International Trade Theory and Development Strategy: Lecture 8 - November 10, 2013 - Asim Jahangir

International Trade Theory and
Development Strategy
Lecture 8 | November 10, 2013 |
Asim Jahangir
Agenda
• Today’s lecture
– Why Trade?
– Some theoretical arguments for trade
– International trade and developing country
experience
• Next lecture
– International Trade strategies
– Specific country experience
– Some critique on free trade
12-2
Key Questions… Why Trade?
• What do developing countries trade?
• Do developing countries gain from trading?
• What should developing countries trade in?
• Who should they trade in?
• Should the governments intervene in international
trade arrangements? Why? Why not?
• Does international trade stimulate growth?
• What effect does international trade have on
poverty? Inequality? Industrialization?
12-3
Key Questions… Why Trade?
• How does trade affect economic growth and
income distribution?
• Does trade promote the achievement of
development objectives?
• Should less developed countries pursue
outward or inward oriented trade policies, or
some combination of the two?
12-4
Globalization: An Introduction
• Globalization- many interpretations
• Core economic meaning- the increased
openness of economies to international trade,
financial flows, and foreign direct investment.
• Concerns with globalization center around the
unevenness of the process
Copyright © 2009 Pearson Addison-Wesley.

12-5
All rights reserved.
International Trade and Finance: Some Key
Issues
• Many developing countries rely heavily on exports of primary
products with attendant risks and uncertainty
• Many developing countries also rely heavily on imports
(typically of machinery, capital goods, intermediate producer
goods, and consumer products)
• Many developing countries suffer from chronic deficits on
current and capital accounts which depletes their reserves,
causes currency instability, and a slowdown in economic
growth

12-6
Figure 12.1 Nonfuel Primary Commodity Prices, Nominal and
Real, by Commodity Group, 1960-2005 (2000 index = 100)

12-7
Figure 12.1 Nonfuel Primary Commodity Prices, Nominal and Real ,
by Commodity Group, 1960-2005 (2000 index = 100) (continued)

12-8
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?
12-9
The Importance of Exports to Different
Developing Nations
• Importance of exports to developing nations
• Exports of LDCs are much less diversified than
those of developed countries

12-10
Table 12.1 Merchandise Exports in Perspective:
Selected Countries, 2005

12-11
Demand Elasticities and Export Earning
Instability
• Low income elasticity of demand for primary
products
• Low price elasticity of demand and supply
• Export earnings instability

12-12
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

12-13
The Traditional Theory of International Trade
• Comparative advantage
– specialization
• Relative factor endowments and international
specialization: the Neoclassical model
– Ricardo and Mill (static model)
– Heckscher and Ohlin (factor endowment theory)
• Different products require productive factors in different ratios
• Countries have different endowments of factors of production

12-14
Figure 12.2 Trade with Variable Factor
Proportions and Different Factor Endowments

12-15
Figure 12.2 Trade with Variable Factor Proportions
and Different Factor Endowments (continued)

12-16
• Main conclusion of the neoclassical model is that all
countries gain from trade
• World output increases with trade
• Countries will tend to specialize in products that use
their abundant resources intensively
• International wage rates and capital costs will
gradually tend toward equalization
• Returns to owners of abundant resources will rise
relatively
• Trade will stimulate economic growth

12-17
• Trade theory and Development: The Traditional

Arguments
– Trade stimulates economic growth
– Trade promotes international and domestic equality
– Trade promotes and rewards sectors of comparative
advantage
– International prices and costs of production determine
trading volumes
– Outward-looking international policy is superior to
isolation

12-18
The Critique of Traditional Free-Trade Theory in
the Context of Developing-Country Experience
• 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

12-19
– Balanced trade and international price
adjustments
– Trade gains accruing to nationals

12-20
• Fixed Resources, Full Employment, and the
International Immobility of Capital and Skilled
Labor
– Challenged by North-South trade models
– Michael Porter’s Competitive Advantage theory
– Vent for Surplus theory

12-21
Figure 12.3 The Vent-for-Surplus Theory of
Trade in LDCs

12-22
• Fixed, Freely Available Technology and
Consumer Sovereignty
– Challenged by the Product Cycle theory
– Development of synthetic substitutes for
developing country exports

12-23
• International Factor Mobility, Perfect Competition,
and Uncertainty: Increasing Returns, Imperfect
Competition, and Issues in Specialization
– Structural realities in developing countries
– Increasing returns and exercise of monopolistic control
over world markets
– Risk and uncertainty inherent in international trading
arrangements

