Trade, Growth and Development

 Main objective:
 The main objective of this chapter is to make students
familiar with trade, growth and development.

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 Introduction
 Trade has been a part of economic development.

 It has the potential to be a significant force for

reducing global poverty by
 spurring economic growth,

 creating jobs,

 reducing prices,

 increasing the variety of goods for consumers,

and
 helping countries acquire new technologies.

 But the way trade affects different people, sectors, and

countries different.
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 Reports show that total trade equals exports plus imports
world trade value was at $38.96 trillion, up 10% from 2018.
 25% of the goods traded are machines and
technology like electrical machinery, computers,
nuclear reactor, boilers, and scientific and precision
instruments.
 Automobiles, including cars, trucks, and buses,
contributed 9%,
 Mineral fuels like oil, gas, coal, and refined
products accounted for 14.4%
 Commodities like plastics, iron, organic chemicals,
pharmaceuticals, and diamonds added up to 13.2%
 International trade accounts for about 27% of the global
economy,
 Until the 2008 financial crisis, world trade grew 1.9
times faster than economic growth.
 Until 2017, trade grew more slowly than the global
economy.
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 Reasons Why Global Trade Slowed
 The 2008 financial crisis slowed trade and growth.
 Many companies became more cautious.

 Consumers were less likely to spend.

 Younger people faced high unemployment rates.

They had a hard time getting their career

started.
That meant they weren't as likely to marry
and buy homes.
Many of them also had large school loans to
pay off.
 Countries implemented more protectionist measures
 In 2015, governments quietly added 539 trade
restrictions.

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 Trade plays key role in poverty reduction via
 Trade is an important stimulator of economic growth.
 It
enlarges a country's consumption capacities, increases
world output
 It provides access to scarce resources and worldwide
markets for products without which poor countries would
be unable to grow.
 Trade tends to promote greater international and
domestic equality by
 equalizing factor prices,
 raising real incomes of trading countries, and
 making efficient use of each nation's and the world's
resource endowments
 Trade helps countries achieve development by
 promoting and rewarding the sectors of the economy
where individual countries possess a comparative
advantage
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 The Terms of Trade and the Prebisch-Singer Thesis
 The relationship or ratio between the price of a typical unit of
exports and the price of a typical unit of imports is called the
commodity terms of trade.
 It is expressed as Px/Pm where Px and Pm represent
the export and import price indexes calculated on the
same base period.

 The terms of trade are said to deteriorate for a country if

Px/Pm falls, that is, if export prices decline relative to
import prices, even though both may rise.
 Historically, the prices of primary commodities have
declined relative to manufactured goods.
 As a result, the terms of trade have on the average
tended to worsen over time for the non-oil-exporting
developing countries
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  The main theory for the declining commodity terms of
trade is known as the Prebisch- Singer thesis, after two
famous development economists who explored its implication
in the 1950s.
 They argued that there was and would continue to
be a secular decline in the terms of trade of primary-
commodity exporters due to a combination of low
income and price elasticity of demand.
 This decline would result in a long-term transfer of
income from poor to rich countries
 that could be combated only by efforts to protect
domestic manufacturing industries through a
process that has come to be known as import
substitution.
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  Both because of this theory and unfavorable terms of
trade trends, developing countries have been doing their
utmost over the past several decades to diversify into
manufactures exports.
 After a slow and costly start, these efforts have
resulted in a dramatic shift in the composition of
developing-country exports, especially among middle-
income LDCs.
 Led at first by the “East Asian Tiger" economies of
South Korea, Taiwan, Hong Kong, and Singapore and
now followed by many other countries in Asia,
including China and India, the share of merchandise
exports accounted for by manufactured goods has
risen strongly in many developing countries.

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 Trade Strategies
1.1. Inward looking Trade Strategies
 Inward looking trade strategies dominated trade thinking
after the Second World War.
 It is interventionist and protectionist in its nature.

 It was adopted by many developing countries in the

1950s and 1960s.
 It guided policy making in many African and Latin
American countries, and in some countries still does.

 Many developing countries including Chile, India,

Ghana, Peru, Brazil, Mexico, Argentina, Ecuador,
Pakistan, Indonesia, Nigeria, Ethiopia, and Zambia
pursued import substitution in the 1950s, 1960s and
1970s (Stiglitz and Charlton in Fair Trade for All, 19).
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  Import substitution is part of inward-oriented
development strategy.

