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International trade and economic development
230● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ●
367
4 Developm
ent Economics
By the end of this chapter, you should be able to:
● explain, and give examples of, international barriers to economic development
HL explain how long term changes in the terms of trade are a barrier to development
● evaluate and give examples of strategies for achieving economic growth and economic development.
International barriers to developmentThere are a number of international factors that act as a barrier to both economic growth and economic development:
1 Over-specialization on a narrow range of productsWhile the share of manufactured goods produced by developing countries as a percentage of total world trade is growing, a number of developing countries are dependent on primary commodities for a significant share of their export revenues, as explained in Chapter 26. Rising commodity prices may, therefore, be beneficial to those countries. It will increase their rate of economic growth and if the revenues are used to finance education, health, and infrastructure, then this can set off a positive cycle in terms of development and future growth. However, if the prices fall then the economies experience deteriorating terms of trade. Current account deficits are likely to increase and it will be very difficult for countries to finance current expenditure and necessary imports. Unless they can change the pattern of their export trade, those countries that are dependent on a narrow range of primary exports will find it difficult to gain much growth through international trade.
Regardless of the types of goods exported, be they commodities, manufactured goods or even services like tourism, if a country is dependent on a narrow range of exports, then they face great vulnerability and uncertainty. For example, economic growth in a tropical country that is reliant on tourism revenues will be limited if the global tourist trade is damaged as a result of terrorism or as a result of a global slowdown in economic growth. It is also vulnerable to other forces outside of its control such as tsunamis. Countries that were dependent on the export of a small range of low-skill manufactured goods such as textiles were damaged when China joined the WTO and sharply increased the supply of textiles on world markets, driving down their prices.
30 ● International trade and economic development
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30 ● International trade and economic development
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Student workpoint 30.1Consider the following article and graph from The Economist and answer the questions that follow:
1 Using the information in the bar chart, explain how farm subsidies have changed in South Korea over the period shown.
2 Contrast this with farm subsidies in the EU.
3 Write a statement using both the bar chart and the figure on the right to explain the role of farm subsidies in the US.
4 Review—draw a diagram to show the effect of a subsidy. Identify the area which shows the payment by the government.
The rich world’s farmers are still reaping handsome subsidiesFARMERS are getting by with fewer subsidies in many countries around the world compared with 20 years ago. Yet subsidies still accounted for more than three-quarters of farmers’ incomes (gross farm receipts) in Norway, Switzerland, and Iceland between 2007 and 2009. And farm subsidies in the EU made up a slightly greater proportion of farmers’ incomes in 2007–09 than two decades beforehand. OECD countries spent $253 billion on farm subsidies in 2009—22% of gross farm receipts, the first increase since 2004.
Source: The Economist online, 01 July 2010
Norway
Agricultural subsidiesProducer support, % of gross farm receipts
Switzerland
Iceland
South Korea
Japan
Turkey
EU
OECD average
Canada
Mexico
United States
Australia
New Zealand
20 40 60 800
3.7
6.2
0.1
17.5
46.5
22.6
120.8
252.5
7.8
5.8
30.6
2007–09*
1986–880.9
0.03$bn, 2009**Provisional estimates †1991–93
An important related issue is tariff escalation, whereby the rate of tariffs on goods rises the more the goods are processed. By doing this, an importing country protects its processing and manufacturing industries by putting lower tariffs on imports of raw materials and components and higher tariffs on processed and finished products. In the most extreme cases the developed countries import raw materials that have low tariffs on them, process the raw materials, adding value to the goods, and then export the finished goods. Tariff escalation creates a significant problem for developing countries in terms of their access to markets. There is little incentive to diversify away from producing raw materials to processing them as the higher prices due to tariffs will make their processed goods uncompetitive. Effectively, it can trap them as suppliers of raw materials. An example of tariff escalation on certain agricultural products in the EU, USA, and Japan is shown in Table 30.1.
2 Price volatility of primary productsThe price elasticity of demand for commodities and the price elasticity of supply for commodities, on the world market, tend to be relatively inelastic. This is shown for the world cotton market in Figure 30.1.
With such inelastic demand and supply, any change in the demand or supply conditions for resources, in this case cotton, will lead to large price fluctuations. In Figure 30.1, a fall or increase in supply, possibly caused by either bad or good weather conditions, would have noticeable increases or decreases in price, from P1 to P3, when supply falls, and from P1to P2 when supply increases.
This will have a marked impact on the export revenue of the countries that are selling the commodities. This price volatility, and subsequent export revenue volatility, makes it very difficult for producers and governments in developing countries to plan ahead. This in turn has an impact on investment in companies, and thus growth, and on government planning for education, health care and infrastructure, and thus development.
3 Inability to access international marketsProtectionism is any economic policy that is aimed at supporting domestic producers at the expense of foreign producers. We have already come across forms of protectionism, such as tariffs, subsidies, quotas, and non-tariff barriers, in Chapter 22. Protectionist measures by developed countries against the exports of developing countries may be very harmful. If the measures prevent developing countries from utilizing their comparative advantages and exporting to developed countries, then developing countries will be limited in their ability to earn foreign exchange.
Protectionism in any market is damaging for developing countries, but it is especially the case in primary product markets. If we take the example of cotton; America’s 25 000 cotton farmers share over $3 billion in government subsidies each year. This encourages farmers to produce more, forcing down the world price, and export their surplus to developing countries that do not have the benefits of subsidies. This is then immensely damaging for the developing country producers. The US does the same with maize, rice, and dairy products. Meanwhile, protected EU farmers overproduce and export sugar, cereals, and dairy produce, lowering world prices and severely damaging markets and local suppliers in developing countries. As these products are sold at lower prices than would be the case without subsidies, it is argued that they are “dumped” in foreign markets. Small scale farmers in developing countries are effectively deprived of the ability to earn a living, provide for their families, and afford schooling for their children, which is clearly a significant barrier to development.