12-24
• The Absence of National Governments in
Trading Relations
– Definite role for State
– Industrial policy is crafted by governments
– Commercial policies instruments (tariffs, quotas)
are state constructs
– International policies can result in uneven
distribution of gains from trade

12-25
• Balanced Trade and International Price
Adjustments
– Unrealistic (oil price hikes of the 70s)

12-26
• Trade gains accruing to nationals
– Enclave economies are promoted by trade
– Difference between GDP and GNI becomes
important

12-27
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

12-28
Trade Strategies for Development: Export
Promotion versus Import Substitution
• Export promotion: looking outward and seeing trade barriers
– Primary-commodity export expansion, limited demand
• Low income elasticities
• Low population growth rates in developing economies
• Decline in prices implies low revenue
• Lack of success with international commodity agreements
• Development of synthetic substitutes
• Agricultural subsidies
– Primary-commodity export expansion, supply rigidities
• Expanding Exports of manufactured goods: Some successes

12-29
• Import substitution: looking inward but still
paying outward
– Tariffs, infant industries, and the theory of
protection

12-30
Figure 12.4 Import Substitution and the
Theory of Protection

12-31
• The IS industrialization strategy and results
– Protected industries get inefficient and costly
– Foreign firms benefit more
– Subsidization of imports of capital goods tilts pattern of
industrialization and contributes to BOP problems
– Overvalued exchange rates hurt exports
– Does not stimulate self-reliant integrated industrialization

12-32
• Tariff Structure and Effective Protection
– Nominal rate of protection
– Effective rate of protection

12-33
The nominal tariff rate, t, is
p  p
t (13.1)
p
Where
p′ is the tariff-inclusive price
p is the free trade price
12-34
Tariff Structures and Effective Protection
The effective tariff rate, g, is
v  v
g (13.2)
v
Where
v′ is the value added per unit of output,
inclusive of the tariff
v is the value added per unit of output
under free trade
12-35
• Standard argument for tariff protection
– Sources of revenue
– Response to chronic BOP problems
– Help foster industrial self-reliance
– Greater control over economic destinies
• Must be applied selectively and wisely

12-36
• Foreign-exchange rates, exchange controls,
and the devaluation decision
– Currencies of developing countries are overvalued
(excess of local demand over available exchange)
• Can run down reserves
• Can curtail excess demand through taxes, tariffs, dual
exchange rates
• Can use exchange controls

12-37
Figure 12.5 Free-Market and Controlled Rates of
Foreign Exchange

12-38
• Chronic payments deficits can be ameliorated
by a currency devaluation
– Difference between depreciation and devaluation
– Higher import prices result in an inflationary
wage-price spiral
– Distributional effects

12-39
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
– Rise of “new protectionism”
• Trade optimist arguments
– Trade Liberalization promotes competition and efficiency
– Generates pressure for product improvement
– Accelerates overall growth

12-40
Trade Optimists and Trade Pessimists:
Summarizing the Traditional Debate
• The industrialization strategy approach to export
policy
– Focus on government interventions to encourage exports
(industrial policy)
– Without proper attention to incentives, industrial policies
may be counterproductive too (South Korean case)
– WTO rules and industrial policies
– Competence and political authority of governments

12-41
Reconciling the Arguments: The Data and
Consensus
• Neither the trade optimists nor the trade
pessimists are always right
• There are many factors that determine
whether trade is good or bad for a country

12-42
South-South Trade and Economic Integration:
Looking Outward and Inward
• Economic Integration: Theory and Practice
– The growth of trade among developing countries.
– Integration encourages rational division of labor among a
group of countries and increases market size
– Provides opportunities for a coordinated industrial strategy
to exploit economies of scale
– Trade creation
– Trade diversion

12-43
South-South Trade and Economic Integration:
Looking Outward and Inward
• Regional trading blocs (economic unions) and the
globalization of trade
– NAFTA
– MERCOSUR
– SADC
– ASEAN
– Local conditions matter
– Do blocs promote growth or retard the progress of
globalization

12-44
Trade Policies of Developed Countries: the
Need for Reform
• Rich-nation economic and commercial policies
matter for LDCs
– Tariff and non-tariff barriers to LDC exports
– Adjustment assistance for displaced workers
– General impact of economic policy
• 1995 Uruguay Round and WTO
• Despite 8 liberalization rounds over 50 years trade
barriers remain in place in agriculture and textiles
• Doha Development Round 2001 has tilted the focus
on the needs of the developing world

