Econ 111 Chapter 12

Regional trading blocs

- NAFTA (North America) - MERCOSUR ( Latin America) - SADC (South Africa) - ASEAN (South east Asia)

Define Globalization

- The increasing integration of national economies into expanding international markets - "A process by which the economies of the world are becoming more integrated" - "The emergence of a global culture in which people consume similar goods and services across countires and use a common language of business" - "The increased openness of economies to international trade, financial flows, and foreign direct investment; the increased integration of national economies into expanding international markets"

Hausmann, Hwang, and Rodrik Export Oriented Industrialization Strategy

- exporting a mix of goods more typical for higher-income countries predicts higher growth: "You become what you export" - Thus, export oriented industrial policy may help overcome market failures in the process of technological progress - without proper attention to incentives (market and rent seeking activites) these policies can become counter productive

Fixed, Freely Available Technology and Consumer Sovereignty

- technology is rapidly improving and affecting international trade, synthetic substitutes for many traditional primary products "rubber, cotton, wool" has led to a decline in the market share of the developing worlds - Challenged by the Product Cycle theory The progressive replacement of more developed countries by less developed countries in the production of manufactures of increasing complexity because they have lower wages - also assumption of fixed consumer tastes is unrealistic, in many developing countries, 90% of all advertising is financed by foreign firms selling in local markets

The Absence of National Governments in Trading Relations

1) Definite role for State 2) Industrial policy "guiding market through strategic coordination of business investments to increase export market shares" is crafted by governments 3)Commercial policies instruments (tariffs, quotas) are state constructs, can maniplate commodity prices and thus their trade position compared to rest of the world. 4)International policies can result in uneven distribution of gains from trade. Rich governments can influence world economic affairs by domestic policies such as dealing with inflation but can have an inverse affect on world but the reverse is not true. developing countries policies do not hurt the developed countries

Demand Elasticities and Export Earnings instability

1) Developing nations are generally more dependent on trade than developed countries (though there is great diversity) 2) Exports of developing countries are generally less diversified than those of developed countries For 40 countries, the production of three of fewer commodities explains all export earnings 3) Volatility affects commodity prices, and also other exports including tourism 4) Developed countries, manufacturers make up a large % of export while for developing countries Agricultural and food make up a high %

Factor endowment theory based on two crucial propositions

1) Different products require productive factors in different relative proporations - agricultural products generally require relatively greater proportions of labor per unit of capital than manufactured goods, which require more machine time(capital) per worker. Assumes that certain products will always be relatively more capital intensive while others are more labor intensive. 2) Countries have different endowments of factors of production - developed countries are relatively capital abundant while most developing countires are labor abundant.

Assumptions of the basic Neoclassical model have been scrutinized

1) Fixed in quantity and constant in quality, full employment, international factor immobility 2) Fixed(classical model) / freely available technology (factor endowment model) spread of technology works to benefit of all. Consumer tastes are also fixed and independent of the influence of producers - vs. product cycle, ongoing development of synthetic substitutes for developing countries exports, and opportunities for dynamic gains in leading sectors 3) Within nations, factors of production are perfectly mobile between different production activities, the economy as a whole is characterized by the existence of perfect competition. vs. different types of structural rigidities and pervasive market power 4) Governmental non-interference in trade, international prices are therefore set by the forces of supply and demand only vs. active trade policies 5) Balanced trade at all times and international price adjustments can be made at any time vs. instability 6) The gain from trade that accure to any country benefit the nationals of that country vs. export enclaves with foreign ownership; distinction between GDP and GNI becomes important

The Industrialization Strategy Approach to Export Policy

1) Focus on government interventions to encourage exports, especially those with higher skill and technology content (industrial policy) 2) Government not trying to manage industry, but to understand their constraints and relax them 3) Problem: without proper attention to incentives, industrial policies may be counterproductive too 4) WTO rules and industrial policies - gray areas remain 5) Problem: level of competence and political authority of governments to carry out policies effectively

Five Basic Questions about Trade and Development

1) How does international trade affect economic growth? (rate, structure and character). This is the traditional "trade as an engine of growth" controversy, set in terms of contemporary development aspirations. 2) How does trade alter the distribution of income and wealth within a country and among different countries? Is trade a force for international and domestic equality or inequality? Are the gains and losses distributed and who benefits? 3) Under what conditions can trade help a nation to achieve its development objectives? 4) Can developing countries determine how much they trade or what to sell by their own actions? 5) Is an outward-looking (freer trade, expanded flows of capital and human resources) or an inward-looking (protectionism in the interest of self reliance) or combination of both, trade policy best?

