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International Trade andDevelopmentHendrik S. Houthakker aa Council of Economic AdvisersPublished online: 28 Jul 2006.

To cite this article: Hendrik S. Houthakker (1970) International Tradeand Development, Review of Social Economy, 28:2, 155-163, DOI:10.1080/00346767000000027

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INTERNATIONAL TRADE AND DEVELOPMENT*

Council of Economic Advisers

The United States is less dependent on international trade than most other major countries. The reason for this fact is simply that the United States is a very large country, both in population and in area, and conse- quently has a large variety of human and nonhuman resources. Even so, our resources are limited, and we can make better use of them by en- gaging in international exchange. Although our imports and exports each account for about 4 percent of our Gross National Product, they account for about 15 percent of total world trade. Consequently, our foreign trade is one of the principal channels through which we influence the rest of the world. To this extent it can be said that our international trade has considerable political significance. But it also has great economic signifi- cance for ourselves, since imports provide us with goods that it would be more expensive to produce here, while exports provide a market for many of our industries. Moreover there is a close connection between our merchandise trade and our international investments, a subject which will not be treated here.

There is no need to elaborate on the elementary proposition that trade in the vast majority of cases benefits both partners in the transaction, the buyer and the seller. There would be no reason even to mention this proposition were it not for the fact that the ancient fallacy of mercantilism, which holds that exports are good and imports are bad, continues to have a distressing amount of influence. Of course, it would be almost as wrong to assert the opposite, namely that exports are bad and imports are good. Exports are normally necessary to finance imports, and moreover exports create employment and may stimulate growth. The first of these con- siderations, which is the balance of payments argument, is by itself enough to give exports a place of importance among the proximate goals of economic policy. The employment-growth argument is of less general significance, since at least in advanced countries appropriate fiscal and monetary policies can see to it that there is an adequate domestic demand for labor, and an adequate rate of growth. Consequently, there is no need to export merely to provide employment or to grow. Conversely, the fear of imports because they might create unemployment can easily be exag- gerated, though it is true that large increases in imports may cause transitional problems with which global economic policies cannot deal

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sufficiently promptly. These problems can be eased by adjustment assis- tance; in his recent trade bill President Nixon proposed a liberalization of the conditions in which such assistance can be given, thus increasing the ability of American firms and workers to adjust to greater imports. Another legitimate concern about imports is that in some cases a country may not wish to become too heavily reliant on foreign supply in a partic- ular industry because this might threaten its national security. However, the security argument needs to be supported by careful analysis to be convincing, since otherwise a country may pay too high a price for free- dom from supply interruptions that may themselves be unlikely to occur.

Apart from these qualifications it is now widely recognized that a large measure of freedom in the international exchange of commodities, services and capital can make a powerful contribution to the economic welfare of all countries. The gradual, and as yet partial, implementation of this conviction has been one of the chief achievements of international economic policy in the period following World War 11. Most of the progress in this area has taken the form of a reduction in tariffs on indus- trial products. Much less has so far been done in the area of nontariff barriers, and in agriculture, where tariffs are not the main obstacle, but where other serious obstacles to a rational international division of labor exists.

Although the remaining tariffs are by no means insignificant, there now appears to be wide agreement that the most urgent immediate prob- lem in the field of international trade is the reduction of nontariff barriers. This is a very difficult subject, because nontariff barriers take many dif- ferent forms, which are not easily put onto a common denominator. Efforts to reduce tariffs were greatly facilitated by the fact that tariffs are expressed in percentages or absolute money figures. Also in the course of the negotiations under the General Agreement on Tariffs and Trade (GATT) certain conventions were adopted for assessing the significance in money terms of any tariff. As a result it was not too diffi- cult to compare the value of the tariff concessions which countries ex- changed during the Kennedy Round and before.

