EC336
Economic Development in a Global
Perspective
ABHISHEK CHAKRAVARTY
2014-15
LECTURE 4
Export Promotion versus Import Substitution
 Import substitution: looking inward but still paying outward

First-stage IS involves substituting domestic production for imported simple consumer goods
using the protection of tariff barriers and import quotas. This aids development of “infant
industry” via economies of scale and learning-by-doing.

Second-stage IS involves diversifying domestic production into more complex manufacturing
goods using the same tariff and quota protection against imports.

The benefits of this strategy involve greater industrial diversification and the potential to
compete in international markets as domestic prices get closer to world prices with declining
costs of production.
Import Substitution and the Theory of Protection
Top diagram:
Before international trade
equilibrium price and quantity are P1 and Q1.
With international trade, there is an infinite
international supply at P2 and the country is a
price taker. Domestic production is Q2 at this
price, and Q2Q3 is imported to meet the
remaining domestic demand. Hence there is loss
of domestic production and employment due to
international competition.
Bottom diagram: If the government imposes a
tariff of t0, the price rises to Pt = P2(1 + t0).
Domestic demand falls to Q5, and domestic
production rises to Q4. The amount imported
falls to Q4Q5 due to reduced demand and higher
domestic production, and the government earns
cdfe in tariff revenue.
Export Promotion versus Import Substitution
 The import substitution (IS) industrialization strategy and results

Protected industries get inefficient and costly due to lack of competition.

Foreign firms often benefit more by locating behind tariff barriers.

Subsidization of imports of capital goods tilts pattern of industrialization towards capitalintensive production, and contributes to balance of payments (BOP) problems.

Overvalued exchange rates hurt exports

Does not stimulate self-reliant integrated industrialization, due to reliance on imported capital
goods rather than backward linkages in domestic industry.
Export Promotion versus Import Substitution
There can be a very large difference between:
• nominal tariff rate the increase in price due to the tariff as a percent of free trade price
• effective tariff rate how much value is added to the product domestically due to the
tariff as a percent of the value added under free trade.
The nominal tariff rate, is: t 
p  p
p
Where p′ is the tariff-inclusive price and p is the free trade price

The effective tariff rate, is:   v  v
v
Where v′ is the value added per unit of output, inclusive of tariff, and v is the value added
per unit of output under free trade
Export Promotion versus Import Substitution
• A country produces and sells cars at the world price of $10,000 without
tariffs. The value added of labour is $2000, with remaining inputs adding
value of $8000, with the price of non-labour inputs being equal to world
prices (so they are freely importable).
• If a nominal tariff rate of 10% is imposed, the price of the car goes up
to $11,000 leaving the price of inputs and labour unchanged. So an extra
$1000 of labour can be applied to production on top of the $2000 worth
that is applied already.
• Hence the effective rate of protection for the local assembly process is
50%, as an additional 50% of the previously needed local labour can be
applied as a result of the 10% nominal tariff.
Export Promotion versus Import Substitution
 Summarising the four basic arguments for tariff protection:




Source of revenue from tariffs for government.
Response to chronic BOP problems from too many imports.
Help foster industrial self-reliance and growth.
Greater control over economic growth and development process.
 Several countries adopted an IS strategy in the 1950s and 60s: Chile, Peru,
India, Argentina, Nigeria, Ethiopia, Ghana, Zambia, etc.
 The infant industry protection strategy has not really worked for most
countries that have tried it. The East Asian tigers are exceptions to this,
having used it to build up local industries and then combining it with
export-oriented policy effectively.
Export Promotion versus Import Substitution
 Trade Optimists and Pessimists: Summarizing the Traditional Debate
 Trade pessimist arguments

Limited growth of world demand for primary exports

Secular deterioration in terms of trade for primary products

Specializing in comparative advantage inhibits industrialization, skills accumulation, and
entrepreneurship

Rise of “new protectionism” in developed countries means WTO benefits are limited in
practice for LDCs
Export Promotion versus Import Substitution
 Trade optimist arguments - trade liberalization:

Promotes competition and efficiency

Generates pressure for product improvement

Accelerates overall growth

Attracts foreign capital and expertise, which are in scarce supply in most developing countries

Generates foreign exchange to use for food imports if agricultural sector lags behind or suffers
natural catastrophes

Eliminates distortions caused by government interventions including corruption and rentseeking activities

Promotes equal access to scarce resources,

Enables developing countries to take full advantage of reforms under the WTO
Export Promotion versus Import Substitution
 Export-led industrialisation as government policy:

There are market failures in transfer of innovations, because firms import less than the social
optimum of superior technologies if their competitors also benefit. This creates a role for
government to promote such imports of technologies.

