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CHAPTER E L E V E N
11
International
Economics
Tenth Edition
International Trade and Economic
Development
Dominick Salvatore
John Wiley & Sons, Inc.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
Learning Goals:
 Understand the relationship between
economic development and international trade
 Understand the relationship between the
terms of trade, export instability, and
economic development
 Compare imports substitution with export
orientation as a development strategy
 Describe the current problems facing
developing countries
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
Introduction
 Today most economists believe that international
trade can contribute significantly to the
development process.
 Until 1980’s, an influential minority of
economists argued that international trade
hindered development in developing nations.
 This chapter addresses these claims.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
The Importance of Trade to Development
 Traditional trade theory: If each nation specializes
in their comparative advantage good, world
output increases and both nations gain.
 This suggests that developing nations should
continue to produce primary goods while
developed nations produce manufactured goods.
 Developing nations believe this pattern keeps
them from reaping dynamic benefits of industry
and maximizing their welfare in the long run.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
The Importance of Trade to Development
 Developing nations view traditional trade theory
as involving adjustments to existing conditions,
while development requires changing existing
conditions.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
The Importance of Trade to Development
 However, traditional trade theory can be
extended to incorporate changes in factor
supplies, technology and tastes by using
comparative statics.

A nation’s pattern of development is not
determined once and for all, but must be
recomputed as conditions change or are expected
to change.

As a developing nation accumulates capital and
improves technology, its comparative advantage
can shift from primary to manufactured goods.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
The Importance of Trade to Development
 Beneficial Effects of Trade on Economic
Development
1.
Can lead to full utilization of underemployed
resources.
2.
Makes possible division of labor and
economies of scale.
3.
Provides vehicle for transmission of new
ideas, new technology, new managerial and
other skills.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
The Importance of Trade to Development
 Beneficial Effects of Trade on Economic
Development
4.
Stimulates and facilitates the international
flow of capital from developed to developing
nations.
5.
Stimulates domestic demand for new
manufactured products until efficient
domestic production becomes feasible.
6.
Stimulates greater efficiency by domestic
producers to meet foreign competition.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
The Importance of Trade to Development
 Endogenous Growth Theory
Lowering trade barriers will speed up the rate of
economic growth and development in the long
run by:
1.
Allowing developing nations to absorb technology
developed in developed nations at faster rate
2.
Increasing the benefits that flow from research and
development
3.
Promoting larger economies of scale in production
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
The Importance of Trade to Development
 Endogenous Growth Theory
Lowering trade barriers will speed up the rate of
economic growth and development in the long
run by:
4.
Reducing price distortions and leading to more
efficient use of domestic resources across sectors
5.
Encouraging greater specialization and more
efficiency in production of intermediate inputs
6.
Leading to more rapid introduction of new goods
and services.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
The Terms of Trade and Economic
Development
 Types of Terms of Trade

Commodity, or net barter, terms of trade (N)


Income terms of trade (I)


Ratio of the export price index to import price index
Measures nation’s export-based capacity to import.
Single factoral terms of trade (S)

Measures amount of imports nation gets per unit of
domestic factors of production embodied in its
exports.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
The Terms of Trade and Economic
Development
 Types of Terms of Trade

I and S can increase even if N does not,
increasing welfare.

Most favorable: increases in N, I and S.

Deterioration in all three terms of trade may
lead to immiserizing growth.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
The Terms of Trade and Economic
Development
 Commodity terms of trade in developing
nations tend to deteriorate over time because:


Most or all productivity increases in developed
nations are passed on to workers in higher wages
and income, while increases in productivity in
developing nations are reflected in lower prices.
Developing nations’ demand for manufactured
exports of developed nations grows faster than
developed nations’ demand for agricultural and raw
material exports of developing nations.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
FIGURE 11-1. Commodity Terms of Trade and Structural Breaks,
1900-1998
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
Export Instability and Economic Development
 Developing world exports tend to face inelastic
international demand.


Price fluctuations in these markets do not
significantly change the quantity sold.
Thus price fluctuations will generate large
movements in revenues collected.
 Fluctuating environmental conditions (weather,
natural disasters, etc.) cause more and larger
supply shifts in the developing world than in the
developed world.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
FIGURE 11-2 Price Instability and the Primary Exports of
Developing Nations.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
Export Instability and Economic Development
 Fluctuating export prices will result in export
earnings that vary significantly from year to year.



