Session 14Trade Policy for

Developing Country

Basic Characteristics of Developing Countries

Many developing countries have comparative advantagesbased on “land” (usually with a tropical climate) and in various resources in the ground.

Many developing countries also have comparative advantages based on “less-skilled labor”.

Four Basic Trade-policy Choices forDeveloping Countries

1. A trade policy that focus on the country’s comparative advantages in land and natural resources.

2. A trade policy that attempts to enhance the gain fromexport primary products by raising the world prices.

Developing Country(as an Exporter)

Larger Country

Small Country

?

?

Joining an international cartel can also achieve this.

3. A trade policy that taxes and restricts imports to protectand subsidize new industries serving the domestic market.

Developing Country

OtherCountries

Import

Restrict Subsidize

4. A trade policy that encourage the development of new industries whose product can be readily exported.

Developing Country

Other Countries

Import

Restrict Encourage

Export

This could be achieve in many ways.

These product are based on the country’s comparative advantages (i.e., products base on land and less-skill labor resources.)

Problems toward Trade Policy for Developing Country

1. Capital markets work less efficiently in developing countries.

2. Labor markets work less efficiently in developing countries.

How can businesses get the money ?

The Long-run Price of Primary Product

1. The price of primary product is depressed.

2. The price of primary product is raised.

1. The price of primary product is depressed.

1.1 Engel’s Law

The increasing in percentage of “income” in

developed country

The increasing in percentage of “expenditure ”

in developed country

<

The result is that the developing country need to reduce the price to cope with the reduced demand.

1.2 Synthetic Substitutes

People are likely to discover ways to replace minerals and other raw materials.

2. The price of primary product is raised.

2.1 Natural Limits

Nature’s scarcity eventually raises the price of primary products.

2.2 Slow productivity growth in the primary sector

The growth of supply increase lower than the demand.

International Cartel to Raise Primary-product Price

MR (with completion)

MCProfit with competition

MR (without completion)

Profit without competition

Impacts of Cartel1. Sagging Demand

The higher price will make buying countries look fornew ways to import the cartel’s products.

hybrid car

2. New competing supply

Buying countries will accelerate the search for additionalsupply in non-cartel country.

Buying Country

CartelCountries

Non-cartelCountries

3. Declining Market share

Price Quantity

For example, “Ecuador withdrew on December 31, 1992 because it was unwilling or unable to pay a $2 million membership fee and felt that it needed to produce more oil than it was allowed to under the OPEC quota”

4. Cheating

Some cartel countries could cheat on the agreement (i.e., selling product over the agreed quota).

Import-substitution Industrialization (ISI)The way in which developing countries shift their production toward developing new industries.

Skilled laborUnskilled labor

As a result, developing countries will be more independent.

Challenges toward ISI

The infant industry argument

The government budget argument

The terms of trade effects

Lack of market information

Rationales for the Success of Export to Industrial Countries

Developing countries have been able to become exporters in standardized manufacturing lines where technological progress has cooled down, such as textiles, tires, and etc.

Developing countries have become locations for low-cost assembly technologically advanced products.