Transcript Terms of trade

An Introduction to
International Economics
Chapter 8: Growth and Development
with International Trade
Dominick Salvatore
John Wiley & Sons, Inc.
Dale R. DeBoer
University of Colorado, Colorado Springs
8-1
Growth and development
• Economic growth is the expansion of a
nation’s ability to produce goods and services
over time.
– This change may be represented by an outward
expansion of the production possibilities frontier
(PPF).
Dale R. DeBoer
University of Colorado, Colorado Springs
8-2
Growth and development
• Economic growth is the expansion of a nation’s
ability to produce goods and services over time.
• Economic development is an improvement in
society’s quality of life or standard of living.
Dale R. DeBoer
University of Colorado, Colorado Springs
8-3
Growth and development
• Economic growth is the expansion of a nation’s
ability to produce goods and services over time.
• Economic development is an improvement in
society’s quality of life or standard of living.
• Need these be the same?
– No
– However, growth is typically seen to encourage
development by providing the ability satisfy more
material needs (shelter, education, medical care,
etc.).
Dale R. DeBoer
University of Colorado, Colorado Springs
8-4
Demonstrating growth
• Growth occurs through
an expansion or
improvement in the
factors of production.
X
X
Dale R. DeBoer
University of Colorado, Colorado Springs
8-5
Demonstrating growth
• Growth occurs through an
expansion or
improvement in the
factors of production.
• Balanced growth arises
when the factors of
production change so
that the ability to
produce commodities is
not skewed in favor of
one commodity over
another.
Dale R. DeBoer
University of Colorado, Colorado Springs
Y
X
8-6
Demonstrating growth
• Unbalanced growth
arises when the factors
of production change
so that the ability to
produce one commodity
is enhanced more the
ability to produce the
other commodity.
Y
X
Dale R. DeBoer
University of Colorado, Colorado Springs
8-7
Trade and development
• International trade allows each trading country
to consume beyond its domestic ability to
produce.
– This is the static gain from trade.
Dale R. DeBoer
University of Colorado, Colorado Springs
8-8
Trade and development
• International trade allows each trading country to
consume beyond its domestic ability to produce.
• International trade also offers potential
dynamic (growth enhancing) gains.
– International trade may offer a vent for surplus
ability to produce.
Dale R. DeBoer
University of Colorado, Colorado Springs
8-9
Trade and development
• International trade allows each trading country to
consume beyond its domestic ability to produce.
• International trade also offers potential
dynamic (growth enhancing) gains.
– International trade may offer a vent for surplus ability
to produce.
– International trade may allow a country to exploit
available economies of scale.
Dale R. DeBoer
University of Colorado, Colorado Springs
8 - 10
Trade and development
• International trade also offers potential
dynamic (growth enhancing) gains.
– International trade may offer a vent for surplus ability
to produce.
– International trade may allow a country to exploit
available economies of scale.
– International trade allows for a freer transmission
of ideas internationally. This transfer may spur
more rapid domestic technological change.
• This connection is explored by endogenous growth
theory.
Dale R. DeBoer
University of Colorado, Colorado Springs
8 - 11
Trade and development
• International trade also offers potential
dynamic (growth enhancing) gains.
– International trade may allow a country to exploit
available economies of scale.
– International trade allows for a freer transmission of
ideas internationally. This transfer may spur more
rapid domestic technological change.
– International trade stimulates the flow of financial
capital that may enhance economic growth.
Dale R. DeBoer
University of Colorado, Colorado Springs
8 - 12
Trade and development
• International trade also offers potential
dynamic (growth enhancing) gains.
– International trade allows for a freer transmission of
ideas internationally. This transfer may spur more
rapid domestic technological change.
– International trade stimulates the flow of financial
capital that may enhance economic growth.
– International trade exposes the domestic
economy to new commodities. This may spur
sufficient domestic demand to generate a new
domestic industry.
Dale R. DeBoer
University of Colorado, Colorado Springs
8 - 13
Trade and development
• International trade also offers potential
dynamic (growth enhancing) gains.
– International trade stimulates the flow of financial
capital that may enhance economic growth.
– International trade exposes the domestic economy to
new commodities. This may spur sufficient domestic
demand to generate a new domestic industry.
– International competition constrains domestic
monopoly power. This constraint reduces the
need for domestic anti-trust activities and spurs
greater domestic efficiency.
Dale R. DeBoer
University of Colorado, Colorado Springs
8 - 14
Issues in trade and development
•
•
•
•
Terms of trade effects
Immiserizing growth
Export instability
Import substitution vs. export promotion
policies
Dale R. DeBoer
University of Colorado, Colorado Springs
8 - 15
Terms of trade
• The terms of trade is the ratio of the price of a
country’s exports to the price of its imports.
