International Trade International Trade and Economics and Economics DevelopmentDevelopment

Important conceptsImportant concepts Endogenous growth theoryEndogenous growth theory Single factoral terms of tradeSingle factoral terms of trade Double factoral terms of tradeDouble factoral terms of trade Export instability Export instability Import substitution industrializationImport substitution industrialization Export oriented industrialization Export oriented industrialization International commodity agreementsInternational commodity agreements Buffer stocksBuffer stocks Purchase contractsPurchase contracts Vent for surplusVent for surplus

IntroductionIntroduction Know the contributions of trade to Know the contributions of trade to

developmentdevelopment Discuss international trade and Discuss international trade and

endogenous growth theoryendogenous growth theory Discuss the various terms of trade and Discuss the various terms of trade and

reasons for their deteriorationreasons for their deterioration Analyze the cause and effects of export Analyze the cause and effects of export

instabilityinstability Discuss how to develop economy thru Discuss how to develop economy thru

import substitution or export promotionimport substitution or export promotion

Trade Theory & Economic Trade Theory & Economic DevelopmentDevelopment

Traditional trade theory---comparative Traditional trade theory---comparative advantageadvantage

Developing nations believe that this pattern Developing nations believe that this pattern of specialization and trade makes them into a of specialization and trade makes them into a subordinate position and keeps them from subordinate position and keeps them from reaping the dynamic benefits of industry and reaping the dynamic benefits of industry and maximizing their welfare in the long run. maximizing their welfare in the long run.

The dynamic benefits are a more trained The dynamic benefits are a more trained labor force, more innovations, higher and more labor force, more innovations, higher and more stable prices for the nation's exports, and stable prices for the nation's exports, and higher income for its people.higher income for its people.

Traditional trade theory may maximize Traditional trade theory may maximize welfare at one point in time but not over time. welfare at one point in time but not over time.

Developing nations demand changes in the Developing nations demand changes in the pattern of trade and reform of the present pattern of trade and reform of the present international economic system to take into international economic system to take into consideration their special development needs.consideration their special development needs.

Contributions of Trade to Contributions of Trade to DevelopmentDevelopment

Trade can lead to the full utilization of Trade can lead to the full utilization of otherwise underemployed domestic otherwise underemployed domestic resources. That is, through trade, a resources. That is, through trade, a developing nation can move from an developing nation can move from an inefficient production point inside its inefficient production point inside its production frontier, with unutilized production frontier, with unutilized resources because of insufficient resources because of insufficient internal demand, to a point on its internal demand, to a point on its production frontier with trade. production frontier with trade.

By expanding the size of the market, By expanding the size of the market, trade makes possible division of labor trade makes possible division of labor and economies of scale. and economies of scale.

International trade is the vehicle for the International trade is the vehicle for the transmission of new ideas, new transmission of new ideas, new technology, and new managerial and technology, and new managerial and other skills. other skills.

Trade also stimulates the international Trade also stimulates the international flow of capital from developed to flow of capital from developed to developing nations. With FDI, the foreign developing nations. With FDI, the foreign capital is likely to be accompanied by capital is likely to be accompanied by foreign skilled personnel to operate it. foreign skilled personnel to operate it.

In large developing nations, the In large developing nations, the importation of new products has importation of new products has stimulated domestic demand until stimulated domestic demand until efficient domestic production of these efficient domestic production of these goods become feasible. goods become feasible.

International trade is an antimonopoly International trade is an antimonopoly weapon because it stimulates greater weapon because it stimulates greater efficiency to meet foreign competition. efficiency to meet foreign competition.

International Trade and Endogenous International Trade and Endogenous Growth TheoryGrowth Theory

It believes that lowering trade barriers will speed up It believes that lowering trade barriers will speed up the rate of economic growth and development in the the rate of economic growth and development in the long run by:long run by:

(1) allowing developing nations to absorb the (1) allowing developing nations to absorb the technology developed in advanced nations at a technology developed in advanced nations at a faster rate than with a lower degree of openness, faster rate than with a lower degree of openness,

(2) increasing the benefits that flow from R&D,(2) increasing the benefits that flow from R&D,(3) promoting larger economies of scale in (3) promoting larger economies of scale in

production, production, (4) reducing price distortions and leading to a more (4) reducing price distortions and leading to a more

efficient use of domestic resources across sectors,efficient use of domestic resources across sectors,(5) encouraging greater specialization and more (5) encouraging greater specialization and more

efficiency in the production of intermediate inputs, efficiency in the production of intermediate inputs, and and

(6) leading to the more rapid introduction of new (6) leading to the more rapid introduction of new products and services. products and services.

