Import
PAT24
lnlernatl:na] Economics- 1 5th Edition 39i9,:
Chapter 13 Tr,rrie rrnd rlle Enr-rronncrrr :1Jrl
polluting process (e.g." foreign steel) or by taxing exports of products that generate pollution when consumed 1e.g., gasoline),
The rest of the chapter takes up discussion of each of three fypes of sources of externai costs noted in Figure 13.3. First rve look at issues when the external costs are ones we impose on ourseives-domestic pollution and similar national eKternalities. Then we analyze cases in which the activity of another country irnposes an external cost on our corlntly-transborde| pollution and simriar cross-country externalities. F'inally. we examine the challenges of global external costs-giobal pollution and similar rvorldwide externalities.
f" iq'+ $ il Fa f'* i3 f,} * *;? H S"ni { F* g- L L* "g' f i; fu Economic activities so;netimes produce significant arnounts of drtffiesti{: pollution (or sin"riiar ent'ironmentai degradation). That is, the costs of the pollution f-all only (or alnrost completely) on people within the country. If'there ure no policies that.fbrt:e nurket rlecision-nwkers tts internalsa these external costs" then we reach two surpris- ing conclusions about trade with domestic pollution. First,.free trude cun rechtce the wetl-being of'the t:ountt1,: Second the countt"l' cat entl up exporting the wrutng prod- ttr:fs: it exports products thatit shouid import, for insiance.
To see this. consider fhe case of an induslry whose production activify creates sub- stantial pollution in the local rivers. lakes. and *{roundrvater. For instance" consider the paper-rnaking industry in a country like Canada. It is very convenient lblpaper com- panies to dutnp their chemical wastes into the local lakes, and the firms vi"ew this as a fi'ee activifv iif the Canadian governrnent has no policy limiting this kind of pollution). The Canadian companies are happy that the lakes are there, and the firms'operations thrive, producing profits, good incornes fbr their workers. and good products for their' custolrers at reasonable prices.
Othel Canadians have a different view olcorirse. Having the lakes 1lrn brcwn with chemical \vaste spoils the scenery the srvimrning, the fishing" and other services that tliey get frorn their lakes. The dumping of rvastes into the lakes imposes an external cost on other users ofthe lakes.
The top haif of Figure 13.4 shou's the Canadian market for paper, with the dontes* tic supply curve reflecting the private marginal cost ol production and ttre domestic demand curve reflecting the private marginal benefits of paper consumption (which are also the sccial ntarginal benefits if there are no external benefits). The bottom half of'Figure 13.4 shows the additicnal costs imposed on the country by tire pollution that results fi'otn producrion of paper in the country. We keep track of this legative externality using the niarginal external costs (MEC) ol the pollution. (This ligure is the analo-* of Figure 10.2, which showed tlre case of external benefits.l 'lo keep thc: analysis sinrple. \\.e assume that the exlernal cost of the pollution is constant af $0.30 per ream ofpaper.
trVirh n* irilernarional trade (and na goyernment policies iinriting pollufion), the papc'r rttarket clears at a pdce of $1 per reanr, lvith 2 bilfion reams produced and consumed per vear. Because there is no recognition in the market of the cost of the pollution. this is overproducion of paper.
310 lnternational Economlcs -Vol, l
i', Part Two Tratlc t'rii,-t
,-;i:i.;ii:: .r i,'l When Domestic protluction Causes Domestic pollution
1.10 1.OO
Marginal external costs from domesti{ production
0.30
0
Quantity j..'] ]..]: l :]::. .. \
lnternational Economics, I 5th Edition 311
Chapter 13 fiirJe rinJ rlr Enlironnrerrr .:lr:l
Consider the shift to free frade, with an international price of Sl.l0 per ream {and sti1l no government policies iimiting pollution). Don:estic production expands to 2.3 billion teams. domestic consumption declines to 1.8 biiiion. and 0.5 billion rean.ls are exported. For the case shown in Figure i3.4, free trade unfbrtunaiely makes the cormtrY rvorse otT. f'he usual gain from trade is shown by the shaded triangle ir in the upper graph, a gain of $25 rnillion. But the extra production brings pollution that has an extra cost of tlre shaded arca h in the lower graph" an externai cost of S90 nrillion {S0.30 per reant on the additional 300 miiijon rearns produced). Free trade reduces the well-berng of the country by $65 million.
The country's gorrernrnent could avoid this loss by prohibiting expc|l1s of paper. But we know from the specificity rule that this is not the best govermrent polic1.. The best policy attacks pollution directly, fbr instance, b1, piacing a tax on pollution from paper production. If there is no way lo reduce pollution per ream producecl thet the tax should add S0.30 per reanl to the firrns'cost of production, Tire tax forces the firms to recognize the cosl of pollution, and it alters their behavior. l-he domestic suppiy shilts up by the amoltnt of the tax, to 5n + $0.30. This ner.v suppiy curve now reflects allsocial costs, both the prtvate production costs and the external pollulion costs.
If this govemment policy is in place. what happens with free trade'J Donestic consuiners stiil buy 1.8 billiori reams of'paper, but ttow domeslic producers supply only 1.4 billion rearrs. As shou,tt. it is actually best lor the countrv to import paper. not export ii. Because the nerv supply curve irvith tiie S0.30 tax) includes the external ccst of pollrttion. we can read the efJ-ects of trade on the coiintr),'ti"on-r rhe top hali'of Frgure l3.4.withoutreferringtothebottomhalf.Weiindtheusuaitrjangleof gains fiom importing. the shaded tliangie e.
