LESSON 27: TRADE POLICIES-ECONOMIC DEVELOPMENT

Structure:
27.1 27.2 27.3 27.4 27.5 Introduction Importance of Foreign Trade Trade strategies Effects of Foreign Trade Favourable effects of foreign trade

27.5.1 Speeds up the process of economic development 27.5.2 Provides necessary infrastructure 27.5.3 Widens the extent of the market 27.5.4 Provides great educative effect 27.5.5 Encourages the inflow of capital 27.5.6 Brings efficiency in production 27.5.7 Other Effects 27.6 Unfavourable effects

27.6.1 Slow and lopsided development

27.6.2 Adverse effects on capital formation 27.6.3 Deterioration in terms of trade 27.7 27.8 27.9 Summary Check your Progress Key Concepts

27.10 Self-Assessment Questions 27.11 Answers to check your progress 27.12 Suggested Readings

Objectives:
After studying this lesson, you will be able to understand Meaning of Foreign Trade

Importance of Foreign Trade

Advantages and disadvantages of Foreign Trade

Impact of Trade policies on economic development

27.1 Introduction:

Dear students, the present chapter deals with the role of foreign trade in economic development. As you know that, foreign trade means the trade with the other economies in terms of exports and imports, because no country is self sufficient. Every country depends upon other countries for exports of some items and imports of others. This gives raise to international trade or international specialization. When country specialises in the production of those goods which it can produce cheaper and import those goods which others can produce at a lower cost, it gains from trade and there is increase in national income which helps to promote economic development. Now I think it is clear to you about the meaning of foreign trade and economic development concepts. Therefore, in this lesson an attempt is made to explain role of foreign trade in economic development. The role of foreign trade in economic development is considerable. The Classical and Neo-classical economists attached so much importance to foreign trade in countries development that they regarded it as an engine of growth. The opposite view is held by structuralist who argue that historically foreign trade has led to international inequality whereby the rich countries have become richer at the expense of the poorer countries.

27.2 Importance of foreign trade:

Foreign trade possesses is of great importance for development of an economy. It provides the urge to develop the knowledge and experience that makes development possible, and the means to accomplish it. Haberler Opines, My overall conclusion is that International trade has made a tremendous contribution to the development of less developed countries in the 19th and 20th centuries and can be expected to make an equally big contribution in the future and that substantial free trade with marginal, insubstantial corrections and deviations is the best policy from the point of view of economic development. In the words of Cairncross, Over the past century and a half, the growth of international trade has continued to open up new opportunities of specialization and development for the countries engaged init. These opportunities were particularly apparent in the primary producing countries overseas that were still in process of settlement, since trade enabled them to bring into use unexploited natural resources and freed them from the limitations of their own domestic markets. The international division

of labor that resulted simultaneously helped the importing countries to meet their expanding requirements of materials and food-stuffs from low cost sources of supply and afforded their export industries the double advantage of a large scale of operations at lower real cost and the further economies that normally accompany a rapid rate of industrial growth.

27.3 Trade Strategies:

Trade strategies can be broadly divided into two groups: they are Inward Oriented Outward Oriented Strategies. Inward oriented strategy, trade and industrial incentives are biased in favor of production for the domestic market over that for export market. This can also called as the import substitution strategy. Outward Oriented Strategy, trade and industrial policies do not discriminate between production for the domestic market and for foreign market goods. This is called as export promotion strategy.

The inward oriented policies are characterized by high levels of protection, direct controls on imports and investments and overvalued exchange rates wheras discriminatory use of tariffs, quotas, tax and credit subsidies etc., is not in consonense with the spirit of purest form of outward oriented strategy. It may be mentioned here, however, that outward oriented strategy does not necessarily imply less government intervention. As pointed out by the World Development Report, some countries have pursued outward orientation by offsetting some of the anti-export bias of important barriers; they have promoted exports by dismantling import barriers only slowly. However, it should be noted that the small countries and their model of development is not suited to big countries and in their case foreign trade has not

contributed much in their economic development. Therefore, some economists have strongly criticized their theories which seek to establish positive relationship between international trade and economic development. There are economists who hold the view that foreign trade hinders the development of underdeveloped countries. Historically, it has resulted in the exploitation of the poor countries by the rich countries. It is, therefore, contended that it would be in the interest of under-developed countries to forego the gains arising from international specialization and follow the policy of import substitution and deliberate industrialization for the economic development of their economies. We now discuss how foreign trade helps or hinders economic development.