 Inward looking trade strategy’s main aim is to produce

goods domestically which are imported to our nation.
 Here, the government protects the domestically
produced goods from foreign competition.
 It is the principle of "learning by doing“

 Proponents of import substitution believe that

comparative advantage is dynamic and can be developed
over time towards more desirable industries with
appropriate industrial and trade policy

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 The general economic strategy was referred to as import
substitution.
 This usually involves
 (i) selecting certain industries to be promoted,
 (ii)
providing subsidies to support these industries, and
 (iii) imposing high tariff barriers to protect domestic
producers.
 Advocates of Import Substitution argues that Import substitution
has two steps:
 In the First Stage, import substitution should start with
imported simple consumer goods (like shoes and clothing)
with domestically produced goods.
 In the second stage, the country should substitute a wide
range of more sophisticated manufactured items with
local products.

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 The benefits of inward looking policies

 Inward looking policies did generate some short term

benefits such as
the protection of infant and declining
industries;
job creation;
increased income and preserving traditional
ways of life.

 However, the consensus is that the challenges

of globalization require a more outward looking
approach.

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 1.2. Outward Looking
 An outward looking strategy is seen as a
more modern approach to development, and one that relies
less on government intervention.
 It encourages free-trade, multinational companies,
open system of communications, and free movement
of capital, labour, enterprises, and students.
 A number of important global events forced many
developing countries to become outward looking:
A rising development gap between countries
adopting inward and outward looking policies.
 The collapse of communism created an opportunity
to adopt more outward looking policies.
 The experiences of outward looking countries,

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including Japan, India and China---Growth and Po13
  An outward oriented strategy is, thus, a neutral strategy.
 It
does not discriminate between production for
the domestic market and exports, or between
purchase of domestic goods and foreign goods.
 It became more popular from the late 1970s.
 This follows the observation that Japan within a
few decades was able to raise itself from a war-torn
country into the second largest economy in the
world.
 Japan economic success was followed by South
Korea, Taiwan, Hong Kong and Singapore.
 Thailand, Indonesia, Malaysia and China also
adopted similar strategy and enjoyed sustained
growth rates.
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  Export-led growth is part of outward-oriented
development strategy.
 Export-led growth is one that encourages efficiency
and growth through free trade and competition.
 It exploits a bigger world markets to achieve
economies of scale.
 It also highlights the economic costs of distorted
prices and cost-effects of protection.
 It also refers to the economic success of East Asian
economies.
 A country that pursues export-led growth strategy adopt:
trade liberalization, free capital movement, a floating
exchange rate, investment in the provision of
infrastructure and minimized government intervention in
the market…….. Market led Policies
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  Market-led strategies are policies that maximize the
operation of market forces and at the same time
minimizes the role of government in the economy.
 Korea and Japan supports large domestic corporate
conglomerates like Samsung, Daewo, Sony and
Mitsubishi and restricted the flow of FDI which
was less than 5 per cent of GDP in the period 1987-
1992
 Singapore and Malaysia actively attracts large
foreign multinational corporations and FDI that
reached more than 30 per cent of GDP in 1992
(Stiglitz and Charlton in Fair Trade for All, 15).
 Although Korea, Japan and Singapore have floating
exchange rates, China and Malaysia had their
currencies pegged to the USD until recently.
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  According to Sachs, in The End of Poverty, East Asian
countries started with
 high human resources (higher adult literacy 70%
compared to 38% in sub-Saharan Africa in 1980)

 high cereal yield (more than twice the yield per

hectare when compared to sub-Saharan Africa in
1980) which allowed capital accumulation (i.e. high
rates of investment in physical and human capital).

 better infrastructure due to a denser population,

more irrigated land that facilitated trade as well as
raising agricultural productivity, and lower fertility
rate that reduced the pressure of demographic trap.
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 Governments of these countries also play a critical role in
the economy.
 According to Stiglitz and Charlton, governments acted
as catalysts which helped markets by
 providing the requisite physical and institutional
infrastructure,
 remedying market failures

 promoting savings and technology

 East and South East Asian countries do not follow the free
market (orthodox free trade) prescription.
 The governments of Asian countries pursued a two-
track policy:
Protecting infant-industries
Promoting industries that could export
competitively in the world markets
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  The benefits of outward looking policies
 The benefits of outward looking policies are derived
from the benefits of free trade. For example,
 Free trade brings welfare gains from tariff
removal
 Free trade increases competition and efficiency.

 Outward looking countries may be better able to

cope with globalization and with external
shocks.

 However, the financial crisis and its after-effects have

forced many national governments to re-think their
policies and to minimize the risks of an outward looking
approach.
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  1-Strategy: Exporting Primary Goods
 Pro
 Many developing countries still have comparative
advantage in producing and exporting primary
goods.
They should develop this "advantage" instead
of looking for non-guarantee future
comparative advantages in other sectors like
manufacturing that required new capitals,
skill and technology that may not available
locally.
 Could generate a lot of employment for relatively
low skilled laborers.
 Earns foreign exchange.
 Trade can be an engine for economic growth.

