Ch 8 – Trade Policies for Developing Nations

1. Ch 8 – Trade Policies for Developing Nations Government’s view of the economy could be summed up in a few short phrases: If it moves, tax it. If it keeps moving, regulate it. And if it stops moving, subsidize it. - Ronald Reagan

2. Ch 8 – Developing Nations • Advanced nations have relatively high levels of per capita GDP, longer life expectancies, higher levels of adult literacy. • North America • Western Europe • Australia • New Zealand • Japan • Traditional international trade theory is not as relevant for developing nations. May actually hinder economic development. • Most of • Africa • Asia • Latin America • Middle East

3. Ch 8 – Developing Nations Characteristics of Developing Nation Trade • Highly dependent on advanced. • Most developing nations exports go to advanced. • Very little inter-developing nation trade. • Tend to export primary products (agricultural, raw materials) or labor-intensive manufactured goods.

4. Ch 8 – Developing Nations Trade Problems of Developing Nations • Unstable Export Markets • Many developing nations depend on a single primary product. • Poor harvest or decreased demand can seriously affect export revenues, disrupting income levels. • Major problem if there is a relatively low price elasticity of demand or supply. • Inelastic demand means the price change is greater than the quantity change, so small shift can induce large price changes.

5. Ch 8 – Developing Nations D2 Trade Problems of Developing Nations • Unstable Export Markets (cont) • Supply is perfectly inelastic (supply is fixed in short run no matter the price) • Demand is relatively inelastic. • SO small shift in demand causes relatively large change in price. P S1 D1 Q

6. Ch 8 – Developing Nations S2 Trade Problems of Developing Nations • Unstable Export Markets (cont) • If demand increases, price will increase in this market. • What if suppliers respond to price increase by planting more? • If demand is relatively inelastic, shift of supply could drive price down. • Export prices and revenues can be extremely volatile when demand and supply are price inelastic. P S1 D2 D1 Q

7. Ch 8 – Developing Nations Trade Problems of Developing Nations • Worsening Terms of Trade • Developing nations claim that their terms of trade have deteriorated over time (prices of their exports have fallen relative to prices of their imports). • Monopoly power in manufacturing industries in industrialized nations drive prices up. Productivity gains lead to profits for manufacturers rather than lower prices. • Primary goods are competitive markets, so prices fluctuate with markets. Gains in productivity do not result in profits (competitive markets have zero economic profits in LR), so prices fall with productivity gains. • Empirical evidence to support this claim is inconclusive.

8. Ch 8 – Developing Nations Call for New International Economic Order • Developing nations have collective demands for policies that would generate economic development for them. • The United Nations Conference on Trade and Development (UNCTAD) was convened in 1964, meet every four years. • Three areas of focus: • Tariff preferences • Primary product price stabilization • Aid from advanced nations to developing nations. • Not very successful because: • Advanced say developing should use macro policy more effectively for development. • Developing should develop K goods at higher rate. • No power to enforce recommendations.

9. Ch 8 – Developing Nations Price Stabilization 1) Commodity Agreements • Multilateral attempts to keep prices stable using collective power of producing and consuming nations. • Prices are maintained between a range of ceilings and floors (min and max prices) • Less distortion of market mechanism when multilateral than unilateral. • Examples: cocoa, tin, coffee, sugar, wheat

10. Ch 8 – Developing Nations Price Stabilization • Cartels • Unilateral attempts to keep prices stable (or high) using collective power of producing nations. • Most successful – Organization of Petroleum Producing Countries (OPEC) 1960. • Goal is to keep prices higher than competitive level. • Individually, each nation cannot affect world market, but collectively they have monopoly (oligopoly) power. • Competition between the member nations is restricted with production quotas. • Cartels behave like profit-maximizing monopolists.

