International Trade Theory and Development Strategy
International Trade Theory and Development Strategy
THEORY AND
DEVELOPMENT STRATEGY
Group Members:
Aliza Azhar
Erum Manzoor
Fatima Bibi
Maha Baloch
Content outline:
International Trade: Some Key Issues
• Importance of Exports to Different Developing Nations
• Demand Elasticities and Export Earnings Instability
• The Terms of Trade and the Prebisch-Singer Hypothesis
The Traditional Theory of International Trade
• Comparative Advantage
• Relative Factor Endowments and International Specialization: The Neoclassical Model
• Trade Theory and Development: The Traditional Arguments
The Critique of Traditional Free-Trade Theory in the Context of Developing-Country Experience
• Fixed Resources, Full Employment, and the International Immobility of Capital and Skilled Labor
• Unemployment, Resource Underutilization, and the Vent-for-Surplus Theory of International Trade
• Fixed, Freely Available Technology and Consumer Sovereignty
• Internal Factor Mobility, Perfect Competition, and Uncertainty: Increasing Returns, Imperfect Competition and Issues in
Specialization
• The Absence of National Governments in Trading Relations
• Balanced Trade and International Price Adjustments
• Trade Gains Accruing to Nationals
• Conclusion
INTERNATIONAL
TRADE :SOME KEY
ISSUES
Importance of exports to different developing
nations
Although the overall figures for export volumes and
values of developing
countries are important indicators of patterns of
trade for the group as a
whole, the varying importance of exports to the
economic well-being of individual
nations is masked by these aggregate statistics.
Table 12.1 has been
compiled to provide a capsule picture of the relative
importance of commodity
export earnings to various developing nations of
different sizes and in different
regions. For purposes of comparison, three key
developed countries are
included at the bottom of the table.
Illustration of chart
Developing countries are typically more dependent on trade than developed countries are. As Table 12.1 indicates,
while large countries are understandably less dependent on trade than small countries, at any given size,
developing countries tend to devote a larger share of their output as merchandise exports than developed
countries do. We see that some large countries like Brazil and India, which have had unusually closed economies,
tend to be less dependent on foreign trade in terms of national income than most relatively small countries. And
some very low income countries such as Niger remain markedly divorced from the global economy.
As a group, however, less developed nations are more dependent on foreign trade in terms of its share in national
income than the very highly developed countries are. Moreover, in general, the exports of developing countries are
much less diversified than those of the developed countries.
While total exports and the share of manufactures in merchandise exports have been rising for many developing
countries and major new exporters such as China have emerged, it is important to keep this rise in perspective. A
few NICs still command a dominant position in developing-country exports.
For example, in 2008, South Korea alone exported far more than either all of South Asia or all of sub-Saharan
Africa.
Demand Elasticities and Export Earnings
Instability
Income elasticity of demand
The responsiveness of the quantity of a commodity demanded to changes in
the consumer’s income, measured by the proportionate change in quantity
divided by the proportionate change in income.
Price elasticity of demand
The responsiveness of the quantity of a commodity demanded to a change in
its price, expressed as the percentage change in quantity demanded divided
by the percentage change in price.
Export earnings instability
Wide fluctuations in developing-country earnings on commodity exports
resulting from low price and income elasticities of demand leading to erratic
movements in export prices.
The Terms of Trade and the Prebisch-
Singer Hypothesis
• Commodity terms of trade
The ratio of a country’s average export price to its
average import price.
• Prebisch - Singer hypothesis
The argument that the commodity terms of trade for
primary-product exports of developing countries tends to
decline over time.
The Traditional Theory of
international Trade:
• The phenomenon of transactions and exchange is a
basic component of human activity throughout the
world.
• A transaction is a completed agreement between a
buyer and a seller to exchange goods or services.
• Preliminary, the most common mode of transaction
used was barter system.
Comparative Advantage:
• David Ricardo extended the ideas of Adam Smith
• Nations could benefit from trade based on
comparative advantage, not just absolute
advantage
• Comparative advantage refers to a country’s ability
to produce a good at a lower opportunity cost than
another country
Sources of Comparative
Advantage:
• Differences in technology
• Differences in climate
• Differences in factor endowments
• Factors of production – land, labor and
capital
Absolute Advantage:
• The natural advantages which one
country has over another in producing
particular commodities are sometimes so
great that it is acknowledged by all the
world to be in vain to struggle with them.
