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Economic Development Lecture 4. International Relationships Development - Lecture 4 1 I. International Trade Theory Gains from trade – Comparative Advantage Theory LDCs should specialize in sectors which intensively use their abundant factor All countries should gain from trade Trade provides engine for growth – Economies of scale Many LDCs are small economies, hence gains from specialization and trade are huge – Increased competition => efficiency – Spead of modern technology through trade Development - Lecture 4 2 I. International Trade Theory Weaknesses of trade theory in the context of development – Assumption of full employment LDCs have high overall unemployment – Opportunity cost is static LDCs may be locked in low tech sectors Growth is dynamic, need to be forward-looking – Prices reflect opportunity cost Imperfect competition government intervention private vs social costs Development - Lecture 4 3 I. International Trade Theory – Assumption of no uncertainty and risk LDCs concentrate on a few primary sectors, which are subject to huge price fluctuations in the SR and downward price trend in the LR Better to diversify, instead of too much specialization (to take advantage of scale economies) – No consideration of who in the countries gain from trade The rich often gains, the poor left out Development - Lecture 4 4 I. International Trade Theory – Economies of scale LDCs find it hard to enter industries which they are supposed to have comparative adv. because these are protected by DCs’ big companies LDCs need to protect “infant industries” to compete with multinationals – Spread of modern technology Multinationals use capital-intensive technologies, replace LDC jobs => growth without development Development - Lecture 4 5 II. Trade Problems of LDCs World Trade Patterns – LDCs rely on primary products exports – World trade moves away from DCs dominated by DCs LDCs overall share of world trade remained the same, but NICs increased trade share while the Least Developed Countries fell behind. This trade pattern leads to problems: – Long Term – Short Term Development - Lecture 4 6 II. Trade Problems of LDCs Long Term Problems – Slow growth of exports volume Low income elasticity of demand (for primary prod.) As income increases, not much increase in demand Relatively low price elasticity of demand (for primary products) Low in the world market (although high for each country) As supply shifts right, large world price decreases Recent developments Agriculture protection in DCs Synthetic substitutes Miniaturization - less need for raw materials Development - Lecture 4 7 II. Trade Problems of LDCs – Fast growth of imports volume High income elaticity of demand for imported manufactures and services As LDC income increases, even higher demand Low price elasticity of demand for imported manufactures and services few substitutes As demand increases, large price increases – Worsening terms of trade Price of imports increase, price of exports decrease Exception: oil and oil-exporting countries Development - Lecture 4 8 II. Trade Problems of LDCs Short Term problem - huge price fluctuations – Primary products have inelastic demand AND supply in the SR Demand: few substitutes Supply: nature of farming and mining – Primary product market subject to huge SR shocks to demand AND supply Demand: business cycles in DCs Supply: uncertainty in farming and mining – Result: huge price fluctuations in the SR Development - Lecture 4 9 II. Trade Problems of LDCs LDCs attempts to counter these problems – International Commodity Agreements Producers: raise prices through cartels restricting supply by issuing production quotas Consumers: stabilize prices through buffer stock buy and sell to keep prices stable – Problems with cartels cheating by members increase in supply by non-members economizing in the use of the product development of substitutes Development - Lecture 4 10 II. Trade Problems of LDCs – Problems with buffer stock perishable goods difficult to stock difficult to choose the right price to keep producers might pressure for higher price long term trend in price decrease if price kept too high, then have to buy too much uncertain need to use buffer stock Would speculators in market do the work? Are price fluctuations really that bad? buffer stock benefits the producers, not necessarily the poor better to subsidize directly than to mess with prices Development - Lecture 4 11 III. International Debt Problem for both LDCs and the entire international financial system Developments of the Debt Problem – Before 1973 Most LDCs had current account deficits They financed the deficits through foreign investment and aid Most foreign loans were “soft” - from governments and int’l orgs on consessional terms – 1973 - 1979 DCs had recession, reduced imports from LDCs LDCs borrowed massively to continue own growth Development - Lecture 4 12 III. International Debt Most loans were “hard” loans from commercial banks at market interest rates – Second oil shock of 1979 DCs, in severe stagflation resorted to strict deflationary policies & raised real interest rates reduced imports from LDCs LDCs import prices rose sharply while exports decreased LDCs held large debts and hence large “debt servicing”, which they could not finance through export sales Severe “capital flight” problem Development - Lecture 4 13 III. International Debt – LDCs forced into rescheduled debts IMF restructuring programs (prerequisite for help and rescheduling) Market orientated, supply-side measures to promote output growth and investment devaluation to encourage exports and discourage imports deflation through tight monetary and fiscal policies to reduce government deficit, inflation, and interest rates hurt the poor immensely due to big cuts in welfare payments and development programs – Debt problem temporarily on hold Development - Lecture 4 14 IV. Multinational Companies MNCs are large and are foreign-owned and controlled are desirable for LDC development??? MNCs help economic growth – – – – increase GDP, employment, savings increase exports, foreign exchange, tax revenue increase technology transfer and human capital But: inefficiency - monopoly power minimize tax payments - transfer pricing LDC gov’ts compete - benefits of FDI reduced Development - Lecture 4 15 IV. Multinational Companies MNCs help development??? – – – – widen inequality (high wage sector) develop dual economy (locating in cities) sell inappropriate products (for the rich only) unfair competition (big budgets on advertising) hurts local enterprise growth – inappropriate modern tech. creates few jobs – big influence on government (often in anti-development policies) Development - Lecture 4 16 V. Foreign Aid Official and unofficial aid – ODA (Official Development Assistance) bilateral aid (by individual govt) multilateral aid (by agencies - World Bank, etc.) – Unofficial by NGOs, e.g. Red Cross, Oxfam, church, and local agencies The amount of aid – DCs less generous than before (0.3% of GDP) – US large in volume, but small in % of GDP Development - Lecture 4 17 V. Foreign Aid Direction of aid – bilateral donors focused on donor’s self-interest (political, military) US - contain Communism Soviet - support Communism UK and France - former colonies OPEC - Arab countries Exception: Nordic - emphasis on development – multilateral donors development criteria but: conditionality Development - Lecture 4 18 V. Foreign Aid – NGOs: dealing with the poor directly development by the poor as opposed to for the poor Arguments for and against Aid – Economic resources gaps ( forex, capital) personnel gap (through technical assistance) – Tied aid donor self-interest must purchase donor country products Development - Lecture 4 19 V. Foreign Aid – Aid maintains income inequality in LDCs (inappropriate tech.) – Aid can help LDC govt postpone reforms Food aid alleviates problem Food aid also reduce incentives for local farmers – Aid allows dictatorial govt to stay in power (aid often politically motivated) – Aid is a poor substitute for trade DCs should remove import barriers from LDCs in textiles LDCs need to get out of dependence cycle! Development - Lecture 4 20