Terms of TradeTerms of Trade 1. The commodity, or net barter, terms of 1. The commodity, or net barter, terms of

trade (N) :trade (N) : It is the ratio of the price index of the It is the ratio of the price index of the

nation's exports (Px to the price index of its nation's exports (Px to the price index of its imports (Pm) multiplied by 100 (to express imports (Pm) multiplied by 100 (to express the terms of trade in percentages). That is: the terms of trade in percentages). That is:

N= (Px/Pm)100 N= (Px/Pm)100 2. Income terms of trade (I) :2. Income terms of trade (I) : They are given by: I= (Px/Pm) Qx They are given by: I= (Px/Pm) Qx 3. Single factoral terms of trade (S):3. Single factoral terms of trade (S): They are given by: S = (Px/PM) ZxThey are given by: S = (Px/PM) Zx 4. Double factoral terms of trade (D),4. Double factoral terms of trade (D), They are given by: D = (Px/Pm)(Zx/Zm) They are given by: D = (Px/Pm)(Zx/Zm)

100100

Change of Terms of TradeChange of Terms of Trade Of the four terms of trade defined, N, I, and S are Of the four terms of trade defined, N, I, and S are

the most important. D does not have much the most important. D does not have much significance for developing nations and is very significance for developing nations and is very seldom measured. The most significant terms of seldom measured. The most significant terms of trade for developing nations are I and S. Since N is trade for developing nations are I and S. Since N is the easiest to measure, most of the discussion in the easiest to measure, most of the discussion in the economic literature has been in terms of N. N the economic literature has been in terms of N. N is often referred to simply as "the terms of trade." is often referred to simply as "the terms of trade."

In the examples, I and S can rise even when N In the examples, I and S can rise even when N declines. This is regarded as favorable to a declines. This is regarded as favorable to a developing nation. The most favorable situation is developing nation. The most favorable situation is when N, I, and S all increase, the worst possible when N, I, and S all increase, the worst possible situation from the point of view or a developing situation from the point of view or a developing nation occurs when all three terms of trade nation occurs when all three terms of trade deteriorate. This may lead to immiserizing growth. deteriorate. This may lead to immiserizing growth.

Reasons for Deterioration in Terms Reasons for Deterioration in Terms of Tradeof Trade

Prebisch and others believe that the commodity Prebisch and others believe that the commodity terms of trade of developing nations tend to terms of trade of developing nations tend to deteriorate over time. deteriorate over time.

The reason is that most or all of the The reason is that most or all of the productivity increases in developed nations are productivity increases in developed nations are passed on to their workers in the form of higher passed on to their workers in the form of higher wages and income, while most or all of the wages and income, while most or all of the productivity increases in developing nations are productivity increases in developing nations are reflected in lower prices. reflected in lower prices.

Thus, developed nations have the best of both Thus, developed nations have the best of both worlds. They retain the benefits of their own worlds. They retain the benefits of their own productivity increases in the form of higher wages productivity increases in the form of higher wages and income for their workers, and at the same and income for their workers, and at the same time they also reap most of the benefits from the time they also reap most of the benefits from the productivity increases taking place in developing productivity increases taking place in developing nations through the lower prices they pay for nations through the lower prices they pay for agricultural exports. agricultural exports.

Reasons for Deterioration Reasons for Deterioration in Terms of Tradein Terms of Trade

Another reason for expecting the terms of Another reason for expecting the terms of trade of developing nations to deteriorate trade of developing nations to deteriorate is that their demand for the is that their demand for the manufactured exports of developed manufactured exports of developed nations tends to grow much faster than nations tends to grow much faster than the latter's demand for the agricultural the latter's demand for the agricultural exports of developing nations. exports of developing nations.

This is due to the much higher income This is due to the much higher income elasticity of demand for manufactured elasticity of demand for manufactured goods than for agricultural commodities. goods than for agricultural commodities. For these reasons, the deterioration in For these reasons, the deterioration in the terms of trade of developing nations the terms of trade of developing nations could be so great as to make them worse could be so great as to make them worse off with trade than without it. off with trade than without it.

