1

Title: Select a country and examine its actual exports and imports. Explain

how these fit with the theory of factor endowments

Julianna Vanessa Baptiste

University of the West Indies

2007

International Business Management MGMT (3037)

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Abstract

This paper intends to examine whether factor proportions determine the structure of trade in

Trinidad and Tobago. It examines the major imports and exports of the country and determines

whether or not factor endowments are a major indicator of Trade. It also looks at the implications

of the structure of trade in the country of Trinidad and gives some recommendations as to what

could be done to further the level and consistency of exports and imports to Trinidad and

Tobago.

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Table of Contents

List of Illustrations……………………………………………………………………………...4

Introduction……………………………………………………………………………………..5

The Theory of Factor Endowments………………………………….......................................7

Heckscher-Ohlin Model Assumptions – Market Structure……………………………...8

Heckscher-Ohlin Model Assumptions – Production………………………………….…9

Heckscher-Ohlin Model Assumptions – Fixed Versus Variable Proportions………….12

Literature Review........................................ ………………………………………………….14

Case Study: Trinidad and Tobago

The Importance of Trade in Trinidad and Tobago……………………………………..16

Merchandise Trade…………………………………………………………..…………17

Recent Trends…………………………………………………………………..17

Exports………………………………………………………………………….18

Imports……………………………………………………………………….…23

Services Trade……………………….. ……..................................................................25

Recent Trends………………………………………………………….………..25

Travel Sector: Tourism, Education, Health……………………………………..25

Transportation Sector: Air and Maritime…………………………………….…27

Commercial Sector: Communication, Financial and Insurance services…….....28

Implications/Recommendations/Conclusion……………………………………………...….29

Bibliography………………………………….……………………………………………..….32

Appendices..................................................................................................................................33

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List of Illustrations

Figure Title Page

1 Merchandise Trade 1990-2004……………………………………..17

2 Sector Composition of Exports 1990-2003………………………...18

3 Services Exports by Area 1990-2003………………………………26

4 Travel and Tourism Exports (Cumulative Real Growth, %)…….…27

Table

1 Top 20 Exports to the World and CARICOM, 2001-2003………....19

Appendix

1 Trinidad and Tobago: Structure of the Energy Sector, 2003……..…33

2 Trinidad and Tobago: Sources and Uses of Energy Resources……...34

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Introduction

The twin-island State of Trinidad and Tobago can be viewed as the economic giant of the

Caribbean. In the 1980s, Trinidad and Tobago was an upper-middle-income, oil-exporting

country that was highly dependent on the world price of oil for its economic growth. The nation

displayed the largest gross domestic product (GDP--see Glossary) of the Commonwealth

Caribbean, one of the highest per capita GDPs among the nations of the Western Hemisphere,

and one of the highest standards of living in the developing world. The country's GDP in 1985

stood at roughly US$7.7 billion at current prices, or about US$6,000 per capita.

The major sectors of the economy were petroleum and petrochemicals, construction, services,

and agriculture. Petroleum had fueled the economy since the early twentieth century and in 1985

still represented roughly 24 percent of GDP and 80 percent of exports. Oil reserves at the current

rate of extraction were expected to last approximately ten years, but the islands enjoyed large

reserves of natural gas. New petrochemical plants, utilizing the country's natural gas resources,

came on-stream in the early 1980s and included ammonia, urea, and methanol. These large

industrial projects were located at the newly built Point Lisas industrial park, which, along with

the park's new iron and steel plant, provided Trinidad and Tobago with an industrial base that

was unmatched throughout the Caribbean.

In the postwar era, the economy experienced two great boom decades, both of which were

followed by decades of slow or negative growth. Growth in import substitution manufacturing

and the economy as a whole waned in the late 1960s, exacerbating the social unrest at the end of

the decade. The quadrupling of oil prices in 1973 revived the economy and created a 9.6-percent

real annual growth rate from 1974 to 1979. Trinidadians and Tobagonians, nicknamed the

"Arabs of the Caribbean," were known throughout the region in the 1970s for the carnival of

consumption that they participated in with their instant oil wealth. The downturn in oil prices in

1982, however, plummeted the economy into a deep depression in 1983 from which the country

had not emerged by 1987. Negative growth peaked in 1984, when the economy contracted by

nearly 11 percent.

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Trinidad and Tobago was a very open economy, dependent on the export of oil to purchase large

amounts of imported food, consumer goods, and capital goods. Oil represented approximately 80

percent of exports, whereas food accounted for as much as 20 percent of imports in the late

1980s. Unlike virtually every other Caribbean country, Trinidad and Tobago generally enjoyed

yearly trade and balance of payments surpluses. The country depended on the United States for

roughly 50 percent of its trade, but the islands also maintained important trade relations with the

European Economic Community (EEC) and the Caribbean Community and Common Market.

Once a donor nation that aided its poorer Caribbean neighbors, Trinidad and Tobago in the late

1980s was increasingly in need of external financing to weather its economic adjustment period.

Despite the recession of the 80s the country has been able to revive itself and improve its trade

performance. The energy sector continues to play a central in the economy. In 2003, it accounted

for nearly 40 percent of GDP, 83 percent of exports of goods, 41 percent of central government

revenues. Also, since the late 1970s, the energy production structure in Trinidad and Tobago has

shifted from primarily oil-based to natural and gas-based petrochemical production. Natural gas

production increased from 346 million cubic feet per day (mmcf/d) in 1975 to 2,594 mmcf/d in

2003. The expansion of the gas sector received a major boost in 1999, when the Atlantic

Liquefied Natural Gas Company (ALNG) began operations. Trinidad and Tobago has developed

its petrochemical and liquid natural gas (LNG) mainly for exports.

