October, 2019

International Trade and Economic Development

1. Traditional trade theory argues that if each nation

specializes in the production and export of the
commodity in which it has a comparative advantage,
then world output will be maximized and each nation
would share the gains from international trade. When
one considers the current pattern of trade based on
comparative advantage, developing countries specialize
in primary products (whose prices fluctuate) while
developed countries specialize in manufactured
products (whose prices tend to rise). Therefore,
developing countries are of the view that this pattern of
specialization would not enable them to reap the
dynamic benefits in the long run. Thus, developing
countries argue that the traditional trade theory is static
and irrelevant for their development process.

2. According to G. Haberler (1963), although international

trade cannot in general be an “engine of growth”, it has
still some potential benefits to the economic growth of
developing countries. He identified four major beneficial
effects of international trade as follows:

1. Trade as a vent for surplus, i.e., an outlet for

potential surplus.
2. By expanding markets, trade makes it possible
division of labor and economies of scale.
 3. Trade acts as a vehicle for transmission of new
ideas, new technology, and new managerial skills.

4. Trade stimulates and facilitates the international

flow of capital (or foreign direct investment, FDI)
accompanied by foreign skilled personnel.

Alternative Trade Strategies

1. The basic question here is: which trade strategies have

enabled countries to attain high growth and to develop
their industrial potential? To answer this question, we
shall examine the economic costs and benefits of
alternative strategies.

2. Trade strategies are broadly divided into two: outward –

oriented and inward – oriented. An outward - oriented
strategy is one in which trade and industrial policies do
not discriminate between production for the domestic
market and production for exports. This strategy does not
also discriminate between purchases of domestic goods
and purchases of foreign goods. In other words, trade is
neutral, i.e., equal incentives are offered to the production
of all tradable. Relatively few developing countries
pursued this strategy though successful progresses have
been achieved by countries (such as the Republic of
Korea, Hong Kong, Taiwan, and Singapore) which
followed this path. The success of an outward – oriented
strategy depends on several factors such as the provisions
of infrastructure, educated manpower, and availability of
foodstuffs and raw materials. It is worth mentioning to
note that the role of the government is very important.

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 3. An inward - oriented strategy is one in which trade and
industrial incentives are biased in favor of production for
the domestic market over the export market. It is also
refereed to as import-substitution strategy. In the post-
war years, this strategy was thought to be the best
strategy for the development process of many developing
countries. However, the experience with this strategy
turned out to be disappointing mainly because of
overvalued exchange rates which discouraged exports.

The Concept of Export Pessimism

What is Export Pessimism?

In the 1950s, many countries (together with economists and
international organizations) became “export pessimistic”, a
convenient label for the view that developing countries have
only limited potential for achieving economic growth
through expansion of exports. Thus, arguments for an
inward-looking type of industrialization (or the policy of
import-substitution) became prevalent.
There are two variants of export pessimism: 1) Terms – of -
trade Pessimism, and 2) Elasticity Pessimism.

1. Terms – of – trade Pessimism: This was advanced by

Prebisch and Singer (1950), who argued that the terms of
trade (the ratio of export prices to import prices) of
primary products had been declining over time and
would continue to do so.
2. Elasticity Pessimism: This was advanced by Nurkse
(1962), who argued that there was low income elasticity of
demand for primary products.

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 What were the explanations for both arguments?

The causes for the deteriorating terms of trade and the low
income elasticity of demand for primary products were
exogenous to the policies of the developing countries
themselves. The two major reasons that were forwarded
include: a) synthetic substitutes for natural resources were
appearing, and b) technical innovations (for example,
recycling) were cutting down the amount of raw materials
needed for industrial production. All these suggested the fall
in the prices of primary products, and the rise in the prices
of manufactures. This provided a justification for
encouraging the production of industrial goods as opposed
to the production of primary goods.

Trade Strategy and Economic Performance

There are studies that were conducted to establish a link

between trade strategy and macroeconomic performance.
The World Bank’s “World Development Report, 1987”
examined the experience of forty-one developing countries
in an attempt to establish such a link. The study covered two
periods: 1963 -73 and 1973 - 85. Over these periods, several
countries underwent policy shifts toward more oriented
orientation – Chile, Turkey, Uruguay, Pakistan, Sri Lanka,
and Tunisia. Others moved in the opposite direction, toward
more inward orientation – Bolivia, Cameroon, Colombia,
Costa Rica, Cote d’Ivoire, Guatemala, Indonesia,
Madagascar, and Nigeria.

