CHAPTER 10
International Trade and
Economic Growth
CHAPTER OUTLINE
I.
II.
III.
IV.
V.
VI.
Introduction
The Developing Countries
A.
Economic Development
B.
GDP of Developing Countries — Table 10.1
Economic Growth
A.
Preconditions for Growth

property rights

rule of law

PASSPORT: Economic Freedom Indexes — Table 10.2
B.
Economic Growth and the Factors of Production
C.
Basic Growth Theory — Figure 10.1
D.
Changes in the Capital Stock and Technology – Figure 10.2
International Trade and Economic Growth
A.
Openness and Growth

PASSPORT: Openness and Growth — Table 10.3
B.
Capital Flows, Technology Transfers, and Economic Growth
Economic Development Strategies
A.
Primary Products

Figure 10.3

Table 10.4

PASSPORT: OPEC — Figure 10.4
B.
Import Substitution
C.
Export Promotion

PASSPORT: Economic Development in East Asia versus Latin America
— Table 10.5
Official Development Assistance
A.
The Role of Official Development Assistance
B.
Flows of Official Development Assistance — Table 10.6
C.
Multilateral Development Organizations
D.
The World Bank and Regional Development Banks
E.
The United Nations Agencies
213
214 Chapter 10
TEACHING NOTES AND TIPS
I.
Introduction
Notes
Over the first nine chapters, some of the economic problems of the developing countries were
mentioned. The purpose of this chapter is to more carefully explore the relationship between
international trade and economic development.
Teaching Tip
Of necessity, this chapter is only half a loaf. Many of the issues facing developing countries in
the world economy are linked to the material covered in the second half of the book. As
mentioned in Chapter 1, international economics can be roughly divided into two parts. As a
result, the coverage of international economics and the developing countries must be covered in
two chapters.
II.
The Developing Countries
Notes
In Chapter 1, we covered the place of the developing countries in the world economy in terms of
output, trade, population, and economic growth. This section starts by introducing the area of
economic development. The second part of the section is a review of some of the data contained
in Chapter 1 (Table 10.1).
Teaching Tip
Economic development is a separate area in economics that touches on almost every other area
in economics. This makes economic development both fascinating and hard to study at the same
time. However, many of the problems associated with developing countries are highly correlated
with GDP per capita. Using GDP per capita as a proxy for many problems is both highly
convenient but also quite realistic. For example, GDP per capita is much higher in Mexico than
it is in Nicaragua. As a result, it would be difficult to find an area where economic conditions in
Nicaragua are better than they are in Mexico.
III.
Economic Growth
Notes
The section starts with the idea that unless certain conditions are met it is hard for any economy
to grow. However, once these preconditions are met it is fairly easy to capture the concept of
economic growth as a function of labor, capital, and technology in a simple graph. Subject to
diminishing returns, increases in the labor force increase real GDP. Increases in the capital stock
and technology cause upward shifts in the production function.
Teaching Tip
Explain that many of the very poorest countries of the world are in this condition because the
government is unable to perform the most basic functions of protecting property and enforcing
International Trade and Economic Growth 215
the law. In high-income countries, we simply take this for granted. Tragically, many of the
world's poorest people cannot.
IV.
International Trade and Economic Growth
Notes
In Chapter 2, we introduced the concept of the dynamic gains from trade. One of these gains is
faster economic growth. At this point, we can define that gain a bit more precisely. International
trade tends to increase total factor productivity in an economy. This increase will shift the
production function upward. There is now sufficient empirical evidence on this point to make us
confident in saying that the more an economy trades with the rest of the world, the faster it will
grow. In a similar vein, the production function will shift upward as a country attracts FDI and
the higher level of technology associated with it.
Teaching Tip
The empirical research on international trade and economic growth is a perfect example of
economics in action. Economists start with a proposition that something logically should be true.
The next step is rather simple empirical tests that mature into more sophisticated tests. If
everything works, the end of this process is something that can be taught to undergraduate
students as being "true."
V.
Economic Development Strategies
Notes
There are three common economic development strategies that have been employed in
developing countries: primary products, import substitution, and export promotion. The
possession of primary products may allow a country to grow faster if the earnings from the
production and export of these products are efficiently invested for economic development.
