1. Chapter 12 International Trade and Development Strategy

2. Basic Questions
How does trade affect rate, structure and character of LDC economic growth?
Does trade serve as an engine of growth?
How does trade affect income distribution?
Should LDC’s adopt outward-looking trade policy?

3. Importance of Exports Y = C + I + G + (E-M)
High levels of exports (relative to imports) have generated high levels of growth in Japan, South Korea, former Hong Kong and China.
Strategic export policy can provide a ‘big push’ to the economy and lead the country out of the poverty cycle.

4. % share of primary products
Importance of Exports
Country
Exports
as % of GDP
% share of primary products
Philippines 42 25
China 34 8
Indonesia 30 53
South Korea 36 9
India 12
Bangladesh
15.5 10
Japan 13 US 7 18

5. Role of Primary Products
Examples – Foodstuffs, rubber, vegetable oil, cotton, leather, jute
Income elasticity is low when income rises in developed countries, demand for primary goods increases slowly.
Foodstuffs 0.6% agricultural raw materials 0.5%. On the other hand, demand for manufactured goods – 1.9%
Relative Price of primary goods declines in the long-run
Price elasticity is also very low
Supply of primary products is also inelastic
It causes instability of export earnings and volatile price fluctuations.

6. Prebisch – Singer Thesis
Commodity terms of trade is defined as the ratio of export price to import price
According to Prebisch – Singer Thesis, there is a secular (long-term) deterioration in commodity terms of trade for primary goods. This is due to low price and income elasticities
Need for diversification to manufactured goods.

7. Trade Strategies – Export Promotion vs Import substitution
Outward-looking or export promotion policies followed by Japan, South Korea, Taiwan, Singapore, Hong Kong and China
Emphasis on Free-Trade, less trade barriers, Free movement of foreign capital
Strategic policies of exports
Export zones & export promotion
Export promotion policies for primary as well as manufactured goods

8. Problems of Export Promotion Policy
Expanding primary goods – demand side
Low income elasticity
Low price elasticity
Low population growth rates in developed countries
Commodity agreements not very successful
Development of synthetic substitutes
Protective policies against food exports, agricultural products – sugar quota, subsidies

9. Export Promotion (2) supply side
Structural rigidities in rural production system – soil, climate, rural institutions, land tenure
Local shortages due to exports
Farmers – risk averse
Fragmented land holdings.
Together, these problems could have an adverse effect on export earnings of LDCs

10. Export Promotion – manufactured goods
In South Korea, Taiwan, export growth was led by manufactured goods (20% or more)
China’s share in manufactured goods exports is increasing
In developing countries share of manufactured goods:
1950 – 6% , – 64%

11. Export Promotion – manufactured goods
Demand side issues
Widespread protection against LDC’s exports of manufactured goods
Assignment – Find supportive statements from page Write a paragraph on how DC can help by imposing less barriers – What are the likely consequences for DC and LDCs

12. Import - Substitution
Substitute domestic goods for imported goods, self-sufficiency
Impose tariffs or quotas on imports
Provide infant industry protection
Government subsidies and intervention
Improve balance of payments
Achieve large scale and lower prices
Reap the benefits of comparative advantages

13. Import Substitution - Disadvantages
Protective policies discourage competition and efficiency – Is industry remain high cost and inefficient industry?
Foreign firms benefit due to tariff walls
Imports of capital intermediate good are costly
Overvalued, artificial exchange rates which raises the price of exports and reduces the price of imports. Overvalued currency helps local manufactures to increase their exports and imports cheap capital goods
Problems of infant industry

14. Tariff Structures and Effective Protection
Self-study
Nominal rate of protection =
Effective rate of protection =

15. Foreign Exchange MarketS D Pa
Quantity of foreign exchange
Prices of foreign exchange (units of domestic currency per unit of foreign currency) Pb Pe M’ M
M’’
Fixed Exchange rate system
Exchange rates are officially fixed. If there is a huge balance of payments deficit, currency will be devalued.
Floating exchange rate system
Exchange rates are determined by demand and supply.
Depreciation implies a decrease in the purchasing power of domestic currency

16. Foreign Exchange Market
Managed Float – Exchange rates fluctuate within a certain range
Asian Crisis of 1997
South Korea, Thailand, Malaysia, Indonesia adopted floating exchange rate system. Currencies lost 30% of their value and IMP bailed out some of these countries.