ECON-313 INTERNATIONAL ECONOMICS

Trade Policy in Developing EconomiesBulent Temel www.bulenttemel.com

Learning points

. How did developing economies develop in the 20th Century?

. How should they develop in the 21st?

. What is import-substitution policy, infant industry argument, export-orientation, free trade?

How did developing econs develop?

M-substitution X-orientation Free trade

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1945 1965 1980 2012

Import substitution

= Protecting domestic manufacturing sector against foreign competitors until they become internationally competitive (Infant industry argument)

How to protect?

. Increasing tariffs

. Import quotas

. Regulations on imports

. Subsidies to manufacturers

. Exchange rate controls

Tariffs

= Taxes on imports

Impact: More expensive importproducts → More chances for cheaper products

Import quotas

= Restricting the volume that can be sold in the domestic market

Impact: Larger unsatisfied local demand for domestic producers → Larger market share

Regulations on imports

= Environmental, economic and health related rules and laws imposed on import products

Impact: Fewer foreign products qualify → Larger market for domestic producers

Subsidies to manufacturers= Providing capital or reducing

tax rates for domestic manufacturers

Impact: Domestic manufacturers can cut their prices and become more competitive against foreign competitors

Exchange rate controls

= Fixing the value of local currency at a low level

Impact: Foreign (domestic) products remain expensive (cheaper) for domestic (foreign) consumers → Smaller imports, larger exports

The role of ¥/$ exchange rate in China-US economic relations

http://www.youtube.com/watch?v=XnAT7FZpmg0

An example of change rate controls to boost trade

China. (Yuan/$ rate was pegged fordecades)

Impact: Chinese products that remained very cheap for American consumers dominatedthe US econ.

Why protect?1) In dvlping econs, capital

markets may be imperfect (they don’t provide venture capital)

2) Appropriatibility problem (First investment requires high costs like infrastructure that followers will not pay for)

Problems with import substitution1) Investing in a capital-intensive

industry may be premature in a labor-intensive econ → High opportunity cost

2) Wrong industries can be protected → National resources are wasted on industries that did not need help

Problems with import substitution3) Protection ↛ Competitive manuf

sector Competitiveness: f(Entrepreneurship, skilled labor, mgmt competence, ...)

4) Protection ↛ ↘ Motivation to improve efficiency → Higher domestic prices than import prices

Problems with import substitution5) In dvlpng econs, dom markets

may be too small to allow scale econ or profitable competition (→ Expensive and low quality dom products)

Q: Restricting imports = Restricting exports?

1965+: Export-based manuf.

= Restrict imports, and manufacture to export to developed econs.

By: ↗ tariffs, ↗ quotas, ↗ X subsidies.

1965+: Export-based manuf.

Ex: HPAEs (High Performance Asian Econs) = 60s+: HK, Taiw, Singap, S Korea; 70s+: Malay, Thai, Indon; 80s+ China.

Avg growth: 8-9% betw 1965-1997

In HK & Sing: Exports > GDP

South Korean GDP (1910-2010)

1980s+ Neoliberalism

= ↘ protection, ↘ regulations

Impact: ↗ int trade, dvlpngs exported more manuf goods and less agric/mining prs.

Outcome: Some grew faster, some slower. Income inequality and corruption ↗ in all.

Free trade vs. protectionism debate http://

www.youtube.com/watch?v=6qqG6OurHaM

Conclusion

Recipe for growth in dvlping econs in a globalized word today:

. Save

. Invest in educ.

. Buy domestic

. Maximize X

. Minimize M(cheap, locally unavailable inputs

only)

Why?

Savings → ↗ $ in fin system →↘ Lower cost of borrowing → ↗ Investments, growth,employment

Why?

Investments in education → (Cost of doing so < Returns from it in terms of efficiency and effectiveness)

Why?

Buying domestic → ↗ $ stays in dom

econ → ↗ Effective demand → ↗ Inv,

growth, employment

Example:

If your consumption decision allows $0.25

to stay in domestic econ, and everyonespends 80% of their income to domesticgoods and services...

Then, your decisionleads to creation of $1.14 in effective demand.

Why?

Maximal exports→ 1) Maximal markets (TR pop:

70 Million, World: 7 Billion)2) Access to faster growing

economies (Poland’s growth rate: 4%, but China’s: 10%)

Why?

Imports = National resources shifting abroad

Justifiable only if it is for cheaper, locally unattainable inputs

Should be minimized when it is for consumption (final goods)

Controlled trade argument: http://

www.bulenttemel.com/uploads/5/9/8/7/5987355/cagdas_kalkinma.pdf

Uncontrolled (free) trade argument: http://

www.youtube.com/watch?annotation_id=annotation_726592&feature=iv&src_vid=6qqG6OurHaM&v=J5maguX5x8c

Further thinking