Chapt 12

Chapter 12
International
Trade Theory and
Development
Strategy
Copyright 2009 Pearson Addison-Wesley. All rights reserved.
Globalization: An Introduction
Globalization- many interpretations
Core economic meaning- the increased
openness of economies to international
trade, financial flows, and foreign direct
investment.
Concerns with globalization center around
the unevenness of the process
Copyright 2009 Pearson AddisonWesley. All rights reserved.
12-2
International Trade and

Finance: Some Key Issues
Many developing countries rely heavily on exports of
primary products with attendant risks and uncertainty
Many developing countries also rely heavily on imports
(typically of machinery, capital goods, intermediate
producer goods, and consumer products)
Many developing countries suffer from chronic deficits on
current and capital accounts which depletes their reserves,
causes currency instability, and a slowdown in economic
growth
12-3
Figure 12.1 Nonfuel Primary Commodity

Prices, Nominal and Real, by Commodity
Group, 1960-2005 (2000 index = 100)
12-4
Figure 12.1 Nonfuel Primary Commodity Prices,

Nominal and Real , by Commodity Group, 19602005 (2000 index = 100) (continued)
12-5
Five Basic Questions about

Trade and Development
How does international trade affect economic
growth?
How does trade alter the distribution of
income?
How can trade promote development?
Can LDCs determine how much they trade?
Is an outward-looking or an inward-looking
trade policy best?
12-6
The Importance of Exports to

Different Developing Nations
Importance of exports to developing nations
Exports of LDCs are much less diversified
than those of developed countries
12-7
Table 12.1 Merchandise Exports in

Perspective: Selected Countries, 2005
12-8
Demand Elasticities and Export

Earning Instability
Low income elasticity of demand for primary
products
Low price elasticity of demand and supply
Export earnings instability
12-9
The Terms of Trade and the

Prebisch-Singer Thesis
Total export earnings depend on:
Total volume of exports sold AND
Price paid for exports
Prebisch and Singer argue that export prices fall

over time, so LDCs lose revenue unless they can
continually increase export volumes
Prebisch and Singer think LDCs need to avoid a
dependence on primary exports
12-10
The Traditional Theory of

International Trade
Comparative advantage
specialization
Relative factor endowments and international

specialization: the Neoclassical model
Ricardo and Mill (static model)
Heckscher and Ohlin (factor endowment theory)
Different products require productive factors in different ratios
Countries have different endowments of factors of production
12-11
Figure 12.2 Trade with Variable Factor

Proportions and Different Factor
Endowments
12-12
Figure 12.2 Trade with Variable Factor

Proportions and Different Factor
Endowments (continued)
12-13

International Trade
Main conclusion of the neoclassical model is that
all countries gain from trade
World output increases with trade
Countries will tend to specialize in products that
use their abundant resources intensively
International wage rates and capital costs will
gradually tend toward equalization
Returns to owners of abundant resources will rise
relatively
Trade will stimulate economic growth
12-14

International Trade
Trade theory and Development: The Traditional
Arguments
Trade stimulates economic growth
Trade promotes international and domestic equality
Trade promotes and rewards sectors of comparative
advantage
International prices and costs of production determine
trading volumes
Outward-looking international policy is superior to
isolation
12-15
The Critique of Traditional Free-Trade

Theory in the Context of DevelopingCountry Experience
The following assumptions of the
Neoclassical model must be scrutinized:
Fixed resources, full employment, and
international factor immobility
Fixed, freely available technology and
consumer sovereignty
Internal factor mobility and perfect competition
Governmental non-interference in trade
12-16

Balanced trade and international price
adjustments
Trade gains accruing to nationals
12-17

Fixed Resources, Full Employment, and the
International Immobility of Capital and
Skilled Labor
Challenged by North-South trade models
Michael Porters Competitive Advantage theory
Vent for Surplus theory
12-18
Figure 12.3 The Vent-for-Surplus

Theory of Trade in LDCs
12-19

Fixed, Freely Available Technology and
Consumer Sovereignty
Challenged by the Product Cycle theory
Development of synthetic substitutes for
developing country exports
12-20

International Factor Mobility, Perfect Competition,
and Uncertainty: Increasing Returns, Imperfect
Competition, and Issues in Specialization
Structural realities in developing countries
Increasing returns and exercise of monopolistic control
over world markets
Risk and uncertainty inherent in international trading
arrangements
12-21

The Absence of National Governments in
Trading Relations
Definite role for State
Industrial policy is crafted by governments
Commercial policies instruments (tariffs, quotas)
are state constructs
International policies can result in uneven
distribution of gains from trade
12-22

Balanced Trade and International Price
Adjustments
Unrealistic (oil price hikes of the 70s)
12-23