• Types of terms of trade
– Commodity, or net barter, terms of trade
• If PX is the price index of exports and PY is the price
index of imports, the commodity terms of trade (N) = (PX
÷ PY) x 100.
• If N = 120, then between the base year and the current
year export prices rose 20 percent relative to import
prices.
Dale R. DeBoer
University of Colorado, Colorado Springs
8 - 16
Terms of trade
• The terms of trade is the ratio of the price of a
country’s exports to the price of its imports.
• Types of terms of trade
– Commodity, or net barter, terms of trade
– Income terms of trade
• If PX is the price index of exports, PY is the price index
of imports, and QX is the nations volume of exports, the
income terms of trade (I) = (PX ÷ PY) x QX.
• If N = 105, then between the base year and the current
year the country’s ability to import based on export
earnings increased by 5 percent from the base year.
Dale R. DeBoer
University of Colorado, Colorado Springs
8 - 17
Terms of trade
• The terms of trade is the ratio of the price of a
country’s exports to the price of its imports.
• Types of terms of trade
• Implications of changing N and I
– As N falls, a nation must export more in order to
purchase the same number of imports.
– A I falls, a nation’s ability to purchase imports
falls.
– Both of these changes are welfare reducing.
Dale R. DeBoer
University of Colorado, Colorado Springs
8 - 18
Terms of trade
• The terms of trade is the ratio of the price of a
country’s exports to the price of its imports.
• Types of terms of trade
• Implications of changing N and I
• What has happened with the terms of trade?
– Prebisch and Singer concluded that the terms of
trade fell between 1938 and 1970.
Dale R. DeBoer
University of Colorado, Colorado Springs
8 - 19
Terms of trade
• Types of terms of trade
• Implications of changing N and I
• What has happened with the terms of trade?
– Prebisch and Singer concluded that the terms of trade
fell between 1938 and 1970.
– Cashin and McDermott found that primary
commodity prices (a key developing country
export) fell by 1 percent per year from 1862 to
1999.
• This implies a fall in N.
Dale R. DeBoer
University of Colorado, Colorado Springs
8 - 20
Terms of trade
• Implications of changing N and I
• What has happened with the terms of trade?
– Prebisch and Singer concluded that the terms of trade
fell between 1938 and 1970.
– Cashin and McDermott found that primary commodity
prices (a key developing country export) fell by 1
percent per year from 1862 to 1999.
– Countering these trends numerous studies have
shown an improvement in I for developing
countries.
Dale R. DeBoer
University of Colorado, Colorado Springs
8 - 21
Immiserizing growth
• Growth is expected to improve quality of life.
• It is possible for this connection not to hold
for a large exporting country.
• In this circumstance, either the incentive to
participate in international trade or to grow
would be undermined.
Dale R. DeBoer
University of Colorado, Colorado Springs
8 - 22
Immiserizing growth
• Suppose a country
faces the accompanying
market situation.
– Under these market
conditions, the country
will be an exporter.
P
S
International
price
D
Q
Dale R. DeBoer
University of Colorado, Colorado Springs
8 - 23
Immiserizing growth
• Suppose a country faces
the accompanying market
situation.
• If the country
experiences growth in
its ability to produce,
domestic supply will
increase.
– This will generate
increased exports, if the
international price
remains unchanged.
Dale R. DeBoer
University of Colorado, Colorado Springs
P
S
D
Q
8 - 24
Immiserizing growth
• If the country experiences
growth in its ability to
produce, domestic supply
will increase.
• However, if the country
is a large exporter, the
international price will
fall with the increase in
domestic supply.
P
S
International
price
D
Q
Dale R. DeBoer
University of Colorado, Colorado Springs
8 - 25
Immiserizing growth
• In this situation, the
welfare gain from the
increase in productive
ability is at least
partially offset by the
welfare loss from the
fall in the export price.
Welfare loss from the
fall in the terms of trade
P
S
International
price
D
Q
Welfare gain
from growth
Dale R. DeBoer
University of Colorado, Colorado Springs
8 - 26
Immiserizing growth
• While the welfare
reducing outcome is
possible, it is also
unlikely.
• Required conditions
Welfare loss from the
fall in the terms of trade
P
S
International
price
– The exporting country is
a large percentage of the
export market.
– The international
demand for imports is
highly inelastic.
D
Q
Welfare gain
from growth
Dale R. DeBoer
University of Colorado, Colorado Springs
8 - 27
Export instability
• Significant short run export earnings
fluctuations undermine development efforts.
