Chapter 12 International Trade and Development Strategy

1. Chapter 12 International Trade and Development Strategy

2. Basic Questions • How does trade affect rate, structure and character of LDC economic growth? • Does trade serve as an engine of growth? • How does trade affect income distribution? • Should LDC’s adopt outward-looking trade policy?

3. Importance of Exports • Y = C + I + G + (E-M) • High levels of exports (relative to imports) have generated high levels of growth in Japan, South Korea, former Hong Kong and China. • Strategic export policy can provide a ‘big push’ to the economy and lead the country out of the poverty cycle.

4. Importance of Exports

5. Role of Primary Products • Examples – Foodstuffs, rubber, vegetable oil, cotton, leather, jute • Income elasticity is low when income rises in developed countries, demand for primary goods increases slowly. • Foodstuffs 0.6% agricultural raw materials 0.5%. On the other hand, demand for manufactured goods – 1.9% • Relative Price of primary goods declines in the long-run • Price elasticity is also very low • Supply of primary products is also inelastic • It causes instability of export earnings and volatile price fluctuations.

6. Prebisch – Singer Thesis • Commodity terms of trade is defined as the ratio of export price to import price • According to Prebisch – Singer Thesis, there is a secular (long-term) deterioration in commodity terms of trade for primary goods. This is due to low price and income elasticities • Need for diversification to manufactured goods.

7. Trade Strategies – Export Promotion vs Import substitution • Outward-looking or export promotion policies followed by Japan, South Korea, Taiwan, Singapore, Hong Kong and China • Emphasis on Free-Trade, less trade barriers, Free movement of foreign capital • Strategic policies of exports • Export zones & export promotion • Export promotion policies for primary as well as manufactured goods

8. Problems of Export Promotion Policy • Expanding primary goods – demand side • Low income elasticity • Low price elasticity • Low population growth rates in developed countries • Commodity agreements not very successful • Development of synthetic substitutes • Protective policies against food exports, agricultural products – sugar quota, subsidies

9. Export Promotion • (2) supply side • Structural rigidities in rural production system – soil, climate, rural institutions, land tenure • Local shortages due to exports • Farmers – risk averse • Fragmented land holdings. Together, these problems could have an adverse effect on export earnings of LDCs

10. Export Promotion – manufactured goods • In South Korea, Taiwan, export growth was led by manufactured goods (20% or more) • China’s share in manufactured goods exports is increasing • In developing countries share of manufactured goods: • 1950 – 6% , 2000 – 64%

11. Export Promotion – manufactured goods Demand side issues • Widespread protection against LDC’s exports of manufactured goods Assignment – Find supportive statements from page 622-623. Write a paragraph on how DC can help by imposing less barriers – What are the likely consequences for DC and LDCs

12. Import - Substitution • Substitute domestic goods for imported goods, self-sufficiency • Impose tariffs or quotas on imports • Provide infant industry protection • Government subsidies and intervention • Improve balance of payments • Achieve large scale and lower prices • Reap the benefits of comparative advantages

13. Import Substitution - Disadvantages • Protective policies discourage competition and efficiency – Is industry remain high cost and inefficient industry? • Foreign firms benefit due to tariff walls • Imports of capital intermediate good are costly • Overvalued, artificial exchange rates which raises the price of exports and reduces the price of imports. Overvalued currency helps local manufactures to increase their exports and imports cheap capital goods • Problems of infant industry

14. Tariff Structures and Effective Protection • Self-study • Nominal rate of protection = • Effective rate of protection =

15. S Pb Pe Prices of foreign exchange (units of domestic currency per unit of foreign currency) Pa D M’’ M’ M Quantity of foreign exchange Foreign Exchange Market • Fixed Exchange rate system • Exchange rates are officially fixed. If there is a huge balance of payments deficit, currency will be devalued. • Floating exchange rate system • Exchange rates are determined by demand and supply. • Depreciation implies a decrease in the purchasing power of domestic currency

16. Foreign Exchange Market • Managed Float – Exchange rates fluctuate within a certain range • Asian Crisis of 1997 • South Korea, Thailand, Malaysia, Indonesia adopted floating exchange rate system. Currencies lost 30% of their value and IMP bailed out some of these countries.