Trade Fundamentals:

Why They Matter Policy Implications How to Use Them

Anne Simmons-Benton Booz Allen Hamilton

March 12 14, 2008 Siem Reap, Cambodia

What We Want to Get From this Presentation

1. Trade Matters (and we should be prepared to always argue in its
favor)

2. Policies need to be grounded in theory in order to be sustainable (understanding theory allows you to understand or
challenge prevailing policies

3. Trade is related to growth and poverty reduction (but the

relationship is debated and the debate is important)

4. There is room for compromise in the debate 5. Understanding the theory and its uses will help you write better RFPs (and assess contractor implementation) 6. Understanding theory can help you shape programs in discussion with host governments 7. Know your data (and where to find it)

Why Bother With Trade?

Because it is a major world economic force..

Grown in absolute terms: 22-fold since 1948 Grown in relative terms: world output rose only 7-fold during the same period Growth is accelerating: world trade/GDP ratio grew from 8% in 1950 to 29.5% in 2000

.benefiting Developing Countries

DC share of world merchandise exports rose from 17% in 1990 to 30% in 2000 Growth in LDC merchandise exports in last two years exceeded growth in world exports

But There are Important Differences

LDC Merchandise Exports by Group

Developing Countries Ten countries account for 64% of all DC exports China and Asian NIEs account for 45% of total DC exports China $249.3 B (13.4%) African merchandise exports S Korea $172.3 B (9.3%) grew by 27% on average in Mexico $166.4 B (8.9%) Taiwan 2000, but actually declined $148.3 B (8%) in 20 Saudi Arabia African countries $84.1 B (4.5%)
Singapore Thailand Indonesia Brazil $78.9B (4.2%) $69.1B (3.7%) $62.1 B, (3.3%) $55.1B, (3.0%)

(Annual Average % Change)

15 10 5 0 -5 -10

World

LDCs with civil strife are those 1990-2000 countries that experienced political or other problems such as Total LDC Afghanistan. As a group, their Oil Exporters exports dropped by an average Manufactures decade. annual 7% over the Exporters

Commodity Exporters LDCs with Civil Strife

Link Between Trade and Growth

Real Per Capita GDP Growth

Trade increases growth

An increase in trade as a share of GDP of 20% increases growth by 0.5%-1% per year In the 1990s, globalizers have grown 5.3% per capita, compared to 0.8% for non-globalizers

6% 5% 4% 3% 2% 1% 0%
1960s 1970s 1980s 1990s

Main effects

Developing countries which Aligns resource allocation with have brought down comparative advantages the absolute level of their tariff Raises productivity the 1990s versus and rates over competitiveness that did not have a those that Ties a country into global an absolute decline. production networks

Rich Countries Globalizers Non-Globalizers

Source: Dollar & Kraay, World Bank

Trade and Poverty Alleviation

Trade is good for the poor

Open economies grow faster, and faster growth is closely linked to income growth of the poor Empirically, increased trade lowers poverty: 1% rise in GDP raises per capita income of the poor by to 2%

But
There are short-run adjustment costs Impacts are unevenlosers may never recover; there are gender differences Complementary policies & initiatives are needed

Some Objectionsare created in new Jobs to Trade

industries mainly exports:
In the United States, 12 million people owe their jobs to exports; 1.3 million of those jobs were created between 1994 and 1998. And those jobs tend to be better-paid with better security.

Developed country concerns

Trade leads to de-industrialization Trade displaces workers and lowers average wages Trade/FDI encourage sub-standard labor conditions and sweatshop wages New jobs tend to be higher Developing country concerns jobs lowerpaying; lost Trade widens incomepaying: inequality Mexico, the best jobs are those related to export WTO exists to protectInindustrial country interestsor more activities: sectors which export 60 per cent 80% of WTO sovereignty 39% higher than the of their members are production, Globalization undermines the economy pay wages rest of developing countries maquiladora (in-bond Averageand times thepaid by wages Mexican assembly) plants pay 3.5 Local industries lose out minimum wage. have been 1.8-2 times MNCs higher than domesticlowered Not true: growth has manufacturing wages income inequality in most developing countries Working practices are better than domestic industry

