Economic Development in Asia

Chapter 6 - International Trade and Investment

 International Trade
• When international trade is introduced into an autarkic
economy, gains are made in both consumption and
production.
• Gains from trade can also be broken down into gains
from exchange and gains from specialization.
• With trade, it is possible to move to a higher
indifference curve – consumer gains (see Figures 6.1
and 6.2).
• Production gains are realized by a country specializing
in the production of commodities that it can produce at
relatively low costs.
The Ricardian Theory of Trade
• In Ricardo’s model,
differences in technology
determine comparative
advantage.
• Tastes, technology and
supply of resources don’t
change in this model.
• Trade is a positive sum
game so there are no
losers across or within
countries.
Hecksher-Olin-Samuelson Model
• The Hecksher-Olin–Samuelson (HOS) model extended
the Ricardian framework focusing on the fact that
countries will trade in goods where it has relatively
abundant factors.

• Poorer countries will export labor intensive products

and rich countries will export capital intensive products.

• Trade will be greater between countries with different

economic structures.
Hecksher-Olin-Samuelson Model
• Extensions of the HOS model include the Rybcznski
theorem which says that an increase in the supply of a
factor will cause an expansion in the production of
goods intensive in the use of that factor.

• It also includes the Samuelson-Stopler theorem which

says that an increase in the price of a good raises the
real return to the factor intensive in the production of
that good and lowers the return to the other factor.
 Imperfect Competition
• There are many assumptions underlying both the
Ricardo and HOS models – perfect competition, factor
immobility between countries, identical production
functions and identical preferences of consumers.

• When these assumptions are relaxed, conclusions

change to some extent.

• For instance, the theory says that countries with similar

relative endowments of factors should not trade much.

• Yet look at trade in Europe and in North America.

 Imperfect Competition
• This arises because of product differentiation and differences
in consumer preferences.

• As a result, and also realizing that monopoly power and

economies of scale exist, the gains and direction of trade are
complex and difficult to analyze.

• If trade results in a decrease (increase) in market power,

then there may be welfare gains (losses).

• The theory also tells us that intra-industry trade will be larger

(as a proportion of the total) when countries are alike in
terms of relative factor endowments.
 Empirical Support

• There is broad empirical support for the theoretical

implications of the monopolistic competition model of
international trade.

• Trade between countries with similar factor

endowments has grown as a proportion of total trade.

• Large oligopolies’ power to distort prices and distort

supply may have been reduced by the forces of
international competition.
 Empirical Support
• An inverse correlation observed for distance between
countries and trade supports the so-called gravity
model of international trade.

• There is a positive relationship between intra-industry

trade and per capita income since tastes are positively
correlated with per capita income.

• As a result, countries that are more alike as measured

by per capita income would trade with each other in
products in the same industry – cars and white goods
for example.
 Trade Experience of Asia and
the World

• Volume of international trade has grown faster

world-wide and in Asia than has the growth in income
(Table 6.1).

• The role of primary products in trade has declined as

has its terms of trade.

• Exports as a share of GDP has correspondingly risen.

 Trade Experience of Asia and the
World
• Though falling, the bulk of trade takes place between
rich countries with similar factor endowments (Table
6.2).

• The factor price equalization theorem (that returns to

labor and capital will tend to equalize across countries
over time) has worked only slowly.

• Wage differentials are still large as are returns on

capital.
 Import Substitution
• In almost all developing countries, certain industries are granted
trade protection so that they may develop without the fear of
international competition.

• This is called “infant industry” protection.

• Inefficient domestic industry is subsidized for a time, while the

government gets to spend the taxes it raises from import levies.
• Import substitution builds up an industrial base and technological
abilities.

• Import substitution is limited by the extent of the market and also

by temptation (and incentives) to remain at a low level of efficiency
and technology.
 Export Promotion
• Started with labor intensive products with strong
backward linkages

• Moved later into skill and capital intensive industries.

• Computers, electronics and pharmaceuticals were

industries where income elasticity of demand in
industrial countries is high.
 Flying Geese Development
Paradigm
• A popular set of stylized facts to describe Asian development.
• It sets up five stages in the life of an industrial enterprise or
general industrial development:

1.Product introduced through importation

2.Import substitution
3.Export orientation
4. Maturing industry as production slows
5. Declining industry relocates or perishes
 Flying Geese Development
Paradigm
• In Asia, the following groups of countries started in stage one and
followed successively through the other four - Japan, followed by
the NIEs and the ASEAN-4 .

• The regional hierarchy allows economic development to trickle

down to individual countries.

• The other countries in the region don’t fit as

nicely into the paradigm, although the
Mekong can be seen as following ASEAN.

• China is developing so rapidly that it is

overtaking ASEAN.
 Flying Geese Development
Paradigm
• South Asia did not participate in the paradigm until the
1990s, so it can be put with the Mekong countries
although it already had a strong domestic industrial
base by the early 1980s.

• The advantage of this paradigm is that it predicts many

of the developments in the region’s trade and FDI
experience.
 Flying Geese Development
Paradigm

• It predicts regional integration and growing interdependence.

• It stresses inter-industry trade as labor intensive products

are produced by the late comers while the advanced
countries specialized in capital and skill intensive products.

• Finally, there is the hollowing out problem at stage five –

witness Japan and more recently Taiwan.
 Issues of Trade in Asia
• Trade protection is an issue
and can be measured by the
“effective rate” of protection.