All this is much more complicated in the case of nontariff barriers. These may take the form of quantitative restrictions (quotas), of limita- tions on procurement by government agencies, of domestic tax regulations that discriminate indirectly against imports, of anticompetitive arrange- ments in the private sector, and still others. Merely to catalog such non- tariff barriers is a monumental undertaking, and even after this is done the quantitative assessment of their significance is mother extensive and

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INTERNATIONAL TRADE AND DEVELOPMENT 157

controversial task. Considerable work is going on in these various areas in GATT and in other international organizations. As was true in the previous tariff negotiations, a reduction of non-tariff barriers which are not illegal under GATT can no doubt be obtained only on a reciprocal basis, in which a country promises to reduce a non-tariff barrier of its own, if another country reduces a non-tariff barrier directed against the first country's exports. From the point of view of economic analysis this reciprocal procedure is open to question, since obstacles to trade may be at least as harmful to the potential importer as to the potential exporter. As far as a country's welfare is concerned, the reduction of a tariff or non-tariff barrier can hardly be said to constitute a sacrifice, (except possibly because of terms-of-trade effects) but international trade nego- tiations have been firmly established on the principle that an increase in imports represents a burden on the importing country for which it must get compensation in the form of increased possibilities for exports. This negotiating principle makes more sense in balance-of-payments terms, since it tends to keep increases in imports and exports in line with each other. Whatever its precise analytical merits, in the case of tariffs the principle has worked fairly well, so we should perhaps not worry about its lack of economic sophistication. Unfortunately one cannot always depend on the other country to recognize the economic advantages of the removal of import barriers on a unilateral basis. Accordingly to establish a more satisfactory equilibrium negotiations are necessary.

Because it is so difficult to calculate the monetary significance of non- tariff barriers, many countries appear to be convinced that other coun- tries' non-tariff barriers are more important than their own. I t must be hoped that the international exercises now in progress will provide some clarification on this point. There can be little doubt that our own exports, for instance, are being held back by non-tariff barriers in a number of important countries. The common agricultural policy of the European Communities is probably the most important example. The quantitative restrictions maintained by Japan, in the face of a very large trade surplus and a rapid growth in exports, are also conspicuous. I t is equally true that in many countries our producers of electrical equipment and similar items have great difficulty in selling to government agencies ; in fact, the regula- tions under our own Buy American Act, which give a small percentage preference to domestic nondefense production, are considerably more liberal than the practice of most other countries. These and others are serious impediments to our exports; nevertheless, it should not be over- looked that our record in other areas is open to considerable improvement.

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One device that has been the target of foreign criticism is the so-called American Selling Price, a special method of valuation which increases the effective protection of certain chemicals. The abolition of ASP, in return for some relaxation of European trade barriers, is among the proposals in the President's trade bill that is now before Congress. But apart from ASP there are quantitative restrictions on our imports of a number of important products, including oil, steel, textiles, beef and dairy products. In some cases these restrictions are "voluntary," but that does not make them any less harmful to the domestic price level or to the state of compe- tition in the domestic market. Obviously these restrictions on imports could not be relaxed without presenting more or less serious adjustment problems to the domestic industries concerned. At the same time it has to be realized that the national interest of the American people goes beyond the vested interest of U.S. producers, and that the national interest in- cludes consumers as well.

There is one factor in our quantitative restrictions that deserves special consideration. This is the lack of competitive strength that has become apparent in the industries mentioned and some others. Of course if these industries were fully competitive they would not need protection of any kind, be it in the form of tariffs or of quotas. Nevertheless, it should be pointed out that the benefits of free trade can be fully realized only if certain conditions are fulfilled. One of these is that a country's exports have reasonably free access to foreign markets ; this is why the removal of nontariff barriers is so important. Another condition, which is less frequently mentioned, is that exchange rates are realistic, in the sense that they reflect the true relative cost of producing imports and exports. When in a country a number of important industries have apparently become uncompetitive, while at the same time that country's balance of payments is in deficit, there is obviously reason to question the realism of the prevailing pattern of exchange rates. It is therefore important to investigate the possibility of improvements in the mechanism by which exchange rates are set, and that is currently being done in the International Monetary Fund.

I have already mentioned the Common Agricultural Policy of the European Economic Community as a serious obstacle to our exports. This policy involves the maintenance of very high domestic price support levels for basic crops and dairy products. For those commodities of which the Community is an importer, the difference betwen the European domestic price and the world price is made up by a so-called variable levy. The proceeds of this levy are used in turn to subsidjze the exports of

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INTERNATIONAL TRADE AND DEVELOPMENT 159

certain commodities of which the Community is a large surplus producer because of the high internal price level. The effect of this scheme is not only that our exports to Europe are curtailed because of high production there, but that our exports to other parts of the world are competing with European surpluses. So far our attempts to persuade the European Com- munity to modify its farm policy have proved unavailing. Although many Europeans themselves realize the economic folly of high farm price sup- ports and resulting surpluses, all proposals to reduce farm prices have so far been voted down. In the Community, which appears to follow our own farm policy with a time lag of some 20 years, it is apparently not generally understood that high farm prices do not necessarily benefit all farmers, since they are also considerable buyers of farm products, for instance for feeding. A rational farm policy should have as its target farm income, not farm prices.