Trade gains accruing to nationals
Enclave economies are promoted by trade
Difference between GDP and GNI becomes
important
12-24
Some Conclusions on Trade Theory

and Economic Development Strategy
Trade can lead to rapid economic growth under
some circumstances
Trade seems to reinforce existing income
inequalities
Trade can benefit LDCs if they can extract trade
concessions from developed countries
LDCs generally must trade
Regional cooperation may help LDCs
12-25
Trade Strategies for Development:

Export Promotion versus Import
Substitution
Export promotion: looking outward and seeing trade
barriers
Primary-commodity export expansion, limited demand
Low income elasticities

Low population growth rates in developing economies
Decline in prices implies low revenue
Lack of success with international commodity agreements
Development of synthetic substitutes
Agricultural subsidies
Primary-commodity export expansion, supply rigidities
Expanding Exports of manufactured goods: Some

successes
12-26

Substitution
Import substitution: looking inward but still
paying outward
Tariffs, infant industries, and the theory of
protection
12-27
Figure 12.4 Import Substitution

and the Theory of Protection
12-28

Substitution
The IS industrialization strategy and results
Protected industries get inefficient and costly
Foreign firms benefit more
Subsidization of imports of capital goods tilts pattern of
industrialization and contributes to BOP problems
Overvalued exchange rates hurt exports
Does not stimulate self-reliant integrated
industrialization
12-29

Substitution
Tariff Structure and Effective Protection
Nominal rate of protection
Effective rate of protection
12-30

Substitution
The nominal tariff rate, t, is
p p
t
p
(13.1)
Where
p is the tariff-inclusive price
p is the free trade price
12-31
Tariff Structures and Effective

Protection
The effective tariff rate, g, is
v v
g
v
(13.2)
Where
v is the value added per unit of output,
inclusive of the tariff
v is the value added per unit of output
under free trade
12-32

Substitution
Standard argument for tariff protection
Sources of revenue
Response to chronic BOP problems
Help foster industrial self-reliance
Greater control over economic destinies
Must be applied selectively and wisely

12-33

Substitution
Foreign-exchange rates, exchange controls,
and the devaluation decision
Currencies of developing countries are
overvalued (excess of local demand over
available exchange)
Can run down reserves
Can curtail excess demand through taxes, tariffs,
dual exchange rates
Can use exchange controls
12-34
Figure 12.5 Free-Market and

Controlled Rates of Foreign Exchange
12-35

Substitution
Chronic payments deficits can be
ameliorated by a currency devaluation
Difference between depreciation and
devaluation
Higher import prices result in an inflationary
wage-price spiral
Distributional effects
12-36
Trade Optimists and Trade Pessimists:

Summarizing the Traditional Debate
Trade pessimist arguments
Limited growth of world demand for primary exports
Secular deterioration in terms of trade
Rise of new protectionism
Trade optimist arguments

Trade Liberalization promotes competition and efficiency
Generates pressure for product improvement
Accelerates overall growth
12-37
Trade Optimists and Trade Pessimists:

Summarizing the Traditional Debate
The industrialization strategy approach to export
policy
Focus on government interventions to encourage
exports (industrial policy)
Without proper attention to incentives, industrial policies
may be counterproductive too (South Korean case)
WTO rules and industrial policies
Competence and political authority of governments
12-38
Reconciling the Arguments:

The Data and Consensus
Neither the trade optimists nor the trade
pessimists are always right
There are many factors that determine
whether trade is good or bad for a country
12-39
South-South Trade and Economic

Integration: Looking Outward and
Inward
Economic Integration: Theory and Practice
The growth of trade among developing countries.
Integration encourages rational division of labor among
a group of countries and increases market size
Provides opportunities for a coordinated industrial
strategy to exploit economies of scale
Trade creation
Trade diversion
12-40
South-South Trade and Economic

Integration: Looking Outward and
Inward
Regional trading blocs (economic unions) and the
globalization of trade
NAFTA
MERCOSUR
SADC
ASEAN
Local conditions matter
Do blocs promote growth or retard the progress of
globalization
12-41
Trade Policies of Developed

Countries: the Need for Reform
Rich-nation economic and commercial policies
matter for LDCs
Tariff and non-tariff barriers to LDC exports
Adjustment assistance for displaced workers
General impact of economic policy
1995 Uruguay Round and WTO

Despite 8 liberalization rounds over 50 years trade
barriers remain in place in agriculture and textiles
Doha Development Round 2001 has tilted the
focus on the needs of the developing world
12-42
Figure 12.6 Effective Tariff Faced

by Income Groups, 1997-1998
12-43
Case Study: Taiwan
12-44
Concepts for Review

Absolute advantage
Autarky
Balanced trade
Barter transactions
Capital account
Collective self-reliance
Comparative
advantage
Current account
Customs Union
Depreciation
Devaluation
Commodity terms of trade
Dual exchange rate
Common Market
Economic Unions
12-45
Concepts for Review

