Chapter 14:
Trade Policies for Developing Countries
Growth Rates, 1990-2012, and Levels of Income Per Capita, 2012
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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
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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
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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?
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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.
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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.
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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.
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Are the Long-Run Price Trend Against
Primary Producers?
Forces depressing primary product prices:
1. 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.
2. 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.
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Are the Long-Run Price Trend Against
Primary Producers?
Forces raising the price of primary products:
1. Nature’s limits. The supply of primary
products grows relatively slowly, tending to
raise primary product prices.
2. Relatively slow productivity growth in the
primary sector vs. the manufactured sector.
Again, the supply of primary products tends
to grow relatively slowly.
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The Relative Price of Primary Products, 1900-2013
All primaries/manufactures
All nonfuel primaries/manufactures
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The Relative Price of Primary Products, 1900-2013
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International Cartels to Raise PrimaryProduct 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.
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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.
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A Cartel as a Profit Maximizing
Monopoly
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What Determines the Cartel Price?
1. The higher the marginal cost of production,
the higher the price.
2. 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.
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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.
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The Erosion of Cartel Power
1. Sagging demand: long-run demand for curve for
imports is more elastic than the short–run demand
curve
2. New competing supply: search for additional
supplies in non-cartel countries
3. Declining market share: the cartel’s world market
share usually falls over time
4. Cheating by cartel members
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Import-Substituting Industrialization (ISI)
at Its Best
1. The infant industry argument with its legitimate
emphasis on the economic and social side benefits
from industrialization.
2. The developing government argument: the
government can get much-needed revenue from
tariffs.
3. For a large country, or a large organization of
countries, replacing imports can bring better termsof-trade effects than expansion of export industries.
4. Replacing existing imports of manufactures is a way of
using cheap and convenient market information.
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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.
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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.
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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.
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The Changing Mix of Exports from
Developing Countries, 1970-2012
1970
1980
1990
2000
2012
Nonfuel primary products 49.90% 18.70% 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
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