Trade & Development I: Import Substitution Industrialization International Political Economy Prof. Tyson Roberts

Brief history globalization & development Mercantilism (1500s-1700s) Globalization through empire Imperial goal: amass the most gold Subsidize exports, tax imports Classical liberalism (1800s– early 1900s ) Increasing free trade promoted by Britain hegemon Continued promotion of trade within empires

How globalization helps developing countries according to classical liberalism 1st Age of Globalization Free trade: poor countries specialize in comparative advantage (e.g., agriculture) & import other products (e.g., manufactures) Free flow of labor: workers move from labor-abundant to labor-scarce economies => wages  Free flow of capital: capital flows freely from capital-rich to capital scarce countries => investment, development

Example 1: Argentina in 1800s Economically backward compared to Britain Land abundant Labor scarce What should we predict regarding policy preferences of each group, and the resulting political coalitions? http://kids.britannica.com/comptons/art-55394/A-gaucho-herds-sheep-on-the-pampas-in-Patagonia-Argentina

Commerce and Coalitions 1st Age of Globalization (increasing free trade) Labor scarce relative to Land Labor abundant Capital rich (Developed countries) Capitalists & Landowners for trade Labor against Capital & Labor for trade Landowners against Capital scarce (LDCs) Landowners for trade Labor & Capitalists against Labor for trade Landowners & Capitalists against

Commerce and Coalitions 1st Age of Globalization (increasing free trade) Labor scarce relative to Land Labor abundant Capital rich (Developed countries) Capitalists & Landowners for trade Labor against Capital & Labor for trade Landowners against Capital scarce (LDCs) Landowners for trade Labor & Capitalists against Labor for trade Landowners & Capitalists against Argentina

Brief history globalization & development Mercantilism (1500s-1700s) Globalization through empire Imperial goal: amass the most gold Subsidize exports, tax imports Classical liberalism (1800s– early 1900s ) Increasing free trade promoted by Britain hegemon Continued promotion of trade within empires World Wars & interwar period (1914-1945) Breakdown of free trade system, nationalist, fascist & communist movements

Crisis: WWI & Great Depression War => increased demand for labor => increased power of labor in economics (unions) and politics (votes) (esp. in sovereign nations) British Navy no longer strong enough to enforce free trade policies in developing countries Rich and poor countries respond to crisis by imposing controls on trade, capital, immigration Communists & Fascists extremely protectionist

Example 2: Argentina in 1930s Economically backward compared to Britain Land abundant Labor scarce What should we predict regarding policy preferences of each group, and the resulting political coalitions?

Commerce and Coalitions Depression of the 1930s (increasing protectionism) Labor scarce relative to Land Labor abundant Capital rich (Developed countries) Capitalists & Landowners for trade Labor against Capital & Labor for trade Landowners against Capital scarce (LDCs) Landowners for trade Labor & Capitalists against Labor for trade Landowners & Capitalists against

Commerce and Coalitions Depression of the 1930s (increasing protectionism) United States: New Deal W. European Fasicism Labor scarce relative to Land Labor abundant Capital rich (Developed countries) Capitalists & Landowners for trade Labor against Capital & Labor for trade Landowners against Capital scarce (LDCs) Landowners for trade Labor & Capitalists against Labor for trade Landowners & Capitalists against South American Populism Asian & East European Fascism

Argentina 1940s-1950s Juan Peron rises to power with support of labor, industrialists (import competing sectors) and military Implements import substitution industrialization policies http://dailycaller.com/2011/12/15/gimme-all-your-luvin-madonna-re-reinvents-herself-slideshow/madonna_evita/ http://www.answers.com/topic/juan-per-n

http://www.youtube.com/watch?v=WxnaZ0SANr8

Structuralist Critique of Economic Liberalism Market imperfections in developing countries Industrialization in modern era requires coordination Complementary demand: need critical mass of wage workers to buy manufactured products Pecuniary external demand: need related industries to invest simultaneously

Coordination Problem in Boom Town Home construction firms Build Homes Don’t build homes Restaurants Invest in restaurants 10, 10 -5, 0 Don’t invest 0, -5 0, 0

Coordination Problem in Boom Town Home construction firms Build Homes Don’t build homes Restaurants Invest in restaurants 10, 10 -5, 0 Don’t invest 0, -5 0, 0 Two Nash Equilibria

