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What are the advantages and disadvantages of using import-substitution to accomplish industrialization rather than using government aid and private investment to develop new manufacturing industries?
Your response should be at least 200 words in length. All sources used, including the textbook, must be referenced; paraphrased and quoted material must have accompanying citations.
(2012). International economics. (Vol. 1, pp. 346-350). The McGraw-Hills Companies.
In-text citation
(International economics, 2012)
lnlernatl:na] Economics- 1 5th Edition 39i9,
:
Chapter 13 Tr,rrie rrnd rlle Enr-rronncrrr :1Jrl
polluting process (e.g.” foreign steel) or by taxing exports of products that generate
pollution when consumed 1e.g., gasoline),
The rest of the chapter takes up discussion of each of three fypes of sources of
externai costs noted in Figure 13.3. First rve look at issues when the external costs are
ones we impose on ourseives-domestic pollution and similar national eKternalities.
Then we analyze cases in which the activity of another country irnposes an external
cost on our corlntly-transborde| pollution and simriar cross-country externalities.
F’inally. we examine the challenges of global external costs-giobal pollution and
similar rvorldwide externalities.
f” iq’+ $ il Fa f’* i3 f,} * *;? H S”ni { F* g- L L* “g’ f i; fu
Economic activities so;netimes produce significant arnounts of drtffiesti{: pollution
(or sin”riiar ent’ironmentai degradation). That is, the costs of the pollution f-all only (or
alnrost completely) on people within the country. If’there ure no policies that.fbrt:e
nurket rlecision-nwkers tts internalsa these external costs” then we reach two surpris-
ing conclusions about trade with domestic pollution. First,.free trude cun rechtce the
wetl-being of’the t:ountt1,: Second the countt”l’ cat entl up exporting the wrutng prod-
ttr:fs: it exports products thatit shouid import, for insiance.
To see this. consider fhe case of an induslry whose production activify creates sub-
stantial pollution in the local rivers. lakes. and *{roundrvater. For instance” consider the
paper-rnaking industry in a country like Canada. It is very convenient lblpaper com-
panies to dutnp their chemical wastes into the local lakes, and the firms vi”ew this as a
fi’ee activifv iif the Canadian governrnent has no policy limiting this kind of pollution).
The Canadian companies are happy that the lakes are there, and the firms’operations
thrive, producing profits, good incornes fbr their workers. and good products for their’
custolrers at reasonable prices.
Othel Canadians have a different view olcorirse. Having the lakes 1lrn brcwn with
chemical \vaste spoils the scenery the srvimrning, the fishing” and other services that
tliey get frorn their lakes. The dumping of rvastes into the lakes imposes an external
cost on other users ofthe lakes.
The top haif of Figure 13.4 shou’s the Canadian market for paper, with the dontes*
tic supply curve reflecting the private marginal cost ol production and ttre domestic
demand curve reflecting the private marginal benefits of paper consumption (which
are also the sccial ntarginal benefits if there are no external benefits). The bottom half
of’Figure 13.4 shows the additicnal costs imposed on the country by tire pollution
that results fi’otn producrion of paper in the country. We keep track of this legative
externality using the niarginal external costs (MEC) ol the pollution. (This ligure is
the analo-* of Figure 10.2, which showed tlre case of external benefits.l ‘lo keep thc:
analysis sinrple. \\.e assume that the exlernal cost of the pollution is constant af $
0.3
0
per ream ofpaper.
trVirh n* irilernarional trade (and na goyernment policies iinriting pollufion), the
papc’r rttarket clears at a pdce of $1 per reanr, lvith 2 bilfion reams produced and
consumed per vear. Because there is no recognition in the market of the cost of the
pollution. this is overproducion of paper.
310 lnternational Economlcs -Vol, l
i’, Part Two Tratlc t’rii,-t
,-;i:i.;ii:: .r i,’l When Domestic protluction Causes Domestic pollution
1.10
1.OO
Marginal external
costs from domesti{
production
0.30
0
Quantity
j..’] ]..]: l :]::. .. \
lnternational Economics, I 5th Edition 311
Chapter 13 fiirJe rinJ rlr Enlironnrerrr .:lr:l
Consider the shift to free frade, with an international price of Sl.l0 per ream {and
sti1l no government policies iimiting pollution). Don:estic production expands to 2.3
billion teams. domestic consumption declines to 1.8 biiiion. and 0.5 billion rean.ls
are exported. For the case shown in Figure i3.4, free trade unfbrtunaiely makes the
cormtrY rvorse otT. f’he usual gain from trade is shown by the shaded triangle ir in the
upper graph, a gain of $25 rnillion. But the extra production brings pollution that has
an extra cost of tlre shaded arca h in the lower graph” an externai cost of S90 nrillion
{S0.30 per reant on the additional 300 miiijon rearns produced). Free trade reduces the
well-berng of the country by $65 million.
The country’s gorrernrnent could avoid this loss by prohibiting expc|l1s of paper. But
we know from the specificity rule that this is not the best govermrent polic1.. The best
policy attacks pollution directly, fbr instance, b1, piacing a tax on pollution from paper
production. If there is no way lo reduce pollution per ream producecl thet the tax
should add S0.30 per reanl to the firrns’cost of production, Tire tax forces the firms
to recognize the cosl of pollution, and it alters their behavior. l-he domestic suppiy
shilts up by the amoltnt of the tax, to 5n + $0.30. This ner.v suppiy curve now reflects
allsocial costs, both the prtvate production costs and the external pollulion costs.
If this govemment policy is in place. what happens with free trade’J Donestic
consuiners stiil buy 1.8 billiori reams of’paper, but ttow domeslic producers supply
only 1.4 billion rearrs. As shou,tt. it is actually best lor the countrv to import paper.
not export ii. Because the nerv supply curve irvith tiie S0.30 tax) includes the external
ccst of pollrttion. we can read the efJ-ects of trade on the coiintr),’ti”on-r rhe top hali’of
Frgure l3.4.withoutreferringtothebottomhalf.Weiindtheusuaitrjangleof gains
fiom importing. the shaded tliangie e.
From this example 1ve see that pollution that imposes costs oltly on tlie local
economy can still have a nta-ior i;npact on hor,v rve think about interrlational trade.
With no goyerntltenr polic.v linititrg pollufion, the country can end up worse olf with
.{ree l-rlrL’. :,rr-cl the trade pattern can be u/rong. }n the case of ,pollution caused by
production that rve examined the coLrntry exported a product that it sliould instead
imporl, (lf-, insteacl, the pollution cost is not so higli. then the problem is that the
country exports too much.)a
The coLrnfry carl correct this type of distortion by using a poiici, that fbrces po11ut-
ers to recogttize the extental cost ol’their pollutiori. In our papet exantple. the goyerrr*
inent used a polh-rtion tax. bul instead it could establish propeffy rights. For instance^
people could be given the right to the rvater. Polluting firms then ntust pav the orvners
lbr the right to poilute. Or a limited number of riglrts to pollute coulcl be created bv the
government, so that firms need to buy these rights if they rvant to pol1ute.