For Example:
Take Australia, and Japan again as examples, this time Australia
is better than Japan at producing both products computers and
wine, and only one factor of production, labor. Australia produces
6 computers for every 4 bottles of wine, and Japan produces 5
computers for every 1 bottle of wine. Absolute advantage
suggests that no trade should occur, because Australia is more
productive than Japan in producing both goods. The theory of
comparative advantage, suggests that trade should still occur, as
Australia is comparatively better than Japan in wine production,
whereas Japan is comparatively better than Australia in the
production of computers.
The Neoclassical Model:
Factor endowment trade theory:
• The Hecksher ohlin neoclassical factor endowment trade
theory Describes the impact of economic growth on trade
patterns and the impact of trade on the structure of national
economies and on the differential returns or payments to
various factors of production.
• Prices depend on the production possibilities curves and tastes
and preferences (demand conditions) in the trading countries.
• Production possibilities curves depend on technology and
resource endowments.
Factor endowment trade
theory:
• Export the product that uses a large
amount of its relatively abundant
resource
• Import the product which in production
uses the relatively scarce resource
U.S.-China trade:
United States
• Relatively abundant: human capital (skills),
scientific talent, and engineering talent are
relatively abundant
• Relatively scarce: unskilled labor is relatively
scarce
China
• Relatively rich: unskilled labor
• Relatively scarce: scientific and engineering
U.S.-China trade:
United States exports to China
• Goods embodying relatively large amounts of skilled labor and
technology
• Aircraft, software, pharmaceuticals, and high-tech components
of electrical machinery and equipment
China exports to the United States
• Goods for which a relatively large amount of unskilled labor is
used
• Apparel, footwear, toys, and the final assembly of electronic
machinery and equipment
Factor Endowments Factor-Price
Equalization:
• Redirect demand away from the scarce resource
• Toward the abundant resource in each nation
• Trade leads to factor-price equalization
• The cheap resource becomes relatively more
expensive
• The expensive resource becomes relatively less
expensive
• Until price equalization occurs
Factor Endowments Factor-Price
Equalization
• Uneven ownership of human capital
• Education, training, skill, and the like
• Not all countries use the same technology
• New and better technology replaces older
technologies – faster in developed countries
• Transportation costs and trade barriers
• Reduce the volume of trade
Trade Theory and Development:
The Traditional Arguments
• Trade is an important stimulator of economic growth. It
enlarges a country’s consumption capacities, increases
world output, and provides access to scarce resources.
• Trade tends to promote greater international and
domestic equality by equalizing factor prices, raising
real incomes of trading countries, and making efficient
use of each nation.
• Trade helps countries achieve development by
promoting and rewarding the sectors of the
economy where individual countries possess a
comparative advantage, whether in terms of
labor efficiency or factor endowments.
• International prices and costs of production
deter- mine how much a country should trade in
order to maximize its national welfare.
• To promote growth and development, an
outward-looking inter- national policy is
required.
12.4 The Critique of Traditional Free Trade Theory in the Context of
Developing-Country Experience
• To see why neoclassical trade theory does not fit well with the real world experience of developing
countries, we need to analyze the main assumptions the theory is based on:
• All productive resources are fixed in quantity and constant in quality across nations and are fully
employed.
• The technology of production is fixed or similar and freely available to all nations. Moreover, the
spread of such technology works to the benefits of all. Consumer tastes are also fixed and
independent of the influence of producers.
• Within countries, factors of production can be transferred from one productive activity to
another without a high cost, and a perfect competition prevails in the economy with no risk or
uncertainties.
• The national government plays no role in international economic relations; trade is carried out
between several anonymous producers seeking to minimize the costs and maximize profits.
International prices are therefore set by the forces of supply and demand.
• Trade is balanced for each country at any point in time, and all economies are readily able to
adjust to changes in the international prices with a minimum of dislocation.
• The gains from trade that accrue to any country benefit the nationals of that country.
• We can examine each assumption in the context of the
positions of developing countries in the international economic
system.