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Chapter 10
International
Trade and
Economic Growth
Topics to be Covered
• Economic Growth and Development
• Economic Development Strategies:



Primary Export-led Strategy
Import-substitution Strategy
Outward-looking Strategy
• Neutral Economic Growth
• Protrade vs. Antitrade Biased Growth
• Types of Technological Change
• International Flows of Labor and Capital
• Economic Analysis of Labor Migration
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Economic Growth
• An economy is said to grow when its
total real output or gross domestic
product (GDP) rises.
• Per capita GDP is a measure of a
country’s standard of living. For
standard of living to rise over time, GDP
must grow faster than the population.
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Economic Development
• Economic Development—refers to the achievement
of a quality of life for the average citizen of a country
that is comparable to that enjoyed by the average
citizen of a country with a modern economy, such as
the U.S.
• Economic development is characterized by:




High levels of consumption
Broad-based educational achievement
Adequate housing
Access to high-quality health care, etc.
• Economic growth is essential for economic
development.
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Strategies for
Economic Development
• Primary Export-led Development Strategy
• Import-Substitution Development Strategy
• Outward-looking Development Strategy
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Primary Export-Led
Development Strategy
• This strategy involves policies designed
to exploit natural comparative
advantage by increasing production of a
few export goods most closely related to
the country’s resource base.
• Country examples include Columbia
(coffee), Mexico and Nigeria
(petroleum), and Malaysia (rubber).
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Advantages of Primary Export-led
Development Strategy
• This strategy would encourage
more intensive use of existing or
abundant resources (vent for surplus)
• It could help attract foreign investment.
• It may provide linkage effects or benefits
to other industries as a result of one
industry expanding.
• Australia, Canada & US growth fits this
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Arguments Against
Primary Export-led Strategy
• The world markets for primary products
do not grow fast enough to support this
type of development.
• The prices of primary products relative
to the prices of manufactured goods will
tend to fall over time due to sluggish
demand or oversupply.
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Terms of Trade
of Developing Countries
• Refer to Figure 10.1
• Terms of trade of oil exporting countries have
experienced sharp increases; non-oil exporters have
more stable, albeit declining, terms of trade.
• A group of countries with market power can improve
its terms of trade by restricting supply (e.g., optimal
export tariff)
• The declining terms of trade of non-oil exporters is
more likely due to policies of other developing
countries (i.e., OPEC) than to market conditions in
developed countries.
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Import-Substitution
Development Strategy
• These policies are designed to promote
rapid industrialization and development
by erecting high barriers to foreign
goods to encourage local production.
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Arguments Against
Import-substitution Strategy
• The high barriers to trade rarely come down.
• This strategy limits the development of
industries that supply inputs to the
protected industries.
• Imported capital goods are used extensively
in local production instead of more laborintensive methods.
• The strategy encourages citizens to spend
scarce resources to lobby or bribe
government officials to protect their industries.
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Outward-Looking
Development Strategy
• These policies involve government
identifying or targeting industries in
which the country has potential
comparative advantage.
• Successful country examples include
Japan, South Korea, Singapore,
and Taiwan.
• Refer to Table 10.1 for more examples.
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Trade and Growth
• Economic growth is shown graphically
as an outward shift of the country’s
production possibility frontier (PPF).
• Since growth affects both production
and consumption, then it also affects
international trade.
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Graphical Analysis:
An Economy Before Growth Occurs
• Refer to Figure 10.2
• Given PPF and terms of trade line,
show:




Equilibrium production point
Equilibrium consumption point
PR line with slope indicating the initial ratio
of production of the two goods
CR line with slope indicating the ratio in
which the two goods are consumed
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Neutral Economic Growth
• A proportionate increase in all resources
and consumption so that trade also
expands proportionately to the growth of
the economy.
• After growth, the economy continues to
produce and consume the two goods in
the same ratios as before growth (refer
to Figure 10.2).
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Conditions Necessary
for Neutral Growth
• Graphically, the new production
possibility frontier (PPF) must be a
proportionate expansion of the old PPF.
• Consumption of both goods must
increase by the same proportion as
income increases. In other words, the
income elasticity of demand for both
goods must be equal (see Table 10.2).
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Other Types of Growth
• Pro-trade Biased Growth
• Anti-trade Biased Growth
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Pro-trade Biased Growth
• When growth occurs as a result of an
increase in the resource used intensively in
the production of export goods, then the
output of export goods will rise relative to
import production, and international trade will
expand by more than the rate of growth of
GDP. This is called pro-trade biased growth
(refer to Figure 10.3 and Table 10.3).
• Graphically, the PR line rotates away from
the CR line.
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Anti-trade Biased Growth
• When growth occurs as a result of an
increase in the resource used intensively in
the production of import goods, then the
output of import goods will rise relative to the
output of export goods, and the international
trade of this country will fall. This is anti-trade
biased growth (refer to Table 10.4).
• Graphically, the PR line rotates toward the CR
line indicating a tendency toward autarky.
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Technological Change
• Technological (technical) change—
occurs when the same amount of output
can be produced with fewer factor
inputs, or when the same amount of
inputs can produce greater amounts
of output.
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Types of Technological Change
• Neutral technological change—an
innovation that reduces by an equiproportionate amount the quantity of factors
required to produce a given level of output.
• Labor-saving (capital-saving) technological
change—an innovation that leads to a
reduction in the use of labor (capital) relative to
other factors in the production of a given level
of output.
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Industry Effects of Technical Change
• If neutral technical progress occurs in
one industry, the output of that industry
will increase at the expense of the other.
• If technical progress allows an industry
to save on the use of the factor it uses
less intensively, then the output of that
industry could rise or fall.
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Economic Growth and
Terms of Trade for a Large Country
• With neutral economic growth, the terms
of trade of the large country will tend to
fall as the country grows.
• Pro-trade biased growth will cause the
terms of trade to deteriorate more than
under neutral growth.
• Anti-trade biased growth will lead to an
improvement in the terms of trade.
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Immizerising Growth
• Immizerising Growth—growth that
results in a reduction of the country’s
welfare level.
• Refer to Figure 10.4 (next slide).
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Is Immizerising Growth Common?
• No, because:

Precise conditions on both the nature of
growth and world demand must hold.

Government policy (e.g., tariffs) can be
used to counteract the negative effects
of growth.
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Dutch Disease
• The phenomenon of a boom or good
fortunes for one part of a country’s
economy eventually leading to very bad
times for the economy as a whole is
known as the Dutch disease.
• Refer to Item 10.1 The Dutch Disease
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International Flows of Factors
• Labor and migration
• Capital and multinational corporations
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Labor Flows
• The U.S., Canada, Australia and
other countries have experienced large
inflows of migrants.
• Migration has resulted from government
policies such as:

Guest worker program (Europe) in which
foreign workers are invited to temporarily
relocate and work in a host country
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Reasons for Migrating
• Better economic circumstances in
another country.
• Refuge from political tyranny or
devastation.
• Reunion with other family members.
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Brain Drain vs. Brawn Drain
• Brain Drain—process whereby skilled
workers leave their homeland and
relocate abroad.
• Brawn Drain—the outflow of unskilled
workers to other countries.
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U.S. Capital Flows
• In the 19th century, the U.S. was a
capital-importing country.
• For much of the 20th century, the U.S.
was a capital exporter.
• Since 1985, the U.S. has moved from
being the world’s largest net creditor to
being the world’s largest net borrower.
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Direct Foreign Investment and MNC’s
• Direct Foreign Investment—happens
when a domestic firm acquires
ownership or control of the operations
of a foreign firm.
• Multinational Corporations (MNCs)—
firms that own and operate capital in
one or more foreign countries.
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Features of U.S. MNCs
• Manufacturing accounts for the largest
share of U.S. MNC employment (refer
to Table 10.6 Employment of Nonbank
U.S. MNCs).
• 65% of U.S. MNC employment is in
developed countries, primarily Western
Europe (refer to Table 10.7).
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What Special Advantages
do MNCs Have?
• MNCs may have access to special
technology.
• There may be increasing returns to
scale that accrue to a firm operating
plants in many locations.
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Outsourcing
• Outsourcing—the movement or
shifting of production by a firm to a
foreign location.
• See Item 10.2 for more details.
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Economic Analysis
of Factor Movements
• The case of labor migration
• Definition of terms:



Marginal Product of Labor (MPL)
Diminishing Returns to Labor
Value of Marginal Product of Labor (VMPL)
• Profit-maximizing Rule
• Effects of immigration of foreign workers
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Marginal Product of Labor (MPL)
• MPL—the additional amount of
output that can be produced with the
addition of one more worker to the
production process.
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Diminishing Returns
• Diminishing returns to labor—the
fact that as more and more workers
are added to the production process,
holding all other factors constant,
the marginal product of labor will
eventually decline.
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Value of
Marginal Product of Labor (VMPL)
• VMPL—the monetary value of the
marginal product of labor or,
alternatively, the marginal revenue
to producers from hiring the last worker.
In equation form:
where P is product price.
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VMPL Curve and Equilibrium
• Refer to Figure 10.5
• VMPL curve is downward-sloping due to
diminishing returns and also represents the
demand-for-labor curve.
• Given a fixed supply of workers, the
interaction of the demand and supply in the
labor market determines the wage rate.
• The area under the VMPL curve represents
labor income and income paid to
capital owners.
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Effects of Foreign Labor Migration
• Wages are driven downward.
• Increase in labor force results in more
output produced.
• There is an income redistribution effect:
domestic labor loses income while
capital owners benefit because the
increased production leads to more
intensive use of capital and to a rise in
its rental prices.
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Chapter 10
Additional
Chapter Art
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