Trade Policies for Developing Countries Chapter 14: Trade Policies for Developing Countries

Growth Rates, 1990-2012, and Levels of Income Per Capita, 2012 © 2016 McGraw-Hill Education. All Rights Reserved.

Trade Policy Alternatives for a Developing Country Focus on exporting primary products Attempt to raise the world prices of primary products that are exported Protect and encourage new industries that produce products sold into the local market Encourage new industries that produce products that are exported © 2016 McGraw-Hill Education. All Rights Reserved.

Which Trade Policy for Developing Countries? Exports of goods and services are about 37% of GDP in developing countries, vs. 28% for developed countries Developing countries are the source of about 46% of all world exports About 42% of exports by developing countries go to industrialized countries, but these are only about 38% of industrial-country imports © 2016 McGraw-Hill Education. All Rights Reserved.

Which Trade Policy for Developing Countries? What role can trade and trade policy play in development process? How can trade and trade policy be used to boost incomes and economic growth in poor countries? Many developing countries have comparative advantage based on land and in various natural resources in the ground Developing countries also have a comparative advantage based on less-skilled labor What should the government of a developing country do about imports and exports to promote economic growth and promote higher standard of living for its people? © 2016 McGraw-Hill Education. All Rights Reserved.

Which Trade Policy for Developing Countries? In choosing a trade policy, should a developing country just use standard analysis of international trade, or are developing countries different and need a separate trade policy analysis? The pros and cons of restricting or subsidizing trade are the same, and specificity rule still applies. One difference is the degree of emphasis put on various policy alternatives. © 2016 McGraw-Hill Education. All Rights Reserved.

Challenges Faced by Developing Countries Another difference is in factor input markets. Capital markets work less efficiently in many developing countries in channeling money to the most productive uses. Labor markets work less efficiently in many developing countries where the wage gap between expanding and declining sectors are greater than in high-income countries, providing a clue that some labor is kept from moving to its most productive use. © 2016 McGraw-Hill Education. All Rights Reserved.

Are the Long-Run Price Trend Against Primary Producers? Many developing countries have exports concentrated in one or a few primary products like petroleum, coffee, cotton, gold, sugar, timber, diamond, and bauxite/aluminum. Raul Prebisch and others have argued that adverse price trends for primary products trap these developing countries into declining incomes relative to incomes in industrialized countries. © 2016 McGraw-Hill Education. All Rights Reserved.

Are the Long-Run Price Trend Against Primary Producers? Forces depressing primary product prices: Engel’s law: Income elasticity of demand for food is less than 1. As global per capita income rises, demand shifts toward luxury goods and away from staples. If world’s supply expands at the same rate for all products, the relative price of foods (and other primary products) are expected to fall. Synthetic substitutes: The more technology advances, the more likely to discover ways to replace minerals and other raw materials with new man-made substitutes. Again, demand shifts away from primary products. © 2016 McGraw-Hill Education. All Rights Reserved.

Are the Long-Run Price Trend Against Primary Producers? Forces raising the price of primary products: Nature’s limits. The supply of primary products grows relatively slowly, tending to raise primary product prices. Relatively slow productivity growth in the primary sector vs. the manufactured sector. Again, the supply of primary products tends to grow relatively slowly. © 2016 McGraw-Hill Education. All Rights Reserved.

The Relative Price of Primary Products, 1900-2013 All primaries/manufactures All nonfuel primaries/manufactures © 2016 McGraw-Hill Education. All Rights Reserved.

The Relative Price of Primary Products, 1900-2013 © 2016 McGraw-Hill Education. All Rights Reserved.

International Cartels to Raise Primary-Product Prices How big could the cartel opportunity be? That is, if a group of nations or firms were to form a cartel, as OPEC did, what is the greatest amount of gain they could reap at the expense of their buyers and world efficiency? If all of the cartel members could agree on simply maximizing their collective gain, they would behave as though they were a perfectly unified profit-maximizing monopolist. © 2016 McGraw-Hill Education. All Rights Reserved.

Classic Monopoly as an Extreme Model for Cartels The cartel members acting as a monopoly would try to find the price level that would maximize the gap between their total export sales revenues and their total costs of producing exports. © 2016 McGraw-Hill Education. All Rights Reserved.

A Cartel as a Profit Maximizing Monopoly © 2016 McGraw-Hill Education. All Rights Reserved.

What Determines the Cartel Price? The higher the marginal cost of production, the higher the price. The higher the elasticity of demand, the lower the price. If demand is elastic, buyers easily find other ways of spending their money if the product price rises much. © 2016 McGraw-Hill Education. All Rights Reserved.

What Determines the Cartel Price? Even a well-functioning cartel usually does not control all of the world’s production. If it doesn’t, then we have two more influences: 3. The larger the share of world production controlled by the cartel, the higher the price. Controlling more of the world production effectively increases the demand for the cartel’s production (rather than having this demand lost to outside producers). 4. The larger the elasticity of supply of noncartel producers, the lower the price. The cartel refrains from raising the price too much because doing so results in too large a loss of its own sales. © 2016 McGraw-Hill Education. All Rights Reserved.

The Erosion of Cartel Power Sagging demand: long-run demand for curve for imports is more elastic than the short–run demand curve New competing supply: search for additional supplies in non-cartel countries Declining market share: the cartel’s world market share usually falls over time Cheating by cartel members © 2016 McGraw-Hill Education. All Rights Reserved.

Import-Substituting Industrialization (ISI) at Its Best The infant industry argument with its legitimate emphasis on the economic and social side benefits from industrialization. The developing government argument: the government can get much-needed revenue from tariffs. For a large country, or a large organization of countries, replacing imports can bring better terms-of-trade effects than expansion of export industries. Replacing existing imports of manufactures is a way of using cheap and convenient market information. © 2016 McGraw-Hill Education. All Rights Reserved.

Actual experience with ISI Deadweight losses from resource misallocation. Governments often are slow to stop protecting local industries that remain inefficient (“do not grow up”). Developing countries shifting to more outward oriented or freer-trade policies have grown more quickly. Examples include the Four Tigers (South Korea, Taiwan, Singapore, Hong Kong), China, and India. © 2016 McGraw-Hill Education. All Rights Reserved.

Exports of Manufactures to Industrial Countries Developing countries have been able to become exporters in standardized manufacturing lines where technological progress has cooled down, such as textiles, tires, and simple electrical appliances. Developing countries have become locations for low-cost assembly of more technologically advanced products like computers, with multinational firms from the industrialized countries providing the advanced technology, the components, and the marketing and distribution of the finished products. © 2016 McGraw-Hill Education. All Rights Reserved.

Exports of Manufactures to Industrial Countries Industrialized countries have imposed barriers to imports of some manufactured products from developing countries. New country-specific barriers like antidumping duties and countervailing duties can limit export increases from already successful developing countries. Such country-specific barriers do not limit exports of manufactured products from new exporting countries. © 2016 McGraw-Hill Education. All Rights Reserved.

The Changing Mix of Exports from Developing Countries, 1970-2012   1970 1980 1990 2000 2012 Nonfuel primary products 49.90% 18.70% 11.50% 14.60% Fuels 32.4 61.3 27.5 21.4 28 Manufactures 17.4 18.5 52.9 65.5 56.1 © 2016 McGraw-Hill Education. All Rights Reserved.