If domestic fin-ns must pay the pollution tax (or pay tbr the right to pollLrte), the;r
probabl-r’ u,ili not be happy. The pollution tax raises their production costs. and tliey
prorluce and seil iess. ltr addition. the-v face competition li’om inrports at the rvorld
pr:ice of S1.10. Even if they accept the reason for the pollution tax, thev nray still
c*mplain about the iniports. lf other countries do not impose a simiiar pollution
jlVl-r;rt ran h;rppen if polluircn is causecj by consurnption, rrot prorjirctioni lri tiris case the couni.y 312 lnternational Economics – Vol. i
Part Two Jl-ralr lllitrl
tax on their producers, then the donestic finns often complain fhat tlie impofs areunfair’ They claim that the lack of foreign polluiion contiols is a fbrm of impilcit what are rve to make of these complaints’? should the country impose collnter-vailing duties on iiuports fron a coLrnti;, wjrh different poffuiton petliciesl) I;ront fhenational perspecfive of the inrporring *u,rtry. the answer is genelariy ,o. Foreignproduction nlay create poilutioir in tlie foreign .o,,nrty” u,rt ,iri, has no irnpact on tlieitnporting countrv if the costs of this foreign pallution affectonly tbreigler.s. As withrnany other complaints-about r’rnfair exports, tie best policy fbr tle impiirting .o.,nr,lfts sin-rply to enjoir tlie.low-price impor:ts. Indeed, under tlie rules of the worlcl Tradeorganization. lax foreign pollution policies are not a legitirnate ieason ibr inposing Fron the perspective of the whole ivorki, it depends on wh}, the foreign polliltiorr “rr or because foreigners place ress value on thelnvjronruent. .ln ou, prp.. e_rainpie. trreprocluction process or tire raw naterials used in foreign production nrav crcate lesspollution. or the foreign courltrv nrav have larger r,vater:r:*rour.*r of r”iJirri’i, ,rirfu, o’ the other ha’d- the foreign co’nhJ may simply have policies rhat are too lax. ‘l In the previous section we considered pollution that had costs only to the courlty Horvever, nlany types of pollution har.e fransborcler eiTects*efl-ects not jLrst on the lnternational Economics, I 5th Edition
Chapter 14 fr,tl: /)olicir.s f ;r Dcuclripnrg L–ouncric: ,:,;i i
2. Similarl.v, lahor nturkets v,tx* less ef/icientlv in tlevelopirzg crruntrie,r’. The wage These differences impiy some special tasks tbr the government of a developing We now explore the altelnatives for trade policy for a developing country in the j.\ ili L:’i +t i; A- {} f\$ fi * Ft t$ ru r- # $ f, fi T ffi il i’\i t: S A # }e i P; L :” It seems natural that developrng countries export primary products (agriculture, for’- A recurring idea is that developing countries’growth is held back by relying on Does the fear of falling prices sound reasonable’l Economic anaiysis shows that The relative price of prirnary products is depressed by Engel’s law and syntfietic ;Be care{ui not to assLrme, as many discussions inrply, that there is a tight link betlveen berng a 335, 335 , lnternational Economics – Vol. I
Part Two Tirrri.’ /};licr
ln 1989, a ma5sive tr”ansition from central Prior to 1989-199i, central planning by each As the transition began, these countries had Transition involves accomplishing three chal_ , lmpue discipline an firms inherilerf from the . Provide encouragernent for new firms that Opening the econonry to trade and Domestic and international refsrms usualiy The Centrai €uropean countries (Czech The members of the Commonweaith of How do trade pattrrns evolve during tran:i- HG\F/ suc(essful have the transition eountries \iqh\ man*iat\ure$ g()ads \ike tex\\\Eg, L\Qtfl” ln eontrast, most CIS countries did not reorient Horv doeE all o{ thi! cornbine to determine lnternational Economict 15th Edition 337
Chapter 14 Tr”iti. 1’r,lirrls i;r Ilrtrsiiit;ln,a (,-rrulrrits
prociuction ireal GDP). ln the beginning iransi- The evidence indicates that the depth and The fast and deep reforn:er: in Central and The nine partiai-reform and less open ClS e\ef, ra{nFa{e{ rdRh tht \hree i\oNe\*\tft t\\ 338 lnternational Economics – Vol. 1
:::: Part Two Thrrir Polii:r
1. Engel| lavt. ln the long nln. per capita incomes risel As they rise, demand 2. S.vnthetic .guhstitutes. Another force depressing the relative prices of prinary ‘World producers in Bmzii, Malaysia. and other countries. Another case is the clevelopment On the other hand, two other basic forces tend to raise the relative prices of primary 1. Nuturels lirnits. Primary products use lancl. water, mineral deposits. and other 2. Relutivel)’ s/ow prutdttr:tittir,vu growttlt irz the prifitory sector: For several centuries So we have two tendencies that depress the relative price of primary products, It depends on wher you look at the data and how far back into lristoly you 1cok. 340 lnternational Economics – Vol. 1
Part Two Titult j’oli*
of depressed pdces cluring world war II, the Korean \&hr of 1950,-1g53^ the troonr inprimary-product prices in the earl1, 1970s. or the rlrn,uf in’.on_,rnodiry prices durin-r:the mid- and late 2000s. Dur”ing ,,,.h ti,,’,.r, many writer.s revived the Malthusian argu-ments about the linrits to planet Earth. a periorl as possible. For Figure 1+.2. irli can scan rire peririd :ga0-2a10, though fol-lorl’ing some price sedes back to 1870 ivouiri tell a siinilar story. For the rop panei. Figure 14,2 shows a fairry clear long-term trend. Fix the {‘p paner, we can seethat the general trencl for ielative nnitu.l prinrary-proar.t pri.*u is ciownrvar Some commodities have declined in price nrore seriously than others. The price ofrttbber snapped downward benveen 1 9 1 0 and 1 920 and has never really bounced back while the net dorvnward trend in primar,u- prices stands as a tentative conclusion” 1 ‘ The .filll in lrunsport r:o,rLr. The available data tend to be gathered at nrarkets inthe indilstrial countrjes. Yet technological inrprovemenrs in trairsportation have beengreat eiiough to reduce the share of transport costs in those final prices in l,on6on. 2. Faster unutu.tured tpralit”v thange in rwnztfltr:ttLrar. We are usiug long runs ofprice data on prcducts tltat have been fetring betier or.er tiine. euatity improvemeilts(inclucling those in the form of’nerv products) are thought to have been more impres- when all is said and done, tlie telatir.’e price olprilnary products lrjay have cleclineci : lnternltisnalEclno-ml1s, tsth Edilion i = 3{1
Chapter 14 -TrLuh Poiicies 1n l)ct’clopirrg (-lolrnnres :lol i
alinost no trcnd. There is a weak case for wonying about being an exporter of agricul- Ei*’i*,fiFi;:r”Y”i{.?f’J*.1i- {effi’g’ill,”ii Perhaps the developing-country producers of primary products can take actions to The OPEC Victories A chain of everrts in late 1973 revolurionized the rvorld oil economy. 1n a t’ew The sequel was a plateau of OPEC prosperiry a ftlrther juntp, and tl’Lert grot’ittq The tale of oil and OPEC in the 1970s and l98ils is one of two dramatic cartel First the victories. The oil sirocks of 1913-1974 and 1979-1980 g,ere not the result The 1973-l97zl and 1979 1980 oi1 price jurrps rvele human-rnade. The key rvas rCPEC r,’vas created by a treaty among frve countries- lran, lraq, Kttr;vait, Saudi AraLria, airC Verrezueia– 346 lnternational Economics – Vol. l
Part Two ?rrcie i’olr,^r
in late 2000. and then remained rather flat to the beginning of 2004. oil prices their So. is rhis the reemergence of OPECb monopoly power? only partly. tn the late t ggt.ls – –
Other Primary Products Histor;’ agrees with this verdict. Of the 72 comrnoclity cartels set up between the Given the limits of internationai cartelpower a developingnation coukl still tax its unfortunately, the political economy of some develbping counrries seems to ; i,.. i:'{:} $i T’= 5 * Li $T*TAi i I r* # ! r,$ a.} u ” ?ffi t,e L gxeT$ {.”} ru { $ 5 *} lnternational Economics, i 5th Edition
Chapter 14 I’rde i’olicir.r fi;r l)rue lofing (i;anrries -:i -i.J
traditional exports brings risks, including what appear 1o be slowiy declining relative To develop. officials ftom rnany countries have argued they must cut their reliance The Creat Depression caused many countries tr: turn toward imp*rt-rxft:stitutit;13 The ISI shategy gained additional prestige arnong newly independent nations in the l5l at lts Best be a fine policy indeed.
1. Tlrc int’unt intlustry ut’Epnn€tlt lrom Chapter 10 returns, with its legitimate empha- 2. The tlet’eloping go”-ernrtet?t (trgzuilenr frorl Chapter 10lends further support to 3. For a large coutltn. or a large organization of cou:rtries, replacing imports cati 348 lnternational Economics – Vol. I
: i:j Part Two Thule polit:t
continuing imports, tend to lorver these q.i.gl {excluding the tanff or orher irnport 4 Replacing irnports of manufacfures is a way of using t].tecp nnc{ rttyyeniertt Experience with lSl “\tplRqrJ 3 .fr.€’a.til’e ve,ul.ic.t their industry against import competitian earlier. whe]r their growth was first accel- Such a casuai reading of history is at least correct in its premise: Ihe industrializeel In contrast to the weaknesses of the evidence for ISI, fhe evidence against it takes By thetnselves. these standard calcnlations of welfare costs of racie barriers are ‘rSee Bela Balassa (1971), Jaqdish Bhagwati and Anne Krueger (1g73-1g76J, and A. Choksi et al. (1991). lnternational Economics, lsth Edition
Chapter ’14 Tririlt: Poiicies Jrn lic.uebping Cnalrries ;i:i:
producer surplus, without allowing protection any chance to lower cost cutves as it is A second kind of test looks at what happens when a collntrv chutges it,s tracle- A third kind of test coftIputes growth nttes o.l’ t:ottntries prat:tidng ISI with ‘fhese
included Argentina, Bangladesh. chile (up ro 1973), inclia, ancl rurkey (to 1973). tite average growth rate r:f real CDP per peffion tvas highest fbr the three coLultt’ies with trn a 2002 study. the World Bank contrasted the experience of developing countries ” had relatively lorv involvenent in international trade and high tariffs in 1980 but ‘ greaily increased their international trade (measured by the increase in the ratio of . substantially lowered their tariff rates.