Import substitution involves implicit or explicit subsidies to manufacturing that replaces imports.
This strategy is being abandoned by most countries that have tried it because it tends to place
resources in what may be comparative disadvantage industries. Export promotion seems to work
better because it encourages the development of manufacturing industries based on the country's
comparative advantage.
Teaching Tip
The decline in the use of import substitution as a development strategy mirrors the increase in the
use of the term "structural adjustment." Some countries in Latin America have ended up with
problems similar to former communist countries such as Hungary or Poland.
VI.
Official Development Assistance
Notes
Over the last 50 years, the governments of the developed countries have attempted to assist the
developing countries through ODA. Theoretically, ODA should allow the developing countries
to develop infrastructure at a faster rate than would have been possible without it. However, this
process has not worked as well as envisioned for several reasons. First, the amount of money
being disbursed has been small relative to the needs of the developing countries. Second, much
216 Chapter 10
of the money has passed from government to government in the form of "tied" aid. This has left
the multilateral institutions such as the World Bank with an astonishingly small amount of
money to disburse relative to the needs of the developing countries. Likewise the UN agencies
are attempting to provide technical assistance on trade, industrialization, and environmental
issues with very little personnel or money.
Teaching Tip
Despite some issues over efficient management and environmental concerns, the World Bank
has been a very successful institution. The IBRD borrows money in a free market, loans it to
developing countries, and easily has maintained its credit rating in the world capital market.
BRIEF ANSWERS TO PROBLEMS AND QUESTIONS FOR REVIEW
1.
Economic development is defined as a goal each country attempts to achieve. The goal
of economic development is the attainment of a standard of living roughly equivalent to
that of the average citizen in a developed country. In most of the world's countries, low
GDP per capita is associated with a host of other factors that reduce the quality of life for
most of humanity. In the poorest countries, there is pervasive malnutrition and
chronically poor housing. Past basic food and housing, the lack of access to basic health
care is also a threat to the lives of billions of people. The goal of economic development
is the alleviation of these dire conditions for billions of people.
2.
The two preconditions for economic growth are property rights and the rule of law. In
order for a market economy to work properly, it is necessary for market participants to
know who owns what. Without this knowledge, it is difficult for the usual buying and
selling that characterizes economic activity to flourish. Second, markets cannot function
properly without the rule of law. Economic activity is something like a game with rules.
Unless the government is there to enforce the rules, market participants will be reluctant
to play the game. As a result, it is necessary for the government to be able to enforce the
rules and arbitrate the disputes that are a part of economic activity.
3.
In the figure below, the size of the labor force is shown on the horizontal axis and real
GDP is shown on the vertical axis. The positive relationship indicates that as the labor
force increases, real GDP will increase. However, along any given production function
the capital stock has been held constant. If the capital stock increases, then the entire
production function would shift upwards from F to F'.
International Trade and Economic Growth 217
F'
Output (GDP)
F
Y2
Y1
Labor Force (L)
L1
4.
A typical production function is shown below with the labor force on the horizontal axis
and real GDP on the vertical axis. This relationship indicates that real GDP would
change if the size of the labor force changed. However, any given production function
assumes that the capital stock and the level of technology is constant. Another way of
expressing technology is total factor productivity. This refers to an economy's ability to
mix capital and labor more efficiently to produce a higher level of output with the same
inputs. If total factor productivity increases, then the entire production function would
shift upward as shown. International trade tends to increase total factor productivity.
Trade tends to move resources from comparative disadvantage industries to comparative
advantage industries. This movement makes the resources that have been moved more
productive and increases the economy's output for any given level of labor and capital.
218 Chapter 10
F2
Real GDP (Y)
F1
Y2
Y1
Labor Force (L)
L1
5.
In the context of economic development, FDI is the process of moving capital from the
capital-abundant developed countries to the capital-scarce developed countries.
However, more than just the capital is being moved. Usually, it would be true that the
level of technology in the developed countries is higher than it is in the developing
countries. The result is that FDI moves not only capital but involves a transfer of
technology. This is beneficial to the developing countries as it allows them access to
higher levels of technology. In terms of economic growth, the production function for
the developing country would shift upward not just because of an increase in the capital
stock but also as a result of an improvement in the level of technology.
6.
