ECON7530

Lecture 12
Trade Policies in Developing Countries
and Trade Controversies
Nhan Phan
UQ School of Economics
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Some Housekeeping Business
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 Part 1
Trade Policies in Developing Countries

Source: Export Delaware

Learning Objectives
• Recapitulate the case for protectionism as it has been historically
practiced in developing countries and discuss import-substitution-led
industrialization and the “infant industry” argument.
• Summarize the basic ideas behind “economic dualism” and its
relationship to international trade.
• Discuss the recent economic history of the Asian countries, such as
China and India, and detail the relationship between their rapid
economic growth and their participation in international trade.
UQ Extend – Introduction Table: Gross Domestic Product per
Capita, 2019 (Dollars, Adjusted for
• Which countries are “developing Differences in Price Levels)
countries”? United States 64,747
• The term “developing countries” does Germany 55,110
not have a precise definition, but it is Japan 43,445
a name given to many low- and South Korea 44,203
middle-income countries.
Mexico 21,294
China 13,548
Bangladesh 4,513
Source: Conference Board Total Economy
Database.
UQ Extend
Import-Substituting Industrialisation
• Encourage domestic industries by Mexico (1960) 26
limiting competing imports. Philippines (1965) 61
Brazil (1966) 113
Infant industry argument:
Chile (1961) 182
• A potential comparative advantage, but Pakistan (1963) 271
not competitive initially.
Table: Effective Protection of
•  Temporary support from governments Manufacturing in Some
to become established. Developing Countries (Percent)
Source: Bela Balassa, The Structure of
Protection in Developing Countries (Baltimore:
Johns Hopkins Press, 1971), p. 82.
UQ Extend
Infant Industry Argument?
Three problems:
1. It may be wasteful to support industries now that will have a
comparative advantage in the future.
2. With protection, infant industries may never “grow up” or become
competitive.
3. There is no justification for government intervention unless there is
a market failure that prevents the private sector from investing in
the infant industry.
UQ Extend
Infant Industries and Market Failures
How can market failures prevent infant industries from becoming
competitive?
1. Imperfect financial asset markets
• Poorly working financial laws and markets, and lack of property rights.
2. The problem of appropriability
• Firms may not be able to privately appropriate the benefits of their
investment in new industries.
• The benefits of these investments are public goods.
• Lack of property rights.
• High tariffs would be a second-best policy for economic growth.
Infant Industries: Did It Work?
• Import-substituting industrialization in Latin American countries
worked to encourage manufacturing industries in the 1950s and
1960s.
• But economic development, not encouraging manufacturing, was the
ultimate goal of the policy.
• Did import-substituting industrialization promote economic
development?
• No, countries adopting these policies grew more slowly than others.
Infant Industries: Did It Work?
• The infant industry argument was not as valid as some had initially
believed.
• New industries did not become competitive despite/because of trade
restrictions.
• Import-substitution industrialization involved costs and promoted
wasteful use of resources:
• Complex, time-consuming regulations.
• High tariff rates for consumers, including firms that needed to buy imported
inputs for their products.
• Promotes inefficiently small industries.
Trade Liberalisation
• Some low- and middle-income countries that had relatively free trade
had higher average economic growth than those that followed import
substitution.
• By the mid-1980s, many governments had lost faith in import
substitution and began to liberalise trade.
• Trade liberalization in developing countries occurred along with a
dramatic increase in the volume of trade.
• A number of developing countries have achieved extraordinary
growth while becoming more, not less, open to trade.
 Trade Liberalisation

Figure: The Growth of

Developing-Country Trade

Figure: Tariff Rates in

Developing Countries

Source: World Bank

Trade Liberalisation
Has trade liberalisation promoted development? The evidence is
mixed.
• Growth rates in Brazil and other Latin American countries have been
slower since trade liberalisation.
• But unstable macroeconomic policies and financial crises contributed to
slower growth since the 1980s.
• Other countries like India have grown rapidly since liberalising trade in
the 1980s.
• Unclear to what degree liberalised trade contributed to growth.
• Some economists also argue that trade liberalisation has contributed
to income inequality, as the Heckscher-Ohlin model predicts.
Trade and Growth: Takeoff in Asia
• Instead of import substitution, several economies in East Asia
adopted trade policies that promoted exports in targeted industries.
• Example: Japan, Hong Kong, Taiwan, South Korea, Singapore, Malaysia,
Thailand, Indonesia, and China
• Rapid growth in various export sectors and rapid economic growth in general.
• These high-performance Asian economies generated a high volume of
exports and imports relative to total production.
• Their policy reforms were followed by a large increase in openness, as
measured by their share of exports in GDP.
• Thus, it is possible to develop through export-oriented growth.
Figures: The Asian Takeoff

