Trade and Development: ISI and Economic Reform

1
Trade and Development ISI and Economic Reform

• Oatley, Chapters 6 and 7

2
Ch. 4 Trade and Development I
Import-Substitution Industrialization

• Mexico heavily protected until 1980s, high
  tariffs. Today, Mexico is one of the most open
  developing countries in the world.
• Contrast with the previous era in which
  developing countries emphasized industrialization
  policies.
• Most countries have now dismantled protectionist
  systems they created in the first 30 years of the
  postwar period.
• Now they are active participants in the WTO.
• This chapter explores why countries had adopted
  protectionism.
• The next chapter focuses on the shift in policy.

3
Trade and Development I Import-Substitution
Industrialization

• First we look at how governments came into power
  that supported import-competing interests.
• We then look at specific policies.

4
Domestic Interests, International Pressures, and
Protectionist Coalitions

• Until WWI developing countries (that were
  independent) opted for liberal trade policies.
• They exported agricultural goods and other
  primary commodities and imported manufactured
  goods.
• By 1950s protectionism dominated trade policies
  (until the late 1980s).
• Trade and development policies shaped by
  political competition between the country and the
  city.

5

• Rural-based agriculture versus urban-based
  manufacturing.
• Factor endowments ( developing countries land
  abundant, capital poor countries, in general)
• Thus, we see that GDP is dominated by agriculture
  and so are exports based on commodities and
  agriculture (see Tables 6.1 and 6.2)
• Many countries were also monoexporters (one
  product).

6

• Agriculture is the export-oriented sector
• Manufacturing is the import-competing sector
• Landowners (of agricultural land) see incomes
  rise from trade but decline under protectionism
• Manufacturers, by contrast, prefer protectionism
• Urban interests people who work for government,
  in retail (the sale of goods directly to the
  consumer) or in other non-manufacturing
  activities (nontrade-goods sector)
• Some goods or services must be performed locally
• International trade affects incomes in the
  nontrade-goods sector primarily through its
  impact on the prices of the traded goods that
  people employed in the nontrade-goods sector
  purchase.

7

• People employed in the nontraded-goods sector
  realize income gains from policies that reduce
  the prices of traded goods and loses from
  policies that raise the prices.
• Oligarchic democracy in various Latin American
  countries contributed to the more liberal
  policies favored by agricultural interests.
• In Asia and Africa colonial structures ensured
  the dominance of export-oriented agricultural
  interests.
• Taiwan and Korea enclave agriculture (result of
  Japanese colonization) rice-export-oriented
  agricultural sectors that had few linkages to
  other parts of the local economy.

8

• India cotton, wheat, tea, rice.
• Ghana cocoa
• But politics began to change in 20th century
• Export-oriented interests gave way to interests
  of import-competing manufacturers
• WWI international economic shocks
• Government mandated rationing of goods and
  primary products in Europe and the US made it
  difficult for Latin American countries to import
  goods from US or Europe.
• Falling commodity prices due to Great Depression
  and disruption of trade patterns reduced foreign
  exchange.

9

• Trade barriers in Latin America was the response
  in order to produce many of the manufactured
  goods that they had previously imported
• Growing urban middle class
• Interest groups, industry based associations, and
  labor unions
• New political coalitions based on support of the
  urban sectors
• Juan Peron in Argentina in the 1940s Gatulio
  Vargas in Brazil in 1950
• Political coalitions where incomes were based on
  import-competing manufacturing
• Protectionism
• India similar led to Indian independence
  movement

10

• Elsewhere in Asia, decolonization following
  defeat of Imperial Japan
• Defeat of nationalist Chinese government (exiled
  to Taiwan)
• Chinese nationalists imposed land reform in
  Taiwan
• Africa decolonized only after 50s and early 60s.
  The nationalist struggles for independence that
  emerged in the 1950s and succeded over the next
  15 years sought to transfer control over existing
  economic practices from colonial governments to
  indigenous elites.
• As a consequence, import-competing manufacturing
  in Africa played a much smaller role in early
  post-independence politics than did the
  nontraded-goods sector. The indigenous elites,
  wanted to inherit the system rather than to
  revolutionise it.

11
The Structuralist Critique Markets, Trade, and
Economic Development

• Structuralism
• The shift of resources from agriculture to
  manufacturing would not occur unless the state
  adopted policies to bring it about.
• Belief that the market would not promote
  industrialization.
• The chapter will first look at the structuralist
  critique of the domestic market in developing
  countries and then turn its attention to the
  structuralist critique of the international
  market and the international trade system.

