CHAPTER SiX

INTERNATIONAL MEASURES FOR ECONOMIC DEVELOPMENT

 

6.1. Foreign Trade and Economic Development

6.1.1. Traditional Views of International Trade
 
 

A) Mercantilists View of Foreign Trade and Economic

Development
• Mercantilists believed that international trade is one of the
means for economic development.
• They used to believe that the level of development or
growth of an economy is reflected by its accumulation of
bullions (precious metals such as gold and silver).
• These precious metals can easily be accumulated
through foreign trade by increasing export of
goods and services.
• Accordingly, their primary emphasis was to
increase the level of exports than imports of goods
and services.
• This is because import of goods and services
implies export of bullions from home to the rest of
the world.
• Indeed, there are two phases for mercantilists’
views of foreign trade: First phase and second
phase.
• During the first phase, imports of goods and
services were totally forbidden, keeping in mind
the outflow of bullions which is contrary to
objective of mercantilists.
• However, there were no nations which are willing
to import products from others without
consideration of their exports.
• Hence, this ideology was replaced by the second
phase’s view.
• During the second phase, a nation was encouraged
to import goods and services from the rest of the
world but with monetary value of less than that of
its exports of goods and services.
• In other words the monetary value of export has to
significantly exceed the monetary value of imports
for the sake of assuring an increase in the
accumulation of bullions to the nation.
• Generally, the mercantilists view of foreign trade is
synonymous to zero-sum games, by which one has
to lose when the other gains.
• The implication is that the development of a
country which is brought about through foreign
trade takes place at the expense of development
of other countries.
• As the result such a view of mercantilists was
criticized by classicals’ school of economic thought
which has a belief that there is mutual benefit for
nations if they are involved in foreign trade.
• Then after, the mercantilists’ view of foreign trade
was dethroned and replaced by that of the
classicals view.
B) Classicals View of Foreign Trade and Economic
Development
• According to the classicals, economic
development of a nation is measured by its level
of real output (goods and services) rather than
accumulation of precious metals, unlike the
mercantilists.
• Hence, emphasis has to be given to increasing
the level of output in the nation. The classicals
believe that there is mutual benefit for nations if
there is foreign trade among them.
• They claim that there are absolute and
comparative advantages which can be derived
through foreign trade, as long as there are
differences in resource endowments among
nations.
• Adam Smith has tried to demonstrate the presence
of absolute advantage if nations are engaged in
foreign trade.
• According to Smith, there are differences in
productivity of producing goods and services
among nations due to the differences in resource
endowments.
• If country A is relatively more productive in
producing X than country B; whereas country B is
relatively more productive than country A in
production of Y, there exists mutual gain when
these countries are engaged in foreign trade with
these two commodities in such a way that country
A specializes in the production of X and country B
specializes in the production of Y.
• What if one of the two countries is more
productive in production of both of these products
than the other?
• David Ricardo answered this question with a claim
that “even when one nation is more productive in
production of all types of products than the other,
there exists comparative advantage when these
nations are engaged in foreign trade”.
• In this case, according to Ricardo, a nation has to
specialize in production of a product on which the
productivity is higher.
• For instance, if country A is more productive in
production of both X and Y than country B (and if
A’s productivity is relatively higher in production of
X than that of Y and B’s productivity is relatively
higher in production of Y than X), these countries
gain comparative advantage when they are
engaged in foreign trade in such a way that country
A specializes in production of X and county B
specializes in production of Y.
6.1.2. New International Economic Order (NIEO)
 

• No matter the view of the classicals (which state all

nations generate economic benefit if they are
engaged in international trade), empirical evidences
show that the return from international trade for
LDCs is very lower compared to that of the
developed countries.
• This is for the fact that LDCs are highly dependent
on export of primary products, for which
international prices are lower, whereas the
developed countries export manufactured goods
having relatively higher level of prices.
• Consequently, the terms of trade between LDCs
and DCs usually favor the DCs.