International trade in goods and services can lead to technology transfers. An example of
this is learning by doing. International trade usually involves countries becoming more
specialized in the production of certain products. Because of specialization, countries
become better at producing certain goods or services. This sort of specialization causes
an improvement in knowledge that increases total factor productivity. The process of
exporting intensifies the learning by forcing firms to compete with other specialized firms
in the world economy. The same types of effects occur when domestic firms are forced
to compete with more efficient foreign firms. The result is that international trade leads
to an increasing accumulation of knowledge that can increase total factor productivity.
7.
First, the production and export of primary products may be quite profitable. This can be
a source of tax revenues for the government that can be used for economic development.
International Trade and Economic Growth 219
Exporting primary products may be a major source of foreign exchange that can be used
to purchase imported capital equipment necessary to enhance economic development.
Finally, primary products may be used as inputs into the production of higher value
added products. This can make it easier for a developing country to industrialize relative
to other countries that do not have primary commodities. However, this type of
industrialization may be difficult if developed countries have a tariff structure where the
effective rate of protection escalates with the degree of processing. Also, the prices of
primary products can be quite volatile. At a minimum, this may lead to instability in the
exchange rate and make the economy more unstable. If the product is a large percentage
of GDP, then large changes in the price of the product may tend to make the whole
economy unstable. The bottom line is that in an economy where primary products are
important, it may be more difficult to keep the economy on a stable growth path.
8.
An import substitution development strategy is an attempt to increase the size of the
manufacturing sector by replacing imports. This is accomplished with some combination
of high tariffs, quotas, or other forms of explicit or implicit subsidies. An export
promotion strategy is an attempt to increase the size of the manufacturing sector by
relying on the maximum growth of industries that rely on the country's comparative
advantage. In the long run, export promotion strategies seem to work better. Import
substitution may involve the transfer of resources into industries for which that country
does not have a comparative advantage. This lowers the total output of the economy. An
export promotion strategy has a better chance of increasing economic growth as resources
are encouraged to flow into industries for which that the country has a comparative
advantage.
9.
Official development assistance (ODA) describes the transfer of resources from
developed to developing countries to assist in the process of economic development.
ODA is a relatively unimportant factor in economic development because it is so small.
In 2002, the total global flow of ODA was less than $65 billion. This amount represents
less than one percent of the collective GDPs of the developing countries. While ODA
may be important for selected countries at particular points in time, it does not have a
substantial effect on overall economic growth in the developing countries.
10.
The name World Bank is really a term used to describe the operations of five different
parts of the institution. The International Bank for Reconstruction and Development
(IBRD) borrows money in the international capital markets and loans it to middle-income
countries for specific economic development projects. The International Development
Association (IDA) gathers money donated by the developed countries and makes
concessionary loans to low-income countries. The International Finance Corporation
(IFC) makes loans to private-sector firms in developing countries. The Multilateral
Investment Guaranty Agency (MIGA) and the International Centre for Settlement of
Investment Disputes encourage FDI in developing countries by providing insurance on
these investments and providing a mechanism for the settlement of disputes, respectively.
11.
The UN provides assistance to economic development primarily in the form of technical
assistance. UNCTAD provides technical assistance to developing countries in the
220 Chapter 10
process of integrating into the global economy and for trade negotiations. UNIDO
provides technical assistance for countries in the process of increasing the industrial
sector of the economy. A large number of other UN agencies have at least a tangential
role in the process of economic development. The activities of these agencies with
respect to economic development are coordinated by the UN Development Program
(UNDP).
MULTIPLE-CHOICE QUESTIONS
1.
*
2.
*
3.
*
The goal of economic development is for the _____ countries to achieve a standard of
living roughly equivalent to that of _____ countries.
a.
developed, developing
b.
developing, developed
c.
middle-income, low income
d.
high-income, middle income
In the low- and middle income countries _____ and _____ of the population respectively
are illiterate.
a.
5%, 10%
b.
7%, 14%
c.
16%, 20%
d.
17%, 38%
GDP per capita in the high-income countries is approximately:
a.
$451.
b.
$2,000.
c.
$15,000.
d.
$26,964.
4.
*
GDP per capita in low-income countries is less than _____ per year.
a.
$500
b.
$2,000
c.
$5,000
d.
$7,500
5.
Which of the following is a precondition for economic growth?
a.