However, can Trinidad and Tobago’s export and import performance be related to the theory of

factor endowments? This theory essentially says a country should export its abundant resources

and import scare ones. Several papers have explored the relationship between country

specialization and factor endowment1. However existing tests of the framework find scant

evidence in favor of endowment-driven trade (e.g. Bowen et al 1987, Trefler 1995)

Therefore, this paper looks at the theory of factor endowments and attempts to examine its fit

with the major exports and imports of Trinidad and Tobago. Firstly, it describes the theory of

factor endowments and looks at example of the model itself. It then looks at the existing

literature regarding the theory of factor endowments and its relation to the exports and imports of

a country. The second part of the paper examines the major exports and imports of Trinidad and

1 For a survey, see Harrigan (2003).

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Tobago2 and examines whether or not the theory of factor endowments fits with the flow of

exports and imports. The paper then identifies measures which would improve the level and

consistency of Trade in Trinidad and Tobago.

The Theory of Factor Endowments

The factor proportions model was originally developed by two Swedish economists, Eli

Heckscher and his student Bertil Ohlin in the 1920s. Many elaborations of the model were

provided by Paul Samuelson after the 1930s and thus sometimes the model is referred to as the

Heckscher-Ohlin-Samuelson (or HOS) model. In the 1950s and 60s some noteworthy extensions

to the model were made by Jaroslav Vanek and so occasionally the model is called the

Heckscher-Ohlin-Vanek model. All versions of the model can be simply called the “Heckscher-

Ohlin (or H-O) theory,” the Factor Endowment Theory, or simply the more generic “Factor

Proportions theory.”

The H-O model incorporates a number of realistic characteristics of production that are left out

of the simple Ricardian model. In the simple Ricardian model only one factor of production,

labor, is needed to produce goods and services. The productivity of labor is assumed to vary

across countries, which implies a difference in technology between nations. It was the difference

in technology that motivated advantageous international trade in the model.

The standard H-O model3 however, begins by expanding the number of factors of production

from one to two. The Model incorporates four main theorems: the Heckscher-Ohlin theorem, the

Stolper-Samuelson Theorem, the Rybczynski theorem, and the factor-price equalization theorem.

The Stolper-Samuelson and Rybczynski theorems describe relationships between variables in the

model while the H-O and factor-price equalization theorems present some of the key results of

the model. The Theory makes a number of assumptions these are described below:

2 Data presented would only be up to the year 2003, since actual data is only available up to this year. The

subsequent years are only estimates and as such assessments may not be necessarily accurate. 3 The “standard” H-O model refers to the case of two countries, two goods and two factors of production. The H-O

model has been extended to a many country, many goods and many factors case but in this paper, and by economists

in general, reference is made to the standard model.

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Heckscher-Ohlin Model Assumptions – Market Structure

Perfect Competition prevails in all markets.

Two countries: The case of two countries is used to simplify the model analysis. For example, let

one country be Trinidad, the other China*. Note: anything related exclusively to China* will be

marked with an asterisk.

Two goods: Two goods are produced by both countries. A barter economy is assumed4. As such,

for trade to occur, goods must be traded for other goods. Thus at least two goods are needed in

the model. Let the two produced goods be steel and clothing.

Two factors: Two factors of production, labor and capital, are used to produce clothing and steel.

Both labor and capital are homogeneous. Thus there is only one type of labor and one type of

capital. The laborers and capital equipment in different industries are exactly the same. It is also

assumed that labor and capital are freely mobile across industries within the country but

immobile across countries. Free mobility makes the H-O model a long-run model (Suranovic

2006).

Factor Constraints: Additionally it is assumed that the total amount of labor and capital used in

production is limited to the endowment of the country. The Labor Constraint is,

Where and are the quantities of labor used in clothing and steel production, respectively. L

represents the labor endowment of the country. Full employment of labor implies the expression

would hold with equality. The Capital Constraint is,

Where and are the quantities of capital used in clothing and steel production, respectively.

K represents the capital endowment of the country. Full employment of capital implies the

expression would hold with equality.

4 This means that there is no money used to make transactions.

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Endowments: The only difference between countries assumed in the model is differences in

endowments of capital and labor5. Thus in this case, Trinidad is capital-abundant relative to

China if:

Where K is the capital endowment, L the labor endowment in the Trinidad. K* is the capital

endowment, L* the labor endowment in China.

Therefore if Trinidad is capital-abundant then China is labor-abundant since the above

inequality can be rewritten to get:

This means that China has more labor per unit of capital for use in production than the Trinidad.

General Equilibrium: The H-O model is a general equilibrium model. The income earned by the

factors is used to purchase the two goods. The industries' revenue in turn is used to pay for the

factor services. The prices of outputs and factors in equilibrium are those which equalize supply

and demand in all markets simultaneously (Suranovic 2006).

Heckscher-Ohlin Model Assumptions - Production

The production functions below represent industry production not firm production. The industry

consists of many small firms in light of the assumption of perfect competition.

Production of Clothing

Trinidad China

5 A country is capital-abundant relative to another country if it has more capital endowment per labor endowment

than the other country.

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where

QC = quantity of clothing produced in Trinidad measured in racks.

LC = amount of labor applied to clothing production in Trinidad measured in labor-hours.

KC = amount of capital applied to clothing production in Trinidad measured in capital-hours.

f( ) = the clothing production function which transforms labor and capital inputs into clothing

output.

and where all starred variables are defined in the same way but refer to the production process in

China.

Production of Steel

Trinidad China

Where

QS = quantity of steel produced in Trinidad measured in tons.

LS = amount of labor applied to steel production in Trinidad measured in labor-hours.

KS = amount of capital applied to steel production in Trinidad measured in capital-hours.

g( ) = the steel production function which transforms labor and capital inputs into steel output.

and where all starred variables are defined in the same way but refer to the production process in

China.

