with cheap labor. I think the people of DR will not have trouble with finding incentive to be reeducated in order for them to grow. They have already started to experience the many benefits of growth and probably do not want to lose their recent increase in life styles.

  3. Conrad Liuon 28 Apr 2008 at 8:05 pm

    Indeed, a core example of the balance of payments at work, as the article said. Like many other people have already said, it just makes sense for the U.S. to decrease their imports from DR, since the now-weak dollar is making DR exports seem more expensive. In any case, the DR should start investing in higher-quality education if they want to increase exports again.

  4. KatherineYangon 28 Apr 2008 at 1:28 pm

    The US is basically doing what any person would do, why pay more if you don't have to? Besides, now that the US is going into, or is in, a recession, the country will naturally want to save money where they can. DR's problem reminds me so much of Darwin's "survival of the fittest", because if DR isn't able to adapt to new situations, then it won't survive, at least not well.

    I don't think it's an incentive issue, so much as it is a money issue. Especially if DR has so many debts, and since its pulling in less income, then where are they going to get the money for education? Even charity organizations can find countries more in need of their money that DR. It just seems like such a precarious position to be in.

  5. KatherineYangon 28 Apr 2008 at 1:31 pm

    The US is basically doing what any person would do; why pay more if you don't have to? Besides, now that the US is in, a recession, the country will naturally want to save money where they can. DR's problem reminds me so much of Darwin's "survival of the fittest", because if DR isn't able to adapt to new situations, then it won't survive, at least not well.

    I don't think it's an incentive issue, so much as it is a money issue. Especially if DR has so many debts, and since its pulling in less income, then where are they going to get the money for education? Even charity organizations can find countries more in need of their money that DR. It just seems like such a precarious position to be in.

  6. KatherineYangon 28 Apr 2008 at 1:32 pm

    er…ignore the repeat…sorry

  7. richardtuon 28 Apr 2008 at 3:06 pm

    Dominican Republic currently has so many debts and thus pulling less and less income. This situation is similar US right now, because US are currently in recession. When a country is in a recession, then the natural response is to be as efficient as possible and save money and resources. This emphasize on the point that if the Dominican Republic cannot be efficient, then they will not be competitive, and thus they would not survive. However, i am sure that the dominican will push themselves to be more and more efficient, the education will increase, thus productivity will go up.

  8. howardlinon 28 Apr 2008 at 3:16 pm

    In order for US (currently in recession) to earn more money, they have to be more efficient, like katherine mensioned, the ecnomic darwinism. DR must become more competitive, otherwise they will not last long.

  9. jackloon 28 Apr 2008 at 3:20 pm

    This cycle of economic change happens to many developing countries. First, your country focuses on agriculture. Then as other more developed countries start to invest in these countries, new capital begins to flow in. Soon enough, the country shifts to industry and starts to manufacture cheap goods for the rest of the world. Then when the DR peso becomes stronger and the US dollar weakens, there will be a shift towards trade balance between the two countries. For DR to move into more advanced industry, they'll have to reeducate their people. Without education, the capital is useless since the workers aren't able to operate these capital to their potential.

  10. Alex Goldmanon 28 Apr 2008 at 3:28 pm

    The Dominican Republic's situation exemplifies one of the reasons people oppose free trade – diversification. The Dominican Republic is so dependent on textiles that once they losing their competitive advantage in that product could mean dire economic circumstances. As the blog points out, in order to stay competitive D.R must "educate and train its workforce to adapt to a more capital, technology and information-based economy." In this case, international trade will either be a helpful wake up call for D.R. or it will exacerbate D.R's economic condition.

  11. Sharon Lion 28 Apr 2008 at 5:42 pm

    I agree the DR needs to become more competitive, but even though education may be costly, in the long run it will give them a competitive edge in the global market. And that competitive edge may increase demand for its exports which would be good.

  12. kxc.024on 28 Apr 2008 at 6:00 pm

    With an open economy, countries are goingn to be constantly looking for other nations with cheap resources to "exploit." While Latin America was the target for several years, China seems to have taken over. Since China's government still plays a large role in its economy, I personally think that China will have this comparative advantage for years to come so the only solution for the Dominican Republic to stimulate their economy is through better education and productivity. It would probably be wise for the government to invest more in the education sector of the country so that in the long run, the country will be better off.