Although the United States has always favored European unification because of its political benefits, there are other economic issues between us and the Europeans. Apart from the agricultural problem a particularly troublesome issue which is of current interest is presented by the asso- ciation agreements that link the EEC to certain nonmember countries. These agreements generally favor EEC exports at the expense of exports from other origins, including our own and thus tend to disrupt the multi- lateral system of trade based on the most-favored-nation principle. Our efforts to safeguard the free access of our exports to European markets are made both more urgent and more difficult by the fact that the Euro- pean Economic Community is still in process of formation. This makes it more urgent because any steps taken now may well become even harder to change later on. I t makes it more difficult because the EEC is not yet fully organized to negotiate with other countries as a unit; the division of responsibility between the European Commission and member coun- tries has not yet been completely clarified. The importance of preserving access to the European market will of course be even greater after the accession of the United Kingdom, Ireland, Denmark and Norway.

Let me now turn to the problem of development. The United States has long been interested in promoting the development of the poorer nations of the world, and indeed for many years carried the burden of foreign aid almost singlehandedly. Despite these efforts, in which other countries and international organizations have joined, the gap between the developed and the less-developed countries has increased over the years, contrary to the original hope. Between 1955 and 1968 the real per capita gross national product of developed countries rose by 3.2 percent

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per year, while that of the LDC's rose by 2.5 percent per year. These figures are averages and hide a great variety of individual countries' experiences. Some LDC's such as South Korea and Nationalist China have had exceptionally high growth rates, and it should not be forgotten that Japan was on the LDC income level as little as two decades ago. But despite these encouraging examples the average gap has grown, and it is appropriate that there is now a great deal of soul searching as to the reasons. I cannot presume to give you a full analysis of this unfortunate phenomenon ; a few remarks must suffice.

In the first place it should be pointed out that the process of economic development is still very imperfectly understood. I t used to be believed that economic development is primarily a questicn of capital accumula- tion. On the basis of this belief there was a tendency to equip LDC's with hydroelectric dams and blast furnaces and other visible signs of indus- trialization. After a while it became clear that such spectacular projects tend to become white elephants unless they are backed up by less spectac- ular projects elsewhere. While capital is indeed essential to the process of economic development, it is by no means suficient. Contrary to the assertions of amateur economists who maintain that in modern produc- tion 90 percent of output is due to capital and only 10 percent to labor, the fact is that according to all professional analyses labor is and remains the most important factor of production.

Perhaps I may throw out as a conjecture, for which I do not yet have adequate proof, that economic development is primarily an improvement in the efficiency with which human resources are used. Individuals differ greatly in the ability with which they can perform various jobs. To obtain the greatest possible output individuals would have to be matched to their jobs according to the principle of comparative zdvantage. This matching process is subject to considerable imperfectior, both in developed and less developed societies, but especially in the latter. One reason for this is the predominance of subsistence agriculture in the LDC's. As long as a large proportion of the labor force is engaged in growing a small number of basic foodstuffs, there is little scope for t'fle adaptation of people's occupations to their abilities. Various social barriers, which are especially strong in traditional societies (the Indian caste system is an example), also prevent the matching process from working adequately. In advanced societies the matching process is aided by greater social and geographical mobility.

In genera1 the more efficient use of human resources requires capital investment. Unless the domestic savings rate is high enough inadequate

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capital investment may therefore be a bottleneck, which may be relieved at least in part, by foreign aid. Unless the efficiency of labor can be in- creased, however, the productivity of additional investment is likely to be low. I t would follow from this analysis that the role of foreign aid in stimulating the development process is supplementary rather than pri- mary. Unless a country is making rapid progress in increasing the effi- ciency of its labor, its ability to benefit from additional investment may be severely restricted. To the extent that foreign official aid is a transfer from the rich to the poor there may well be a gain in world welfare, but such charity while laudable, has little to do with stimulating economic development. Private foreign investment is more likely to be helpful because it is more closely geared to saleable output and tends to avoid the spectacular.