Cause & Effects of Export Cause & Effects of Export InstabilityInstability

Cause & Effects: Demand Cause & Effects: Demand SideSide

The demand side:The demand side: The demand for many primary exports of The demand for many primary exports of

developed nations is price inelastic because developed nations is price inelastic because individual households in developed nations spend individual households in developed nations spend only a small proportion of their income on such only a small proportion of their income on such commodities as coffee, tea, cocoa, and sugar. commodities as coffee, tea, cocoa, and sugar. Consequently, when the prices of these Consequently, when the prices of these commodities change, households do not commodities change, households do not significantly change their purchases of these significantly change their purchases of these commodities, resulting in a price-inelastic commodities, resulting in a price-inelastic demand. demand.

On the other hand, the demand for many On the other hand, the demand for many minerals is price inelastic because few minerals is price inelastic because few substitutes are available. The demand for the substitutes are available. The demand for the primary exports of developing nations is unstable primary exports of developing nations is unstable because of business cycle fluctuations in because of business cycle fluctuations in developed nations. developed nations.

Cause & Effects: Supply Cause & Effects: Supply SideSide

The supply side:The supply side:

The supply of the primary exports of The supply of the primary exports of developing nations is price inelastic developing nations is price inelastic because of internal rigidities and because of internal rigidities and inflexibilities in resource uses, inflexibilities in resource uses, especially in the case of tree crops especially in the case of tree crops that involve long gestation periods. that involve long gestation periods. Supplies are unstable or shifting Supplies are unstable or shifting because of weather conditions, pests, because of weather conditions, pests, and so onand so on

Measures to Control Measures to Control Export InstabilityExport Instability

International commodity International commodity agreementsagreements

Buffer stocks Buffer stocks Export controlsExport controls Purchase contractsPurchase contracts

Buffer StocksBuffer StocksBuffer stocksBuffer stocks It is the purchase of the commodity when the It is the purchase of the commodity when the

commodity price falls below an agreed commodity price falls below an agreed minimum price, and the sale of the minimum price, and the sale of the commodity out of stock when the price rises commodity out of stock when the price rises above the established maximum price. above the established maximum price. Example: International Tin Agreement.Example: International Tin Agreement.

DisadvantagesDisadvantages (1) high cost; (1) high cost; (2) If the minimum is set(2) If the minimum is set above the equilibrium level,above the equilibrium level, the stock grows larger the stock grows larger and larger overtime.and larger overtime.

Export ControlExport ControlExport controlsExport controls It seeks to regulate the quantity of a It seeks to regulate the quantity of a

commodity exported by each nation commodity exported by each nation in order to stabilize commodity in order to stabilize commodity prices.prices.

Advantage: Reducing the cost of Advantage: Reducing the cost of maintaining stocks.maintaining stocks.

Disadvantage: Leading to Disadvantage: Leading to inefficiencies and requiring all major inefficiencies and requiring all major exporters of the commodity exporters of the commodity participate.participate.

Purchase ContractPurchase ContractPurchase contractsPurchase contracts They are the long term multilateral They are the long term multilateral

agreements that stipulate a minimum agreements that stipulate a minimum price at which importing nations agree price at which importing nations agree to purchase a specified quantity of the to purchase a specified quantity of the commodity and a maximum price at commodity and a maximum price at which exporting nations agree to sell which exporting nations agree to sell specified amounts of the commodity. specified amounts of the commodity.

It avoids the disadvantages of buffer It avoids the disadvantages of buffer stock and export controls but result in stock and export controls but result in a two-price system for the commodity.a two-price system for the commodity.

CommentsComments With the exception of international With the exception of international

coffee agreement, they either failed or coffee agreement, they either failed or have very limited success in stabilizing have very limited success in stabilizing and increasing the export prices and and increasing the export prices and earnings of developing nations. earnings of developing nations.

One reason for this is the high cost of One reason for this is the high cost of operating them and the general lack of operating them and the general lack of support by developed nations since they support by developed nations since they would have to shoulder most of the would have to shoulder most of the burden of setting up and running these burden of setting up and running these international agreements.international agreements.

Import Substitution or Import Substitution or Export OrientationExport Orientation

How can developing countries How can developing countries develop the economy?develop the economy?

To realize industrialization, To realize industrialization, because all rich nations are because all rich nations are industrial while most poor industrial while most poor nations are primarily nations are primarily agricultural. agricultural.

Import SubstitutionImport Substitution To produce products to replace imports.To produce products to replace imports. Three advantages of this strategy:Three advantages of this strategy:(1) Risks are reduced in setting up an industry to (1) Risks are reduced in setting up an industry to

replace imports because the market for the replace imports because the market for the product already exists, as evidenced by imports product already exists, as evidenced by imports of the commodity;of the commodity;

(2) It is easier for developing nations to protect (2) It is easier for developing nations to protect their domestic market against foreign their domestic market against foreign competition than to force developed nations to competition than to force developed nations to lower trade barriers against their manufactured lower trade barriers against their manufactured exports. exports.

