UNIT 5

TRADE AND DEVELOPMENT

 OBJECTIVES

 International trade: trends and patterns

 Theories of international trade

 Development throught trade in primary products

 Import substitution industrialization strategy

 Export-Oriented Industrialization Strategy

2
INTERNATIONAL TRADE: TRENDS AND PATTERNS

 Exports and imports from high-income nations continue to

dominate global exchange: The high-income economies
produce 80 percent of world output, they also produce almost
75 percent of world exports and imports.
 There has been significant growth in exports from low and
middle-income economies since late 1970s.
 Hong Kong, Korea, Singapore, Taiwan and China had
considerable success with trade serving as an engine of
economic growth.
 For developing countries as a whole, imports plus exports on
goods and services combined are now equivalent to over 64
percent of their total output, indicating that large portions of
these economies are influenced by global markets.
3
 GROWTH IN WORLD EXPORTS BY REGIONS, 1973-2022
3.0E+13

2.5E+13

2.0E+13

1.5E+13

1.0E+13

5.0E+12

0.0E+00
1973
1974
1975
1976
1977
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
2021
2022
4
East Asia & Pacific OECD members Sub-Saharan Africa
Middle East & North Africa Latin America & Caribbean South Asia
 IMPORTANCE OF TRADE TO ECONOMIES
70.0

60.0

50.0

40.0

30.0

20.0

10.0

0.0
1976-80 1981-85 1986-90 1991-95 1996-2000 2001-05 2006-10 2011-15 2016-20
5
East Asia & Pacific OECD members Sub-Saharan Africa
Latin America & Caribbean South Asia
 VIETNAM’S EXPORTS AND IMPORTS, 1986-2022
100
(% GDP)
90

80

70

60

50

40

30

20

10

Imports of goods and services (% of GDP) Exports of goods and services (% of GDP)

Source: WDI
 muchonsupplyfromoutside
Depends

7
8
 IMPORTANCE OF MANUFACTURED EXPORTS BY
REGIONS (% of merchandise exports)
Manufactured share of merchandise exports (%)

90

80

70

60

50

40

30

20

10

0
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021
9
East Asia & Pacific Latin America & Caribbean Middle East & North Africa
South Asia OECD members Sub-Saharan Africa
STRUCTURE OF MERCHANDISED EXPORTS: SELECTED COUNTRIES, 2017

10
 VIETNAM’S STRUCTURE OF MERCHANDISE
100%
EXPORTS (%)
90%

80%

70%

60%

50%

40%

30%

20%

10%

0%

11
Agricultural raw materials exports Food exports Fuel exports
Ores and metals exports Manufactures exports
 THE PRINCIPLE OF
COMPARATIVE ADVANTAGE

 The producer that requires a smaller quantity of inputs

to produce a good is said to have an absolute
advantage in producing that good.
 The producer who has the smaller opportunity cost of
producing a good is said to have a comparative
advantage in producing that good.
 Trade is based on comparative advantage: specialize in
producing and exporting goods with comparative
advantages and import goods with comparative
disadvantages.
 ABSOLUDE AND COMPARATIVE ADVANTAGE

Minutes needed to Opportunity cost

make 1 kg of:
Meat Rice Meat Rice
Vietnam 60 min/kg 15 min/kg 4 kg rice .25 kg meat
Australia 20 min/kg 10 min/kg 2 kg rice .5 kg meat

 Which country has the Absolute Advantage in each

product?
o Australia: in both products.
 Which country has the Comparative Advantage in each
product?
o Australia: in meat
o Vietnam: in rice
13
 SOURCES OF COMPARATIVE ADVANTAGE

 ProductivityDifferences (Ricardian model)

 technological differences  labor productivity
differences
 Factor Abundance (Heckscher-Ohlin model)

 labor-abundant countries export labor-intensive

products
 EFFICIENCY IN PRODUCTION
Output Efficiency
An economy produces output efficiently only if, for each consumer,