• The effective rate is higher

than the nominal tariff, since it
is computed using value
added as a base.

• Trade taxes in Asia have

fallen but are still high in
South Asia.
http://www.freeimages.co.uk/
 Issues of Trade in Asia
• Free trade is a goal for many integrated regions and
has been achieved in Europe and North America to a
significant extent.
• Taxes on trade distort the workings of the free market
and work to nullify comparative advantage.
• When trade is freed up, exports can be more effective
in lifting productivity and stimulating growth.
 Issues of Trade in Asia
• There is evidence from cross-country analysis that exports
and outward orientation are important determinants of rates
of growth.

• There is an argument that latecomers to the export

promotion strategy will be disappointed.

• Such an argument fails to realize the power of dynamic

comparative advantage and the additional room that still
exists for greater import penetration into industrial
economies.

• The Asian economies are the most open to FDI among all
developing regions.
 Issues of Trade in Asia
• Subsidiaries of TNCs have higher productivity than local
firms.
• Evidence of positive spillovers from TNCs to local firms
is more tenuous.
• Partnerships with TNCs bring access to marketing,
industrial organization and new technology that
domestic firms would otherwise not have access to.
• The share of East Asia and Southeast Asia in world
exports is now over 20% up from 12 % in 1990
 Issues of trade in Asia

• The share of East Asia and Southeast Asia in world

exports is now over 20% up from 12 % in 1990

• Intra-regional trade has expanded at a more rapid pace

than trade with the rest of the world.

• It now accounts for more than half of trade volume in

East Asia (including Southeast Asia)
 Issues of trade in Asia

• There has also been a shift in the commodity

composition of international trade.

• Exports have shifted from light manufacturing include

textiles, wood and paper products and furniture to
machinery, particularly electronics and
telecommunications equipment.

• This shift was particularly rapid in ASEAN countries

 Pattern of FDI Flows
• China, Singapore and Hong Kong have attracted the
lion share of FDI into Asia.

• The rate of inflow has increased in other countries,

such as India, Korea and Malaysia, from a low base
(see Table 6.3).

• Education and timing were important factors in how

technology was adopted.

• Since East Asia had high educational levels, it could

adopt overseas technology to local conditions.
 Pattern of FDI Flows
• Since savings rates were high and because of
government policy, the NIEs did not have much FDI
with exception of Japanese investment in Korea.

• In Southeast Asia, industrialization began later and they

had to rely on export earnings from primary products to
begin the industrialization process.
 Pattern of FDI Flows
• They relied more on FDI from the US and Japan to
bring new technology.
• The Plaza Accord created incentives for stronger FDI
from Japan into traditional labor intensive industries and
to simple electronics assembly.
• These options were not available to the NIEs, who
relied on their own resources to “bootstrap” their way to
industrialization.
Institutional Factors Facilitating
Trade
• The exchange rate is the most important target variable
since it has a direct impact on the profitability of firms.
• Other things equal, exchange rate depreciation brings
greater international competitiveness.
• Foreign capital inflows have also become more
important over the years, including equity investment
and short-term bank lending.
• In the build up to the Asian crisis, the current account
deficit, international competitiveness and absorptive
capacity of the economy were other important factors.
 Asia’s Experience in
Intra-regional Trade
• There has been an increase in intra-regional trade within Asia
(including Japan) in the last 2 to 3 decades to over 50 percent of
exports and imports.

• Growth in income and geographic proximity has stimulated trade.

• There has been a growth in regional cooperation within Asia.

• Developments in technology and transportation have stimulated

intraregional trade.

• Growth of manufactured goods exports has stimulated

intra-regional trade in very much the same way as trade in the EU
has expanded.
 Asia’s Experience in
Intra-regional Trade
• Change in exchange rate alignments following the Plaza
accord led to outsourcing and FDI from Japan to the rest of
Asia.

• There was liberalization of FDI regulations in several

countries.

• Intellectual property is becoming an important factor in the

flow of FDI.

• To protect intellectual property, firms may choose FDI rather

than licensing.
 Asia’s Experience in
Intra-regional Trade
• Compared with other regions, there are fewer formal
mechanisms to facilitate regional cooperation in Asia.

• ASEAN and SAARC are the only two formal regional

trade organizations in Asia.

• There has been more emphasis on unilateral

agreements.

• Special economic zones have also been developed.

 Asia’s Experience in Intra-
regional Trade
• The rapid rise of China both in terms of income
and international trade has dramatically changed
the landscape of Asia
• China is now the 5th largest economy in the
world and the third largest in trade behind the
US and Germany.
• Its exports have grown at more than 20 % per
year and its incomes at around 10 percent over
the last decade or so
 Asia’s Experience in
Intra-regional Trade
• Intense competition for export markets within Asia has
resulted in specialization in high technology exports
• This has generally raised the level of comparative
advantage and economic efficiency.
• There has also been a commensurate increase in the
variety of new products
 Asia’s Experience in
Intra-regional Trade
• This has reduced the start up costs

• It has also created increasing returns to scale as

measured by revealed comparative advantage
 Summary
• Introduction to international trade theories.
• Changing pattern of international trade in Asia.
• Import-substitution regime versus export promotion
regimes.
• “Flying Geese” development paradigm.
• Important issues and considerations in trade.