The Demand for LDC Exports of Manufactures: Estimates from Hong Kong: A Comment

Abstract

In the March I 988 issue of this JOURNAL, Riedel claims that the findings of relatively low price elasticity of demand by 'the bulk of time series work' are based on the assumption of infinite price elasticity of export supply and that the demand parameters derived from a fully specified, simultaneous equation model strongly contradict the consensus view (on the basis of his results suggesting infinitely price elastic demand for exports of manufactures from Hong Kong). In this Comment, both of his claims and his results are disputed. The author's conclusion concerning infinite price elasticity of demand for exports can be objected to on at least three grounds: First, in the context of his formulation, it implies an abnormally large degree of 'money illusion' on the part of the importers of manufactures. Second, in using the inverse form of the demand function rather than the normal form he would necessarily produce a much larger estimate of price elasticity than otherwise. Using his approach, one can quite easily produce an estimate of the marginal propensity to consume in excess of unity or an implausibly large estimate of the marginal propensity to save. Third, infinite price elasticity is inferred from the statistical nonsignificance of the coefficient of export quantity in the inverse form of demand (which represents the inverse of price elasticity). However, it can be argued that the estimate of the coefficient of export quantity is not statistically significant because of the high intercorrelation (multicollinearity) between quantity and income. In view of the obvious upward bias involved in his approach to the estimation of price elasticity of export demand, it is not only possible but also most probable that the adoption of his approach will also yield very high estimates of price elasticities of demand generally. It is conceivable that one can produce a highly elastic demand for primary exports not only at individual country level but also at the world level, using his approach. If LDCs wrongly believe that demand for their primary exports is price elastic when in fact it is not, unwarranted expansion of production could cause a significant fall in their export earnings with grave consequence for their economic development. It is therefore most important to point out the weaknesses of his approach before it is widely adopted by other researchers keen to get high price elasticities of demand.