Fundamentals of Trade

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Trade Fundamentals:Why They Matter

Policy ImplicationsHow to Use Them

March 12 – 14, 2008Siem Reap, Cambodia

Anne Simmons-BentonBooz Allen Hamilton



What We Want to Get From thisPresentation

1. Trade Matters (and we should be prepared to always argue in its

favor)

2. Policies need to be grounded in theory in order to be

sustainable (understanding theory allows you to understand or

challenge prevailing policies

3. Trade is related to growth and poverty reduction (but the

relationship is debated and the debate is important)

4. There is room for compromise in the debate

5. Understanding the theory and its uses will help youwrite better RFPs (and assess contractor implementation)

6. Understanding theory can help you shape programs in

discussion with host governments

7. Know your data (and where to find it)



Why Bother With Trade?

• Because it is a major world economic force….. – Grown in absolute terms: 22-fold since 1948

– Grown in relative terms: world output rose only 7-foldduring the same period

– Growth is accelerating: world trade/GDP ratio grew from8% in 1950 to 29.5% in 2000

• ….benefiting Developing Countries – DC share of world merchandise exports rose from 17%

in 1990 to 30% in 2000

– Growth in LDC merchandise exports in last two yearsexceeded growth in world exports



But There are Important Differences

Developing Countries

• Ten countries account for64% of all DC exports

• China and Asian NIEs account for 45% of total DCexports

• African merchandise exports grew by 27% on average in2000, but actually declinedin 20 African countries

-10

-5

0

5

10

15

1990-2000

Total LDC

Oil Exporters

Manufactures Exporters

Commodity Exporters

LDCs with Civil Strife

LDC Merchandise Exports by Group(Annual Average % Change)

World

China $249.3 B (13.4%)S Korea $172.3 B (9.3%)Mexico $166.4 B (8.9%)Taiwan $148.3 B (8%)

Saudi Arabia $84.1 B (4.5%)Singapore $78.9B (4.2%)Thailand $69.1B (3.7%)Indonesia $62.1 B, (3.3%)Brazil $55.1B, (3.0%)

LDCs with civil strife are thosecountries that experienced politicalor other problems such asAfghanistan. As a group, theirexports dropped by an averageannual 7% over the decade.



Link Between Trade and Growth

• Trade increases growth – An increase in trade as a share of

GDP of 20% increases growth by0.5%-1% per year

– In the 1990s, ‖globalizers‖ have

grown 5.3% per capita, comparedto –0.8% for ―non-globalizers‖

• Main effects – Aligns resource allocation with

comparative advantages

– Raises productivity and

competitiveness – Ties a country into global

production networks

0%

1%

2%

3%

4%

5%

6%

1960s 1970s 1980s 1990s

Rich Countries

GlobalizersNon-Globalizers

Source: Dollar & Kraay, World Bank

Real Per Capita GDP Growth

Developing countries whichhave brought down theabsolute level of their tariff

rates over the 1990’s versusthose that that did not have aan absolute decline.



Trade and Poverty Alleviation

• Trade is good for the poor –Open economies grow faster, and faster growth is

closely linked to income growth of the poor

–Empirically, increased trade lowers poverty: 1% rise in

GDP raises per capita income of the poor by ½ to 2%• But…

–There are short-run adjustment costs

– Impacts are uneven—losers may never recover; thereare gender differences

–Complementary policies & initiatives are needed



Some Objections to Trade

• Developed country concerns –Trade leads to ―de-industrialization‖

–Trade displaces workers and lowers average wages

–Trade/FDI encourage sub-standard labor conditions

and sweatshop wages• Developing country concerns

–Trade widens income inequality

–WTO exists to protect industrial country interests

–Globalization undermines sovereignty

–Local industries lose out

Jobs are created in newindustries mainly exports:In the United States, 12 million people owe their jobs

to exports; 1.3 million of those jobs were created

between 1994 and 1998. And those jobs tend to bebetter-paid with better security.

Average wages paid byMNCs have been 1.8-2 timeshigher than domesticmanufacturing wages

Working practices are better

than domestic industry

New jobs tend to be higher-paying; lost jobs lower-paying:In Mexico, the best jobs are those related to export

activities: sectors which export 60 per cent or more

of their production, pay wages 39% higher than the

rest of the economy and maquiladora (in-bond

assembly) plants pay 3.5 times the Mexicanminimum wage.