DID yoU know?According to oxfam, “the rich world spends $1 billion a day subsidizing its agricultural industries”
Visit www.maketradefair.com for excellent resources on this important topic.
Figure 30.1 The world market for cotton
Pric
e of
cot
ton
($)
Q1Q2Q3
Quantity of cotton (tonnes million)
P1
P2
S3 S1 S2
P3
D
30 ● International trade and economic development
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30 ● International trade and economic development
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Student workpoint 30.1Consider the following article and graph from The Economist and answer the questions that follow:
1 Using the information in the bar chart, explain how farm subsidies have changed in South Korea over the period shown.
2 Contrast this with farm subsidies in the EU.
3 Write a statement using both the bar chart and the figure on the right to explain the role of farm subsidies in the US.
4 Review—draw a diagram to show the effect of a subsidy. Identify the area which shows the payment by the government.
The rich world’s farmers are still reaping handsome subsidiesFARMERS are getting by with fewer subsidies in many countries around the world compared with 20 years ago. Yet subsidies still accounted for more than three-quarters of farmers’ incomes (gross farm receipts) in Norway, Switzerland, and Iceland between 2007 and 2009. And farm subsidies in the EU made up a slightly greater proportion of farmers’ incomes in 2007–09 than two decades beforehand. OECD countries spent $253 billion on farm subsidies in 2009—22% of gross farm receipts, the first increase since 2004.
Source: The Economist online, 01 July 2010
Norway
Agricultural subsidiesProducer support, % of gross farm receipts
Switzerland
Iceland
South Korea
Japan
Turkey
EU
OECD average
Canada
Mexico
United States
Australia
New Zealand
20 40 60 800
3.7
6.2
0.1
17.5
46.5
22.6
120.8
252.5
7.8
5.8
30.6
2007–09*
1986–880.9
0.03$bn, 2009**Provisional estimates †1991–93
An important related issue is tariff escalation, whereby the rate of tariffs on goods rises the more the goods are processed. By doing this, an importing country protects its processing and manufacturing industries by putting lower tariffs on imports of raw materials and components and higher tariffs on processed and finished products. In the most extreme cases the developed countries import raw materials that have low tariffs on them, process the raw materials, adding value to the goods, and then export the finished goods. Tariff escalation creates a significant problem for developing countries in terms of their access to markets. There is little incentive to diversify away from producing raw materials to processing them as the higher prices due to tariffs will make their processed goods uncompetitive. Effectively, it can trap them as suppliers of raw materials. An example of tariff escalation on certain agricultural products in the EU, USA, and Japan is shown in Table 30.1.
2 Price volatility of primary productsThe price elasticity of demand for commodities and the price elasticity of supply for commodities, on the world market, tend to be relatively inelastic. This is shown for the world cotton market in Figure 30.1.
With such inelastic demand and supply, any change in the demand or supply conditions for resources, in this case cotton, will lead to large price fluctuations. In Figure 30.1, a fall or increase in supply, possibly caused by either bad or good weather conditions, would have noticeable increases or decreases in price, from P1 to P3, when supply falls, and from P1to P2 when supply increases.
This will have a marked impact on the export revenue of the countries that are selling the commodities. This price volatility, and subsequent export revenue volatility, makes it very difficult for producers and governments in developing countries to plan ahead. This in turn has an impact on investment in companies, and thus growth, and on government planning for education, health care and infrastructure, and thus development.
3 Inability to access international marketsProtectionism is any economic policy that is aimed at supporting domestic producers at the expense of foreign producers. We have already come across forms of protectionism, such as tariffs, subsidies, quotas, and non-tariff barriers, in Chapter 22. Protectionist measures by developed countries against the exports of developing countries may be very harmful. If the measures prevent developing countries from utilizing their comparative advantages and exporting to developed countries, then developing countries will be limited in their ability to earn foreign exchange.
Protectionism in any market is damaging for developing countries, but it is especially the case in primary product markets. If we take the example of cotton; America’s 25 000 cotton farmers share over $3 billion in government subsidies each year. This encourages farmers to produce more, forcing down the world price, and export their surplus to developing countries that do not have the benefits of subsidies. This is then immensely damaging for the developing country producers. The US does the same with maize, rice, and dairy products. Meanwhile, protected EU farmers overproduce and export sugar, cereals, and dairy produce, lowering world prices and severely damaging markets and local suppliers in developing countries. As these products are sold at lower prices than would be the case without subsidies, it is argued that they are “dumped” in foreign markets. Small scale farmers in developing countries are effectively deprived of the ability to earn a living, provide for their families, and afford schooling for their children, which is clearly a significant barrier to development.
DID yoU know?According to oxfam, “the rich world spends $1 billion a day subsidizing its agricultural industries”
Visit www.maketradefair.com for excellent resources on this important topic.
Figure 30.1 The world market for cotton
Pric
e of
cot
ton
($)
Q1Q2Q3
Quantity of cotton (tonnes million)
P1
P2
S3 S1 S2
P3
D
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Non-convertible currencies are often over-valued at their official, pegged, exchange rate. This will usually mean that a black market for the convertible currency will arise and this may be very damaging for the economy. In some cases, the domestic currency will become almost unacceptable within the country and this damages local trade as well as international trade.
4 Long term changes in the terms of tradeLong term changes in the terms of trade, i.e. changes in the relative prices of exports and imports, can have a marked effect upon the ability of developing countries to trade internationally. If commodity prices are falling over time, and many developing countries are primarily exporters of commodities, then their export revenues, and so their ability to buy imports, will be decreasing. (More information on this topic can be found in Chapter 26.)