Coordination Problem Electricity Firm Invest in Dam Don’t invest Manufacturer Invest in factory 10, 10 -5, 0 0, -5 0, 0

Coordination Problem in newly-independent Ghana Electricity Firm Invest in Dam Don’t invest Manufacturer Invest in factory 10, 10 -5, 0 0, -5 0, 0 Two Nash Equilibria

Solution to coordination problem: “Big Push” by Government http://www.ghanaweb.com/GhanaHomePage/tourism/akosombo.php http://gamoonbat.blogspot.com/2007/03/valco-ghana-kwame-nkrumah.html Volta Dam, Ghana Major electricity producer Valco aluminum smelter Major electricity user

Structuralist Critique of Economic Liberalism Market imperfections in developing countries Industrialization in modern era requires coordination Declining terms of trade Imported manufactures prices rise Export commodity prices fall Result: core country real incomes rise, periphery country real incomes fall

Solution to Declining Terms of Trade Problem: ISI Easy ISI: Promote local production of consumer goods Sufficient local demand to enable economies of scale Sufficient local labor for labor intensive production Necessary technology available for import (in part in form of foreign capital: machines, etc.) Benefits: wage-based employment, human capital

Solution to Declining Terms of Trade Problem: ISI Easy ISI Second step options Secondary ISI Move up to consumer durables (cars, etc.), intermediate inputs (steel, etc.), and capital goods (machines, etc.) Common in Latin America, South Asia, etc. Export substitution Expand consumer good production for export Common in some East Asian countries

ISI Policies Government planning (5-year plans, etc.) Government investment Roads, rail, electricity, telecom, etc. State-owned & mixed-ownership enterprises Trade barriers Tariffs (on manufactured goods) Import quotas (on manufactured goods) Overvalued and/or multitiered exchange rates to enable import of capital goods

Sources of funds for investment Foreign aid Foreign borrowing Taxes on agricultural exports (marketing boards) Tariffs on imports

$2 $1 $1 Pictures from http://blog.lizearle.com/lizearle/2011/04/cocoa-beans-great-adventure.html http://gamoonbat.blogspot.com/2007/03/valco-ghana-kwame-nkrumah.html http://www.cirad.fr/en/research-operations/research-results/2011/evaluating-cocoa-agroforestry-systems-to-design-new-cropping-systems

Winners & Losers from ISI Policies Workers & firms in import-competing industries Higher market share & prices for produced goods Government Jobs, opportunities for rent-seeking Urban residents Subsidized government services Export-oriented farmers Lower producer prices => reduced production Consumers Higher prices for manufactured goods Manufacturers in export-oriented industries (if any) Overvalued exchange rates increase price of exports, etc.

Assume the world equilibrium price for cocoa is $2 Assume the world equilibrium price for cocoa is $2. How much would Ghana cocoa farmers be willing to produce? Price of cocoa SC 3 2 DC 1 Quantity of Ghanaian Cocoa 2 4 6

Assume the world equilibrium price for cocoa is $2 Assume the world equilibrium price for cocoa is $2. How much would Ghana cocoa farmers be willing to produce? Price of cocoa SC 3 2 DC 1 Quantity of Ghanaian Cocoa 2 4 6

How would cocoa farmers respond if the government sets the producer price at $1? Price of cocoa SC 3 2 DC 1 Quantity of Cocoa 2 4 6

How would cocoa farmers respond if the government sets the producer price at $1? Price of cocoa SC 3 2 DC 1 Quantity of Cocoa 2 4 6

ISI policies successfully promoted industrialization & GDP growth in 60s & 70s GDP/capita growth 1960s & 70s Latin America 2.3% Sub-Saharan Africa 1.4% Middle East & N. Africa 3.7% East Asia 5.2 % South Asia 1.2% Southeast Asia 3.1% But for most countries (all but East Asia), those growth rates would not prove sustainable…

Conclusions International and domestic developments and new belief systems => ISI Policies World Wars & Depression strengthened relatively scarce factor owners Political changes strengthened workers, domestic industrialists, urban voters, etc. Marxism, Structuralist critique of economic liberalism, etc.

Conclusions ISI policies increased industrialization & GDP growth, but … Urban workers & industrialists benefitted to detriment of export-oriented farmers Governments (esp. in “weak states”) took advantage of rent-seeking opportunities to over-extend protection of inefficient manufacturers Budget & trade deficits left countries exposed to global downturn