Chapter 12
International Trade and
Development Strategy
Basic Questions
1. How does trade affect rate, structure and character of
LDC economic growth?
2. Does trade serve as an engine of growth?
3. How does trade affect income distribution?
4. Should LDC’s adopt outward-looking trade policy?
Importance of Exports
Y = C + I + G + (E-M)
High levels of exports (relative to imports) have
generated high levels of growth in Japan, South Korea,
former Hong Kong and China.
Strategic export policy can provide a ‘big push’ to the
economy and lead the country out of the poverty cycle.
Importance of Exports
Country
Exports
as % of GDP
% share of
primary
products
Philippines
42
25
China
34
8
Indonesia
30
53
South Korea
36
9
India
12
30
15.5
10
Japan
13
8
US
7
18
Bangladesh
Role of Primary Products
Examples – Foodstuffs, rubber, vegetable oil, cotton, leather,
jute
1. Income elasticity is low when income rises in developed
countries, demand for primary goods increases slowly.
Foodstuffs 0.6% agricultural raw materials 0.5%. On
the other hand, demand for manufactured goods – 1.9%
2. Relative Price of primary goods declines in the long-run
3. Price elasticity is also very low
4. Supply of primary products is also inelastic
5. It causes instability of export earnings and volatile price
fluctuations.
Prebisch – Singer Thesis
 Px 
•Commodity terms of trade  P  is defined as the
 m
ratio of export price to import price
•According to Prebisch – Singer Thesis, there is a
secular (long-term) deterioration in commodity terms
of trade for primary goods. This is due to low price
and income elasticities
•Need for diversification to manufactured goods.
Trade Strategies
– Export Promotion vs Import substitution
• Outward-looking or export promotion policies followed
by Japan, South Korea, Taiwan, Singapore, Hong Kong
and China
- Emphasis on Free-Trade, less trade barriers, Free
movement of foreign capital
- Strategic policies of exports
- Export zones & export promotion
• Export promotion policies for primary as well as
manufactured goods
Problems of Export Promotion Policy
(1) Expanding primary goods – demand side
• Low income elasticity
• Low price elasticity
• Low population growth rates in developed countries
• Commodity agreements not very successful
• Development of synthetic substitutes
• Protective policies against food exports, agricultural
products – sugar quota, subsidies
Export Promotion
(2) supply side
• Structural rigidities in rural production system – soil,
climate, rural institutions, land tenure
• Local shortages due to exports
• Farmers – risk averse
• Fragmented land holdings.
Together, these problems could have an adverse effect
on export earnings of LDCs
Export Promotion – manufactured goods
• In South Korea, Taiwan, export growth was led by
manufactured goods (20% or more)
• China’s share in manufactured goods exports is
increasing
• In developing countries share of manufactured goods:
1950 – 6% , 2000 – 64%
Export Promotion – manufactured goods
Demand side issues
• Widespread protection against LDC’s exports of
manufactured goods
Assignment – Find supportive statements from page
622-623. Write a paragraph on how DC can help by
imposing less barriers – What are the likely consequences
for DC and LDCs
Import - Substitution
• Substitute domestic goods for imported goods, selfsufficiency
• Impose tariffs or quotas on imports
• Provide infant industry protection
• Government subsidies and intervention
• Improve balance of payments
• Achieve large scale and lower prices
• Reap the benefits of comparative advantages
Import Substitution - Disadvantages
• Protective policies discourage competition and efficiency –
Is industry remain high cost and inefficient industry?
• Foreign firms benefit due to tariff walls
• Imports of capital intermediate good are costly
• Overvalued, artificial exchange rates which raises the
price of exports and reduces the price of imports.
Overvalued currency helps local manufactures to increase
their exports and imports cheap capital goods
• Problems of infant industry
Tariff Structures and Effective Protection
Self-study
Nominal rate of protection =
P'  P
t
P
Effective rate of protection =
V ' V
g
V
•Fixed Exchange rate system
Exchange rates are officially
fixed. If there is a huge balance
of payments deficit, currency
will be devalued.
•Floating exchange rate system
Exchange rates are
determined by demand and
supply.
Depreciation implies a
decrease in the purchasing
power of domestic currency
Prices of foreign exchange (units of domestic
currency per unit of foreign currency)
Foreign Exchange Market
S
Pb
Pe
Pa
D
M’
M
M’’
Quantity of foreign exchange
Foreign Exchange Market
• Managed Float – Exchange rates fluctuate within
a certain range
• Asian Crisis of 1997
South Korea, Thailand, Malaysia, Indonesia
adopted floating exchange rate system.
Currencies lost 30% of their value and IMP bailed
out some of these countries.