Trade pessimist arguments (4)

1) Limited growth of world demand for primary exports results in lower export prices and a transfer of income from poor to rich countries 2) Secular deterioration in terms of trade, high elasticity of developing countries' demand for imports, combined with the low elasticity for their exports, means developing countries must grow slowly to avoid chronic balance of payments and foreign exchange crisis 3) Specializing in comparative advantage"primary products" inhibits industrialization, skills accumulation, and entrepreneurship 4) Rise of "new protectionism"; WTO benefits limited in practice, developing economies lacking the high power lawyers and other resources needed to pry developed markets open

Primary-commodity export expansion - Limited Demand 6 factors working against rapid expansion "export promotion"

1) Low income elasticities "inelastic demand" 2) Low population growth rates in developed economies so little expansion can be expected from this source 3)Decline in prices and low price elasticities of demand imply low revenue (some periods of price spikes, incl. recent years, but very l/r trend has been downward) 4) Lack of success with international commodity agreements, attempt to guarantee participating nations a relatively fixed share of world export earnings and a more stable world price for their commodity, either ends in fail or largely ignored. 5)Development of synthetic substitutes, act as a brake against higher commodity prices and as a direct source of competition in world export markets. 6) Agricultural protection in the developed countries, in the form on tariffs euotas and increasingly nontariff barriers such as arbitaray sanitary laws

Demand Elasticities and Export Earning Instability

1) Often low price elasticity of demand "inelastic" for agricultural commodities but supply shocks 2) Often low price elasticity of supply for basic commodities but demand shocks 3) Result can be export earnings instability; risks to income 4) Also, low income elasticity of demand for primary products -> tendency for the relative price of primary products to decline over time... 5) when income rise in rich countries, their demand for food products, raw materials from developing countries goes up slowly whereas demand for manufactures goes up relatively rapidly.

Trade optimist arguments - trade liberalization (8)

1) Promotes competition, improved resource allocation, economies of scale and efficiency. costs of production are consequently lowered 2) Generates pressure for product improvement and technical change, thus raising factor productivity and further lowering costs of production 3) Accelerates overall growth, raises profits and promotes greater savings and investment and thus furthers growth 4) Attracts foreign capital and expertise, which are in scarce supply in most developing countries 5) Generates foreign exchange to use for food imports if agricultural sector lags behind or suffers natural catastrophes 6) Eliminates distortions caused by government interventions including corruption and rent-seeking activities 7) Promotes equal access to scarce resources, 8) Enables developing countries to take full advantage of reforms under the WTO may be difficult at first with limited gains "compared to first stage import substitution" but over the longer run the economic benefits tend to gain momentum

The import substitution (IS) industrialization strategy and results "five undesirable outcomes"

1) Protected industries remain inefficient and costly because get to hid behind protective tariff walls and immune from competitive pressures 2) Foreign firms often benefit more, the ones let in to teach the companies how to run, then remitted aboard 3) Subsidization of imports of capital goods tilts pattern of industrialization and contributes to balance of payments (BOP) problems, increases a need for imported capital-good inputs and intermediate products, while a good part of the profits is remitted abroad in the form of private transfer payments from (2) 4) Overvalued exchange rates hurt exports, notably agricultural product, worsened the local distribution of income by favoring the urban sector and higher income groups while discriminating against the rural sector and lower income groups 5) Does not stimulate self-reliant integrated industrialization, increases the costs of inputs/production for forward-linked industries and decreases demand for backward-linked industries "they purchases inputs from overseas instead"

Trade Policies of Developed Countries: The Need for Reform and Resistance to New Protectionist Pressures

1) Rich-nation economic and commercial policies matter for developing countries 2) Double standards: "You liberalize, we subsidize" 3) 2010: OECD estimates that its members agricultural subsidies totaled $227 billion (though this was 10% less than the previous three years). By contrast, aid was $130 billion. 4) effective, trade-weighted tariffs faced by the poor are much higher than those faced by the nonpoor. 5) developed countries did not live up to their part of the bargin in the Uruguay round.