Trade strategies for economic growth and economic developmentGrowth strategies are economic policies and measures designed to gain growth, and development strategies are economic policies and measures designed to achieve human development, i.e. to improve the well-being of the people. Remember that economic growth is not economic development, but if it can generate extra income for governments, firms, and people then it may lead to development, depending upon how that extra income is used. We can now look at a number of different strategies.
1 Import substitutionImport substitution is more fully known as import substitution industrialization (ISI). It may also be referred to as an inward-oriented strategy. It is a strategy that says that a developing country should, wherever possible, produce goods domestically, rather than import them. This should mean that the industries producing the goods domestically will be able to grow, as will the economy, and then will be able to be competitive on world markets in the future, as they gain from economies of scale. It is the opposite of export-led growth and is not supported by those economists who believe in the advantages of free trade based on comparative advantage.
In order for the strategy to work there are some necessary conditions:
● The government needs to adopt a policy of organizing the selection of goods to produce domestically. Historically, this has been labour-intensive, low-skill manufactured goods such as clothing or shoes.
● Subsidies are made available to encourage domestic industries.● The government needs to implement a protectionist system with
tariff barriers to keep out foreign imports.
There are a number of perceived advantages and disadvantages with ISI:
Advantages● ISI protects jobs in the domestic market, since foreign firms are
prevented from competing so domestic firms dominate.
Student workpoint 30.2Be an inquirer
Continue your investigation into your chosen developing country by researching possible international trade barriers that may be hindering its growth and development.
Product European Union (%)
United States (%)
Japan (%)
Traditional tropical products
Coffee – Raw 7.3 0.1 6.0
Coffee – Final 12.1 10.1 18.8
Cocoa – Raw 0.5 0.0 0.0
Cocoa – Intermediate 9.7 0.2 7.0
Cocoa – Final 30.6 15.3 21.7
New expanding products
Fruits – Raw 9.2 4.6 5.0
Fruits – Intermediate 13.3 5.5 10.6
Fruits – Final 22.5 10.2 11.6
Vegetables – Raw 9.9 4.4 4.9
Vegetables – Intermediate 18.5 4.4 4.3
Vegetables - Final 18.0 6.5 9.1
Source: World Trade organisation integrated database
Table 30.1 Tariff escalation in selected agricultural product groups (%)
We’ll use cocoa as our example. As we can see in Table 30.1, the tariff for cocoa, if it is raw and therefore unprocessed, is minimal or nothing in the three countries. However, if the cocoa is partially processed before exporting the tariff in the EU rises to 9.7% and in Japan becomes 7.0%. Fully processed cocoa, when exported, has tariffs of 30.6% in the EU, 15.3% in the USA, and 21.7% in Japan.
If tariff escalation is successful in reducing the imports of the more processed goods, then the final processing, along with the packaging and marketing, are done in the developed countries. Since these add the highest value to the product in terms of the price at which it is sold, this is where the largest gains are to be made. Ideally, the developing country producers would like to diversify by investing in the processing stages, but the tariff escalation takes away the potential benefits. Tariff escalation is widely observed in the agricultural markets of meat, sugar, fruit, coffee, cocoa, and tobacco.
A final factor that prevents developing countries from gaining access to international markets is that many of them have non-convertible currencies. These are currencies that can only be used domestically and that are not accepted for exchange on the foreign exchange markets. Most developing countries operate a fixed exchange rate system, where the domestic currency is pegged to a more acceptable currency, often the US dollar, at a certain rate.
Non-convertibility means that trade is less likely to occur. Traders would be taking more of a risk dealing in a non-convertible currency and are likely to go elsewhere to conduct their business. The same is true of foreign investment.
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Non-convertible currencies are often over-valued at their official, pegged, exchange rate. This will usually mean that a black market for the convertible currency will arise and this may be very damaging for the economy. In some cases, the domestic currency will become almost unacceptable within the country and this damages local trade as well as international trade.
4 Long term changes in the terms of tradeLong term changes in the terms of trade, i.e. changes in the relative prices of exports and imports, can have a marked effect upon the ability of developing countries to trade internationally. If commodity prices are falling over time, and many developing countries are primarily exporters of commodities, then their export revenues, and so their ability to buy imports, will be decreasing. (More information on this topic can be found in Chapter 26.)
Trade strategies for economic growth and economic developmentGrowth strategies are economic policies and measures designed to gain growth, and development strategies are economic policies and measures designed to achieve human development, i.e. to improve the well-being of the people. Remember that economic growth is not economic development, but if it can generate extra income for governments, firms, and people then it may lead to development, depending upon how that extra income is used. We can now look at a number of different strategies.
1 Import substitutionImport substitution is more fully known as import substitution industrialization (ISI). It may also be referred to as an inward-oriented strategy. It is a strategy that says that a developing country should, wherever possible, produce goods domestically, rather than import them. This should mean that the industries producing the goods domestically will be able to grow, as will the economy, and then will be able to be competitive on world markets in the future, as they gain from economies of scale. It is the opposite of export-led growth and is not supported by those economists who believe in the advantages of free trade based on comparative advantage.
In order for the strategy to work there are some necessary conditions:
● The government needs to adopt a policy of organizing the selection of goods to produce domestically. Historically, this has been labour-intensive, low-skill manufactured goods such as clothing or shoes.
● Subsidies are made available to encourage domestic industries.● The government needs to implement a protectionist system with
tariff barriers to keep out foreign imports.
There are a number of perceived advantages and disadvantages with ISI:
Advantages● ISI protects jobs in the domestic market, since foreign firms are
prevented from competing so domestic firms dominate.
