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International Trade Theory and Development Strategy

This document outlines the key topics and theories around international trade and development strategies. It discusses: 1) The importance of exports to developing nations and issues like export earnings instability. 2) Traditional trade theories like comparative advantage and how differences in factors of production drive trade patterns. 3) Critiques of traditional free trade theories as they relate to the experiences of developing countries, questioning assumptions around fixed resources, technology, and factor mobility.

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mashal rehman
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0% found this document useful (0 votes)
158 views34 pages

International Trade Theory and Development Strategy

This document outlines the key topics and theories around international trade and development strategies. It discusses: 1) The importance of exports to developing nations and issues like export earnings instability. 2) Traditional trade theories like comparative advantage and how differences in factors of production drive trade patterns. 3) Critiques of traditional free trade theories as they relate to the experiences of developing countries, questioning assumptions around fixed resources, technology, and factor mobility.

Uploaded by

mashal rehman
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
You are on page 1/ 34

INTERNATIONAL TRADE

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.

1. Fixed Resources, Full employment, and Immobile Factors of


Production (Capital and Skilled Labor)
2. Unemployment, Resource Underutilization, and the Vent-for-
Surplus Theory of International Trade
3. Fixed, Freely Available Technology and Consumer
Sovereignty
1. Fixed Resources, Full employment, and Immobile Factors of
Production (Capital and Skilled Labor)
• In reality the world economy experiences rapid change, factors of
production are not fixed in quantity or quality. Also factors often do not
determine international specialization in production; rather international
forces directly affect specialization in production and factor use.
Example: LDC’s can be locked into a low growth situation because they
specialized initially in labor-intensive primary products, and did not benefit
from increased domestic capital, technical skills, and entrepreneurship
from producing capital-intensive goods.
Also factors of production are seldom fully employed in production,
especially in LDCs. There usually widespread unemployment of productive
resources, specifically labour.
North-South Trade Models of Unequal Trade
• This theory focus on trading relations between rich and poor
countries.
• A capital abundant industrialized North country experiences
external economies in manufacturing and higher profit rates.
This combined with monopoly power generates higher Northern
growth rates through greater capital accumulation.
• Further adding higher income elasticity of demand for
manufactured goods creates a competitive advantage for the
North over the poorer, slower growing South that is less
industrialized.
Porter’s Competitive Advantage of Nations Theory

• There are big differences in quality of factors of production


between rich and poor countries. Standard models assume
basic, identical factors like undeveloped physical resources and
unskilled labour.