Coordination failures may make industrialisation problematic, so governments can design
sector-wide policy to promote firm behaviour that benefits industrialisation.

There may be learning by doing (or “watching”) effects in manufacturing sectors that spill
over into other sectors, as with foreign technologies learned from exporting.

Performance is rigorously tested when firms attempt to export and export targets more visible;
so governments can focus on more manageable problems.

Hausmann, Hwang, and Rodrik: exporting a mix of goods more typical for higher-income
countries predicts higher growth
East Asian Miracle
 Ranis (1995) focuses on the experience of Taiwan and the Republic of
Korea and argues that their success has to do with favourable initial
conditions, the early stage of ISI, flexible labour markets, human capital
policies, early macroeconomic stabilisation, and adequate government
intervention.
 Both Taiwan and Korea were part of the Japanese colonial network. They
were relatively small countries with labour surpluses and poor natural
resources in the 1950s.
 However they had high literacy rates, and engaged in substantial
redistribution of lands.
East Asian Miracle
 Import substitution (1953-63): ISI in Taiwan and Korea were not
discriminatory of the agricultural sector which in the 1950s was the
leading sector in Taiwan. It provided savings, foreign exchange, labour,
and other benefits.
 In Taiwan, agricultural surpluses financed the development of non-
agricultural activities and the formation of small and medium scale
enterprises in rural areas, strengthening the links (backward and forward)
between agricultural and non agricultural output.
 In Korea, the increase in non-agricultural activities was mostly financed by
a combination of industrial reinvestment and foreign capital.
East Asian Miracle
 The Labour-Intensive Export Substitution (1963-73): In Taiwan, the rapid
growth supported initially by agriculture, fuelled labour intensive
industrial expansion and resulted in increasing employment and a
favourable income distribution.
 Both manufacturing output and employment increased substantially. Most
reallocation of labour consisted of people not actually leaving rural
households because of the expansion of rural industry and services.
 The export sector in EACs earned foreign currency but and generated
investment funds for diversifying the industrial sector. In Korea, the
proceeds from this stage financed the stage of heavy industrialisation
(1972-79) and the deepening of the export oriented drive.
East Asian Miracle
 Export orientation from mid 1970s: In Taiwan and Korea, this stage has been
characterised by: non reliance on agriculture which instead, has been subsidised.
 The increasing shortage of labour has shifted the industrial output and export mix
(from textiles and other light industries to electronics, science and technology
intensive).
 The government has been paying increased attention to infrastructure related to
science and technology and promoting R&D.
 The government accommodated the shifts in the output mix by guiding investment,
regulating the banking sector, enhancing human capital, by considering
institutional investment in science and technology as a priority public good; and
providing directed credit to export-oriented industries.
South-South Trade and Economic Integration
 Economic Integration: Theory and Practice

Integration encourages rational division of labor among a group of countries and
increases market size by promoting free trade between participating members and
protecting the integrated area from external competition.

It provides opportunities for a coordinated industrial strategy to exploit economies of
scale by increasing the size of the market available to local producers beyond the
domestic market.

Trade creation occurs as production shifts from high-cost to low-cost members, and trade
barriers between them are lifted.

Trade diversion occurs as domestic industry is allowed to develop without competition
from producers in non-member countries.
South-South Trade and Economic Integration
 Regional trading blocs and the globalization of trade



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NAFTA
MERCOSUR
SADC
ASEAN
 It is still unclear whether trading blocs help or hinder economic growth.

Countries with a enough of a comparative advantage over their partners can benefit more
from a trading bloc, leading to a divergence of incomes between member states.