Student workpoint 30.2Be an inquirer
Continue your investigation into your chosen developing country by researching possible international trade barriers that may be hindering its growth and development.
Product European Union (%)
United States (%)
Japan (%)
Traditional tropical products
Coffee – Raw 7.3 0.1 6.0
Coffee – Final 12.1 10.1 18.8
Cocoa – Raw 0.5 0.0 0.0
Cocoa – Intermediate 9.7 0.2 7.0
Cocoa – Final 30.6 15.3 21.7
New expanding products
Fruits – Raw 9.2 4.6 5.0
Fruits – Intermediate 13.3 5.5 10.6
Fruits – Final 22.5 10.2 11.6
Vegetables – Raw 9.9 4.4 4.9
Vegetables – Intermediate 18.5 4.4 4.3
Vegetables - Final 18.0 6.5 9.1
Source: World Trade organisation integrated database
Table 30.1 Tariff escalation in selected agricultural product groups (%)
We’ll use cocoa as our example. As we can see in Table 30.1, the tariff for cocoa, if it is raw and therefore unprocessed, is minimal or nothing in the three countries. However, if the cocoa is partially processed before exporting the tariff in the EU rises to 9.7% and in Japan becomes 7.0%. Fully processed cocoa, when exported, has tariffs of 30.6% in the EU, 15.3% in the USA, and 21.7% in Japan.
If tariff escalation is successful in reducing the imports of the more processed goods, then the final processing, along with the packaging and marketing, are done in the developed countries. Since these add the highest value to the product in terms of the price at which it is sold, this is where the largest gains are to be made. Ideally, the developing country producers would like to diversify by investing in the processing stages, but the tariff escalation takes away the potential benefits. Tariff escalation is widely observed in the agricultural markets of meat, sugar, fruit, coffee, cocoa, and tobacco.
A final factor that prevents developing countries from gaining access to international markets is that many of them have non-convertible currencies. These are currencies that can only be used domestically and that are not accepted for exchange on the foreign exchange markets. Most developing countries operate a fixed exchange rate system, where the domestic currency is pegged to a more acceptable currency, often the US dollar, at a certain rate.
Non-convertibility means that trade is less likely to occur. Traders would be taking more of a risk dealing in a non-convertible currency and are likely to go elsewhere to conduct their business. The same is true of foreign investment.
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Developing countries may attempt to export either primary products and/or manufactured products (although some have tried to export services, usually in the form of tourism). We should consider the differences involved in using the export of primary or manufactured products as the engine for growth.
● Many developing countries depend upon the export of primary products in order to gain export revenue. However, the overall trend in primary product prices, with the exception of oil and some metals, has been downward for many years. This is due to increasing supply and relatively insignificant increases in demand for a number of different reasons (see Chapter 26). This, combined with increased protectionism by developed countries, means that export-led growth based on export primary products is unlikely to be achieved.
● The focus of export-led growth is usually on increasing manufacturing exports. The success of countries such as Japan, South Korea, Hong Kong, Singapore, and Taiwan, known as the “Asian tigers”, is usually used to illustrate the effectiveness of such a strategy. These countries exported products in which they had a comparative advantage, usually based upon low-cost labour, and were extremely successful in doing so. Over time, the type of product being exported by the majority of these countries has also tended to change from products that were produced using labour-intensive production methods, requiring low skill levels from the workers, to more sophisticated products, using capital-intensive production methods and more highly skilled workers. Improvements in education systems were essential for this.
Although it would appear that export-led growth is an obvious way to gain success, this is not necessarily the case. There are a number of problems associated with export-led growth.
● The success of the “Asian tigers”, since around 1965, has led to increased protectionism in developed countries against manufactured products from developing countries. Trade unions and workers in developed countries argued that they could not compete against the imports from low-wage developing countries and that this was unfair. They lobbied their governments to put tariffs and quotas on the lower-priced goods. Price increases as a result of tariffs effectively removed the comparative advantage of the exporting countries. Tariff escalation also reduced the ability of the developing countries to export processed goods and assembled products, forcing many to export primary products and low-skilled manufactured goods instead.
● Certain assumptions were made about the necessary conditions for export-led growth. If we look at the successful countries, these conditions were not necessarily met. Many economists would argue that the role of the state in successful export-led growth is vital and that minimizing government intervention is not the way forward. In the “Asian tiger” countries, governments played an important role by providing infrastructure, subsidizing output through low credit terms via central banks, and promoting savings and improvements in technology. In addition, governments adopted policies where they protected domestic industries that
● ISI protects the local culture and social habits by practically isolating the economy from foreign influence.
● ISI protects the economy from the power, and possibly bad influence, of multinational corporations.
Disadvantages● ISI may only protect jobs in the short run. In the long run,
economic growth may be lower in the economy and the lack of growth may lead to a lack of job creation.
● ISI means that the country does not enjoy the benefits to be gained from comparative advantage and specialization, so producing products relatively inefficiently, when they could be imported from efficient foreign producers.
● ISI may lead to inefficiency in domestic industries, because competition is not there to encourage research and development.
● ISI may lead to high rates of inflation due to domestic aggregate supply constraints.
● ISI may cause other countries to take retaliatory protectionist measures.
The main countries to adopt ISI strategies were in Latin America, including Argentina, Brazil, Mexico, Chile, and Uruguay. As former colonies gained their independence many also adopted inward-oriented strategies. These included India, Nigeria, and Kenya. These policies showed some success in the 1960s and 1970s, but the policies started to fail in the early 1980s. Government overspending and the debt crisis led to the inability of governments to repay the loans they had taken and in the 1980s many of the countries were forced to go to the IMF for help.
