The role of international trade
Barriers to primary export-led growth
Overspecialisation on a narrow range of primary exports cannot effectively lead to the way of economic development. Here are some of the reasons for this:
- Demand for most primary exports is income inelastic and, as a result, market for such products in high-income countries do not grow fast enough to help accelerate growth.
- Prices received for many primary products have decreased through time. For example, technology and an increase in the number of coffee-producing countries have pushed down the world price for coffee.
- Agricultural exports have to face the trade protection that advanced economies (the USA, the European Union, and Japan) grant their farmers in the form of subsidies. The resulting inability to access these markets is a more general barrier developing countries face. The statement does not indiscriminately apply to all developing countries, though, as many falsely believe. It mainly applies to the so-called Cairns Group of developing countries, which includes Argentina, Brazil, Chile, Colombia, Costa Rica, Indonesia, Malaysia, Philippines, South Africa, Thailand, and Uruguay which are mostly middle-income countries with a strong comparative advantage in agriculture. It follows that the main beneficiaries of liberalising trade in agriculture would be this group of countries. The last developed countries as defined by the UN (which include all countries in SUb-Saharan Africa; Afghanistan, Bangladesh, Bhutan, Cambodia, Lao, Maldives, and Nepal in Asia; and Haiti in Central America) will actually be hurt by this liberalisation, the main reason for this being that most of these countries are net food importers and elimination of agricultural subsidies will translate into higher food prices for them.
The strategy of protection: import-substitution industrilisation (ISI)
In the 1950s it was thought that the problem of development was a structural problem in that developing countries relied to heavily on the primary sector and did not have a manufacturing sector. The greation of an industrial base to substitute domestically manufactured goods for imports became known as ISI. The goods targeted were non-durable manufactured goods (for example textiles) that were simple to produce and were for doemstic consumption. Trade barriers were erected to protect the newly established domestic firms. These barriers would stay in place until the firms grew sufficiently in size anad acquired the necessary know-how to lower averagecosts. Trade barriers were reduced when the firms were able to compete with importans and survive within the domestic markets.
Typically, the exchange rate was kept overvalued so that prices of necessary imported materials and intermediate products (machines and other manufactured inputs) used by the infant industries were artificially low.
Several problems are associated with an inward-oriented strategy. Since the domestic industry had its own 'captive' markey to sell its products, it never had the incentive to become efficient. The price and cost disciplines that competitive imposes on firms were totally absent. In some cases, low-quality, high-cost, and high-priced goods were produced.
The overvalued exchange rate acted as a tax on traditional primary exports as f armers earned less omestic currency for each dollar of primary exports. Poverty for large segments of the population therefore increased. In some developing countries the ISI strategy created a privilege for élite which became more and more powerful as the industrial sector grew. In many cases, the protective trade barriers were never eliminated. In addition, the new established industries were often capital-intensive, employing inappropriate technologies which led to jobless growth as minimal employment opportunities were created. Remember that jobless growth is a type of growth to avoid as development does not follow.
Export promotion: outward-oriented strategies
In some East Asian countries, including those known as the four East Asian Tigers (Korea, Taiwan, Hong King, and Singapore), the structural change that the ISI strategy represented was follow by an attempt to export the simple, non-durable, manufactured goods these countries had been producing for their markey. These, and later other developing countries, adopted an outward orientation.
In this process, the role of the state varied among countries but, in all of them, it played a sifnificant, complementary role. It provided guidance and assistance to the private firms buy only if they achieved specific performance standards typically associated with export targets. These firms were forced to produce low-price, high-quality goods in order to continue to enjoy any state subsidies or cheaper loans from banks.
Export promotion is not sufficient to promote development and to ensure the sustainability of the process. The state in these countries invested heavily in education, slowly creating a more productive labour force with higher skills. The state also ensured that the fruits of economic growth were enjoyed by all. This meant that these countries avoided the costs associated with rising income inequality.
The first Asian country to intiate such an approach to the growth and development problem was Japan. It was followed by the four East ASian Tigers (and other countries, such as Malaysia, INdonesia, Thailand, and Vietnam, have been added to this list). China and India are the current starts of the export-or outward-oriented strategy.
Advantages of outward-oriented strategies
- Focusing initially on the production and export of simple, manufactured non-durable goods changed the structure of these economies. Employment opportunities increased for the rural migrants, asthese industries were mostly labour-intensive.