(3) Foreign firms are induced to establish so-(3) Foreign firms are induced to establish so-called tariff factories to overcome the tariff wall called tariff factories to overcome the tariff wall of developing nations. of developing nations.

Disadvantages of import substitution policy:Disadvantages of import substitution policy: Domestic industries can grow accustomed to Domestic industries can grow accustomed to

protection from foreign competition and protection from foreign competition and have no incentive to become more efficient. have no incentive to become more efficient.

Import substitution can lead to inefficient Import substitution can lead to inefficient industries industries

After the simpler manufactured imports are After the simpler manufactured imports are replaced by domestic production, import replaced by domestic production, import substitution becomes more and more substitution becomes more and more difficult and costly (in terms of the higher difficult and costly (in terms of the higher protection and inefficiency) as more capital-protection and inefficiency) as more capital-intensive and technologically advanced intensive and technologically advanced imports have to be replaced by domestic imports have to be replaced by domestic production. production.

Export OrientationExport OrientationTo produce for the purpose to export.To produce for the purpose to export. Advantages of export-oriented Advantages of export-oriented

industrialization: industrialization: It overcomes the smallness of the domestic It overcomes the smallness of the domestic

market and allows a developing nation to take market and allows a developing nation to take advantage of economies of scale. This is advantage of economies of scale. This is particularly important for the many particularly important for the many developing countries that are both very poor developing countries that are both very poor and small.and small.

Production of manufactured goods for export Production of manufactured goods for export requires and stimulates efficiency throughout requires and stimulates efficiency throughout the economy. This is especially important the economy. This is especially important when the output of an industry is used as an when the output of an industry is used as an input of another domestic industry. input of another domestic industry.

The expansion of manufactured exports is not The expansion of manufactured exports is not limited (as in import substitution) by the limited (as in import substitution) by the growth of the domestic market. growth of the domestic market.

Two serious disadvantages: Two serious disadvantages: It may be very difficult for developing It may be very difficult for developing

nations to set up export industries nations to set up export industries because of the competition from the because of the competition from the more established and efficient more established and efficient industries in developed nations.industries in developed nations.

Developed nations often provide a high Developed nations often provide a high level of effective protection for their level of effective protection for their industries producing simple labor-industries producing simple labor-intensive commodities in which intensive commodities in which developing nations already have or can developing nations already have or can soon acquire a comparative advantage. soon acquire a comparative advantage.

SummarySummary

Import substitution may be of some benefit Import substitution may be of some benefit in the early stages of development in the early stages of development (especially for larger developing nations), (especially for larger developing nations), while an export orientation becomes an while an export orientation becomes an absolute necessity only later in the absolute necessity only later in the development process. development process.

Thus, rather than being alternatives, Thus, rather than being alternatives, policies of import substitution and export policies of import substitution and export orientation could profitably be applied to orientation could profitably be applied to some extent sequentially, especially in some extent sequentially, especially in the larger developing nations. the larger developing nations.

Current Problems and Current Problems and Demands of Developing Demands of Developing

CountriesCountries Serious problems facing developing nationsSerious problems facing developing nations1. The conditions of complete poverty prevailing 1. The conditions of complete poverty prevailing

in many countries.in many countries.2. The huge international debt of most 2. The huge international debt of most

developing nations.developing nations.3. The trade protectionism of developed nations 3. The trade protectionism of developed nations

against developing nations' exports.against developing nations' exports. Demands of developing nationsDemands of developing nations They demand a new international economic They demand a new international economic

order based on the establishment of order based on the establishment of international commodity agreements, increased international commodity agreements, increased access of their exports to developed nations' access of their exports to developed nations' market and increased flow of foreign aid.market and increased flow of foreign aid.

Discussion QuestionsDiscussion Questions Why can international trade not be expected to Why can international trade not be expected to

be an engine of growth for today’s developing be an engine of growth for today’s developing nations?nations?

What is meant by the commodity terms of What is meant by the commodity terms of trade? The income terms of trade? single and trade? The income terms of trade? single and double factoral terms of trade? Which are the double factoral terms of trade? Which are the most significant terms of trade for developing most significant terms of trade for developing nations?nations?

Why do some economists believe that the Why do some economists believe that the commodity terms of trade of developing nations commodity terms of trade of developing nations have a tendency to deteriorate over time?have a tendency to deteriorate over time?

What is import substitution and export What is import substitution and export orientation?orientation?