Not true: growth has loweredincome inequality in mostdeveloping countries

80% of WTO members are

developing countries



Trade Liberalization

• Trade liberalization has multiple,sometimes offsetting, effects –Consumers—greater variety of lower-

priced goods

–Producers—better access to lower cost

inputs, technology versus greatercompetition

–Fiscal revenues—reduction in trade taxesversus income from new industries, growth

–Employment—loss of import-competing

jobs versus new employment in newindustries; immediate impact on thepoorest groups—but transitory



CLICK TO ADD BREAKERSLIDE TITLETrade Fundamentals



Mercantilism

Absolute advantage

Comparative advantage

Krugman’s Clarity

Trade Fundamentals and Growth

Trade Fundamentals and theConstruction of RFPs

Presentation Outline



Mercantilism

• 16th century concept

• A nation’s wealth depends on accumulated treasure

• It is in a nation’s best interest to have a trade surplus – Maximize exports through subsidies

– Minimize imports through tariffs and quotas

• Zero-sum game: one country can gain only at the expenseof another

• Mercantilism declined as an explanation of trade due toDavid Hume’s specie-flow mechanism argument

– In the long-run the accumulation of gold (specie) will raise prices in theaccumulating country making the exports of that country relatively less attractiveto foreign buyers and imports relatively more attractive to domestic residents—

since foreign prices are relatively lower.

• Neo-mercantilism is still alive!

• Growth was measured in terms ofaccumulation of specie (gold and silver).

• Force trade through one state, acquirecolonies to supply cheap raw materials to bemanufactured in the Home country and sold

domestically and abroad• It focused on promoting domestic industries

and domestic trade• Opened up domestic trade, favored large

monopolies, drove out internationalcompetition and reaped the monopolyrents—Dutch East India Company, British

East India Company--examples

It was not a theory—rather a policy to build theNation-State—it was the theory of David Humeand the physiocrates that showed the fallacy ofMercantilism as a Policy and forced a change.

• Neo-Mercantilism is present in the form ofpolicies to Protect monopolies (such asTrade Unions or older oligopolisticindustries-car manufacturing, steelproduction etc.)

• Very similar lines of logic to the 16th century,favor domestic business at the expense ofother countries, raise tariff barriers to insurethis protection, focus on exporting goods

• The theory of trade runs counter to theseneo-mercantilist arguments—long-runarguments favor open trade.



Absolute Advantage

• Smith disagreed that trade was a zero sumgame

• Countries have different capabilities to producemore of a product with the same amount of input

• Produce only goods where you are the mostefficient and trade for those where you are notefficient

• Smith (and Hume) used observations of tradedynamics to show the deficiencies of currentpolices since they were really concerned with

long-run economic growth and welfare.• Thus. powerful theory was used to change

current policies.



Ricardo and Comparative Advantage

• When Country A is relatively more efficient atproducing a good or service than Country B, then ithas a comparative advantage

• Main insights – Trade is determined by opportunity (not absolute) costs

– Countries should specialize in the production of goods and serviceswhere they have a comparative advantage

– Specialization raises world output and increases consumptionlevels—trade is a positive sum game

• Heksher-Olin Updates of Comparative Advantage and

Opportunity Cost• Hecksher-Ohlin—differences in factor endowments

• The H-O description is important for current policydebates

• Where Ricardo showed that

comparative advantage determinestrade, H-O shows us that relative factorendowments determine comparativeadvantage since they determineopportunity costs.

• Countries do not actually trade

goods—rather they trade factors ofproduction—this impacts policyformation in trade and how its impact isassessed.

• By trading in factors ofproduction it takes the argumentaway from goods trade and thefocus on the loss of jobs in aparticular industry—it shows thatlabor migrates across goodsmarkets—as a factor of

production.• Factor productivity causes wage

rates not new lower paying jobselsewhere in the world



Krugman’s Clarity

• Countries export so they can import• Objective of increasing productivity is to enable

a country to produce more

• Emphasis on ―high-value‖ sectors is misplaced;

countries that don’t produce high value goods

benefit from trade

• Trade policy has no effect on net job creation

(the natural rate of unemployment is relatively

unchanged over time); rather trade policy

causes reallocations but not a net long-termchange in employment.

• Wages do not fall if workers compete globally

for ―scarce‖ jobs; wages are dependent on

productivity



Trade Fundamentals and the Construction

of RFPs

• What is important about trade theory for theconstruction of an RFP in your region of USAID – Know the data

– Know the level and composition of trade

– Know the specific relationship between trade and growth inyour region

• Standard sources to consult – Balance of Payments data

– Fiscal and Monetary data

– Recent FIAS Administrative Barrier studies, BizCLIR study

– Customs data

– WTO, Country Reports

– World Bank, Doing Business Survey

– USTR, National Trade Estimate Report on Foreign TradeBarriers

Documents

Fundamentals of Trade