4: Trade Policy In Developing Countries Flashcards
Before 1970s what was economic development thought to heavily depend on (i.e so what should trade policy be aimed towards)
Manufacturing - thus ISI to protect domestic manufacturing from international competition
But since 1980s trade liberalisation benefits have been highlighted.
What was East Asia trade policy
Policy to promote exports in targeted industries (export-oriented industrialisation, EOI)
Import substituting industrialisation (ISI)
How did this come about (historically what did developing countries export and import)
Division of labour - largely exported primary products, while importing finished goods
Prebisch argued, this keeps less-developed countries poor and exploited by rich. (He supported ISI)
ISI relationship with protection
Positive -
Higher ISI = Higher protection - ISI protects domestic sector from foreign competition
Effective rate of protection
B) how is it calculated
Measures how much protection a tariff (or other trade policies) provides to domestic producers.
E.g tariffing imported cars to protect domestic producers.
B) % change in value added.
E.g selling a car for 8000 and costs 6000 to produce. Value added is 2000. Then add 25% tariff on imported cars. Charge 10000 now. Value added is 4000 now.
Effective rate protection is difference between value added. 100%
Reason for ISI - why protect domestic manufacturing
Infant industry argument - cannot initially compete with established competition, so protect allow them to compete internationally
Economic development (not encourage manufacturing) was the ultimate goal of the ISI policy:
Was ISI successful?
What other indicators did it impact (2)
No, companies adopting import-substituting industrialisation grew slower than others.
Also aggravated income inequality and unemployment
Why ISI unsuccessful? (5)
Not only low imports, but low exports! Drew resources away from actual or potential export sectors.
Complex, time consuming e.g quotas
Higher costs for firms and consumers - tariffs impacted firms needing imported components
Promoted inefficiently small industries. Domestic market wasn’t large enough (to exploit EOS fully)
Doesn’t directly address efficiency issues: e.g how poor countries lack skilled labour (similar to trade policy to address environment; doesn’t directly address it, better to target production (pigouvian tax) on
Ultimately ISI allows survival, but not increase efficiency! E.g doesnt address lack of skilled labour in poor countries
Problems with infant industry argument
It is wasteful on resources: may never grow up or become competitive with protection (complacency traps)
2 arguments for why market failures prevent infant industries from becoming competitive
Imperfect financial asset markets
Problem of appropriability
Imperfect financial asset markets
as a reason for infant industry failure to become competitive
Poor markets, firms cannot save or borrow to invest in production
Problem of appropriability:
2nd market failure keeping industries inefficient
Not worth to invest in knowledge, since public goods; people free-ride since ideas aren’t protected by property rights
Example of infant industry failure Brazil
Brazil banned imported PCs.
So domestic firms had to buy domestic PCs
Industry never matured and technological gap between Brazil and RoW widened; protected industry just copied low end foreign computers and sold them at inflated prices.
Export oriented industrialisation ; which Asia did and saw rapid growth
3 stages of East Asian Mircale
Japan 1945
Asian tigers (HK, Taiwan, SK, Singapore) 1960s (HK and Singapore have export as a share of GDP >100%
Malaysia, Thailand, Indonesia and China 1970s
Exported oriented industrialisation: less restrictive and have seen growth, however many trade restrictions still existed
What country is an exception
HK - very open
Latin America (Mexico and Brazil) tried to copy EOI (liberalise trade and promote exports in targeted industries)
However it did not see the same success.
What factors played role in Asia’s miracle? (5)
Timing
High education (productive labour force)
Hard working culture
High saving and investment rates
Some Asian countries subsidised R&D
Thus economies lost faith in ISI by mid 1980s, so stopped pursuing it (shown by a dramatic fall in tariff rates in developing countries)
For example: how much did Indias tariff fall by 1990-2005
80% tariff cut to under 20%
What was average annual growth rate of exports in East Asia compared to Latin America & Caribbean
1980-89
10% compared to 3.6%
What happened to exports as a share of GDP for Asian countries
Increased
So has trade liberalisation promoted development
Mixed evidence - growth rate in Brazil and Latin America has slowed, while India has grown rapidly. (Tariff fall 80 to 20%
So unclear to what degree trade liberalisation has placed in both instances in growth
What did OECD find in terms of evidence
B) Jung and Marshall
C) Harrison
Says trade increases growth: Open economies consistently outperform countries with restrictive trade
B) Says trade doesn’t cause growth:
Found only 4/37 developing countries pass causality test between export growth to output growth
C) Reverse causality between growth and trade
Supports mixed evidence…
Theory on whether trade openness raises growth rates
Is this true? What does it depends on?
Ambiguous - depends on whether market failures exist
No market failure: trade restrictions reduce national welfare (for small open economy always, large economy if optimal tariff not set)
With market failure : trade restrictions can increase real GDP (although rarely 1st best option)
Neoclassical growth models:
How does trade openness affect growth?
Through capital accumulation
Eval: trade openness doesnt impact long run growth rate
Learning-by-doing models
What does trade openness affect growth through?
B) when may it not increase growth
Growth through productivity growth and specialisation
B) if they specialise in the wrong industry (i.e one they dont have a comparative advantage in)
Endogenous growth models
b) name key example (in topic 7)
Trade impacts growth by shifting incentives to invest in R&D
B) Grossman and Helpman - trade and growth (endogenous growth) theory. Growth depends on rate of tech transfer (if quicker imitation, more tech transfer, drives more innovation and growth)
So ultimately hard to link relationship between trade and growth. (EOI worked for Asia, but not in Latin America, where ISI had faster growth)
So what does it depend on (2)
the details of model
e.g market failures or not (with no MF, small country prefers free trade. Large will also prefer free trade if optimal tariff not set. With MF, trade restrictions can increase GDP however rarely 1st best option)
specific factors (e.g reasons for Asia success was timing, education, high saving/investment rates, hard working culture, some Asia countries subsidised R&D)
