So far….

• What is absolute advantage?

• Trade patterns emerging from absolute advantage

• Specialisation

• Resource mobilization

• Terms of trade (price of export / price of import) improvement and

improvement on consumption possibility

• Temporary unemployment

• Restrictive and problematic assumptions

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 Doubt clarification
When trade is allowed, price changes (falls) in the importing country.
Does price change (rises) in the exporting country as well?
Why?

2000 2000 2000

1600 1600 1600

Q(
1000 1000 DM 1000
)

300 800 Qw 200 700

Home World Foreign

2
Exercise

Consider the framework of absolute advantage, among two countries A and

B. Each country can produce goods X and Y.
Labour needed for unit Labour needed for unit Total labour
production of good X production of good Y supply
A 10 22 1000
B 20 8 100

Consider no international movement of workers.

A) Which country is a likely exporter of good X, if trade is allowed?
B) What is the maximum level of per unit transport cost for X that can be
accommodated, so that X is considered a tradable commodity?
C) Is there any gain from trade to the country smaller in size?
D) In an autarkic situation A produces equal amount of X and Y with the
available resources. How is the labour force divided between two
sectors?
E) When trade is allowed how many workers shift between sectors in A?

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 Hint for part D and E
D) In an autarkic situation A produces equal amount of X and Y. How is the labour
force divided between two sectors?

Total labour supply [1000] = labour used in X [10 X Qx] + labour used in Y [22 X Qy]
And Qx = Qy
Find out how much labour was used in X and Y

E) When trade is allowed how many workers shift between sectors?

The country A specialises in X . Hence all those engaged in Y moves to X.

4
Exercise

Following table shows the transport costs and pre-trade prices in India and
Mexico of 5 commodities. Markets for all commodities are competitive and
production subject to constant returns to scale.
commodities Price in India Price in Mexico transport cost/unit
v 50 75 13
w 90 45 10
x 42 49 10
y 600 400 0
z 6 40 34

Which of the following free trade price combinations are reasonable?

commodities Price in India Price in Mexico
v 60 73
w 60 50
x 45 55
y 500 500
z 6 40

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Leaders in world exports (2019)
Selected commodities
commodities Leading Share of world
exporters exports (approx)
Coffee Brazil 15%
Tea China 27%
Cinnamon Sri Lanka 23%
Perfumes France 27%
Pepper India 26%
Clocks and watches Switzerland 22%
Wine from fresh grapes France 30%

‘conditions are favourable’ for production

Trade on the basis of natural advantage
• Climate / Natural resource
• Acquired skill

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 Cashew:
India’s natural and acquired advantage
Long term trends
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The Products

• Three different products can be obtained from cashew

trees.
1. The cashew apples
- possible commercial uses to produce candy, jam,
carbonated drinks, wines, chutney, vinegar, syrups etc.
2. The nuts
- Apples and nuts of the same tree can not be
consumed. By the time the nut matures, the apple is
spoiled.
- Time consuming and tedious production but relatively
durable
- Relatively higher priced in market, compared to the
other 2.
3. Cashew nut shells
- Used in friction dusts in formulation of brake lining and
clutch facing. Prohibitively high cost of production.
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Cashew growing areas

• Originally grown in Brazil, where the apple was harvested, the nut was
forgone.

• Then it was introduced to Portuguese traders, who brought it to other

tropical countries

– India
– South east Asia (Indonesia, Vietnam )
– East Africa (Kenya, Mozambique, Tanzania) and Nigeria

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India: advantage in cashew nut processing

• India not only exports nuts produced in India, but also imports raw nuts
from Brazil and Africa and re-exports them after processing
• India enjoyed an advantage in cashew production and processing due to
– Climate
– Early identification of domestic market
– Cashew processing households – workers grow up learning, so that
by the time they join the workforce, they are more equipped
compared to their counterparts elsewhere
– Low labour costs (Cashew processing in India has been a labour
intensive process)
– Politically protected market in USSR (high prices, large volumes
exported)
– Development of effective pesticides reduced wastage

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Changing market conditions and India’s advantage:

1950s:
– Growing demand in the western countries has led to the entry of East
Africa as one of the exporters in 1950s.
– But India maintained its cost advantages. Imported raw nuts and exported
processed ones.
1970s:
– Cashew processing machinery (replacing the hand processing) developed
in UK, Switzerland and Italy, exported to other cashew growing regions in
1970s.
– But India managed to maintain its advantage by use of advanced
pesticides, differentiating the product qualitatively.
– Political protection from USSR ceased in 1990s.
2000-2010:
– Improvement of productivity in the Cashew processing machinery used in
Vietnam
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 Share (in value) in world exports
(brazil nuts, cashew nuts, coconuts)

Exporters 2002 2003 2004 2005 2006 2007 2008 2009 …. 2017 2018

Vietnam 13 19 21.5 21.3 21.2 23.2 25.5 25.1 …. 39 32

India 31.1 24.5 24.3 25.7 24.1 19.6 19 18.7 …. 10.5 8
Brazil 8.7 10.4 10.3 9.2 9.1 9.2 6.1 7.8 …. 1.7 1.8

In 2018,
Vietnam has
lost market
share to Cote
The trend though includes other products, d’Ivorie
Vietnam has been emerging as a major exporter (12%).
in cashew nuts.

