Trade Policies In Developing Countries

By Marika Gabelaia2012

CONTENTIntroduction Free Trade: Pros & Cons Infant Industry Argument Immiserizing growth Trade Policies ERP & DRC Distortions

Inequality promotes growth?!Trade is action of buying and selling goods & services. Trade s fundamental objective are:Poverty reduction Growth Social and political development Equity

Unequal DistributionOver five-sixths of Distribution of World Population the worlds population lives in High third world Income countries. The world Middle and Low generally pays them Income far too little heed.

The contributions of trade to developmentTrade can lead to the full utilization of otherwise underemployed domestic resources; Trade makes possible division of labor and economies of scale (such as Taiwan, HK, Singapore); International trade is the vehicle for the transmission of new ideas, technology, managerial and other skills; Trade also stimulates and facilitates the international flow of capital from developed to developing countries; The importation of new manufactured products has stimulated domestic demand until efficient domestic production of these goods become feasible (Brazil. India); International trade is an excellent anti-monopoly weapon because it stimulates greater efficiency by domestic producers to meet foreign competition.

Classification of NationsAdvanced nationsthe countries of North America and Western Europe, plus Australia, New Zealand & Japan

Developing Countries/ LDCs (less developed countries)- most of those in Africa, Asia, Latin America& the Middle East. (South Korea, Taiwan, Singapore and China are industrial countries at present. The argument that China should be treated as a developing country is becoming increasingly tenuous.

Emerging Markets-

Brazil, Russia, India and China accounts for 13% of world trade. Its growth rate is 9%, compared to 2.6% in advanced nations.

Why developing countries are poor?Lack of Infrastructure Lack of skills Culture Inefficient Trade with West Lack of Incentives

Trade Characteristics of developing countriesDependence on Developed countries Primary Products Labor Incentive products

Free trade: prosThe theory of comparative advantage. Reducing Tariff barriers leads to trade creation Increased Exports. Economies of Scale: Increased Competition. Trade is an engine of growth. Tariffs may encourage inefficiency

The removal of tariffs leads to lower prices for consumers and an increase in consumer surplus of areas 1 + 2 + 3 + 4 Imports will increase from Q3-Q2 to Q4Q1 The government will lose tax revenue of area 3 Domestic firms producing this good will sell less and lose producer surplus equal to area 1 However overall there will be an increase in economic welfare of 2+4 (1+2+3+4 - (1+3) The magnitude of this increase depends upon the elasticity of supply and demand. If demand elastic consumers will have a big increase in welfare

Arguments against Free TradeInfant Industry Argument. To diversify the economy Raise revenue for the govt. Cultural Identity Protection against dumping Environmental However supporters of free trade would argue that it is up to individual countries to create environmental legislation

Infant industryAn infant industry is a new industry that is in the process of developing. Infant industries are very vulnerable to competition and weakness in the market because they are not well established. And some economist believe that infant industries should be protected as they develop, under the infant industry argument. In nations with protectionist trade policies, infant industries may be protected with quotas, tariffs, and other limits on goods from foreign competitors Protection allows an infant industry to flourish and develop so that it can catch up with competitors.

Infant industry ArgumentIf developing countries have industries that are relatively new, then at the moment these industrys would struggle against international competition. However if they invested in the industry then in the future they may be able to gain Comparative Advantage. This shows that comparative advantage can change over time Therefore protection would allow them to progress and gain experience to enable them to be able to compete in the future.

Primary products in developing countriesThe primary sector of the economy is the sector od an economy making direct use of natural resources. This includes agriculture, forestry and fishing, mining, and extraction of oil and gas. Primary industry is a larger sector in developing countries.

Immiserizing GrowthPrimary products

mftg

A country begins exporting primary products for manufacturing goods, and Has the good fortune of growth, so the PPC shifts out.

Immiserizing GrowthPrimary products T

T

mftg

But with this growth in primary goods (here and elsewhere), world supplies increase and prices fall relative to mftg. So the terms of trade, T, shift to T. Now, notice how much primary product export is necessary to secure the same import of manufacturing goods at the new prices!

Immiserizing GrowthPrimary products

mftg

With the lower prices now earned for primary goods, the country will be exporting more and enjoying it less. In an extreme case like this, we can see the overall loss of satisfaction in the lower community indifference curve attained after (immiserizing) growth has occurred.