Production functions are assumed to be identical across countries within an industry. Thus both

Trinidad and China share the same production function f(.) for clothing and g(.) for steel. This

means that the countries share the same technologies. Neither country has a technological

advantage over the other. This is different from the Ricardian model which assumed that

technologies were different across countries.

A simple formulation of the production process is possible by defining the unit-factor

requirements.

Let,

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represent the unit-labor requirement in clothing production.

It is the number of labor-hours needed to produce a rack of clothing.

Let,

represent the unit-capital requirement in clothing production.

It is the number of capital-hours needed to produce a rack of clothing.

Similarly,

is the unit-labor requirement in steel production.

It is the number of labor-hours needed to produce a ton of steel.

And, is the unit-capital requirement in steel production. It is the number of

capital-hours needed to produce a ton of steel.

By taking the ratios of the unit-factor requirements in each industry a capital-labor (or labor-

capital) ratio can be defined. These ratios, one for each industry, represent the proportions in

which factors are used in the production process. They are also the basis for the model's name.

First, is the capital-labor ratio in clothing production. It is the proportion in which capital

and labor are used to produce clothing.

Similarly is the capital-labor ratio in steel production. It is the proportion in which capital

and labor are used to produce steel. It is said that steel production is capital-intensive relative to

clothing production if:

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This means steel production requires more capital per labor-hour than is required in clothing

production. Clearly, if steel is capital-intensive, clothing must be labor-intensive. Clothing

production is labor-intensive relative to steel production if:

This means clothing production requires more labor per capital-hour than steel production

Heckscher-Ohlin Model Assumptions - Fixed versus Variable Proportions

Two different assumptions can be applied in a Heckscher-Ohlin model: fixed and variable

proportions. A fixed proportions assumption means that the capital-labor ratio in each production

process is fixed. A variable proportions assumption means that the capital-labor ratio can adjust

to changes in the wage rate for labor and rental rate for capital.

Fixed proportions is a more simplistic and also less realistic assumption. However, many of the

primary results of the H-O model can be demonstrated within the context of fixed proportions.

Thus the fixed proportions assumption is useful in deriving the fundamental theorems of the H-O

model. The variable proportions assumption6 is more realistic but makes solving the model

significantly more difficult analytically7

Fixed Factor Proportions

Fixed factor proportions means that aKC, aLC, aKS, and aLS are exogenous to the model and are

fixed. Since the capital-output and labor-output ratios are fixed, the capital-labor ratios, and

, are also fixed. Thus, clothing production must use capital to labor in a particular proportion

6 Under variable proportions the capital-labor ratio used in the production process is endogenous. The ratio will vary

with changes in the factor prices. Thus if there were a large increase in wage rates paid to labor, producers would

reduce their demand for labor and substitute relatively cheaper capital in the production process. This means aKC and

aLC are variable rather than fixed. So as the wage and rental rates change, the capital output ratio and the labor

output ratio are also going to change. 7 Steven M. Suranovic (2006) “International Trade Theory and Policy”

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regardless of the quantity of clothing produced. The ratio of capital to labor used in steel

production is also fixed but is assumed different from the proportion used in clothing production.

Therefore, based on these assumptions, The Factor Endowment theory predicts the pattern of

trade between countries based on the characteristics of the countries. It says that a capital-

abundant country will export the capital-intensive good while the labor-abundant country will

export the labor-intensive good.

This is because, a capital-abundant country is one that is well endowed with capital relative to

the other country. This gives the country a propensity for producing the good which uses

relatively more capital in the production process, i.e., the capital-intensive good. As a result, if

these two countries were not trading initially, i.e., they were in autarky, the price of the capital-

intensive good in the capital-abundant country would be bid down (due to its extra supply)

relative to the price of the good in the other country. Similarly, in the labor-abundant country the

price of the labor-intensive good would be bid down relative to the price of that good in the

capital-abundant country.

Once trade is allowed, profit-seeking firms will move their products to the markets that

temporarily have the higher price. Thus the capital-abundant country will export the capital-

intensive good since the price will be temporarily higher in the other country. Likewise the labor-

abundant country will export the labor-intensive good. Trade flows will rise until the price of

both goods are equalized in the two markets.

The Factor endowment theory thus demonstrates that differences in resource endowments as

defined by national abundancies is one reason that international trade may occur

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Literature Review

This review will look at some of the existing literature on the fit of theory of Factor endowments

with the trade performance of a coutry. Much of the traditional empirical studies on the location

of production are based on the Heckscher-Ohlin theory. This theory can be seen as a combination

of the Rybczynski theorem with the assumption of identical preferences.

The Rybczynski theorem shows that as endowment of a given factor increases, the

country will increase production of the good that uses that factor intensively. For

example, suppose that China is relatively abundant in labour. An increase in labour

endowment will then have the effect of increasing the production of labour-intensive

goods such as textiles. Combining the results of the Rybcyznski theorem with identical

preferences across countries gives us the conclusion that countries will export goods

whose production are intensive in the factors that are relatively abundant in that

countries.

Traditionally, empirical work on the Heckscher-Ohlin theory has been carried out using trade

data. However, recently, there have been a number of papers that explored the implications of the

Heckscher-Ohlin model from the production side. Harrigan (1995) uses data from a group of

OECD countries to examine the importance of factor endowments to manufacturing. He finds

that endowments of capital are a source of comparative advantage for most industries while the

effects of endowments of skilled and unskilled labour on comparative advantage are ambiguous.

Part of the reason for the ambiguity of the results of skilled labour may be due to the fact that the

services sector is more skill-intensive than manufacturing. As a result, an increase in the

endowment of skilled labour will lead to larger services sector and relative contraction of

manufacturing. Harrigan (1997) expands on this result and shows that technological differences

are important in explaining the variation of output in a panel of OECD countries. Using a dataset

containing a mixture of both OECD and non-OECD countries, Harrigan and Zakrajsek (2001)

also find an important role for factor endowments in determining the location of production.

