BUS606: Operations and Supply Chain Management

The conventional definition of the RCA measure was first proposed by Balassa. Export RCA of country j's sector k is defined as the share of exports (X) of sector k in j's total exports relative to the world average share of the same sector k in world exports as follows:

$R C A_{j}^{k}=\left(\frac{X_{j}^{k}}{\sum_{k=1}^{K} X_{j}^{k}}\right) /\left(\frac{\sum_{i=1}^{G} X_{i}^{k}}{\sum_{k=1}^{K} \sum_{i}^{G} X_{i}^{k}}\right)$, where country $i, j=1,2, ..G ;$ sector $k=1,2, ..K$

where G is the total number of countries in the world. The RCA measure has been used extensively in the literature to measure the competitiveness of a country in a particular sector. When the RCA exceeds one, the country is deemed to have a revealed comparative advantage in that sector; when it is below one, the country is deemed to have a revealed comparative disadvantage in that sector. 

Koopman, Wang, and Wei and Wang, Wei, and Zhu point out that the traditional RCA ignores both domestic production sharing and international production sharing. First, it ignores the fact that a country-sector's value added may be exported indirectly via the country's exports in other sectors. Second, it ignores the fact that a country-sector's gross exports partly reflect foreign content.  A conceptually correct measure of comparative advantage needs to exclude foreign-originated value added and pure double counted terms in gross exports, and to include indirect exports of a sector's value added through other sectors of the exporting country. When a country uses imported intermediate goods intensively to produce for its exports, Koopman, Wang and Wei show that RCA based on gross exports can be misleading. The problem of double counting of certain value added components in the official trade statistics suggests that the traditional computation of RCA could be noisy. The gross export decomposition method suggested by Koopman, Wang, and Wei provides a way to remove the distortion of double counting by focusing on domestic value-added in exports. Following Wang, Wei, and Zhu, we calculate RCA based on domestic valued added (DVA) in gross exports, rather than gross exports, for country i in sector k as follows $(i=1,2, \ldots, \mathrm{G}; k=1,2, \ldots, \mathrm{N})$. 

$R C A_{k}^{i}=\left(\frac{D V A_{k}^{i}}{\sum_{k=1}^{N} D V A_{k}^{i}}\right) /\left(\frac{\sum_{i=1}^{G} D V A_{k}^{i}}{\sum_{k=1}^{N} \sum_{i=1}^{G} D V A_{k}^{i}}\right)$

The above new RCA measure is the share of a country-sector's forward linkage-based measure of domestic value added in exports in the country's total domestic value added in exports relative to that sector's total forward linkage-based domestic value added in exports from all countries as a share of global value added in exports. The domestic value added (DVA) in gross exports in the above formula is the sum of value added exports (VAX) and returned domestic value added consumed at home (RDV). Because it describes the characteristics of a country's production or total domestic factor content in output, it does not depend on where the output is absorbed. By comparison, VAX are produced at home but ultimately absorbed abroad. For those applications in which a production-based RCA is the right measure as in this paper, we should use DVA in exports rather than VAX to compute RCA. 

In addition, RCA based on gross exports (the dependent variable) can cause an endogeneity problem because the embodied services (an explanatory variable) are part of gross manufacturing exports. In our paper, manufacturing RCA is based on the value added by the factors employed in manufacturing sectors, not including the embodied services in gross exports which are contributed by the factors employed in services sectors, so our approach is free from the above-mentioned endogeneity problem. Intuitively, we focus on how services help factors employed in manufacturing sectors to create value by improving their productivity, reducing costs, or both.