LESSON 27: TRADE POLICIES-ECONOMIC

DEVELOPMENT
27.1 Introduction

27.2 Importance of Foreign Trade

27.3 Trade strategies

27.4 Effects of Foreign Trade

27.5 Favourable effects of foreign trade

27.5.1 Speeds up the process of economic development

27.5.2 Provides necessary infrastructure

27.5.3 Widens the extent of the market

27.5.4 Provides great educative effect

27.5.5 Encourages the inflow of capital

27.5.6 Brings efficiency in production

27.5.7 Other Effects

27.6 Unfavourable effects

27.6.1 Slow and lopsided development

27.6.2 Adverse effects on capital formation

27.6.3 Deterioration in terms of trade

27.7 Summary

27.8 Check your Progress

27.9 Key Concepts

27.10 Self-Assessment Questions

27.11 Answers to check your progress

27.12 Suggested Readings

Objectives:
After studying this lesson, you will be able to understand

• Meaning of Foreign Trade

• Importance of Foreign Trade

• Advantages and disadvantages of Foreign Trade

• Impact of Trade policies on economic development

27.1 Introduction:
Dear students, the present chapter deals with the role of foreign trade in economic
development. As you know that, foreign trade means the trade with the other economies
in terms of exports and imports, because no country is self sufficient. Every country
depends upon other countries for exports of some items and imports of others. This gives
raise to international trade or international specialization. When country specialises in the
production of those goods which it can produce cheaper and import those goods which
others can produce at a lower cost, it gains from trade and there is increase in national
income which helps to promote economic development. Now I think it is clear to you
about the meaning of foreign trade and economic development concepts. Therefore, in
this lesson an attempt is made the explain role of foreign trade in economic development.
The role of foreign trade in economic development is considerable. The Classical and
Neo-classical economists attached so much importance to foreign trade in countries
development that they regarded it as an engine of growth. The opposite view is held by
structuralist who argue that historically foreign trade has led to international inequality
whereby the rich countries have become richer at the expense of the poorer countries.

27.2 Importance of foreign trade:

Foreign trade possesses is of great importance for development of an economy. It

provides the urge to develop the knowledge and experience that makes development
possible, and the means to accomplish it. Haberler Opines,” My overall conclusion is that
International trade has made a tremendous contribution to the development of less
developed countries in the 19th and 20th centuries and can be expected to make an equally
big contribution in the future and that substantial free trade with marginal, insubstantial
corrections and deviations is the best policy from the point of view of economic
development. In the words of Cairncross, “Over the past century and a half, the growth
of international trade has continued to open up new opportunities of specialization and
development for the countries engaged init. These opportunities were particularly
apparent in the primary producing countries overseas that were still in process of
settlement, since trade enabled them to bring into use unexploited natural resources and
freed them from the limitations of their own domestic markets. The international division
of labor that resulted simultaneously helped the importing countries to meet their
expanding requirements of materials and food-stuffs from low cost sources of supply and
afforded their export industries the double advantage of a large scale of operations at
lower real cost and the further economies that normally accompany a rapid rate of
industrial growth.

27.3 Trade Strategies:

Trade strategies can be broadly divided into two groups: they are

 Inward Oriented
 Outward Oriented Strategies.

 Inward oriented strategy, trade and industrial incentives are biased in favor
of production for the domestic market over that for export market. This
can also called as the import substitution strategy.

 Outward Oriented Strategy, trade and industrial policies do not

discriminate between production for the domestic market and for foreign
market goods. This is called as export promotion strategy.

The inward oriented policies are characterized by high levels of protection, direct
controls on imports and investments and overvalued exchange rates wheras
discriminatory use of tariffs, quotas, tax and credit subsidies etc., is not in consonense
with the spirit of purest form of outward oriented strategy. It may be mentioned here,
however, that outward oriented strategy does not necessarily imply less government
intervention. As pointed out by the World Development Report, “ some countries
have pursued outward orientation by offsetting some of the anti-export bias of
important barriers; they have promoted exports by dismantling import barriers only
slowly”. However, it should be noted that the small countries and their model of
 development is not suited to big countries and in their case foreign trade has not
contributed much in their economic development. Therefore, some economists have
strongly criticized their theories which seek to establish positive relationship between
international trade and economic development.