Source: Total Economy Database & World Bank

Vietnam: A Tiger Cub
Economy
Vietnam: A Tiger Cub Economy
https://www.economist.com/finance-and-economics/2021/08/30/the-economy-that-covid-19-could-not-stop

• In the past decade, exports by domestic firms have risen by 137%,

while those by foreign-owned companies have surged by 422%.
• Instead of being similar to China, Vietnam’s deep connection to global
supply chains and high levels of foreign investment make it seem
more like Singapore.
• Since 1990 Vietnam has received average FDI inflows worth 6% of GDP each
year, more than twice the global level – and far more than China or South
Korea have ever recorded over a sustained period.
Trade and Growth
• However, Latin American nations such as Mexico and Brazil, which
also sharply liberalized trade and shifted toward exports, did not see
comparable economic takeoffs.
• Unclear if the high volume of exports and imports caused rapid
economic growth or was merely correlated with rapid economic
growth.
•  Perhaps other factors played a crucial role in the Asian miracle?
• High saving and investment rates.
• Rapid growth in education led to high literacy and numeracy rates.
• Other economic reforms.
 Part 2
Controversies in Trade Policy

Source: Adobe Stock

Learning Objectives
• Summarise the arguments for interventionist trade policy, especially
those related to externalities and economies of scale.
• Evaluate the claims of the anti-globalization movement related to
trade effects on workers, labour standards, and the environment in
light of the counterarguments.
• Discuss the role of the World Trade Organization (WTO) as a forum for
resolving trade disputes and the tension between the rulings of the
WTO and individual national interests.
• Discuss key issues in the debate over trade policy and the
environment.
Introduction – Topics
1. Technology and Externalities (UQ Extend)
2. Imperfect Competition and Strategic Trade Policy (UQ Extend)
3. Trade and Low-Wage Labour
4. Trade and the Environment
5. Trade and Culture
UQ Extend – Activist Trade Policy
Activist trade policy: government
policies that actively support export
industries through subsidies.
• Import-substituting industrialization
• Externalities or an appropriability
problem
• Imperfect competition that results in
revenues that exceed all (opportunity)
costs: “excess” profits.

Source: Adobe Stock

UQ Extend
Technology and Externalities
• Appropriability problem: Firms that invest in new technology
generally create knowledge that other firms can use without paying.
• Actively encourage investment in technology when there are externalities in
new technologies
• Should the U.S. government subsidise high-technology industries?
• To consider:
1. The ability of governments to subsidize the right activity.
2. The economic importance of externalities.
3. Externalities may occur across countries as well.
Technology and Externalities in the U.S.
• Some argue that the United States should have a deliberate policy of
promoting high-technology industries and helping them compete
against foreign rivals.
• Fear in the 1980s that Japan’s dominance of the semiconductor
memory market would translate into a broader dominance of
computers and related technologies proved to be unfounded.
• More recently, the decline in U.S. employment in the information,
communication, and technology (ICT) industries, and large U.S. trade
deficits in ICT goods have renewed fears.
 Technology and Externalities in the U.S.

Figure: U.S. Manufacturing Employment

Figure: U.S. Trade Balance in R&D-

Intensive Goods
Source: National Science Foundation, Science and Engineering
Indicators 2012.

Source: Bureau of Labor Statistics.

UQ Extend – Imperfect Competition and
Strategic Trade Policy
• Imperfectly competitive industries: typically dominated by a few firms
that generate monopoly profits or excess profits.
• Government subsidies can shift excess profits from a foreign firm to a
domestic firm.

Source: FT | AP
UQ Extend – The Brander-Spencer Analysis
• Predicted outcome depends on which firms invest/produce first.