The 24 nervlv globalizing developing countries have a totai popuiation of 3 billion -,FSe, 35O r lnternational Economics – Vol. ‘l
ir Part Two lrarl,|dicr
‘rhailand, and urugltay. The other deveioping countries have a totai population of The world Bank found that the newly globalizing developing countries achieved such direct comparisons (as in these severil World Bank studies) betrveen toturtries *virtLre ity: They’ look directly at the trvo variables of interest (trarie policies and economic ot evrdence against ISI and restricting trade is sub-iect to the suspicion that maybe lf theory suggests that iSI can work weil, why does experience make it look like a Outward-oriented policies encourage domestic firms to make use of the country’s or”td,ii unuld be better if ir hail ‘l lnternational Economics, I 5th Edition 348 lnternational Economics – Vol. I lnternational Economics, lsth Edition 35O r lnternational Economics – Vol. ‘l or”td,ii unuld be better if ir hail ‘l lnternational Economics, I 5th Edition
tends to consume ioo much of the prodirct, so the country could imporr a product tl-ral it should
instead expori (o; at least, it irnpcrts too muclr cf the pro
subsidy, 01’that the foreign rirms are engaged in ..eco-dumpi.g” uaseo on rax fbreigngo\.ernlnent poli cies,
countervaii ing duties.
policies are diflerent fiom tliose of the intporting corintrv. lt may be etllcient {br thefbreign country to have ciifTerent. and perhaps more lax, poliution policies. The poliu-
lion caused by foreign production nlay not be so costll,, uarow* irr* foreign productio’
itseif creates less polrution, because ihe tbreign enviiorurent i,
,*”n?0,;;fi#,;
case the pollution is not,so clanraging because the foreign environineni has a lareer
“assinriative capaciry.”.orthe fbreign country may assig’a high value to p.oarrlig
income tc purchase basic gootls beciuse its people ur. p-oo. unjor* therefbre willing
to accept sorne extra poliution nrore rearlilv.
From the point of view of the tbreign counfi’y ind tire
it si 1* 5 # {_;r ri i””! ia i1: * i”: i- !.. i”i T” i # $,,.i
doing the pollution. whiie rve reacheci iome surprising conclusitxs ab6ut fr-ee trade
itt the absence of governrnent policies limiting poituuori, we aiso had a ready sol’rion.
The governrnent sirould implenient some foim of poliry aOO.essing pollution rlat is
occurring in its countt’y. If each country’s government addresses its orvn local pollution
problenrs. then each can enhattce its own narional well-being. lu the process, worlci
ivell-being rs also raised.
country doing the poliutioli brii also on neigliboling countries. Exanples inclrrcle airpollution like particulates and sulfur dioxide that Jritts across national borders and
water pollLition wiren the body of water (river or lake) is in twa or irlorc co’ntries.’i l”-:’;-r:ilrr-.i’j’r,l r:lili.;1ii-;ltr4j5ggrnajorissr-iesfbrgoveillmentpoticiestgyarcipoliutiog.
gaps between expanding and deciining sectors are greater than in higher-inconre
countries. The wider wage gaps are an indirect clue that some lalror is being kept lrom
moving ro its most productive use.
country. There is a case for considedng rvhich sectors to protect or subsidize or give
cheap loans to, if the government camot quickly eliminate the barriers tcl efficie nr
capital and labor markets. Tire government must also decjde u’hether it is realistic
to try to change the nation\ comparative advantage. for instance, by increasing its
investntent in education and health care to expand the country’s endowment of hu:nan
skiils. The shift ftom central pianning to a market economy requires yet other policy
decisions, as discussed in the box “special Challenges of Transition.”
order that we presented thern for Ghana: focus on exporlrng prirnary products, ilse
export taxes or international cattels to influence the r,vorld prices of these prirnary
products, use import protection to develop new manufactiiring industries, or encour-
agd the development of export-oriented new manufacturing indristries.
Fii ; i’!t AF?,\’ FFE# il? # s;ff ffi S ?
estry, tuels. and minerals), and these are often- ealled tt’aditional ex.ports. The maior-
ity of developing countries get half or mol’e of their export revenrles from primary
products. Many developilrg countries have exports concentrated in one or a i’elv
products like peh’oleutn, coffbe, cotton, gold. sugar, timirer, diauronds, and bauxite/
alurniuurn.
exports of prirnary products. In the 1950s, Raul Prebisch and others argued that devel-
opittg countries are hurt by a downward trend {and instability) in primary-product
prices. Intemational markets, ran the argument. distribute income unfairly. Since
developing countries are net exporters of primary products, thev are trapped into
declining incomes relative to incomes in the industrialized worid.:
there are at least two major forces depressing. and at least two forces raising, the trenc{
in the prices of primaries relative to matrufactures.
subslil utes.
de’veloping coLrnlry and bein,g an exporter of prirnary products, Overali, the clevelopinq conntries are oniy
mcdr:raie rei exporters of primary products ancl import sigr-rificant amci.tnts of them frorn Nortlr Arnerica,
Ausiraiia, and Ne$.r Zealand. An
planning to market economies began in the
forrnerly:ocialist countries of Centraj and
Southeastern Eurcpe. With the breakup of the
Soviet Union in 1991. the former Soviet Union
countries joined this transition. This is the most
drarnatic episode of econornic liberalization in
history” What role have changing policies toward
international trade played in th€ transition?
government directed the economies in these
countries. National self-sufficiency was a policy
goal. lmports were used tr: close gaps in the
plan, and a state bureaucracy controlled exports
and imporis. When trade was necessary, the
countries favored lracie among thrmselves and
strongly disccuraged trade with outside coun_
Uies. They tended to use bilaterai barter trade,
with lists of exports and imparts for each pair
of countries. The trade pattern had the Soviet
Unron specializing in exporting oil and natu-
ral g;rs (at prices well below v’;orld prices) and
other countries exporting inclustrial and farm
products.
a legacy of poor decision-making under (entrai
planning, including overdevelopment of heavy
industries (like steel and defense), outdated
technology, environmental problems, and little
established trade with rnarket economies. They
needed to remove state control of transac_
tions and undertake a major reorganization of
production.
lenging tasks: (l) shifting to competitive mar-
kets anci market,deterrnined prices, with a new
process of resource ailocation; (2) establishing
private ownership. with privatization of state
businesses; and {3) establishing a legal system.
with contract laws and property rights. For suc-
ress, the transition pro{ess must
era of centrai planning,
are not dependent cn the qcvernment.
‘nternat;onal
direct investments lry foreign firms can be part
of both the discipline {through the competition
provided by’ imports) and the encouragement
(through access to new export markets ancJ to
foreign te.hnology and know-howl.
advanced together in a transition country, and
success requires a consistent combination of
reforms. We can identify severai different groups
of countries that pursued reforms in different
v..,ays and at different speeds.
