International Trade

1. International Trade Mgmt. 418 Assoc. Prof. Dr. Şule Lokmanoğlu Aker

2. Chapter 18 International Trade and the Developing Countries

3. Developing countries in the world economy • They are more then ¾ of the world population, and yet they account for les than ¼ of world’s production and income. • They are not a homogenous group. There are many differences among them in levels of income, type of industrial structure, degree of participation in international trade, anf types of problems face in the world economy.

4. Economic and non-economic characteristics of developing countries and high-income countries: Low income Lower-middle Upper-middle High income income income Pop. 3,182.2 (mill) 1,096.9 472.8 849.9 GNP/capita $3801,590 4,640 23,420 Growth 3.4% -1.2 1.4 1.9 Inflation 59.0% 326.4 347.1 2.5 Labor in Agr. 69% 36 21 5 Urban Pop. 28% 56 64 76 Infant Mortality 58 36 36 7 Life 63 67 69 77 expectancy

5. World Bank categorization of countries • Low income countries – Annual per capita income is less than $725. • Lower-middle income countries – Per capita income is between $726-$2,900. • Upper-middle income countries – Per capita income is between $2,901-$8,955. • High-income countries – Per capita income is more than $8,955.

6. Characteristics of the international trade sector of developing countries and high-income countries: Low income Middle income Upper-middle High income income Export Growth 9.1% 7.0 7.8 5.1 Import Growth 13.0% 9.8 10.4 4.6 Primary Product X 38% 51 48 18 Manufactured Goods X 62% 49 53 82 Primary Product I 27% 27 26 25 Manufactured Goods I 74% 73 74 76 International reserves monthly covering İmports 5 months 3.1 3.8 2.6

7. Most of the developing countries can be characterized as; • Having low per capita incomes, • Relatively high inflation rates, • Relatively low percentage of their population in urban areas, • Higher percentage of the labor force in the agricultural sector, • High infant mortality, • Lower expectancy of life, • Higher per capita income growth rate, • Higher ratio of primary products to manufactured goods in their export bundles than in their import bundles.

8. The role of trade in fostering economic development There are both static and dynamic effects of trade on economic development. A goverment with economic and trade policies must meet the needs of its citizens.

9. The static effect of trade policy on economic development If a country can export relatively cheaper domestic products and import relatively cheaper imports, the country can increase efficiency. However it is not happening, because it is not easy to move factors of production from one sector to the other. Adjustment process is not happening or happening slowly. Imports can bring two benefits; quality for the consumers, and/or productivity in the case of intermediate and capital inputs.

10. Static impact of trade on production • It occurs when the economy produces more of the export good through specialization and through expanding the production using more of the abundant factor of production in the country. • In most of the developing countries it results in expanding the labor-intensive sectors, insead of expanding more modern, capital-intensive sectors. It means expanding traditional agriculture, primary goods, and labor-intensive manufactures.

11. Desirability of growth in the production of traditional goods, agriculture, and labor-intensive manufacturers: • Not desirable if this development is at the expense of modern manufacturing. • Not desirable if it halts technological development. • Most of these goods have low income and price elasticities of demand. • Supply of these products are unstable due to factors such as weather conditions. • If the country largely produces for exports, it will lead to undesirabe terms-of-trade effects that will reduce the country’s gains from trade (the developed country will gain). • Importing manufactured goods from developed countries, and exporting primary products to developing countries will increase the developing countries dependency on developed countries for manufactured products.

12. The dynamic effects of trade on development • On the positive side; • The developing coutries achieve economies of scale as they increase production for exporting rather than producing only for the limited domestic market. • They achieve international competitiveness which they may not have in an isolated domestic market. • Because comparative advantages change over time, industries in developing countries that became part of that system can adapt and benefit from the changes international trade. • They benefit from the positive antitrust effects of trade. • Increased investments as a result of changes in the international economic environment. • They benefit from the increased dissemination of technology into the developing country (eg. Product life-cycle). • Exposure to new and different products. • Changes in institutions that accompany the increased exposure to different countries, cultures, and products.

13. The dynamic effects of trade on development • On the negative side; • Trade may hinder economic development, because the country starts producing for exports and may stay behind for the needs of the country. • Producing for exports may create negative externalities, like pollution. • Production in some subsidiaries may contribute little to the domestic economy, if raw materials, and some inputs are imported, and than product is exported. • International trade can lead to export instability. Export instability refers to the situation where export earnings fluctuate more for developing countries than for industrialized countries. With high degree of openness (international trade/GDP), fluctuations in export earnings bring about instability in GDP. • LT terms-of-trade deterioration. It refers to the situation where terms of trade (price of exports/price of imports) to fall for developing countries.