– Planning is extremely difficult.
– Fluctuations increase investment risk which slows
the pace of capital formation.
Dale R. DeBoer
University of Colorado, Colorado Springs
8 - 28
Export instability
• Significant short run export earnings fluctuations
undermine development efforts.
• Why would export earning be unstable?
– Developing world exports tend to face inelastic
international demand.
• Price fluctuations in these markets do not significantly
change the quantity sold.
• Thus price fluctuations will generate large movements
in revenues collected.
Dale R. DeBoer
University of Colorado, Colorado Springs
8 - 29
Export instability
• Significant short run export earnings fluctuations
undermine development efforts.
• Why would export earning be unstable?
– Developing world exports tend to face inelastic
international demand.
– Fluctuating environmental conditions (weather,
natural disasters, etc.) cause more and larger
supply shifts in the developing world than in the
developed world.
Dale R. DeBoer
University of Colorado, Colorado Springs
8 - 30
Export instability
• Significant short run export earnings fluctuations
undermine development efforts.
• Why would export earning be unstable?
• Responses
– Marketing boards
• National organizations that buy excess stocks during
“good” years and sell stockpiles during “bad” years to
stabilize prices.
• An example is the cocoa marketing board of Ghana.
Dale R. DeBoer
University of Colorado, Colorado Springs
8 - 31
Export instability
• Significant short run export earnings fluctuations
undermine development efforts.
• Why would export earning be unstable?
• Responses
– Marketing boards
– International commodity agreements
• International organizations that intervene to control
markets supplies in order to stabilize prices.
• OPEC is an example of such an international
organization.
Dale R. DeBoer
University of Colorado, Colorado Springs
8 - 32
Import substitution vs. export
promotion
• During the 1950s, 1960s, and 1970s
developing nations made deliberate efforts to
move production away from primary goods
towards more industrialized production.
– Potential gains
•
•
•
•
Faster technological progress and growth
Creation of higher paying jobs
Improved terms of trade
Relief from balance of payments difficulties
Dale R. DeBoer
University of Colorado, Colorado Springs
8 - 33
Import substitution vs. export
promotion
• During the 1950s, 1960s, and 1970s developing
nations made deliberate efforts to move
production away from primary goods towards
more industrialized production.
• Strategies for industrialization
– Import substitution industrialization (ISI)
• Replace imports of industrial goods with domestic
production by reducing import access to the domestic
economy.
Dale R. DeBoer
University of Colorado, Colorado Springs
8 - 34
Import substitution vs. export
promotion
• During the 1950s, 1960s, and 1970s developing
nations made deliberate efforts to move
production away from primary goods towards
more industrialized production.
• Strategies for industrialization
– Import substitution industrialization (ISI)
– Export oriented industrialization
• Expand industrialization through efforts to expand
domestic exports of industrialized products.
Dale R. DeBoer
University of Colorado, Colorado Springs
8 - 35
Advantages of ISI
• The market for the product already exists
• It is easier to close the domestic market to
imports than to establish new industries in the
face of foreign competition.
• Foreign firms will be encouraged to invest
domestically to avoid the barriers to trade.
Dale R. DeBoer
University of Colorado, Colorado Springs
8 - 36
Disadvantages of ISI
• Protected industries have reduced incentives
to improve and become competitive.
• The domestic economy may be too small to
exploit available economies of scale.
• Import substitution is difficult for more
complex products.
Dale R. DeBoer
University of Colorado, Colorado Springs
8 - 37
Advantages of export orientation
• Allows for the exploitation of available
economies of scale
• International competition spurs greater
domestic efficiency
• Industrial expansion is not limited by the scale
of the domestic economy.
Dale R. DeBoer
University of Colorado, Colorado Springs
8 - 38
Disadvantages of export orientation
• It may prove difficult for infant industries to
become established in the face of foreign
competition.
• It may prove difficult to export in the face of
protectionist measures in potential
international markets.
Dale R. DeBoer
University of Colorado, Colorado Springs
8 - 39
Current problems facing developing
nations
• Poverty
– World Bank global poverty statistics
• WWW link
Dale R. DeBoer
University of Colorado, Colorado Springs
8 - 40
Current problems facing developing
nations
• Poverty
• Foreign debt
Dale R. DeBoer
University of Colorado, Colorado Springs
8 - 41
Current problems facing developing
nations
• Poverty
• Foreign debt
• Barriers to trade facing developing countries
Dale R. DeBoer
University of Colorado, Colorado Springs
8 - 42