Effective Rate of
Protection
Enclave economies
Flexible exchange rate
Exchange Control
Export dependence
Export earnings
instability
Factor endowment trade
theory
12-46
Concepts for Review (contd)

Factor mobility
Factor-price equalization
Growth poles
Import substitution
Foreign-exchange
earnings
Free trade
Income elasticity of
demand
Income terms of trade
Gains from trade

General Agreement on
Tariffs and Trade (GATT
Globalization
Increasing returns
Industrial policy
Industrialization Strategy
Approach
12-47

Infant industry
International commodity
agreements
Inward-looking
development policies
Managed float
Monopolistic market
control
Multi-Fiber Arrangement
(MFA)
New protectionism
Nominal rate of protection
Nontariff trade barriers
North-south trade models
Official exchange rate
Oligopolistic market control
12-48

Outward-looking
development policies
Overvalued exchange rate
Parallel exchange rate
Prebisch-Singer thesis
Price elasticity of demand
Primary products
Product Cycle
Quotas
Regional trading bloc
Rent
Returns to scale
Risk
Specialization
Subsidies
Synthetic substitutes
Tariffs
Trade creation
Trade deficits
12-49

Trade diversion
Trade liberalization
Trade optimists
Trade pessimists
Uncertainty
Undervalued exchange
rate
Uruguay Round
Vent-for-surplus theory of
international trade
Wage-price spiral
World Trade Organization
(WTO)
Value added
12-50

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Chapter 12

Copyright 2009 Pearson Addison-Wesley. All rights reserved.

International Trade and

Copyright 2009 Pearson AddisonWesley. All rights reserved.

Figure 12.1 Nonfuel Primary Commodity

Copyright 2009 Pearson AddisonWesley. All rights reserved.

Figure 12.1 Nonfuel Primary Commodity Prices,

Copyright 2009 Pearson AddisonWesley. All rights reserved.

Five Basic Questions about

The Importance of Exports to

Copyright 2009 Pearson AddisonWesley. All rights reserved.

Table 12.1 Merchandise Exports in

Copyright 2009 Pearson AddisonWesley. All rights reserved.

Demand Elasticities and Export

Copyright 2009 Pearson AddisonWesley. All rights reserved.

The Terms of Trade and the

Prebisch and Singer argue that export prices fall

The Traditional Theory of

Relative factor endowments and international

Copyright 2009 Pearson AddisonWesley. All rights reserved.

Figure 12.2 Trade with Variable Factor

Copyright 2009 Pearson AddisonWesley. All rights reserved.

Figure 12.2 Trade with Variable Factor

Copyright 2009 Pearson AddisonWesley. All rights reserved.

The Traditional Theory of

The Traditional Theory of

The Critique of Traditional Free-Trade

The Critique of Traditional Free-Trade

Copyright 2009 Pearson AddisonWesley. All rights reserved.

The Critique of Traditional Free-Trade

Copyright 2009 Pearson AddisonWesley. All rights reserved.

Figure 12.3 The Vent-for-Surplus

Copyright 2009 Pearson AddisonWesley. All rights reserved.

The Critique of Traditional Free-Trade

Copyright 2009 Pearson AddisonWesley. All rights reserved.

The Critique of Traditional Free-Trade

Copyright 2009 Pearson AddisonWesley. All rights reserved.

The Critique of Traditional Free-Trade

The Critique of Traditional Free-Trade

Copyright 2009 Pearson AddisonWesley. All rights reserved.

The Critique of Traditional Free-Trade

Copyright 2009 Pearson AddisonWesley. All rights reserved.

Some Conclusions on Trade Theory

Trade Strategies for Development:

Low income elasticities

Primary-commodity export expansion, supply rigidities

Expanding Exports of manufactured goods: Some

Trade Strategies for Development:

Copyright 2009 Pearson AddisonWesley. All rights reserved.

Figure 12.4 Import Substitution

Copyright 2009 Pearson AddisonWesley. All rights reserved.

Trade Strategies for Development:

Trade Strategies for Development:

Copyright 2009 Pearson AddisonWesley. All rights reserved.

Trade Strategies for Development:

Tariff Structures and Effective

Copyright 2009 Pearson AddisonWesley. All rights reserved.

Trade Strategies for Development:

Must be applied selectively and wisely

Trade Strategies for Development:

Figure 12.5 Free-Market and

Copyright 2009 Pearson AddisonWesley. All rights reserved.

Trade Strategies for Development:

Trade Optimists and Trade Pessimists: