CHAPTER 8B
Trade Theory & Development
Introduction
Impact of international trade is one of the most controversial issues in development economics
-Theory has until recently emphasized gains
-Now new models stress potential losses
- In the end, the issue is an empirical question
Anti-globalization critics are often not opposed to trade; rather they are opposed to some of the
international rules that govern trade, and many suggest that there is not enough trade.
Two Lectures
*Lecture 8B: stylized facts, assumptions, and conclusions of neoclassical trade theory *Lecture 12B:
trade policy; various strategies, empirical controversies on the trade/growth and trade/inequality
debate.
Lecture Outline
Introduction
I‐Stylized facts
A‐Trade patterns of developing countries
B‐Trade experience of developing countries
II‐Theory of international trade
A‐Comparative advantage
B‐Neoclassical factor endowment trade theory
C‐Criticisms of traditional free‐trade theory in the context of developing countries
D‐What explains that a country become a globalizer or non-globalizer: What determines how much a
country trades?
Conclusion: pessimism and optimism
Stylized Facts
A-Trade Patterns of Developing Countries
As a fraction of total world trade, trade involving developing countries trade is small: roughly
17% in 1990 (up from 7% in 1970) overwhelmingly dominated by Asia
1-Developing Countries do little trade
A-Trade patterns of Developing Countries
2- Marginalization of the poorest countries (LDCs)
Whereas the other developing countries make their way to globalization; thanks to a
breakthrough in manufacturing exports, which itself is the most dynamic sector of the world
merchandize trade, the LDCs are trapped at the bottom level.
3-Poorest Countries mainly produce and export commodities while richer countries mainly
produce and export manufactured goods.
4-Mono-Product dependency (typically primary products) is common.
5-Share of Agricultural products is declining in world trade.
I-Stylized Facts
B-Trade Experience of Developing Countries
1-New feature of the third wave of globalization (since the 1980s): large developing
countries chose to open up to foreign trade.
2-Globalizers appear to out perform both developed countries and non-globalizers.
3-Increased trade does not seem to affect the distribution of income on average (y hat) but a
lot of variation across country.
Pause
This gives us some preliminary evidence on the potential effects of trade
-International trade appears to be an important stimulus to rapid economic growth for the
post-1980s globalizers
-Increased trade does not seem to be significantly associated with within country change
in distribution: variation is however large.
Questions Remain
What explains that a country becomes a globalizer or non-globalizer: what determines how
much a country trades?
-Is it a choice (policy-induced)?
-Is it predetermined: geography? Size? Other preconditions for effectiveness of trade
policy?
Theory of International Trade
II-Theory of International Trade
A-Comparative Advantage (Ricardo)
1-Basic Insights.
Two countries:
-Labor(L) is the only input
-Each country has 600 units of labor
-two products, computers (manufacturing) and rice (agriculture)
Matrix shows how many hours of work it takes to make one unit of each
Country/Region
Computers
Rice
North
10
15
South
40
20
In case of no trade (=autarky)
Country/Region
Computers
Rice
Ratio of prices: Computers/Rice
North
10
15
10/15 = 2/3
South
40
20
40/20 = 2
Suppose that trade can occur and for simplicity that the price of rice =1
Country/Region
Computers
Rice
North
10
15
South
40
20
The new price of computers will be somewhere between 2/3 and 2.
The actual price will depend on the total demand for computers and rice.
But trade will occur, and at least one country will specialize.
Case of the price of computers =1.5
Country/Region
Computers Rice
North
10
15
1 sack of rice =1.5. Computer buys
2.25 of rice
South
40
20
1 computer = 2 sacks of rice; buys
2/1.5= 4/3 computers
Full specialization: two countries are better off (North more than South)
Case of price of computers =2
Country/Region
Computers
Rice
North
10
15
1 sack of rice =1.5 computer; buys 3 sacks of
rice
South
40
10
1 computer = 2 sacks of rice; buys 2/2= 1
computer
In the South, people are indifferent between making rice and computers; and make both.
They are not better off- they are exactly the same as before (because demand for computers
was so high), except now they export computers and import rice.
2- Conclusion
-The gains from trade are not evenly shared.
-When each country specializes, both countries will be better off, but the extent to which
they are better off depends on the final price
-Gains are higher for country producing a good that is in most demand.
II-Theory of International Trade
B-Neoclassical Factor Endowment Trade Theory
1-Crucial Propositions
-Countries have different factor endowments of factors of production and similar
technology: given relative factor endowments, relative factor prices will differ: (labor (L) is
relatively cheap in labor-abundant countries).
-Proportion in which factors are used to produce different goods depends on their relative
prices: different factor intensity.
-Perfect Competition: production using the production function where relative production
(opportunity) costs (represented by the slope of the tangent to the production possibility
frontier) are just equal to relative prices.