From this example 1ve see that pollution that imposes costs oltly on tlie local economy can still have a nta-ior i;npact on hor,v rve think about interrlational trade. With no goyerntltenr polic.v linititrg pollufion, the country can end up worse olf with .{ree l-rlrL'. :,rr-cl the trade pattern can be u/rong. }n the case of ,pollution caused by production that rve examined the coLrntry exported a product that it sliould instead imporl, (lf-, insteacl, the pollution cost is not so higli. then the problem is that the country exports too much.)a
The coLrnfry carl correct this type of distortion by using a poiici, that fbrces po11ut- ers to recogttize the extental cost ol'their pollutiori. In our papet exantple. the goyerrr* inent used a polh-rtion tax. bul instead it could establish propeffy rights. For instance^ people could be given the right to the rvater. Polluting firms then ntust pav the orvners lbr the right to poilute. Or a limited number of riglrts to pollute coulcl be created bv the government, so that firms need to buy these rights if they rvant to pol1ute.
If domestic fin-ns must pay the pollution tax (or pay tbr the right to pollLrte), the;r probabl-r' u,ili not be happy. The pollution tax raises their production costs. and tliey prorluce and seil iess. ltr addition. the-v face competition li'om inrports at the rvorld pr:ice of S1.10. Even if they accept the reason for the pollution tax, thev nray still c*mplain about the iniports. lf other countries do not impose a simiiar pollution
jlVl-r;rt ran h;rppen if polluircn is causecj by consurnption, rrot prorjirctioni lri tiris case the couni.y tends to consume ioo much of the prodirct, so the country could imporr a product tl-ral it should instead expori (o; at least, it irnpcrts too muclr cf the pro<luct).
312 lnternational Economics - Vol. i
Part Two Jl-ralr lllitrl
tax on their producers, then the donestic finns often complain fhat tlie impofs areunfair' They claim that the lack of foreign polluiion contiols is a fbrm of impilcit subsidy, 01'that the foreign rirms are engaged in ..eco-dumpi.g" uaseo on rax fbreigngo\.ernlnent poli cies,
what are rve to make of these complaints'? should the country impose collnter-vailing duties on iiuports fron a coLrnti;, wjrh different poffuiton petliciesl) I;ront fhenational perspecfive of the inrporring *u,rtry. the answer is genelariy ,o. Foreignproduction nlay create poilutioir in tlie foreign .o,,nrty" u,rt ,iri, has no irnpact on tlieitnporting countrv if the costs of this foreign pallution affectonly tbreigler.s. As withrnany other complaints-about r'rnfair exports, tie best policy fbr tle impiirting .o.,nr,lfts sin-rply to enjoir tlie.low-price impor:ts. Indeed, under tlie rules of the worlcl Tradeorganization. lax foreign pollution policies are not a legitirnate ieason ibr inposing countervaii ing duties.
Fron the perspective of the whole ivorki, it depends on wh}, the foreign polliltiorr policies are diflerent fiom tliose of the intporting corintrv. lt may be etllcient {br thefbreign country to have ciifTerent. and perhaps more lax, poliution policies. The poliu- lion caused by foreign production nlay not be so costll,, uarow* irr* foreign productio' itseif creates less polrution, because ihe tbreign enviiorurent i,
"rr ,*"n?0,;;fi#,;
or because foreigners place ress value on thelnvjronruent. .ln ou, prp.. e_rainpie. trreprocluction process or tire raw naterials used in foreign production nrav crcate lesspollution. or the foreign courltrv nrav have larger r,vater:r:*rour.*r of r"iJirri'i, ,rirfu, case the pollution is not,so clanraging because the foreign environineni has a lareer "assinriative capaciry.".orthe fbreign country may assig'a high value to p.oarrlig income tc purchase basic gootls beciuse its people ur. p-oo. unjor* therefbre willing to accept sorne extra poliution nrore rearlilv.
o' the other ha'd- the foreign co'nhJ may simply have policies rhat are too lax. From the point of view of the tbreign counfi'y ind tire $'or"td,ii unuld be better if ir hail tougher pollution policies. As a type of secor:d-best approach, impilrr limits by other countries can improve things. But these limits r.vill nL? mate'the inpor-ting country better o{f. even though theiz nright mise world well_being.
'l it si 1* 5 # {_;r ri i""! ia i1: * i": i- !.. i"i T" i # $,,.i
In the previous section we considered pollution that had costs only to the courlty doing the pollution. whiie rve reacheci iome surprising conclusitxs ab6ut fr-ee trade itt the absence of governrnent policies limiting poituuori, we aiso had a ready sol'rion. The governrnent sirould implenient some foim of poliry aOO.essing pollution rlat is occurring in its countt'y. If each country's government addresses its orvn local pollution problenrs. then each can enhattce its own narional well-being. lu the process, worlci ivell-being rs also raised.
Horvever, nlany types of pollution har.e fransborcler eiTects*efl-ects not jLrst on the country doing the poliutioli brii also on neigliboling countries. Exanples inclrrcle airpollution like particulates and sulfur dioxide that Jritts across national borders and water pollLition wiren the body of water (river or lake) is in twa or irlorc co'ntries.'i l''-:';-r:ilrr-.i'j'r,l r:lili.;1ii-;ltr4j5ggrnajorissr-iesfbrgoveillmentpoticiestgyarcipoliutiog.
lnternational Economics, I 5th Edition
Chapter 14 fr,tl: /)olicir.s f ;r Dcuclripnrg L--ouncric: ,:,;i i
2. Similarl.v, lahor nturkets v,tx* less ef/icientlv in tlevelopirzg crruntrie,r'. The wage gaps between expanding and deciining sectors are greater than in higher-inconre countries. The wider wage gaps are an indirect clue that some lalror is being kept lrom moving ro its most productive use.
These differences impiy some special tasks tbr the government of a developing country. There is a case for considedng rvhich sectors to protect or subsidize or give cheap loans to, if the government camot quickly eliminate the barriers tcl efficie nr capital and labor markets. Tire government must also decjde u'hether it is realistic to try to change the nation\ comparative advantage. for instance, by increasing its investntent in education and health care to expand the country's endowment of hu:nan skiils. The shift ftom central pianning to a market economy requires yet other policy decisions, as discussed in the box "special Challenges of Transition."