Standard argument for tariff protection

1) Sources of revenue, relatively easy form of taxation to impose and even easier to collect 2) Import restrictions represent an obvious response to chronic balance of payments and debt problems 3) Help foster industrial self-reliance, economies of scale, positive externalities (general IS) 4) Greater control over economic destinies, become competitive enough to export to open market - Must be applied selectively and wisely - Infant industry protection argument Many examples of perceived failures, but some success in East Asia

South-South Trade and Economic Integration

1) South-South Trade through regional trading blocs and the globalization of trade 2) Local conditions matter, such as opportunities for dynamic gains and the specifics of South-South Agreements which at their best are about more than merely setting common tariffs 3) Still not fully answered: Do blocs promote growth or retard the progress of globalization - a customs union among developing countries could provide its biggest benefits to the highest income nations within the group as they attract the manufacturing sector 4) regional integration is a good idea, but not behind high external barriers

Primary-commodity export expansion - supply rigidities factors working against rapid expansion "export promotion"

1) Structural rigidities "limited resources, poor climate, social economic institutions" of rural production systems, dont have to capital to build new farms if demand increases 2) Uneven distribution of growth in export earnings, dualistic farming structure big corps and many small farmers, growth goes to the big corps 3) Agricultural marketing boards, act as middle men

Expanding Exports of manufactured goods

1) Success include South Korea, Singapore, Hong Kong, Taiwan and China, over 20% growth which manufactured goods contributed over 80% too 2) In these countries, the production and composition of exports resulted from planned intervention by government with ample use of the profit motive 3) Widespread protection against manufactures from the developing world - E.g. Multifiber Arrangement (MFA) - in effect until 2005, estimated to have cost developing countries $24 billion a year in lost textile and clothing export earnings 4) trade agreements like NAFTA and EU discriminate against exports from nonmember developing countries

Developed countries' economic and commercial policies are most important from the perspective of future developing countries in three major areas

1) Tariff and non-tariff barriers to developing country exports 2) Adjustment assistance for displaced workers in developed country industries hurt by freer access of labor intensive, low cost developing country exports 3) General impact of rich country domestic economic policy on developing economies

Economic Integration: Theory and Practice

1) The growth of trade among developing countries (1981 - 2011: 8% to 26% of world merch. trade) hard for developing countries to break into developed markets due to poor reputation. 2) Integration "raise a common tariff wall against the products of nonmembers while freeing internal trade among member" encourages rational division of labor among a group of countries and increases market size - the country with lower cost "comparative advantage" will begin to make that product for all other members 3) Provides opportunities for a coordinated industrial strategy to exploit economies of scale 4) Trade creation 5) Trade diversion

Export-Oriented Industrialization Strategy "Theory focuses on market failures"

1) There are market failures in transfer of innovations 2) Coordination failures may make industrialization problematic 3) Exporting allows access to a much larger market 4) Export expansion may facilitate technology transfer through contacts with foreign firms, industry spillovers, scale economies 5) There may be learning by doing (or "watching") effects in manufacturing sectors 6)Performance is rigorously tested when firms attempt to export 7) Export targets more visible; focus on manageable problems

The Terms of Trade and the Prebisch-Singer Hypothesis

1) Total export earnings depend upon: -Total volume of exports sold; and, -Price paid for exports 2) Prebisch and Singer argued commodity export prices fall over time, so developing countries lose revenue unless they can continually increase export volumes because most of their export is commodities. 3) commodity prices fall "export" while import prices "manufactured goods" have risen relatively 4) They concluded that developing countries need to avoid dependence on primary exports and diversify into manufactures exports 5) structural change from above has not benefited as much because relative prices within manufacture have also diverged, developing countries can only produce basic manufactured goods "textiles" while rich countries make advance products, planes, machinery 6)Recently, prices of basic manufactured goods have also fallen relative to the advanced products exported by rich countries,

Conclusions on Trade Theory and Economic Development Strategy "Five Basic Questions about Trade and Development"

