VII.D Trade Policies for Development I.Import Substitution. II.Export Promotion The “Industrialization Strategy” Approach III.Regional Economic Integration.

VII.D Trade Policies for Development

I. Import Substitution. II. Export Promotion• The “Industrialization Strategy” Approach

III. Regional Economic Integration

See text, Chapter 12, Sections 12.5, 12.6 and 12.7, pp. 630-659

ECON 3508 December 2, 2015

I. Import Substituting Industrialization (ISI)

1. Basic Character of the Approach:• Definition• Objectives:

– Industrialization and structural Change;– Employment creation in the "modern

sector"– Balance of payments considerations:

reduce imports– "Economic Independence"

2. Method, or "policy tools:“

– Analyze import pattern;

– “Protect” and subsidize new industries replacing most significant imports via

• Tariffs• Non-Tariff Barriers (NTBs)• Low interest lending• Subsidies of various sorts to the "ISI" activities• Tax advantages of various sorts• Provision of infrastructure

3. Origins of the approach:

•Development theorizing, 1943-1960;• Experience of the higher income countries earlier in their histories: (USA, Canada, Germany, etc.)• The Soviet economic model in some cases;• The Latin American development experience: 1930s and WW II eras;• Classical Economics: the Infant Industry argument changed to an "infant economy" argument.

4. Strengths of the Approach

– initial potentiality of substituting for some major import products;

– ISI as a "natural process" – The larger the country, the greater the

potential of ISI due to the existence of a larger market.

[e.g. compare Brazil with Nicaragua]

5. Results:

– Initially, from 1945 to around 1970. reasonably good especially for larger countries;

• Rapid growth and significant industrialization plus structural change in many countries;

– Later, around the late 1960s into the 1980s, the approach was "running out of steam”

• Growth slowed down; inefficiencies with the approach became overpowering in many cases.

6. Problems with the approach:

– Indiscriminate and extreme implementation in many cases;

– Thwarting of various types of economies of scale

– "Miniature replica effect"– promotion of oligopoly and monopoly power

through protection against imports;

– discrimination against all non-protected sectors (usually agriculture and resource based activities)

– blockage of intra-industry specialization;– impacts on income distribution

– Balance of Payments impacts often adverse (due to high demand for imported capital goods, and inputs; • and to the impact on the exchange rate

– tendency to exhaust itself

Technical Note: Partial Equilibrium Analysis of a Tariff.Given Sdom and Ddom and Sworld for a productFree trade situation: Sw and DD at Q1 prevail, with 0Q2 domestically produced and Q2Q1 imported.Suppose that a tariff is imposed, with the Tariff is “t0”.

Relevant Supply curve is now Sw+to at Pd and relevant price is Pd = Pworld = to

Who wins and who loses as a result of the higher tariff??Consumers: lose areas: a + b + c + dProducers: gain area: aGovernment: gains area: “c” as tax revenue

Net loss to society: -a –b –c –d +a + d = -b -c

(“Deadweight loss” to society = - b – c)

Technical Note: Nominal and Effective Rates of ProtectionNominal Rate of Protection: the rate of protection when a tariff levied on

imports of a product, usually as a percentage of the value of the product.

i.e. the rate of protection then is simply the % rate applied

Effective Rate of Protection: the rate of protection on the Value Added

domestically of the product on which the tariff is levied.

Example:

A country imposes a 100% tariff on cars.

Suppose an imported car costs $20,000 plus the 100% tariff (of 20,000.) or $40,000.

The domestic price of similar locally made cars can then rise to the level of $40,000.

Suppose the domestic value added of the car is the final price, less the costs of the imported inputs, which are 50% of the world price or $10,000.

Then the 100% nominal tariff (of $20,000.) is applied to the domestic value added which is 10,000. The effective protection is then 20,000 on the domestic value added of 10,000 or 200%.

i.e. the effective rate of protection exceeds the nominal rate considerably when the domestic value added is less than 100%, that is when inputs are imported at lower world prices.

II. Export-Oriented Development Strategies

1. Basic Character of the Approach– Definition– Relationship with other aspects of External-

Orientation;– Objectives:

• Achieve accelerated and economically sustainable growth and development;

• Accelerate high-productivity employment creation

• Improve income levels

• Relieve balance of payments constraints on development

2. Policy Tools or Methods:

– lower tariffs and non tariff barriers (NTBs) – cut other types of subsidization for old ISI

firms;– provide transitional support for export

activities or the "clusters" of economic activities around major export activities'

– let the exchange rate float, i.e. let the exchange rate realities prevail by permitting a market determined rate;

3. Range of Approaches:– Complete "Apertura" – Generalized multilateral trade liberalization;– Regional trade liberalization;– Restricted liberalization in some sectors

only;– Some bilateral liberalization– "Export Processing Zones" – various combinations of the above.