2 Export promotionExport promotion, often called export-led growth, is an outward-oriented growth strategy, based on openness and increased international trade. It is where growth is achieved by concentrating on increasing exports and export revenue as a leading factor in the aggregate demand of the country. Increasing exports should lead to increasing GDP and this in turn should lead to higher incomes and, eventually, growth in domestic and exporting markets. The country concentrates on producing and exporting products in which it has a comparative advantage of production.
In order to achieve export-led growth, it is assumed that a country will need to adopt certain policies. These include:
● Liberalized trade: Open up domestic markets to foreign competition in order to gain access to foreign markets.
● Liberalised capital flows: Reduce restrictions on foreign direct investment
● A floating exchange rate.● Investment in the provision of infrastructure to enable trade to take place.● Deregulation and minimal government intervention.
The list illustrates the theoretical “package” of policies associated with export-led growth. In reality, countries that adopt an outward-oriented strategy do not necessarily adopt all of these policies.
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Developing countries may attempt to export either primary products and/or manufactured products (although some have tried to export services, usually in the form of tourism). We should consider the differences involved in using the export of primary or manufactured products as the engine for growth.
● Many developing countries depend upon the export of primary products in order to gain export revenue. However, the overall trend in primary product prices, with the exception of oil and some metals, has been downward for many years. This is due to increasing supply and relatively insignificant increases in demand for a number of different reasons (see Chapter 26). This, combined with increased protectionism by developed countries, means that export-led growth based on export primary products is unlikely to be achieved.
● The focus of export-led growth is usually on increasing manufacturing exports. The success of countries such as Japan, South Korea, Hong Kong, Singapore, and Taiwan, known as the “Asian tigers”, is usually used to illustrate the effectiveness of such a strategy. These countries exported products in which they had a comparative advantage, usually based upon low-cost labour, and were extremely successful in doing so. Over time, the type of product being exported by the majority of these countries has also tended to change from products that were produced using labour-intensive production methods, requiring low skill levels from the workers, to more sophisticated products, using capital-intensive production methods and more highly skilled workers. Improvements in education systems were essential for this.
Although it would appear that export-led growth is an obvious way to gain success, this is not necessarily the case. There are a number of problems associated with export-led growth.
● The success of the “Asian tigers”, since around 1965, has led to increased protectionism in developed countries against manufactured products from developing countries. Trade unions and workers in developed countries argued that they could not compete against the imports from low-wage developing countries and that this was unfair. They lobbied their governments to put tariffs and quotas on the lower-priced goods. Price increases as a result of tariffs effectively removed the comparative advantage of the exporting countries. Tariff escalation also reduced the ability of the developing countries to export processed goods and assembled products, forcing many to export primary products and low-skilled manufactured goods instead.
● Certain assumptions were made about the necessary conditions for export-led growth. If we look at the successful countries, these conditions were not necessarily met. Many economists would argue that the role of the state in successful export-led growth is vital and that minimizing government intervention is not the way forward. In the “Asian tiger” countries, governments played an important role by providing infrastructure, subsidizing output through low credit terms via central banks, and promoting savings and improvements in technology. In addition, governments adopted policies where they protected domestic industries that
● ISI protects the local culture and social habits by practically isolating the economy from foreign influence.
● ISI protects the economy from the power, and possibly bad influence, of multinational corporations.
Disadvantages● ISI may only protect jobs in the short run. In the long run,
economic growth may be lower in the economy and the lack of growth may lead to a lack of job creation.
● ISI means that the country does not enjoy the benefits to be gained from comparative advantage and specialization, so producing products relatively inefficiently, when they could be imported from efficient foreign producers.
● ISI may lead to inefficiency in domestic industries, because competition is not there to encourage research and development.
● ISI may lead to high rates of inflation due to domestic aggregate supply constraints.
● ISI may cause other countries to take retaliatory protectionist measures.
The main countries to adopt ISI strategies were in Latin America, including Argentina, Brazil, Mexico, Chile, and Uruguay. As former colonies gained their independence many also adopted inward-oriented strategies. These included India, Nigeria, and Kenya. These policies showed some success in the 1960s and 1970s, but the policies started to fail in the early 1980s. Government overspending and the debt crisis led to the inability of governments to repay the loans they had taken and in the 1980s many of the countries were forced to go to the IMF for help.
2 Export promotionExport promotion, often called export-led growth, is an outward-oriented growth strategy, based on openness and increased international trade. It is where growth is achieved by concentrating on increasing exports and export revenue as a leading factor in the aggregate demand of the country. Increasing exports should lead to increasing GDP and this in turn should lead to higher incomes and, eventually, growth in domestic and exporting markets. The country concentrates on producing and exporting products in which it has a comparative advantage of production.
In order to achieve export-led growth, it is assumed that a country will need to adopt certain policies. These include:
● Liberalized trade: Open up domestic markets to foreign competition in order to gain access to foreign markets.
● Liberalised capital flows: Reduce restrictions on foreign direct investment
● A floating exchange rate.● Investment in the provision of infrastructure to enable trade to take place.● Deregulation and minimal government intervention.
The list illustrates the theoretical “package” of policies associated with export-led growth. In reality, countries that adopt an outward-oriented strategy do not necessarily adopt all of these policies.
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ent Economics
increasingly criticized by economists who were not supporters of such policies. The criticisms have formed the basis of what has come to be known as the anti-globalization movement.
They feel that reforms such as the Washington Consensus are just a way to ensure that MNCs have access to cheap labour markets in developing countries. In this way the MNCs can produce inexpensive products, which are then sold for high prices in developed countries. The MNCs make high profits and the workers in developing countries gain little. According to this view the Washington Consensus, and so liberalization of trade, did not lead to high economic growth. Instead, there have been economic crises and increased debt and such policies have lead to increased income inequality and exploitative working conditions, thus working against the goal of economic development.