27.4 Effects of foreign trade: Foreign trade will have two types of effects, they
are: Favorable Effects Unfavorable Effects.

Among the favorable effects, some of the important of them are: speeds up the process of economic development provides necessary infrastructure widens the extent of the market provides great educative effect encourages the inflow of capital brings efficiency in production

The following are some of the important unfavorable effects of foreign trade: slow and lopsided development adverse effects on capital formation deterioration in terms of trade Let us have a in-depth analysis of the above stated favorable and unfavorable effects of foreign trade on economic development.

27.5

Favorable Effects:

Some of the important favorable effects of foreign trade are as follows:

27.5.1 Speeds up the process of economic development

It encourages the setting up of basic and key industries such as iron and steel industry, heavy electricals and engineering goods industries. Such industries require the imports of plant, machinery equipment and other appliances as they cannot be produced at home in the initial stages of economic development. Such imports which help to expand the productive capacity of the economy are termed as developmental imports. A developing country needs both developmental and maintenance imports for promoting economic development. At the same time to pay for the imports, exports must also increase proportionately. Exports must match the imports failing which the pace of economic development will slow down. Thus both imports and exports are essential for the economic development of a country.

27.5.2

Provides necessary infrastructure

The under developed countries generally exchange food-stuffs and rawmaterials which have low growth potential against machinery and capital goods which have

high growth potential. This quickens the pace of economic development by providing social and economic overheads and directly productive activites.

27.5.3 Widens the extent of the market

Foreign trade can help to break the vicious circle of poverty by widening the market, stimulating the inducement to invest and thereby raising the volume of saving and investment. Not only this, the expansion of the market results in various types of internal and external economies which lower the cost of production and widen the market still further. This makes the process of economic development cumulative in character.

27.5.4

Provides great educative effect

Foreign trade possesses an educative effect. Underdeveloped countries lack in critical skills, which are a greater hindrance to development than is the scarcity of capital goods. Foreign trade tends to overcome this weakness.

27.5.5 Encourages the inflow of capital

Foreign capital not only increases the level of income, output and employment but also helps to tide over balance of payments difficulties and inflationary pressures. It also bring with it entrepreneurship, managerial talents, technical known-how, skills and ideas which play a vital role in economic development. International trade thus serves as the vehicle for the international movements of capital and ideas.

27.5.6 Brings efficiency in production

Foreign trade creates remunerative markets for the agriculture produce and thereby helps to transform the subsistence sector into a commercial sector. It promotes greater

international and domestic equality by equalising factor prices, raising real incomes of trading countries and making efficient use of each nations and the worlds resources.

27.5.7 Other effects:

When a country specializes in the production of a few goods due to international trade and division of labor, it exports those commodities which it produces cheaper in exchange for what others can produce at a lower cost. It gains from trade and there is increase in national income which in turn raises the level of output through trade tends to break the vicious circle of poverty and promotes economic development. LDC is hampered by the small size of its domestic market which fails to absorb sufficient volume of output. This leads to low inducement to investment. The size of the market is also small because of low per capita income and of purchasing power. International trade widens the market and increases the inducement to invest income and saving through more efficient resources allocation. Moreover, many under developed countries specialize in the production of one or two staple commodities. If efforts are made to export them, they tend to widen the market. Thus existing resources are employed more productively and the resources allocation becomes more efficient with given production functions. As a result, unemployment and under employment are reduced; domestic saving and investment increase; there is a larger inflow of factor inputs into the expanding export sector; and greater backward and forward linkages with other sectors of economy. This is known as the staple theory of economic growth, associated with Watkins. Foreign trade also helps to transform the subsistence sector into the monetized sector by providing markets for farm produce and raises the income and the standard of living of the peasantry. The expansion of the market leads to a number of internal and external economies, and hence, to reduction in cost of production. These are the direct or static gains from international trade.

27.6 Unfavorable effects:

Some of the important unfavorable effects of foreign trade are mentioned below:

27.6.1 Slow and lopsided development

Foreign capital was mostly employed in extractive industries producing raw-materials and primary products for manufacturing industries established in the countries of foreign investors. This led to the exploitation of the exhaustable mineral and natural resources of the capital importing countries and it prevented the growth and development of their economies.

