International Economics

1. International Economics Li Yumei Economics & Management School of Southwest University

2. International Economics Chapter 11 International Trade and Economic Development

3. Organization • 11.1 Introduction • 11.2 The Importance of Trade to Development • 11.3 The Terms of Trade and Economic Development • 11.4 Export Instability and Economic Development • 11.5 Import Substitution versus Export Orientation • 11.6 Current Problems Facing Developing Countries • Chapter Summary • Exercises

4. 11.1 Introduction • This chapter examine the special trade problems faced by developing countries • Labor-intensive goods • Terms of trade • Import substitution and Export-orientation • The international trade can contribute significantly to the development of poor nations • The importance of trade to development can give rise to some special problems requiring joint action by both developed and developing nations • Disparities between developed and developing countries • Trade disputes between developed and developing countries

5. 11.2 The Importance of Trade to Development • Trade Theory and Economic Development • Trade as an Engine of Growth • The Contributions of Trade to Development • International Trade and Endogenous Growth Theory(内生性增长理论) • Conclusion

6. Trade Theory and Economic Development • Developed Countries and Developing Countries • Developed countries are characterized in general by high average real per capita income, a low proportion of the labor force in agriculture , high life expectancies, low rates of illiteracy, low rates of population growth, and high rates of growth in average real per capita income • Developing countries is the opposite characteristics of developed countries • Traditional Trade Theory Traditional trade theory postulates that if each nation specializes in the production of the commodity of its comparative advantage, world output will be greater and , through trade, each nation will share in the gains

7. Trade Theory and Economic Development • Trade Theory and Developing Countries • According to the trade theory, developing countries should focus on the production of primary goods and export of raw materials, fuels, minerals and food to developed nations in exchange for manufactured products • Developing countries attack traditional trade theory as static and irrelevant to the development progress (except in short run) • One nation’s pattern of development is not determined once and for all, but must be recomputed as underlying conditions change or are expected to change over time • The dynamic benefits from industry can theoretically be incorporated into the original calculations of comparative advantage and into subsequent changes in comparative advantage over time

8. Trade as an Engine of Growth • Figure 1

12. The Contributions of Trade to Development • To the full utilization of underemployed domestic resources (from inefficient production to inefficient production) • By expanding the size of the market, trade makes possible division of labor and economies of scale • Trade is the vehicle for the transmission of new ideas, new technology and new managerial and other skills • Trade stimulates and facilitates the international flow of capital from developed to developing nations

13. The Contributions of Trade to Development • For several large developing countries (Brazil, India and China), the importation of new manufactured products has stimulated domestic demand until efficient domestic production of these goods become feasible • International trade is an excellent antimonopoly weapon due to the greater efficiency by domestic production to meet the foreign producers ( especially keeping the low cost and price of intermediate or semi-finished products used as inputs in the domestic production of other commodities)

14. International Trade and Endogenous Growth Theory • Endogenous Growth Theory • Romer (1986) and Lucas(1988) provide a more convincing and rigorous theoretical basis for the positive relationship between international trade and long-run economic growth and development • Theory postulates that lowering trade barriers will speed up the rate of economic growth and development in the long run by 1. Allowing developing nations to absorb the technology developed in advanced nations at a faster rate than with a lower degree of openness

15. International Trade and Endogenous Growth Theory 2. Increasing the benefits that flow from research and development 3. Promoting larger economies of scale in production 4. Reducing price distortions and leading to a more efficient use of domestic resources across sectors 5. Encouraging greater specialization and more efficiency in the production of intermediate inputs 6. Leading to the more rapid introduction of new products and services Case Study 11-1 page 362 See the following tables

21. Conclusion Although the level and the rate of economic development depend primarily on internal conditions in developing nations, international trade can contribute significantly to the development process. Some economists believed that international trade and the functioning of the present international economic system benefited developed nations at the expense of developing nations

22. 11.3 The Terms of Trade and Economic Development • The Various Terms of Trade • Alleged Reasons for Deterioration in the Commodity Terms of Trade • Historical Movement in the Commodity and Income Terms of Trade • Conclusion

23. The Various Terms of Trade • Types of Terms of Trade • Commodity or net barter terms of trade(净贸易条件) • Income terms of trade(收入贸易条件) • Single factor terms of trade(单因素贸易条件) • Double factor terms of trade(双因素贸易条件) • Commodity or net barter terms of trade It is the ratio of the price index of the nation’s exports (PX) to the price index of its imports (PM) multiplied by 100 N=(PX/ PM) 100 • Income terms of trade I =(PX/ PM) QX (QX the index of the volume of exports)

24. The Various Terms of Trade • Single factor terms of trade S=(PX/ PM) ZX ZX the productivity index in the nation’s export sector • Double factor terms of trade D=(PX/ PM) (ZX/ZM) ZX the productivity index in the nation’s export sector; ZM the productivity index in the nation’s import sector • Evaluation of the Types of terms of trade • N, I and S are the most important. D does not have much significance for developing nations and is very seldom • N is the easiest to measure • Developing nations tend to deteriorate the terms of trade in over time