    In the short run, DR's economy is quite similiar to China's. If they can keep the peso weak like the RMB, then consumers will start buying their products again.

  13. T. Sunon 28 Apr 2008 at 6:29 pm

    Katherine nice triple-post.

    Economic darwinism anyone? We shouldn't be trying to help out the Dominican Republic and let its economy falter. We're only encouraging a misallocation of resources in trying to help them. They can go figure out what to do with their money.

    Education seems like an investment of some sort (a financial one, even). I'd say to go for it, but it's up to the government and not some lowly AP Econ student, right?

  14. kevinchiuon 28 Apr 2008 at 7:42 pm

    Why wouldn't the US spend their money in cheaper labor… when the US is in a recession itself, and need to take every opportunity to minimize on input costs? Doesn't seem too bad to me, but then again I am American.

    I concur with Tim, education IS an investment; although parents will never admit it, having your kid go to SAS for $22,000 is an investment!

  15. jacqueszhangon 28 Apr 2008 at 7:59 pm

    Economic darwinism is right. In this case, the best thing for the Dominican Republic to do is probably to spend more on educating people for higher-wage, more advanced jobs rather than staying in the race for textile making. China has indubitably surpassed DR's economy in that aspect, and it should thus move on, lest it become extinct.

  16. Trevor Sunon 28 Apr 2008 at 8:49 pm

    heh of course they should spend more on education…1.5% of government spending only? Well whatever the case it is that causes them to allocate such a tiny amount, the D.R. should try to allocate a little more.

  17. Chan Min Parkon 28 Apr 2008 at 9:41 pm

    We can see how being so dependent on another countries economy is so dangerous. Being in a free trade world may help countries in ways such as comparative advantage, but it is very important to continuously keep up and find their own ways to contribute. As every mentioned, since countries are now looking towards other countries for labor intensive goods, Dominican Republic isnt able to keep up their advantage. They are going to need to find ways to make themselves attractive and profitable for countries to trade with. As people mentioned, education I think is important.

  18. Jo Loon 28 Apr 2008 at 10:27 pm

    Like Conrad said, a country that relies on another country for economic growth is prone to failure. Take Cuba for example. After the fall of the Soviet Union, Cuba was left with virtually no ally, and was left to fend for itself. Since it relied heavily on the Soviets, they had very weak infrastructure and no strong economic policy in place. Cuba's decline into poverty was in part due to the Soviet fall (of course the communist regime also had something to do with Cuba's decline, but I'm not here to talk about it).

    To prevent a recession like the one currently in the US, the DR must increase their education spending to educate the populace so more educated and skilled workers enter the labor force, thus increasing economic growth and livelihood.

  19. Margaret Liuon 28 Apr 2008 at 10:38 pm

    It's too bad that the DR didn't take advantage of its compartive advantage and squeeze as much out of it as they could while they could….because they could have used the income from its exports to fund things exactly like education. Is economics all about exploitation?

  20. Kristie Chungon 28 Apr 2008 at 10:53 pm

    Well right now, I think the DR has become too dependent on its textile industry. DR will face major problems in its economy if they lose the comparative advantage in producing textiles. I agree, and think it's really important for the DR to increase how much they spend on educating the people. Educated and skilled workers would help the DR stay competitive.

  21. Jessicaon 29 Apr 2008 at 9:51 pm

    China…well, China basically has the power to take over any industry. It can definitely produce labor intensive goods. This is a good example of how the economies of many nations tie in with each other; as the USD value falls, so does the peso. Is there a lot of tourism to the Dominican Republic?

  22. Jonathan Lauon 29 Apr 2008 at 10:25 pm

    This is a perfect example illustrating one of the problems of a free trading market. The Dominican Republic did not maximize its comparative advantage of producting textiles, and now it is beginnning to lose that advantage. Now would be a good time for the Domincan Republic to catch up with the rest of the world and either retain its soon to be lost comparative advantage or to find another. Educating its workers is a good start.

  23. Michael Dailyon 29 Apr 2008 at 11:30 pm

    As long as the Dominican Republic has a free-floating exchange rate system in effect, its exports will soon increase again because of the self-correcting power of the economy. As the DR peso is depreciating the exports from the DR should be cheaper and more attractive to countries such as the US. However, of course, if it does not implement better educational standards, this cycle will not do the economy of the DR much good.