27.6.2 Adverse effects on capital formation

It is contended that international trade adversely affects the rate of saving in the poor countries through international demonstration effect. International trade causes awareness of the superior consumption patterns of rich countries. Therefore, it effects the capital formation in the country.

27.6.3 Deterioration in terms of trade

It is maintained by certain economists like Raul Prebish and HW Singar that there has been secular deterioration in the terms of trade of the less developed countries and consequently gains from international trade have gone more to rich countries at the cost of poor countries.

To overcome the various problems and difficulties in the foreign trade attempts have been made in recent years for promoting regional economic cooperation among the developing countries. This enables them to overcome constraint of a small size of domestic market from which these countries suffer and helps them to rep advantages of the economies of large scale production. Later these countries can explore the possibilities of coordinated industrial planning by abolishing trade barriers amongst themselves. However, it requires political will to sacrifice national self-interest and subordinate political considerations to the promotion of common economic interests.

27.7 Summary
Therefore, foreign trade, in addition to the static gains resulting from efficient resource allocation with given production functions, powerfully contributed in four ways indicated above, by transforming existing production functions and pushing upwards and outwards. Important advantages are; speeds up the process of economic development, provides necessary infrastructure, widens the extent of the market , provides great educative effect, encourages the inflow of capital, brings efficiency in production. And important disadvantages are; slow and lopsided development, adverse effects on capital formation, deterioration in terms of trade. Therefore, foreign trade may either promote or hinder economic development depending upon specific situation. 27.8 Check your Progress

State whether the statements are True or False: 1. Foreign trade means trade other economies 2. Neo-classicals viewed that the foreign trade as an engine of growth 3. Out-ward oriented strategy is one of the development strategy 4. Educative Effect is one of the unfavorable effect of trade 5. Deterioration of terms of trade is one of the unfavorable effect of trade 27.9 Key Concepts

Foreign trade : Foreign trade means the trade with the other economies in terms of exports and imports, because no country is self sufficient.

Economic development : It refers to the development of all sectors such as primary, secondary and Tertiary sectors. Inward oriented strategy : Inward oriented strategy, trade and industrial incentives are biased in favor of production for the domestic market over that for export market. This can also called as the import substitution strategy. Outward oriented strategy: Outward Oriented Strategy, trade and industrial policies do not discriminate between production for the domestic market and for foreign market goods. This is called as export promotion strategy. Import substitution strategy : Import Oriented Strategy can also called as the import substitution strategy Export promotion strategy : : Outward Oriented Strategy can also called as the Export Promotion substitution strategy Educative effect : Foreign trade possesses an educative effect. Underdeveloped

countries lack in critical skills, which are a greater hindrance to development than is the scarcity of capital goods. Foreign trade tends to overcome this weakness. Subsistence sector : Agriculture sector in general identified with subsistence sector because people in this sector avail the earnings at low level. Capital formation ; it is essential component for economic development. Therefore by mobilizing savings from household, public and private sectors capital can be mobilized. It is known as capital formation.

Terms of trade: Trade with foreign economies should follow certain terms related to trade. They are categorized as single factor and two factor terms of trade. Regional economic cooperation: Co-operation among different economies in terms of exports and imports is must for their development. 27.10 Self-Assessment Questions Short Answer Questions 1. Distinguish the inward oriented and outward oriented strategies? 2 What do you mean by foreign trade? 3 What are the determinants of exports and imports? 4 Enlist the favorable and unfavorable effects of foreign trade? Long Answer Questions 1. Is foreign trade a help or a hindrance to economic development? 2 Do you think that there is conflict between growth and trade-Discuss 3. Explain how free trade maximizes the gains from trade? 4. Foreign trade and not aid should be stressed in a growing economy. Discuss 5. For financing economic development trade is to be preferred to aid. Discuss 6. Examine the contribution of Indias foreign trade to her economic development. 7. Write a critical note on: Export vs. import-led strategy of economic growth.

27.11 Answers to check your progress 1. True 2. True 3. False 4. False 5 True 27.12 Suggested Readings Kindleberger C.P., Meier G.M. Taneja & Myer Jhingan M L Economic development Economic development Economics of Development and planning The Economics of Development and planning