12-45
Figure 12.6 Effective Tariff Faced by Income
Groups, 1997-1998

12-46
Unorthodox view of trade policy
Inward vs. Outward Orientation
• Standard View:
– Outward Orientation Causes Economic Growth
– Outward Orientation increases Productivity
– Outward Orientation increases FDI
• Critique
– How is outward orientation measured/ defined?
– Endogeniety
– Small economy bias
– Correlation is not causation
– No time series analysis
– A lot depends on how we classify east asian economies (specifically Korea)
HC Chapter 12 12-47
WTO and International Trading Order (1)
• WTO formed after 1995 Uruguay Round of

GATT
– Large scale reduction in tariff barriers
• Start of “Free Trade” Era?
– No complete abolishment of tariffs
– Disagreement on what “free trade” means
– Labor vs. environmental policies
– One country one vote structure of WTO
HC Chapter 12 12-48
WTO and International Trading Order (2)
1. Not everything was permitted under “old

regime”
2. Tariff reduction but not complete abolishment
3. Infant industry protection is still allowed for 8
years; emergency tariff increase also allowed
4. Not all subsidies are illegal.
5. WTO restrictions only cover “Trade policy”
issues. Countries are allowed to use trade
related measures to manage domestic policies
12-49
Intellectual Property Rights and Trade
• TRIPS agreement enables countries to impose

trade sanctions against IPR violations
• Why do TRIPS?
• Problems:
– Patents for common knowledge
– High rents for live saving medicines, equipment
– Patents for every small product hinder innovation
12-50
Unorthodox view of Trade Policy
• Developed countries rig the rules of game in their own favor
– Use complicated / incomplete definitions
– Benefit developed country firms
– Delay tactics
– Price manipulation
• Developed countries didn’t comply to current “free trade” paradigm
when they were growing
– Develop infant industries (German Auto Industry)
– State intervention in trade policy (Smoot–Hawley Tariff Act)
– Continuing domestic industry support, even under WTO (Agri Industry in Europe)
– Weak protection of Private IPR (Made in England goods in USA)
– Weak protection of foreigners IPR (Foreigners not allowed to register patents in
US)
12-51
Case Study: Challenges of WTO
• Quantitative restrictions on exports of Pakistani combed
cotton yarn to US in 1998
• US used anti-dumping clause in the Agreement of Textiles and
Clothing (ATC) of the WTO to invoke the restraints
• The case went through all stages of dispute settlement of WTO
• Finally, Pakistan won the case in principle in XXXX
• The case study highlights:
– coordination problems within public and private sector
– Role of institutional barriers against exports from developing
countries
– Management issues for trade policy administration
12-52
“Free Trade” after end of MFA
• WTO phased out Multi Fiber Agreement (MFA) in 1995
– MFA included quotas for developing countries for export of
cotton products and derivatives
• US tried to thwart bilateral trade in 1996 through non
tariff barriers
• Trade barriers had huge implications on Pakistan
economy as textile sector contributed 8.5% of GDP,
employed 38% of labor force, and earned 60% of exports
• Textile sector viewed the WTO as a protector of western
economic interests at the cost of
12-53
Not setting the precedence
• Defending the case the through channels of
WTO was important because:
– To reinstate economic benefits of textile exports
– Understand the workings of WTO for long term
trade management
– Not set grounds for US, or other trade partners, to
use the quota restraints as precedence for future
trade barriers
12-54
Players
• APTMA: All Pakistan Textile Manufacturers Association.
Worked as a coordinating body between local
manufacturers, Ministry of Commerce and WTO
• Ministry of Commerce: The relevant ministry for dealing
with the case. At that time, MoC had limited knowledge of
dealing with such disputes, and mainly dealt by hiring and
paying for international consultants and lawyers
• International Development Systems: DC based consultancy
firm that successfully defended Pakistan’s case against US
in 1996. They worked on the case through the first stage of
settlement (TMB Review)
12-55
At the deliberations: Bilateral
• First, Pakistan started bilateral settlement talks
with US
• The talks failed in 1999, after which US
imposed quota restrictions on Pakistan for
three years
• The importance of the case to US was made
evident by high level diplomatic presence on
the US side
12-56
At the deliberations: TMB
• US case was based on decline in domestic producers’
volume due to Pakistani combed cotton yarn
• Pakistan rebutted the claim by challenging the
numbers presented
– Incomplete definition of “domestic producers”
– Lack of causality between exports and decline
• TMB ruled in favor of Pakistan and recommended
immediate lift of quota
• … US appealed against the decision and didn’t lift the
quota
12-57
Dispute Settlement Board
• After failure of US to comply to TMB, Pakistan took
the case to DSB of WTO
• DSB review took longer due to payment delays and
lack of coordination between MoC and APTMA
• The delay resulted in forgoing of valuable export
earnings for Pakistani textile exporters
• US also engaged in another round of bilateral talks
in late 1999 which further delayed the settlements
12-58
DSB Proceedings
• Finally, DSB review was held in November 2000
• Review of DSB, unlike TMB, involved a hefty amount of paperwork
• Outcomes
– DSB awarded decision in favor of Pakistan in May 2001
– US appealed against the decision in July 2001
– Panel upheld the decision in August 2001
– US government finally lifted the quota in November 2001
• Dispute settlement took 2 years and 9 months to settle; just 3 months
before the quote was set to expire
“At the end of the day both parties won, Pakistan because it got a decision
in its favour and the United States because it was able to keep the quota
restraints for almost the entire three-year period, thanks to the duration of
the case.” – Akbar Sheikh, lead consultant for Pakistan
12-59
Lessons learnt on the case
• Government
• APTMA
• Local businesses/ exporter
12-60
Broader Lessons for trade policy
• Even “free trade” under WTO is not so Free
• Countries employ various techniques to