A high level of technology
b.
A high K/L ratio
c.
The rule of law
d.
Free trade
*
International Trade and Economic Growth 221
6.
*
7.
*
The rule of law is important to economic growth as it is necessary for the enforcement of
_____ .
a.
free trade
b.
emigration
c.
contracts
d.
industrial policy
Which of the following is not one of the factors of production?
a.
Land
b.
Labor
c.
Capital
d.
Property rights
8.
*
Which of the following countries has a large amount of economic freedom?
a.
Hong Kong
b.
Libya
c.
Zimbabwe
d.
Laos
9.
In order for GDP per capita to grow, it is necessary for _____ growth to be in excess of
_____ growth.
a.
population, GDP
b.
labor, capital
c.
GDP, population
d.
land, capital
*
10.
*
11.
*
The graphical relationship between real GDP and the size of the labor force is known as:
a.
the Kuznets curve.
b.
the production function.
c.
the technology curve.
d.
the demand curve.
The production function:
a.
is linear.
b.
is undefined for low-income countries.
c.
slopes downward and to the right.
d.
slopes upward to the right.
222 Chapter 10
Real GDP (Y)
Y4
Y3
Y2
Y1
Labor Force (L)
L1
L2
L3
L4
12.
*
In the figure above, an increase in the labor force:
a.
increases real GDP.
b.
decreases real GDP.
c.
shifts the production function upward.
d.
shifts the production function downward.
13.
In the figure above, which of the following would cause an upward shift in the production
function?
a.
An increase in the labor force.
b.
A decrease in the labor force.
c.
An increase in the capital stock.
d.
A decrease in the capital stock.
*
14.
*
In the figure above, which of the following would cause an increase in real GDP?
a.
A decline in the labor force
b.
An improvement in technology
c.
A decrease in the capital stock
d.
A decline in technology
International Trade and Economic Growth 223
15.
*
16.
*
17.
*
18.
*
19.
*
20.
*
21.
*
In the figure above, an increase in real GDP with an unchanged labor force could happen
as a result of:
a.
a smaller capital stock.
b.
a higher level of technology.
c.
a lower level of technology.
d.
higher oil prices.
An improvement in technology would tend to:
a.
cause a movement to the right along an existing production function.
b.
cause a movement to the left along an existing production function.
c.
cause an upward shift in the production function.
d.
have no effect on the production function.
The theory of comparative advantage indicates that international trade should increase the
output of the economy by moving resources from _____ to _____ industries.
a.
comparative advantage, comparative disadvantage
b.
comparative disadvantage, comparative advantage
c.
smaller, larger
d.
efficient, inefficient
An increase in economic growth that cannot be accounted for by increases in either the
labor force or the capital stock is known as an increase in:
a.
inefficiency.
b.
total factor productivity.
c.
labor input.
d.
managerial productivity.
FDI in a developing country would tend to cause:
a.
a reduced level of technology.
b.
exploitation of workers.
c.
an upward shift of the production function.
d.
lower tariff revenues.
Which of the following is responsible for the largest movements of FDI into developing
countries?
a.
UNIDO
b.
UNCTAD
c.
MNCs
d.
the WTO
Which of the following would not cause an upward shift in the production function in a
developing country?
a.
FDI
b.
Technology transfers
c.
Increasing openness
d.
Immigration
224 Chapter 10
22.
*
23.
*
Importing and exporting of goods and services can lead to increases in specialization and
knowledge that can:
a.
decrease GDP per capita.
b.
increase total factor productivity.
c.
shift the production function downwards.
d.
cause an increase in population.
Which of the following refers to natural resources or the ability to produce certain
agricultural products?
a.
primary products
b.
cheap products
c.
import substitution
d.
total factor productivity promotion
24.
*
The possession of primary products in a developing country could:
a.
provide a convenient source of revenue for the government.
b.
reduce the amount of foreign exchange available.
c.
make the development of infrastructure more difficult.
d.
retard industrial development.
25.
In many cases, both the demand and supply of primary products are _____ .
a.
elastic
b.
inelastic
c.
perfectly elastic
d.
undefined
*
26.
*
27.
*
28.
*
If primary products are a high percentage of a country's exports then large changes in the
price of these commodities could influence the _____ .
a.
tariff
b.
terms of trade
c.
effective rate of protection
d.
structure of protection
Which of the following is a cartel that attempts to influence the world price of crude oil?
a.
