Trade & Development I: Import Substitution Industrialization International Political Economy Prof. Tyson Roberts

Brief history globalization & development Mercantilism (1500s-1700s) – Globalization through empire – Imperial goal: amass the most gold – Subsidize exports, tax imports Classical liberalism (1800s– early 1900s ) – Increasing free trade promoted by Britain hegemon – Continued promotion of trade within empires

How globalization helps developing countries according to classical liberalism 1 st Age of Globalization Free trade: poor countries specialize in comparative advantage (e.g., agriculture) & import other products (e.g., manufactures) Free flow of labor: workers move from labor- abundant to labor-scarce economies => wages  Free flow of capital: capital flows freely from capital- rich to capital scarce countries => investment, development

Example 1: Argentina in 1800s Economically backward compared to Britain Land abundant Labor scarce What should we predict regarding policy preferences of each group, and the resulting political coalitions?

Commerce and Coalitions 1 st Age of Globalization (increasing free trade) Labor scarce relative to Land Labor abundant relative to Land Capital rich (Developed countries) Capitalists & Landowners for trade Labor against Capital & Labor for trade Landowners against Capital scarce (LDCs) Landowners for trade Labor & Capitalists against Labor for trade Landowners & Capitalists against 5

Commerce and Coalitions 1 st Age of Globalization (increasing free trade) Labor scarce relative to Land Labor abundant relative to Land Capital rich (Developed countries) Capitalists & Landowners for trade Labor against Capital & Labor for trade Landowners against Capital scarce (LDCs) Landowners for trade Labor & Capitalists against Labor for trade Landowners & Capitalists against 6 Argentina

In 1800s, Latin America ruled by landowners; much of Asia & Africa ruled by empires Collective Action Cost HighLow Factors Mobile & Majoritarian Inst. (e.g., democracy, not oligarchy) Rampant free riding No trade policy coalitions Exit (?) Rogowski Factors Mobile & Non-maj. Inst. (e.g., oligarchy) Rampant free riding Trade policy coalitions Exit (?) Class-based coalitions possible, but not necessary for victory Factors Specific & Majoritarian Inst. Individual interest groups unable to affect trade policy Consumer groups inactive Universalistic logroll (?) Cross sector coalitions (logrolling) or coalitions with labor Consumer groups active Factor Specific & Non-maj. Inst. Standard trade policy Model (Pareto,Olson, etc) Lobbying for protection Consumer groups inactive Cross sector coalitions (logrolling) or coalitions with labor possible, but not necessary for victory Consumer groups active

Brief history globalization & development Mercantilism (1500s-1700s) – Globalization through empire – Imperial goal: amass the most gold – Subsidize exports, tax imports Classical liberalism (1800s– early 1900s ) – Increasing free trade promoted by Britain hegemon – Continued promotion of trade within empires World Wars & interwar period ( ) – Breakdown of free trade system, nationalist, fascist & communist movements

Crisis: WWI & Great Depression War => increased demand for labor => increased power of labor in economics (unions) and politics (votes) (esp. in sovereign nations) British Navy no longer strong enough to enforce free trade policies in developing countries Rich and poor countries respond to crisis by imposing controls on trade, capital, immigration Communists & Fascists extremely protectionist

War => increased demand for labor => increased power of labor in economics and politics (votes) Collective Action Cost HighLow Factors Mobile & Majoritarian Inst. (e.g., democracy, not oligarchy) Rampant free riding No trade policy coalitions Exit (?) Rogowski Factors Mobile & Non-maj. Inst. (e.g., oligarchy) Rampant free riding Trade policy coalitions Exit (?) Class-based coalitions possible, but not necessary for victory Factors Specific & Majoritarian Inst. Individual interest groups unable to affect trade policy Consumer groups inactive Universalistic logroll (?) Cross sector coalitions (logrolling) or coalitions with labor Consumer groups active Factor Specific & Non-maj. Inst. Standard trade policy Model (Pareto,Olson, etc) Lobbying for protection Consumer groups inactive Cross sector coalitions (logrolling) or coalitions with labor possible, but not necessary for victory Consumer groups active

Example 2: Argentina in 1930s Economically backward compared to Britain Land abundant Labor scarce What should we predict regarding policy preferences of each group, and the resulting political coalitions?

