Export Led Development:

Industrial vs Primary Exports

Eswaran & Kotwal (JDE, 1992)

Tópicos en Desarrollo Económico

Universidad de Piura 2020-I
Introduction
Introduction
• Authors point out that several works in the literature
argue that trade with the North is more likely to retard
economic development in the South rather than to aid it.

• Indeed, despite exporting primary goods for over a

hundred years, a significant number of countries in Latin
American, Africa and South Asia have remained poor.
Introduction
• An important distinction between a success story such as South
Korea and a failure such as Honduras is that the former has grown
through exporting manufactured goods to the developed
countries, whereas the latter has remained backward while
exporting primary goods (bananas and coffee).
• In this paper authors suggest one reason why the success of an
export-led growth strategy might depend upon what kind of good
is being exported.
• They propose a simple two-country general equilibrium model to
investigate the effect of trade on a country’s GNP.
The Model
Model
• Two countries: India and England. Parameters and
quantities pertaining to these countries will be
subscripted by i and e, respectively.
• Each country has an endowment of two factors of
production: land and labour. Country j E {i, e} has an
amount of land equal to Hj and a working population of
Nj.
• Agents in both countries have identical preferences
defined over labour effort (n) and two goods: food (F)
and cloth (C).
Model
• We assume that these preferences are represented by the
utility function:

• Let p, w and u, respectively, denote the price of cloth, the

wage rate and the land rental rate, with food as the numeraire
good.
• From the above utility function the demand functions for
leisure (giving labour supply), food and cloth can be easily
computed.
Model
• On the production side, we assume that in country j food is
produced according to a production function that is Cobb-Douglas
and linearly homogeneous in the amount of land (h) and labour (L):

• Cloth production, however, is assumed to use only labour and the

constant returns production function for cloth is taken to be:
Model
• There is no presumption that the total factor
productivities Aj and j are the same for the two
countries.
• Differences in these parameters could not only reflect
differences in the technologies in use in the two
countries but also differences in the amounts of capital
available to them.
• We assume that under both autarky and free trade all
goods and factor markets are competitive.
Model
• In order to assess the impact of free trade on the GNP of
each country, we need to compare its GNP under autarky
with its GNP under free trade.
• And in order to make sure that this is not merely a terms of
trade effect we should evaluate the GNP under each case at
the same relative price of cloth with respect to food.
• Therefore, we first compute each country’s food and cloth
consumptions under autarky and free trade equilibria
respectively. We then compute the GNPs in both cases by
evaluating the consumptions of food and cloth at the free
trade prices.
Model
• In order to solve for the general equilibrium of this
simple economy, we obtain the demand and supply
functions for all goods and factors analytically.
• The complete characterization of the general
equilibrium, however, requires a numerical solution.
These steps are followed first for the autarky case
and then for the free trade case.
• Under free trade, the price of food (= 1) and of cloth
( =p) will be the same across the two countries.
Model

• Since labour is assumed to be immobile

between countries and the production
technologies are not necessarily the
same for the two countries, the factor
prices will not be equalized.
Model
• The details of the determination of the general
equilibrium are similar to those under autarky
except for one complication: a country might
specialize in food production and import all the
cloth requirements from the other.
• This possibility - which was not present under
autarky given the nature of the preferences - must
now be reflected in the equilibrium conditions.
Intuition
Intuition
• It may be helpful to point out the intuition underlying
the main result in the context of this model.
• As long as there is not complete specialization, the
nominal wage in country j is given by wj= jp. Free
trade would determine p.
• If the resultant world terms of trade, p, fell because
England becomes more productive in the industrial
good (cloth), then wi the wage rate in India must fall for
given i.
Intuition
• As the industrial sector shrinks, labour is released into
agriculture where combined with a fixed factor it is
subject to diminishing returns.
• The labour market thus equilibrates at a lower nominal
wage. From the utility function given in (1), the labour
supply can be shown to be:
Intuition
• Thus, the labour supply in India will decline as p declines. This,
in our analysis, will account for the adverse effects of trade
with England on India.

• We should note that the decrease in real wage (and hence in

the labour supply) would be greater, the higher is the
expenditure share of food in the worker’s budget. By Engel’s
law, the poorer the workers the greater would be the impact of
a decline in p on the real wage.
Results
Results
Results
Results
Conclusion
Conclusion
• The key for a developing country is not to trade according to
comparative advantage but to acquire comparative advantage
in the kind of activities that utilizes mainly price-elastic factors.
• It can be seen that India’s GNP would increase faster under
free-trade than under autarky if she can increase her industrial
productivity vis-a-vis England.
• This is clearly the path followed by the success stories like
South Korea and Taiwan. The model reconciles the successes
and failures of free trade among the developing countries.
Conclusion
• It may be argued that the main point of this paper is based on
the unrealistic assumption of elastic labour supply.
• For simplicity, we have taken labour to be the only factor of
production in the industrial sector and hence the whole
argument is presented in terms of labour effort.
• In reality, cheap imports of an industrial good will reduce the
marginal returns to all the factors employed in industrial
production.
Conclusion
• These factors such as physical and human capital
and industrial entrepreneurship, are augmentable,
unlike land, and respond to incentives.
• The key to the success of export-led development
is whether the pattern of trade creates incentives
or disincentives to these augmentable factors.
Conclusion
• An individual’s effort can generate positive externalities while
his consumption of leisure does not.
• The process of development, therefore, entails breaking a low-
level equilibrium trap by creating institutions and incentive
structures that would induce greater effort by entrepreneurs,
workers and savers.
• Trade with the North can affect this incentive structure in
either direction. If the South is content to export primary
goods in exchange for manufactured goods, it ends up
increasing rents at the expense of incentives for effort.