However, there is as yet limited consensus on the appropriate empirical proxy for measuring

resource abundance. Leamer (1984) argues that standard Heckscher-Ohlin trade theory dictates

that the appropriate measure is net exports of resources per worker. Though this measure has

15

been the basis for extensive research on the determinants of trade patterns (e.g., Trefler 1995,

Antweiler and Trefler 2002, Estevadeordal and Taylor 2002)

to date there has been essentially no

empirical work testing its impact on growth.8 Also, the Heckscher-Ohlin framework is

essentially static in that the classical world is characterized by a fixed level of technology for

each country (though it may be differential across countries). Hence the theory does not deal

with the dynamics of the creation of comparative advantage and the question of how comparative

advantage may change over time (Özçelik and Taymaz 2002).

Additionally, facts casually and not so casually collected seem to be adding up a convincing case

against the HO model. The first was Leontief’s (1953) troubling discovery that U.S imports in

1947 were more capital intensive than U.S exports. For several decades this blow to the HO

model was thought to have knock-out power but Learner (1980) showed that it missed the mark

because of a misreading of the theory. Bowen, Leamer and Sveikauskus (1987) did not intend to

attack the HO model but, although doing the correct calculation, found what seems to be

disappointingly small association across countries between factors embodied in traded and factor

supplies. Another critique was provided by the Grubel and Lloyd (1975), who cataloged the

surprising amount of two-way trade in even finely disaggregated trade data. Furthermore, trade

among the industrial countries has apparently become more similar in their factor endowments9

Despite these criticisms, there is still some support of the theory. Recent research (Wood, 1994;

Aldaz-Carroll, 2002) shows that H-O theory has a lot of explanatory power if its domain is

restricted to broad product categories (rather than specific goods, for which scale economies are

often the main determinant of trade) and if capital – physical and financial – is excluded from the

list of production factors, because of its international mobility. Keesing (1966) calculated simple

correlations of US export performance with skill intensities. The largest positive correlations

occurred at the highest skill levels, while export performance was negatively correlated with the

unskilled labor share.

8 It is worth mentioning that the cited references show that the H-O model of factor endowments performs relatively

well for natural resources net exports, but it performs less well for manufactures. 9 Leamer (1995) “the Heckscher-Ohlin Model in Theory and Practice”

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Case Study Trinidad and Tobago

Importance of Trade In Trinidad and Tobago

To begin our analysis, we outline the importance of trade to the twin island of Trinidad and

Tobago. In this dual economy, external trade plays a dominant role. One way of illustrating this

is by looking at the value of Trinidad and Tobago’s external transactions relative to its total

output, a measure referred to as trade openness. Trinidad and Tobago displays a high degree of

openness10

Another way of illustrating the importance of trade in the national economy is by looking at how

trade flows affect the country’s balance of payments. Trade surpluses recorded for the period

2001-2005 had an immediate and positive effect on the current account.11

This has also resulted

in considerable increases in the official reserves of the country. It is clearly evident therefore that

Trinidad and Tobago has maintained a healthy export performance so that exports exceed

imports consistently.

It is important to establish from the outset, that Trinidad and Tobago is endowed with vast

amounts of energy resources (See Appendix 1). As discussed below, the petroleum sector,

which emerged based on these resources, constitute a significant part of the country’s exports.

However, energy prices are very volatile in the world market and, as a result, a downward trend

in these prices affect the country’s main export commodities, oil and gas, and could easily wipe

out the existing trade surplus, pushing the current account into a deficit. Over the period 2001-

2005 however, oil prices have manifested an upward trend.11

In 2005, the external current

account strengthened to the equivalent of 18.5 percent of GDP, reflecting higher export volumes

and record prices for oil and petrochemicals.

10

Its Trade/GDP Ratio (exports plus imports of Goods and Services divided by GDP) is close to 100 percent one of

the highest in the Western Hemisphere. Calculation are based on IMF-DOTS and IMS, and World Bank-WDI 11

See Balance of Payments 2005 in Appendix

17

Merchandise Trade12

Recent Trends

Over the past decade, Trinidad and Tobago’s merchandise trade has been characterized by strong

growth and volatility. Between 1990 and 2004, exports grew by an average of 10.6 percent a

year, faster than the 7.2 percent growth in world trade. Export growth, while significant in

overall terms, fluctuated wildly over the period (from –18 percent in 1996 to +73 percent in

2003). Import growth averaged 10.9 percent a year, and fluctuated almost as strongly (from +62

percent in 1995 to –14 percent in 2000). Such volatility is mainly related to variations in

international fuel prices. Figure 1 illustrates the country’s vulnerability to such price shocks.

Figure 1: Merchandise Trade 1990 - 2004

Source: IDB Integration and Regional Programs Department using IMF-DOTS.Note: 2003–2004 are IMF estimates.

Trinidad and Tobago relies heavily on the United States as a destination for its merchandise

exports. Between 2000 and 2004, nearly 60 percent of its exports went to the U.S. As regards

other export destinations, there is a clear trend toward a growing concentration on regional

markets. Over the past decade, the country has more than doubled its exports to the Caribbean

Community (CARICOM), taking advantage of opportunities offered by preferential access to

that market. Since 2000, exports to CARICOM have averaged 19 percent of total exports, up

from 12 percent in 1990. Today, Trinidad and Tobago exports more than twice as much to

CARICOM as to the European Union (EU) and more than 10 times what it sends to Canada.

