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INTERNATIONAL MEASURES FOR ECONOMIC DEVELOPMENT

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INTERNATIONAL MEASURES FOR ECONOMIC DEVELOPMENT

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61
oreign Tr Foreign Trade and Dev Economic De velopment
INTRODUCTION
The role of foreign trade in economic development is considerable. The classical and neoclassical economists attached so much importance to international trade in a counrys development that they regarded it as an engine of growth. The opposite view holds that historically foreign trade has led to international inequality whereby the rich countries have become richer at the expense of the poor countries. It is, therefore, contended that even if LDCs are required to sacrifice the gains from international specialisation, they can attain a higher rate of development by following the policies of import substitution. We shall first discuss how international trade helps economic development and then the opposite view as to how far it has inhibited the development of LDCs.

IMPORTANCE OF FOREIGN TRADE

Foreign trade possesses great importance for LDCs. It provides the urge to develop the knowledge and experience that make development possible, and the means to accomplish it. Haberler opines, My overall conclusion is that international trade has made a tremendous contribution

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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.1 DIRECT BENEFITS When a country specialises in the production of a few goods due to international trade and division of labour, 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 and the growth rate of economy. Thus, the higher level of output through trade tends to break the vicious circle of poverty and promotes economic development. An 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 savings through more efficient resource allocations. Myint2 has applied Smiths vent for surplus theory to the LDCs for measuring the effects of gain from international trade. The introduction of foreign trade opens the possibility of a vent for suplus (or potential surplus) in the primary producing LDCs. Since land and labour are underutilised in the traditional subsistence sector in such a country, its opening up to foreign trade provides larger opportunities to produce more primary products for export. It can produce a surplus of primary products in exchange for import of FIG. 1 manufactured products which it cannot itself produce. Thus, it benefits from international trade. The vent for surplus theory, as applied to an LDC, is explained in Fig. 1. Before trade with under-utilised resources, the country is producing and consuming OX1 of primary products and X1E of manufactured products at point E inside the production possibility curve AB. With the opening up of foreign trade, the production point shifts from E to D on the production possibility curve AB. Now the utilisation of formerly underutilised land and labour enables the country to increase its production of primary exportables from OX1 to OX2 without any sacrifice in the production of other goods and services. Given the international terms of trade line PP1, the country exchanges ED (= X1X2) more of primary exportables against EC larger manufactured importables. Moreover, many under-developed countries specialise in the production of one or two staple commodities. If efforts are made to export them, they tend to widen the market. The existing resources are employed more productively and the resources allocation becomes more efficient
1. G. Haberler, International Trade and Economic Development, 1959. Italics mine. 2. H. Myint, The Classical Theory of Intenational Trade and the Under-developed Countries, E.J., June, 1958.

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with given production functions. As a result, unemployment and under-employment are reduced; domestic savings 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 the economy. This is known as the staple theory of economic growth, associated with Watkins.3 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 standards 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. INDIRECT BENEFITS Besides, there are indirect dynamic benefits of a high order from foreign trade, as pointed out by Mill. By enlarging the size of the market and the scope of specialisation, international trade makes a greater use of machinery, encourages inventions and innovations, raises labour productivity, lowers costs and leads to economic development. Moreover, foreign trade acquaints people with new products, tempts and goads them to work harder to save and accumulate capital for the satisfaction of their new wants. It also leads to the importation of foreign capital and instills new ideas, technical know-how, skills, managerial talents and entrepreneurship. Lastly, it fosters healthy competition and checks inefficient monopolies. Let us study these indirect benefits of foreign trade to under-developed countries in detail. 1. Import of Capital Goods Against Export of Staple Commodities. Foreign trade helps to exchange domestic goods having low growth potential for foreign goods with high growth potential. The staple commodities of under-developed countries are exchanged for machinery, capital goods, raw materials, and semi-finished products required for economic development. Being deficient in capital goods and materials, they are able to quicken the pace of development by importing them from developed countries, and establishing social and economic overheads and directly productive activities. Thus, larger exports enlarge the volume of imports of equipment that can be financed without endangering the balance of payments and the greater degree of freedom makes it easier to plan domestic investment for development. 2. Important Educative Effects. Foreign trade possesses an educative effect. Under-developed countries lack in critical skills, which are a greater hindrance to development that is the scarcity of capital goods. Foreign trade tends to overcome this weakness. For, it is, in the words of Haberler, the means and vehicle for the dissemination of technical knowledge, the transmission of ideas, for the importation of know-how skills, managerial talents and entrepreneurship. The importation of ideas, skills and know-how is a great stimulus to technological progress in under-developed countries. It provides them with an opportunity to learn from the successes and failures of the advanced countries. Foreign trade helps in accelerating the development of poor countries by facilitating the selective borrowing of ideas, skills and know-how from the developed countries and adopting them in accordance with their factor endowments. Even the rapid development of the USA, Japan and Soviet Russia has been the result of the educative effect of foreign trade. 3. Basis for Importation of Foreign Capital. Foreign trade provides the basis for the importation of foreign capital in LDCs. If there were no foreign trade, foreign capital would not flow from
3. M.H. Watkins, The Staple Theory of Economic Growth, Canadian Journal of Economics and Political Science, May, 1963.

