CHAPTER E L E V E N

11
International Trade and Economic Development

Introduction
Today most economists believe that international

trade can contribute significantly to the development process.

Until 1980s, an influential minority of

economists argued that international trade hindered development in developing nations.

This chapter addresses these claims.

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.

The Importance of Trade to Development

Developing nations view traditional trade theory

as involving adjustments to existing conditions, while development requires changing existing conditions.

The Importance of Trade to Development

However, traditional trade theory can be

extended to incorporate changes in factor supplies, technology and tastes by using comparative statics.

A nations 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.

The Importance of Trade to Development

Beneficial Effects of Trade on Economic

Development
1.

Can lead to full utilization of underemployed resources. Makes possible division of labor and economies of scale. Provides vehicle for transmission of new ideas, new technology, new managerial and other skills.

2.

3.

The Importance of Trade to Development

Beneficial Effects of Trade on Economic

Development
4.

Stimulates and facilitates the international flow of capital from developed to developing nations. Stimulates domestic demand for new manufactured products until efficient domestic production becomes feasible. Stimulates greater efficiency by domestic producers to meet foreign competition.

5.

6.

The Importance of Trade to Development

Endogenous Growth Theory

Lowering trade barriers will speed up the rate of economic growth and development in the long run by:
1.

Allowing developing nations to absorb technology developed in developed nations at faster rate Increasing the benefits that flow from research and development Promoting larger economies of scale in production

2.

3.

The Importance of Trade to Development

Endogenous Growth Theory

Lowering trade barriers will speed up the rate of economic growth and development in the long run by:
4.

Reducing price distortions and leading to more efficient use of domestic resources across sectors Encouraging greater specialization and more efficiency in production of intermediate inputs Leading to more rapid introduction of new goods and services.

5.

6.

The Terms of Trade and Economic Development

Commodity terms of trade 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.

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.

Export Instability and Economic 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.

Export Instability and Economic 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.

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

Import Substitution versus Export Orientation

Strategies for industrialization

Import substitution industrialization (ISI)

Replace imports of industrial goods with domestic production by reducing import access to the domestic economy. Expand industrialization through efforts to expand domestic exports of industrialized products. Proven to be more effective than import substitution.

Export oriented industrialization

Import Substitution versus Export Orientation

Import substitution industrialization (ISI)

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.

Import Substitution versus Export Orientation

Import substitution industrialization (ISI)

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.

Import Substitution versus Export 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.

Import Substitution versus Export 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.

Current Problems Facing Developing Countries

Conditions of stark poverty prevailing in many

countries, particularly Sub-Saharan Africa.

Unsustainable foreign debt of poorest

developing nations.
Remaining trade protectionism of developed

nations against developing nations exports.