12
Market Imperfections in Developing Countries

• Belief that domestic market could not be expected
  to bring about the necessary shift of resources
  for industrialization.
• Market would not promote investment in
  manufacturing industries.
• Coordination problems that would limit investment
• Complementary demand not enough manufacturing
  for consumption (no single entrepreneur has an
  incentive to create a manufacturing enterprise)
• Big push overcome the coordination problems
• Economic planning

13
Market Imperfections in the International Economy

• Singer-Prebisch theory divides the world into
  two distinct blocks-the advanced-industrialized
  core and the developing world-periphery.
• Participation in the GATT would make it harder
  for developing countries to industrialize by
  depriving them of critical resources
• An improvement in a countrys terms of trade
  means that the price of the goods it exports is
  rising relative to the price of the goods it
  imports.
• As a countrys terms of trade decline, it must
  exchange a larger volume of domestic production
  (it must export more) for a given amount of
  foreign production (imports).
• For a developing country- a fall in the price of
  primary commodities relative to that of
  manufactured goods lowers developing countries
  incomes. A rise in the price of primary
  commodities relative to that of manufactured
  goods raises their incomes.

14

• The Singer-Prebisch theory argues that developing
  countries terms of trade deterioate steadily
  over time
• Different consequences of productivity increase
  in the core and the periphery
• Core-country countries labour is strong,
  productivity improvements are transformed into
  rising wages and stable prices.
• Periphery countries labour is weak, productivity
  improvements are transformed into stable wages
  and falling prices.
• Falling prices means the amount that developing
  countries must export to acquire a given volume
  of imports rises continously over time.

15

• Engels law (Erst Engel) people spend smaller
  percentage of their total income on food and
  other primary commodities as their incomes rise.
• As incomes rise in the core countries, a smaller
  percentage will be spent on imports of primary
  commodities, but as incomes rise in peripheral
  countries, a larger percentage of their incomes
  will be spent on manufactured products imported
  from core countries.

16
Domestic and International Elements of Trade and
Development Strategies

• State-led development strategies, sheltered by
  high protectionist barriers.
• Rapid industrialization
• In the international arena, concern about the
  distributional implications of international
  trade led developing countries to seek
  far-reaching changes to the GATT-based trade
  system.

17
Import Substitution Industrialization

• Soviet Union as a model
• Import substitution industrialization (ISI)
• Substitute domestically produced goods for
  previously imported manufactured items
• 2 stage strategy
• Easy ISI simple consumer goods soda, beer,
  apparel, shoes and furniture
• Second stage either export substitution
  strategy-(the export of labour-intensive
  manufactured goods) or
• Secondary ISI emphasis shifts from the
  manufacture of simple consumer goods to the
  production of consumer durable goods.
• Increasing percentages of locally produced
  components
• Backward linkages increases in demand in
  industries that supply components for the
  production of one good (e.g. cars)

18
Import Substitution Industrialization

• Trade barriers, government planning, and
  investment policy.
• The justification for trade barriers was provided
  by the infant-industry argument and by recurrent
  lack of foreign exchange.
• Five year plans were designed to serve as
  guidelines for public expenditures and for
  economic policies. Planning was used to
  determine which industries would be targeted for
  development and which would not.
• State-owned enterprises (investment policies in
  targeted industries) (mixed or state ownership)

19
Import Substitution Industrialization

• Although import-competing manufacturing benefited
  from ISI, export-oriented agriculture bore many
  of its costs.
• Typically, government-owned marketing board
  would purchase crops from domestic farmers at
  prices well below the world price and then would
  sell the commodities in the world market at the
  world price.
• The difference between the price paid to domestic
  farmers and the world price represented a tax on
  the agricultural incomes that the state could use
  to finance government-favoured projects in
  industry.

20
Import Substitution Industrialization

• Thus, income was transferred from rural
  agriculture to urban manufacturing and
  nontraded-good sectors (ISI redistributed
  income).
• Rapid economic growth

21
Reforming the International Trade System

• Since developing countries were skeptical that
  trade could contribute to economic development,
  one of the principal objectives was to reform the
  trade system in ways that would transfer income
  from core countries to the periphery as
  compensation for the losses resulting from their
  deteriorating terms of trade.
• 1958 GATT-directed study, the Haberler
  Report-explored the poor trade performance of
  developing countries, arguing that commodity
  price movements and high tariffs in the advanced
  industrialized countries harmed developing
  countries.
• The report provided intellectual support for the
  structuralists main arguments by suggesting that
  the GATT was relatively unfavourable to primary
  producing countries and by concluding that
  developing countries were losing ground under the
  GATT.

