Trade Policy in Developing Trade Policy in Developing CountriesCountries

o Import-Substituting Industrialization (ISI)o Economic Dualism

o Link

Lecture 1

Volume of world exports & GDPVolume of world exports & GDP

IntroductionIntroduction

• There is a great diversity among the developing countries in terms of their income per capita.– the key to economic development was creation of a strong

manufacturing sector.– The most important economic - infant industry argument.

Import-Substituting Import-Substituting IndustrializationIndustrialization

• The Infant Industry Argument– Potential comparative advantage

Protect and Nurture• Example: The U.S. and Germany had high tariff rates on

manufacturing in the 19th century, while Japan had extensive import controls until the 1970s.

Support for Import-Substituting Support for Import-Substituting Industrialization – Market FailureIndustrialization – Market Failure

Arguments in favor of Infant Industry Protection

– Two market failures are identified as reasons why infant industry protection may be a good idea:

• Imperfect capital markets justification– financial institutions: growth of new industries will be restricted.

• Appropriability argument– Firms in a new industry generate social benefits for which they are not

compensated (e.g. start-up costs of adapting technology).

• Underdevelopment of other adjoining Sectors

Didn’t performDidn’t perform

– import-substituting industrialization did not work the way it was supposed to

– The infant industry argument was not as universally valid as many people assumed.

Against - Import-Substituting Against - Import-Substituting Industrialization Industrialization

Problems with the Infant Industry Argument1. TimingExample: In the 1980s South Korea became an exporter of

automobiles, whereas in the 1960s its capital and skilled labor were still very scarce

2. Wrong AssumptionProtecting manufacturing does no goodExample: Pakistan and India have protected their heavy

manufacturing sectors for decades and have recently begun to develop significant exports of light manufactures like textiles.

3. Small Domestic Market (Demand)Inefficient Scale of production of import competing sector.

Import-Substituting Import-Substituting Industrialization ?Industrialization ?

Import-substituting industrialization generated:• High rates of effective protection• Inefficient scale of production• Higher income inequality and unemployment

Import-Substituting Import-Substituting IndustrializationIndustrialization

Effective Protection of Manufacturing in Some Developing Countries (percent)

Economic DualismEconomic Dualism

Problems of the Dual EconomyProblems of the Dual Economy

Development often proceeds unevenly and results in a dual economy consisting of a modern sector and a traditional sector.

The Symptoms of Dualism• The modern/Industrial sector typically differs with a

traditional/Agriculture sector in that it has:– Higher value of output per worker– Wage differential: Higher wages

(WM) >(WA).

– Higher capital intensity– Persistent unemployment (especially in urban areas)

Dualism and Trade – The link Dualism and Trade – The link

ISI would ease DualismSo, if duality exists we should adapt ISI

Dualism is worsened by ISISo, might actually be a cause for Severe levels of Dualism.

Argument in favor of ISI: Argument in favor of ISI:

Protection/Import substitution Industrialization would help ease dual economy, by reducing unemployment/ increasing employment in the Industrial sector.

ISI would ease DualismSo, if duality exists we should adapt ISI

BUT it didnBUT it didn’’t work like that in some t work like that in some casescases

The creation of the dual economy (an economy that is characterized by economic dualism) has been helped by import-substitution policies.

Dualism is worsened by ISISo, might actually be a cause for Severe levels of Dualism.

Let’s see how?Let’s see how?

The Harris-Todaro model– It links rural-urban migration and unemployment – undermines the case for favoring manufacturing employment,

even though manufacturing does offer higher wages.Evidence

• Countries with highly dualistic economies also seem to have a great deal of urban unemployment.

An increase in the number of manufacturing jobs will lead to a rural-urban migration so large that urban unemployment actually rises.

Traditional SectorTraditional Sector

Problems of the Dual EconomyProblems of the Dual Economy

• Trade Policy as a Cause of Economic Dualism– Trade policy has been accused both of:

• Widening the wage differential between manufacturing and agriculture

• Fostering excessive capital intensity

– Wage differentials are viewed as:• A natural market response

• The monopoly power of unions whose industries are sheltered by import quotas from foreign competition

Dealing with Economic DualismDealing with Economic Dualism

Solving the problem of Rural-Urban Migration

• The National Rural Employment Guarantee Bill goes beyond describing a set of employment generating schemes, and goes into the nitty-gritty, listing the broad responsibilities of the officials at the district, block and panchayat levels. Tweaked slightly and implemented as an Act, it can over time evolve into a means of rapid, all-round infrastructure development in rural India, says Bhanoji Rao.

Trade Policy in Developing Trade Policy in Developing CountriesCountries

o Import-Substituting Industrialization (ISI)o Economic Dualism

o Link

Lecture 1