Output Efficiency
The efficient combination
of outputs is produced
when the marginal rate of
transformation between
the two goods is equal to
the consumer’s marginal
rate of substitution. slope MRS
 EFFICIENCY IN PRODUCTION
Efficiency in Output Markets
When output markets are perfectly competitive, all consumers
allocate their budgets so that their marginal rates of substitution
between two goods are equal to the price ratio. For our two goods,
food and clothing,

At the same time, each profit-maximizing firm will produce its output
up to the point at which price is equal to marginal cost. Again, for
our two goods,

and

Because the marginal rate of transformation is equal to the ratio of the

marginal costs of production, it follows that
 THE GAINS FROM FREE TRADE
An Expanded Utility
International
Clothing
Nont relative price
(units)
rada
bles IC1 3
Without trade, C3
production and
consumption are at 1
C1
point 1. c IC3
With trade at a higher
Pre-trade
relative prive of relative price
agricultrural products,
domestic production is
now at 2, while
C2 .4 2
domestic consumption
is at 3. Free trade has
allowed utility to
increase from IC1 to IC2. F1 F3 F2 Food
(units)
 OTHER BENEFITS OF TRADE
 Trade exposes domestic firms to competition =>
firms may invest less in rent seeking and more
in increasing efficiency and lowering costs =>
improving the use of scarce resources and raise
output levels.
 Trade, especially in intermediate goods
including machinery and other forms of capital,
often embodies new technologies that raise
productivity.
 Trade increases not only the amount of goods a
nation can consume but also the quality and
18
variety of goods available.
 WINNERS AND LOSERS FROM
INTERNATIONAL TRADE
 When a country allows trade and becomes an
exporter of a good, domestic producers of the
good are better off. They receive a higher price
and a higher producer surplus.
 However, domestic consumers of the good are
worse off. They pay a higher price and receive
a smaller consumer surplus.
 Trade raises the economic well-being of a
nation
 Gains of the winners exceed the losses of the
losers
THE EQUILIBRIUM WITHOUT INTERNATIONAL TRADE

Price of
textiles Domestic
Supply

Consumer
surplus
Equilibrium
price Producer
surplus
Domestic
Demand

0 Equilibrium Quantity of textiles

quantity

When an economy cannot trade in world markets, the price adjusts to balance
domestic supply and demand. This figure shows consumer and producer surplus in
an equilibrium without international trade for the textile market in the imaginary
country of Isoland.
 INTERNATIONAL TRADE IN AN EXPORTING COUNTRY
Price of
textiles
Domestic
Exports Supply
Price A
after World
trade D Price
B
Price
before
trade
C
Domestic
Demand
Exports

0 Domestic Domestic Quantity of textiles

Quantity Quantity
Demanded Supplied
The area D shows
Before trade After trade Change the increase in
total surplus and
Consumer Surplus A+B A -B represents the
Producer Surplus C B+C+D +(B+D) gains from trade
Total Surplus A+B+C A+B+C+D +D 21
 INTERNATIONAL TRADE IN AN IMPORTING COUNTRY
Price of
textiles
Domestic
Supply

A
Price
before
trade
Price B D
World
after Price
trade
C
Domestic
Imports Demand

0 Domestic Domestic Quantity of textiles

Quantity Quantity
Supplied Demanded
The area D shows
Before trade After trade Change the increase in
total surplus and
Consumer Surplus A A+B+D +(B+D) represents the
Producer Surplus B+C C -B gains from trade
Total Surplus A+B+C A+B+C+D +D 22
 WINNERS AND LOSERS FROM
FREE INTERNATIONAL TRADE