It is interesting to note that there seems to have been a movement towards the left in a number of Latin American countries, such as Venezuela, Bolivia, and Brazil, and these countries, along with Cuba, have been very vocal in their condemnation of the Washington Consensus. Argentina has, in the last few years, moved back towards an ISI approach to growth and there seems to have been some success.
4 Bilateral and regional preferential trade agreementsAs we know from Chapter 25, preferential trade agreements are related to preferential trading areas. Countries in a trading bloc give preferential access to products from other member countries. This is usually done by reducing, but not necessarily abolishing, tariffs. These agreements may be between two countries, in which case they are bilateral, or they may be between two regional groups, such as the EU and the APC.
The belief is that the more agreements that are made, the greater will be the ability of developing countries to trade and so gain growth and, eventually, development.
5 Diversification One major problem for a number of developing countries has been over-dependence upon exporting a limited range of primary commodities. In many cases countries have been dependent upon export earnings from one, or possibly two, commodities.
A number of developing countries are now pursuing export diversification as a means to gain economic growth. The aim is to move from the production and export of primary commodities and to replace these with the production and export of manufactured and semi-manufactured products. In doing this they hope to protect themselves from the volatile changes in primary product prices, to stabilize or increase export revenue and to stabilize or increase employment. There will also be an increased use of technology and an increased demand for more highly skilled workers.
There are a number of barriers to the strategy of diversification. One is the practice of tariff escalation, which was discussed earlier in the chapter. A second is the need for a more highly qualified workforce in order to produce relatively more sophisticated products.
were not yet able to compete with foreign firms and promoted the industries that were ready for competition in export markets. This illustrates the “infant industry” argument for protection. This topic is one of great debate amongst development economists and many argue that intervention is vital. Others argue that state intervention in these economies actually slowed down growth rates.
● If countries attempt to kick-start their export-led growth by attracting MNCs, there is always the fear that the MNCs may become too powerful within the country and that this may lead to problems. We will look at the role of MNCs and FDI in Chapter 31.
● It is argued by some economists that free-market, export-led growth may increase income inequality in the country. If this is the case, then economic growth may be achieved at the expense of economic development.
3 Trade liberalization Trade liberalization is the removal, or at least reduction, of trade barriers that block the free trade of goods and services between countries. It involves the elimination of such things as tariff barriers, quotas, export subsidies, and administrative legislation.
The belief is that trade liberalization will increase world trade and will enable developing countries to concentrate on the production of goods and services in which they have a comparative advantage. The advantages of free trade are covered in Chapter 21.
The World Trade Organisation (WTO) is an institution that attempts to promote trade liberalization and so to encourage free trade. Its role in world trade is described in Chapter 21.
In 1989 the American economist, John Williamson, identified ten common reforms that were necessary for economic growth in developing countries. One of the key reforms was trade liberalization. The World Bank, the International Monetary Fund, and the US Treasury Department agreed with this list and, as a result, Latin American economies seeking economic help were encouraged to adopt such market-based reforms. The policies were:
● Fiscal discipline, that is, balanced budgets● Redirect spending priorities from things like indiscriminate
subsidies to basic health and education● Lower marginal tax rates and broaden the tax base● Interest rate liberalization● A competitive exchange rate● Trade liberalization● Liberalization of FDI inflows● Privatization● Deregulation● Secure property rights
Because the reforms were common to the World Bank, the IMF, and the US Treasury Department, they became known as the Washington Consensus. You should be able to recognize that these reforms are similar to the market-based supply side policies discussed earlier. By the end of the 20th century, the Washington Consensus was
Theory of KnowledgeAlthough the topic of “Fairtrade” is not specifically on the IB syllabus, we feel that it is a valuable development strategy and an important global movement that deserves your attention. What is “Fairtrade”?
30 ● International trade and economic development
374
4 D
evel
opm
ent E
cono
mic
s
30 ● International trade and economic development
375
4 Developm
ent Economics
increasingly criticized by economists who were not supporters of such policies. The criticisms have formed the basis of what has come to be known as the anti-globalization movement.
They feel that reforms such as the Washington Consensus are just a way to ensure that MNCs have access to cheap labour markets in developing countries. In this way the MNCs can produce inexpensive products, which are then sold for high prices in developed countries. The MNCs make high profits and the workers in developing countries gain little. According to this view the Washington Consensus, and so liberalization of trade, did not lead to high economic growth. Instead, there have been economic crises and increased debt and such policies have lead to increased income inequality and exploitative working conditions, thus working against the goal of economic development.
It is interesting to note that there seems to have been a movement towards the left in a number of Latin American countries, such as Venezuela, Bolivia, and Brazil, and these countries, along with Cuba, have been very vocal in their condemnation of the Washington Consensus. Argentina has, in the last few years, moved back towards an ISI approach to growth and there seems to have been some success.
4 Bilateral and regional preferential trade agreementsAs we know from Chapter 25, preferential trade agreements are related to preferential trading areas. Countries in a trading bloc give preferential access to products from other member countries. This is usually done by reducing, but not necessarily abolishing, tariffs. These agreements may be between two countries, in which case they are bilateral, or they may be between two regional groups, such as the EU and the APC.
The belief is that the more agreements that are made, the greater will be the ability of developing countries to trade and so gain growth and, eventually, development.
5 Diversification One major problem for a number of developing countries has been over-dependence upon exporting a limited range of primary commodities. In many cases countries have been dependent upon export earnings from one, or possibly two, commodities.