• As the result, a New International Economic Order

was necessitated in pursuit of bringing fair
distribution of gain from international trade.
• On an aggregate level, the economic performance
of the developing countries had been fairly good in
the 1950s.
• By in the early 1960s, however, many developing
countries were frustrated with their growth
prospects and started demanding a better deal.
• Rallying in such organizations as the Non-Aligned
Movement, they created the United Nations
Conference on Trade and Development (UNCTAD)
where they argued for fairer terms of trade and
more liberal terms for financing development.
• The North responded with pious declarations of its
good intentions - but also with a hard-nosed
insistence that the proper forum for any economic
changes continued to be the Bretton Woods
institutions where they held the balance of power.
• By the early 1970s, however, the postures of the
developing countries were changing:
1) A substantial shift occurred in the developing countries’ perception
of the gains to be had from economic relations with the developed
countries under the existing rules of the game.
2) At the same time, the developing countries perceived their own
economic and hence political power via-a-vis the developed
countries to be sufficiently substantial to warrant a strategy of
effective trade unionism to change the rules of the game and
thereby to wrest a greater share of the world’s wealth and income.
3) Finally, a straightforward political desire to participate more
effectively in decision making on the international economic
matters was evident. Participation was demanded not merely to
ensure that the developing countries’ interests were safeguarded,
but equally as an assertion of their rights as members of an
international community, and as a desired feature of a just
international order.
 • The NIEO is essentially a 8 section document that
seeks certain changes in the international system
that would allow less-developed countries
opportunity to build their way out of the never-
ending cycle of poverty.
• Several main articles stand out including:
1) adoption of an integrated approach to price
supports for an entire group of developing
country commodity exports;
2) the indexation of developing country export
prices to tie them to rising prices of developed
countries’ manufactured exports;
3) the attainment of official development assistance to reach
the target of 0.7 percent of GNP of the developed
countries;
4) the linkage of development aid with the creation of the
IMF’s Special Drawing Rights (SDRs);
5) the negotiated redeployment of some developed
countries’ industries to the developing countries;
6) the lowering of tariffs on the exports of manufactures from
the developing countries;
7) the development of an international food program; and
8) the establishment of mechanisms for the transfer of
technology to developing countries separate from direct
capital investment.
6.3. Two-Gap Model
• Most of the Solow-type models of economic growth focus on
closed economies.
• They do not show if or how opening up an economy will affect
the rates of growth of GDP and per capita income over the short,
medium and long term.
• But this model focuses on positive externalities and economies
of scale brought about by the production of export goods.
• Linkages between openness and growth have more recently
been analyzed by the younger generation of endogenous growth
models.
• Most of these models concentrate on the effects of trade
liberalization on economic growth.
• Dismantling barriers to trade and integration into
world markets for goods is one important and
crucial part of a development strategy of (joining)
globalization.
• Furthermore, those “new globalizes” also have to
decide how far to open the capital account, too, by
eliminating controls of international capital flows
and integrating into international financial
markets.
• This model addresses growth dynamics in open economies
under the framework of a traditional Solow-type
neoclassical model.
• This open economy Solow-Model is applied to a low income
developing country (LIC) where low savings restrain the
potential for investment-driven growth (savings gap).
• Opening up to the international financial markets may pave
the way out of a poverty trap in which a number of income
developing country(LICs) are caught.
• If domestic investors (via domestic commercial banks) gain
access to world financial markets, the savings gap could be
overcome by financing domestic (excess) investment out of
the savings from high income countries (HICs) i.e. by capital
imports.
• These capital imports can take the form of
commercial or – in the case of a LIC – concessional
lending abroad, foreign direct investment (FDI)
inflows and portfolio investment by foreigners.
• This model focuses on investment financing
through foreign loans (from international capital
markets and financial aid).
• The effects of these capital imports are analyzed
with a “two gap version” of a neoclassical Solow-
Model of a small, open LIC-economy whose second
gap coming from opening up is the shortage of
foreign exchange needed to finance imports of
goods (foreign exchange gap).
6.4. Foreign capital and aid in economic
development
• Foreign assistance comes from abroad in three
ways including:
 Foreign grants
 Foreign loans
 Foreign Investment (FDI)
• The Foreign Grants are free and are not to be returned.
• These can be in the form of goods or economic grants.
• On the other hand, Foreign Loans are to be returned.
• Foreign Loans can be bilateral and multilateral.
• There are two types of loans: Soft Loans and Hard Loans.
• In soft loans, Interest Rate is very low and time period to
return loan is long and also there are no strict instructions
in terms of usage of these loans.
• Whereas, in hard loans, the Interest Rate is very high, time
to return the loan is short and there are strict policies on
the usage of loan.
• The Foreign Investment is brought in to a country for business
purposes.
• Foreign Investment can be Direct and Indirect and it can also be
Public Investment and Private Investment.
• In Direct Investment, the control over the capital lays in the hands
of investor.
• Whereas, in Indirect Investment, the investor just has some
shares, just like a sleeping partner.
• In Public Investment, the investment is done while considering
the needs of the peoples.
• It is important in accelerating economic development.
• In Private Investment, the investors invest in the fields which they
think can yield maximum profit, irrespective of how this
investment is going to affect the peoples.
• Merits of Foreign Capital and Aid in Economic Development:

1) Accelerates Economic Development

2) Helps in setting up industry and bringing industrialization
3) Helps in capital formation
4) Enables to create and increase employment opportunities
5) Transfer of technology & knowledge takes place with foreign
capital and aid
6) Peoples purchasing power increases with foreign capital and aid
7) Helps in building economic & social development
 
Question: What are the demerits of Foreign Capital and Aid?