 When a country allows trade and becomes an

importer of a good, domestic consumers of the
good are better off. They pay a lower price
and receive a higher consumer surplus.
 However, domestic producers of the good are
worse off. They receive a lower price and a
smaller producer surplus.
 Trade raises the economic well-being of a
nation
 Gains of the winners exceed the losses of
the losers
 WINNERS AND LOSERS FROM TRADE
 The gains and losses of an importing country
 When a country allows trade and becomes an
importer of a good
 Domestic producers of the good are worse off
 Domestic consumers - are better off
 Trade raises the economic well-being of a nation
 Gains of the winners exceed the losses of the

losers
 Trade can make everyone better off

24
 DEVELOPMENT THROUGHT TRADE IN
PRIMARY PRODUCTS
 Primary products are agricultural raw materials,
food, fuels, minerals, or ores.
 Primary products still represent about one third
of the value of all traded goods.
 For most developing economies, international
trade often began with primary products
 The growth performance of resource-rich
economies often has been disappointing,
referred to as the resource curse and
seemingly the opposite of the predictions of
comparative advantage 25
26
TRADE IN PRIMARY PRODUCTS: ITS POTENTIAL
 Helping an economy use its current factor endowments more
intensively and more efficiently:
 Some low and middle-income economies have comparative
advantage in primary products that face limited demand at home
but significant demand abroad.
 Vent for surplus: Trade enables the country to employ either
land or labor more fully and sell the goods produced with its
“surplus” land and labor to the rest of the world.
 Primary export–led growth can spur increases in foreign investment
to complement the fixed factors of production, land, and natural
resources.
 The possibility of stimulating production in other, related sectors.
 Backward linkages
 Forward linkages
 Infrastructure linkages. 27
 Primary export sectors also may stimulate human capital linkages
THE VENT-FOR-SURPLUS THEORY OF TRADE
EMPIRICAL EVIDENCE ON PRIMARY EXPORT-LED GROWTH
 A few resource-rich developing countries have performed
relatively well, including Botswana, Indonesia, Malaysia,
Mauritius, and some of the oil-rich states of the Persian Gulf.
 Many others have grown very slowly or not at all, or have
experienced increases in GDP per capita, which have been
accompanied by little economic development
 Many of the fastest growing Asian economies are resource-
poor—for example, Korea, Singapore, Taiwan, and, more
recently, India and Vietnam
 Jeffrey Sachs and Andrew Warner examined the relationship
between primary product exports and economic growth in a
sample of 95 countries from around the world between 1970
and 1989:
 Dependent variable: GDP per capita growth
 Independent variables: initial per capita income, openness to
trade, government efficiency, investment rates, inequality, and
the share of primary product exports in GDP
 Results: an increase of 10 percentage points in the ratio of 29
primary exports to GDP was associated with a 0.7 percentage
point slower annual rate of growth of per capita income.
EMPIRICAL EVIDENCE ON PRIMARY EXPORT-LED GROWTH

 Since the 1950s, some economists and the leaders of

many developing countries have argued that, despite
the possible benefits, primary exports cannot effectively
lead the way to economic development.
 The markets for primary products grow too slowly to
fuel growth,
 The relative prices received for these commodities
have been declining,
 Earnings are too unstable,
 Linkages do not work,
 The fiscal windfall more often than not breeds
corruption and civil strife rather than growth and
development. 30
31
 EXPORT PESSIMISM
 Prebisch-Singer hypothesis: Over the long run, prices for primary
commodity exports on world markets tend to fall relative to prices of
manufactured goods
 Reasons:
 The Engel’s law: The demand for staple foods grows more slowly than
income, while the demand for manufactured goods is income elastic =>
Developing nations would wind up earning relatively less for their
exports and paying relatively more for their imports
 Technological change in manufacturing also works against the demand
for raw materials and the nations that produce them:
 New technologies and improved machinery help firms reduce

wastage so that less raw material is needed in the production

process.
 new technologies allow for the substitution of synthetics for raw
materials
 Manufacturing firms in developed countries tended to have market
power, whereas primary producers in developing countries faced much
greater competition => With productivity growth, primary producers 32
would face lower prices due to competition from other producers
33
34
 DUTCH DISEASE
 Dutch disease, The Netherlands after 1960: Major reserves of
natural gas were discovered. During the 1970s, the Dutch
economy suffered from rising inflation, declining export of
manufactures, lower rates of income growth, and rising
unemployment. Tácđộnggiảmmạnhhơntácđộngtăng
 The oil boom of the 1970s and early 1980s produced similar
paradoxes in a number of countries, including Mexico, Nigeria,
and Saudi Arabia.

