1 Lecture 18 Don DeVoretz Trade as an “Engine of Growth’ Some Best and Worst Practices?

2 Case for Free Trade Empirical Evidence: 1990’s to present –China: trade related growth has reduced poverty –Asian Tigers, Trade as an “Engine of Growth” –India, Brazil and Russian Trade, FDI plus Domestic markets

3 Case Against Free Trade Empirical Evidence: Con 1990’s to present –Mexico: NAFTA and collapse of Peso Emigration and destabilization –Argentina: Dollarized economy Emigration and destabilization –Asian Tigers Capital Flight and collapse of economies

4 Overvalued Exchange Rates Why have most LDCs opted for Overvalued Exchange Rate ? –Overvalued exchange rates reduce price of Ms hope to get capital goods cheaper However, luxury items also cheaper –Consequence DUAL EXCHANGE RATES Argentina : two exchange rates: –overvalued for capital goods –undervalued for consumer goods Eventual devaluation

5 Some Indicators of Trouble Balance of Trade –Income and Price terms of Trade Balance of Payments –Capital Flight –Direction of FDI –Size of remittances –Aid

6 Strategy I: Devaluation What are consequences of a 10% devaluation ? 1. real wages fall by 5% 2. GDP falls by 1 to 4 % 3. inflation 1 to 10% 4. need 15 % rise in foreign aid to most countries to offset effects of devaluation ?

7 Corruption and Overvaluation

8 Foreign Aid:Facts 1960 to present : a. $1.6 trillion in foreign Aid b. 40 % of developing world gets about twice the aid as poorest. 2. ODA from OECD has actually increased in early 1980s by.5% per annum. 3. Case for Aid is close foreign exchange gap

9 Strategy II: Debt Repayment Buy-back debt: –issue new Bonds to pay for old bonds which are at 40 % of ace value. a. at what price? –is it wise for LDCs to simply buy back debt ?

10 Strategy III: Political Struggles Lobby DCs to a. lower effective rates of protection in DCs b. or supply special funds from IMF or multi-lateral banks c. debt forgiveness Loans from IMF and others on concessionary terms

11 Strategy IV: Restructuring ? Inward-looking commercial policies ? Ingredients: Low effective rate of protection –Nominal rate T= !(p’-p)/p! where p’ and p are unit prices with and without tariffs –Effective rate G=[(v’-v)/v](100) where v’ and v are value added with and without tariffs. –Effective rate can be positive or negative

12 Actual Effective rates CountryAverage Effective Rate Pakistan356 % India 69% Thailand 27 % –Singapore22 % –South Korea-1%

13 Perverse Effects of Effective Tariffs by Type of Good Developing countries have - high effective rates on final goods - low effective rates on intermediate and capital goods –Implications: –backward linkages can not develop –no development of a capital-goods industries using labour intensive techniques

14 Arguments For Tariff Protection Tariff duties are major source of revenue Import restrictions rebalance payments Reduce economic dependence Encourage foreign firms to come behind tariff wall - How have these arguments panned out in history ?

15 Outward-looking Policies Zero effective rates No quantity restrictions Convertible currencies Fluctuating exchange rates Membership in WTO: play by the rules ?

16 Trade Optimists Produces competition Increases efficiency, technical change Attracts foreign capital Generates foreign ex for food Ends rent-seeking and corruption Equal access to resources

17 Trade Pessimists High effective rates in developed countries Mfg. is oligopolistic Low income elasticity of demand for LDC products LDC exports grow slowly LDC terms of trade declining

18 End of Show