1) Trade can be an important stimulus to rapid economic growth under some circumstances. access to markets allows for greater utilization of idle human and capital resources. 2)Trade seems to reinforce existing income inequalities, factors such as the widespread existence of increasing returns, the highly unequal distribution of economic assets and power, the influence of large multinational companies, and the combined ability of both government and businesses to manipulate international prices, levels of production, and patterns of demand leads to less developed benefiting disproportionately. 3)Trade can benefit developing countries if they can extract trade concessions from developed countries. the ability to deal effectively with multinational corporations in guaranteeing a fair share of the benefits to local citizens is extremely important. 4)Developing countries generally must trade, the issue is finding the balance between seeling for the domestic market and exporting and whether to encourage exporting across the board or to promote targeted sectors. 5)Regional cooperation may help developing countries by trading at least with each other, ASEAN in south Asia, trading agreements. either or but probably outward

Five Basic Questions about Trade and Development: The Traditional Arguments "Answers"

1) Trade is an important simulator of economic growth. enlarges a country's consumption capacities, increase world output, and provides scarce resources to developing countries 2)Trade promotes international and domestic equality by equalizing factor prices, raising real incomes of trading countries, and making efficient use of each nation's and world's resource endowments. 3) Trade helps countries achieve development by promoting and rewarding sectors of comparative advantage "take advantage of economies of scale" 4) In a world of free trade, international prices and costs of production determine how much a country should trade in order to maximize its national welfare. "follow principle of comparative advantage" 5) Outward-looking international policy is superior to isolation

Porter's "Competitive Advantage" theory

1) Traditional trade theory applies only to basic factors (unskilled labor, physical resources) 2) departure from the standard theory is to posit a qualitative difference basic factors and advanced factors of production 2)But creation of advanced factors (knowledge resources, specialized infrastructure) is the first priority 3) Central task to "escape from the straightjacket of factor-driven"standard model" national advantage

Unemployment, Resource Underutilization and the Vent-for-Surplus Theory of International Trade

1) assumption of full employment vioolates the reality of unemployment and underemployment in developing countries 2) Opening of world markets to remote agrarian societies creates opportunities not to reallocate fully employed resources as in the traditional models but rather to make use of formerly underemployed land and labor resources to produce greater output for export to foreign markets 3)High unemployment and underemployment, so they assume producing at point V well within the confines of the production possibility frontier 4)Consumption shifts from V to C which is outside the production function.

Tariffs, infant industries, and the theory of protection "IS"

1) desire to create Infant industries protected by tariff wall 2) Reduced dependence and increased self-reliance 3) Building a domestic industrial base 4) Tax revenue generated from tariff 5) An IS strategy becomes the prerequisite for an EP strategy.

Trade gains accruing to nationals

1) question of who owns the land capital and skills that are rewarded as of the trade 2)Enclave economies are promoted by trade, foreign pay low rent and low wages to locals but generate a ton of revenue 3) Difference between GDP and GNI becomes important, not a trade between rich and poor nations, in reality, trade conducted by rich nations and other nationals of rich nations operating in developing countries.

Import substitution: looking inward but still paying outward

1)Strategy is first to erect tariffs barriers or quotas on certain imported commodities 2)Then to try to set up a local industry to produce these goods. typically involves joint venture with foreign companies which are encouraged to set up plants behind the wall of tariff protection and given tax and investment incentives. 3) initially costs are probably higher then imports would be but 4) idea is the industry eventually be able to reap the benefits of large scale production and lower costs or that the balance of payments will be improved as fewer consumer goods are imported.

Internal Factor Mobility, Perfect Competition, and Uncertainty

1)Structural realities in developing countries, can not possible switch from production of primary products to manufacturing products as easily due to low capital and infrastructure. 2) developing countries that do begin to expand capacities to produce basic manufactured goods have found their exports blocked by tariffs and non-tariff barriers set up by developed countries 3) Developed countries exercise Increasing returns and exercise of monopolistic control over world markets, they take advantage of these economies of scale and differentiated products to perpetuate their dominant position in world markets. 4)Risk and uncertainty inherent in international trading arrangements, may not be in low income country's long term interest to invest heavily in primary product export since unpredictable and not diversified

Import substitution

A deliberate effort to replace consumer imports by promoting the emergence and expansion of domestic industries

Globalization introduction

Benefits and risks greater for Less developed countries Rules of the game WTO MNCs; intellectual property rules are in favor of developed countries

The Globalization Trilema

Choose two - any two 1. Hyperglobalization: A world in which there are virtually no political or cultural barriers to the location of goods and investment. 2. Democracy within nation states: This means that the government respects both individual liberty and political equality. 3. National sovereignty: Each national government can pursue policies that it chooses without any significant limits imposed on it by other nations or by global institutions.