There are economists who hold the view that foreign trade hinders the development of
underdeveloped countries. Historically, it has resulted in the exploitation of the poor
countries by the rich countries. It is, therefore, contended that it would be in the interest
of under-developed countries to forego the gains arising from international specialization
and follow the policy of import substitution and deliberate industrialization for the
economic development of their economies.

We now discuss how foreign trade helps or hinders economic development.

27.4 Effects of foreign trade: Foreign trade will have two types of effects, they
are:

 Favorable Effects
 Unfavorable Effects.

Among the favorable effects, some of the important of them are:

• speeds up the process of economic development

• provides necessary infrastructure
• widens the extent of the market
• provides great educative effect
• encourages the inflow of capital
• brings efficiency in production
The following are some of the important unfavorable effects of foreign trade:

 slow and lopsided development

 adverse effects on capital formation
 deterioration in terms of trade

Let us have a in-depth analysis of the above stated favorable and unfavorable effects of
foreign trade on economic development.

27.5 Favorable Effects:

Some of the important favorable effects of foreign trade are as follows:

27.5.1 Speeds up the process of economic development

It encourages the setting up of basic and key industries such as iron and steel industry,
heavy electricals and engineering goods industries. Such industries require the
imports of plant, machinery equipment and other appliances as they cannot be
produced at home in the initial stages of economic development. Such imports which
help to expand the productive capacity of the economy are termed as developmental
imports. A developing country needs both developmental and maintenance imports
for promoting economic development. At the same time to pay for the imports,
exports must also increase proportionately. Exports must match the imports failing
which the pace of economic development will slow down. Thus both imports and
exports are essential for the economic development of a country.

27.5.2 Provides necessary infrastructure

 The under developed countries generally exchange food-stuffs and rawmaterials
which have low growth potential against machinery and capital goods which have
high growth potential. This quickens the pace of economic development by providing
social and economic overheads and directly productive activites.

27.5.3 Widens the extent of the market

Foreign trade can help to break the vicious circle of poverty by widening the market,
stimulating the inducement to invest and thereby raising the volume of saving and
investment. Not only this, the expansion of the market results in various types of
internal and external economies which lower the cost of production and widen the
market still further. This makes the process of economic development cumulative in
character.

27.5.4 Provides great educative effect

Foreign trade possesses an “educative effect’. Underdeveloped countries lack in

critical skills, which are a greater hindrance to development than is the scarcity of
capital goods. Foreign trade tends to overcome this weakness.

27.5.5 Encourages the inflow of capital

Foreign capital not only increases the level of income, output and employment but
also helps to tide over balance of payments difficulties and inflationary pressures. It
also bring with it entrepreneurship, managerial talents, technical known-how, skills
and ideas which play a vital role in economic development. International trade thus
serves as the vehicle for the international movements of capital and ideas.

27.5.6 Brings efficiency in production

Foreign trade creates remunerative markets for the agriculture produce and thereby helps
to transform the subsistence sector into a commercial sector. It promotes greater
international and domestic equality by equalising factor prices, raising real incomes of
trading countries and making efficient use of each nation’s and the world’s resources.

27.5.7 Other effects:

When a country specializes in the production of a few goods due to international trade
and division of labor, it exports those commodities which it produces cheaper in
exchange for what others can produce at a lower cost. It gains from trade and there is
increase in national income which in turn raises the level of output through trade tends to
break the vicious circle of poverty and promotes economic development.

LDC is hampered by the small size of its domestic market which fails to absorb sufficient
volume of output. This leads to low inducement to investment. The size of the market is
also small because of low per capita income and of purchasing power. International trade
widens the market and increases the inducement to invest income and saving through
more efficient resources allocation.

Moreover, many under developed countries specialize in the production of one or two
staple commodities. If efforts are made to export them, they tend to widen the market.
Thus existing resources are employed more productively and the resources allocation
becomes more efficient with given production functions.

As a result, unemployment and under employment are reduced; domestic saving and
investment increase; there is a larger inflow of factor inputs into the expanding export
sector; and greater backward and forward linkages with other sectors of economy. This is
known as the “staple theory of economic growth”, associated with Watkins. Foreign trade
also helps to transform the subsistence sector into the monetized sector by providing
markets for farm produce and raises the income and the standard of living of the
peasantry. The expansion of the market leads to a number of internal and external
economies, and hence, to reduction in cost of production. These are the direct or static
gains from international trade.