12

Despite recent growth in its services trade, Trinidad and Tobago differs from most other Caribbean Islands in that

goods still account for the bulk of its external trade (85 percent of total trade and an equal share of its exports) as

such, these would be discussed in great detail

18

Latin American countries absorb about 9 percent, while sales to the rest of the world have

declined in both absolute and relative terms. Import sources are more diversified, with about 31

percent from the U.S., 24 percent from Latin America, 21 percent from the EU, and 19 percent

from the rest of the world. CARICOM and Canada each supply less than 3 percent of Trinidad

and Tobago imports13

Exports

Product and Sector Composition

Despite recent attempts at export diversification, oil and gas account for about 60 percent of

Trinidad and Tobago’s total exports (average for the 2000–03 period) (Figure 2)14

Over the last

decade, that share has not declined appreciably; trends in international fuel prices, to a great

extent, have explained annual variations. Manufactured goods increased their share in total

exports from 30 percent in 1990–93 to 34 percent in 2000–03. Most of these exports are natural-

gas-based products (ammonia, methyl alcohol and urea). Sector diversification has remained

limited; in 2003, for example, only six products accounted for 66 percent of the value of total

manufactured exports. Food products, accounting for 5 percent of total exports, grew by only 2

percent in 2000–03. The share of agricultural raw materials and ores and metals in total exports

was negligible

Figure 2: Sector Composition of Exports 1990-2003

13

Source: IDB Integration and Regional Programs Department 14

Throughout the analysis period averages were mostly used since, in the context of strong year-to-year fluctuations

in fuel prices and thus export income, they represent trends more accurately than do single years.

19

Fuels dominate sales to all of Trinidad and Tobago’s major export destinations, accounting for

nearly 66 percent of exports to the U.S. and 50-60 percent of exports to CARICOM, Latin

America, and the EU.15

There are, however, notable variations in the sectoral composition of

exports to each of these markets. Food exports, for example, account for a larger share of exports

to CARICOM (17 percent) and the EU (8 percent) than to the U.S. (1 percent). Conversely,

manufactured goods account for a larger share of sales to the U.S. and EU (35 percent) than to

CARICOM (25 percent).

Of the more than 2,000 products Trinidad and Tobago exported during 2001–03, the top 20

Accounted for 84 percent of total exports (in value terms); 10 of them were fuel products (Table

1). Aside from the effects of fluctuating commodity prices, the share and composition of the top

20 in total exports has remained constant over the years. The share is somewhat lower (72

percent) in exports to CARICOM, where the top-20 list includes a number of food and

manufactured items that are not among the main products exported to the world

15

According to the Balance of Payments 2005 the energy sector comprising exploration and production, refining

and the production of petrochemicals, account for a significant 85.9% of merchandise export receipts and 42.9 and

46.1 % of GDP and government revenues respectively in that said year.

20

Table 1: Top 20 Exports to the World and Caricom, 2001-2003

Source: IDB Integration and Regional Programs Department, Using UN-Commodity Trade Statistics Database

As a result of the large share of energy reserves, the island has attracted significant amounts of

foreign direct investment in the sector from multinational companies.16

The Petroleum Company

of Trinidad and Tobago Limited (PETROTRIN), a wholly state-owned integrated oil company,

is involved in a large range of petroleum-related activities17

, Its refinery in Point-a-Pierre

processes 160,000 barrels of oil per day (bopd), sourcing additional crude from Venezuela,

Brazil and other suppliers. The company exports 85% of its refined products with the balance

being used up locally.18

On the matter of natural gas, Trinidad and Tobago has benefited significantly from these natural

mineral reserves, with benefits being passed on to the local companies and the export market. In

2005, natural gas production averaged 3,219 million cubic feet per day (mmcf/d). The LNG

industry accounted for 49.2 percent of total usage, followed by the ammonia industry (16.5

percent), the methanol industry (12.4 percent) and power generation (7.6 percent). The remainder

16

These include British Petroleum (BP), British Gas (BG), Repsol, Petro Canada and Atlantic LNG 17

Including: exploration, development and production; transportation from the oilfields to its refinery; purchase of

crude oil on the international markets; manufacturing; and services including third-party crude oil processing 18

Petro Connect Corporate News at a glance, Pg 52, December 21st 2005.

21

was absorbed by the iron and steel industry and other small consumers. The United States market

claimed the largest share of LNG exports (89.6 percent), with a further 4.6 percent going to

Puerto Rico, 3.6 percent to Spain and 1.6 percent to the Dominican Republic. The market for

Trinidad and Tobago’s LNG exports expanded during the year to include Belgium which

received its first shipment of LNG from this country.

Existing data indicates that approximately 99 percent of natural gas liquids produced each year is

exported with the remaining 1 percent being utilized locally. Clearly, we see the factor

endowment theory holding true in the case of this twin island thus far, as evidence has shown

thus far that our major exports (fuels) are goods from existing resources that are abundant.19

As was noted previously, manufactured goods account for a growing share in the nation’s export

market. In the 1980s, the manufacturing sector was supposed to have contributed towards the

structural transformation of the country away from petroleum and sugar. Today however,

statistics reveal that the greater proportion of these exports are still linked to the petroleum sector

in the form of natural gas-based products namely, nitrogenous fertilizers, ammonia, methyl

alcohol and urea.

The industries which correspond to this list of activities will be considered as manufacturing

industries, and when taken all together, will be called the manufacturing sector. They are enlisted

as follows:

Food, Beverages and Tobacco

Textiles, Garments and Footwear

Printing, Publishing etc

Wood and Related Products

Chemicals and Non-Metallic Materials

Assembly type and Related Industries

Miscellaneous Manufacturing

19

Appendix 2 shows this clearly

22

Returning to the theory which forms the basis of our study; the factor proportions theory states

that countries produce and export goods that require resources (factors) that are abundant.

Considering that the cost of any resource is simply the result of supply and demand, ceteris

paribus, then the factors in great supply relative to demand will be less costly than factors in

short supply relative to demand. This simple analysis forms the foundation for the rapid growth

of the manufacturing sector in the country.

