Eastwood's ECO486 assignments   

Chapter 10 Trade Policy in Developing Countries

Summary

1. Trade policy in less-developed countries can be analyzed using the same analytical tools used to discuss advanced countries. The particular issues characteristic of developing countries are, however, different. In particular, trade policy in developing countries is concerned with two objectives: promoting industrialization and coping with the uneven development of the domestic economy.

2. Government policy to promote industrialization has often been justified by the infant industry argument, which says that new industries need a temporary period of protection from competition from established competitors in other countries. The infant industry argument is valid only if it can be cast as a market failure argument for intervention. Two usual justifications are the existence of imperfect capital markets and the problem of appropriability of knowledge generated by pioneering firms.

3. Using the infant industry argument as justification, many less-developed countries have pursued policies of import-substituting industrialization in which domestic industries are created under the protection of tariffs or import quotas. Although these policies have succeeded in promoting manufacturing, by and large they have not delivered the expected gains in economic growth and living standards. Many economists are now harshly critical of the results of import substitution, arguing that it has fostered high-cost, inefficient production.

4. Most developing countries are characterized by economic dualism: A high-wage, capital-intensive industrial sector coexists with a low-wage traditional sector. Dual economies also often have a serious problem of urban unemployment.

5. The difference in wages between the modem and traditional sectors has sometimes been used as a case for tariff protection of the industrial sector. This is the wage differentials case for protection. This view no longer receives much credence among economists, however. More recent analyses suggest that protection will lead to more rural-urban migration, which worsens the urban unemployment problem and may worsen the symptoms of dualism.

6. The view that economic development must take place via import substitution and the pessimism about economic development that spread as import-substituting industrialization seemed to fail have been confounded by the rapid economic growth of a number of Asian economies. These high-performance Asian economics (HPAEs) have industrialized not via import substitution but via exports of manufactured goods. They are characterized both by high ratios of trade to national income and by extremely high growth rates. The reasons for the success of the HPAEs are highly disputed. Some observers point to the fact that, while they do not practice free trade, they do have lower rates of protection than other developing countries. Others assign a key role to the interventionist industrial policies pursued by some of the HPAEs. Recent research suggests, however, that the roots of success may lie largely in domestic causes, especially high savings rates and rapid improvements in education.

 

Identify these key terms:

appropriability

imperfect capital markets

developing countries

import-substituting industrialization

dual economy

wage differentials argument

economic dualism

high performance Asian economies

1. "Japan’s experience makes the infant industry case for protection better than any theory. In the early 1950s Japan was a poor nation that survived by exporting textiles and toys The Japanese government protected what at first were inefficient, high-cost steel and automobile industries, and those industries came to dominate world markets." Discuss critically.

2. A country currently imports automobiles at $8000 each. Its government believes domestic producers could manufacture autos for only $6000 given time but that there would be an initial shakedown period during which autos would cost $ 10,000 to produce domestically.

a. Suppose that each firm that tries to produce autos must go through the shakedown period of high costs on its own. Under what circumstances would the existence of the initial high costs justify infant industry protection?

b. Now suppose, on the contrary, that once one firm has borne the costs of learning to produce autos at $6000 each, other firms can imitate it and do the same. Explain how this can prevent development of a domestic industry, and how infant industry protection can help.

3. Why might import-substituting industrialization be more successful in large developing countries such as Brazil than in smaller nations such as Ghana?

4. The very small economy of Cantabrigia has a total labor force of 20 workers. These workers can produce two goods, manufactures and food. In production of manufactures, the marginal product of labor depends on employment as follows:

In the food sector the marginal product of labor is independent of employment, and is 9. The world price of a unit of manufactures is $ 10, so is the world price of a unit of food.

a. Suppose there were no distortion in the labor market. Find the wage rate, the allocation of labor between manufactures and food, and the output of each good.

b. Now suppose that for some reason the minimum wage in the manufactures sector is $150. Full employment, however, is maintained. Find the output of the economy in this case. How large is the cost of the distortion?

c. Finally, suppose that workers migrate from the country to the city until the wage of city workers multiplied by the probability of being employed equals the rural wage. Find the level of output and unemployment.

5. Suppose a country has the Harris-Todaro problem. That is, for some reason urban wages are much higher than rural, leading to inefficiently low manufacturing production, but at the same time there is high urban unemployment because rural workers migrate to the cities in search of high-wage jobs. What policy or combination of policies would you advocate to solve this problem?

6. "Import quotas on capital-intensive industrial goods and subsidies for the import of capital equipment were meant to create manufacturing jobs in many developing countries. Unfortunately, they have probably helped create the urban unemployment problem." Explain this remark.

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