22
Reforming the International Trade System

• By the early 1960s, a coalition of developing
  countries dedicated to far-reaching reform of the
  international trade emerged. Its important
  success was achieved with the formation of the
  United Nations Conference on Trade and
  Development (UNCTAD) in March 1964.
• UNCTAD was established as a body dedicated to
  promoting the developing countries interests in
  the world trade system. At the conclusion of this
  first UNCTAD conference, 77 developing country
  governments signed a joint declaration that
  called for reform of the international trade
  system.
• During the next 20 years, trade relations between
  the developing world and the advanced
  industrialized nations revolved almost wholly
  around competing conceptions of how to organize
  international trade embodied in the GATT and
  UNCTAD.

23
Reforming the International Trade System

• Although the advanced industrialized nations
  defended market-based GATT, the group of 77 used
  the UNCTAD, and the UN more broadly to try to
  reduce the GATTs role in international trade and
  to redistribute global income from the core to
  the periphery.

24

• During the 1960s, developing countries used the
  UNCTAD to pursue three international mechanisms
  that would provide them a larger share of the
  gains from trade
• Developing countries pressed for the creation of
  commodity price stabilization schemes.
• Commodity price stabilization was achieved by
  setting a floor below which commodity prices
  would not be allowed to fall, and by creating a
  finance mechanism, funded largely by the advanced
  industrialized countries, to purchase commodities
  when prices threatened to fall below the
  established floor.

25
Reforming the International Trade System

• Developing countries also sought direct financial
  transfers from the advanced industrialized
  countries.
• Developing countries also sought greater access
  to core-country markets, pressuring the advanced
  industrialized countries to eliminate trade
  barriers on primary commodities and to provide
  manufactured exports from developing countries
  with preferential access to the core countries
  markets.

26
Reforming the International Trade System

• These reform efforts yielded very few concrete
  results. Core countries agreed to modify the GATT
  charter to incorporate concerns specific to
  developing countries.
• In 1964, three articles focusing on developing
  countries were included in the GATT Part IV.
• Part IV called upon core countries to improve
  market access for commodity exporters, to refrain
  from raising barriers to the import of products
  of special interest to the developing world, and
  to engage in joint action to promote trade and
  development.

27
Reforming the International Trade System

• Yet in the absence of meaningful changes in the
  trade policies pursued by the advanced
  industrialized countries, Part IV provided few
  concrete gains.
• Developing countries that belonged to the GATT
  were able to benefit from trade reductions
  without having to offer concessions in return.
• Benefits from this concession were more apparent
  than real because GATT negotiations focused
  mainly on manufactured goods produced by the
  advanced industrialized countries and excluded
  agriculture, textiles and many other
  labour-intensive goods. (few products exported by
  developing countries were benefiting from reduced
  tariffs).

28
Reforming the International Trade System

• Late 60s, advanced industrialized countries
  agreed to the Generalized System of Preferences
  under which manufactured exports from developing
  countries gained preferential access to advanced
  industrialized countries markets.
• Yet this concession was also of limited
  importance because advanced industrialized
  countries often limited the quantity of goods
  that could enter under preferential tariff rates
  and excluded some manufacturing sectors from the
  arrangement entirely.

29
Reforming the International Trade System

• Even though their efforts during the 60s achieved
  few concrete gains, the Group of 77 (check
  http//www.g77.org/doc/) escalated its demands
  for systemic reform in the early 1970s.
• A set of more radical demands came to the agenda
  later. New International Economic Order (NIEO),
  an attempt by the Group of 77 to create an
  international trade system whose operation was to
  be made subordinate to the perceived development
  needs of developing countries.
• The NIEO was adopted by the UN General Assembly
  in December 1974, embodied a set of reforms that
  would have radically altered the operation of the
  international economy.

30
Reforming the International Trade System

• In addition to encompassing the three mechanisms
  that developing countries had demanded during the
  1960s, the NIEO included rules that would give
  governments in developing countries
• greater control over multinational corporations
  operating in their countries
• easier and cheaper access to northern
  technology,
• a reduction in foreign debt,
• increased foreign aid flows,
• and a larger role in the decision making
  mechanism processes of the WB and the IMF.

