Trade Policy in Developing Countries

Question 1

Import substituting industrialisation?

Answer 1

• Trade policy adopted by many low and middle income countries before the 80s
• Aimed to encourage domestic industries by limiting competing imports

Question 2

Principal justification of import substituting industrialisation?

Answer 2

Infant Industry Argument
* Countries may have a potential comparative advantage in some countries, but these industries cannot initially compete with well-established industries in other countries
* To allow these industries to establish, gov should temporarily support them until they have grown strong enough to compete internationally

Question 3

Problems with infant industry argument?

Answer 3

• May be wasteful to support industries now that will have comparative adv in future
• With protection, infant industries may never grow up
• No justification for gov intervention unless there is a market failure that prevents the private sector investing in the infant industry

Question 4

Infant industries and market failure?

Answer 4

• 2 arguments for how market failures prevent infant industries becoming competitive
• 1. Imperfect financial asset markets –
• Bc of poorly working financial laws and markets, firms cannot save/borrow to invest in production process
• If creating better functioning markets isn’t feasible, high tariffs are a 2nd best policy to increase profits in new industries
• 2. Appropriability –
• Firms may not be able to privately appropriate the benefits of their investment in new industries bc those benefits are public goods
• Knowledge created when starting an industry may not be appropriable (may be a public good) bc of lack of property rights
• If establishing a system of property rights isn’t feasible, high tariffs would be 2nd best policy in encourage growth

Question 5

Import-substituting industrialisation - in practice?

Answer 5

• In Latin America encouraged manufacturing industries in the 50s and 60s
• But economic development was the ultimate goal
• However, countries adopting these policies grew slower than others
• Appeared infant industry argument not as valid as initially believed
• Import-substitution industrialisation involved costs and promoted wasteful use of resources –
• Involved complex, time consuming regulations
• Set high tariff rates for consumers, including firms that needed to buy imported inputs
• Promoted inefficiently small industries

Question 6

Trade Liberalisation?

Answer 6

• Some that had relatively free trade had higher average economic growth
• By mid 80s, many gov lost faith in import sub and began to liberalise
• Dramatic fall in tariff rates in India and Brazil, less drastic reductions in many other developing countries
• Trade lib occurred along with a dramatic increase in vol of trade
• Share of trade in GDP tripled 1970-88, with most happening after 85
• Share of manufactured goods in developing country exports surged, coming to dominate the exports of the biggest developing economies

Question 7

Evidence for promoted development - trade lib?

Answer 7

Evidence mixed
* Growth rates in Brazil and other Latin American countries slower than they were during import-substituting industrialisation
* But unstable macroeconomic policies and financial crises contributed to slower growth since the 80s
* Others like India grown rapidly since liberalising in the 80s, but unclear to what degree liberalisation contributed
* Some argue it has contributed to income inequality as Heckscher-Ohlin predicts

Question 8

Trade and growth - takeoff in Asia?

Answer 8

• Instead of import-sub, several East Asian countries adopted policies promoting exports in targeted industries (Japan, Hong Kong, Taiwan, South Korea, Singapore, Malaysia, Thailand, Indonesia, China)
• Generated high volume of exports and imports relative to total production
• Possible to develop through export-oriented growth
• However, Latin American nations such as Mexico and Brazil did not see comparable take-offs – suggest other factors must have played a role in Asia
• High saving and investment rates as a contributor
• Rapid growth in education led to high literacy and numeracy rates – important for productive labour force
• Also undertook other economic reforms