Development - Lecture 4 1 Economic Development Lecture 4. International Relationships

Development - Lecture 4

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Economic Development

Lecture 4.

International Relationships


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I. International Trade Theory Gains from trade

– Comparative Advantage Theory LDCs should specialize in sectors which intensively use their

abundant factor All countries should gain from trade Trade provides engine for growth

– Economies of scale Many LDCs are small economies, hence gains from specialization

and trade are huge

– Increased competition => efficiency

– Spead of modern technology through trade


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I. International Trade Theory Weaknesses of trade theory in the context of development

– Assumption of full employment LDCs have high overall unemployment

– Opportunity cost is static LDCs may be locked in low tech sectors Growth is dynamic, need to be forward-looking

– Prices reflect opportunity cost Imperfect competition government intervention private vs social costs


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I. International Trade Theory

– Assumption of no uncertainty and risk LDCs concentrate on a few primary sectors, which are subject to

huge price fluctuations in the SR and downward price trend in the LR Better to diversify, instead of too much specialization (to take

advantage of scale economies)

– No consideration of who in the countries gain from trade The rich often gains, the poor left out


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I. International Trade Theory

– Economies of scale LDCs find it hard to enter industries which they are supposed to have

comparative adv. because these are protected by DCs’ big companies LDCs need to protect “infant industries” to compete with

multinationals

– Spread of modern technology Multinationals use capital-intensive technologies, replace LDC jobs

=> growth without development


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II. Trade Problems of LDCs

World Trade Patterns– LDCs rely on primary products exports

– World trade moves away from DCs dominated by DCs LDCs overall share of world trade remained the same, but NICs

increased trade share while the Least Developed Countries fell behind.

This trade pattern leads to problems:– Long Term

– Short Term


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Long Term Problems– Slow growth of exports volume

Low income elasticity of demand (for primary prod.) As income increases, not much increase in demand

Relatively low price elasticity of demand (for primary products) Low in the world market (although high for each country) As supply shifts right, large world price decreases

Recent developments Agriculture protection in DCs Synthetic substitutes Miniaturization - less need for raw materials


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– Fast growth of imports volume High income elaticity of demand for imported manufactures and

services As LDC income increases, even higher demand

Low price elasticity of demand for imported manufactures and services

few substitutes As demand increases, large price increases

– Worsening terms of trade Price of imports increase, price of exports decrease Exception: oil and oil-exporting countries


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Short Term problem - huge price fluctuations– Primary products have inelastic demand AND supply in the SR

Demand: few substitutes Supply: nature of farming and mining

– Primary product market subject to huge SR shocks to demand AND supply

Demand: business cycles in DCs Supply: uncertainty in farming and mining

– Result: huge price fluctuations in the SR


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LDCs attempts to counter these problems– International Commodity Agreements

Producers: raise prices through cartels restricting supply by issuing production quotas

Consumers: stabilize prices through buffer stock buy and sell to keep prices stable

– Problems with cartels cheating by members increase in supply by non-members economizing in the use of the product development of substitutes


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– Problems with buffer stock perishable goods difficult to stock difficult to choose the right price to keep

producers might pressure for higher price long term trend in price decrease if price kept too high, then have to buy too much

uncertain need to use buffer stock Would speculators in market do the work? Are price fluctuations really that bad?

buffer stock benefits the producers, not necessarily the poor better to subsidize directly than to mess with prices


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III. International Debt

Problem for both LDCs and the entire international financial system

Developments of the Debt Problem– Before 1973

Most LDCs had current account deficits They financed the deficits through foreign investment and aid Most foreign loans were “soft” - from governments and int’l orgs on

consessional terms

– 1973 - 1979 DCs had recession, reduced imports from LDCs LDCs borrowed massively to continue own growth


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III. International Debt Most loans were “hard” loans from commercial banks at market

interest rates

– Second oil shock of 1979 DCs, in severe stagflation

resorted to strict deflationary policies & raised real interest rates

reduced imports from LDCs LDCs import prices rose sharply while exports decreased LDCs held large debts and hence large “debt servicing”, which they

could not finance through export sales Severe “capital flight” problem


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III. International Debt

– LDCs forced into rescheduled debts IMF restructuring programs (prerequisite for help and rescheduling)

Market orientated, supply-side measures to promote output growth and investment

devaluation to encourage exports and discourage imports deflation through tight monetary and fiscal policies to reduce

government deficit, inflation, and interest rates hurt the poor immensely due to big cuts in welfare payments and

development programs

– Debt problem temporarily on hold


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IV. Multinational Companies MNCs

are large and are foreign-owned and controlled are desirable for LDC development???

MNCs help economic growth– increase GDP, employment, savings

– increase exports, foreign exchange, tax revenue

– increase technology transfer and human capital

– But: inefficiency - monopoly power minimize tax payments - transfer pricing LDC gov’ts compete - benefits of FDI reduced


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IV. Multinational Companies

MNCs help development???– widen inequality (high wage sector)

– develop dual economy (locating in cities)

– sell inappropriate products (for the rich only)

– unfair competition (big budgets on advertising) hurts local enterprise growth

– inappropriate modern tech. creates few jobs

– big influence on government (often in anti-development policies)


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V. Foreign Aid

Official and unofficial aid– ODA (Official Development Assistance)

bilateral aid (by individual govt) multilateral aid (by agencies - World Bank, etc.)

– Unofficial by NGOs, e.g. Red Cross, Oxfam, church, and local agencies

The amount of aid– DCs less generous than before (0.3% of GDP)

– US large in volume, but small in % of GDP


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V. Foreign Aid

Direction of aid– bilateral donors focused on donor’s self-interest (political,

military) US - contain Communism Soviet - support Communism UK and France - former colonies OPEC - Arab countries Exception: Nordic - emphasis on development

– multilateral donors development criteria but: conditionality


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V. Foreign Aid

– NGOs: dealing with the poor directly development by the poor as opposed to for the poor

Arguments for and against Aid– Economic

resources gaps ( forex, capital) personnel gap (through technical assistance)

– Tied aid donor self-interest must purchase donor country products


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V. Foreign Aid

– Aid maintains income inequality in LDCs (inappropriate tech.)

– Aid can help LDC govt postpone reforms Food aid alleviates problem Food aid also reduce incentives for local farmers

– Aid allows dictatorial govt to stay in power (aid often politically motivated)

– Aid is a poor substitute for trade DCs should remove import barriers from LDCs in textiles LDCs need to get out of dependence cycle!

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Development - Lecture 4 1 Economic Development Lecture 4. International Relationships