31
Reforming the International Trade System

• Governments in the advanced industrialized
  countries again proved unwilling to make
  significant concessions, and by the mid-80s the
  NIEO had fallen from the agenda of the world
  trade system.
• Why?
• Developing countries were unable to establish and
  maintain a cohesive coalition.

32
Reforming the International Trade System

• Many developing countries were facing serious
  balance-of-payments problems and were forced to
  turn to the IMF and the World Bank for financial
  support.
• The need to obtain IMF and World Bank assistance
  gave the advanced industrialized countries
  considerable influence over economic and trade
  policies in the developing world.

33
Ch. 7 Trade and Development II Economic Reform

• Development strategies since 1980s dominated by
  neoliberalism and export-oriented
  industrialization.
• In contrast to structuralism, with its skepticism
  of the market and faith in state.
• Neoliberalism highly skeptical of the states
  ability to allocate resources efficiently and
  places greater faith in the markets ability to
  do so.

34

• Neoliberalism has greatly affected policy
  deregulaton of domestic markets,export oriented
  production.
• Shift from structuralism to neoliberalism.
• ISI was generating economic imbalances.
• East Asian countries were outperforming others
  based on an export-led growth strategy.

35

• In only 30 years, these East Asian countries
  transformed themselves from
• traditional agricultural societies into powerful
  industrialized economies capable of producing
  sophisticated products that were sold in Western
  markets.
• East Asian societies achieved this success
  through what many viewed as a neoliberal
  strategy Rather than insulate themselves from
  the global economy, they integrated deeply into
  world markets.

36

• (though it should be underlined that there are
  alternative readings of the East Asian countries
  success).
• A severe economic crisis in the early 1980s
  forced governments to embark
• on reform IMF and World Bank encouraged reform
  based on the neoliberal model.

37
Emerging Problems with ISI

• Persistent deficits because of heavy government
  involvement
• State-owned enterprises never became profitable-
  deficits
• Domestic politics aggravated budget deficits
• Government subsidies for essential items such as
  electricty, water transportation, telephone
  service and food. This was made possible only by
  using government revenues to cover the difference
  between the true cost and the price charged.

38
Emerging Problems with ISI

• Current account deficits (a country is importing
  more than it is exporting)
• Demand for capital goods and inputs (an ironic
  byproduct of ISI)
• Exports declined non-competitive manufacturing
  industry and weakened agricultural sector (due to
  heavy taxation).

39

• Overvalued exchange rates
• An exchange rate is overvalued when it implies
  that the currency is stronger(worth more) than it
  is according to a long-run market-determined
  rate.
• For example, if a government sets its exchange
  rate as 20 shillings/dollar but the market rate
  is 40 shillings/dollar, then the currency is
  overvalued.

40

• However, under ISI, many governments
  intentionally set the exchange rate higher than
  that, and as a result, foreign goods were cheaper
  in the home market than they should have been and
  domestic goods were more expensive in foreign
  markets than they should have been.

41

• Because foreign goods are underpriced in the
  domestic market, capital goods and intermediate
  inputs could be acquired from abroad at a lower
  cost than they could be produced at home.
• This difference in price created a strong
  incentive to import, rather than creating the
  capacity to produce the goods locally.

42

• The result was rising imports. Because domestic
  goods were overpriced in foreign markets,
  domestic producers, even when efficient, found it
  difficult to sell their markets in those markets.
  The result was falling exports.

43

• Furthermore, domestic politics made it difficult
  for governments to implement far-reaching reforms
  to remove the imbalances
• Rent-seeking environment (efforts by private
  actors to use the political system to achieve a
  higher than market return on economic activity).

44
The East Asian Model

• Hong Kong, Singapore, South Korea, Taiwan
  outperformed other developing countries
• Rate of per capita growth
• Manufacturing growth rapid
• Exports grew rapidly
• Export-oriented strategy (importance of
  manufacturing grew-agriculture diminished)
• Experts disagree on whether to emphasize the role
  of the state or the market in explaining the
  success of East Asian economies
• IMF/World Bank interpretation (market-friendly
  policies) versus state-oriented interpretation

45

• The IMF and the World Bank contend that East
  Asias economic success derived from their
  adoption of a neoliberal approach to development.
• Most East Asian governments adopted ISI
  strategies in the immediate postwar period.

46

• Unlike governments in Latin America and Africa,
  however East Asian governments shifted to
  export-oriented strategies once they had
  exhausted the gains from easy ISI.
• Thus the East Asian governments followed easy ISI
  by encouraging the manufacturing industries they
  had created under ISI to export to the advanced
  industrialized countries.