We now explore the altelnatives for trade policy for a developing country in the order that we presented thern for Ghana: focus on exporlrng prirnary products, ilse export taxes or international cattels to influence the r,vorld prices of these prirnary products, use import protection to develop new manufactiiring industries, or encour- agd the development of export-oriented new manufacturing indristries.
j.\ ili L:'i +t i; A- {} f\$ fi * Ft t$ ru r- # $ f, fi T ffi il i'\i t: S A # }e i P; L :" Fii ; i'!t AF?,\' FFE# il? # s;ff ffi S ?
It seems natural that developrng countries export primary products (agriculture, for'- estry, tuels. and minerals), and these are often- ealled tt'aditional ex.ports. The maior- ity of developing countries get half or mol'e of their export revenrles from primary products. Many developilrg countries have exports concentrated in one or a i'elv products like peh'oleutn, coffbe, cotton, gold. sugar, timirer, diauronds, and bauxite/ alurniuurn.
A recurring idea is that developing countries'growth is held back by relying on exports of prirnary products. In the 1950s, Raul Prebisch and others argued that devel- opittg countries are hurt by a downward trend {and instability) in primary-product prices. Intemational markets, ran the argument. distribute income unfairly. Since developing countries are net exporters of primary products, thev are trapped into declining incomes relative to incomes in the industrialized worid.:
Does the fear of falling prices sound reasonable'l Economic anaiysis shows that there are at least two major forces depressing. and at least two forces raising, the trenc{ in the prices of primaries relative to matrufactures.
The relative price of prirnary products is depressed by Engel's law and syntfietic subslil utes.
;Be care{ui not to assLrme, as many discussions inrply, that there is a tight link betlveen berng a de'veloping coLrnlry and bein,g an exporter of prirnary products, Overali, the clevelopinq conntries are oniy mcdr:raie rei exporters of primary products ancl import sigr-rificant amci.tnts of them frorn Nortlr Arnerica, Ausiraiia, and Ne$.r Zealand. An<j iheir comparative ach.,antage rn primary prociucts varies greaily. 5onre developing r:ountries ie.g., Saudi Arabia) export lnosily primary products, while others (e.g.,5oullr Kcrea) export -lirlost no prin-:ary prodr.rcls ancl are heavily dependent on inrporting thenr.
335,
335 , lnternational Economics - Vol. I
Part Two Tirrri.' /};licr
ln 1989, a ma5sive tr"ansition from central planning to market economies began in the forrnerly:ocialist countries of Centraj and Southeastern Eurcpe. With the breakup of the Soviet Union in 1991. the former Soviet Union countries joined this transition. This is the most drarnatic episode of econornic liberalization in history" What role have changing policies toward international trade played in th€ transition?
Prior to 1989-199i, central planning by each government directed the economies in these countries. National self-sufficiency was a policy goal. lmports were used tr: close gaps in the plan, and a state bureaucracy controlled exports and imporis. When trade was necessary, the countries favored lracie among thrmselves and strongly disccuraged trade with outside coun_ Uies. They tended to use bilaterai barter trade, with lists of exports and imparts for each pair of countries. The trade pattern had the Soviet Unron specializing in exporting oil and natu- ral g;rs (at prices well below v';orld prices) and other countries exporting inclustrial and farm products.
As the transition began, these countries had a legacy of poor decision-making under (entrai planning, including overdevelopment of heavy industries (like steel and defense), outdated technology, environmental problems, and little established trade with rnarket economies. They needed to remove state control of transac_ tions and undertake a major reorganization of production.
Transition involves accomplishing three chal_ lenging tasks: (l) shifting to competitive mar- kets anci market,deterrnined prices, with a new process of resource ailocation; (2) establishing private ownership. with privatization of state businesses; and {3) establishing a legal system. with contract laws and property rights. For suc- ress, the transition pro{ess must
, lmpue discipline an firms inherilerf from the era of centrai planning,
. Provide encouragernent for new firms that are not dependent cn the qcvernment.
Opening the econonry to 'nternat;onal
trade and direct investments lry foreign firms can be part of both the discipline {through the competition provided by' imports) and the encouragement (through access to new export markets ancJ to foreign te.hnology and know-howl.
Domestic and international refsrms usualiy advanced together in a transition country, and success requires a consistent combination of reforms. We can identify severai different groups of countries that pursued reforms in different v..,ays and at different speeds.
The Centrai €uropean countries (Czech Republic, HL,nqary, poland, Slovak Repubiic, ancl Slovenia), the Balti{ countries {Estonia, Latvia, and Lithuania), and the Southeastern European countries (Albania, Bosnia, Bulgaria, Croatia, Macedonia, l,/lontenegro, liomania, and Serbia) pursu_ed strong, rapid liberalizations {except for Bosnia, Serbia, and Montenegrr:, which were involved in fighting). As we discussed in Chapter 12, the Central European and gaitic countries joineci the European Union in 2004, and BulEaria and Romania joined in 2007.
The members of the Commonweaith of lnd*pendent States {ClS, the eountries that were formerly part of the Soviet Union, excluding the Baltic countries) have inste*d foliowed paths of less liberalization. Three countries, Belarus, Turkmenistan, and Uzbekistan" continue to resist enacting reforms. The other CIS counr tries {Armenia, Azerbaijan, Georgia, Kazakhstan, Kyrgyz Republic. Moldova, Russia, Tajikistan, and Ukraine) enacted partial refornrs that were adopted slowly over time and that sometimes were reversed.
How do trade pattrrns evolve during tran:i- tion? One pressure is clear, toward rapid growth of imports, especially consumer goods, based on pent-*p demand. Transiticn countries mus'i expori to pay for their rising imparts, and West€rn Europe and other industrialized coun- iries are crucial as majcr markets for expanding their exports. However, exporting to demand- ing customers in the competitive markets of the industrialized countries was not going to be easy. Under central planning these countries had rrrajor deficiencies in their products and br-rsinesses, includinq poor product quaiity, lack af marketing capabilities, and lack of trade f irlanc;ng.