11. Ch 8 – Developing Nations P1 PC Q1 QC Price Stabilization • Cartels (cont) • As a group, cartel behaves as profit-maximizing monopolist. • Profit-maximizing output is set where MC = MR. • Output is restricted, and price is higher than it would be in competitive market where D=MR=MC. CARTEL P MC D Q MR

12. Ch 8 – Developing Nations Profit QCHEAT Cheating • Cartel assigns output for each member that will maintain high market price. • Members have profit incentive to cheat and increase output on their own. • What will happen to market price if enough individual members increase output beyond quota? Price Stabilization • Cartels (cont) CARTEL INDIVIDUAL NATION P P S MC MC AC P1 D Q1 Q QQUOTA Q MR

13. Ch 8 – Developing Nations Price Stabilization • Cartels • Other problems with cartels: • Number of sellers • Fewer sellers increases likelihood of success. • Easier to coordinate, regulate • Cost and demand differences • Difficult to agree on price and output when larger and smaller nations collude. • Different profit-max prices, cost curves, etc. • Potential competition • Increased profits attract new competitors. • New entry increases supply, pushed down price. • Cartel must be able to block entry. • Economic downturns • If demand falls, profits may fall, so firms will have incentive to cut prices to reduce losses. • Substitute goods • If substitutes exist or are developed, more difficult to maintain cartel power.

14. Ch 8 – Developing Nations Economic Trade Strategies • Import Substitution • Inward-oriented strategy. • Use of trade barriers to protect domestic industries from import competition. • Developing nations meet their own domestic demand without imports. • High tariffs and barriers push up import prices and protect domestic industries. Advantages: • Low risk because there is already domestic demand. • Easier than forcing individual nations to reduce barriers. • Foreigners have incentive to locate manufacturing plants in developing nations to avoid high tariffs, providing jobs for domestic workers.

15. Ch 8 – Developing Nations Economic Trade Strategies • Import Substitution • Inward-oriented strategy. • Use of trade barriers to protect domestic industries from import competition. • Developing nations meet their own domestic demand without imports. • High tariffs and barriers push up import prices and protect domestic industries. Disadvantages: • No incentive for sheltered industries to increase efficiency. • Small market prevents domestic economies of scale. • Nations discriminate against other industries with respect to resource allocation.

16. Ch 8 – Developing Nations Economic Trade Strategies • Export-Led Growth • Outward-oriented strategy. • Export subsidies to encourage exports and offset barriers. • By 1970’s, many developing nations shifted from import substitution to export-led growth. • Empirical evidence shows outward-oriented policies contribute to more growth than inward-oriented. Advantages: • Encourages comparative advantage industries • Larger market, so industries can enjoy economies of scale. • Promotes efficiency in domestic firms. Disadvantages: • Depends on advanced nations to absorb export of manufactured goods.

17. Ch 8 – Developing Nations Economic Trade Strategies • Asian Tigers • High and sustained economic growth over last three decades. • Invested in human K. • Stayed open to international trade. • Actively sought foreign technology. • Discouraged trade unions • Prevented minimum wage legislation • Rapid growth led to growing protectionist sentiment toward Asian nations in US, increased pollution.

18. Ch 8 – Developing Nations Taiwan Japan Malaysia Economic Trade Strategies Flying Geese Growth Pattern • Comparative advantage tends to be a function of technological ability. • Comparative advantage can be dynamic, can shift as technology develops. • In Asian Tiger economies, exports shift from most developed nations to less developed as technology changes. • Japan produces and exports textiles. • As technology develops and human K grows, Japan shifts to automobiles, textile production moves to Taiwan and Malaysia. • And so on . . .

19. Ch 8 – Developing Nations Economic Trade Strategies Why didn’t Asian Miracle Continue? • Tiger growth unsustainable because not based on productivity gains from technology advances, but mostly on K growth. • If growth is based on K growth instead of productivity gains, marginal productivity of K will decline. Y Increase in K K

20. Ch 8 – Developing Nations Economic Trade Strategies Why didn’t Asian Miracle Continue? • Tiger growth unsustainable because not based on productivity gains from technology advances, but mostly on K growth. • If growth is based on K growth instead of productivity gains, marginal productivity of K will decline. Y Increase in technology, increase in output per unit of K K