Trade and Development: ISI and Economic Reform Oatley, Chapters 6 and 7

Trade and Development: ISI Trade and Development: ISI and Economic Reformand Economic Reform

Oatley, Chapters 6 and 7

Ch. 4: Trade and Development I: Import-Substitution Ch. 4: Trade and Development I: Import-Substitution IndustrializationIndustrialization

Mexico: heavily protected until 1980s, high tariffs. Today, Mexico is one of the most open developing countries in the world.

Contrast with the previous era in which developing countries emphasized industrialization policies.

Most countries have now dismantled protectionist systems they created in the first 30 years of the postwar period.

Now they are active participants in the WTO.

This chapter explores why countries had adopted protectionism.

The next chapter focuses on the shift in policy.

Trade and Development I: Import-Substitution Industrialization

First we look at how governments came into power that supported import-competing interests.

We then look at specific policies.

Domestic Interests, International Pressures, and Protectionist Coalitions

Until WWI developing countries (that were independent) opted for liberal trade policies.

They exported agricultural goods and other primary commodities and imported manufactured goods.

By 1950s protectionism dominated trade policies (until the late 1980s).

Trade and development policies shaped by political competition between the country and the city.

Rural-based agriculture versus urban-based manufacturing.

Factor endowments ( developing countries: land abundant, capital poor countries, in general)

Thus, we see that GDP is dominated by agriculture and so are exports based on commodities and agriculture (see Tables 6.1 and 6.2)

Many countries were also monoexporters (one product).

Agriculture is the export-oriented sector Manufacturing is the import-competing sector Landowners (of agricultural land) see incomes rise from trade

but decline under protectionism Manufacturers, by contrast, prefer protectionism Urban interests: people who work for government, in retail

(the sale of goods directly to the consumer) or in other non-manufacturing activities (nontrade-goods sector)

Some goods or services must be performed locally International trade affects incomes in the nontrade-goods

sector primarily through its impact on the prices of the traded goods that people employed in the nontrade-goods sector purchase.

People employed in the nontraded-goods sector realize income gains from policies that reduce the prices of traded goods and loses from policies that raise the prices.

‘Oligarchic democracy’ in various Latin American countries contributed to the more liberal policies favored by agricultural interests.

In Asia and Africa colonial structures ensured the dominance of export-oriented agricultural interests.

Taiwan and Korea: enclave agriculture (result of Japanese colonization) – rice-export-oriented agricultural sectors that had few linkages to other parts of the local economy.

India: cotton, wheat, tea, rice.Ghana: cocoaBut politics began to change in 20th centuryExport-oriented interests gave way to interests of

import-competing manufacturersWWI: international economic shocksGovernment mandated rationing of goods and primary

products in Europe and the US made it difficult for Latin American countries to import goods from US or Europe.

Falling commodity prices due to Great Depression and disruption of trade patterns reduced foreign exchange.

Trade barriers in Latin America was the response in order to produce many of the manufactured goods that they had previously imported

Growing urban middle class Interest groups, industry based associations, and labor

unions New political coalitions based on support of the urban

sectors Juan Peron in Argentina in the 1940s; Gatulio Vargas in

Brazil in 1950 Political coalitions where incomes were based on import-

competing manufacturing Protectionism India similar – led to Indian independence movement

Elsewhere in Asia, decolonization following defeat of Imperial Japan

Defeat of nationalist Chinese government (exiled to Taiwan) Chinese nationalists imposed land reform in Taiwan Africa decolonized only after 50s and early 60s. The nationalist

struggles for independence that emerged in the 1950s and succeded over the next 15 years sought to transfer control over existing economic practices from colonial governments to indigenous elites.

As a consequence, import-competing manufacturing in Africa played a much smaller role in early post-independence politics than did the nontraded-goods sector. The indigenous elites, “wanted to inherit the system rather than to revolutionise it”.

The Structuralist Critique: Markets, Trade, and The Structuralist Critique: Markets, Trade, and Economic DevelopmentEconomic Development

Structuralism:The shift of resources from agriculture to manufacturing

would not occur unless the state adopted policies to bring it about.

Belief that the market would not promote industrialization.

The chapter will first look at the structuralist critique of the domestic market in developing countries’ and then turn its attention to the structuralist critique of the international market and the international trade system.

Market Imperfections in Developing CountriesMarket Imperfections in Developing Countries

Belief that domestic market could not be expected to bring about the necessary shift of resources for industrialization.

Market would not promote investment in manufacturing industries.

Coordination problems that would limit investmentComplementary demand: not enough manufacturing

for consumption (no single entrepreneur has an incentive to create a manufacturing enterprise)

Big push: overcome the coordination problemsEconomic planning

Market Imperfections in the International Market Imperfections in the International EconomyEconomy

Singer-Prebisch theory: divides the world into two distinct blocks-the advanced-industrialized core and the developing world-periphery.