HG\F/ suc(essful have the transition eountries been in recrienting their trade patterns? By 1998 the Central Iuropean, Saltic. and Eoutheastern European ccuntries on average were seiiing over 60 percent cf their exports to buyers in industri- alized countries. Rapid and deep liberalizations, along with favarable geographic location close to the markets of Western Europe, have facili- tated the shift by these countries ts a desirabie export pattern. They increased their exports of
\iqh\ man*iat\ure$ g()ads \ike tex\\\Eg, L\Qtfl'' ing, and iootvreat. They a\so ustd the\{ \oy,l-ios\ skitled iabat to expand export of surh products as vehicles and machinery.
ln eontrast, most CIS countries did not reorient their exports much. and on averag€ only about fi quarter af their exports went to industrialiaed {ountries in the [ate 1990s. Many Cl5 countries resisted trade liberalizaiions and continued to produce low-quality manufa{tureci products that could not be exported out:icje tfre region. A: oi early 2011, only five ClS coi..rntries had i:ecome members of the Worki Trade Organizatir:n.
Horv doeE all o{ thi! cornbine to determine the sLiccess of *concmic lransilian? One broad indicator is the grcwth or decline of domesiic
lnternational Economict 15th Edition 337
Chapter 14 Tr"iti. 1'r,lirrls i;r Ilrtrsiiit;ln,a (,-rrulrrits
prociuction ireal GDP). ln the beginning iransi- iion is likely to cause a recession, as bus!ness prac- tices and economic relationships are disrupted. Only alter reforms begin to rake hold tan the economy beEin to grow. This ilrocess is like that of the shi{t from no tracie to free international trade. As w'e sa\r beginning in Chapter 2, the gains f rom opening to trade are Lrased largeiy on disrupting previous patterns of production and consunrption activities.
The evidence indicates that the depth and speed of reforms matter for the sutcess af transi- tion. 1n addition, as with develcping countries generaily. vv€ see gr€ater success for those coun- tries adopting more cpen and outward-oriented trade policies.
The fast and deep reforn:er: in Central and Southeastern Europe suffered thraugh early- transiiion recessions that were not that de*p and not that long. The recessions in the Baltic countries were somewhat longer anci somewhat deeper. Then, starting beiween 199J and 1996. each of these col,ntries has generally had sr-lb- stantial and sustained growth.
The nine partiai-reform and less open ClS Luul rlr 1tj - rroh e't,' br ccrl t'p,::'crrf n rmpd- .th tr l^/.ll(i.
e\ef, ra{nFa{e{ rdRh tht \hree i\oNe\*\tft t\\ countries. Most partial-refarm Cl! countries experienced deep early-ttansitian recessions, and three (inciuding Russia) cjid n*t return to sustained growth until 1998 or later. They seemed to be caught in a trap in which spe- cial interests, oligarths, and insicers whc !:en- efit {rom the partia{ reforms gafn the politkal power to block or slow further reform. One advantage of speed in reform is that the reforms are enacted and the increased interr:ational trade and greater market competition impose discipiine and offer encouragement, before sucit special interest groups have time to coale5ce and exert their powtr.
338 lnternational Economics - Vol. 1
:::: Part Two Thrrir Polii:r
1. Engel| lavt. ln the long nln. per capita incomes risel As they rise, demand shifts toward luxuries-goods for which the income elasticity of detrand (percent rise in quantity demanded,,percent rise in income causing the change in der:rand; is greater than 1. At the same time, the world's demand shifts away ftom staples--goods tbr which the ircome elasticity of demand is less than 1 . The l gth-century German economist Ernst Engel (not Friedrich Engels) discovered u.&at has becone known as Engel's iaw: The income elasticity of dernand tbr food is less than i (i.e.. food is a staple). Engel's law is the most durable law in economics that does not follorr'fi'om definitions or axioms. lt means fl:ouble for food producers in a prospering world. if the world's supply expanded at the exact same rate for all products" the relative pnce of fbods wouid go olt dropping because Engel's law says that demand would keep shifting (relatively) away fiom tbod torvard luxuries.
2. S.vnthetic .guhstitutes. Another force depressing the relative prices of prinary products is the development of new human-made substitutes ior these natural materi- als. The more techlology advances, the nlor"e lve are likely to discover ways to replace trttirsrarb attu'ulrlcr taw *tolctia.ls. ?lht r?a-r-Jr+.Cr?r?ta"+i,+ g.?s'-,"3: ,rhg del'elclalfetft Af synthetic rubber around the time of
'World War I, which ruined the incomes of rubber
producers in Bmzii, Malaysia. and other countries. Another case is the clevelopment of synthetic ilbers. which have iowered dernand for cotton and rvool.
On the other hand, two other basic forces tend to raise the relative prices of primary plodr"rcts:
1. Nuturels lirnits. Primary products use lancl. water, mineral deposits. and other limited natural resoLlrces. As population anil incomes expan{ the natural inputs become increasingly scarce, other things being equal. Nature's scarcity eventLially raises the reiative price of primary products, which use natuml resoruces nrore inten- sivell' than do manufactures,
2. Relutivel)' s/ow prutdttr:tittir,vu growttlt irz the prifitory sector: For several centuries prodLrctivity has advanced more siowly in agriculture, mining, and other primar5r sectors than in manufacturing. A reason is the tendency for cost-cutting break- throughs in knowledge to be inore important in nanufacturing than in primaries. Slow productivity advance translates into a slorver reiative advance of supply cllrves in prirnary-product matkets than in ntanufacturing markets, and therefore a rising relative ptice of prirnaries (or a falling relative price of manutactures), other things being equal.
So we have two tendencies that depress the relative price of primary products, and we have trvo that raise it. Horv does the tug-of'-war rvork out in the long rrur? Figure 14.2 sunrmarizes the experience since 1900.