14. The causes of export instability There are three reasons for export instability. All three are associated with the fact that developing countries export mainly primary products. • They have inelastic supply curve for exports. • They have inelastic demand for their exports. • They have high degree of commodity concentration in the export bundle. This lack diversification can cause fluctuations in export earnings. Eg. Saudi Arabia, in petroleum (86% of X), Zambia, copper (56% of X), Uganda, Coffee (21% of X), Guyana, raw sugar (28% of X), Cote d’Ivoire, Cocoa, (42% of X).

15. Long –run terms-of-trade deterioration The terms-of-trade have been improving for industrialized countries (ICs), at the expense of the developing countries (LDCs). The international trade is transferring real income from LDCs to ICs. Prebisch-Singer hypothesis pointed out that TOT had dramatically risen for Great Britain in the last 100 years. However, there are quality changes in products. Generally, the quality improvements have been greater in manufactured goods than in primary goods. So some economists insist that the LDCs are paying more, but they are buying high quality products. But it is true that there is long run relative decline in primary-product prices.

16. Differing income-elasticites of demand Another explanation for declining TOT for developing countries is differing income elasticities of demand for primary products and the manufactured goods. Studies show that income elasticities are higher for manufactured goods than for primary goods (more than 1.0 for manufactured products and less than 1.0 for primary products). Thus, as countries get richer, they pay more of their income for manufactured products, and less of their income on primary products. So TOT gets worse for LDCs. Prices of exports increase for ICs, and prices of imports go down. Visa versa for LDCs.

17. Unequal market power • Another explanation for TOT deterioration for LDCs is the unequal market power in product and factor markets in ICs and LDCs. Generally, primary products is sold in competitive markets, whereas manufactured goods are sold in imperfectly competitive markets setting higher prices for the goods sold. • Also, because of the existence of strong labor unions, wages and prices are set higher in ICs. • There may also be an asymmetry in price behaviour; primary-product prices are slow to rise in upswings in the business cycle, and they fall faster during down swings. However, manufactured-goods prices rise faster during upswings, and they are slow to fall during down swings.

18. Technical change • Technical change reduced the the growth rate of demand for the primary products, such as the synthetic rubber and fiber. • The technical change in ICs economized the use of raw materials in production, such as energy-saving technology, or solar energy. • ICs improved recycling and conservation.

19. Multinational corporations and transfer pricing MNCs send inputs to other subsidiaries, and they send the products to other subsidiaries, which is called intra-firm trade. The prices registered in intra-firm trade are not real prices (market prices). They price the goods in this trade in a way that it benefits the firm. Eg. Showing the profits lower. The intra-firm trade benefits the MNCs at the expense of LDCs.

20. Trade, economic growth, and development: an empirical evidence • Studies analyzing the link between export growth with growth in incomes found a strong positive link between the two and defined exports as “engine of growth”. • The link between trade (exports and imports) and income growth is less clear.

21. Trade policy and developing countries Trade policy can influence and promote economic growth in developing countries in three ways: (None of them have been very successful in practice) • Export stability • Terms-of-trade behaviour • Inward versus outward-looking development strategies

22. 1) Policies to stabilize export prices or export earnings • International buffer stock arrangement (eg. International Tin Agreement, which is currently inoperative) In 1974, at the UN, it was proposed that producing nations set up an international agency that would stabilize the prices of the commodities. If the world prices would fall down below the floor, the agency would buy the commodity to increase its price, and when the price rises above a ceiling, the agency would sell the commodity.

23. Continued... • International export quota agreement (eg. International Coffee Agreement) Association of Coffee Producing Countries was active between 1993-2002. In this agreement, the producing countries choose a target price for the good (eg. $2.5 per pound of coffee) and make the forecast for the demand in the coming year, and produce accordingly. The producing countries would have a quota, and no country would produce more than this quota not to reduce the target price. The price stability would be achieved if the forecast for the demand is correct.

24. Continued... • Compensatory financing is a mechanism to neutralize the effect of export instability. IMF, for example, would be giving loans to the developing country if the export earnings fall below the forecast level. Similarly, when the export earning rise above the forecast, the country would be paying back the loan.