Commerce and Coalitions Depression of the 1930s (increasing protectionism) Labor scarce relative to Land Labor abundant relative to Land Capital rich (Developed countries) Capitalists & Landowners for trade Labor against Capital & Labor for trade Landowners against Capital scarce (LDCs) Landowners for trade Labor & Capitalists against Labor for trade Landowners & Capitalists against 12

Commerce and Coalitions Depression of the 1930s (increasing protectionism) Labor scarce relative to Land Labor abundant relative to Land Capital rich (Developed countries) Capitalists & Landowners for trade Labor against Capital & Labor for trade Landowners against Capital scarce (LDCs) Landowners for trade Labor & Capitalists against Labor for trade Landowners & Capitalists against Asian & East European Fascism W. European Fasicism United States: New Deal South American Populism 13

Argentina 1940s-1950s Juan Peron rises to power with support of labor, industrialists (import competing sectors) and military Implements import substitution industrialization policies

ANr8 ANr8

Structuralist Critique of Economic Liberalism Market imperfections in developing countries – Industrialization in modern era requires coordination Complementary demand: need critical mass of wage workers to buy manufactured products Pecuniary external demand: need related industries to invest simultaneously

Coordination Problem Electricity Firm Invest in DamDon’t invest ManufacturerInvest in factory10, 10-5, 0 Don’t invest0, -50, 0

Coordination Problem Electricity Firm Invest in DamDon’t invest ManufacturerInvest in factory10, 10-5, 0 Don’t invest0, -50, 0

Solution to coordination problem: “Big Push” by Government Volta Dam, Ghana Major electricity producer Valco aluminum smelter Major electricity user

Structuralist Critique of Economic Liberalism Market imperfections in developing countries – Industrialization in modern era requires coordination – Declining terms of trade Imported manufactures prices rise Export commodity prices fall Result: core country real incomes rise, periphery country real incomes fall

Solution to Declining Terms of Trade Problem: ISI 1.Easy ISI: – Promote local production of consumer goods Sufficient local demand to enable economies of scale Sufficient local labor for labor intensive production Necessary technology available for import (in part in form of foreign capital: machines, etc.) Benefits: wage-based employment, human capital

Solution to Declining Terms of Trade Problem: ISI 1.Easy ISI 2.Second step options – Secondary ISI Move up to consumer durables (cars, etc.), intermediate inputs (steel, etc.), and capital goods (machines, etc.) Common in Latin America, South Asia, etc. – Export substitution Expand consumer good production for export Common in some East Asian countries

ISI Policies Government planning (5-year plans, etc.) Government investment – Roads, rail, electricity, telecom, etc. – State-owned & mixed-ownership enterprises Trade barriers – Tariffs (on manufactured goods) – Import quotas (on manufactured goods) – Overvalued and/or multitiered exchange rates to enable import of capital goods

Sources of funds for investment Foreign aid Foreign borrowing Taxes on agricultural exports (marketing boards) Tariffs on imports

$2 $1

Winners & Losers from ISI Policies Winners Workers & firms in import- competing industries – Higher market share & prices for produced goods Government – Jobs, opportunities for rent- seeking Urban residents – Subsidized government services Losers Export-oriented farmers – Lower producer prices => reduced production Consumers – Higher prices for manufactured goods Manufacturers in export- oriented industries (if any) – Overvalued exchange rates increase price of exports, etc.

Assume the world equilibrium price for cocoa is $2. How much would Ghana cocoa farmers be willing to produce? Price of cocoa SCSC DCDC Quantity of Ghanaian Cocoa

Assume the world equilibrium price for cocoa is $2. How much would Ghana cocoa farmers be willing to produce? Price of cocoa SCSC DCDC Quantity of Ghanaian Cocoa

How would cocoa farmers respond if the government sets the producer price at $1? Price of cocoa SCSC DCDC Quantity of Cocoa

How would cocoa farmers respond if the government sets the producer price at $1? Price of cocoa SCSC DCDC Quantity of Cocoa

ISI policies successfully promoted industrialization & GDP growth in 60s & 70s GDP/capita growth 1960s & 70s Latin America2.3% Sub-Saharan Africa1.4% Middle East & N. Africa3.7% East Asia5.2 % South Asia1.2% Southeast Asia3.1% But for most countries (all but East Asia), those growth rates would not prove sustainable…

Conclusions International and domestic developments and new belief systems => ISI Policies – World Wars & Depression strengthened relatively scarce factor owners – Political changes strengthened workers, domestic industrialists, urban voters, etc. – Marxism, Structuralist critique of economic liberalism, etc.

Conclusions ISI policies increased industrialization & GDP growth, but … Urban workers & industrialists benefitted to detriment of export-oriented farmers Governments (esp. in “weak states”) took advantage of rent-seeking opportunities to over- extend protection of inefficient manufacturers Budget & trade deficits left countries exposed to global downturn