In general, the evidence from the study suggested that the

economic performance of the outward – oriented economies
has been superior to that of the inward - oriented economies.
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 To reach this conclusion, the “World bank Report” used
various criteria such as real GDP, real GNP per capita,
gross domestic savings, incremental capital-output ratio,
rate of inflation, and manufactured exports.

According to the “World Bank Report”, the reasons for the

superior performance of outward – oriented economies are
as follows:
1. Outward orientation encourages efficient firms and
discourages inefficient firms.
2. Outward orientation creates a more competitive
environment for both the private and public sectors, and
thus promotes higher productivity and faster economic
growth.

The World Bank’s findings have led to the recommendation

that developing countries have to adopt more outward –
oriented policies. However, some economists and policymakers
are reluctant to embrace the strategy, arguing that some mix
or sequence of the two strategies may be appropriate in some
cases. For example, South Korea engaged in import
substitution before embarking on its export-led growth path.
In cases of infant industries, where protection is justified, this
may be a good strategy.

Some economists have suggested that economic integration

among developing countries may offer benefits because it is a
combination of both strategies. On the one hand, economic
integration leads to freer trade with other developing countries
(i.e., outward-looking). On the other hand, the integrated
union is turning away from the rest of the world (inward –
looking).

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Conclusion:

1. Whether a country should turn outward or inward depends

on internal and external characteristics of that country. In
other words, the policies that are to be recommended can be
decided only on a case-by-case basis.

2. There are issues that are related to the recent phenomenon

of the “new protectionism” that is adopted by the industrial
countries. The question is thus, how outward – orientation can
be successful under this adverse circumstances?

3. Another important question is the transition (the movement)

from inward-orientation to outward orientation. In other
words, the policies should be selected, phased, and sequenced
to gain the benefits of reform as quickly as possible while
minimizing transitional costs and political resistance.

The Process of Trade Liberalization

Some Basic Concepts:

1. Laissez Faire Policy in Trade: Absence of impediments to

the free flow of goods and services, i.e., free trade.

2. Autarky: A state of isolation where no international trade

occurs.

These two are extreme cases do not exist in the real world.
Instead, the real world consists of countries that fall
somewhere between those two extremes. This situation is
illustrated by using the figure below which is referred to as
trade policy spectrum.

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Trade Policy Spectrum

Protectionism Trade Liberalization

Autarky Free Trade

Many policy discussions on trade focus on which direction a

country should move along the trade policy spectrum. That is,
whether policies should move in the direction of free trade or
in the direction of autarky. The movement in the direction of
free trade occurs when regulations on trade are progressively
removed over time (as a process) and, thus increasing the
amount of international trade. This is refereed to as trade
liberalization. The movement in the direction of autarky
occurs when a new trade policy further restricts the free flow
of goods and services and, thus reducing the volume of
international trade. This is refereed to as protectionism.

The Process of Trade Liberalization

There is an extensive literature comparing trade policies and

economic performance in outward – oriented and inward -

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oriented economies. But, until recently less attention has been
paid to the transition from one to the other.

What is meant by trade liberalization?

Trade liberalization may have two meanings:

1. A reduction in the levels and dispersions of rates of
protection. This may necessitate reforming tariffs by
creating institutions such as tariff commissions to set new
tariffs on a case-by-case basis. It should be noted that
institutions are carriers of policies. In the absence of
appropriate and accountable institutions, policies can not
be translated into actions.
2. A change in the form of protection from quantitative
restrictions (non-tariff barriers) to tariffs. It is broadly
accepted that tariffs are more transparent than non-tariff
barriers.

The most important and politically sensitive cost in this process

of trade liberalization is (temporary) unemployment. In other
words, the protected sectors may contract as protection is
lowered. This results in temporary unemployment, especially if
certain skills are specific to certain sectors. In the long run,
however, the level of unemployment will depend on the
efficiency of the labor market and macroeconomic policies.

Conclusion:

1. Trade policy reform is a complicated process. It is closely

linked to other policies of liberalization. In other words,
liberalization policies in capital, labor, and product
markets.

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 2. Trade policy reform is partly a political process, in which
credibility and expectations play an important role. Any
policy reform will involve costs and benefits and, thus one
needs to weigh these costs and benefits at societal level.