World Trade Organization - "Trade Policies of Developed Countries: The Need for Reform and Resistance to New Protectionist Pressures"

Despite 8 liberalization rounds over 50 years, trade barriers remain in place in agriculture; and, through various mechanisms, to a degree in other sectors Doha Development Round begun 2001 tilted the nominal focus to needs of developing world; but talks remained stalled through the end of 2010, a self-imposed deadline, and were still deadlocked in 2014. The latest talks in Nairobi in 2015 led to ambiguous outcomes.

Outward vs inward looking development policies

Distinction actually less clear Most successful East Asian export promoters also pursued IS strategies in certain industries, and cannot be called free traders, although they are outward oriented

National sovereignty

Each national government can pursue policies that it chooses without any significant limits imposed on it by other nations or by global institutions.

Infant industry support - Export Oriented Industrialization Strategy

Empirically: " periods of significant export expansion are almost always preceded by periods of strong import substitution" Zedillo commission, 2001: "However misguided the old model of blanket protection intended to nurture import substitute industries, it would be a mistake to go to the other extreme and deny developing countries the opportunity of actively nurturing the development of an industrial sector" doesnt mean it would work today but has in the past

The Traditional Theory of International Trade

Gains from trade, specialization and comparative advantage Ricardo and Mill (static model) Relative factor endowments and international specialization: the Neoclassical model - concept of relative cost and price differences is basic to the theory of international trade - principle of comparative advantage

Export promotion

Governmental efforts to expand the volume of a country's exports through increasing export incentives, decreasing disincentives, and other means in order to generate more foreign exchange and improve the current account of its balance of payments or achieve other objectives

Two implications for analyzing effective versus nominal tariff structures

In developing countries 1) high rates of effective protection of final good industries and less effective protection for intermediate goods -> attracts scare resources away from intermediate goods to the inefficient production of final goods -> backward linkages do not develop -> intermediate good import costs rise -> indigenous capital-goods industry is impeded 2) In developed countries, duty-free imports of raw materials and apparently low tariffs on processed products can mean very high rates of effective protection: Copra: Duty-free. Coconut oil: 10% tariff. If the value added in making oil from copra is 5%, the process is being protected at 200% -> This greatly inhibits the development of food and other raw-materials-processing industries in developing countries -> and cuts back on their potential earnings of foreign exchange

The Traditional Theory of International Trade "neoclassical model of free trade conclusion"

Main conclusion of the neoclassical model is that 1)all countries gain from trade 2) World output increases with trade 3) Factor price equalization: Int'l wage rates and capital costs will gradually tend toward equalization - due to given identical technologies of production throughout the world led to equalization of domestic product ratios with international free trade price ratio. 4) Returns to owners of abundant resources will rise in relation to owners of scarce resources as the abundant factor is more intensively used, promoting more equality in developing country domestic income distributions 5) By enabling countries to move outside their production possibility frontiers and secure capital as well as consumptions of goods from other parts of the world, Trade will stimulate economic growth

International trade: Some key issues

Many developing countries 1) rely heavily on exports of primary products with attendant risks and uncertainty "export dependence" 50-90% of exports from one commodity 2) also rely heavily on imports (typically of machinery, capital goods, intermediate producer goods, and consumer products) 3) import demands exceeded their capacity to generate sufficient revenues from the sale of exports. 4) have chronic deficits on their current accounts which depletes their reserves, causes currency instability, and may slow economic growth 5) have recently sought to promote exports and accumulate large foreign exchange reserves to cushion against crises

Export-Oriented Industrialization Strategy

Outward oriented and optimistic about export-led development, Active role for government in influencing the type and sequencing of exports (progressively more advanced products) Theory focuses on market failures There are market failures in transfer of innovations Coordination failures may make industrialization problematic Exporting allows access to a much larger market Export expansion may facilitate technology transfer through contacts with foreign firms, industry spillovers, scale economies There may be learning by doing (or "watching") effects in manufacturing sectors Performance is rigorously tested when firms attempt to export Export targets more visible; focus on manageable problems