Republic, HL,nqary, poland, Slovak Repubiic, ancl
Slovenia), the Balti{ countries {Estonia, Latvia,
and Lithuania), and the Southeastern European
countries (Albania, Bosnia, Bulgaria, Croatia,
Macedonia, l,/lontenegro, liomania, and Serbia)
pursu_ed strong, rapid liberalizations {except for
Bosnia, Serbia, and Montenegrr:, which were
involved in fighting). As we discussed in Chapter
12, the Central European and gaitic countries
joineci the European Union in 2004, and BulEaria
and Romania joined in 2007.
lnd*pendent States {ClS, the eountries that were
formerly part of the Soviet Union, excluding the
Baltic countries) have inste*d foliowed paths
of less liberalization. Three countries, Belarus,
Turkmenistan, and Uzbekistan” continue to
resist enacting reforms. The other CIS counr
tries {Armenia, Azerbaijan, Georgia, Kazakhstan,
Kyrgyz Republic. Moldova, Russia, Tajikistan,
and Ukraine) enacted partial refornrs that were
adopted slowly over time and that sometimes
were reversed.
tion? One pressure is clear, toward rapid growth
of imports, especially consumer goods, based
on pent-*p demand. Transiticn countries mus’i
expori to pay for their rising imparts, and
West€rn Europe and other industrialized coun-
iries are crucial as majcr markets for expanding
their exports. However, exporting to demand-
ing customers in the competitive markets of
the industrialized countries was not going to
be easy. Under central planning these countries
had rrrajor deficiencies in their products and
br-rsinesses, includinq poor product quaiity, lack
af marketing capabilities, and lack of trade
f irlanc;ng.
been in recrienting their trade patterns? By 1998
the Central Iuropean, Saltic. and Eoutheastern
European ccuntries on average were seiiing over
60 percent cf their exports to buyers in industri-
alized countries. Rapid and deep liberalizations,
along with favarable geographic location close
to the markets of Western Europe, have facili-
tated the shift by these countries ts a desirabie
export pattern. They increased their exports of
ing, and iootvreat. They a\so ustd the\{ \oy,l-ios\
skitled iabat to expand export of surh products as
vehicles and machinery.
their exports much. and on averag€ only about
fi quarter af their exports went to industrialiaed
{ountries in the [ate 1990s. Many Cl5 countries
resisted trade liberalizaiions and continued to
produce low-quality manufa{tureci products that
could not be exported out:icje tfre region. A: oi
early 2011, only five ClS coi..rntries had i:ecome
members of the Worki Trade Organizatir:n.
the sLiccess of *concmic lransilian? One broad
indicator is the grcwth or decline of domesiic
iion is likely to cause a recession, as bus!ness prac-
tices and economic relationships are disrupted.
Only alter reforms begin to rake hold tan the
economy beEin to grow. This ilrocess is like that
of the shi{t from no tracie to free international
trade. As w’e sa\r beginning in Chapter 2, the
gains f rom opening to trade are Lrased largeiy on
disrupting previous patterns of production and
consunrption activities.
speed of reforms matter for the sutcess af transi-
tion. 1n addition, as with develcping countries
generaily. vv€ see gr€ater success for those coun-
tries adopting more cpen and outward-oriented
trade policies.
Southeastern Europe suffered thraugh early-
transiiion recessions that were not that de*p
and not that long. The recessions in the Baltic
countries were somewhat longer anci somewhat
deeper. Then, starting beiween 199J and 1996.
each of these col,ntries has generally had sr-lb-
stantial and sustained growth.
Luul rlr 1tj – rroh e’t,’ br ccrl t’p,::’crrf n rmpd- .th tr l^/.ll(i.
countries. Most partial-refarm Cl! countries
experienced deep early-ttansitian recessions,
and three (inciuding Russia) cjid n*t return
to sustained growth until 1998 or later. They
seemed to be caught in a trap in which spe-
cial interests, oligarths, and insicers whc !:en-
efit {rom the partia{ reforms gafn the politkal
power to block or slow further reform. One
advantage of speed in reform is that the reforms
are enacted and the increased interr:ational
trade and greater market competition impose
discipiine and offer encouragement, before sucit
special interest groups have time to coale5ce
and exert their powtr.
shifts toward luxuries-goods for which the income elasticity of detrand (percent
rise in quantity demanded,,percent rise in income causing the change in der:rand; is
greater than 1. At the same time, the world’s demand shifts away ftom staples–goods
tbr which the ircome elasticity of demand is less than 1 . The l gth-century German
economist Ernst Engel (not Friedrich Engels) discovered u.&at has becone known as
Engel’s iaw: The income elasticity of dernand tbr food is less than i (i.e.. food is a
staple). Engel’s law is the most durable law in economics that does not follorr’fi’om
definitions or axioms. lt means fl:ouble for food producers in a prospering world. if
the world’s supply expanded at the exact same rate for all products” the relative pnce
of fbods wouid go olt dropping because Engel’s law says that demand would keep
shifting (relatively) away fiom tbod torvard luxuries.
products is the development of new human-made substitutes ior these natural materi-
als. The more techlology advances, the nlor”e lve are likely to discover ways to replace
trttirsrarb attu’ulrlcr taw *tolctia.ls. ?lht r?a-r-Jr+.Cr?r?ta”+i,+ g.?s’-,”3: ,rhg del’elclalfetft Af
synthetic rubber around the time of
War I, which ruined the incomes of rubber
of synthetic ilbers. which have iowered dernand for cotton and rvool.
plodr”rcts:
limited natural resoLlrces. As population anil incomes expan{ the natural inputs
become increasingly scarce, other things being equal. Nature’s scarcity eventLially
raises the reiative price of primary products, which use natuml resoruces nrore inten-
sivell’ than do manufactures,
prodLrctivity has advanced more siowly in agriculture, mining, and other primar5r
sectors than in manufacturing. A reason is the tendency for cost-cutting break-
throughs in knowledge to be inore important in nanufacturing than in primaries.
Slow productivity advance translates into a slorver reiative advance of supply cllrves
in prirnary-product matkets than in ntanufacturing markets, and therefore a rising
relative ptice of prirnaries (or a falling relative price of manutactures), other things
being equal.
and we have trvo that raise it. Horv does the tug-of’-war rvork out in the long rrur?
Figure 14.2 sunrmarizes the experience since 1900.
Studying Figure 14.2A, we can understand why the fbar of f’alling relative prirnary
prices was greatest in the 1950s (when Prebisch’s argument achievedpopularity) and
the 1980s. Those were periods of f’allin-e prirnary prices. On the other han4 little was
written about falling primary prices just before worid War I. the historical he3’day of
high prices for farm producls and other raw materials. Nor was there inuch discr.rssion
To stand back frorn the,volatile swings in cornnroditv prices. let,s look over as long
we also have to alrow fbr the vely rarge increar. in.n*.g1: pr.r.., silce r999. rvhich
canses a divergence bet$een the relative price of all ptirri.y prodr-rcts and rhe rejati’cprice of nont-uel prir’ary producrs at the ind of the time p..iJo.
since’ The relative prices ol r.vool. cocoa. alunrinum. .i.r, .o1ton. and sugar declrned
by more than half during the 20fh centur,v. In confrast. the relative p,ice, ot la1rb”
timber, and beef more than doubled.
there are rwo biases in the avairabre rneasures. ilke ttrose preilnrJi; ii;; i;;.”‘
NervYork. orTok_v-o. That has lefr nrore and nrore of rrre firial pr.-!..i.”1;;1.,* h;;:
of the prirnary-product exporters. Quantifying ttris tnown ci,uig. ,”oul,t tilt the rrendi* the prices received bir producers torvard a flatt*r, iess downrvlrd fend.
sive in tnanufachtres (and services) tiran in primary proiucts. So lvhat might look like
a rise in the relative price of manrfactures migtrt ue just u .ir* in their relitive quality,
with no trend itt the relative price for given quality. This clata problenr is potentialll,
serious. given that rnany 2Oth-century data have, ror r”ampt., lollowert the prices ol.nlachinery expofis per ton cf exports, as if a ton of today’rcornputers ivere the samething as a ton of old electric inotors.
as muclr ils 0,8 percent a year since i900 (as in Figure t+.2}, uthere cor:lclhar.e bee’
fural or extractive products on price-trend grounds.
“{{} fqiii1:fi f’ffigf*&.ffi.Y-$3#”*:irii:”T $rftii{“ili;
turn the price trencls in their favor. Perhaps the primary-prodrtct exporters cait tlecoitre
rnore powerlirl if tlrev coopetate rvitlt each other. ttsitrg, ol
other types ot’concerted actiou.
History records nany atlernpts at in€rnational cafiels {internalional agreenletrts
to restrict competition alnong sellers). The greatest seizure of :nonopoly power in
r.r’crld hiStOry was the priCe-raising triurnph o1’the , ;,j ‘ ” i:’;’:, .”i i’,’riis,a:lir::.
t:::-.=t-‘,:{iit+ “”-*r.r*lriq:1 ii-iiri l. :r in i973-1974 and again in 1979-1980.
months’ time” the 12 members of OPEC effectively quadmpled the dollar price of
crurie oil. fi’om $2.59 to $11.65 a barrel. Oil-exporting countries became rich alruost
or.ernight. The industrial oil-consuming conntries sank into theii deepcst recession
silice tite 1930s. The reiative price of oil {what the price of a barrel oloil ccuid bu.v in
terms of manufactured exports frorn inditstrial nations) {ripled.
signs of weakrress. Franr 1974 to 1978. the relative price of oii dipped by abotit a
sixth. but stayed much higher than it had been at any time before 1973. Next came the
set:onri wave oIOPEC price hikes. lhe secotid “oil shock,” in 1979- 1980. Led by the
lranian Revoiution and grorving panic among oi1 buyers, the relative oil price ntore
than doubled. In the mid-1980s. however. OPEC weakened. The relative price of oii
dropped sudcleniy in late 1985. ticxn lour to five times the o’ld (pre-1973; real price il
1980*198.1to less than firyo times the oid price fbr I9B6-1989.
l’ictories and a subsequent retleat. The victories and the retreat both need explanalion.
of a lailure olsuppl.v or exhaustion of earth’s availabie resources. The u’orld'”s “proved
reserves” of known and usable oil uere growi:rg faster than rvorld oil consumption.