The abundance of natural gas in the country has resulted in this energy resource being regarded

as relatively cheaper or less costly for manufacturers in this country as compared to

manufacturers in other Caribbean islands. Consequently, the number of manufacturing plants

seeking to take advantage of this reduced-input-cost advantage is great and is expected to

increase in years to come.20

The latest development in this area has been marked by

government’s initiative to allow the setting up of 2 Aluminum Smelter Plants (Alcoa and

Alutrin) in the southern part of the island, near the major energy resources. The process of

processing the chemical alumina into aluminum requires significant amounts of energy and so,

locating these plants where energy sources are abundant reduces cost and will in effect, increase

exports for the country.

In 2005, production and exports of methanol increased significantly, reflecting the coming-on-

stream of two of the largest methanol plants in the world. The first of these plants, Atlas

methanol facility came on stream in 2004 with the second, M5000 starting operations in 2005.

The addition of these two plants pushed domestic production up to a capacity of 6.4 million

tonnes per year, cementing our position as the number one exporter of methanol.

Ammonia production is also very considerable to the economy and to export performance, with

the operation of nine ammonia plants in the country. In the case of exports of nitrogenous

fertilizers and urea, these average 92 percent and 98 percent of production respectively. With

regards to the production of iron and steel products, exports over the period 2001-2005 constitute

an average of 60 percent of production, with the balance of production used in local

consumption.

20

See Table 4 for a list of existing gas-based plants for the year 2005.

23

In addition to the manufacture and export of chemicals and other natural gas-based products, the

production and export of beverages and tobacco play a major part in the attainment of trade

surpluses in the economy over extended periods in previous years. Exported products such as

juices and soft drinks manufactured by SM Jaleel and Co.; beers such as Carib and Stag

manufactured by Carib Brewery Ltd.; and alcoholic beverages (including the renowned

Angostura’s Bitters) made by Angostura Ltd. are just a few of the manufactured items that can

be seen on the shelves of stores outside of Trinidad and Tobago. Exports in this category of

manufacturing activity exceed import demand by approximately four times, thereby creating a

favourable trade balance in this area.21

The Sugar Industry could also be used as an example of the relationship between a country’s

exports and imports and its factor endowments. In the 70’s, an examination of the island would

prove that Trinidad had the potential to be one of the most economically viable of all West

Indian Islands. Its size, fertility and geographical location were all in its favour.22

Exports of

sugar to the United States, Europe and other external markets generated additional revenue to the

economy for years and thus served as a complement to the rich oil sector. For the year 2000,

exports reportedly brought in foreign exchange earnings equivalent of TT$243.6 million.

However, the decline of the sugar industry was eminent.23

Attributing to the demise of the sugar

industry were factors such as the high cost of operations, the erosion of protection in the

European Union (EU) which has resulted in reductions in preferential prices. Clearly Trinidad

and Tobago could not compete with countries whose factor endowments consisted of land and

Capital (machinery) as such could produce sugar much cheaper. And applying the factor

endowment theory here, we began to import sugar because the endowments necessary for low

cost manufacture, and supply was not available.

Imports

Trinidad and Tobago’s factor endowment would relate to the amount of resources that this

country possesses and can exploit. Our imports are based on the need for goods and services

which we cannot supply due to the lack of technology, machinery, and merely because of

21

One Possible reason for the success of this aspect of manufacturing activity is the availability sugar and

subsidized fuel prices to operate machinery. 22

Note: most Caribbean Islands including Trinidad and Tobago were given preferential treatment 23

The Annual Economic 2002 reported the sugar industry as being uncompetitive and unviable.

24

sociological factors which affect customers such as changes in individuals’ income and lifestyles

and subsequent changes in demand.

The United States accounts for significant percentage of imports to Trinidad and Tobago.

Existing data24

shows that 27.2% of total imports came from the US during the period January to

February 2006. 11.4% or TT$615 million came from Brazil, 8.6% or TT$464 million came from

Colombia and 6.8% or TT$367 million came from Gabon. But what exactly does this country

import?

According to the World Fact Book (2005), the major imports to Trinidad and Tobago include

machinery, transportation equipment, manufactured goods, food and live animals

It is important to note that motor vehicle imports and imports of oil and gas equipment have

contributed towards a major portion of Trinidad and Tobago’s import bill for the period 2003 to

2005. During this period the total import bill of automotive parts and service equipment

increased by 10 percent. Trinidad and Tobago also imports a significant amount of Crude Oil;

the Leontief Paradox may appear to have some weight here this is because, Trinidad and Tobago

is significantly endowed with mineral resources yet it imports crude oil, mineral fuel and

lubricants. Upon further investigation we see that Trinidad and Tobago is actually utilizes

imported crude oil along with domestic supplies in the production process so as to create refined

petroleum this is exported25

The petrochemical sector is the greatest contributor to Trinidad and Tobago’s Gross Domestic

Product. US investors have sought to capitalize on this area by exporting line pipe used for oil or

gas, drill pipe, casings and tubing for drilling, parts for gas turbines, pumps and parts for filling

station pumps. Machinery for liquefying air or other gases and filtering or purifying machinery

are also in great demand in Trinidad and Tobago.

The expansion of the Telecommunications Services of Trinidad and Tobago, together with the

additional six Internet providers, the already existing competition in the cable service provision,

24

The Central Statistical Office (CSO) Trade Bullent Vol. 12 No. 363 25

See Appendix 2

25

radio broadcasting and satellite services, has created the increase in the need for

telecommunications equipment. There are now two cellular operators in business in this country.

Imports to this sector were valued at US$16m in 2003 and more than doubled to US$38m in

2004. 2005 saw and increase to US$40.1m.

Businesses in Trinidad and Tobago have recognized the need to automate their operations hence

the increase in computer and peripheral purchases. Computers are also used by individuals in

their homes, in schools and in libraries. Many financial institutions have provided special loans

to facilitate such purchases. Computer and peripheral imports rose from US$47.7m to

US$51.1m during the period 2003 to 2005.

