4: Trade Policy In Developing Countries

Question 1

Before 1970s what was economic development thought to heavily depend on (i.e so what should trade policy be aimed towards)

Answer 1

Manufacturing - thus ISI to protect domestic manufacturing from international competition

Question 2

But since 1980s trade liberalisation benefits have been highlighted.

What was East Asia trade policy

Answer 2

Policy to promote exports in targeted industries (export-oriented industrialisation, EOI)

Question 3

Import substituting industrialisation (ISI)

How did this come about (historically what did developing countries export and import)

Answer 3

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)

Question 4

ISI relationship with protection

Answer 4

Positive -
Higher ISI = Higher protection - ISI protects domestic sector from foreign competition

Question 5

Effective rate of protection

B) how is it calculated

Answer 5

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%

Question 6

Reason for ISI - why protect domestic manufacturing

Answer 6

Infant industry argument - cannot initially compete with established competition, so protect allow them to compete internationally

Question 7

Economic development (not encourage manufacturing) was the ultimate goal of the ISI policy:

Was ISI successful?

What other indicators did it impact (2)

Answer 7

No, companies adopting import-substituting industrialisation grew slower than others.

Also aggravated income inequality and unemployment

Question 8

Why ISI unsuccessful? (5)

Answer 8

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

Question 9

Ultimately ISI allows survival, but not increase efficiency! E.g doesnt address lack of skilled labour in poor countries

Question 10

Problems with infant industry argument

Answer 10

It is wasteful on resources: may never grow up or become competitive with protection (complacency traps)

Question 11

2 arguments for why market failures prevent infant industries from becoming competitive

Answer 11

Imperfect financial asset markets

Problem of appropriability

Question 12

Imperfect financial asset markets

as a reason for infant industry failure to become competitive

Answer 12

Poor markets, firms cannot save or borrow to invest in production

Question 13

Problem of appropriability:

2nd market failure keeping industries inefficient

Answer 13

Not worth to invest in knowledge, since public goods; people free-ride since ideas aren’t protected by property rights

Question 14

Example of infant industry failure Brazil

Answer 14

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.

Question 15

Export oriented industrialisation ; which Asia did and saw rapid growth

3 stages of East Asian Mircale

Answer 15

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

Question 16

Exported oriented industrialisation: less restrictive and have seen growth, however many trade restrictions still existed

What country is an exception

Answer 16

HK - very open

Question 17

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)

Answer 17

Timing
High education (productive labour force)
Hard working culture
High saving and investment rates
Some Asian countries subsidised R&D

Question 18

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

Answer 18

80% tariff cut to under 20%

Question 19

What was average annual growth rate of exports in East Asia compared to Latin America & Caribbean

1980-89

Answer 19

10% compared to 3.6%

Question 20

What happened to exports as a share of GDP for Asian countries

Answer 20

Increased

Question 21

So has trade liberalisation promoted development

Answer 21

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

Question 22

What did OECD find in terms of evidence
B) Jung and Marshall
C) Harrison

Answer 22

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…

Question 23

Theory on whether trade openness raises growth rates

Is this true? What does it depends on?

Answer 23

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)

Question 24

Neoclassical growth models:
How does trade openness affect growth?

Answer 24

Through capital accumulation

Eval: trade openness doesnt impact long run growth rate

Question 25

Learning-by-doing models

What does trade openness affect growth through?

B) when may it not increase growth

Answer 25

Growth through productivity growth and specialisation

B) if they specialise in the wrong industry (i.e one they dont have a comparative advantage in)

Question 26

Endogenous growth models

b) name key example (in topic 7)

Answer 26

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)

Question 27

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)

Answer 27

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)