25. Problems with international commodity Agreements • In a buffer stock agreement, it is difficult to set the ceiling prices and the floor prices. If the floor prices are too high, the agency would be purchasing the commodity and accumulating large quantities of the commodity. It would be difficult to unload it. • There are also forecasting difficulties with export quota agreements. If long run demand is weaker, then the prices would be less than predicted and suppliers will suffer from depressed prices. If the long run demand stronger, than the supplying countries would be losing the earning they otherwise would accumulate. • In export quota agreement, even if the demand is correctly forecasted, the members may not strictly follow the quotas allocated to them. So without full participation and and adequate enforcement, the agreement can not perform. • Not all the producers may participate in the agreement.

26. Problems... In short; without full participation and adequate enforcement procedures, export quota agreements will not perform a stabilizing function.

27. In the real world Primary goods prices have demonstrated considerable price instability, causing economic adjustment problems for the developing world. Eg, during 2000-2010, commodity prices have boomed and export earnings of countries like Peru and Chile, exporting copper, skyrocketed. Chilean Finance Minister Andres Velasco, saved $20 billion for the “rainy days”. This way, he also reduced the pressure on inflation. When copper prices started going down, these savings helped the citizens to continue their living standards, and public services. In 2009, Chilean Government started with a stimulus package, including infrastructure projects, housing construction, road construction, airport upgrading, tax breaks for the businesses.

28. To improve TOT • Export diversificationinto manufactured goods by the LDCs. However, it is not easy to implement, because it is difficult to change the production sysytem, use of inputs, the availability of necessary know-how and skills, etc. Long-term measures, such as increased education and training may be required. Many developing countries have increased the share of manufactured products in their exports.

29. Continued... • Export cartels can be formed by developing countries, such as OPEC. For export cartels to be successful; -all exporting countries must be part of the process, -there must not be strong substitution possibilities for the good in question, -the members of the agreement must not cheat on the agreement.

30. Continued... • Import and export restrictions may improve TOT in developing countries, imposing tariffs on certain imports, for example (assuming there will be no retaliation). It may deprive some LDCs from some necessary imports, like machinery, transport equipment, etc.

31. Continued... • Economic integration projects may lead to stronger economic units of developing countries. They can be in the form of free trade areas, customs union, or common markets. They can; *LDCs can avoid the TOT problem with ICs by increasing the trade among themselves, *they will have more market power in the world, *enlarged market size may stimulate investments, production of manufactured goods, and diversification. In recent decades, there are many regional integrations, like NAFTA, MERCOSUR, APEC, CARICOM, ANDEAN Pact, etc.

32. Inward-Looking versus Outward-Looking Trade Strategies • Inward-Looking strategy is an attempt to withdraw, at least in the short-run, from full participation in the world economy. It emphasizes import substitution (the production of goods at home that would otherwise be imported). This can economize on scarce FE and leads to production of manufactured goods at home. It uses tariffs, import quotas, and othe rmeasures to restrict imports.

33. Continued... • Outward-Looking Strategy emphasizes participation in international trade. The countries produce according to their comparative advantages, and the prices should not be distorted. Export promotion is part of the strategy whereby the governments can support exports by export subsidies, training the labor force, use of more advanced technology, tax breaks on producers of export goods, etc.

34. Trade strategy and economic performance • Strongly-outward-oriented-economy (few trade controls and floating currencies), eg, Hong Kong, S. Korea, Singapore. • Moderately-outward-oriented-economy (production slightly biased toward home market and ER slightly biased), eg, Brazil, Israel, Malaysia, Thailand. • Modertely-inward-oriented-economy (production for the home market rather than exports, and relatively high protection, and ER discouraging exports), eg, El Salvadore, Honduras, Kenya, Mexico, Nicaragua, the Philippines, Senegal, and Yugoslavia. • Strongly-inward-oriented-economy (incentives for import substitution), eg, Argentina, Bangladesh, Burundi, Dominican Republic, Ethiopia, Ghana, India, Peru, Sudan, Tanzania, and Zambia.

35. Trade strategies... The figures suggest that the economic performance of the countries with outward orientation is superior to these that are inward orientation in terms of; • Average growth rates, • Average per capita GNP rates, • Savings as a percentage of GDP, • Growth rates of manufactured exports, • More efficient capital use (lower quantities of capital use to get additional units of output)

36. Problems with outward-oriented trade strategies • Expansion of manufactured exports can run into protectionist barriers in ICs, eg, textiles. • Export path may require skills and large committment of resources.