There is a major construction boom in Trinidad and Tobago. Residential homes, industrial

buildings, and new office buildings are being erected during this major thrust. Imports of

construction equipment have risen from US$36m to US$38.1m from 2003 to 2005.

The food import bill for Trinidad and Tobago is very significant. In 2003 for example, Trinidad

and Tobago’s total agricultural imports were $352m of which consumer oriented fish and

seafood products comprised roughly 57. Moreover, this country only supplies 30 percent of rice

domestically; the other 70 percent is imported.

Services Trade

In Trinidad and Tobago, unlike other Caribbean islands, services still account for a relatively

small share of total exports (12 percent) and GDP (7 percent).26

These shares have fluctuated

considerably over the years, with no apparent upward trend. Despite moderate growth in the past,

services constitute an important source of export revenue and jobs, with significant potential.27

Recent Trends

During the 1990–2003 periods, services exports grew at an average annual rate of 5.8 percent in

value terms, just below the world’s average rate of 6.5 percent.28

Over the period, annual growth

26

This estimate is based on data from the IDB Regional Programming Paper of CARICOM and the U.S. Trade

Representative’s Fourth Report on the CBI (for exports to the U.S) 27

Unfortunately, scarcity of reliable services data-resulting from a system deficient in data collection and

dissemination, severely limits the scope of analysis on services trade. 28

Derived from WTO databases

26

rates fluctuated significantly. The importance of certain sectors within the country’s services

portfolio has changed over time. From 1990–95 to 2000–03, the share of transportation earnings

in total services exports declined from 50 to 35 percent. The cause was not a drop in earnings,

but strong growth in travel services, which increased their participation in services exports from

24 to 37 percent. Over the period, commercial and government services maintained their

respective shares of approximately 25 and 4 percent (Figure 3).

Travel Sector: Tourism, Education, and Health

Figure 3 also shows, the importance of travel in total services exports is growing. In 1995–2003,

travel earnings increased by an average of 16 percent a year, compared to about 3 percent for

transportation and commercial and government services. Receipts from personal travel tripled,

reaching US$ 200 million in 2003; business travel grew at a slower rate. Over the period, 50

percent of all tourist arrivals were from the U.S. and Canada, 22 percent from the Caribbean, and

20 percent from Europe.

Figure 3: Services Exports by Area (1990-2003)

Such strong growth in travel receipts is partly a result of concerted efforts to develop the

country’s tourism industry. Additionally, in relation to factor endowments, as a tourism

destination, Trinidad and Tobago has much to offer. The small country boasts a wealth of natural

and cultural resources, with Trinidad serving as an internationally renowned centre for music and

27

dance, and Tobago offering some of the Caribbean’s most pristine beaches and some of the best

diving locations. More than 430 species of birds can be found on the two islands and Tobago is

home to the oldest protected rainforest in the Western Hemisphere. The island is also

internationally recognized for its drift dives- its seas are home to 300 species of South Atlantic

coral and a variety of multicolored fish.

In 2005, Travel and Tourism services and merchandise exports for Trinidad and Tobago totaled

approximately TT$9.7 billion, or US$1.5 billion (34 percent by visitors, 66 percent by exported

consumer and capital goods). The World Travel and Tourism Council (WTTC) reported that

over the past 15 years, the gains for Travel and Tourism Visitor Exports in Trinidad and Tobago

have been impressive. The report continues by acknowledging that over the total 16 year period,

(1988-2004), Trinidad and Tobago’s Visitor Exports have grown by 86 percent in real terms.

Over the next nine years, these exports are expected to grow by a strong 7.2 percent per annum,

Travel and Tourism Merchandise Exports (non-visitor exports) are also expected to show healthy

growth at 5.1 percent per annum. This can be shown in Figure 4 below.

Figure 4: Travel and Tourism Exports (Cumulative Real Growth, %)

Source: World Tourism Council 2004

Trinidad and Tobago’s travel sector also has growth potential in education and health-related

services. The St. Augustine campus of the University of the West Indies attracts many student

visitors to Trinidad. While earnings from student travel have been marginal in recent years, there

is potential to attract additional regional and extra-regional tertiary-level students. The health-

28

services industry also has growth potential, given the country’s proximity to North American

markets, favorable climate, educated work force, well-developed domestic health infrastructure,

and well-trained health practitioners (World Bank 2005).

Transportation Sector: Air and Maritime

Between 1990 and 2003, transportation services exports grew moderately, at 3 percent a year.

Passenger fares were the largest contributor to earnings, representing an average of 80 percent of

transportation and 33 percent of total services exports. A major player in the regional airline

market at the time was Trinidad and Tobago’s national carrier, British West Indian Airways

(BWIA).29

The maritime transport sector is also important, given Trinidad and Tobago’s large

export-oriented energy and chemical industries and its geographical location as a trans-shipment

point.

Commercial Sector: Communications, Financial, and Insurance Services

Trinidad and Tobago’s commercial-services export has proven vulnerable in recent years. A

healthy 12-percent annual growth rate in 1990–99 gave way to stagnant growth over the next

five-year period. This weak performance is primarily attributed to the communications sector,

particularly to adjustments in the accounting rate used for incoming telephone calls. Exports of

communications services increased by 10 percent a year, reaching US$ 110 million in the late

1990s; subsequently, they dropped significantly, now accounting for about US$ 35 million in

annual earnings.

The prospects for financial and insurance services are better. In Trinidad and Tobago, although

data on the country’s trade in financial services is not readily available, there are indications that

this sector is an important player in both domestic and regional markets. Insurance is an

increasingly important segment of the country’s services-sector portfolio. Among the services

sectors, exports of insurance services performed best, growing fivefold over the last decade. In

2000–03 alone, earnings from insurance services accounted for over half of all commercial-

services exports, growing by an average of 33 percent per year.