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the rich to the poor countries. The volume of foreign capital depends, among other factors, on the volume of trade. The larger the volume of trade, the greater will be the ease with which a country can pay back interest and principal. It is, however, much easier to get foreign capital for export-increasing industries than for import substitution and public utility industries. But from the point of view of the importing country, the use of foreign capital for import substitution, public utilities and manufacturing industries is more beneficial for accelerating development than merely for export promotion. Foreign capital not only helps in increasing employment, output and income but also smoothens the balance of payments and inflationary pressures. Further, it provides machines, equipments, know-how, skills, ideas, and trains native labour. 4. Checking of Inefficient Monopolies. Foreign trade benefits an LDC indirectly by fostering healthy competition and checking inefficient monopolies. Healthy competition is essential for the development of the export sector of such economies and for checking inefficient exploitative monopolies that are usually established on the grounds of infant industry protection. Conclusion. Thus foreign trade, in addition to the static gains resulting from efficient resource allocation with given production functions, powerfully contributes in four ways indicated above, by transforming existing production functions and pushing them upwards and outwards. ITS CRITICISMS The foregoing analysis, based as it is on the comparative cost doctrine, has been criticised by economists like Prebisch, Singer and Myrdal.4 They opine that historically international trade has retarded the development of LDCs. Three arguments are usually advanced in support of this view that international trade has impeded development. 1. Strong Backwash Effects. International trade has strong backwash effects on the LDCs, according to Myrdal. He writes, Trade operates (as a rule) with a fundamental bias in favour of the richer and progressive regions (and continues) and in disfavour of the less developed countries. Unhampered trade between two countries of which one is industrial and the other underdeveloped, strengthens the former and impoverishes the latter. The rich countries have a large base of manufacturing industries with strong spread effects. By exporting their industrial products at cheap rates to LDCs, they have priced out the small-scale industry and handicrafts of the latter. This has tended to convert the backward countries into the producers of primary products for exports. The demand for primary products being inelastic in the export market, they suffer from excessive price fluctuations. As a result, they are unable to take advantage of either a fall or a rise in the world prices of their exports. The importing countries take advantage of the cheapening of their products because of the inelastic market for their exports. Similar advantages follow when there is any technology improvement in their export production. When the world prices of their products rise, they are again unable to benefit from it. Increased export earnings lead to inflationary pressures, malallocation of investment expenditure and balance of payments difficulties when they are wasted in speculation, conspicuous consumption, real estate, foreign exchange holdings, etc. 2. Adverse Effect of International Demonstration Effect. It has been contended that the
4. R. Prebisch, The Economic Development of Latin America and its Principal Problems, 1950; H.W. Singer, The Distribution of Gains between Investing and Borrowing Countries, American Economic Review, May 1950; G. Myrdal, An International Economy, 1956.

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operation of the international demonstration effect through foreign trade has adversely affected capital formation in LDCs. 3. Secular Deterioration in Terms of Trade. In the opinion of Prebisch there has been a secular deterioration in the terms of trade of the LDCs. It implies that there has been an international transfer of income from the poor to the rich countries and that the gains from international trade have gone more to developed countries at the expense of the former, thereby, reducing their level of real income and hence capacity for development. OVERVIEW But all these criticisms are unfounded. There is no empirical evidence to prove that the development of the export sector has been at the expense of the domestic sector. Foreign trade has not always stood in the way of domestic investment. Nevertheless, as pointed out by Nurkse, even unsteady growth through foreign trade is surely better than no growth at all. The adverse effects of the demonstration effect are also exaggerated. Emulation of higher standards of living and superior consumer goods act as incentives to increased efforts and productivity on the part of the people of LDCs. It encourages the development of service occupations to supply superior goods. It also exercises a healthy influence in stimulating local initiative and enterprise. Again, the adoption of the Western consumption standards tends to influence the subsistence sector favourably. The incorporation of milk, eggs, vegetables, and fruits in diet induces agriculturists to produce them more for the market, in addition to subsistence production. It involves the investment of more capital and making improvements in agriculture, dairy and poultry production. This also provides increased employment, income and leads to further capital accumulation. The subsistence economy itself tends to be converted to an exchange economy gradually. The government is encouraged to provide more amenities in the form of improved means of transport, communications, irrigation, power etc. There is also a tendency on the part of the people to move from the villages to towns to seek jobs in those secondary and service occupations which produce the new consumer goods and services. Imitation of advanced production methods further helps in increasing the rate of capital accumulation in LDCs. Governments in such countries have encouraged the transmission of improved techniques like the L-D process of steel production, the introduction of high-yielding maize hybrids, and Mexican wheat, the Japanese method of rice cultivation, improved seeds and fertilizers, etc. It is, therefore, not wholly correct to say that international demonstration effect inhibits the propensity to save and the rate of capital formation in LDCs. In fact, by imitating the consumption and investment patterns of the advanced countries, they have been able to accelerate the pace of economic development. So far as the problem of deterioration in the terms of trade of the LDCs is concerned, it is conjectural and based on obsolete data. In the first instance, every LDC is dependent upon a very narrow range of export of primary products. Moreover, such countries produce only a part of the worlds total exports of minerals and agricultural products. Lastly, this view fails to take into account changes in the pattern of exports and imports of under-developed countries. LDCs are no longer exporters of primary products and importers of manufactures. According to GATT, they import only one-third of their total consumption of manufactured articles and even this proportion is on the decline. They produce the remaining two-thirds at home. Mostly they import capital goods, raw materials and foodstuffs. Manufactured consumer goods hardly form 10 per cent of their total imports. On the other hand, their exports consist of textiles, light engineering goods, machine tools, steel, and a variety of manufactured consumer goods. The

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reason for the deterioration in terms of trade of underdeveloped countries has not been the declining world demand for their primary products, but inflationary pressures leading to high costs and prices, and a large external deficit which acts as a drag on their exports. CONCLUSION Thus it is an erroneous view that international trade has operated as a mechanism of international inequality and has retarted the development of LDCs. Rather, foreign trade has acted as an engine of growth for them. Thus Cairncross is right in saying, Over the past century and a half the growth of international trade has continued to open up new opportunities of specialisation and development for the countries engaged in it. These opportunities were particularly in the primary producing countries overseas that were still in the 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.