It depends on wher you look at the data and how far back into lristoly you 1cok. Studying Figure 14.2A, we can understand why the fbar of f'alling relative prirnary prices was greatest in the 1950s (when Prebisch's argument achievedpopularity) and the 1980s. Those were periods of f'allin-e prirnary prices. On the other han4 little was written about falling primary prices just before worid War I. the historical he3'day of high prices for farm producls and other raw materials. Nor was there inuch discr.rssion
340 lnternational Economics - Vol. 1
Part Two Titult j'oli*
of depressed pdces cluring world war II, the Korean \&hr of 1950,-1g53^ the troonr inprimary-product prices in the earl1, 1970s. or the rlrn,uf in'.on_,rnodiry prices durin-r:the mid- and late 2000s. Dur"ing ,,,.h ti,,',.r, many writer.s revived the Malthusian argu-ments about the linrits to planet Earth. To stand back frorn the,volatile swings in cornnroditv prices. let,s look over as long
a periorl as possible. For Figure 1+.2. irli can scan rire peririd :ga0-2a10, though fol-lorl'ing some price sedes back to 1870 ivouiri tell a siinilar story. For the rop panei. we also have to alrow fbr the vely rarge increar. in.n*.g1: pr.r.., silce r999. rvhich canses a divergence bet$een the relative price of all ptirri.y prodr-rcts and rhe rejati'cprice of nont-uel prir'ary producrs at the ind of the time p..iJo.
Figure 14,2 shows a fairry clear long-term trend. Fix the {'p paner, we can seethat the general trencl for ielative nnitu.l prinrary-proar.t pri.*u is ciownrvar<i. Statisticaily, if rve f-it the best trend line to the clata orier this entire tinre periocL rvefind that these prices are declining at about 0.8 perceirt f.t y.ut. (Fbr all irrinrarvproducts, including enegy fuers, the general trend is arso dorvnwarc1, but the spike since the laie 1990s pr-rlls the tlend line up somervhat. Statisticaily. the best trend iine shows a price clecline of about 0.5 percent per year.) soinehow. Engel.s law ancl the technological biases torvard replacing primary products huu. o,,trun nature's ljmits attd the relative slowness of productivity gro*in in primary sectors. (or. in shorthand. Prebisch olltran Malthus. )
Some commodities have declined in price nrore seriously than others. The price ofrttbber snapped downward benveen 1 9 1 0 and 1 920 and has never really bounced back since' The relative prices ol r.vool. cocoa. alunrinum. .i.r, .o1ton. and sugar declrned by more than half during the 20fh centur,v. In confrast. the relative p,ice, ot la1rb" timber, and beef more than doubled.
while the net dorvnward trend in primar,u- prices stands as a tentative conclusion" there are rwo biases in the avairabre rneasures. ilke ttrose preilnrJi; ii;; i;;."'
1 ' The .filll in lrunsport r:o,rLr. The available data tend to be gathered at nrarkets inthe indilstrial countrjes. Yet technological inrprovemenrs in trairsportation have beengreat eiiough to reduce the share of transport costs in those final prices in l,on6on. NervYork. orTok_v-o. That has lefr nrore and nrore of rrre firial pr.-!..i."1;;1.,* h;;: of the prirnary-product exporters. Quantifying ttris tnown ci,uig. ,"oul,t tilt the rrendi* the prices received bir producers torvard a flatt*r, iess downrvlrd fend.
2. Faster unutu.tured tpralit"v thange in rwnztfltr:ttLrar. We are usiug long runs ofprice data on prcducts tltat have been fetring betier or.er tiine. euatity improvemeilts(inclucling those in the form of'nerv products) are thought to have been more impres- sive in tnanufachtres (and services) tiran in primary proiucts. So lvhat might look like a rise in the relative price of manrfactures migtrt ue just u .ir* in their relitive quality, with no trend itt the relative price for given quality. This clata problenr is potentialll, serious. given that rnany 2Oth-century data have, ror r"ampt., lollowert the prices ol.nlachinery expofis per ton cf exports, as if a ton of today'rcornputers ivere the samething as a ton of old electric inotors.
when all is said and done, tlie telatir.'e price olprilnary products lrjay have cleclineci as muclr ils 0,8 percent a year since i900 (as in Figure t+.2}, uthere cor:lclhar.e bee'
:
lnternltisnalEclno-ml1s, tsth Edilion i = 3{1
Chapter 14 -TrLuh Poiicies 1n l)ct'clopirrg (-lolrnnres :lol i
alinost no trcnd. There is a weak case for wonying about being an exporter of agricul- fural or extractive products on price-trend grounds.
Ei*'i*,fiFi;:r"Y"i{.?f'J*.1i- {effi'g'ill,"ii "{{} fqiii1:fi f'ffigf*&.ffi.Y-$3#"*:irii:"T $rftii{"ili;
Perhaps the developing-country producers of primary products can take actions to turn the price trencls in their favor. Perhaps the primary-prodrtct exporters cait tlecoitre rnore powerlirl if tlrev coopetate rvitlt each other. ttsitrg, ol other types ot'concerted actiou.
The OPEC Victories History records nany atlernpts at in€rnational cafiels {internalional agreenletrts to restrict competition alnong sellers). The greatest seizure of :nonopoly power in r.r'crld hiStOry was the priCe-raising triurnph o1'the , ;,j ' " i:';':, ."i i','riis,a:lir::. t:::-.=t-',:{iit+ ""-*r.r*lriq:1 ii-iiri l. :r in i973-1974 and again in 1979-1980.
A chain of everrts in late 1973 revolurionized the rvorld oil economy. 1n a t'ew months' time" the 12 members of OPEC effectively quadmpled the dollar price of crurie oil. fi'om $2.59 to $11.65 a barrel. Oil-exporting countries became rich alruost or.ernight. The industrial oil-consuming conntries sank into theii deepcst recession silice tite 1930s. The reiative price of oil {what the price of a barrel oloil ccuid bu.v in terms of manufactured exports frorn inditstrial nations) {ripled.