A number of developing countries are now pursuing export diversification as a means to gain economic growth. The aim is to move from the production and export of primary commodities and to replace these with the production and export of manufactured and semi-manufactured products. In doing this they hope to protect themselves from the volatile changes in primary product prices, to stabilize or increase export revenue and to stabilize or increase employment. There will also be an increased use of technology and an increased demand for more highly skilled workers.
There are a number of barriers to the strategy of diversification. One is the practice of tariff escalation, which was discussed earlier in the chapter. A second is the need for a more highly qualified workforce in order to produce relatively more sophisticated products.
were not yet able to compete with foreign firms and promoted the industries that were ready for competition in export markets. This illustrates the “infant industry” argument for protection. This topic is one of great debate amongst development economists and many argue that intervention is vital. Others argue that state intervention in these economies actually slowed down growth rates.
● If countries attempt to kick-start their export-led growth by attracting MNCs, there is always the fear that the MNCs may become too powerful within the country and that this may lead to problems. We will look at the role of MNCs and FDI in Chapter 31.
● It is argued by some economists that free-market, export-led growth may increase income inequality in the country. If this is the case, then economic growth may be achieved at the expense of economic development.
3 Trade liberalization Trade liberalization is the removal, or at least reduction, of trade barriers that block the free trade of goods and services between countries. It involves the elimination of such things as tariff barriers, quotas, export subsidies, and administrative legislation.
The belief is that trade liberalization will increase world trade and will enable developing countries to concentrate on the production of goods and services in which they have a comparative advantage. The advantages of free trade are covered in Chapter 21.
The World Trade Organisation (WTO) is an institution that attempts to promote trade liberalization and so to encourage free trade. Its role in world trade is described in Chapter 21.
In 1989 the American economist, John Williamson, identified ten common reforms that were necessary for economic growth in developing countries. One of the key reforms was trade liberalization. The World Bank, the International Monetary Fund, and the US Treasury Department agreed with this list and, as a result, Latin American economies seeking economic help were encouraged to adopt such market-based reforms. The policies were:
● Fiscal discipline, that is, balanced budgets● Redirect spending priorities from things like indiscriminate
subsidies to basic health and education● Lower marginal tax rates and broaden the tax base● Interest rate liberalization● A competitive exchange rate● Trade liberalization● Liberalization of FDI inflows● Privatization● Deregulation● Secure property rights
Because the reforms were common to the World Bank, the IMF, and the US Treasury Department, they became known as the Washington Consensus. You should be able to recognize that these reforms are similar to the market-based supply side policies discussed earlier. By the end of the 20th century, the Washington Consensus was
Theory of KnowledgeAlthough the topic of “Fairtrade” is not specifically on the IB syllabus, we feel that it is a valuable development strategy and an important global movement that deserves your attention. What is “Fairtrade”?
30 ● International trade and economic development
376
4 D
evel
opm
ent E
cono
mic
s
30 ● International trade and economic development
377
4 Developm
ent Economics
● The producer must use sustainable farming methods to produce the good.
● The trader also pays a Fairtrade premium to the producer. The producers use these funds to aid local community development. The producers decide how the money will be spent, but it is usually used to promote health care, education, or other social schemes. The producers are accountable to the FLO for the appropriate use of the funds.
Fairtrade certified food products include bananas, cocoa, coffee, dried fruit, fresh fruit and vegetables, honey, juices, nuts/oil seeds and purees, quinoa, rice, spices, sugar, tea, and wine. Non-food products include cotton, cut flowers, ornamental plants, and sports balls.
Although the price might sometimes be slightly higher for Fairtrade certified products than non-Fairtrade products, it is clear that many consumers are willing to pay to contribute to better conditions for producers. Global sales of Fairtrade products were valued at just over ?1.1 billion for 2005, an increase of 37% on 2004.2 Fairtrade products are making their way into more and more shops and restaurants as firms become aware of the increasing popularity. Fairtrade, with its emphasis on granting a living income, giving security, demanding proper working conditions, encouraging sustainable production, and funding local community development, is clearly a strategy that leads to development as well as growth.
“The guarantee of the minimum price brings stability. We,
producers, are not totally subjected to the law of supply and demand.
We know that we will be paid at least US$69 the quintal. This
guarantee makes it possible to plan long-term, to invest, to develop
technical support, in one word, to develop our business,’ says Felipe Cancari Capcha, a producer from El Ceibo Cooperative, a Fairtrade
cocoa producer in Bolivia.”
www.fairtrade.net.
2 FLo News Bulletin, July 2006
Student workpoint 30.3Be caring
Fairtrade organizations
Find out if there are Fairtrade products available in your country. If so, make a list of the products and where they can be purchased. Then be sure to try some—the chocolate is excellent!
END OF chaPTEr rEvIEw qUESTIONS1 Explain how each of the following may prevent developing countries from
achieving economic growth:
a over-specialization on a narrow range of products
b Volatile commodity prices
c Trade protection in more developed countries
2 Compare and contrast an import substitution policy with an export promotion strategy.
3 Explain how diversification may help a developing country to achieve economic growth.
Development strategies
Fairtrade organizationsIn many developing countries many small-scale farmers and workers are unable to make a living income. Low world prices for primary products, high profits for middlemen, tariff escalation, and poor working conditions make life extremely difficult.
Fair trade schemes are an attempt to ensure that producers of food, and some non-food, products in developing countries receive a fair deal when they are selling their products. If consumers are aware of the harsh and often unfair conditions facing the farmers, then perhaps they may be willing to buy from producers who pay a fair price to the farmers.