Participation in the GATT would make it harder for developing countries to industrialize by depriving them of critical resources

An improvement in a country’s terms of trade means that the price of the goods it exports is rising relative to the price of the goods it imports.

As a country’s terms of trade decline, it must exchange a larger volume of domestic production (it must export more) for a given amount of foreign production (imports).

For a developing country- a fall in the price of primary commodities relative to that of manufactured goods lowers developing countries’ incomes. A rise in the price of primary commodities relative to that of manufactured goods raises their incomes.

The Singer-Prebisch theory argues that developing countries’ terms of trade deterioate steadily over time:

Different consequences of productivity increase in the core and the periphery

Core-country countries: labour is strong, productivity improvements are transformed into rising wages and stable prices.

Periphery countries: labour is weak, productivity improvements are transformed into stable wages and falling prices.

Falling prices means the amount that developing countries must export to acquire a given volume of imports rises continously over time.

Engel’s law (Erst Engel): people spend smaller percentage of their total income on food and other primary commodities as their incomes rise.

As incomes rise in the core countries, a smaller percentage will be spent on imports of primary commodities, but as incomes rise in peripheral countries, a larger percentage of their incomes will be spent on manufactured products imported from core countries.

Domestic and International Elements of Trade and Domestic and International Elements of Trade and Development StrategiesDevelopment Strategies

State-led development strategies, sheltered by high protectionist barriers.

Rapid industrialization

In the international arena, concern about the distributional implications of international trade led developing countries to seek far-reaching changes to the GATT-based trade system.

Import Substitution IndustrializationImport Substitution Industrialization

Soviet Union as a model Import substitution industrialization (ISI) Substitute domestically produced goods for previously imported

manufactured items 2 stage strategy: Easy ISI: simple consumer goods: soda, beer, apparel, shoes and

furniture Second stage: either export substitution strategy-(the export of

labour-intensive manufactured goods) or Secondary ISI: emphasis shifts from the manufacture of simple

consumer goods to the production of consumer durable goods. Increasing percentages of locally produced components Backward linkages: increases in demand in industries that supply

components for the production of one good (e.g. cars)


Trade barriers, government planning, and investment policy.

The justification for trade barriers was provided by the infant-industry argument and by recurrent lack of foreign exchange.

Five year plans: were designed to “serve as guidelines for public expenditures and for economic policies”. Planning was used to determine which industries would be targeted for development and which would not.

State-owned enterprises (investment policies in targeted industries) (mixed or state ownership)


Although import-competing manufacturing benefited from ISI, export-oriented agriculture bore many of its costs.

Typically, government-owned marketing board would purchase crops from domestic farmers at prices well below the world price and then would sell the commodities in the world market at the world price.

The difference between the price paid to domestic farmers and the world price represented a tax on the agricultural incomes that the state could use to finance government-favoured projects in industry.


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

Rapid economic growth

Reforming the International Trade SystemReforming the International Trade System

Since developing countries were skeptical that trade could contribute to economic development, one of the principal objectives was to reform the trade system in ways that would transfer income from core countries to the periphery as compensation for the losses resulting from their deteriorating terms of trade.

1958 GATT-directed study, the Haberler Report-explored the poor trade performance of developing countries, arguing that commodity price movements and high tariffs in the advanced industrialized countries harmed developing countries.

The report provided intellectual support for the structuralists main arguments by suggesting that the GATT was “relatively unfavourable to primary producing countries” and by concluding “that developing countries were losing ground under the GATT”.


By the early 1960s, a coalition of developing countries dedicated to far-reaching reform of the international trade emerged. Its important success was achieved with the formation of the United Nations Conference on Trade and Development (UNCTAD) in March 1964.

UNCTAD was established as a body dedicated to promoting the developing countries’ interests in the world trade system. At the conclusion of this first UNCTAD conference, 77 developing country governments signed a joint declaration that called for reform of the international trade system.

During the next 20 years, trade relations between the developing world and the advanced industrialized nations revolved almost wholly around competing conceptions of how to organize international trade embodied in the GATT and UNCTAD.


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

During the 1960s, developing countries used the UNCTAD to pursue three international mechanisms that would provide them a larger share of the gains from trade:

Developing countries pressed for the creation of commodity price stabilization schemes.

Commodity price stabilization was achieved by setting a floor below which commodity prices would not be allowed to fall, and by creating a finance mechanism, funded largely by the advanced industrialized countries, to purchase commodities when prices threatened to fall below the established floor.


Developing countries also sought direct financial transfers from the advanced industrialized countries.