Nor u’ere tlie costs of oii extraction rising tnuch.
that rvorlcl demand was grou’ing iar laster than non-OIIEC supplies. Oil cliscoveries
had been very Llneveltly distributed among countries. The share of OPE{I coun-
tlies irr rvorld crude oii production rose to over 50 percelt by 1972. Furthertllore,
in lg60.siilcethdttime,tirefollorrirrgcountriesiravejciired: Qatarilgtil),Libya(1962), l..lnited,rrrab
[*:ilate: (‘1 967), /riqeria (1969), Nigeria {19}1}, and Angola (20t-]7). Ecuador jorlred irr 1973, rvithclrerv
in 129?, ariC reloinecl in 21107. lrrctonesia joirrecl in i9ij2 and i,rrithcirew in 2009. Gal:on joined irr 1975
;nC ,,vrthd;etv in 1995.
climbecl’ with a price spike in 2001*2008 that had a piak pr[e of over S lag per banel
tn June 2008. with the recession that accompanied the gtlud filancial and econornic
c::isis. oil prices collapsed to less than S40 per barrel in iooq. As global demancl began
to increase again. oil prices rose rapidly, rnoving above $100 per barrel i1 earl;r 201L
and early 2000s OPEC did attenrpt rvith some success to reduce its iroguction ro raise
the pr:ice. However, much of,the price rise seems to reflect the br:oader dynamics of the
indush”y, dynamics that are based on the competitive aspects ofthe market. Demand from
China gr”ew r”apidly’ with additronal strong slernand gror,vth in such other countries as
India and the United States. Furlhermore, the years oirather low oilprices cliscoLragecl
investment in new crude oil production capabilities, ieacling to tight supply and a lacliof
spate production capacitv. As a result of the demand ingeases aia p,nAirction lirrrits, oil
prices rose well above OPEC price targets in 2008 (and perhaps ugiin i,, 201 1). The big
price rise in the mid- and late 2000s looks more like a boom pe*oA in a highly cyclicai
industry than it looks like the planned exercise of market power by the cartet.
Do tlteory and OPEC experience hold out hope for developing counfries wanting to make
Iarge national gains by joining cartels in other primary pioOicts tresicles oill, Not much.
There are good reasons for believing that international cirtels u,ould collapse f’aster, with
less interim profil for-the non-oil primary products. For agricultrual crops in particular,
there is tire problem of competing supply other countdes usirally can ea.sii5, e,rpand the
acreage lhev devote to a given crop.
two u’orld rvars, only 2 survived past 1945. Of”the ferv dozen fet up in the 1970s” only
5 lived as late as 1985: cocoa. coffee, rubber, sugar, and tin. These 5 cartels have been
so weak that they have had little effect on commodity rnarkets since 1985.
owtt prin:ary-product exports for the sake of econonric deveioprnent. In principle, the
strategy could rvort well. A tax on exporls of Nigerian oil. Ghanaian cocoa, or Philippine
coconuts could generate revenues for building schools. hospitals, and roads.
divert tlte export-tax revenries an’ay from the most productivJuses (as we noted in
Chapter l0 when discussing the deveioping government argunrent for inrport tar-
iffs). So it has been with the three examples just irnaginecl. Nigeriat oil revelues are
lost in a srvoilen governrnent bureaucracy and ravenous cornrption. For two decades
Ghana’s cocoa rnarketing board r-rsed its heavy taxation of iocoa f’armers to sup-
port luxury imports by ofTiciais. The Marcos government distributed the philippine
coconut-tax revenues among a handful of Marcos,s friends ancl relatives.
Exporting primary products is a way for many developing countries to use their
comparative advantages based on land and natr.tral resources. But reliance on such
prices of these products and exposure to the wide srvings in world prices, Perhaps
sirifting the emphasis toward developing new industries. especially in manufactuljng,
is better for countries that rvant to grow more rapidly. Atter all. most high-income
countries have industri alized.
on exporting primarS’ products and must adopt governlnenl policies allowing industry
to grow at the expense of the agricultural and mining sectors. Can thjs emphasis orr
industrialization be justitied? If so^ should it be carried out by restricting imports of
manufacalres?
i:r*r;lili;:iir;’!i;{}ir ti1li. In the early 1920s and again in the early 1930s, world prices
of rnost primary products plunmeted. Although these price declines diel not prove
that primary exporters were sufTering more than industrial countries. it was coltlmon
to suspect that this was so. Several primary-product-exporting cor-rntries. arnong them
Brazil and Australia. launched industrializatron at the expense of industrial irnports in
the 1930s.
1950s and 1960s. This approach soon prevailed in most developing countries whose
barriers against manufactured imports eame to match those of the most protectionist
prewar industr:ializers. Though nlany countries have sr,vitched folvard more pro-tracle
and export-oriented policies since the urid- 1960s, ISI remains an important policy for
developing countries.
To see the merits and drawbacks of ISI, let ris begin by noting the four main arguments
in its-fqvor. Lf ISI corrld be fine-turied to make the most of these arguments- it would
sis on the economic and sociai side benefits fi’orn industrialization, These side benefits
may include gains in technological knowledge and worker skil1s transcending the indi-
vidual firm, new attitudes more conducive to growth, and national pride. As we saw in
Chapter 10, the economist can imagine other tools more suitabie to each of these tasks
thatr itnport barriers. But in an imperfect r.vodd these better options may not ire at hand,
and protection for an infant modern-manufacturing sector could bring gains.
lSI. Suppose that tlie only rvay thal a govenlrrent can raise revenues for any kind of
econonic developrnent is to tax imports and exports. Such taxation can bring gains to
a natiou rvhose gor:erment cannot mobilize resources for heaith. edueration. and so on
rvithout taxing trade. ISI is a by-product of such taxation of fbreign trade.
bring better {ent*-ttl-trude elfuct.r than expansion of export industries. Here we refurn
to a therue sounderl first in the discussion of “ilmiserizing growth” in Chapter 7 and
again during Chapter
charge) and offbr the nation a better bargain. If you can a#ect the prices at wtricnlrou
trade^ wouldn’t ir be be.tter to expand your supply of import-competing indusfiies,
fbrcing foreigners to sefi you the remaining r*port, at a lo*er price )
mtrrket inlbrmation A developing colrn{ry may rack the expJtise to jLrdge jusr lvtich
of the thousands of heterogeneous indusirial goods it coutd best martet abroad. But
government officials {and private industrialists) have ail easy way to f.ind which nrod-
ern manufacfures would sell in their own markets. they need orily look at the iniport
figures. Here is a handy menn of goods with proven nrarkets.
History and recetlt economic strrdies offer lbur kinds of evidence on the merits of ISI.
Castral historical evidence suggests a slightly charitable vier.l,. u,hile three kinds of
-#f,ELlsd,ts*$,s
in support’ of ISI, it can be said that today’s ieacling industrial countries protecfed
erating, The United States, for example, practiced ISI fiom ill. Ciuit War until the
end of World War lI. r.vhen most American firms no longer needed protection againsr
imports. Japan, in the 1950s, launched its clrive for leaJership in sieel. uutonrJbil*r,
and eiectronics with hear,y govemment protection against impbrts. When these indus-
tries lvere able to compete securely in world markets, Japan removed its redundant
protection against imports into Japan.
countries did at tirnes give import protection to industriei that became their export
strengths. But it is wrong to infer that most cases of indush’ialprotection nutured iec-
tors that responded with strong productivity gains, On the contrary. even Japan, like
the United States and most other industrialized countries, gave its strongesr protecrion
to sectors whose decline u’as long-lasting. ISI in the earlier history of these counh.ies
may well have slorved down their economic growth. Most of the infant industries, ip
other rvords. never grew up.
three forms that in combination add up to a strong case. The first kind if t.*t casting
serious doubt on the merits of ISI is the estimarion of its static e.ffbcts on natiani!
n-ell-heing, using the rnethods introduced in Chapter 8. A series oi cletailed country
sttldies quantified the rveitare eff’ects of a host of developing-counfry trade barrier:s in
the 1960s and early I970s. many of which were designed to plomote industrialization.
