4.4: International trade and economic development

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    Definitions

     

    1. Tariff escalation is when the rate of tariffs on good rises more than the goods that are processed. This protects an importing country’s manufacturing industry by placing lower tariffs on imports of raw materials, and higher tariffs on finished products.
    2. Non-convertible currency can only be used domestically and that is not accepted for exchange on the foreign exchange market.
    3. Import substitution/Import substitution industrialization is an inward-oriented growth strategy encouraging the domestic production of goods, rather than importing them.
    4. Export promotion/Export-led growth is an outward-oriented growth strategy based on openness and international trade. Growth is achieved by concentrating on increasing exports, and export revenue, as a leading factor in the aggregate demand of an economy.
    5. Trade liberalization is the removal or reduction of trade barriers that prevent free trade between countries. It involves the elimination of tariffs, quotas, export subsidies etc.

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    International barriers to economic development

     

    1. Over-specialization on a narrow range of products

    • Many developing countries rely on production of primary sector products as their share of export revenues.
    • Rising commodity prices → Increase rate of economic growth → Set off a positive cycle in terms of development and future growth if the revenues are used to finance health, education and infrastructure.
    • Current account deficits will increase → Difficult for countries to finance current expenditure and necessary imports.
    • If a country is dependent on narrow range of products → The country faces great vulnerability and uncertainty.

    2. Price volatility of primary products

    • Price elasticity of demand (PED) & price elasticity of supply (PES) of primary products are inelastic due to developing countries buying the product regardless of the price.
    • Changes in demand and supply will lead to large price fluctuations → Have a significant impact on the export revenues.
    • Price volatility → Difficult for producers and governments in developing countries to go ahead with future plans → Affects investment in companies → Negatively affects economic growth + government spending on merit goods + economic development.

     

    3. Inability to access international markets

    • If protectionist measures prevent developing countries to utilize comparative advantages and exporting to developed countries → Developing countries will be limited in how much they can earn in the foreign exchange market.
    • Tariff escalation creates a huge problem for developing countries as they are limited in their presence in foreign markets → Little incentives to diversify from producing raw materials to processing them due to high tariffs → Makes the products uncompetitive in terms of foreign countries and trap suppliers.
    • Countries with non-convertible currencies prevents them in entering new markets.
    • Non-convertibility → Less likely for trade to occur.
    • Non-convertible currencies tend to be over-valued at their official pegged exchange rate → Results in black market for the convertible currency → Damages the economy, local trade and international trade.

     

    4. Long term changes in the terms of trade

    • Fall in commodity prices → Loss of export revenues → Decrease in ability to buy imported goods.

     

    Trade strategies for economic growth and economic development

     

    1. Import substitution

    • Inward-oriented strategy where a developing country should produce good domestically rather than import them.

    ●       Conditions of import substitution

    • Government needs to adopt a policy of organization selection of products that should be produced domestically.
    • Subsidies are available to encourage domestic firms.
    • Government needs to implement protectionist measures to keep out foreign imports in the economy.

     

    ●       Advantages:

    • Protects jobs in the domestic market.
    • Isolating the economy from foreign influence → Protects local culture and social habits of the country.
    • Protects the economy from the power of multinational corporations.

    ●       Disadvantages:

    • Only protects jobs in the short run. In the long run, lower economic growth → Lack of job creations.
    • Doesn’t enjoy benefits to be gained from comparative advantage → Production is relatively inefficient.
    • Lack of encouragement for research and development → Inefficiencies in domestic industries.
    • Cause other countries to take retaliatory protectionist measures.

     

    2. Export promotion

    • Outward-oriented approach, concentrating on increasing export revenue as a leading factor of aggregate demand in an economy.
    • Increasing exports → Increases GDP → Higher incomes → Growth in domestic and exporting industries.

    ●       Conditions of export promotion

    • Open up domestic markets to foreign competition to gain access to foreign markets.
    • Reduce restrictions on FDI.
    • Floating exchange rate.
    • Investment in provision of infrastructure to enable trade to take place.
    • Deregulation and minimal government intervention.

    ●       Advantages:

    • Most developing countries depend on exports of primary products → Increases their GDP → Helps with economic growth.
    • Increase in manufacturing exports → Comparative advantage on low-cost labor.
    • Economic growth led to economies going from labor intensive production method with low skilled labor to capital intensive production method for sophisticated products and specialized workers.

    ●       Disadvantages:

    • Increased protectionism against manufactured products in developing countries → → Forces exporting industries to export primary products and low skilled manufactured goods instead of export processed goods and assembled products.
    • Fear that MNCs would take too much power into the economy of the country.
    • Increase income inequality.

    3. Trade liberalization

    • Removal/reduction of trade barriers that block free trade of products between countries.
    • Elimination of tariff barriers, quotas, export subsidies, administrative legislation.
    • Trade liberalization → Increase world trade → Comparative advantage on products in developing countries.
    • MNCs tend to earn high profits but workers earn very little → Trade liberalization → Economic crises and increased debt → Increased income inequality + Exploitative working conditions.

     

    4. Bilateral and regional preferential trade agreements

    • More bilateral and regional PTAs → Greater the ability of developing countries to trade → Economic growth and development.

     

    5. Diversification

    • Many countries are pursuing export diversification as one method of economic growth.
    • Aim is to move from primary sector to secondary sector → Protects themselves from price volatility to stabilize/increase export revenues and employment + Increased use of technology and demand for high-skilled labor.
    • Tariff escalation and highly qualified workforce can be a problem for export diversification due to making sophisticated products.