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


These reform efforts yielded very few concrete results. Core countries agreed to modify the GATT charter to incorporate concerns specific to developing countries.

In 1964, three articles focusing on developing countries were included in the GATT Part IV.

Part IV called upon core countries to improve market access for commodity exporters, to refrain from raising barriers to the import of products of special interest to the developing world, and to engage in “joint action to promote trade and development”.


Yet in the absence of meaningful changes in the trade policies pursued by the advanced industrialized countries, Part IV provided few concrete gains.

Developing countries that belonged to the GATT were able to benefit from trade reductions without having to offer concessions in return.

Benefits from this concession were more apparent than real because GATT negotiations focused mainly on manufactured goods produced by the advanced industrialized countries and excluded agriculture, textiles and many other labour-intensive goods. (few products exported by developing countries were benefiting from reduced tariffs).


Late 60s, advanced industrialized countries agreed to the Generalized System of Preferences under which manufactured exports from developing countries gained preferential access to advanced industrialized countries’ markets.

Yet this concession was also of limited importance because advanced industrialized countries often limited the quantity of goods that could enter under preferential tariff rates and excluded some manufacturing sectors from the arrangement entirely.


Even though their efforts during the 60s achieved few concrete gains, the Group of 77 (check http://www.g77.org/doc/) escalated its demands for systemic reform in the early 1970s.

A set of more radical demands came to the agenda later. New International Economic Order (NIEO), an attempt by the Group of 77 to create an international trade system whose operation was to be made “subordinate to the perceived development needs” of developing countries.

The NIEO was adopted by the UN General Assembly in December 1974, embodied a set of reforms that would have radically altered the operation of the international economy.


In addition to encompassing the three mechanisms that developing countries had demanded during the 1960s, the NIEO included rules that would give governments in developing countries

greater control over multinational corporations operating in their countries

easier and cheaper access to northern technology, a reduction in foreign debt, increased foreign aid flows,and a larger role in the decision making mechanism

processes of the WB and the IMF.


Governments in the advanced industrialized countries again proved unwilling to make significant concessions, and by the mid-80s the NIEO had fallen from the agenda of the world trade system.

Why?Developing countries were unable to establish and

maintain a cohesive coalition.


Many developing countries were facing serious balance-of-payments problems and were forced to turn to the IMF and the World Bank for financial support.

The need to obtain IMF and World Bank assistance gave the advanced industrialized countries considerable influence over economic and trade policies in the developing world.

Ch. 7: Trade and Development II: Economic RefoCh. 7: Trade and Development II: Economic Reformrm

Development strategies since 1980s dominated by neoliberalism and export-oriented industrialization.

In contrast to structuralism, with its skepticism of the market and faith in state.

Neoliberalism: highly skeptical of the state’s ability to allocate resources efficiently and places greater faith in the market’s ability to do so.

Neoliberalism has greatly affected policy: deregulaton of domestic markets,export oriented production.

Shift from structuralism to neoliberalism.

ISI was generating economic imbalances.

East Asian countries were outperforming others based on an export-led growth strategy.

In only 30 years, these East Asian countries transformed themselves from:

traditional agricultural societies into powerful industrialized economies capable of producing sophisticated products that were sold in Western markets.

East Asian societies achieved this success through what many viewed as a neoliberal strategy: Rather than insulate themselves from the global economy, they integrated deeply into world markets.

(though it should be underlined that there are alternative readings of the East Asian countries’ success).

A severe economic crisis in the early 1980s forced governments to embark

on reform IMF and World Bank encouraged reform based on the neoliberal model.

Emerging Problems with ISIEmerging Problems with ISI

Persistent deficits because of heavy government involvement

State-owned enterprises never became profitable- deficits

Domestic politics aggravated budget deficits

Government subsidies for essential items such as electricty, water transportation, telephone service and food. This was made possible only by using government revenues to cover the difference between the true cost and the price charged.

Emerging Problems with ISIEmerging Problems with ISI

Current account deficits (a country is importing more than it is exporting)

Demand for capital goods and inputs (an ironic byproduct of ISI)

Exports declined: non-competitive manufacturing industry and weakened agricultural sector (due to heavy taxation).

Overvalued exchange rates: An exchange rate is overvalued when it

implies that the currency is stronger(worth more) than it is according to a long-run market-determined rate.

For example, if a government sets its exchange rate as 20 shillings/dollar but the market rate is 40 shillings/dollar, then the currency is overvalued.

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

Because foreign goods are underpriced in the domestic market, capital goods and intermediate inputs could be acquired from abroad at a lower cost than they could be produced at home.

This difference in price created a strong incentive to import, rather than creating the capacity to produce the goods locally.