3. Feasible policy choices may differ from country to

country. There is no single optimal path to reform.

4. Some reform programs may become vulnerable (or

sensitive) to the international environment. Therefore,
policymakers need to have a clear understanding of both
the domestic and the international situations.

The Role of the State

The root cause of Asia’s success was thought to lie in state

neutrality towards economic sectors. However, it was later
recognized that many Asian States were not at all neutral in
their promotion of individual sectors. These governments
fostered export competitiveness by using mechanisms such as
the maintenance of export - friendly effective exchange rates
and the granting of large subsidies to exporters.

Many scholars have also articulated that today’s most

advanced economies (other than the “Asian Miracle”) used a
range of industrial and trade policy tools during early stages of
their development to support emerging industries. For
example, France, Germany, and Japan pursued industrial
development in a highly controlled context. The States also
intervened to build economic competitiveness by maintaining
low interest rates, protecting selected infant industries,
providing export subsidies and credit, and establishing export-
support institutions.

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Conclusion

The new thinking stressed the complementary roles being

played by the State and by the market. State intervention
became necessary because of market failures (i.e., the inability
of markets to provide certain goods at an optimal level). In
general, the conditions that might interfere with perfect
competition are: imperfect competition (where economic actors
exert some market power in determining price), externalities
(where the action of one agent affects the environment of
another agent), public goods (non-excludable and non-rival),
and imperfect information (or asymmetric information, where
one agent knows something that another agent does not).

Current Problems Facing Developing Countries

Currently, there are at least three most serious problems that

face developing countries. These are: 1) poverty, particularly
those of Sub-Saharan Africa, 2) foreign debt of some of the
poorest developing countries, and 3) trade protectionism of
developed countries against developing countries.

1. Regarding the first problem, i.e., poverty, there are

empirical evidences that show that many developing
countries are characterized by low per capita income, high
infant mortality rate, and low life expectancy. The situation
is worse in Sub-Saharan Africa as a result of drought, wars,
rapid population growth, and the general failure of the
development effort.

2. During the 1970s and early 1980s, developing countries

accumulated a substantial foreign debt, which subsequently
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 they found very difficult to service (that is, repay the
principal or even pay the interest). This seriously hampered
the development plans of many developing countries. The
major factors that led to developing countries’ debt
problem include the oil price hikes of 1973 – 74 and 1979 –
81 (known as “oil shocks”), recession in industrialized
countries affecting exports by developing countries, the
behavior of real interest rates which were low and thus
encouraging new loans, the deteriorating terms of trade of
oil-importing countries and thus necessitating additional
borrowing, poor domestic policies which encouraged the
loans for consumption rather than for productive
investment, capital flight because of domestic inflation, and
loan pushing by industrialized countries because of the
recycled petrodollars (banks were awash in funds).

3. Trade protectionism of developed countries against

developing countries’ exports. This led to a demand by the
developing countries for a New International Economic
Order (NIEO). The NIEO refers to the demands made by
developing countries as a group at the United Nations in
June 1974 for the removal of the alleged inequalities/
injustices in the operation of the present international
economic system. Specifically, the demands include the
stabilization of export earnings (STABEX), preferential
access to developed countries’ markets, transfer of
technology, and greater role in decision – making process.
However, with most industrial countries turning inward to
address their own internal problems, the NIEO stopped
being a hotly debated issue.

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 Possible Questions in this Chapter

1. Why did some economists regard traditional trade theory

as irrelevant for the developing nations and the
development process?

2. Distinguish between static and dynamic analysis in

international trade.

3. State and explain at least four major beneficial effects of

trade according to G. Haberler (1963).

4. What are the two broad categories of trade strategies?

Explain.

5. What is meant by neutrality in trade?

6. Define export pessimism. What are the two variants of

export pessimism?

7. According to the “World Development Report of the World

Bank, 1987,” outward-oriented trade policies were
successful than inward-oriented policies.

a) What are the Bank’s explanations for the success of

outward-oriented policies?
b) What is your view about the two policies above in
the context of developing countries in general and
Ethiopia in particular?

8. a) What is meant by trade liberalization?

b) Explain the process of trade liberalization.
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 9. a) Explain the role of the government in economic
development. Give examples.
b) What necessitates government intervention in the
development process?

10. a) State and explain the major problems of developing

countries.
b) What are the prospects for resolving these problems?

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