Trade Liberalization

Trade liberalization has multiple, sometimes offsetting, effects

Consumersgreater variety of lowerpriced goods Producersbetter access to lower cost inputs, technology versus greater competition Fiscal revenuesreduction in trade taxes versus income from new industries, growth Employmentloss of import-competing jobs versus new employment in new industries; immediate impact on the poorest groupsbut transitory

CLICK TO ADD BREAKER Trade Fundamentals SLIDE TITLE

Presentation Outline

Mercantilism Absolute advantage Comparative advantage Krugmans Clarity Trade Fundamentals and Growth

Trade Fundamentals and the Construction of RFPs

Growth was measured in terms of accumulation of specie (gold and silver). Force trade through one state, acquire colonies to supply cheap raw materials to be manufactured in the Home country and sold domestically and abroad 16th century concept It focused on promoting domestic industries and domestic Neo-Mercantilism is present in the form of A nations wealth depends on accumulated trade trade, favored large treasure Opened up domestic policies to Protect monopolies (such as monopolies, drove out international older oligopolistic Trade Unions orIt is in a nations best interest to have a trade surplus competition and reaped the monopoly industries-car manufacturing, steel Maximize exports through subsidies rentsDutch East India Company, British production etc.) Minimize imports through tariffs and quotas East India Company--examples Very similar lines of logic to the 16th century, favor domestic business at the game: of Zero-sum expense one country can gain only at the expense other countries, raise tariff barriers to insure of another this protection, focus on exporting goods The theory of trade runs counter to declined as an explanation of trade due to Mercantilism these neo-mercantilist argumentslong-run It was not a theoryrather a policy to build the David Humes specie-flow mechanism argument was the theory of David Hume arguments favor open trade. Nation-Stateit In the long-run the accumulation of gold (specie) the physiocratesin theshowed the fallacy of and will raise prices that accumulating country making the exports of that country relatively less attractive a change. Mercantilism as a Policy and forced to foreign buyers and imports relatively more attractive to domestic residents since foreign prices are relatively lower.

Mercantilism

Neo-mercantilism is still alive!

Absolute Advantage
Smith disagreed that trade was a zero sum game Countries have different capabilities to produce more of a product with the same amount of input Produce only goods where you are the most efficient and trade for those where you are not efficient Smith (and Hume) used observations of trade dynamics to show the deficiencies of current polices since they were really concerned with long-run economic growth and welfare. Thus. powerful theory was used to change current policies.

Ricardo and Comparative Advantage

Where Ricardo showed that By trading in factors of comparative advantage When Country A is relatively more efficient at determines production it takes the argument trade, H-O shows us that relative factor away producing a good or service than Country B, then it from goods trade and the endowments determine comparative focus has a loss of jobs in a advantage advantage since they determine on the comparative particular industryit shows that opportunity costs. migrates across goods labor Main insights Countries do not actually trade marketsas a factor of Trade is determined by opportunity (not absolute) costs goodsrather they trade factors of production. Countries should specialize in the production of goods and services productionthis impacts policy Factor productivity causes wage where they have a comparative advantage formation in trade and how its impact is rates not new lower paying jobsworld output and increases consumption Specialization raises assessed. elsewherelevelstrade is a positive sum game in the world

Heksher-Olin Updates of Comparative Advantage and Opportunity Cost Hecksher-Ohlindifferences in factor endowments The H-O description is important for current policy debates

Krugmans Clarity
Countries export so they can import Objective of increasing productivity is to enable a country to produce more Emphasis on high-value sectors is misplaced; countries that dont produce high value goods benefit from trade Trade policy has no effect on net job creation (the natural rate of unemployment is relatively unchanged over time); rather trade policy causes reallocations but not a net long-term change in employment. Wages do not fall if workers compete globally for scarce jobs; wages are dependent on productivity

Trade Fundamentals and the Construction of RFPs What is important about trade theory for the construction of an RFP in your region of USAID
Know the data Know the level and composition of trade Know the specific relationship between trade and growth in your region

Standard sources to consult

Balance of Payments data Fiscal and Monetary data Recent FIAS Administrative Barrier studies, BizCLIR study Customs data WTO, Country Reports World Bank, Doing Business Survey USTR, National Trade Estimate Report on Foreign Trade Barriers