4. Origins of the Approach:– the earlier experience of some major cases,

e.g. Japan, the G-4 (or Asian Tigers)– economic theory and argumentation– problems with ISI;– regional integration experiences, esp.

European Common Market;

– Now, the experience also of China, Chile, Mexico and other countries that have used the approach successfully

5. Strengths:• Actual Historical Experiences:

– Highly successful: Asian Tigers; China; India; Malasia, HK, Taiwan, S. Korea, Chile

– Positive but debatable: Mexico, much of Latin America;• Vis-a –vis Disaster ISI cases: e.g. N. Korea

• Reduction of Economic Waste (improved efficiencies; rising productivity)

– improved economies of scale;– intra-industry specialization becomes possible;

• Reduced discrimination against non-protected sectors;

• Intensified dynamic effects of "learning through competition;"

• Reduced monopoly-oligopoly power for domestic firms;

• Reduced rent-seeking activities? Maybe.

• Positive and more sustainable effect on balance of payments;

• Increased foreign exchange earnings permit increased importation of capital goods and thence increased technological transfer;

• Higher productivity employment permits rising real wages and incomes, and thence improved family well-being and human development;

• Improved growth permits increased taxation and social expenditures and thence improved human development;

6. Problems with the Approach:• Disadvantages of being a “latecomer”: China

and a few other big countries have seized many of the opportunities already.

• Some countries may not be in a position to benefit quickly if human resources, institutions and other policies are weak.

• Short-term transitional costs of restructuring may make the approach unsustainable at first;

• Vested interests may block implementation;• Major gains in employment and wages may be

slow in coming;• May accelerate "resource stripping" if environmental

policies are weak and inappropriate;

Export Orientation: Industrialization Strategy Approach

• Supportive government policy is needed to support new industrial export activities; laissez faire is not enough.

• Patterned after experiences of South Korea, Taiwan and Singapore, perhaps Brazil, as well.

VIII.E REGIONAL ECONOMIC INTEGRATION Among Developing

Countries

ECON 3508 November 2, 2015See textbook, pp. 655-659

1. How does REGIONAL ECONOMIC INTEGRATION Work? Advantages

2. Potential Disadvantages

3. Forces promoting economic integration

4. Types of Integration Scheme

5. Experience with Economic Integration

6. Some Specific Integration Schemes: Africa, Latin America and Asia

The Historical Record:

Some comments on:1. The US common market after 1776;

Germany after 1870 unification

2. The European Common Market: from 6 members to 23 or so.

3. LAFTA; NAFTA; CAFTA

4. Hugo Chavez “Bolivarian Alternative (?)

5. Asian, African and other integration attempts

Italy, 1843 and Germany to 1866

1. How does REGIONAL ECONOMIC INTEGRATION Work?

It makes possible productivity improvements,– i.e. it permits more output to be squeezed out of

given quantities of human, natural and capital resources.

It thus can contribute to – increasing real incomes in a country, thereby

permitting – improved human development by individuals and

families for themselves, and – by governments through increased taxation and social

expenditures (health, education, social security, infrastructure etc.)

It can also promote economic development through– strengthening the tax base of governments so that– more can be invested in public goods or other

purposes directed more specifically at economic development.

 The economic expansion facilitated by economic

integration may make possible public investment in safeguarding the environment? Maybe

Does Economic Integration promote stability and peace among countries?

Evidence and argumentation pro:Evidence contra:

How does Regional Economic Integration promote productivity improvements?

1. Permits Implementation of Economies of Scale and Consequent Resource Saving (human, natural and capital resources):– Larger plant size

– Larger enterprise size

– Increased length of “production runs”

– Increased intra-industry specialization

– Increased vertical specialization

– Increased agglomerative economies.

These are some of the “dynamic benefits” of improved rationalization of economic structure.

2. Static Benefits: gains from comparative advantage from trade creation

3. Impacts of Increased Competition within the Integration Area:

– Stimulates domestic product quality improvement;

– Stimulates improvements i.e. reductions, in production costs.

4. Expanded Market Size can Promote Increased (and more efficient) Investment.

5. Strengthened Ability for the Region to develop successful “clusters” of economic activities and thus to integrate and compete in the international economy

6. Strengthened Ability for the Region to Face External Competition for its own domestic markets.

.

