International Economics: International Trade and Economic Development

CHAPTER E L E V E N
11 International Economics
Twelfth Edition
International Trade and Economic

Development
Dominick Salvatore
John Wiley & Sons, Inc.
Salvatore: International Economics, 12th Edition © 2016 John Wiley & Sons, Inc.
Learning Goals:
 Understand the relationship between economic
development and international trade
 Understand the relationship between the terms of
trade, export instability, and economic
development
 Compare imports substitution with export
orientation as a development strategy
 Describe the current problems facing developing
countries
11.1 Introduction
 Until 1980s, an influential minority of economists

argued that international trade hindered
development in developing nations.
 Today most economists believe that international
trade can contribute significantly to the
development process.
 This chapter addresses these claims.
Growth and development
 Economic growth is the expansion of a
nation’s ability to produce goods and
services over time.
 This change may be represented by an
outward expansion of the production
possibilities frontier (PPF).
4
nation’s ability to produce goods and services
over time.
 Economic development is an improvement
in society’s quality of life or standard of
living.
5
nation’s ability to produce goods and services
over time.
 Economic development is an improvement in
society’s quality of life or standard of living.
 Need these be the same?
 No
 However, growth is typically seen to
encourage development by providing the
ability satisfy more material needs (shelter,
education, medical care, etc.). 6
Demonstrating growth
 Growth occurs through
an expansion or
X
improvement in the
factors of production.
7
 Growth occurs through
an expansion or
improvement in the Y
factors of production.
 Balanced growth arises
when the factors of
production change so
that the ability to
produce commodities
is not skewed in favor X
of one commodity over
another.
8
 Unbalanced growth
arises when the factors
Y
of production change
so that the ability to
produce one
commodity is
enhanced more the
ability to produce the
other commodity.
X
9
11.2 The Importance of Trade to Development
 Traditional trade theory: If each nation specializes in

their comparative advantage good, world output
increases and both nations gain.
 This suggests that developing nations should continue to
produce primary goods while developed nations produce
manufactured goods.
 Developing nations believe this pattern keeps them from
reaping dynamic benefits of industry and maximizing their
welfare in the long run.
 Developing nations view traditional trade theory as
involving adjustments to existing conditions, while
development requires changing existing conditions.
 However, traditional trade theory can be

extended to incorporate changes in factor
supplies, technology and tastes by using
comparative statics.
 A nation’s pattern of development is not
determined once and for all, but must be
recomputed as conditions change or are expected
to change.
 As a developing nation accumulates capital and
improves technology, its comparative advantage
can shift from primary to manufactured goods.
 During the 19th century, increases in production

and population in resource-poor Great Britain
acted as an engine of growth for regions of more
recent settlement.
 Endowment of resources, movement of workers
and capital to new areas caused rapid growth in
these areas.
 But demand growth is less today, and today’s
developing nations are less well-endowed with
resources.
Beneficial Effects of Trade on Economic Development

1. Can lead to full utilization of underemployed resources.
2. Makes possible division of labor and economies of scale.
3. Provides vehicle for transmission of new ideas, new
technology, new managerial and other skills.
4. Stimulates and facilitates the international flow of capital
from developed to developing nations.
5. Stimulates domestic demand for new manufactured
products until efficient domestic production becomes
feasible.
6. Stimulates greater efficiency by domestic producers to meet
foreign competition.
Endogenous Growth Theory

 Seeks to explain how endogenous technological
change creates externalities that offset the
diminishing returns to capital accumulation.
 Theorizes that lowering trade barriers will speed
up the rate of economic growth and development
in the long run.
Growth and development will thus occur by

1. Allowing developing nations to absorb technology developed
in developed nations at faster rate
2. Increasing the benefits that flow from research and
development
3. Promoting larger economies of scale in production
4. Reducing price distortions and leading to more efficient use of
domestic resources across sectors
5. Encouraging greater specialization and more efficiency in
production of intermediate inputs
6. Leading to more rapid introduction of new goods and services.
11.3 The Terms of Trade and Economic
Development
Types of Terms of Trade

 Commodity, or net barter, terms of trade (N)
 Ratio of the export price index to import price index
 Income terms of trade (I)
 Measures nation’s export-based capacity to import.
 Single factoral terms of trade (S)
 Measures amount of imports nation gets per unit of
domestic factors of production embodied in its exports.
 Double factoral terms of trade (D)
 Measures how many units of domestic factors embodied in
exports are exchanged per unit of foreign factors embodied in
imports.
11.3 The Terms of Trade and Economic
Development
Types of Terms of Trade
 N, I, and S are the most important.

 N is what is commonly meant by “terms of trade.”
 Most significant for developing nations are I and S.
 D is seldom measured.
 I and S can increased even when N declines.
 Ideally, I, S, and N increase.
 Deterioration in all three terms of trade may lead to
immiserizing growth.
The Terms of Trade and Economic
Development
 Commodity terms of trade (N) in developing nations

tend to deteriorate over time because:
 Most or all productivity increases in developed nations are
passed on to workers in higher wages and income, while
increases in productivity in developing nations are
reflected in lower prices.
 Developing nations’ demand for manufactured exports of
developed nations grows faster than developed nations’
demand for agricultural and raw material exports of
developing nations.
FIGURE 11-1. Commodity Terms of Trade and Structural Breaks,
1900-1998
11.4 Export Instability and Economic
Development
 Developing world exports tend to face inelastic

international demand.
 Price fluctuations in these markets do not
significantly change the quantity sold.
 Thus price fluctuations will generate large
movements in revenues collected.
 Fluctuating environmental conditions (weather,
natural disasters, etc.) cause more and larger
supply shifts in the developing world than in the
developed world.
FIGURE 11-2 Price Instability and the Primary Exports of
Developing Nations.
Development
 Fluctuating export prices will result in export

earnings that vary significantly from year to year.
 When export earnings rise, exporters increase
consumption, investment and bank deposits,
which multiply through the economy.
 A subsequent fall in export earnings results in a
multiple contraction of national income, savings
and investment.
 These boom-bust periods make development
planning difficult.
Development
 Empirical Research (MacBean, 1966)