OPRAH
b.
OPEC
c.
UNOCAL
d.
EXXON
The development strategy based on developing industries that will reduce imports is
known as:
a.
primary production.
b.
import substitution.
c.
export promotion.
d.
FDI intervention.
International Trade and Economic Growth 225
29.
*
30.
*
31.
*
Which of the following is not associated with an import substitution development
strategy?
a.
High tariffs
b.
Quotas
c.
Government subsidies to manufacturing
d.
Lower prices for consumers
An import substitution strategy tends to lead to:
a.
faster economic growth.
b.
more jobs in the economy.
c.
greater efficiency in the use of resources.
d.
more rent seeking behavior.
A development strategy based on developing industries in line with a country's
comparative advantage is known as:
a.
Dutch development.
b.
import substitution.
c.
export promotion.
d.
WTO experiment.
32.
*
Which of the following regions has tended to grow fastest during the 1990s?
a.
East Asia
b.
Latin America
c.
Central America
d.
Africa
33.
*
Which of the following statements is incorrect?
a.
Manufacturing requires very little infrastructure.
b.
Manufacturing usually is more infrastructure intensive than agriculture.
c.
Manufacturing doesn't require increases in human capital.
d.
Low taxes on manufacturing will increase exports.
34.
High tariffs are a feature of which of the following development strategies?
a.
primary products
b.
import substitution
c.
export promotion
d.
WTO promotion
*
35.
*
Economies using an export promotion development strategy tend to:
a.
grow more slowly.
b.
create more jobs.
c.
earn less foreign exchange.
d.
not import products for which that country has a comparative disadvantage.
226 Chapter 10
36.
*
37.
*
38.
*
The correct term for "foreign aid" is:
a.
foreign exchange.
b.
unilateral transfers.
c.
grants.
d.
official development assistance (ODA).
Which of the following is not part of basic infrastructure in a developing country?
a.
water systems
b.
electricity systems
c.
urban transportation systems
d.
UNIDO
ODA in the world economy is approximately:
a.
$20 billion.
b.
$65 billion.
c.
$500 billion.
d.
$1 trillion.
39.
*
ODA is less than _____ percent of the collective GDPs of the developing countries.
a.
1
b.
3
c.
5
d.
10
40.
U.S. ODA is approximately _____ billion.
a.
$1
b.
$16
c.
$50
d.
$77
*
41.
*
42.
*
ODA as a percentage of GDP for all developed countries is approximately _____ .
a.
0.10
b.
0.26
c.
0.52
d.
0.86
A transfer of money from a developed country government to a developing country
where there is no repayment involved is known as a _____ .
a.
grant
b.
loan
c.
policy statement
d.
nonofficial ODA
International Trade and Economic Growth 227
43.
*
44.
*
45.
*
46.
*
47.
*
48.
*
49.
*
ODA that involves restrictions on how and where the aid may be spent is known as:
a.
corrupt aid.
b.
mislaid aid.
c.
tied aid.
d.
useless aid.
Which of the following part of the World Bank primarily makes loans to middle-income
countries for infrastructure?
a.
IBRD
b.
IDA
c.
MIGA
d.
UNCTAD
Which of the following part of the World Bank primarily makes loans to low-income
countries?
a.
IBRD
b.
IDA
c.
UN
d.
IADB
Which part of the World Bank makes loans to private sector firms in developing
countries?
a.
IBRD
b.
IDA
c.
IFC
d.
MIGA
During the 1980s and 1990s, the World Bank was criticized for not taking _____
concerns into account when making loans.
a.
solvency
b.
discrimination
c.
environmental
d.
business
The most recent World Bank initiatives involve the reduction of _____ in developing
countries.
a.
malaria
b.
bird flu
c.
crime
d.
corruption
Which of the following UN agencies was established to assist developing countries in the
process of integrating into the world economy?
a.
WHO
b.
UNCTAD
c.
UNIDO
d.
UNDP
228 Chapter 10
50.
*
51.
*
52.
*
Which of the following UN agencies assists developing countries with problems
associated with industrialization?
a.
MIGA
b.
UNCTAD
c.
UNESCO
d.