Today, Fairtrade Labelling Organization International (FLO) coordinates Fairtrade labelling in 20 countries, including the Fairtrade foundation in the UK. The schemes aim to help small farmers and landless workers. Fair trade schemes have operated for over 50 years, but the real growth of the movement has come with the advent of Fairtrade labelling. This began in the Netherlands in 1988 when the Max Havelaar Foundation began to sell coffee from Mexico with the first Fairtrade consumer guarantee label.
This is a system where products can be certified if they meet the standards of the FLO, which gives them the right to display the International Fairtrade Certification Mark. This recognizable mark means that consumers will be able to identify Fairtrade products, know that they are approved, and buy them knowing that the producer of the good was paid a fair price. FLO regularly inspects and certifies around 500 producer organizations in more than 50 countries in Africa, Asia, and Latin America, which results in fair trading conditions for approximately one million farmers, workers, and their families.1
A trading company wishing to qualify for the International Fairtrade Certification Mark must meet certain FLO criteria.
● The product must reach the trader as directly as possible with few, if any, intermediaries.
● The product must be purchased at least at the Fairtrade minimum price. This is a guaranteed price that covers production costs and provides a living income. It covers the cost of “sustainable production”.
● The producer receives a premium if the product is certified as organic.● The trader must be committed to a long-term contract, which in
turn gives security to the producer.● The producer has access to credit from the trader, upon request, of
up to 60% of the purchase price.● Where small farmers are involved the product must come from
producers that are managed democratically. If the product comes from plantations then the workers must benefit from internationally recognized employment standards including trade unions, if they wish, and there must be no use of child labour.
1 www.fairtrade.net
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● The producer must use sustainable farming methods to produce the good.
● The trader also pays a Fairtrade premium to the producer. The producers use these funds to aid local community development. The producers decide how the money will be spent, but it is usually used to promote health care, education, or other social schemes. The producers are accountable to the FLO for the appropriate use of the funds.
Fairtrade certified food products include bananas, cocoa, coffee, dried fruit, fresh fruit and vegetables, honey, juices, nuts/oil seeds and purees, quinoa, rice, spices, sugar, tea, and wine. Non-food products include cotton, cut flowers, ornamental plants, and sports balls.
Although the price might sometimes be slightly higher for Fairtrade certified products than non-Fairtrade products, it is clear that many consumers are willing to pay to contribute to better conditions for producers. Global sales of Fairtrade products were valued at just over ?1.1 billion for 2005, an increase of 37% on 2004.2 Fairtrade products are making their way into more and more shops and restaurants as firms become aware of the increasing popularity. Fairtrade, with its emphasis on granting a living income, giving security, demanding proper working conditions, encouraging sustainable production, and funding local community development, is clearly a strategy that leads to development as well as growth.
“The guarantee of the minimum price brings stability. We,
producers, are not totally subjected to the law of supply and demand.
We know that we will be paid at least US$69 the quintal. This
guarantee makes it possible to plan long-term, to invest, to develop
technical support, in one word, to develop our business,’ says Felipe Cancari Capcha, a producer from El Ceibo Cooperative, a Fairtrade
cocoa producer in Bolivia.”
www.fairtrade.net.
2 FLo News Bulletin, July 2006
Student workpoint 30.3Be caring
Fairtrade organizations
Find out if there are Fairtrade products available in your country. If so, make a list of the products and where they can be purchased. Then be sure to try some—the chocolate is excellent!
END OF chaPTEr rEvIEw qUESTIONS1 Explain how each of the following may prevent developing countries from
achieving economic growth:
a over-specialization on a narrow range of products
b Volatile commodity prices
c Trade protection in more developed countries
2 Compare and contrast an import substitution policy with an export promotion strategy.
3 Explain how diversification may help a developing country to achieve economic growth.
Development strategies
Fairtrade organizationsIn many developing countries many small-scale farmers and workers are unable to make a living income. Low world prices for primary products, high profits for middlemen, tariff escalation, and poor working conditions make life extremely difficult.
Fair trade schemes are an attempt to ensure that producers of food, and some non-food, products in developing countries receive a fair deal when they are selling their products. If consumers are aware of the harsh and often unfair conditions facing the farmers, then perhaps they may be willing to buy from producers who pay a fair price to the farmers.
Today, Fairtrade Labelling Organization International (FLO) coordinates Fairtrade labelling in 20 countries, including the Fairtrade foundation in the UK. The schemes aim to help small farmers and landless workers. Fair trade schemes have operated for over 50 years, but the real growth of the movement has come with the advent of Fairtrade labelling. This began in the Netherlands in 1988 when the Max Havelaar Foundation began to sell coffee from Mexico with the first Fairtrade consumer guarantee label.
This is a system where products can be certified if they meet the standards of the FLO, which gives them the right to display the International Fairtrade Certification Mark. This recognizable mark means that consumers will be able to identify Fairtrade products, know that they are approved, and buy them knowing that the producer of the good was paid a fair price. FLO regularly inspects and certifies around 500 producer organizations in more than 50 countries in Africa, Asia, and Latin America, which results in fair trading conditions for approximately one million farmers, workers, and their families.1
A trading company wishing to qualify for the International Fairtrade Certification Mark must meet certain FLO criteria.
● The product must reach the trader as directly as possible with few, if any, intermediaries.
● The product must be purchased at least at the Fairtrade minimum price. This is a guaranteed price that covers production costs and provides a living income. It covers the cost of “sustainable production”.
● The producer receives a premium if the product is certified as organic.● The trader must be committed to a long-term contract, which in
turn gives security to the producer.● The producer has access to credit from the trader, upon request, of
up to 60% of the purchase price.● Where small farmers are involved the product must come from
producers that are managed democratically. If the product comes from plantations then the workers must benefit from internationally recognized employment standards including trade unions, if they wish, and there must be no use of child labour.
1 www.fairtrade.net