 While export instability is greater for developing
nations, the degree of instability is not very large
in an absolute sense.
 Great fluctuation in export earnings of developing
nations did not lead to significant fluctuations in
their national income, savings and investments,
and did not interfere with development efforts.
 MacBean concluded costly commodity agreements
demanded by developing nations are not
warranted.
Development
 Commodity Agreements
 Buffer Stocks involve the purchase of the commodity when
the commodity price falls below an agreed minimum price,
and the sale of the commodity out of the stock when the
commodity price rises above the maximum price.
 Example: International Tin Agreement, 1956
 Export controls regulate the quantity of a commodity
exported by each nation in order to stabilize commodity
prices.
 Example: International Sugar Agreement, 1954
Development
 Commodity Agreements
 Purchase contracts are long-term multilateral agreements
that stipulate a minimum price at which importing nations
agree to purchase a specified quantity of the commodity and
a maximum price at which exporting nations agree to sell
specified amounts of the commodity.
 Example: International Wheat Agreement, 1949
11.5 Import Substitution versus Export
Orientation
 During the 1950s, 1960s, and 1970s developing

nations made deliberate efforts to move
production away from primary goods towards
more industrialized production.
 Potential gains
 Faster technological progress and growth
 Creation of higher paying jobs
 Higher multipliers and accelerators through
greater linkages in production process
 Improved terms of trade, price stability
 Relief from balance of payments difficulties
Orientation
 Strategies for industrialization

 Import substitution industrialization (ISI)
 Replace imports of industrial goods with
domestic production by reducing import access

to the domestic economy.
 Export oriented industrialization
 Expand industrialization through efforts to
expand domestic exports of industrialized

products.
 Proven to be more effective than import
substitution.
Orientation

Advantages:
 The market for the product already exists
 It is easier to close the domestic market to
imports than to establish new industries in the
face of foreign competition.
 Foreign firms will be encouraged to invest
domestically to avoid the barriers to trade.
Orientation

Disadvantages:
 Protected industries have reduced incentives
to improve and become competitive.
 The domestic economy may be too small to
exploit available economies of scale.
 Import substitution is difficult for more
complex products.
Orientation
 Export-oriented Industrialization
Advantages:
 Allows for the exploitation of available
economies of scale
 International competition spurs greater
domestic efficiency
 Industrial expansion is not limited by the scale
of the domestic economy.
Orientation
 Export-oriented Industrialization
Disadvantages:
 May be difficult to set up export industries
due to competition from more established
industries
 Developed nations often provide high level of
effective protection for industries producing
simple labor-intensive commodities in which
developing nation may have comparative
advantage.
Orientation
Experience with Import Substitution

 Limited success, much failure.
 High rates of effective protection and subsidies
led to inefficient industries.
 Excessive capital intensity, little labor
absorption
 Neglect of agriculture and primary sectors
 Countries that used import substitution generally
fared much worse than those that used export
orientation.
Orientation
 Trade Liberalization and Growth in

Developing Countries
 Many countries that had earlier followed
import substitution strategies began to
liberalize, starting in the 1980s.
 Facilitated by the World Bank.
 Improvements in productivity and growth.
Orientation
11.6 Current Problems Facing Developing
Countries
 Poverty
 Low per capita incomes
 Low income growth
 Poor health indicators
 Foreign Debt
 Serious levels of debt that are worsened by
currency depreciation.
 Trade Problems
 Protectionism reduces trade as an engine of
growth.
Countries
Countries
Case Study 11-1 The East Asian Miracle of
Growth and Trade
Case Study 11-2 Change in Commodity Prices
over Time
Case Study 11-3 The Growth of GDP of Rich
Countries, Globalizers, and Nonglobalizers
Case Study 11-4 Manufactures in Total
Exports of Selected Developing Countries
Appendix to Chapter 11
Appendix to Chapter 11: The World by Income
Appendix to Chapter 11: The World by Income
The Economist
https://www.youtube.com/watch?v=VfKfSUqn_GY

International Economics: International Trade and Economic Development

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

International Economics: International Trade and Economic Development

Uploaded by

Copyright:

Available Formats

CHAPTER E L E V E N

International Trade and Economic

 Until 1980s, an influential minority of economists

 Traditional trade theory: If each nation specializes in

 However, traditional trade theory can be

 During the 19th century, increases in production

Beneficial Effects of Trade on Economic Development

Endogenous Growth Theory

Growth and development will thus occur by

Types of Terms of Trade

Types of Terms of Trade

 N, I, and S are the most important.

 Commodity terms of trade (N) in developing nations

 Developing world exports tend to face inelastic

 Fluctuating export prices will result in export

 Empirical Research (MacBean, 1966)

 During the 1950s, 1960s, and 1970s developing

 Strategies for industrialization

domestic production by reducing import access

expand domestic exports of industrialized

 Import substitution industrialization (ISI)

 Import substitution industrialization (ISI)

Experience with Import Substitution

 Trade Liberalization and Growth in

You might also like