UNIDO
Which of the following UN agencies assists the developing countries with trade
negotiations?
a.
UNCTAD
b.
UNDP
c.
IFC
d.
WTO
Which of the following is not a UN agency?
a.
UNIDO
b.
UNCTAD
c.
UNDP
d.
IFC
TRUE FALSE QUESTIONS
1. F
Economic development is unrelated to the concept of GDP per capita.
2. F
Access to basic health care is not part of the problem of economic development.
3. F
GDP per capita in the low-income countries is approximately $1,877 per year.
4. T
Mexico is a familiar example of a middle-income country.
5. T
The low-income countries contain over 40 percent of the world's population but produce
only 3.5% of world output.
6. T
The high-income countries are concentrated in North America and Western Europe.
7. F
Property rights are not a precondition for economic growth.
8. F
Economic growth can be enhanced by a reduction in the size of the labor force.
9. F
An example of a country with a substantial amount of economic freedom is North Korea.
10. T Low-income countries usually have high birth rates.
11. F With respect to economic growth, only the capital stock in the private sector is important.
International Trade and Economic Growth 229
12. F A change in technology means that an economy can produce less output with more
inputs.
13. F Because of the shape of the production function, an equal increase in the labor force in a
developing versus developed country would tend to yield more economic growth in the
latter.
14. F An increase in the capital stock would tend to shift the production function upward while
an increase in technology would tend to shift it downward.
15. F Increases in the capital stock and improvements in technology are mutually exclusive.
16. T The theory of comparative advantage indicates that international trade should increase the
total output of an economy by moving resources from comparative disadvantage to
comparative advantage industries.
17. T Empirical tests of openness and economic growth usually show a positive correlation
between the two.
18. T In order to show that openness causes faster economic growth, it is necessary to show
that openness causes the production function to shift upward.
19. T More open economies tend to have faster rates of growth of total factor productivity.
20. T Empirical research on economic growth indicates that openness tends to increase real
GDP.
21. T It is difficult for a poor country to rapidly increase its stock of capital.
22. T Technology transfers into developing countries tend to lead to an upward shift in the
production function.
23. T International trade in goods and services can lead to technology transfers even in the
absence of FDI.
24. T The structure of protection in developed countries may make it difficult for some
developing countries to develop a manufacturing industry based on primary products.
25. T Frequently, the prices of primary products are volatile because both the demand and
supply curves are inelastic.
26. T If primary products are a high percentage of a country's GDP then instability in the prices
of these products could translate into instability of GDP.
27. F Countries that possess primary products always grow faster than countries that do not.
28. F OPEC has obviously been successful in always maintaining high prices for oil.
230 Chapter 10
29. T High tariffs on manufactured products normally are part of an import substitution
development strategy.
30. F Countries pursuing import substitution development policies always grow faster than
those that do not.
31. T Because of rent seeking behavior, an import substitution development strategy may be
difficult to get rid of.
32. F An export promotion development strategy calls for virtually no actions on the part of the
government.
33. F An export promotion development strategy tends to create fewer jobs than an import
substitution strategy.
34. F Many developing countries are abandoning export development strategies because they
lead to lower economic growth.
35. F By prudently following import substitution development policies, most countries in Latin
America have been able to grow faster than the countries of East Asia.
36. T ODA is a small part of the picture of economic development.
37. T Many developing countries may have difficulty building basic infrastructure because of
weak internal capital markets or a lack of foreign exchange.
38. T Denmark is the only developed country in which ODA is more than one percent of GDP.
39. T "Tied" aid may involve restrictions on how the developing country can spend the aid.
40. F The U.S. is the most generous country in the world because it uses a higher percentage of
its GDP for ODA than any other country.
41. T The money for IDA lending comes from periodic donations by the developed countries.
42. F The World Bank never makes project-specific loans.
43. F The World Bank legally is prohibited from lending money to private sector firms in
developing countries.
44. F The World Bank has been so successful that it has never faced any significant difficulties.
45. F The World Bank does not promote FDI because it would be a conflict of interest.
46. F The World Bank is critical because it is the only economic development bank in the
world.
International Trade and Economic Growth 231
47. T Institutions such as the InterAmerican Development Bank are important because they can
focus on lending projects that are too small for the World Bank.
48. F The UN is not formally involved in either economic development or official development
assistance.