- The export revenues earned alleviated problems with the balance of payments as they were used to finance the importantion of necessary intermediate and capital goods. There was less danger of the economy running into foreign exchange and foreign debt problems. Rising export revenues also increased aggregate demand (AD), so they can fuel growth in output and incomes.
- Focusing on the larger export markets forced firms to grow in size and acquire economies of scale (EOS). This is especially important for small countries.
- Firms were forced to learn more about manufacturing their products more efficiently. International competition provided the stimulus. The state also invited technical assistance from abroad but it usually limited contracts so that they lasted no more than three years, forcing domestic firms to learn the necessary technology. Operating successfully in world markets enable firms to acquire the markey, financial, managerial and, most importantly, entrpreneurial skills. Exposure to world competition allowed a local entrepreneurial class to evolve and mature.
- Through varing degrees of state guidance these economies slowly shifted their comparative advantage and production to more sophisticated and complex manufactured products and later to knowledge-based and technology-intensive products. Their economies therefore diversified and were more insulated frm industry-specific risks.
Possible disadvantages of outward-oriented growth
- Since the growth process is driven by exports, it depends on how fast the adcanced economies are growing. If their incomes are rising fast then they will be absorbing more imports which are the exports of the developing countries. A deep recession in the USA or in EUrope, though, will be costly as it will slow down the process, especially if domestic demand is weak and the government is not in a position to adopt expansionary fiscal policiy. In response to the 2008 global crisis, China was not able to adopt a huge fiscal stimulus programme, but not all countries were able to do the same.
- Outward-oriented growth must successfully overcome the barriers created by trade proteciton in developed countries.
- Outward-oriented strategies may lead to worsening income distribution as the rural sectory may be left behind. A larger share of national income will accrue to those involved in the export sector. It follows that only if there are redistributive policies in place will development ensue (using the term 'redistributive policies' in its broad sense here − that is, including spending on better health and education).
- The drive to produce cheaply for export markets may lead policy makers to ignore the costs of environmental degragation. This is very evident in China where export-driven growth is seriously damaging the natural resource base of the country and generating major environmental costs, undermining the sustainability of the country's long-term growth and development prospects.
- Achieving outward-oriented growth forces policy makers to keep the exchange rate artificially undervalued to provide an extra competitive edge to their exports, risking not only rising protectionist sentiment abroad but also inflation at home.
- Focusing on outward-oriented growth may lead policy makers to postpone the creation of a social safety net that would include state pensions and health insurance, as the growth process does not rely on te ability of the population to spend on domestic goods and services.
Preferential trading agreements
Regional integration among developing countries is often referred to as south-south integration. Originally, in the 1960s and 1970s, developing countries had attempted to create a number of preferential trading agreements as a way of reducing the cost of ISI through opening their markets to other developing countries. A block would increase the size of the potential market for each exporting firm and so it would lead to EOS. Any complementarities in production would also help reduce costs and allow specialisation. The regional agreements since the 1990s are referred to as a 'new regionalism' and are part of a broader trade liberalisation scheme where export promotion is featured as the grow and development strategy of choice.
Expamples of preferential trading agreements among developing countries include the Latin America Free Trade Association (LAFTA), formed in 1961; MERCOSUR, a customs union among Argentina, BRazil, Urugua, and Paragua formed in 1991; the Asia-Pacific Economic Cooperation (APEC), a group of 21 nations that border the Pacific Ocean, established in 1989 and promoting freer trade and cooperation among its members; the Economic Community of Central African States (ECCAS), established in 1982 and including Burundi, Cameroon, Central African Republic, Chad, COngo, Equatorial Giunea, Gabon, Rwanda, São Tomé, and Principe; and the Economic COmmunity of West African States (ECOWAS), established in 1975, with 16 member countries.
Possible benefits of increased regional cooperation among developing countries include:
- increased trade creation as a result of the resulting expanded market,
- the possibility of EOS that may lead to more exports outside the bloc,
- greater political and bargaining power in negotiations with developed economies, and
- a decreased level of dependence on developing countries' markets.
Here are some reasons many attempts at regional cooperation among developing countries have faile or have resulted in limited success:
- The structure of production and of trade in developing countries lacks a sufficient complementary nature. The similarity of their economies has result in more trade diversion that trade creation.
- Many attempts have encountered significan organisational and administrative problems.
- Political rivalry both between and within countries and lack of commitment have also prevented problems.
- Transaction costs are often high due to the high share of raw materials and non-duirables in these countries' mututal trade. There are high transport costs, especially since infrastructure is poor (for example, there are few roads).