protect and manage their trade issues
• Dispute settlement comes at a cost
12-61
Korea: Unorthodox Trade Policy
Growth from one of the poorest countries to

one of the richest
12-62
Remarkable Growth in Exports

12-63
Whats wrong with the export led growth
hypothesis
• The switch to export incentives wasn’t enough
to account for the growth
12-64
hypothesis (2)
• Why export boom should lead to investment
boom?
• Contribution of exports in economic growth
– Less than 5% in 1960
– Contribution to growth, less than 10% in 1976
• Productivity spillovers from export growth
– Manufactured exports accounted less than 25% of
total exports
12-65
hypothesis (3)
• Rising share of exports in GDP are consistent
with export-led-growth argument.
… or are they?
12-66
How… or why did Korea growth then?
• Role of initial conditions

• Investment Coordination
• Import Substitution… done well
12-67
Case Study: Taiwan

12-68
Concepts for Review
• Absolute advantage • Comparative advantage
• Autarky • Current account
• Balanced trade • Customs Union
• Barter transactions • Depreciation
• Capital account • Devaluation
• Collective self-reliance • Dual exchange rate
• Commodity terms of • Economic Unions
trade
• Common Market
12-69
Concepts for Review
• Effective Rate of
Protection • Flexible exchange rate
• Enclave economies
• Exchange Control
• Export dependence
• Export earnings
instability
• Factor endowment
trade theory

12-70
Concepts for Review (cont’d)
• Factor mobility • Growth poles
• Factor-price equalization • Import substitution
• Income elasticity of demand
• Foreign-exchange
• Income terms of trade
earnings
• Increasing returns
• Free trade
• Industrial policy
• Gains from trade • Industrialization Strategy
• General Agreement on Approach
Tariffs and Trade (GATT
Globalization

12-71
• Infant industry • Multi-Fiber Arrangement
• International commodity (MFA)
agreements • New protectionism
• Inward-looking • Nominal rate of protection
development policies • Nontariff trade barriers
• Managed float • North-south trade models
• Monopolistic market control • Official exchange rate
• Oligopolistic market control

12-72
• Outward-looking • Rent
development policies
• Overvalued exchange rate • Returns to scale
• Parallel exchange rate • Risk
• Prebisch-Singer thesis • Specialization
• Price elasticity of demand
• Subsidies
• Primary products
• Product Cycle • Synthetic substitutes
• Quotas • Tariffs
• Regional trading bloc • Trade creation
• Trade deficits
12-73
• Trade diversion • Vent-for-surplus theory of
• Trade liberalization international trade
• Trade optimists • Wage-price spiral
• Trade pessimists • World Trade Organization
• Uncertainty (WTO)
• Undervalued exchange rate
• Uruguay Round
• Value added

12-74

International Trade Theory and Development Strategy: Lecture 8 - November 10, 2013 - Asim Jahangir

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International Trade Theory and

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• Trade theory and Development: The Traditional

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The nominal tariff rate, t, is

The effective tariff rate, g, is

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• WTO formed after 1995 Uruguay Round of

1. Not everything was permitted under “old

• TRIPS agreement enables countries to impose

• Local businesses/ exporter

• Countries employ various techniques to

• Dispute settlement comes at a cost

Growth from one of the poorest countries to

Copyright © 2009 Pearson Addison-Wesley.

• Role of initial conditions

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