Chapter 12

Trade Theory and

Development
Experience

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International Trade and Finance:
Some Key Issues
 Many LDCs rely heavily on exports (usually
primary products)
 Many LDCs also rely heavily on imports
(typically of machinery, capital goods,
intermediate producer goods, and consumer
products)

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Table 12.1

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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?

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The Importance of Trade for
Development
 LDC exports: trends and patterns
(see Table 12.2)
 Importance of exports to developing nations

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Table 12.2

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The Importance of Trade for
Development
 LDC exports: trends and patterns
 Importance of exports to different
developing nations
 Demand elasticities and export earnings
instability

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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

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The Traditional Theory of
International Trade
 The principle of comparative advantage
 Relative factor endowments and
international specialization: the Neoclassical
model

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 Figure 12.1

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The Traditional Theory of
International Trade
 The principle of comparative advantage
 Relative factor endowments and
international specialization: the Neoclassical
model
 Trade theory and development: the
traditional arguments

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Some Criticisms of Traditional Free-Trade
Theory in the Context of Developing-
Country Experience
 Six assumptions of the Neoclassical model
must be scrutinized:

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The Six Assumptions

 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

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The Six Assumptions (cont’d)

– Balanced trade and international price

adjustments
– Trade gains accruing to nationals

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Figure 12.2

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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

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Figure 12.3

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Concepts for Review

 Absolute advantage  Comparative advantage

 Balanced trade  Current account
 Barter transactions  Enclave economies
 Capital account  Export dependence
 Collective self-reliance  Export earnings
 Collusion instability
 Commodity terms of
 Factor endowment
trade trade theory

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Concepts for Review (cont’d)

 Factor mobility  Income elasticity of

 Factor-price equalization demand
 Foreign-exchange  Income terms of trade
earnings  Increasing returns
 Free trade  Industrial policy
 Gains from trade  Monopolistic market
 Globalization control
 Growth poles

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Concepts for Review (cont’d)

 North-south trade  Product cycle

models  Product differentiation
 Oligopolistic market  Quotas
control  Regional trading blocks
 Prebisch-Singer thesis  Returns to scale
 Price elasticity of  Risk
demand  Specialization
 Primary products

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Concepts for Review (cont’d)

 Subsidies  Uncertainty
 Synthetic substitutes  Vent-for-surplus theory
 Tariffs of international trade
 Trade deficits

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