Implied Comparative Advantage

Abstract:

The comparative advantage of a location shapes its industrial structure. Current theoretical models based on this principle do not take a stance on how comparative advantages in different industries or locations are related with each other, or what such patterns of relatedness might imply about the evolution of comparative advantage. We build a simple Ricardian-inspired model and show that hidden information on inter-industry and inter-location relatedness can be captured by simple correlations between the observed structure of industries across locations, or the structure of locations across industries. We then use this recovered information to calculate a measure of implied comparative advantage, and show that it explains much of the location’s current industrial structure. We give evidence that these patterns are present in a wide variety of contexts, namely the export of goods (internationally) and the employment, payroll and number of establishments across the industries of subnational regions (in the US, Chile and India). In each of these cases, the deviations between the observed and implied comparative advantage in the past tend to be highly predictive of future industry growth, especially at horizons of a decade or more; this explanatory power holds at both the intensive as well as the extensive margin. These results suggest that a component of the long-term evolution of comparative advantage is already implied in today’s patterns of production.

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