  24. mina.songon 29 Apr 2008 at 11:39 pm

    I also agree that education is important, but I think Dominican Republic should find something better than education, because raising average education of Dominican Republic people will take more than a decade. isn't it?

  25. Howard Jingon 30 Apr 2008 at 1:25 am

    I agree with Mina that education seems to be more of a long run plan since it takes so long to show its effects. Maybe the Dominican Republic can focus on streamlining its efficiency in other ways, such as more up to date textile factories and such? The DR is in a real tough spot and there is really no clear way to get out in the short run.

  26. Drew Venkatramanon 04 May 2008 at 6:54 pm

    I agree with mina and howard that education is a long run plan. I think that the DR should focus on increasing production efficency with the accquisition of capital. If they have up to date faciliities they will perform even better when the people have gotten smarter

  27. Mikeon 07 Nov 2008 at 1:23 am

    Please explain something.

    The US buys cars from Japan and sends them USD. Japan then takes the USD and buys EUROS on the foreign exchange market. Japan then uses those EUROS to buy products from Europe. How does this money get spent back in the US if Europe doesn't buy any products from the US?

  28. Jason Welkeron 07 Nov 2008 at 2:11 am

    @Mike, Great question! Keep in mind that whoever ends up holding those US dollars can only do one of three things with them. 1) Buy US made goods, 2) Invest in real or financial assets in the US, which keep interest rates low and puts money back in Americans' hands, or 3) hold the dollars as foreign reserves to use to draw down on future trade deficits with the US. The 3rd option is the least likely to happen, since, first of all, 14 of the US's 15 larges trading partners already have trade surpluses with the US, so there's no reason to hold on to dollars as reserves.

    The biggest reasons NOT to simply hold USD as an asset are inflation and depreciation. If Japanese and others prefer to buy European goods, for which they demand Euros, then the Euro will appreciate and the dollar depreciate on the foreign exchange market. Europeans, therefore, want to buy dollars to keep the dollar strong, thus keeping European goods competitive in price. Inflation is another reason Europeans will not simply sit on their dollars; inflation can be defined as the rate of decrease in the value of money. As price levels in the US rise, the dollars lose their value, meaning the Europeans holding dollars are losing money.

    For these reason, and most importantly because Europeans, Japanese, and everyone else WANTS to buy US goods, because buying stuff just feels GOOD, dollars that get spend on Japanese products and then swapped for Euros so Japan can buy European goods will ultimately end up back in Americans' pockets, either through European consumption of our goods, European investment in our stock, bond or financial markets, or European investment in real assets like factories, plants and real estate in the US.

  29. Maddion 16 Dec 2008 at 6:44 pm

    To go back to what Drew said: It makes sense that education is a long run scheme. Education takes more time than the DR are probably willing to waste, what with the decrease in expenditures on their exports by the Americans, and the increased competition by Asian companies. Obviously in this current situation the best course of action for DR would be to increase efficiency of their industries to gain back some of their comparative advantage or even hope for a depreciation of their currency, in order for their goods to seem more attractive to foreign consumers. Education should be a secondary plan to this, perhaps to be slowly developed by raising funds from the government over time, making for a more educated workforce in the long run, able to increase production possibilities for DR.

  30. Jonathan Ron 04 Nov 2009 at 2:55 am

    I find it very interesting how, with floating exchange rates, issues with trade are almost self-fixing. Case-in-point: now that there is relatively little demand for exports from the Dominican Republic (as D.R. exports are becoming internationaloly competitive due to shifting comparative advantages), the demand for pesos will decrease. This will cause a fall in the value of the peso – a depreciation. Because the peso is now worth less, exports from the D.R. become (more) internationally competitive and its exports may once more increase.

    However, at the same time, I think there are some fundamental structural inefficiencies in the economy of the Dominican Republic that need to be addressed. First and foremost, education is an area which needs to be addressed in the near future. Even if exports may increase in the short run, the key asset in the D.R.'s future economy will surely be its skilled and educated workforce, as opposed to the cheap labor it relies on today. I believe the long-term viability and survival of the D.R.'s economy is dependent on a major commitment now to education, which will allow future generations to reap major benefits and help alleviate the overreliance on exports to the United States.