49. T The UN has a large number of agencies such as the WHO that are part of the larger
organization.
50. T The UN agencies do not provide ODA but do provide technical assistance for developing
countries.
51. F It is unfortunate that UNCTAD headquarters is in Canada because much of its work
involves assisting developing countries in trade negotiations and the headquarters of the
WTO is in Geneva.
52. T UNIDO assists developing countries in the management of pollution problems associated
with industrialization.
53. F UNDP is a new UN agency that has replaced the now defunct UNCTAD.
SHORT ANSWER ESSAY
1.
Describe what the term economic development means.
2.
List GDP per capita for low-, middle-, and high-income countries. Show how these
numbers are the result of the mismatch between the percentage of world population living
in the three types of countries and the percentage of world output produced by each type
of country.
3.
List and describe the preconditions necessary for economic growth theory to work
properly.
4.
List and describe the factors of production.
5.
Describe how the production function relates real GDP to the size of the labor force.
How does the concept of diminishing returns affect the production function?
6.
How do increases in the capital stock or improvements in technology affect real GDP?
7.
Describe how openness enhances economic growth.
8.
What role do MNCs play in the economic growth of developing countries?
232 Chapter 10
9.
How can the possession of primary products enhance economic growth?
10.
What are the elements of an import substitution development policy? Why are many
countries now abandoning this strategy?
11.
Describe an export promotion development strategy?
12.
What is the relative importance of ODA in the economic development process?
13.
List and briefly describe the major multilateral development organizations.
BRIEF ANSWERS TO SHORT ANSWER ESSAY
1.
Economic development is defined as a goal that developing countries are attempting to
achieve. The primary goal is for these countries to achieve a standard of living
equivalent to that which prevails in the developed countries. This goal usually is defined
in terms of GDP per capita. However, GDP per capita is really a proxy for a number of
other conditions associated with the developed countries. These conditions include
adequate food and housing; access to basic health care; access to basic amenities such as
clean water; and basic education.
2.
GDP per capita in the low-, middle-, and high-income countries is $451, $1,877, and
$26,964, respectively. These differences are the result of the large percentage of the
world's population living in the low- and middle-income countries relative to the
percentage of world output originating in these countries. 40.2 and 44.2 percent of the
world's population live in low- and middle-income countries. On the other hand, only 3.5
and 15.9 percent of the world's output originates in these countries. A large percentage of
the world's population living in these countries coupled with a relatively small percentage
of world output results in GDP per capita being much lower than that of the high-income
countries. These countries contain 15.6 percent of the world's population but produce
80.6 percent of the world's output.
3.
There are two preconditions necessary for economic growth theory to work properly:
property rights and the rule of law. Property rights are essential to the workings of a
market economy. For economic transactions to occur smoothly it must be clear exactly
who owns what. If market participants cannot be sure of this, then a large number of
economic transactions that enhance economic growth will not occur. Second, normal
economic transactions frequently involve contractual obligations between parties. In the
routine course of economic activity, disputes over contracts will occur. Market
participants need to be certain that in the case of any disputes, the government provides
mechanisms for dealing with these potential problems. Otherwise, the amount of total
economic activity occurring will be reduced and damage the rate of economic growth.
4.
The factors of production are land, labor, capital, and technology. Because land is
difficult for a country to acquire, we usually assume that the amount of land is fixed.
Labor refers to the size of a country's labor force. The labor force of a developing
International Trade and Economic Growth 233
country usually is growing rapidly as a result of a high birth rate coupled with a declining
mortality rate. The capital stock of a country is the amount of money invested in
business structures and equipment. Part of the capital stock is in the public sector in
terms of investments made in infrastructure such as roads and schools. Technology also
is a factor of production. In economics, we define technology as the ability to produce
more output with the same amount of inputs or the same output with fewer inputs.
Improvements in technology can be attributable to either improvements in the capital
stock or improvements in the quality of management.
5.
Along any given production function, the size of the capital stock and the level of
technology remain constant. As a result, any variations in the size of the labor force
cause a change in the level of real GDP. However, the relationship between the labor
force and real GDP is not constant. Since the capital stock is a constant, increases in the
size of the labor force subject the economy to the concept of diminishing returns.
Initially, as the labor force increases real GDP grows rapidly. However, past some point
adding additional workers leads to diminishing increases in real GDP.