The barriers imposed significant costs on Argentina, chile. colombia, Egypt, Ghana.
India. Israel. Mexico, Pakistan. the Philippines, Sonth Korea” Tairvan,lnd Turkey.
Only in Malaysia did the import barriers bring a slight gain, here because of a favor-
able terms-of-trade eff-ect.6
vulnerable to the charge ol assuming, not proving, that lsl is bad. such calcula_
tions assume that all the relevant efl’ects are captured by measures ol consurner and
imagined to do in the ini-ant industry case, It would be fair to demand firmer proof,
1x;lic.t, orientution toward manuf-actures, away fi’om restricting irnports (ISi), and
torvard charnpioning expofis. Here there \.vere two drarnatic early cases. Until the late
1950s, Taiwan used ISI but then switched to a policy that encouraged exports. It sulrse-
quently achieved growth rates of about 10 percent pe r year. South Korea useci ISI until
policy refcrnns in the early 1960s increased its incentives for exports and lowered its
$Port barriers. Its growth rate incrcased to about l0 percent per year. Hong Kong and
Singapore also used policies that encouraged exports and achieved high giowth iates.
Other countdes have achieved substantial effects. In the case of Ghana. ihe ISI strat-
egy was part of a larger heavy hand of government that turned early growth inta a 42
percent decline of Chana’s living standards over the rlecade 1974*.1984. The country
was saddled rvith costly industlial white elephants that never became efficient. Onlv
after paltial reforms that included a partial liberalizatiol of trade policy dicl Ghana
regain positive economic growth.
grov’th rctes o.l’ t:i;rmtries using policies that ernphusize exporfi;lg. fhe iqgZ Wurltl
Devekspnenl Reporl presented the resLrlts of the World Bank’s sfudy ol’growtfu rates
in 41 countries, which were piaced inio four categories accorrling to their irade pr:lic_v:
strongly outward-oriented. ntoderately outward-oriented, moderately inwarcl-olientecl
and strongly inward-ori:ented. Hong Kong, South Korea, and singapore foilorved
strongly outward-oriented policies. with low trade barriers and some pse of e.\port
subsidies. The strongly in’u,’ard-oriented countries used high trade ba’n’iers.
In the two time periods that rhe V/orld Bank examined 1963-1973 and 1973*1985,
strongly outward-onentecl trade pollcies (o.y percenT ano ).-./ per{.enr ilcr yciu, rcbpcu-
tir.ely).The average grou,th rate in the counffies with sfrongly inward-oriented n’ade poli-
cies was lorvest in both periods ( 1.6 percent and -0.1 percent per year. respectively). An
update in the 1994 Wrltl Developntent Report found tlrat this pattern also held for the
time period l980-1992 (a 6.2 percent annual growth rate for sh”ongly ouhvard-oriented
cottttffies, and a *0.4 annual growth rate for sfrongly inuard-oriented counfries).
that have increased their integration into world markets since 1980 with the experience
of other countries. The neu’l,v glohulizing det,ek;ping cowttt’ies, as the World Bank
calls them. are countries that
tiren
expofis and imports to national GDP) and
and inciude Argentina. Bangladesh. Brazil- Clhina, Colombia. India, lriicaragua.
aLlout 2 billion and include ntanv African countries and coulrtries of the forruer
Soviet Uniott. Most of these other developing countries concentrare on exporting
primary pr.odncts.
averagegrowthratesofGDPperpersonof3.5percentou*n[tni tqtosanci5.0per-
cenf during the 1990s’ These average growth .ite, *e.e above their average annual
growth rates in the 1960s {1.4 percent) and 1970s {2.9 percent). Their average grorvth
rates in the 1980s and 1990s r.vere also higher than theavemge grorvth rates of other
developing.countries {0.8 percent and 1.4 percent, respectivet,vl a’* of the industrial-
ized countries (2’3 percent and2.2 percent, respecrivei). rhei;trerences betweeil tile
newly globalizing and other develcping countries do not seem to regect favorable ini-
tial economic conditions fbr the new globalizers. In 1980 the peopie in rhe two _qr.oupshad comparable average levels of education, and the newly gtouutirirrg countries gn
average had somewhat lower incomes per capita.
praL’ti(ing ar udapting ./reer-trude. regintes and c’ountries prut:tir:ing a variurtl aJ ISt
or rcsi’sting lurtlter libetalizcttioft q/’tl:e\ trurle polici”r harre the
of simplic-
. Stnwth.)’ Yet here. as always. corrclation cannot prove causation. By itself. rhis kind
some other force caused ecottomic gror.vth to be correlated with freer-trade poiicies.
c)r perhaps the eausation ran the opposite u,ay-perhaps successfill growth itself
brings freer-trade policies, even though policies departing fiorn l?ee lrade helped
promote growth. While it ls not possible to answer these concerns fully. ecorlonrists
have conducted nore cornplicated tests of the-statistical significance oi trade poiicy.
Afler allowing for the eft-ects of orher variabies such as iivest,nent. iniiiut incoue.
and education, the research tends to confinn that ISI-type tracle barriers are a negative
inf’luence on econonric growth.
bad idea’.) There is no direct contradiction becauie theory only assertecl that ISI r:urtbe
better than free trade under certain conditions. It iust so-happens that those conditions
have not held since the early 1960s. The theory failed, above all. in the assumption that
an informed government tries to nraximize national income. Real-worlcl governments
are ill-inforrled, and they lack the power to stop protecting industries that lurn oul to
be inefficient. Worse. many govemftents trave fleir o*r self-interesr, which conflicts
with the gcal of maximizing national well-being. Embarking on a policy of iSI has
so fbr not.turned any economy into a supergrowir iike Soutir Korea. Moie often, the
ISI ror:te is the road that turns a South Korea into a North Korea. ISI often results irr
industries in which domestic firns have high costs and domestic monopoly power a1d
produce products of lorv qualit-v.
abundant resources. zurd the firms can use sales into international rnarkets to achieve
scale econor:ries. The efforts to succeed in lbreign markets also nrean that domestic
firms t’ace.internatiotral competitive pressure, so that they are driven to raise product
quality and resource productivity. The country can use iti rising exports to pay l.or its
tougher pollution policies. As a type of secor:d-best approach, impilrr limits by other
countries can improve things. But these limits r.vill nL? mate’the inpor-ting country
better o{f. even though theiz nright mise world well_being.
it si 1* 5 # {_;r ri i””! ia i1: * i”: i- !.. i”i T” i # $,,.i
In the previous section we considered pollution that had costs only to the courlty
doing the pollution. whiie rve reacheci iome surprising conclusitxs ab6ut fr-ee trade
itt the absence of governrnent policies limiting poituuori, we aiso had a ready sol’rion.
The governrnent sirould implenient some foim of poliry aOO.essing pollution rlat is
occurring in its countt’y. If each country’s government addresses its orvn local pollution
problenrs. then each can enhattce its own narional well-being. lu the process, worlci
ivell-being rs also raised.
Horvever, nlany types of pollution har.e fransborcler eiTects*efl-ects not jLrst on the
country doing the poliutioli brii also on neigliboling countries. Exanples inclrrcle airpollution like particulates and sulfur dioxide that Jritts across national borders and
water pollLition wiren the body of water (river or lake) is in twa or irlorc co’ntries.’i l”-:’;-r:ilrr-.i’j’r,l r:lili.;1ii-;ltr4j5ggrnajorissr-iesfbrgoveillmentpoticiestgyarcipoliutiog.
Chapter 14 fr,tl: /)olicir.s f ;r Dcuclripnrg L–ouncric: ,:,;i i
2. Similarl.v, lahor nturkets v,tx* less ef/icientlv in tlevelopirzg crruntrie,r’. The wage
gaps between expanding and deciining sectors are greater than in higher-inconre
countries. The wider wage gaps are an indirect clue that some lalror is being kept lrom
moving ro its most productive use.