Trade PoliciesCountries, according to the structure of their international trade,mainly apply two different industrialization strategies: import substitution (IS) and export promotion (EP) Imoprt-substitution- A strategy for economic development which encourages industrial growth within a nation in order to reduce imports of manufactures, save foreign exchange, provide jobs, and reduce dependency export promotion activities is to encourage increased sales of products that are currently available for export. All promotional efforts are based on existing production and aim at the value of foreign sales by a given target.

Import-Substituting IndustrializationAnticipated benefits include greater technological progress, increased workers skills, national pride and self-sufficiency. Terms-of-trade effects are possible for large countries: through greater independence, import less, and get those products for less. It is hard to know what exports to develop for tradebased economic development, but its easy to know what to produce in ISI. You just check your old import lists.

But, does this system work?

Import-Substituting IndustrializationBut, does this system work? Apparently not! The faster growing countries have already mostly abandoned this approach. Studies have shown the countries with the greater net losses were those with the higher trade barriers. The high protection leads to waste and inefficiency with firms not needing to perform competitively. Most countries dont have the size or the resources to develop across a broad spectrum of industries. According to Pugel and Lindert, countries that paid high costs for their ISI experiment include Argentina, Chile, Colombia, Egypt, Ghana, India, Israel, Mexico, Pakistan, the Philippines, South Korea, Taiwan, and Turkey.

Export Oriented Industrialization

Instead of import substituting industrialization, several countries in East Asia adopted trade policies that promoted exports in targeted industries. Japan, Hong Kong, Taiwan, South Korea, Singapore, Malaysia, Thailand, Indonesia, and China are countries that have experienced rapid growth in various export sectors and rapid economic growth in general.These economies or a subset of them are sometimes called high performance Asian economies.

Export Oriented IndustrializationThe high performance Asian economies have generated a high volume of exports and imports relative to total production.But it is debatable to what degree these economies established free trade. Although evidence suggests that these economies did have less restricted trade than other low and middle income countries, some trade restrictions were sometimes still in effect.

Export Oriented IndustrializationIt is also unclear if the high volume of exports and imports caused rapid economic growth or was merely correlated with rapid economic growth.Some economists argue that the cause of rapid economic growth was high saving and investment rates, leading to both rapid economic growth in general and rapid economic growth in export sectors. In addition, almost all of the high performance Asian economies have experienced rapid growth in education, leading to high literacy and numeracy rates important for a productive labor force.

Effective Rate of ProtectionThe Effective Rate of Protection measures the percentage effect of the entire tariff structure on the value added per unit of output in each industry.

Effective Rate of ProtectionTariff StructureTariff structure refers to the relationship among tariffs in related industries.

Value AddedValue added is the difference between the selling price and the cost of intermediate goods. V = PA - PSa

Effective Rate of ProtectionERP = ( V- V ) / VERP = Effective Rate of Protection V = Value Added with tariff V = Value added with free trade

Effective Rate of ProtectionERP = (tf ati) / (1 a)Where tf is the nominal tariff on the imported finished good, a is the value of imported inputs as a share of the value of the final good under free trade, and ti is the tariff on imported inputs used by the domestic producers.

DRCDomestic Resource Cost (DRC) Indicator of efficiency with which a country's domestic resources (labor, capital, land) are converted into output measured as value added at world market prices, where value added is the value of output minus the cost of all tradable inputs DRC = (Labor + Capital + Land)/Value Added in Pw DRC is a cost/benefit ratio, with costs in numerator and net benefits in denominator If DRC1, domestic resources used greater than value added created = comparative disadvantage

DRCDomestic resource cost ratio measures cost in terms of domestic non-tradable resources relative to value added in world prices fsj Ps* DRC = -------------Pwj - aij Pwiwhere fsj is a technical coefficient relating non-tradable primary factor s (land, labor, capital) to output j, Ps* is the economic opportunity cost or shadow price of non-tradable factor s,

DistortionsAny departure from the ideal of perfect competition that therefore interfaces with economic agents maximizing social welfare when they maximize their own. Includes taxes, subsidies, tariffs, externalities, incomplete information and imperfect competition. Same as market imperfection.Each particular distortion has its own associated recourse pulls. Not all can be analyzed within one framework. And Almost anything can happen in response to any stimulus, depending upon the nature of the distortion

DistortionBefore choosing policies under distortions, there are some points we have to pay attentionThere is sizable literature on choice of policy instrument when first best policies are infeasible Cost benefit analysis - systematic process for calculating and comparing benefits and costs of a project The problem of shadow prices- Shadow price is the true economic price/cost of an activity: its opportunity cost. "shadow prices' or "social values' cannot be directly observed

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