• However, a subsidy by the EU can alter the outcome by making it

profitable for Airbus to produce regardless of Boeing’s action.
• The subsidy raises profits more than
the amount of the subsidy itself.
• Deterrent effect on foreign
competition.
UQ Extend – Imperfect Competition and
Strategic Trade Policy
• Strategic trade policy: government policy to give a domestic firm a
strategic advantage in production.
• Criticism:
1. Practical use of strategic trade policy requires more information
about firms than is likely available.
2. Foreign retaliation also could result.
• Beggar-thy-neighbour trade policy.
3. Strategic trade policy, like any trade policy, could be manipulated by
politically powerful groups.
Trade and Low-Wage Labour
• Manufactured exports from low- and middle-income countries have
been increasing.
• Compared to rich-country standards, workers who produce these
goods are paid low wages and may work under poor conditions.
• Some have opposed free trade for this reason.
Trade and Low-Wage Labour
• Example: maquiladora sector
• Mexican firms that produce for export to the United States.
• Easier for employers to replace high-wage workers in the United States with
low-wage workers in Mexico?
• Does trade hurt workers in U.S.? Mexico?
• Ricardian model: while wages in Mexico should remain lower than
those in the United States due to low productivity in Mexico, they will
rise relative to their pre-trade level.
• Heckscher-Ohlin model: unskilled workers in the United States will
lose from NAFTA, but unskilled workers in Mexico will gain.
Trade and Low-Wage Labour
Despite the low wages earned by workers in Mexico, both theories
predict that those workers are better off with trade than they would
be if trade had not taken place.
• Evidence consistent with these predictions would show that wages in
maquiladoras have risen relative to wages in other Mexican sectors.
• Compare working conditions in maquiladoras with the working
conditions in other Mexican sectors, rather than with those in the
United States.
Trade and Low-Wage Labour
• Some labour activists want to include labour standards in trade
negotiations.
• Opposed by governments of low- and middle-income countries.
• Standards set by high-income countries would be expensive for low- and middle-income
producers.
• International standards could be used as a protectionist policy or a basis for lawsuits.
• Compromise: a system that monitors wages and working conditions
and makes this information available to consumers.
• Certified as made with acceptable wage rates and working conditions.
Trade and the Environment

Figure: Degraded air quality in two megacities:

(a) Los Angeles in 1948 (Source: Los Angeles Times Photographic Archive, UCLA)
(b) Beijing 65 years later (Source: JasonLee/Reuters/Corbis)
Trade and the Environment
• Compared to rich-country standards, environmental standards in low-
and middle-income countries are lax.
• Some have opposed free trade for this reason.
• But we cannot conclude that trade hurts the environment.
• Consumption and production in the absence of trade have degraded the
environment.
• Environmental activists want to include environmental standards in
trade negotiations.
• Opposed by governments of low- and middle-income countries.
• Expensive standards for low- and middle-income producers.
• International standards could be used as a protectionist policy or a basis for lawsuits.
Environmental Kuznets Curve
• As poor countries grow richer, they
produce more and can consume more
 more environmental degradation.
• But as countries grow richer, they want
to pay for more stringent environment
protection.
• Represented as an environmental
Kuznets curve:
• Inverted “U-shaped” relationship
between environmental degradation and
income per person
Trade and the Environment
• Environmentally hazardous activities may be
moved to poor countries.
• Rich countries usually have strict environmental
regulations.
• Poor countries do not.
• Pollution haven: economic activity that is
subject to strict environmental controls in
some countries is moved to (sold to) other
countries with less strict regulation.
• Evidence that pollution havens are
insignificant relative to the pollution that Source: Global Carbon Project.
occurs without international trade.
Trade and the Environment
• Pollution in some countries may cause a negative externality for other
countries.
• Production in China could cause air pollution in Korea.
• To the degree that pollution causes negative externalities for other
countries, they should want to include it in international negotiations.
• Emissions of carbon dioxide is an example of pollution that causes a
negative externality and that has been included in international
negotiations.
Trade and Culture
• Some activists believe that trade
destroys culture in other countries.
• Case Study: Bhutan, and the “Gross
National Happiness”
• “You don't quantify Buddhism.”
• “Farmer Sonam Tshering, a father of three,
laments the loss of Bhutan's driglam namzha
or etiquette. “People are losing this sense,”
he says citing, for example, the casual
clothes young people wear, like jeans and a
T-shirt, rather than the traditional dress: the
knee-length, kimono-like gho robe for men,
and the ankle-length dress worn by women
known as the kira. “It is a challenge to our Source: Julie McCarthy/NPR
culture,” he says, “it is saddening to see.””

https://www.npr.org/sections/parallels/2018/02/12/584481047/the-birthplace-of-gross-national-happiness-is-growing-a-bit-cynical
Trade and Culture
• Cambridge dictionary: Culture is “the way of life, especially the
general customs and beliefs, of a particular group of people at a
particular time.”
• The anti-trade belief neglects the principle that we should allow
people to define their culture through the choices that they make,
not through standards set by others.
• Also, any economic change, not just trade, leads to changes in
everyday life.
Summary
• Import-substituting industrialisation.
• The infant industry argument.
• The effect of liberalized trade on national welfare is still being
debated.
• Several East Asian economies adopted export-oriented instead of
import-substituting industrialization.
• Unclear to what degree this policy contributed to overall economic growth,
especially since other countries have not had similar successes.
Summary
Arguments for activist trade policy:
• Investment in high-technology industries produces externalities for the
economy.
• Governments can give domestic firms a strategic advantage in industries
with excess profits.
• Workers in low- and middle-income countries earn lower wages and have
worse working conditions than workers in high-income countries.
• Trade negotiations should involve labour, environmental, or “cultural”
standards
• These standards are generally opposed by governments of low- and middle-income
countries.