Outward looking development policies

Policies that encourage exports, often through the free movement of capital, workers, enterprises, and students, a welcome to multinational corporations and open communications - export promotion

Inward looking development policies

Policies that stress economic self-reliance on the part of developing countries including domestic development of technology, the imposition of barriers to imports, and the discouragement of private foreign investment. - import substitution

Benefits from Globalization

Possible benefits include 1) gains from trade 2) rapid innovation and technology transfer 3) protection from war

Comparative advantage

Production of a commodity at a lower opportunity cost than any of the alternative commodities that could be produced

Trade creation

Shift, upon formation of a customs union, in the location of production from higher-cost to lower-cost member states

Trade diversion

Shift, upon formation of a customs union, of the location of production of formerly imported goods from a lower cost nonmember state to a higher cost member nation. everyone is worst off

Prebisch-Singer hypothesis

The argument that the commodity terms of trade for primary-product exports of developing countries tends to decline over time

New protectionism

The erection of various nontariff trade barriers by developed countries against the manufactured exports of development nations

Fixed Resources, Full Employment, and the International Immobility of Capital and Skilled Labor

The initial assumption about the static nature of international exchange, "resources fixed, fully utilized, and production functions identical" is central to the traditional theory of trade but in reality everything is changing rapidly - therefore the relative factor endowments and comparative costs are not given but are in a state of constant change - 'Static efficiency can become dynamic inefficiency' - Challenged by North-South trade models

Factor endowment trade theory

The neoclassical model of free trade, which postulates that countries will tend to specialize in the production of commodities that make use of their abundant factors of production(land, labor, capital)

Commodity terms of trade

The ratio of a country's average export price to its average import price

Hyperglobalization

Thesis that globalization is so powerful, it will overwhelm the power of nation-states, forcing convergence of economic policies

Democracy within nation states

This means that the government respects both individual liberty and political equality.

North-South trade models

Trade and development theories that focus on the unequal exchange between the North developed countries and the South developing countries in an attempt to explain why the South gains less from trade than the North. - argues that initial higher endowments of capital in the industrialized North generate external economies in manufacturing output and higher profit rates. - in contrast, the south endowed with abundant supplies of unskilled labor will specialize in products that are intensively use unskilled labor for which the world demand prospects and terms of trade may be very unfavorable, find themselves locked into a stagnant situation that perpetuates their comparative advantage in unskilled labor instead of moving to capital.

Balanced Trade and International Price Adjustments

Unrealistic (example: impact of oil price hikes of the 1970s), international product and resource prices do not adjust instantaneously to conditions of supply and demand

Tariff Structure and Effective Protection

Whatever the means to used to restrict imports, such restrictions always protects domestic firms from competition with producers from other countries. To measure the degree of protection we need to see how much these restrictions cause the domestic prices of imports to exceed what their prices would have been. Two ways to measure 1) The nominal rate of protection 2) the effective rate of protection

Principle of comparative advantage

asserts that a country should and under competitive conditions will, specialize in the export of the products that it can produce at the lowest RELATIVE cost

Concerns from Globalization

center around the unevenness of the process, and risks 1) inequalities may be accentuated both across and within countries 2) that environmental degradation may be accelerated 3) that the international dominance of the richest countries may be expanded and locked in 4) some peoples and regions get left further behind

The nominal tariff rate, t

t = (p' - p) / p Where p′ is the tariff-inclusive price p is the free trade price shows the extent, in percentages, to which the domestic price of imported goods exceeds what their price would be in the absence of protection

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 effective tariff rate, ρ

ρ = (v′ - v) / 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 shows the percentage by which the value added at a particular stage of processing in a domestic industry can exceeds what it would be without protection. --- shows net effect on a firm or industry of restrictions on the imports of both its outputs and inputs. The effective rate is greater, the smaller the value added of the process: ρ = t/(1-α) where α is the proportionate value of importable inputs in a free market Average rates of effective protection in developing countries can be very high: Pakistan and Uruguay 300%, Argentina and Brazil 100%, Philippines 50%