29

Note: This Airline went out of Operation in January 2007 and was replaced by Caribbean Airlines.

29

Implications, Conclusions and Recommendations

The concept of comparative advantage hinges on the endowments of factor inputs available in a

given country: labor, capital, and natural resources. Many countries and businesses have tried to

compete by undercutting each other’s labor costs or exploiting and creating vulnerable reliance

on commodities and natural endowments. In an increasingly global economy, factor inputs have

become less important as sources of productivity and sustained growth. Countries are no longer

constrained by their factor inheritance in creating competitive firms and environments; thus,

competitive advantage no longer rests on a country’s natural endowments but on its ability to

create a business environment, along with supporting institutions that allow the nation’s inputs to

be used and upgraded in the most productive manner (Porter 1990).

Trinidad and Tobago lacks successful firms that innovate, upgrade, and export complex products

by staying abreast of customers’ needs. Such competitive firms can charge premium prices for

their products, which they can then invest in workers’ skills. They can, in turn, pay workers

higher salaries, leading to a virtuous cycle of national prosperity. Like the energy industry itself,

Trinidad and Tobago’s manufacturers have used their comparative advantage to generate

income. But they have not built the types of products and brands that can lead to wealth in the

absence of comparative advantage.

One noteworthy example is Hydro Aluminum, a local smelter that produces alumina from

bauxite extracted from nearby Guyana. In this case, the comparative advantages are location and

cheap energy. Yet the smelter’s production is exported before any downstream products are

made. Many such products could be re-sold to locally operating energy companies, creating a

competitive advantage. Applying the factor endowment theory here, yes the country is exporting

its abundant resources but, it is not developing the resources so as to maximize returns.

Upgrading the competiveness of a nation’s export competitiveness requires a shared

understanding of competitiveness within the nation. Competitiveness is not simply a favorable

exchange rate, a positive trade balance, or low inflation. Rather, competitiveness is determined

by the productivity with which resources are deployed: human, capital, and physical assets. Since

competitiveness relies on the productive deployment of resources, industry sectors and their

30

firms, not nations, compete. More accurately, clusters of related and supporting firms constitute

the building blocks of a competitive economy (Fairbanks and Lindsay 1997).

Ironically, the scale of Trinidad and Tobago’s comparative advantage may have stunted

development of its potential competitive advantage. Trinidad and Tobago’s non-energy

manufacturers, which contribute seven percent of the country’s GDP,30

have succeeded in

exporting to their less efficient Caribbean neighbors. While the country’s per-capita income has

grown beyond that of its larger neighbors, its other cost advantages, including low energy prices

and import duties used to safeguard the manufacturing sector, have allowed Trinidad and Tobago

manufacturers to export basic goods at well below the cost of production. The national business

model is simple: import raw materials, manufacture low value-added goods far less expensively

than neighboring countries, and export those goods to substitute for equally low value-added

goods locally produced.

While depletion of oil or gas is not an imminent threat, it is understood that even the largest

reserves will eventually dry up. In fact, the interim sense of economic security derived from this

oil and gas windfall has created complacency at the expense of physical and social capital

depletion; in fact, Trinidad and Tobago has been decapitalizing the country by converting natural

resources to currency. Still more troublesome, fluctuating energy prices and substitutes make

Trinidad and Tobago’s much enjoyed stability largely dependent on external conditions.

Indeed, the nation’s increased dependence on energy resources through recently discovered

natural gas means that any price shock would be disastrous to the economy. It took the country

more than a decade to recover from the last shocks. At present projections, energy reserves will

be exhausted in 20 years. In this pressing context, it is in the nation’s best interest to act swiftly

to transform its economy by channeling oil and gas rents into sustainable endeavors that will

ultimately insulate the country against future swings of fortune.

Trinidad and Tobago’s biggest trade challenge is to maintain high export growth. Given that

most of the country’s exports are now based on its endowment of finite energy reserves, the only

way to achieve sustainable export growth into the future is through export diversification into

30

International Financial Statistics (IFS)

31

non-fuel activities. Diversification efforts should mainly target products and services that face

growing worldwide demand. This goes against Factor endowment theory which says to export

resources that are in abundant. However, Trinidad and Tobago’s abundant resources are finite

and as such, this country must seek to develop other sectors of the economy so as to insulate

itself from in changes in internal or external conditions.

Diversifying into products embedded with insight requires building superior industry structures

and product traits that cater to sophisticated customers. Superior industries are characterized by

low rivalry and high demand, while weak ones have the opposite traits. At the same time,

attractive products embody customer needs; they usually weigh less and are well branded and

they are attractive to price insensitive customers. Insight, brand, and focus are the building

blocks of world-class strategies Porter (1990)

In this context, Trinidad and Tobago has a long road ahead to fully achieve its competitive

advantages. Economic growth and prosperity have centered on natural-resource extraction.

Business development has focused on oil and gas extraction and exploitation of readily available

resources, without any effort to upgrade inputs or reach more sophisticated consumers. The few

industries that have developed outside the oil and gas sector remain largely entrenched in the

same pattern: reliance on low labor costs, production of commodity products, and dependence on

the lingering artificial advantages from an import-substitution model that the Government

followed years ago. In many cases, domestic producers assume that advantages in natural

resources and cheap labor will win them leading positions in export markets. However, today’s

successful nations create wealth by exporting products and services that embody insight into

customer needs, technologies and processes, distribution channels, and relative competitive

positions and not necessarily on abundant resources as put forth by the factor endowment

theory.

32

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33

Appendix 1: Trinidad and Tobago: Structure of the Energy Sector 2003

34

Appendix 2: Trinidad and Tobago: Sources and Uses of Energy Resources