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 Contra
 Trade can lead to more unequal distribution of income in
the society.
 Low income elasticity of demand for primary goods
leads to adverse terms of trade. Ed for sugar, cacao, tea,
coffee, and banana range from 0.3 to 0.5 (inelastic).
 Low demand growth because
 developed nations have substitution goods for
primary goods
 technological advances lead to reduce inputs of primary
goods, higher efficiency in utilizing raw materials.
 low population growth rate in developed nations.

 Developing countries face high protectionism on

agricultural goods from developed nations
 Commercial agriculture may lead to negative
externalities.
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2-Exporting Manufactured Goods
 Pro
 Many developing nations may have comparative advantages
in manufacturing simple consumer goods.
 Historically, Japan, South Korea and Hong Kong
utilized their cheap labour to produce low skilled
and labour-intensive goods like textile.
 Even simple manufacturing processes increase value-added
especially on agricultural goods.
 Bottling, canning, preserving, packaging are some
common methods to add values to agricultural
goods.
 Removes economic inefficiency from import substitution
strategies.
 Increase local competition.
 Encourage investments and may attract FDI.

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  Contra
 Industrialization often leads to environmental
degradation.
 Integration into the world economy also means more
exposure to the up and down of the world economy.
 Industrialization also often leads to problems links to
urbanization.
 Possible more income inequality (R-U) in the nation.
 The success of East and South East Asian countries in
applying the export-led growth has led to more
protectionism from developed nations.
 Multinational corporations can become too powerful
within a country.

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 3-Import Substitution
 Pro
 Unless the country take the initiative to establish new
industries and learn by doing these industries may
not developed locally.
 Newly established industries may benefit from
favorable change in comparative advantages but they
need to go through a period of learning before they
can compete in the global market.
 Thus, protection is essential to help these
industries to learn and acquire new know-how.
 Import reduction saves much needed foreign
exchanges [i.e. reduces leakage.]
 Reduces economic dependency on multinational
corporations.
 Could protect local culture and social habits by
keeping out foreign influence
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 Contra
 Encouraging import substitution usually involves price-distortion
practices like generous subsidies and artificially low pricing for
resources.
 This market distortion leads to economic inefficiency.
 Encourage local monopoly.
 Lead to high urban wages.
 May lead to more unequal distribution of income.
 Government may resort to overvalued exchange rate to keep
imports low.
 The process of import substitution may not move beyond the first
stage and cannot successfully develop the economy leading to
lower growth and lack of job creation as experienced by Latin
American countries in the 1980s.
 Firms that were protected in the second stage are likely to object to
open competition from abroad.
 This is a problem of rent-seeking and economic inefficiency
developed in the system.
 Trade protection can lead to retaliatory protectionist measures
from other countries.
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 Important Points
 Trade should be accompanied by rural development.
 Increase in national incomes
 should be invested into maintaining and providing
infrastructure, education, sanitation and healthcare.
 There should also be provision to distribute these increased
income to the poor.
 Increase in trade should be pursued with sustainable development.
 Trade liberalization does not ensure economic growth and
ineffective if country does not invest in education, lack of
investment in infrastructure, suffered from low level of innovation
(and R&D), and possesses weak institutions including poor
regulatory effectiveness and corruption.
 The country can capitalize on its comparative advantage by
 cooperating with other developing countries, this could be done
through regional cooperation
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  During the last few years international trade patterns have
been characterized
 first by anaemic growth (2012-2014), it was because
of a continuing result from the great recession of 2009
 then by a downturn (2015 and 2016)--declining
commodity prices, weak demand in major economies
and United States dollar appreciation
 finally by a strong rebound (2017 and 2018)—it was
largely unanticipated--the upward trend in
commodity prices played an important role (oil prices
have recovered strongly during 2017 and the half of
2018) and another factor contributing to the increase
in value of international trade was the United States
dollar.

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  International trade’ recent cyclical pattern is evident by
examining a commonly used indicator to gauge the status
of international trade: ratio of the value of world trade in
goods and services to the total value of world output.
 This indicator has fallen from just below 30 per cent
in 2014 down to 27 per cent in 2016.
 Global trade-to-output ratio has returned to about 30
per cent in 2018.
 Forecasts for 2019 and 2020 indicate less spectacular
growth in international trade, although still above the
levels of global output growth.
 According to these projections, by 2020 the trade-to-
GDP ratio will reach 31 per cent.

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 Effects of Import Tariff on Tariff Imposing Country
 Tariff is an important tool of commercial policy.

 Although it is primarily a protectionist device yet it proves to be

a double-edged weapon.
 On the one hand, it limits consumers’ choice by forcing
them to cut consumption of the goods they like.
 on the other hand, it shifts the use of resources from one use
to another.

 The effect of tariffs is to change relative prices of goods, services and

factors of production.

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