• Foreign
exchange
A BOOM
inflow=> Export of THE • Growth
IN
PRIMARY E ER manufactur ECONOMY
EXPORTS es SUFFERED • Unemplo
• Imcone=> yment 
AD = P

The real exchange rate: RER = (E*P

MA F)/P
35
Where: E is the exchange rate, PFis the foreign price, and P is
AI
the domestic price.
 CVPt ngoạisinh
RER
P
 THE RESOURCE TRAP
 The populations of Botswana, Chile, and Indonesia have
experienced economic development; those of Nigeria,
Sierra Leone and Zambia have not => Governance and
politics played a large role in these different outcomes.
 Collier identifies a natural resource trap: Resource
revenues worsen governance:
 Dutch disease and the appreciation of the RER can crowd out
nonprimary product exports
 Price volatility during the boom often leads to public
expenditures wasted on white elephant projects, expansions in
civil service employment motivated more by political patronage,
or outright theft by corrupt officials.
 Commodity booms often are also associated with increased
foreign borrowing and the accumulation of debt => the
economy faces a debt burden and must service its debt often
by cutting essential development expenditures.
36
Dependence on resource revenues=> widespread
corruption and poor governance => lower economic growth
 CONFLICT TRAP
 The existence of mineral wealth significantly increases
the likelihood of civil war, as greed motivates many rebel
groups and mineral wealth itself helps finance conflict.
 Competition over the control of valuable natural resources
for export certainly played a role in the civil wars in
Angola, Congo, Sierra Leone, and Sudan.
 Collier’s critics agree that correlations between resource
abundance and poor development outcomes are
relatively robust, but find far less statistical support for the
causal channels Collier identifies. And even if a resource
trap exists, there are examples of nations that have
escaped.
37
 IMPORT SUBSTITUTION INDUSTRIALIZATION
STRATEGY
A policy of replacing imports by domestic
production under the protection of high tariffs or
import quotas.
 By the 1950s and 1960s the emphasis on import
substituting industrialization was further reinforced
in South America.
 An intellectual rationale:

 The low income and price elasticities of demand

for developing countries’ exports of raw
materials => all or most of the benefits of foreign
trade go to the already industrialized nations 38
 THE EFFECTS OF A TARIFF
 Tariff
 Tax on goods produced abroad and sold domestically
 Free trade

 Domestic price = world price

 Tariff on imports

 Price – rises by the amount of the tariff

 Domestic quantity demanded – decrease
 Domestic quantity supplied – increase
 Reduces the quantity of imports
 Moves the domestic market closer to its equilibrium
without trade
 Domestic sellers – better off 39

 Domestic buyers – worse off

 THE EFFECTS OF A TARIFF
Price of textiles
Domestic
Supply

A Tariff
Price with tariff B
C D E F
Price without World Price
tariff G
Imports
with tariff Domestic
Demand
0 Q1S Q2S Q2D Q1D Quantity of textiles

Imports without tariff

The area D + F
shows the fall in
Before tariff After tariff Change total surplus and
represents the
Consumer Surplus A+B+C+D+E+F A+B -(C+D+E+F) deadweight loss of
Producer Surplus G C+G +C the tariff
Government Revenue None E +E
Total Surplus A+B+C+D+E+F+G A+B+C+E+G -(D+F)
 THE WINNERS AND LOSERS FROM TRADE
POLICY
 The effects of a tariff
 Before the tariff
 Consumer surplus

 Producer surplus

 Government tax revenue = 0

 With a tariff
 Consumer surplus - smaller

 Producer surplus - bigger

 Government tax revenue

 Total surplus - smaller

41
THE IS INDUSTRIALIZATION STRATEGY AND RESULTS

 Protected industries get inefficient and costly

 Foreign firms often benefit more
 Subsidization of imports of capital goods tilts
pattern of industrialization and contributes to
balance of payments (BOP) problems
 Overvalued exchange rates hurt exports
 Does not stimulate self-reliant integrated
industrialization
 ARGUMENTS FOR IMPORT SUBSTITUTION
 Standard argument for tariff protection
 Sources of revenue
 Response to chronic BOP problems
 Help foster industrial self-reliance (general IS)
 Greater control over economic destinies
 The infant-industry argument