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

Furthermore, domestic politics made it difficult for governments to implement far-reaching reforms to remove the imbalances

Rent-seeking environment (efforts by private actors to use the political system to achieve a higher than market return on economic activity).

The East Asian ModelThe East Asian Model

Hong Kong, Singapore, South Korea, Taiwan outperformed other developing countries

Rate of per capita growthManufacturing growth rapidExports grew rapidlyExport-oriented strategy (importance of manufacturing

grew-agriculture diminished)Experts disagree on whether to emphasize the role of the

state or the market in explaining the success of East Asian economies

IMF/World Bank interpretation (market-friendly policies) versus state-oriented interpretation

The IMF and the World Bank contend that East Asia’s economic success derived from their adoption of a neoliberal approach to development.

Most East Asian governments adopted ISI strategies in the immediate postwar period.

Unlike governments in Latin America and Africa, however East Asian governments shifted to export-oriented strategies once they had exhausted the gains from easy ISI.

Thus the East Asian governments followed easy

ISI by encouraging the manufacturing industries they had created under ISI to export to the advanced industrialized countries.

The shift to export-oriented strategies was followed by selective import liberalization. Asian governments did not engage in wholesale import liberalization.

The Taiwanese and South Korean governments continued to rely heavily on tariff and non-tariff barrier greater than 30 percent, and as late as 1980 more than 40 percent of imports faced protection greater than 30 percent.

However, selective liberalization helped promote exports by reducing the cost of critical inputs.

By reducing tariffs on key intermediate goods, such as looms and yarn in textile industry, domestic producers were able to acquire inputs at world prices.

This kept exports competitive in international markets.

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

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

Other scholars argued that East Asia’s succesful pursuit of an export-oriented development strategy had less to do with allowing markets to work and much more to do with well-designed government industrial policies.

East Asian model of development, economic development is conceptualized as a series of distinct stages of industrialization. Government intervention at each stage is aimed at identifying and promoting specific industries that are likely to be profitable in the face of international competition.

First Stage: Industrial policy promotes labour-intensive light industry, such as textiles and other consumer durables.

Second Stage: Industrial policy emphasizes heavy industries such as steel, shipbuilding, and synthetic fibers.

Third Stage: Governments target skill and research and development (R&D) intensive consumer durables and industrial machinery, such as machine tools, semiconductors, computers, telecommunication equipment, robotics and biotechnology.

Governments design policies and organizations to promote the transition from one stage to the other.

In the East Asian model of development therefore, government policy derive industrialization from initial low skilled, labour-intensive production to capital-intensive forms of production and from there to industries that rely on high-skilled labour and R&D.

Each stage is associated with particular types of government policies.

Structural Adjustment and Structural Adjustment and the Politics of Reformthe Politics of ReformEconomic crises of 1980s IMFStructural Adjustment ProgramsPrivatizationExpectation: reduce average incomes and redistribute

income across groups, with faster growth and higher average incomes in the long run.

Economic costs triggered a realignment of interests, discrediting groups associated with the old regime.

New political consensus for new strategy to be adopted.Estimates suggest that growth rates in 1980s and 1990s

were higher than what would have been the case if reforms had not been implemented.

Developing Countries and Developing Countries and the WTOthe WTODeveloping countries have a comparative advantage in

agriculture and textiles but face obstacles from advanced countries.

3 aspects of advanced industrialized country policies make it difficult for developing countries to capitalize on this advantage.

Tariffs, agricultural subsidies especially on agriculture

tariff escalation: practice of imposing higher tariffs on goods whose production involves more processing- makes it difficult for developing countries to export processed food to the industrialized countries.

Unprocessed agricultural commodities face the lowest tariffs, fully processed face still higher tariffs. Such a structure makes it difficult for developing countries to move into the higher segments of the food industry.

protectionism in textile and apparel industries

Manufactured goods exported from the developing world face tariffs that are four times higher than the tariffs applied to exports from other advanced industrialized countries.

Introduction of notion of core labor standards in WTO

The discrepancy arises solely from the commodity composition of exports in the two regions.

Developing countries produce and export goods that compete with import-competing sectors in the advanced industrialized world, and the industries in these sectors have been succesful at maintaining protection.

The gains that developing countries could realize from the elimination of trade barriers are substantial.

Analysis leading to the Doha Round- eliminating existing barriers to developing countries could yield as much as 500$ billion in additional income to developing countries over a ten year period.

If developing countries stand to gain so substantially from Doha Round why then G20 governments been reluctant to conclude an agreement?

Perhaps G20 governments see no benefits in the offer on table, and the US and the EU are unable to offer a better deal.

Perhaps the offer on table does provide benefits but G20 governments would like to extract more if possible.

Documents

Trade and Development: ISI and Economic Reform Oatley, Chapters 6 and 7