These gains can be greatest for small country partners

2. POTENTIAL DISADVANTAGES OF REGIONAL INTEGRATION

1. Costs of Transition to Larger Markets:Some industries or types of economic activity may

not be able to compete with imports.

The result is then labour displacement, economic dislocation, and unemployment.

– Are these “costs” of economic integration borne by the workers and enterprises themselves, or does society share in their burden?

– enterprise and industry restructuring costs;

2. Possible Longer Term Negative Impacts:– “agglomerative dis-economies” for some

regions or countries– consequent loss of economic activity and

employment; (e.g. the Maritime provinces in Canada?)

3. Trade diversion may harm some partners

What is “Trade Diversion?

3. Forces behind the attempts to form larger economic communities:

Economic theory and argumentation Problems with ISI;

Other regional integration experiences, esp. the European Common Market, but

Also the USA and Asian and L. American

Demonstration effects

Political arguments: • peace and stability and

• regional bargaining power

4. Types of Integration Scheme1. Specific Functional Cooperation

Agreement to cooperate for specific purposes

(watershed management; transport, energy….)

2. Free Trade Area (FTA);Lowering and elimination of trade barriers between two or more

countries; separate tariff structures for the rest of the world

2. Customs Union (CU)CU = FTA + Common External Tariff

3. Common Market (CM):Common Market = CU + Factor Mobility (capital & labour)

4. Economic and Monetary Union (EMU):EMU = CM + Single Currency (monetary &Exchange rate policy)

5. Political Union (PU)Political Union = EMU + Common foreign & security policy

Obstacles to Successful Integration

Achieving effective economic integration is complex and politically difficult. Why?

1. Vested interests of enterprise may object due to fear of competition from neighbors; workers may object given the probability of some job loss as well as job gain.

2. Political or philosophical differences among neighboring countries

e.g. East African Community with Idi Amin, Nyrere and Kenyatta

3. Trade Diversion may damage some partners and induce them to leave

4. Distributional Issues: fear that some countries gain disproportionately while others lose

5. Weaknesses in the supranational institutions

6. Infrastructural weaknesses prevent meaningful economic interaction

Developing Country Experiences with Economic Integration: Africa

1. Early ambitious “Pan-Africanists” and modest gradualists;

2. Moderates unwilling to sacrifice national independence so soon after achieving it. A gradualist approach for some time, but with high aspirations

3. Major difficulties have hindered progress Antagonisms among countries

4. Logistic Obstacles: Infrastructure Gaps (see map)

5. Physical Magnitude of Integration Task (see map)

African Economic Integration Schemes

1. Southern African Development Community (SADC)

2. East African Community (EAC)

3. Economic Community of West African States (ECOWAS)

4. Economic Community of Central African States (ECCAS)

5. Common Market for Eastern and Southern Africa (COMESA)

6. Arab Maghreb Union (UMA)

7. Southern Africa's Common Monetary Area (CMA)

8. African Economic Community, (AEC)

African Economic Community,

including

H. African Economic Community

(The Community of Common Markets)

Founded in 1991;

The Sub-Saharan Integration Scheme, including all others except Mahgreb

Ambitious objectives: • Promote ec., soc., &cultural development and integration

• Establish a framework for the mobilization af all resources

• Promote cooperation in al fields of human endeavour

• Harmonize policies of all existing and future economic communities

“Fund for community solidarity and compensation”

Envisages rather complete union ultimately.Common currency; common Central Bank, Pan-African parliament

African Intra-Bloc Exports as a Per Cent of Total Exports

Integration Scheme

1970 1980 1990 2000 2007

COMESA 9.1 6.1 6.6 6.0 4.7

EAC 16.9 8.9 13.3 17.6 20.4

ECCAS 2.2 1.4 1.4 1.0 0.6

ECOWAS 2.9 10.1 7.8 10.8 9.4

SADC 1.4 0.3 2.8 12.2 15.2

Source: Text, p. 490 and World Bank, World Development Indicators, 2009. p. 349

Latin American Experience with Economic Integration

Early Beginnings;

Limited Early Achievements

Current Schemes

Prospects

Asociación Latinoamericana de

Integración

ALBA Alianza Bolivariana para los Pueblos de Nuestra

América

Central American Common Market

Grupo Andino

Caribbean Associations

Mercosur

ASEAN

Conclusion:Numerous attempted integration schemes;Mixed results;Some schemes excessively ambitious, falter in

implementation;Difficulties in establishing effective integration

movements are immense;Success re integration is vital for Asia’s,

Africa’s and Latin America’s Future.