 “New industries need temporary trade restriction to

help them get started”
 Difficult to implement in practice
 The “temporary” policy – hard to remove
 Protection is not necessary for an infant industry to
grow
 Many examples of perceived failures, but some
success in East Asia
 EXPORT PROMOTION VERSUS IMPORT SUBSTITUTION

 Trade Optimists and Trade Pessimists:

Summarizing the Traditional Debate
 Trade pessimist arguments

 Limited growth of world demand for primary

exports
 Secular deterioration in terms of trade
 Specializing in comparative advantage inhibits
industrialization, skills accumulation, and
entrepreneurship
 Rise of “new protectionism”; WTO benefits
limited in practice
 EXPORTS OF MANUFACTURES
Successfulexportersof manufactures such as SouthKorea Singapore HongKong Taiwan

China
worldas a whole manufactured exportsgrewfrom 6 oftheirtotal
For the developing
merchandise exports in 1950 to almost
64 by2000
export expansion of manymanufactures
Thedemand problems for alsofallen
Relativeprices basic manufactured goods have
of the most
developed nations against themanufacturedexports of
Widespread protection in
developing countries
developing countryexports than
TheirRates of protection were considerably higher against
countries
against those of high income
voluntary export Restraints andsanitary
Regulation
There are the nontariff barriers
antidumping

SOUTH SOUTH TRADE AND ECONOMIC

INTEGRATION

Economic Integration Theory and Practice

developingcountries
Thegrowth of trade among countries
a
encourages rationaldivision of labor among group of
Integration
and increases market size
coordinated industrial strategyto exploit
Provides opportunities for a
economies of scale
Trade creation
Trade diversion
Regional trading blocs and theglobalization
of trade

NAFTA
MERCOSUR

SADC
ASEAN
OR retard the progress
answered Do blocs promote growth
Still not fully
of globalization
TRADE OPTIMIST ARGUMENTS - TRADE LIBERALIZATION
 Promotes competition and efficiency
 Generates pressure for product improvement

 Accelerates overall growth

 Attracts foreign capital and expertise, which are in

scarce supply in most developing countries
 Generates foreign exchange to use for food imports if
agricultural sector lags behind or suffers natural
catastrophes
 Eliminates distortions caused by government
interventions including corruption and rent-seeking
activities
 Promotes equal access to scarce resources,

 Enables developing countries to take full advantage of

reforms under the WTO
EXPORT-ORIENTED INDUSTRIALIZATION STRATEGY
 There are market failures in transfer of innovations
 Coordination failures may make industrialization problematic
 Export expansion may facilitate technology transfer through
contacts with foreign firms, industry spillovers, scale
economies
 There may be learning by doing (or “watching”) effects in
manufacturing sectors
 Performance is rigorously tested when firms attempt to
export
 Export targets more visible; focus on manageable problems
 Hausmann, Hwang, and Rodrik: exporting a mix of goods
more typical for higher-income countries predicts higher
growth
 Thus, export oriented industrial policy may help overcome
market failures in the process of technological progress
THE INDUSTRIALIZATION STRATEGY APPROACH
TO EXPORT POLICY
 Focus on government interventions to encourage
exports, especially those with higher skill and
technology content (industrial policy)
 Problem: without proper attention to incentives,
industrial policies may be counterproductive too
 WTO rules and industrial policies – gray areas
remain
 Problem: level of competence and political
authority of governments to carry out policies
effectively
SOUTH-SOUTH TRADE AND ECONOMIC INTEGRATION

 Regional trading blocs and the globalization of

trade
 NAFTA
 MERCOSUR
 SADC
 ASEAN
 Still not fully answered: Do blocs promote
growth or retard the progress of globalization