6.
A change in the capital stock will shift the production function upward. This means that
for any given amount of labor, real GDP will be higher. The same effect occurs if there
is an improvement in technology. Again, the production function would shift upward.
For any given amount of labor, real GDP will increase. Both increases in the capital
stock and improvements in technology would tend to increase real GDP.
7.
The theory of comparative advantage indicates that an economy that trades should
produce more output as resources are transferred from comparative disadvantage to
comparative advantage industries. It has been shown empirically that this is the case by
the positive correlation between openness and economic growth. More detailed studies
of this correlation have found a positive relationship between openness and total factor
productivity. Total factor productivity refers to increases in real GDP that are not
accounted for by changes in the labor force or the capital stock. Because a number of
studies have found this positive relationship, we can be fairly certain that the more an
economy trades the faster will be its rate of economic growth.
8.
MNCs provide two important factors in economic growth. First, increases in the capital
stock increase real GDP. Since FDI increases a country's capital stock, it normally will
increase the rate of economic growth. This addition to the capital stock is especially
important in developing countries. Second, the level of technology in developing
countries is usually below that which prevails in the developed countries. Most FDI in
developing countries originates in the developed countries. Almost invariably, this FDI
also transfers technology to the developing countries. This improvement in technology
would cause an increase in the rate of economic growth.
9.
Primary products may be relatively cheap to produce and the production and export of
these products may be quite profitable. In this case, primary products may be a reliable
source of revenue that the government can use to enhance economic development.
Second, these products may lead to the initial stages of industrialization that involves
transforming the products into higher value added manufactures. Finally, the export of
234 Chapter 10
primary products may yield foreign exchange that can be used to purchase capital
equipment for both the private and public sectors that would increase economic growth.
10.
An import substitution development strategy involves the attempt to increase the size of
the manufacturing sector by replacing imports. This strategy usually involves a
combination of high tariffs, quotas, low taxes, and other forms of government subsidies.
However, this strategy has produced a number of economic problems. First, consumers
and producers end up paying higher prices for locally produced goods that also may be of
lower quality. Second, the expanding manufacturing sector is taking resources from
other sectors that might be able to use them more efficiently. In turn, this may cause a
reduction in the rate of economic growth and a loss of job opportunities. Finally, the
strategy involves a substantial amount of protectionism. This leads to a large amount of
rent seeking activity that is a further waste of resources.
11.
An export promotion development strategy fundamentally means allowing the economy
to develop along the lines dictated by comparative advantage. In the case of developing
countries, this usually means developing labor-intensive industries. The role of the
government is to provide the necessary conditions that allow these industries to produce
as much as possible. This means the provision of essential infrastructure in urban areas
as the economy transfers resources from the agricultural sector to the manufacturing
sector. The government also needs to provide a framework conducive to the transfer of
capital and technology into the country from the developed countries. If executed
properly, export promotion tends to improve the rate of economic growth and provide
more job opportunities in a labor-abundant country.
12.
ODA amounts to less than 1 percent of the collective GDPs of the developing countries.
Although, this is a relatively small amount of money, it can be critical in the economic
development process. In order to increase economic growth, the developing countries
need to improve their economic infrastructure. ODA can be important in this process by
providing capital that would be difficult to raise in local capital markets and providing
long-term loans at reasonable rates of interest. Also, much of this investment requires
capital equipment from the developed countries. ODA may provide the foreign exchange
necessary for countries to purchase this capital equipment that may be in short supply in
the developing countries.
13.
The major multilateral development agencies are the World Bank and the United Nations
agencies. The World Bank makes loans for economic infrastructure projects in both
middle- and low-income countries. It also makes loans to private sector firms. The
World Bank is involved in enhancing the flow of FDI to developing countries by
providing insurance and arbitration procedures. The African, Asian, and Interamerican
Development Banks supplement the activities of the World Bank by providing smaller
loans for development projects in their respective regions. There are three UN agencies
heavily involved with economic development. UNCTAD provides technical assistance
to countries integrating into the world economy. UNIDO provides assistance to countries
that are in the process of industrializing. The UNDP coordinates the activities of all the
UN agencies that to a greater or lesser extent are involved with the process of economic
development.
International Trade and Economic Growth 235