Trade Policies for Developing Countries

Trade Policies for Developing Countries International Economics Prof. Bryson Marriott School Based on Pugel and Lindert, International Economics, Ch. 13.

Unequal Distribution • Over five-sixths of the world’s population lives in third world countries. The world generally pays them far too little heed. Distribution of World Population

Primary Products in the Long Run “A reoccurring idea is that developing countries’ growth is held back by relying on exports of primary products” • Engel’s Law: as incomes rise, buyers shift away from staples and primary goods products • Synthetic Substitution: Man-made products replace primary goods. • Nature’s Limits: as populations rise and resources shrink, relative prices of primary products rise. • Relatively slow productivity growth is normal for primary products.

Primary Products Over Time

Primary Product Prices Over Time • People were most concerned with falling primary prices in the 30s, 50s (Argentinian economist Raoul Prebisch) and 80s. • Nobody worried just before WWI, during the Korean War (’50-’53), or the OPEC energy crunch in the early 70’s.

Primary Product Prices Over Time • These measures have three downward-trend biases: 1. The fall in transport costs. Price data are gathered at the markets in the industrial countries. With technological improvements and falling transport prices, more of the final price remains in the hands of the developing, exporting countries.

Primary Product Prices Over Time • These measures have three downward-trend biases: 2. Faster unmeasured quality change in manufactures. Manufacturing has more hidden quality improvements. A rise in their prices may just reflect a rise in their relative quality. A ton of computers is not the same as a ton of old electric motors.

Primary Product Prices Over Time • These measures have three downward-trend biases: 3. Price cuts on new products are often unmeasured. After their introduction, prices on manufactured goods often drop rapidly before stabilizing. They don’t make it into the price indices until the product has aged and the price has fallen considerably. Such measurement lags overstate the relative fall of primary-product prices.

Immiserizing Growth • A country begins exporting primary products for manufacturing goods, and • Has the good fortune of growth, so the PPC shifts out. Primary products mftg

Immiserizing Growth • But with this growth in primary goods (here and elsewhere), world supplies increase and prices fall relative to mftg. So the terms of trade, T, shift to T’. • Now, notice how much primary product export is necessary to secure the same import of manufacturing goods at the new prices! Primary products T’ T mftg

Immiserizing Growth • With the lower prices now earned for primary goods, the country will be exporting more and enjoying it less. • In an extreme case like this, we can see the overall loss of satisfaction in the lower community indifference curve attained after (immiserizing) growth has occurred. Primary products mftg

Exports of Manufactures to Industrial Countries • Disadvantages • Discrimination • Advantages • Third-world countries can become experts in standardized manufacturing and • Low-cost assembly

International Cartels to Raise Primary-Product Prices • History records many attempts to form international cartels, which are international agreements to restrict selling competition. OPEC is a good example.

A Cartel as a Profit Maximizing Monopoly • A well-disciplined cartel will behave like a pure monopoly. It will never compete like a competitive industry at point C. • A cartel will set prices higher after restricting output, as shown at point B. • At this level of output, profit is maximized because the MC = MR solution holds.

Pros and Cons of Cartels in Developing Countries PROS • A cartel is a short run way of extracting maximum profits from its buyers. • Net gains can more than double if global demand for the product is great enough. (This depends on three parameters) 1. The elasticity of world demand for the product. 2. The elasticity of competing non-cartel supply of the product. 3. The cartel’s share of the world market. • For a time, OPEC controlled more than two-thirds of the world’s future oil production.

The cons outweigh the pros CONS • Cartels will always erode with time. • Sagging demand. • New competing supply. • Declining Market Share. • Cheating on the cartel. “Let some other country restrict their output, we need the revenues now.”

Import-Substituting Industrialization This approach to development is based on • Distrust of the imperialist-dominated world market. • Desire for strong, multi-sectoral industrial development. To develop, many countries cut their reliance on exporting primary product and adopted government policies intended to allow industry to grow at the expense of the agricultural and mining sectors.

Import-Substituting Industrialization Anticipated benefits include greater technological progress, • increased workers skills, • national pride and self-sufficiency. • Terms-of-trade effects are possible for large countries: through greater independence, import less, and get those products for less. • It is hard to know what exports to develop for trade-based economic development, but it’s easy to know what to produce in ISI. You just check your old import lists. But, does this system work?

Import-Substituting Industrialization But, does this system work? Apparently not! • The faster growing countries have already mostly abandoned this approach. Studies have shown the countries with the greater net losses were those with the higher trade barriers. • The high protection leads to waste and inefficiency with firms not needing to perform competitively. • Most countries don’t have the size or the resources to develop across a broad spectrum of industries. • According to Pugel and Lindert, countries that paid high costs for their ISI experiment include Argentina, Chile, Colombia, Egypt, Ghana, India, Israel, Mexico, Pakistan, the Philippines, South Korea, Taiwan, and Turkey.

Trade Policies for Developing Countries