47

• The shift to export-oriented strategies was
  followed by selective import liberalization.
  Asian governments did not engage in wholesale
  import liberalization.
• The Taiwanese and South Korean governments
  continued to rely heavily on tariff and
  non-tariff barrier greater than 30 percent, and
  as late as 1980 more than 40 percent of imports
  faced protection greater than 30 percent.

48

• However, selective liberalization helped promote
  exports by reducing the cost of critical inputs.
• By reducing tariffs on key intermediate goods,
  such as looms and yarn in textile industry,
  domestic producers were able to acquire inputs at
  world prices.
• This kept exports competitive in international
  markets.

49

• East Asian governments also maintained stable
  macroeconomic environments low inflation,
  exchange rates that allowed domestic firms to
  remain competitive in foreign markets (there is
  no rise in value of domestic currency in value
  against foreign currencies), conservative fiscal
  policies (borrowed little).

50

• To sum up, according to the World Bank and the
  IMF, East Asia succeded because markets played a
  large role, and states played a small role, in
  allocating resources.

51

• Other scholars argued that East Asias succesful
  pursuit of an export-oriented development
  strategy had less to do with allowing markets to
  work and much more to do with well-designed
  government industrial policies.
• East Asian model of development, economic
  development is conceptualized as a series of
  distinct stages of industrialization. Government
  intervention at each stage is aimed at
  identifying and promoting specific industries
  that are likely to be profitable in the face of
  international competition.

52

• First Stage Industrial policy promotes
  labour-intensive light industry, such as
  textiles and other consumer durables.
• Second Stage Industrial policy emphasizes heavy
  industries such as steel, shipbuilding, and
  synthetic fibers.
• Third Stage Governments target skill and
  research and development (RD) intensive consumer
  durables and industrial machinery, such as
  machine tools, semiconductors, computers,
  telecommunication equipment, robotics and
  biotechnology.

53

• Governments design policies and organizations to
  promote the transition from one stage to the
  other.
• In the East Asian model of development therefore,
  government policy derive industrialization from
  initial low skilled, labour-intensive production
  to capital-intensive forms of production and from
  there to industries that rely on high-skilled
  labour and RD.
• Each stage is associated with particular types of
  government policies.

54
Structural Adjustment and the Politics of Reform

• Economic crises of 1980s
• IMF
• Structural Adjustment Programs
• Privatization
• Expectation reduce average incomes and
  redistribute income across groups, with faster
  growth and higher average incomes in the long
  run.
• Economic costs triggered a realignment of
  interests, discrediting groups associated with
  the old regime.
• New political consensus for new strategy to be
  adopted.
• Estimates suggest that growth rates in 1980s and
  1990s were higher than what would have been the
  case if reforms had not been implemented.

55
Developing Countries and the WTO

• Developing countries have a comparative advantage
  in agriculture and textiles but face obstacles
  from advanced countries.
• 3 aspects of advanced industrialized country
  policies make it difficult for developing
  countries to capitalize on this advantage.
• Tariffs, agricultural subsidies especially on
  agriculture

56

• tariff escalation practice of imposing higher
  tariffs on goods whose production involves more
  processing- makes it difficult for developing
  countries to export processed food to the
  industrialized countries.
• Unprocessed agricultural commodities face the
  lowest tariffs, fully processed face still higher
  tariffs. Such a structure makes it difficult for
  developing countries to move into the higher
  segments of the food industry.

57

• protectionism in textile and apparel industries
• Manufactured goods exported from the developing
  world face tariffs that are four times higher
  than the tariffs applied to exports from other
  advanced industrialized countries.
• Introduction of notion of core labor standards in
  WTO

58

• The discrepancy arises solely from the commodity
  composition of exports in the two regions.
• Developing countries produce and export goods
  that compete with import-competing sectors in the
  advanced industrialized world, and the industries
  in these sectors have been succesful at
  maintaining protection.
• The gains that developing countries could realize
  from the elimination of trade barriers are
  substantial.

59

• Analysis leading to the Doha Round- eliminating
  existing barriers to developing countries could
  yield as much as 500 billion in additional
  income to developing countries over a ten year
  period.
• If developing countries stand to gain so
  substantially from Doha Round why then G20
  governments been reluctant to conclude an
  agreement?

60

• Perhaps G20 governments see no benefits in the
  offer on table, and the US and the EU are unable
  to offer a better deal.
• Perhaps the offer on table does provide benefits
  but G20 governments would like to extract more if
  possible.
•