These differences impiy some special tasks tbr the government of a developing
country. There is a case for considedng rvhich sectors to protect or subsidize or give
cheap loans to, if the government camot quickly eliminate the barriers tcl efficie nr
capital and labor markets. Tire government must also decjde u’hether it is realistic
to try to change the nation\ comparative advantage. for instance, by increasing its
investntent in education and health care to expand the country’s endowment of hu:nan
skiils. The shift ftom central pianning to a market economy requires yet other policy
decisions, as discussed in the box “special Challenges of Transition.”
We now explore the altelnatives for trade policy for a developing country in the
order that we presented thern for Ghana: focus on exporlrng prirnary products, ilse
export taxes or international cattels to influence the r,vorld prices of these prirnary
products, use import protection to develop new manufactiiring industries, or encour-
agd the development of export-oriented new manufacturing indristries.
j.\ ili L:’i +t i; A- {} f\$ fi * Ft t$ ru r- # $ f, fi T ffi il i’\i t: S A # }e i P; L :”
Fii ; i’!t AF?,\’ FFE# il? # s;ff ffi S ?
It seems natural that developrng countries export primary products (agriculture, for’-
estry, tuels. and minerals), and these are often- ealled tt’aditional ex.ports. The maior-
ity of developing countries get half or mol’e of their export revenrles from primary
products. Many developilrg countries have exports concentrated in one or a i’elv
products like peh’oleutn, coffbe, cotton, gold. sugar, timirer, diauronds, and bauxite/
alurniuurn.
A recurring idea is that developing countries’growth is held back by relying on
exports of prirnary products. In the 1950s, Raul Prebisch and others argued that devel-
opittg countries are hurt by a downward trend {and instability) in primary-product
prices. Intemational markets, ran the argument. distribute income unfairly. Since
developing countries are net exporters of primary products, thev are trapped into
declining incomes relative to incomes in the industrialized worid.:
Does the fear of falling prices sound reasonable’l Economic anaiysis shows that
there are at least two major forces depressing. and at least two forces raising, the trenc{
in the prices of primaries relative to matrufactures.
The relative price of prirnary products is depressed by Engel’s law and syntfietic
subslil utes.
;Be care{ui not to assLrme, as many discussions inrply, that there is a tight link betlveen berng a
de’veloping coLrnlry and bein,g an exporter of prirnary products, Overali, the clevelopinq conntries are oniy
mcdr:raie rei exporters of primary products ancl import sigr-rificant amci.tnts of them frorn Nortlr Arnerica,
Ausiraiia, and Ne$.r Zealand. An
: i:j Part Two Thule polit:t
continuing imports, tend to lorver these q.i.gl {excluding the tanff or orher irnport
charge) and offbr the nation a better bargain. If you can a#ect the prices at wtricnlrou
trade^ wouldn’t ir be be.tter to expand your supply of import-competing indusfiies,
fbrcing foreigners to sefi you the remaining r*port, at a lo*er price )
4 Replacing irnports of manufacfures is a way of using t].tecp nnc{ rttyyeniertt
mtrrket inlbrmation A developing colrn{ry may rack the expJtise to jLrdge jusr lvtich
of the thousands of heterogeneous indusirial goods it coutd best martet abroad. But
government officials {and private industrialists) have ail easy way to f.ind which nrod-
ern manufacfures would sell in their own markets. they need orily look at the iniport
figures. Here is a handy menn of goods with proven nrarkets.
Experience with lSl
History and recetlt economic strrdies offer lbur kinds of evidence on the merits of ISI.
Castral historical evidence suggests a slightly charitable vier.l,. u,hile three kinds of
-#f,ELlsd,ts*$,s
“\tplRqrJ 3 .fr.€’a.til’e ve,ul.ic.t
in support’ of ISI, it can be said that today’s ieacling industrial countries protecfed
their industry against import competitian earlier. whe]r their growth was first accel-
erating, The United States, for example, practiced ISI fiom ill. Ciuit War until the
end of World War lI. r.vhen most American firms no longer needed protection againsr
imports. Japan, in the 1950s, launched its clrive for leaJership in sieel. uutonrJbil*r,
and eiectronics with hear,y govemment protection against impbrts. When these indus-
tries lvere able to compete securely in world markets, Japan removed its redundant
protection against imports into Japan.
Such a casuai reading of history is at least correct in its premise: Ihe industrializeel
countries did at tirnes give import protection to industriei that became their export
strengths. But it is wrong to infer that most cases of indush’ialprotection nutured iec-
tors that responded with strong productivity gains, On the contrary. even Japan, like
the United States and most other industrialized countries, gave its strongesr protecrion
to sectors whose decline u’as long-lasting. ISI in the earlier history of these counh.ies
may well have slorved down their economic growth. Most of the infant industries, ip
other rvords. never grew up.
In contrast to the weaknesses of the evidence for ISI, fhe evidence against it takes
three forms that in combination add up to a strong case. The first kind if t.*t casting
serious doubt on the merits of ISI is the estimarion of its static e.ffbcts on natiani!
n-ell-heing, using the rnethods introduced in Chapter 8. A series oi cletailed country
sttldies quantified the rveitare eff’ects of a host of developing-counfry trade barrier:s in
the 1960s and early I970s. many of which were designed to plomote industrialization.
The barriers imposed significant costs on Argentina, chile. colombia, Egypt, Ghana.
India. Israel. Mexico, Pakistan. the Philippines, Sonth Korea” Tairvan,lnd Turkey.
Only in Malaysia did the import barriers bring a slight gain, here because of a favor-
able terms-of-trade eff-ect.6
By thetnselves. these standard calcnlations of welfare costs of racie barriers are
vulnerable to the charge ol assuming, not proving, that lsl is bad. such calcula_
tions assume that all the relevant efl’ects are captured by measures ol consurner and
‘rSee Bela Balassa (1971), Jaqdish Bhagwati and Anne Krueger (1g73-1g76J, and A. Choksi et al. (1991).
Chapter ’14 Tririlt: Poiicies Jrn lic.uebping Cnalrries ;i:i:
producer surplus, without allowing protection any chance to lower cost cutves as it is
imagined to do in the ini-ant industry case, It would be fair to demand firmer proof,
A second kind of test looks at what happens when a collntrv chutges it,s tracle-
1x;lic.t, orientution toward manuf-actures, away fi’om restricting irnports (ISi), and
torvard charnpioning expofis. Here there \.vere two drarnatic early cases. Until the late
1950s, Taiwan used ISI but then switched to a policy that encouraged exports. It sulrse-
quently achieved growth rates of about 10 percent pe r year. South Korea useci ISI until
policy refcrnns in the early 1960s increased its incentives for exports and lowered its
$Port barriers. Its growth rate incrcased to about l0 percent per year. Hong Kong and
Singapore also used policies that encouraged exports and achieved high giowth iates.
Other countdes have achieved substantial effects. In the case of Ghana. ihe ISI strat-
egy was part of a larger heavy hand of government that turned early growth inta a 42
percent decline of Chana’s living standards over the rlecade 1974*.1984. The country
was saddled rvith costly industlial white elephants that never became efficient. Onlv
after paltial reforms that included a partial liberalizatiol of trade policy dicl Ghana
regain positive economic growth.
A third kind of test coftIputes growth nttes o.l’ t:ottntries prat:tidng ISI with
grov’th rctes o.l’ t:i;rmtries using policies that ernphusize exporfi;lg. fhe iqgZ Wurltl
Devekspnenl Reporl presented the resLrlts of the World Bank’s sfudy ol’growtfu rates
in 41 countries, which were piaced inio four categories accorrling to their irade pr:lic_v:
strongly outward-oriented. ntoderately outward-oriented, moderately inwarcl-olientecl
and strongly inward-ori:ented. Hong Kong, South Korea, and singapore foilorved
strongly outward-oriented policies. with low trade barriers and some pse of e.\port
subsidies. The strongly in’u,’ard-oriented countries used high trade ba’n’iers.
‘fhese
included Argentina, Bangladesh. chile (up ro 1973), inclia, ancl rurkey (to 1973).
In the two time periods that rhe V/orld Bank examined 1963-1973 and 1973*1985,
tite average growth rate r:f real CDP per peffion tvas highest fbr the three coLultt’ies with
strongly outward-onentecl trade pollcies (o.y percenT ano ).-./ per{.enr ilcr yciu, rcbpcu-
tir.ely).The average grou,th rate in the counffies with sfrongly inward-oriented n’ade poli-
cies was lorvest in both periods ( 1.6 percent and -0.1 percent per year. respectively). An
update in the 1994 Wrltl Developntent Report found tlrat this pattern also held for the
time period l980-1992 (a 6.2 percent annual growth rate for sh”ongly ouhvard-oriented
cottttffies, and a *0.4 annual growth rate for sfrongly inuard-oriented counfries).
trn a 2002 study. the World Bank contrasted the experience of developing countries
that have increased their integration into world markets since 1980 with the experience
of other countries. The neu’l,v glohulizing det,ek;ping cowttt’ies, as the World Bank
calls them. are countries that
” had relatively lorv involvenent in international trade and high tariffs in 1980 but
tiren
‘ greaily increased their international trade (measured by the increase in the ratio of
expofis and imports to national GDP) and
. substantially lowered their tariff rates.