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Sources of advantage:
• ‘conditions are favourable’ for production
• Trade on the basis of natural advantage
– Climate
– Natural resource
• Trade on the basis of acquired advantage
– Learning by doing,
– improved technology

Advantage:
Exporter’s relative productivity of labour is high.
Or Labour requirement for production is relatively less.

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• Difference in labour productivity has determined the size of the export
market.

• Even natural / acquired cost advantage is not a permanent

phenomenon.

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Business issues
• If the government has opted for a free trade
regime, which product to export?
• What prices to expect?
• How to ensure that export markets do not
shrink?

Social concerns
• How reliable is the export market?
• Should the nation depend on export markets
for steady employment?
• Or should we develop self sufficiency?

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Why is India loosing its advantage in cashews?

• primarily because of technology development in other countries for

cashew nut processing.

• rising price of imported raw cashew from Indonesia and west Africa.
Vietnam has a higher supply of raw cashew than India.

• Also, the markets for apples and shells were not developed so far.
– Cashew apples were foregone as they are substitutes to nut
production.
– Cashew shells were too costly to process

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Problem:

India’s cashew processing sector is

losing market and employment
due loss of the cost advantage.

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What can be done to retain cashew advantage?

1. Import cashew processing machinery?

- Will risk the cashew processing household industry

2. Not import the cashew processing machinery? Continue with hand

processing?
- Will eventually loose export markets, due to higher prices
- Will risk the cashew processing household industry

3. Concentrate on cashew apples?

- Will have to forego the nut, risk the hand processing industry

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4. Concentrate on cashew shells?
- Too costly now – need to develop a cost-effective technology
- This can not be an option if the nut is not produced.
- In that case need to produce / import nuts… and not process it?
- or process it. Hand process or import machinery?

5. Find a politically protected export market?

- Not an easy job, given that we are loosing the cost advantage

6. Allow / invite FDI in cashew processing machinery production?

- Will risk the household cashew nut processing industry
- Need to learn the skill
- A capital-intensive technology will require workers in smaller numbers

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7. Move to some other area of expertise, leaving cashew processing to
Vietnam?
- Require to develop other industries
- Will take some time – temporary unemployment
- Need for trade adjustment assistance

8. Learn from experience

That specialisation involves risk. There is a need to diversify in other
products / industries.
Not depend on growth based on primary exports only
- Simultaneously develop other industries
- Develop state of the art technologies, in cashew processing or otherwise
- Follow Prebisch and Singer’s prescriptions

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 Trade adjustment assistances
• Government’s support to workers who lose their jobs because of import
competition and to businesses that can not stand up to the competition.
• Available in developed countries like US, Germany etc.

Examples

• Employment insurance program,

Making workers eligible to claim a fixed sum when they are laid off.

• Training support to acquire new skills

• Financial assistance to businesses managing sudden trade competition.

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• Should India try to maintain / grow cashew exports at all?

Free trade increases consumption possibilities.

If free trade leads India to export something other than cashew, then that
other product will raise consumption possibilities.

Agriculture based export may not be dependable source of employment in

the long term.

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 Prebisch Singer Hypothesis*
• The relative price of primary (agriculture and mining) goods would decline
over time relative to manufactured goods.

Prescription:
Nations should not depend on primary goods exports for sustained
employment and earning.

Such dependence will reduce their export earning relative to their import bill
in the long run, thereby reducing consumption possibility.

*Raúl Prebisch and Hans Singer

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 Prebisch Singer Hypothesis
• The relative demand and hence relative price of primary (agriculture and mining)
goods would decline over time relative to manufactured goods.
Reason:
1. As level of income rises, people spend lesser proportion of their income on food.
2. Use of minerals / metals are replaced with synthetic materials (plastic, fibre etc.)
over time.
Prescription:
Nations should not depend on primary goods exports for sustained employment.
Such dependence will reduce their export earning relative to their import bill, thereby
reducing consumption possibility.
Counter argument:
Contrary to this prediction ,
Electronic goods (DVD players, mobile phones, computers) prices are falling and
Petroleum, Timber, etc. prices are rising over time relative to average manufacturing
prices.
There is no general trend as predicted.

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Learning

Technical changes are inevitable.

So are the requirements for acquiring new skills to keep export markets.

Losing export markets necessitates continuous mobilisation of resources

from one industry to another.

Trade adjustments assistances can soften the adverse effects but can not
stop them altogether.

Too much dependence on export for employment involves risk.

Diversification in several industries helps keep employment in the long term.

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Reading

From reading material on module 1-

“Trade and Technology – The Ricardian Model ”

http://economictimes.indiatimes.com/markets/commodities/cheap-
vietnamese-nuts-shell-indian-cashew-market/articleshow/42891923.cms

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