• However, these theories do not apply when one considers


advanced factors like labour with specialized skills, knowledge
resources like government institutes and research universities
etc.
2. Unemployment, Resource Underutilization, and the Vent-for-
Surplus Theory of International Trade
New trade theories also focuses on how LDCs can exploit
underutilized factors of production to benefit from trade. An
example is the Vent-for-Surplus theory.
• Vent-for-Surplus Theory The contention of opening world markets
to developing countries through international trade allows those
countries to make better use of formerly underutilized land and
labor resources so as to produce larger primary product outputs,
the surpluses of which can be exported.
This theory shows how LDCs can move from producing inside
the production possibility frontier to the frontier itself, and then
consume outside the frontier to benefit from trade.
We see that before trade, the resources of
this closed developing-world the economy
were underutilized. Production was
occurring at point V, well within the
confines of production possibility frontier,
and 0X primary products and 0Y
manufactures were being produced and
consumed. The opening up of the nation
to foreign markets (Probably as a result of
colonization) provides the economic
impetus to utilize these idle resources
(mostly excess land and labor) and
expand primary product exportable
production from 0X to 0X’ at point B on
the production frontier. Given the
international price ratio Pa/Pm, X’-X
(equal to VB) primary products can now
be exported in exchange for Y’-Y (equal to
VC) manufactures, with the result that the
final consumption point, C, is attained
with the same primary product (X) being
consumed as before but with Y’-Y more
imported manufactures now available.
3. Fixed, Freely Available Technology and Consumer Sovereignty
• Technological change is taking place rapidly and directly affecting
international trading relationships. E.g. Since World War II, Synthetic
Substitutes for such diverse commodities as rubber, wool, cotton,
sisal, jute, hides and skin have been manufactured in increasing
quantities. The developing world’s market shares of these sectors
have fallen steadily.
• However, the availability of new technologies has also benefited
many developing countries by allowing them to follow product cycle
of developed countries in production and fill in the manufacturing
gaps left by latter.
• Consumer taste are also deeply affected by advertising campaigns
initiated by MNCs, and therefore not fixed and immovable as theory
suggest.
Internal Factor Mobility, Perfect Competition,
and Uncertainty: Increasing Returns, Imperfect
Competition and Issues in Specialization
• The assumption that nations are readily able to adjust their
economic structures to the changing dictates of world prices
and markets is not realistic.
• Reallocations of resources are extremely difficult to achieve in
practice:
• Structural realities in developing countries.
• Increasing returns and decreasing cost of productions.
• Exercise of monopolistic control over world markets.
• Risk and uncertainty inherent in international trading arrangements
The Absence of National Governments in Trading
Relations:
• Cumulative processes for inequality within nation-states by which
growth poles may expand rapidly while other regions stagnate can be
modified by government through legislation, taxes, transfer payments,
subsidies, social services, regional development programs, and so forth.
• There is no international government in case of generation of growth
poles.
• Highly uneven gain from trade can easily become self-sustaining
• Industrial policy is crafted by government.
• Commercial instruments (tariffs, quotas) are state construct.
• International policies can result in uneven distribution of gains from
trade.
The Absence of National Governments in Trading
Relations (Cont..)
• Governments often serve to reinforce the unequal distribution of
resources and gains from trade resulting from differences in
size and economic power. Rich-country governments can
influence world economic affairs by their domestic and
international policies, shaped by their often common interests.
• Despite the growing role of the World Trade Organization, there
is no superagency or world government to protect and promote
the interests of the weaker parties—especially the least
developed countries—in such international affairs.
Balanced Trade and International Price
Adjustments:
• The theory of international trade, is not only a full-employment model but
also one in which flexible domestic and international product and
resource prices always adjust instantaneously to conditions of supply and
demand.
• In particular, the terms of trade (international commodity price ratios)
adjust to equate supply and demand for a country’s exportable and
importable products so that trade is always balanced; that is, the value of
exports (quantitytimes price) is always equal to the value of imports.
• The rapid increase in international oil prices in the 1970s, balance of
payments deficits and the consequent depletion of foreign reserves (or the
need to borrow foreign funds to cover commodity deficits) become a
major cause of concern for all nations, rich and poor.
Trade Gains Accruing to Nationals:

• If Developing countries benefit from trade, it is the people of these


countries who reap the benefits.
• However, enclave Economies are promoted by trade.e.g.
Foreigners often pay very low rents for the right of using land.
• Bring their own foreign capital.
• Bring their own foreign skill labor.
• Hire local cheap unskilled labor.
• Therefore, minimum effect on the rest of economy.
• Difference b/w GDP and GNI becomes important.
Trade Gains Accruing to Nationals:
• GDP is the most widely used measure of economic activity. . . . However, it
has often been treated as if it were a measure of economic well-being. . . .
production can expand while income decreases or vice versa when
account is taken of . . . income flows into and out of a country.”25 To the
extent that the export sector, or for that matter any sector of the economy,
is foreign owned and -operated, GDP will be that much higher than GNI,
and fewer of the benefits of trade will actually accrue to nationals of
developing countries.
• With the proliferation of multinational corporations and increasing foreign
ownership of companies in a wide range of countries, aggregate statistics
for developing-country export earnings (and, indeed, GDP) may mask the
fact that a country’s own citizens, especially those in lower income
brackets, may not benefit from these exports.
CONCLUSION:

• Trade can lead to rapid economic growth under some


circumstances.
• Trade can reinforce existing income inequities.
• Least developing countries (LDCs) must generally trade.
• Trade can help developing countries if they are can extract
concessions from developed countries.
• Regional cooperation may help developing countries.

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