The 24 nervlv globalizing developing countries have a totai popuiation of 3 billion
and inciude Argentina. Bangladesh. Brazil- Clhina, Colombia. India, lriicaragua.
-,FSe,
ir Part Two lrarl,|dicr
‘rhailand, and urugltay. The other deveioping countries have a totai population of
aLlout 2 billion and include ntanv African countries and coulrtries of the forruer
Soviet Uniott. Most of these other developing countries concentrare on exporting
primary pr.odncts.
The world Bank found that the newly globalizing developing countries achieved
averagegrowthratesofGDPperpersonof3.5percentou*n[tni tqtosanci5.0per-
cenf during the 1990s’ These average growth .ite, *e.e above their average annual
growth rates in the 1960s {1.4 percent) and 1970s {2.9 percent). Their average grorvth
rates in the 1980s and 1990s r.vere also higher than theavemge grorvth rates of other
developing.countries {0.8 percent and 1.4 percent, respectivet,vl a’* of the industrial-
ized countries (2’3 percent and2.2 percent, respecrivei). rhei;trerences betweeil tile
newly globalizing and other develcping countries do not seem to regect favorable ini-
tial economic conditions fbr the new globalizers. In 1980 the peopie in rhe two _qr.oupshad comparable average levels of education, and the newly gtouutirirrg countries gn
average had somewhat lower incomes per capita.
such direct comparisons (as in these severil World Bank studies) betrveen toturtries
praL’ti(ing ar udapting ./reer-trude. regintes and c’ountries prut:tir:ing a variurtl aJ ISt
or rcsi’sting lurtlter libetalizcttioft q/’tl:e\ trurle polici”r harre the
*virtLre
of simplic-
ity: They’ look directly at the trvo variables of interest (trarie policies and economic
. Stnwth.)’ Yet here. as always. corrclation cannot prove causation. By itself. rhis kind
ot evrdence against ISI and restricting trade is sub-iect to the suspicion that maybe
some other force caused ecottomic gror.vth to be correlated with freer-trade poiicies.
c)r perhaps the eausation ran the opposite u,ay-perhaps successfill growth itself
brings freer-trade policies, even though policies departing fiorn l?ee lrade helped
promote growth. While it ls not possible to answer these concerns fully. ecorlonrists
have conducted nore cornplicated tests of the-statistical significance oi trade poiicy.
Afler allowing for the eft-ects of orher variabies such as iivest,nent. iniiiut incoue.
and education, the research tends to confinn that ISI-type tracle barriers are a negative
inf’luence on econonric growth.
lf theory suggests that iSI can work weil, why does experience make it look like a
bad idea’.) There is no direct contradiction becauie theory only assertecl that ISI r:urtbe
better than free trade under certain conditions. It iust so-happens that those conditions
have not held since the early 1960s. The theory failed, above all. in the assumption that
an informed government tries to nraximize national income. Real-worlcl governments
are ill-inforrled, and they lack the power to stop protecting industries that lurn oul to
be inefficient. Worse. many govemftents trave fleir o*r self-interesr, which conflicts
with the gcal of maximizing national well-being. Embarking on a policy of iSI has
so fbr not.turned any economy into a supergrowir iike Soutir Korea. Moie often, the
ISI ror:te is the road that turns a South Korea into a North Korea. ISI often results irr
industries in which domestic firns have high costs and domestic monopoly power a1d
produce products of lorv qualit-v.
Outward-oriented policies encourage domestic firms to make use of the country’s
abundant resources. zurd the firms can use sales into international rnarkets to achieve
scale econor:ries. The efforts to succeed in lbreign markets also nrean that domestic
firms t’ace.internatiotral competitive pressure, so that they are driven to raise product
quality and resource productivity. The country can use iti rising exports to pay l.or its
tougher pollution policies. As a type of secor:d-best approach, impilrr limits by other
countries can improve things. But these limits r.vill nL? mate’the inpor-ting country
better o{f. even though theiz nright mise world well_being.
it si 1* 5 # {_;r ri i””! ia i1: * i”: i- !.. i”i T” i # $,,.i
In the previous section we considered pollution that had costs only to the courlty
doing the pollution. whiie rve reacheci iome surprising conclusitxs ab6ut fr-ee trade
itt the absence of governrnent policies limiting poituuori, we aiso had a ready sol’rion.
The governrnent sirould implenient some foim of poliry aOO.essing pollution rlat is
occurring in its countt’y. If each country’s government addresses its orvn local pollution
problenrs. then each can enhattce its own narional well-being. lu the process, worlci
ivell-being rs also raised.
Horvever, nlany types of pollution har.e fransborcler eiTects*efl-ects not jLrst on the
country doing the poliutioli brii also on neigliboling countries. Exanples inclrrcle airpollution like particulates and sulfur dioxide that Jritts across national borders and
water pollLition wiren the body of water (river or lake) is in twa or irlorc co’ntries.’i l”-:’;-r:ilrr-.i’j’r,l r:lili.;1ii-;ltr4j5ggrnajorissr-iesfbrgoveillmentpoticiestgyarcipoliutiog.
Chapter 14 fr,tl: /)olicir.s f ;r Dcuclripnrg L–ouncric: ,:,;i i
2. Similarl.v, lahor nturkets v,tx* less ef/icientlv in tlevelopirzg crruntrie,r’. The wage
gaps between expanding and deciining sectors are greater than in higher-inconre
countries. The wider wage gaps are an indirect clue that some lalror is being kept lrom
moving ro its most productive use.
These differences impiy some special tasks tbr the government of a developing
country. There is a case for considedng rvhich sectors to protect or subsidize or give
cheap loans to, if the government camot quickly eliminate the barriers tcl efficie nr
capital and labor markets. Tire government must also decjde u’hether it is realistic
to try to change the nation\ comparative advantage. for instance, by increasing its
investntent in education and health care to expand the country’s endowment of hu:nan
skiils. The shift ftom central pianning to a market economy requires yet other policy
decisions, as discussed in the box “special Challenges of Transition.”
We now explore the altelnatives for trade policy for a developing country in the
order that we presented thern for Ghana: focus on exporlrng prirnary products, ilse
export taxes or international cattels to influence the r,vorld prices of these prirnary
products, use import protection to develop new manufactiiring industries, or encour-
agd the development of export-oriented new manufacturing indristries.
j.\ ili L:’i +t i; A- {} f\$ fi * Ft t$ ru r- # $ f, fi T ffi il i’\i t: S A # }e i P; L :”
Fii ; i’!t AF?,\’ FFE# il? # s;ff ffi S ?
It seems natural that developrng countries export primary products (agriculture, for’-
estry, tuels. and minerals), and these are often- ealled tt’aditional ex.ports. The maior-
ity of developing countries get half or mol’e of their export revenrles from primary
products. Many developilrg countries have exports concentrated in one or a i’elv
products like peh’oleutn, coffbe, cotton, gold. sugar, timirer, diauronds, and bauxite/
alurniuurn.
A recurring idea is that developing countries’growth is held back by relying on
exports of prirnary products. In the 1950s, Raul Prebisch and others argued that devel-
opittg countries are hurt by a downward trend {and instability) in primary-product
prices. Intemational markets, ran the argument. distribute income unfairly. Since
developing countries are net exporters of primary products, thev are trapped into
declining incomes relative to incomes in the industrialized worid.:
Does the fear of falling prices sound reasonable’l Economic anaiysis shows that
there are at least two major forces depressing. and at least two forces raising, the trenc{
in the prices of primaries relative to matrufactures.
The relative price of prirnary products is depressed by Engel’s law and syntfietic
subslil utes.
;Be care{ui not to assLrme, as many discussions inrply, that there is a tight link betlveen berng a
de’veloping coLrnlry and bein,g an exporter of prirnary products, Overali, the clevelopinq conntries are oniy
mcdr:raie rei exporters of primary products ancl import sigr-rificant amci.tnts of them frorn Nortlr Arnerica,
Ausiraiia, and Ne$.r Zealand. An