27.6 Unfavorable effects:

Some of the important unfavorable effects of foreign trade are mentioned below:

27.6.1 Slow and lopsided development

Foreign capital was mostly employed in extractive industries producing raw-materials

and primary products for manufacturing industries established in the countries of
foreign investors. This led to the exploitation of the exhaustable mineral and natural
resources of the capital importing countries and it prevented the growth and
development of their economies.

27.6.2 Adverse effects on capital formation

It is contended that international trade adversely affects the rate of saving in the poor
countries through international demonstration effect. International trade causes
awareness of the superior consumption patterns of rich countries. Therefore, it effects
the capital formation in the country.

27.6.3 Deterioration in terms of trade

It is maintained by certain economists like Raul Prebish and HW Singar that there has
been secular deterioration in the terms of trade of the less developed countries and
consequently gains from international trade have gone more to rich countries at the
cost of poor countries.
To overcome the various problems and difficulties in the foreign trade attempts have
been made in recent years for promoting regional economic cooperation among the
developing countries. This enables them to overcome constraint of a small size of
domestic market from which these countries suffer and helps them to rep advantages of
the economies of large scale production. Later these countries can explore the
possibilities of coordinated industrial planning by abolishing trade barriers amongst
themselves. However, it requires political will to sacrifice national self-interest and
subordinate political considerations to the promotion of common economic interests.

27.7 Summary

Therefore, foreign trade, in addition to the static gains resulting from efficient resource
allocation with given production functions, powerfully contributed in four ways indicated
above, by transforming existing production functions and pushing upwards and outwards.
Important advantages are; speeds up the process of economic development, provides
necessary infrastructure, widens the extent of the market , provides great educative effect,
encourages the inflow of capital, brings efficiency in production. And important
disadvantages are; slow and lopsided development, adverse effects on capital formation,
deterioration in terms of trade. Therefore, foreign trade may either promote or hinder
economic development depending upon specific situation.

27.8 Check your Progress

1. Foreign trade means trade other economies
2. Neo-classicals viewed that the foreign trade as an engine of growth
3. Out-ward oriented strategy is one of the development strategy
4. Educative Effect is one of the unfavorable effect of trade
5. Deterioration of terms of trade is one of the unfavorable effect of trade

27.9 Key Concepts

Foreign trade : Foreign trade means the trade with the other economies in terms of
exports and imports, because no country is self sufficient.

Inward oriented strategy : Trade and industrial incentives are biased in favor of
production for the domestic market over that for export market. This can also called as
the import substitution strategy.

Outward Oriented Strategy: Trade and industrial policies do not discriminate between
production for the domestic market and for foreign market goods. This is called as export
promotion strategy.

Import substitution strategy : Inward oriented strategy also called as import

substitution strategy

Export promotion strategy: Outward oriented strategy also called as export promotion
strategy

Educative effect : Foreign trade possesses an “educative effect’. Underdeveloped

countries lack in critical skills, which are a greater hindrance to development, foreign
trade tends to overcome this weakness.

27.10 Self-Assessment Questions

Short Answer Questions

1. Distinguish the inward oriented and outward oriented strategies?

2 What do you mean by foreign trade?
3 What are the determinants of exports and imports?
4 Enlist the favorable and unfavorable effects of foreign trade?
Long Answer Questions

1. Is foreign trade a help or a hindrance to economic development?

2 Do you think that there is conflict between growth and trade-Discuss
3. Explain how free trade maximizes the gains from trade?
4. “Foreign trade and not aid should be stressed in a growing economy”. Discuss
5. “For financing economic development trade is to be preferred to aid”. Discuss
6. Examine the contribution of India’s foreign trade to her economic development.
7. Write a critical note on:
Export vs. import-led strategy of economic growth.

27.11 Answers to check your progress

1. True 2. True 3. False 4. False 5 True

27.12 Suggested Readings

Kindleberger C.P., Economic development

Meier G.M. Economic development
Taneja & Myer Economics of Development and planning
Jhingan M L The Economics of Development and planning