The sequel was a plateau of OPEC prosperiry a ftlrther juntp, and tl'Lert grot'ittq signs of weakrress. Franr 1974 to 1978. the relative price of oii dipped by abotit a sixth. but stayed much higher than it had been at any time before 1973. Next came the set:onri wave oIOPEC price hikes. lhe secotid "oil shock," in 1979- 1980. Led by the lranian Revoiution and grorving panic among oi1 buyers, the relative oil price ntore than doubled. In the mid-1980s. however. OPEC weakened. The relative price of oii dropped sudcleniy in late 1985. ticxn lour to five times the o'ld (pre-1973; real price il 1980*198.1to less than firyo times the oid price fbr I9B6-1989.
The tale of oil and OPEC in the 1970s and l98ils is one of two dramatic cartel l'ictories and a subsequent retleat. The victories and the retreat both need explanalion.
First the victories. The oil sirocks of 1913-1974 and 1979-1980 g,ere not the result of a lailure olsuppl.v or exhaustion of earth's availabie resources. The u'orld'"s "proved reserves" of known and usable oil uere growi:rg faster than rvorld oil consumption. Nor u'ere tlie costs of oii extraction rising tnuch.
The 1973-l97zl and 1979 1980 oi1 price jurrps rvele human-rnade. The key rvas that rvorlcl demand was grou'ing iar laster than non-OIIEC supplies. Oil cliscoveries had been very Llneveltly distributed among countries. The share of OPE{I coun- tlies irr rvorld crude oii production rose to over 50 percelt by 1972. Furthertllore,
rCPEC r,'vas created by a treaty among frve countries- lran, lraq, Kttr;vait, Saudi AraLria, airC Verrezueia-- in lg60.siilcethdttime,tirefollorrirrgcountriesiravejciired: Qatarilgtil),Libya(1962), l..lnited,rrrab [*:ilate: ('1 967), /riqeria (1969), Nigeria {19}1}, and Angola (20t-]7). Ecuador jorlred irr 1973, rvithclrerv in 129?, ariC reloinecl in 21107. lrrctonesia joirrecl in i9ij2 and i,rrithcirew in 2009. Gal:on joined irr 1975 ;nC ,,vrthd;etv in 1995.
346 lnternational Economics - Vol. l
Part Two ?rrcie i'olr,^r
in late 2000. and then remained rather flat to the beginning of 2004. oil prices their climbecl' with a price spike in 2001*2008 that had a piak pr[e of over S lag per banel tn June 2008. with the recession that accompanied the gtlud filancial and econornic c::isis. oil prices collapsed to less than S40 per barrel in iooq. As global demancl began to increase again. oil prices rose rapidly, rnoving above $100 per barrel i1 earl;r 201L
So. is rhis the reemergence of OPECb monopoly power? only partly. tn the late t ggt.ls and early 2000s OPEC did attenrpt rvith some success to reduce its iroguction ro raise the pr:ice. However, much of,the price rise seems to reflect the br:oader dynamics of the indush"y, dynamics that are based on the competitive aspects ofthe market. Demand from China gr"ew r"apidly' with additronal strong slernand gror,vth in such other countries as India and the United States. Furlhermore, the years oirather low oilprices cliscoLragecl investment in new crude oil production capabilities, ieacling to tight supply and a lacliof spate production capacitv. As a result of the demand ingeases aia p,nAirction lirrrits, oil prices rose well above OPEC price targets in 2008 (and perhaps ugiin i,, 201 1). The big price rise in the mid- and late 2000s looks more like a boom pe*oA in a highly cyclicai industry than it looks like the planned exercise of market power by the cartet.
- -
Other Primary Products Do tlteory and OPEC experience hold out hope for developing counfries wanting to make Iarge national gains by joining cartels in other primary pioOicts tresicles oill, Not much. There are good reasons for believing that international cirtels u,ould collapse f'aster, with less interim profil for-the non-oil primary products. For agricultrual crops in particular, there is tire problem of competing supply other countdes usirally can ea.sii5, e,rpand the acreage lhev devote to a given crop.
Histor;' agrees with this verdict. Of the 72 comrnoclity cartels set up between the two u'orld rvars, only 2 survived past 1945. Of"the ferv dozen fet up in the 1970s" only 5 lived as late as 1985: cocoa. coffee, rubber, sugar, and tin. These 5 cartels have been so weak that they have had little effect on commodity rnarkets since 1985.
Given the limits of internationai cartelpower a developingnation coukl still tax its owtt prin:ary-product exports for the sake of econonric deveioprnent. In principle, the strategy could rvort well. A tax on exporls of Nigerian oil. Ghanaian cocoa, or Philippine coconuts could generate revenues for building schools. hospitals, and roads.
unfortunately, the political economy of some develbping counrries seems to divert tlte export-tax revenries an'ay from the most productivJuses (as we noted in Chapter l0 when discussing the deveioping government argunrent for inrport tar- iffs). So it has been with the three examples just irnaginecl. Nigeriat oil revelues are lost in a srvoilen governrnent bureaucracy and ravenous cornrption. For two decades Ghana's cocoa rnarketing board r-rsed its heavy taxation of iocoa f'armers to sup- port luxury imports by ofTiciais. The Marcos government distributed the philippine coconut-tax revenues among a handful of Marcos,s friends ancl relatives.
; i,.. i:'{:} $i T'= 5 * Li $T*TAi i I r* # ! r,$ a.} u " ?ffi t,e L gxeT$ {."} ru { $ 5 *} Exporting primary products is a way for many developing countries to use their comparative advantages based on land and natr.tral resources. But reliance on such
lnternational Economics, i 5th Edition
Chapter 14 I'rde i'olicir.r fi;r l)rue lofing (i;anrries -:i -i.J
traditional exports brings risks, including what appear 1o be slowiy declining relative prices of these products and exposure to the wide srvings in world prices, Perhaps sirifting the emphasis toward developing new industries. especially in manufactuljng, is better for countries that rvant to grow more rapidly. Atter all. most high-income countries have industri alized.
