INTERNATIONAL TRADE AND AGREEMENTS

Topic 10: The Trade Policy in Developing

Countries
 INTERNATIONAL TRADE AND AGREEMENTS

Topic 10

THE TRADE POLICY IN DEVELOPING COUNTRIES

A. OVERVIEW

This chapter examine some of the country which has its own distinctive history and
issues, but in discussing economic policy one obvious difference between countries is in
their income levels. This chapter describes the rationale for the strategy of import-
substituting industrialization, as well as the main concern of economic policy in developing
countries wherein it has been the low overall level of income, it is also the case that many
developing countries are characterized by large differences in income between regions and
sectors.

B. OBJECTIVES

1. Understand the Import-Substituting Industrialization, and Export-Oriented

Industrialization.
2. Be guided with the content of the succeeding topics.

C. LEARNING OBJECTIVES
Expose students in analyzing different trade policy in the developing countries and
its effect to industrialization.

D. INSTRUCTIONS

1. Kindly read and comprehend Topic X: The Trade Policy in Developing Countries.
2. Should you have any questions or concerns, do not hesitate to message me.
3. Enjoy your own pace, ‘cause learning is never a race. In these hard and trying times, I
understand that you are walking on a rough patch. Do not forget to pause, breathe, and
carry on! You got this! ☺
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E. DISCUSSION
Trade Policy in Developing Countries

Have you ever wondered why other countries are poorer/richer than the others? Do you
know that there is also diversity among developing countries in terms of income per capita? In
developing countries, trade policies are crafted together with the idea that a strong manufacturing
sector is the key to economic development. How do they maintain this? It is through protecting
domestic manufacturers from international competition.

Import-Substituting Industrialization
Until 1970s, most of the developing countries limited imports of manufactured goods to
protect the domestic manufacturing sector, with the attempt of accelerating development. The
infant industry argument is the most important argument for protecting manufacturing
industries.
The infant industry argument states that developing countries have a potential
comparative advantage in manufacturing trough initial period of protection. Basically, it implies
that imposing tariffs and import quotas as temporary measures to get industrialization started is a
good move.
Problems with infant industry argument:
a. It is not always good to try to move today into industries that will have a
comparative advantage in the future.
Example: In 1960s, South Korea’s capital and skilled labor were very scarce,
but in 1980s, it became an exporter of automobiles.
b. Protecting manufacturing is no good unless the protection itself makes such
industry competitive.
Example: Pakistan and India have always protected their heavy manufacturing
sectors, but have recently begun to export textiles.

Market failure justifications for infant industry protection

There are two market failures marked as reasons why infant industry protection
may be a good thing to do:
 INTERNATIONAL TRADE AND AGREEMENTS

a. Imperfect capital markets justification- Growth will be restricted if a

developing country does not have a ser of financial institutions that allow
savings from traditional sectors to be used to finance investment in new sectors.
b. Appropriability argument- Firms in new industry benefit socially without just
cost on them.

Promoting manufacturing through protection

Import-Substituting industrialization- limiting imports of manufactured goods to
encourage domestic industry to produce more. Is this strategy towards economic
development? Many economists argued that it has generated high cost and inefficient
production.
Why not encourage both import substitution and exports? First, a tariff that
reduces imports also reduces exports. Until the 1970s, many developing countries were
hesitant about exporting manufactured goods. Also, there are political biases in import
substitution.

Results of Favoring Manufacturing: Problems of Import-Substituting

Industrialization
Statistically, many countries that tried import substitution do not show any signs of
catching up with developed countries. Take India for example, in a span of 20 years from
1950-1970, its per capita income was only a few percentages higher than before. The reason
why import substitution does not work the way it is supposed to be is because the infant
industry argument was not universally valid than perceived. Import substitution led to
higher rates of effective protection, inefficient scale of production, higher income
inequality and unemployment.
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Problems of the Dual Economy

Most developing countries are
characterized by economic dualism. A
high-wage, capital-intensive industrial
sector coexists with a low-wage
traditional sector. Dualism is associated
with trade policy because a. Dualism is
a sign of market failure, and b.
Economic dualism is crafted with the
aid of import substitution policies.
How to know when there is
dualism?
It is when an economy is not working well, especially its labor markets. The wage
differential argument:
a. The wage differences between manufacturing and agriculture is a justification
for encouraging manufacturing at agriculture’s expense.
b. When there is a wage differential, the manufactures wage (WM) must be higher
than the food wage (WF).

Trade Policy as a cause of Economic Dualism

Trade policy has been accused of widening the wage differential between manufacturing
and agriculture and fostering capital intensity. Wage differentials are natural market response and
a monopoly power of unions whose industries are protected from foreign competition.

F. REFERENCES

Krugman, Paul R. (2003). International Economics Theory and Policy, 6th Edition. 75
Arlington St., Suite 300, Boston, MA 02116: Pearson Education, Inc.