Developing countries may not benefit as much as theorised from South-South cooperation:
lack better technology to transfer to each other, means to pay higher prices, influence in
global negotiations. Widening gaps between them also means diverging priorities.
Trade Policies of Developed Countries
 Rich-nation policies matter for developing countries


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Tariff and non-tariff barriers to developing country exports
Adjustment assistance for displaced workers
General impact of economic policy
 Despite 8 liberalization rounds over 50 years under GATT and then the
WTO, trade barriers remain in place in agriculture; and, through various
mechanisms, to a degree in other sectors
 Doha Development Round of WTO talks begun in 2001 tilted the nominal
focus to needs of developing world; but talks remained stalled through the
end of 2010, a self-imposed deadline
Effective Tariff Faced by Income Groups, 1997-1998
DOHA Round of WTO Talks
 The declaration for the DOHA “Development” round stated explicitly that
the agenda is to achieve “substantial improvements in market access;
reduction with a view of phasing out all forms of export subsidies; and
substantial reductions in trade-distorting domestic support..”
 Developing countries were meant to be the main beneficiaries from this
round, being promised “special and differential treatment” and “duty free,
quota-free access” to foreign markets.
 Tariffs on agricultural products were addressed directly, as these products
are seen as the main exports of developing countries. The average applied
tariff on agricultural goods in the early 2000s was also twice that on
industrial goods, at 17% versus 9%.
DOHA Round of WTO Talks
 The tariff structure differs substantially between developed and developing
countries, with developed countries having lower average tariffs but much
higher peaks in individual rates.
 The formula proposed in July 2004 included tiered cuts in tariffs to
account for these differences, rejecting a formula proposed by the EU and
United States that would have made average cuts but maintained relatively
high peak rates.
 Subsidies to agriculture are the major bone of contention. These were
classified into three different types in the 1995 Uruguay Round:



Clearly trade-distorting - Amber box
Potentially distorting, but intended to limit production – Blue box
Little or no distorting effects – Green box
DOHA Round of WTO Talks
 The July 2004 proposal advocates that all Amber and Blue box subsidies
be reduced by 20% in the first year of implementation. It also calls for an
end to all export subsidies, except those by least developed countries.
 Domestic subsidies to agriculture are to be reduced to a maximum capped
level, with no current commitment to reducing green box subsidies.
 The impacts on developing countries of these agreements are varied. The
tariff cuts will only affect a few countries like India and Pakistan, that have
maintained high agricultural tariff rates. Least developed countries and
most other developing countries will not have to change their tariffs.
DOHA Round of WTO Talks
 However the tariff cuts will give Latin American and Asian developing
countries much greater access to developed country markets relative to
least developed and African countries that already get preferential access.
 Negotiations have seen several collapses since 2001, highlighting the
difficulties in coordinating policy between difference countries.
 Paris, 2005: The US, Australia, the EU, Brazil and India - who managed
to get the talks back on track in July 2004 after they had foundered, failed
to agree chicken, beef and rice tariffs.
 Hong Kong, 2005:
Trade ministers representing most of the world's
governments reached a deal that sets a deadline for eliminating subsidies
of agricultural exports by 2013.
DOHA Round of WTO Talks
 Geneva, 2006: The in Geneva failed to reach an agreement about reducing
farming subsidies and lowering import taxes, and negotiations took months
to resume.
 Potsdam, 2007: Major disagreement between India, the US, the EU, and
Brazil over reducing rich nation farm subsidies and opening of agricultural
and industrial markets.
 Geneva, 2008: U.S. Trade Representative announced that the U.S. would
cap its farm subsidies at $15 billion a year from $18.2 billion in 2006.
However, there were disagreements special protection for Chinese and
Indian farmers and African and Caribbean banana imports to the EU.
DOHA Round of WTO Talks
 At the 2011 annual conference of the World Economic Forum in Davos,
David Cameron called for the Doha talks to conclude by the end of the
year: "We've been at this Doha round for far too long. It's frankly
ridiculous that it has taken 10 years to do this deal.“
 In December 2013, negotiations finally yielded an agreement called the
Bali Package at the Ninth Ministerial Conference held in Nusa Dua, Bali,
Indonesia.
 The trade facilitation measures agreed in Bali could cut the global cost of
shipping goods around the world by an estimated 10%, raising global
output by over $400 billion a year, with benefits flowing
disproportionately to poorer countries. – The Economist, Dec 2013