1. International Trade and Economic Growth
Chapter 10
International Trade and Economic Growth

2. Topics to be Covered Trade and Development Trade and Growth
Trade and Growth: Some Additional Comments
International Flows of Factors

3. Economic Growth
An economy is said to grow when its total real output or gross domestic product (GDP) rises.
Per capita GDP is a measure of a country’s standard of living. For standard of living to rise over time, GDP must grow faster than the population.
Solow growth model: 𝑌=𝐴 𝐾^𝛼 𝐿^(1−𝛼)
The share of labour in the total output is always higher than capital.
The values of 𝛼 and (1−𝛼) as mentioned in the original Cobb-Douglas production function are 0.75 for labour share and 0.25 for capital share (Cobb, and Douglas 1928) but these always vary for each country concerned because of different production functions based on the labour and capital intensiveness.
These share are almost stable over the longer period around 0.6 or 0.7 for labour and 0.3 or 0.4 for capital as Dettori, Marrocu and Paci (2012) have already confirmed.
Jorgenson, and Stiroh (2000) have considered the procedure for output calculation and future growth projections as adopted by the Congressional Budgetary Office (CBO), whereby the production function opted by CBO considers capital and labour share at 0.3 and 0.7 respectively.

4. Economic Development
Economic Development—refers to the achievement of a quality of life for the average citizen of a country
Economic development is characterized by:
High levels of consumption
Broad-based educational achievement
Adequate housing
Access to high-quality health care, etc.
Economic growth is essential for economic development.

5. Strategies for Economic Development
Primary Export-led Development Strategy
Import-Substitution Development Strategy
Outward-looking Development Strategy

6. Primary Export-Led Development Strategy
This strategy involves policies designed to exploit natural comparative advantage by increasing production of a few export goods based on natural endowment resources.
Country examples include
Columbia: coffee
Mexico and Nigeria: petroleum
Malaysia: rubber

7. Advantages of Primary Export-led Development Strategy
This strategy would encourage more intensive use of existing abundant resources.
It could help attract foreign investment.
It may provide linkage effects (backward and forward) to other industries as a result of one industry expanding.
Cotton industry  Textile industry  Clothing industry
(Backward linkage effect) (Forward linkage effect)
Backward linkages can be defined as "the growth of an industry leads to the growth of the industries that supply inputs to it". Forward linkages exist when the growth of an industry leads to the growth of other industries that uses its output as input.

8. Arguments Against Primary Export-led Strategy
The world markets for primary products do not grow fast enough to support this type of development.
The prices of primary products relative to the prices of manufactured goods will tend to fall over time due to sluggish demand or oversupply.

9. Terms of Trade of Developing Countries
Refer to Figure 10.1
Terms of trade of oil exporting countries have experienced sharp increases; non-oil exporters have more stable, albeit declining, terms of trade.
A group of countries with market power can improve its terms of trade by restricting supply.
The declining terms of trade of non-oil exporters is more likely due to policies of other developing countries (i.e., OPEC)
Note that two TOT downturns coincided with oil shocks

10. FIGURE 10.1 Terms of Trade of Developing Countries

11. Import-Substitution Development Strategy
These policies are designed to promote rapid industrialization by setting high trade barriers to a specific industry (for instance, consumer goods).
Because of low tariffs to capital goods, imported capital goods can be used extensively in local production.
A good example of import-substitution development strategy is infant industry argument.

12. Arguments Against Import-substitution Strategy
The high barriers to trade rarely come down.
This strategy limits the development of industries that supply inputs to the protected industries  Stakeholders of protected industries (usually consumer goods) are against the gov’t policies aiming to increase the costs of their inputs.
The problem of picking winners  Officials are easily bribed.

13. Outward-Looking Development Strategy
These policies involve government supporting for manufacturing sectors in which the country has potential comparative advantage.
Well endowed with low-skilled labor  Encouraging the low-skilled labor-intensive industries
Successful cases include Japan, Korea, Singapore, Taiwan and recently China.

14. Trade and Growth
Economic growth is shown graphically as an outward shift of the country’s production possibility frontier (PPF).
Since growth affects both production and consumption, then it also affects international trade.

