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Economic Development
Lecture 4.
International Relationships
Development - Lecture 4
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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
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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
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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
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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
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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
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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
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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
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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
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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
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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
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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
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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
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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
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IV. Multinational Companies

MNCs
 are large and are foreign-owned and controlled
 are desirable for LDC development???

MNCs help economic growth
–
–
–
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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
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IV. Multinational Companies

MNCs help development???
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–
–
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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)
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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
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V. Foreign Aid

Direction of aid
– bilateral donors focused on donor’s self-interest (political,
military)
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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
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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
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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!
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