When export earnings rise, exporters increase
consumption, investment and bank deposits,
which multiply through the economy.
A subsequent fall in export earnings results in a
multiple contraction of national income, savings
and investment.
These boom-bust periods make development
planning difficult.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
Export Instability and Economic Development
 Empirical Research (MacBean, 1966)

While export instability is greater for developing
nations, the degree of instability is not very large
in an absolute sense.

Great fluctuation in export earnings of developing
nations did not lead to significant fluctuations in
their national income, savings and investments,
and did not interfere with development efforts.

MacBean concluded costly commodity
agreements demanded by developing nations are
not warranted.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
Export Instability and Economic Development
 Commodity Agreements

Buffer Stocks involve the purchase of the
commodity when the commodity price falls
below an agreed minimum price, and the sale
of the commodity out of the stock when the
commodity price rises above the maximum
price.

Example: International Tin Agreement, 1956
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
Export Instability and Economic Development
 Commodity Agreements

Export controls regulate the quantity of a
commodity exported by each nation in order
to stabilize commodity prices.

Example: International Sugar Agreement, 1954
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
Export Instability and Economic Development
 Commodity Agreements

Purchase contracts are long-term multilateral
agreements that stipulate a minimum price at
which importing nations agree to purchase a
specified quantity of the commodity and a
maximum price at which exporting nations
agree to sell specified amounts of the
commodity.

Example: International Wheat Agreement, 1949
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
Import Substitution versus Export Orientation
 During the 1950s, 1960s, and 1970s developing
nations made deliberate efforts to move
production away from primary goods towards
more industrialized production.
 Potential gains





Faster technological progress and growth
Creation of higher paying jobs
Higher multipliers and accelerators through
greater linkages in production process
Improved terms of trade, price stability
Relief from balance of payments difficulties
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
Import Substitution versus Export Orientation
 Strategies for industrialization

Import substitution industrialization (ISI)


Replace imports of industrial goods with
domestic production by reducing import access
to the domestic economy.
Export oriented industrialization


Expand industrialization through efforts to
expand domestic exports of industrialized
products.
Proven to be more effective than import
substitution.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
Import Substitution versus Export Orientation
 Import substitution industrialization (ISI)
Advantages:

The market for the product already exists
 It is easier to close the domestic market to
imports than to establish new industries in the
face of foreign competition.
 Foreign firms will be encouraged to invest
domestically to avoid the barriers to trade.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
Import Substitution versus Export Orientation
 Import substitution industrialization (ISI)
Disadvantages:



Protected industries have reduced incentives
to improve and become competitive.
The domestic economy may be too small to
exploit available economies of scale.
Import substitution is difficult for more
complex products.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
Import Substitution versus Export Orientation
 Trade Liberalization and Growth in
Developing Countries



Many countries that had earlier followed
import substitution strategies began to
liberalize, starting in the 1980s.
Facilitated by the World Bank.
Improvements in productivity and growth.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
Import Substitution versus Export Orientation
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
Import Substitution versus Export Orientation
 Export-oriented Industrialization
Advantages:



Allows for the exploitation of available
economies of scale
International competition spurs greater
domestic efficiency
Industrial expansion is not limited by the scale
of the domestic economy.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
Import Substitution versus Export Orientation
 Export-oriented Industrialization
Disadvantages:


May be difficult to set up export industries
due to competition from more established
industries
Developed nations often provide high level of
effective protection for industries producing
simple labor-intensive commodities in which
developing nation may have comparative
advantage.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
Import Substitution versus Export Orientation
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
Current Problems Facing Developing
Countries
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
Case Study 11-1 The East Asian Miracle of
Growth and Trade
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
Case Study 11-2 Change in Commodity Prices
over Time
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
Case Study 11-3 The Growth of GDP of Rich
Countries, Globalizers, and Nonglobalizers
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
Case Study 11-4 Manufactures in Total
Exports of Selected Developing Countries
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
Case Study 11-5 The Foreign Debt Burden of
Developing Countries
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
Appendix to Chapter 11
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
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Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.