To develop. officials ftom rnany countries have argued they must cut their reliance on exporting primarS' products and must adopt governlnenl policies allowing industry to grow at the expense of the agricultural and mining sectors. Can thjs emphasis orr industrialization be justitied? If so^ should it be carried out by restricting imports of manufacalres?
The Creat Depression caused many countries tr: turn toward imp*rt-rxft:stitutit;13 i:r*r;lili;:iir;'!i;{}ir ti1li. In the early 1920s and again in the early 1930s, world prices of rnost primary products plunmeted. Although these price declines diel not prove that primary exporters were sufTering more than industrial countries. it was coltlmon to suspect that this was so. Several primary-product-exporting cor-rntries. arnong them Brazil and Australia. launched industrializatron at the expense of industrial irnports in the 1930s.
The ISI shategy gained additional prestige arnong newly independent nations in the 1950s and 1960s. This approach soon prevailed in most developing countries whose barriers against manufactured imports eame to match those of the most protectionist prewar industr:ializers. Though nlany countries have sr,vitched folvard more pro-tracle and export-oriented policies since the urid- 1960s, ISI remains an important policy for developing countries.
l5l at lts Best To see the merits and drawbacks of ISI, let ris begin by noting the four main arguments in its-fqvor. Lf ISI corrld be fine-turied to make the most of these arguments- it would
be a fine policy indeed.
1. Tlrc int'unt intlustry ut'Epnn€tlt lrom Chapter 10 returns, with its legitimate empha- sis on the economic and sociai side benefits fi'orn industrialization, These side benefits may include gains in technological knowledge and worker skil1s transcending the indi- vidual firm, new attitudes more conducive to growth, and national pride. As we saw in Chapter 10, the economist can imagine other tools more suitabie to each of these tasks thatr itnport barriers. But in an imperfect r.vodd these better options may not ire at hand, and protection for an infant modern-manufacturing sector could bring gains.
2. The tlet'eloping go"-ernrtet?t (trgzuilenr frorl Chapter 10lends further support to lSI. Suppose that tlie only rvay thal a govenlrrent can raise revenues for any kind of econonic developrnent is to tax imports and exports. Such taxation can bring gains to a natiou rvhose gor:erment cannot mobilize resources for heaith. edueration. and so on rvithout taxing trade. ISI is a by-product of such taxation of fbreign trade.
3. For a large coutltn. or a large organization of cou:rtries, replacing imports cati bring better {ent*-ttl-trude elfuct.r than expansion of export industries. Here we refurn to a therue sounderl first in the discussion of "ilmiserizing growth" in Chapter 7 and again during Chapter $'s discussion of the nationally optifiral tariff. Replacing irnports with domestic ptrduction rvill. il it has arry eflect at ali on the foreign price of the
348 lnternational Economics - Vol. I
: i:j Part Two Thule polit:t
continuing imports, tend to lorver these q.i.gl {excluding the tanff or orher irnport charge) and offbr the nation a better bargain. If you can a#ect the prices at wtricnlrou trade^ wouldn't ir be be.tter to expand your supply of import-competing indusfiies, fbrcing foreigners to sefi you the remaining r*port, at a lo*er price )
4 Replacing irnports of manufacfures is a way of using t].tecp nnc{ rttyyeniertt mtrrket inlbrmation A developing colrn{ry may rack the expJtise to jLrdge jusr lvtich of the thousands of heterogeneous indusirial goods it coutd best martet abroad. But government officials {and private industrialists) have ail easy way to f.ind which nrod- ern manufacfures would sell in their own markets. they need orily look at the iniport figures. Here is a handy menn of goods with proven nrarkets.
Experience with lSl History and recetlt economic strrdies offer lbur kinds of evidence on the merits of ISI. Castral historical evidence suggests a slightly charitable vier.l,. u,hile three kinds of -#f,ELlsd,ts*$,s
"\tplRqrJ 3 .fr.€'a.til'e ve,ul.ic.t in support' of ISI, it can be said that today's ieacling industrial countries protecfed
their industry against import competitian earlier. whe]r their growth was first accel- erating, The United States, for example, practiced ISI fiom ill. Ciuit War until the end of World War lI. r.vhen most American firms no longer needed protection againsr imports. Japan, in the 1950s, launched its clrive for leaJership in sieel. uutonrJbil*r, and eiectronics with hear,y govemment protection against impbrts. When these indus- tries lvere able to compete securely in world markets, Japan removed its redundant protection against imports into Japan.
Such a casuai reading of history is at least correct in its premise: Ihe industrializeel countries did at tirnes give import protection to industriei that became their export strengths. But it is wrong to infer that most cases of indush'ialprotection nutured iec- tors that responded with strong productivity gains, On the contrary. even Japan, like the United States and most other industrialized countries, gave its strongesr protecrion to sectors whose decline u'as long-lasting. ISI in the earlier history of these counh.ies may well have slorved down their economic growth. Most of the infant industries, ip other rvords. never grew up.
In contrast to the weaknesses of the evidence for ISI, fhe evidence against it takes three forms that in combination add up to a strong case. The first kind if t.*t casting serious doubt on the merits of ISI is the estimarion of its static e.ffbcts on natiani! n-ell-heing, using the rnethods introduced in Chapter 8. A series oi cletailed country sttldies quantified the rveitare eff'ects of a host of developing-counfry trade barrier:s in the 1960s and early I970s. many of which were designed to plomote industrialization. The barriers imposed significant costs on Argentina, chile. colombia, Egypt, Ghana. India. Israel. Mexico, Pakistan. the Philippines, Sonth Korea" Tairvan,lnd Turkey. Only in Malaysia did the import barriers bring a slight gain, here because of a favor- able terms-of-trade eff-ect.6
By thetnselves. these standard calcnlations of welfare costs of racie barriers are vulnerable to the charge ol assuming, not proving, that lsl is bad. such calcula_ tions assume that all the relevant efl'ects are captured by measures ol consurner and
'rSee Bela Balassa (1971), Jaqdish Bhagwati and Anne Krueger (1g73-1g76J, and A. Choksi et al. (1991).