25. Alleged Reasons for Deterioration in the Commodity Terms of Trade • Productivity increases are reflected in lower prices in developing nations while higher wages and income of the workers in developed nations • In developed nations, workers can benefit from their own increasing productivity, meanwhile benefit from the increasing productivity of developing nations due to the lower prices of exported commodities • Different internal labor markets between developed (relatively scarce and labor unions) and developing (surplus labor, large unemployment, weak or non-existent labor unions) nations

26. Alleged Reasons for Deterioration in the Commodity Terms of Trade • The demand for the manufactured export tends to grow much faster in developing nations than the demand for the agricultural and raw material exports of developing nations • Due to the much higher income elasticity of demand for manufactured goods than for agricultural commodities and raw materials • Many developing nations have experienced a large increase in the share of manufactured exports in their total export, it makes the calculation of terms of trade more complicated

27. Historical Movement in the Commodity and Income Terms of Trade • Controversial Topic • Prebisch and Singer research • Other research • Uncertain answer See some data

38. Conclusion • The terms of trade in developing nations are not certain due to the fluctuation of the imported and exported of commodities in the world market • In a certain period of time , the terms of trade in developing nations can be improved, and can be also deteriorated • The studies on the terms of trade in developing nations have no unique answer

39. 11.4 Export Instability and Economic Development • Cause and Effects of Export Instability • Measurements of Export Instability and Its Effect on Development • International Commodity Agreements • Conclusion

40. Cause and Effects of Export Instability • Developing nations may face large short-run fluctuations in their export prices and earnings that could seriously hamper their development • Inelastic demand of the primary export • Inelastic supply of the primary export • Illustration (Figure 11.1 page 369) • With D and S, the equilibrium price is P; • If D decreases to D’ or S increases to S’, the price falls sharply to P’; • If D and S both shift , the price to P’’ Conclusion: inelastic and unstable demand and supply curves for the primary exports of developing countries can lead to wild fluctuations in the prices that these nations receive for their exports

41. FIGURE 11-1 Price Instability and the Primary Exports of Developing Nations.

42. Measurements of Export Instability and Its Effect on Development • Measurement of Export Earnings MacBean (1966) defined the index of instability of export earnings as the average percentage deviation of the dollar value of export proceeds from a five-year moving average and measured on a scale of 0 to 100 • Export instability MacBean postulates that the greater export instability depended primarily on the type of commodities exported E.G. The export of rubber, jute, and cocoa faced much more unstable export earnings than petroleum, bananas, sugar and Tabacco • International Commodity Agreement Importance to stabilize the export earning of developing nations

43. International Commodity Agreements There are three basic types of international commodity agreements: Buffer Stocks(缓冲存货), Export Controls(出口管制), Purchase Contracts(购货合同) • Buffer Stocks • It involves the purchase of the commodity when the commodity price falls below an agreed minimum price, and the sale of the commodity out of the stock when the commodity price rises above the established maximum price. ( International Tin Agreement) • Disadvantages: (1) some commodities stored with high cost; (2) if the minimum price is set above the equilibrium level, the stock grows larger and larger over time

44. International Commodity Agreements • Export Control • It seeks to regulate the quantity of a commodity exported by each nation in order to stabilize commodity prices • Main Advantage: it avoids the cost of maintaining stocks • Main disadvantage: it introduces the inefficiencies and requires all major exporters of the commodity participate International Sugar Agreement, International Coffee Agreement E.G. OPEC (See the table)

46. International Commodity Agreements • Purchase Contracts • It is a long-term multilateral agreement that stipulate a minimum price at which importing nations agree to purchase a specified quantity of the commodity and a maximum price at which exporting nations agree to sell specified amounts of the commodity • It can avoid the disadvantage of buffer stocks and export controls • Disadvantage: it results in a two-price system for the commodity International Wheat Agreement

47. Conclusion • Only a few (International Coffee Agreement) of these are in operation today, and none seems particularly effective. One reason for this is that the very high operating costs and the general lack of the support from developed nations • Modest Compensatory Financing Scheme (set up in 1966 by IMF) To compensate the developing nations below the previous five- year moving average of export earnings

48. 11.5 Import Substitution versus Export Orientation • Development Through Import Substitution versus Exports • The Experience with Import Substitution • Recent Trade Liberalization and Growth in Developing Countries • Conclusion

49. Development Through Import Substitution versus Exports • Industrialization • Faster technological progress • The creation of high-paying jobs to relieve the serious unemployment and underemployment problems • Higher multipliers and accelerators through greater backward and forward linkages in production process • Rising terms of trade and more stable export prices and earnings • Relief from balance-of-payments difficulties

50. Development Through Import Substitution versus Exports • Two Types of Industrialization • Import-substitution industrialization Advantages: (1) reduced risks to set up an industry to replace imports; (2) easier to compete with foreign competitors; (3) induced tariff factories to set up Disadvantages: (1) domestic industries accustomed to domestic protection; (2) leading to inefficient industries; (3) more difficult to produce more capital-intensive and high technological imports