15. Graphical Analysis: An Economy Before Growth Occurs
Refer to Figure 10.2
Given PPF and terms of trade line, show:
Equilibrium production point
Equilibrium consumption point
Slope of PR (production ratio) line indicates the initial ratio of production of the two goods
Slope of CR (consumption ratio) line represents the ratio in which the two goods are consumed

16. FIGURE 10.2 Patterns of Production and Consumption with Neutral Growth

17. Neutral Economic Growth
A proportionate increase in all resources and consumption so that trade also expands proportionately to the growth of the economy.
After growth, the economy continues to produce and consume the two goods in the same ratios as before growth (refer to Figure 10.2).

18. Conditions Necessary for Neutral Growth
Graphically, the new production possibility frontier (PPF) must be a proportionate expansion of the old PPF.
The PPF preserves its original shape as it becomes larger
Consumption of both goods must increase by the same proportion as income increases.
In other words, the income elasticity of demand for both goods must be equal.
See Table 10.1 for example.

19. TABLE 10.1 Example of Neutral Economic Growth

20. Other Types of Growth
Protrade Biased Growth
Antitrade Biased Growth

21. Protrade Biased Growth
When the resource used intensively in the production of export goods increases, then the output of export goods will rise relative to production of import goods.
And international trade will expand by more than the rate of growth of GDP. This is called protrade biased growth (refer to Figure 10.3 and Table 10.2).
Graphically, the PR line rotates away from the CR line.

22. FIGURE 10.3 Location of Production Following Protrade Biased Growth

23. TABLE 10.2 Example of Protrade Biased Growth

24. Antitrade Biased Growth
When the resource used intensively in the production of import goods increases, then the output of import goods will rise relative to the output of export goods.
And the international trade of this country will fall. This is antitrade biased growth (refer to Table 10.3).
Graphically, the PR line rotates toward the CR line indicating a tendency toward autarky.

25. TABLE 10.3 Example of Antitrade Biased Growth

26. Technological Change Technological (technical) change occurs
when the same amount of output can be produced with fewer inputs, or
when the same amount of inputs can produce greater amounts of output.

27. Types of Technological Change
Neutral technological change—an innovation that results in an equi-proportionate reduction in the use of all factors to produce a one unit of output.
Labor-saving (capital-saving) technological change—an innovation that leads to a reduction in the use of labor (capital) relative to other factors to produce a one unit of output.

28. Industry Effects of Technical Change
If neutral technical progress occurs in one industry instead of economy wide, the output of that industry will increase at the expense of the other.
If technical progress allows an industry to save on the use of the factor it uses less intensively, then the output of that industry could rise or fall.
Innovation lowers costs of that industry  Output expand
The output of the other industry must rise to absorb the “saved” factors  Recall the Rybczynski theorem
※ Rybczynski Theorem: If a country experiences an increase in the supply of one factor, it will produce more of the product whose production is intensive in that factor and less of the other.

29. Economic Growth and Terms of Trade for a Large Country
With neutral economic growth, the terms of trade of the large country will tend to fall as the country grows.
Protrade biased growth will cause the terms of trade to deteriorate more than under neutral growth.
Antitrade biased growth will lead to an improvement in the terms of trade.

30. Immizerizing Growth
Immizerizing Growth—growth that results in a reduction of the country’s welfare level.
Bhagwati (1958): Economic growth can possibly make a country worse off.
Refer to Figure 10.4.
Strong protrade biased growth  PPF shifts out along the S axis and produce more of exporting goods  Inelastic demand for that good lowers the price  TOT falls  low welfare level

31. FIGURE 10.4 Immizerizing Growth

32. Is Immizerizing Growth Common?
No, because:
Precise conditions on both the nature of growth and world demand must hold.
The country is large enough with strong protrade biased growth
Inelastic demand for goods exported
Government policy (e.g., imposing an export tariff) can be used to counteract the negative effects of growth.

33. Dutch Disease
Causal relationship b/w growth of a specific sector (natural resources) and a decline in other sectors (manufacturing sector or agriculture).
Example of the Dutch disease
In the 1960s, natural gas was discovered in the Netherlands
Adopted energy-intensive production techniques and overall wage rates rise
After two oil-price shocks, higher energy costs coupled with higher wages forced some manufacturing industries out of business and other sectors caught the disease also