Until the process of economic development is better understood the role of official foreign aid is likely to be limited. The American people are second to none in their willingness to help the less favored of the world, but we also like to see results. Since the results of foreign aid have so far been disappointingly slow to materialize, it is not surprising that public support for foreign aid has declined, and Congressional appro- priations with it. We may deplore this decline as a sign of a lack of con- cern, but this is not the whole story. Until we know how to use foreign aid more effectively to stimulate economic development, there is little to be gained in formulating foreign aid targets in terms of some arbitrary percentage of the donor countries' GNP.

The absence of a generally accepted theory of economic development has at various times led to the widespread adoption of more simple- minded ideas, such as the notion mentioned earlier that capital accumula- tion is the sole cause of economic development. This notion has not stood the test of experience, but this has not discouraged the prescription of other panaceas. One that is currently popular is population control. I t may well be true that some underdeveloped countries are overpopulated, but there is no evidence that this is true in general. Among developed countries, too, there are great differences in population density. As far as I am aware it has not been demonstrated that there exists any close causal relation between the growth of per capita GNP and the growth of population and there is no obvious reason why there should be. Since labor is the most important factor of production, an increase in population increases the supply of output as well as the demand for it. The use of facile biological analogies obscures the fact that man is a producer as well as a consumer. There is also some evidence that population growth leads

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to economies of scale in production, which may account for the fact that, at least in advanced countries, population growth and growth in per capita output usually go together. This may not be true in agrarian societies where land is a limiting factor, but this is only a temporary phase in economic development.

All this is not to say that population should be left unchecked. I t does suggest, however, that depending on the circumstances population control may or may not be an effective ingredient of a development policy. Pro- vided it is acceptable to local custom, there is nothing wrong with supply- ing individuals with the means to limit their families to the number they desire. Unless there are specific indications that p~pulation growth will interfere with the attainment of a desired standard of living governments might do well to be cautious in interfering with what is essentially a private matter.

In this connection it should perhaps also be said that there is little reason to expect overpopulation for the world as a whole in the foresee- able future. Most serious studies of the subject suggest that the food supply can be expanded to accommodate a much larger population than now exists on earth. Certain minerals may become scarce and thus rise in price, but substitution should prevent this from becoming a critical problem. What is of course more serious is that overpopulation may lead to a degradation of the social and physical environment, but this appears to be more a matter of the proper distribution of the population than of total numbers. Much can be done to improve the environment without attempting to influence population trends.

Finally, I want to link the two main subjects of this paper, trade and development. I t is obvious that as countries become more productive they also become capable of competing on the world market, not only with the primary products that have so far been the staple output of the LDC's, but also with manufactures. Unless they are able to sell these manufac- tures in the world market, their development will evidently be held back. The LDC's themselves in most cases do not offer a sufficiently large market. There is no good reason why the developed countries should prevent competition from the LDC's, because the developed countries, by importing these products, can improve their own standard of living, and shift their labor force to more productive and better paid occupations. The fact remains, however, that various trade barriers make it difficult for the LDC's to sell their manufactured products. As I have noted earlier, mercantilism is by no means dead. I t is clearly in the general interest that the exports of LDC's be given access to the rich markets

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of the developed countries, and the demands of the LDC's to this effect have not gone unheeded. As a result much thought is now being given to the introduction of trade preferences, which would make the exports of LDC's subject to lower tariff rates than similar products from devel- oped countries. A number of schemes to this effect have been put forward by the United States, by the European Economic Community, and by other countries. These proposals differ in a number of respects, but there are grounds for hoping that the differences will not prove to be insuper- able, and that the developed countries may be able to agree on the adoption of a general preference scheme in the not too distant future. I t would perhaps be still better if, instead of giving preferences to LDC's, tariffs were reduced on a most-favored-nation basis, that is to say for all coun- tries. But since this appears to be impractical for the time being, trade preferences are probably the best available solution. An increase in im- ports of manufactures from the LDC's may occasionally give rise to some dislocation, but adjustment assistance is designed to take care of that. The importance of integrating the less developed countries into the world economy is so great that an occasional dislocation may have to be taken in stride. It may be politically necessary to exclude certain categories of products from a preference scheme, but clearly these exceptions should be kept to a minimum. Even so it appears that the additional LDC exports made possible by preferences would not reach large volumes within the next several years.

Trade preferences are not intended as a substitute for foreign aid where it promises to be effective, but together with increased private investment these two measures should be of considerable help in bridging the gap between the developed and the underdeveloped world, and thus serve the best interests of both.

* The paper is based upon remarks presented March 25, 1970 at American IJniversity at a seminar on National Economic Policy.

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