lnternational Economics, lsth Edition
Chapter '14 Tririlt: Poiicies Jrn lic.uebping Cnalrries ;i:i:
producer surplus, without allowing protection any chance to lower cost cutves as it is imagined to do in the ini-ant industry case, It would be fair to demand firmer proof,
A second kind of test looks at what happens when a collntrv chutges it,s tracle- 1x;lic.t, orientution toward manuf-actures, away fi'om restricting irnports (ISi), and torvard charnpioning expofis. Here there \.vere two drarnatic early cases. Until the late 1950s, Taiwan used ISI but then switched to a policy that encouraged exports. It sulrse- quently achieved growth rates of about 10 percent pe r year. South Korea useci ISI until policy refcrnns in the early 1960s increased its incentives for exports and lowered its $Port barriers. Its growth rate incrcased to about l0 percent per year. Hong Kong and Singapore also used policies that encouraged exports and achieved high giowth iates. Other countdes have achieved substantial effects. In the case of Ghana. ihe ISI strat- egy was part of a larger heavy hand of government that turned early growth inta a 42 percent decline of Chana's living standards over the rlecade 1974*.1984. The country was saddled rvith costly industlial white elephants that never became efficient. Onlv after paltial reforms that included a partial liberalizatiol of trade policy dicl Ghana regain positive economic growth.
A third kind of test coftIputes growth nttes o.l' t:ottntries prat:tidng ISI with grov'th rctes o.l' t:i;rmtries using policies that ernphusize exporfi;lg. fhe iqgZ Wurltl Devekspnenl Reporl presented the resLrlts of the World Bank's sfudy ol'growtfu rates in 41 countries, which were piaced inio four categories accorrling to their irade pr:lic_v: strongly outward-oriented. ntoderately outward-oriented, moderately inwarcl-olientecl and strongly inward-ori:ented. Hong Kong, South Korea, and singapore foilorved strongly outward-oriented policies. with low trade barriers and some pse of e.\port subsidies. The strongly in'u,'ard-oriented countries used high trade ba'n'iers.
'fhese
included Argentina, Bangladesh. chile (up ro 1973), inclia, ancl rurkey (to 1973). In the two time periods that rhe V/orld Bank examined 1963-1973 and 1973*1985,
tite average growth rate r:f real CDP per peffion tvas highest fbr the three coLultt'ies with strongly outward-onentecl trade pollcies (o.y percenT ano ).-./ per{.enr ilcr yciu, rcbpcu- tir.ely).The average grou,th rate in the counffies with sfrongly inward-oriented n'ade poli- cies was lorvest in both periods ( 1.6 percent and -0.1 percent per year. respectively). An update in the 1994 Wrltl Developntent Report found tlrat this pattern also held for the time period l980-1992 (a 6.2 percent annual growth rate for sh"ongly ouhvard-oriented cottttffies, and a *0.4 annual growth rate for sfrongly inuard-oriented counfries).
trn a 2002 study. the World Bank contrasted the experience of developing countries that have increased their integration into world markets since 1980 with the experience of other countries. The neu'l,v glohulizing det,ek;ping cowttt'ies, as the World Bank calls them. are countries that
" had relatively lorv involvenent in international trade and high tariffs in 1980 but tiren
' greaily increased their international trade (measured by the increase in the ratio of expofis and imports to national GDP) and
. substantially lowered their tariff rates.
The 24 nervlv globalizing developing countries have a totai popuiation of 3 billion and inciude Argentina. Bangladesh. Brazil- Clhina, Colombia. India, lriicaragua.
-,FSe,
35O r lnternational Economics - Vol. 'l
ir Part Two lrarl,|dicr
'rhailand, and urugltay. The other deveioping countries have a totai population of aLlout 2 billion and include ntanv African countries and coulrtries of the forruer Soviet Uniott. Most of these other developing countries concentrare on exporting primary pr.odncts.
The world Bank found that the newly globalizing developing countries achieved averagegrowthratesofGDPperpersonof3.5percentou*n[tni tqtosanci5.0per- cenf during the 1990s' These average growth .ite, *e.e above their average annual growth rates in the 1960s {1.4 percent) and 1970s {2.9 percent). Their average grorvth rates in the 1980s and 1990s r.vere also higher than theavemge grorvth rates of other developing.countries {0.8 percent and 1.4 percent, respectivet,vl a'* of the industrial- ized countries (2'3 percent and2.2 percent, respecrivei). rhei;trerences betweeil tile newly globalizing and other develcping countries do not seem to regect favorable ini- tial economic conditions fbr the new globalizers. In 1980 the peopie in rhe two _qr.oupshad comparable average levels of education, and the newly gtouutirirrg countries gn average had somewhat lower incomes per capita.
such direct comparisons (as in these severil World Bank studies) betrveen toturtries praL'ti(ing ar udapting ./reer-trude. regintes and c'ountries prut:tir:ing a variurtl aJ ISt or rcsi'sting lurtlter libetalizcttioft q/'tl:e\ trurle polici"r harre the
*virtLre of simplic-
ity: They' look directly at the trvo variables of interest (trarie policies and economic . Stnwth.)' Yet here. as always. corrclation cannot prove causation. By itself. rhis kind
ot evrdence against ISI and restricting trade is sub-iect to the suspicion that maybe some other force caused ecottomic gror.vth to be correlated with freer-trade poiicies. c)r perhaps the eausation ran the opposite u,ay-perhaps successfill growth itself brings freer-trade policies, even though policies departing fiorn l?ee lrade helped promote growth. While it ls not possible to answer these concerns fully. ecorlonrists have conducted nore cornplicated tests of the-statistical significance oi trade poiicy. Afler allowing for the eft-ects of orher variabies such as iivest,nent. iniiiut incoue. and education, the research tends to confinn that ISI-type tracle barriers are a negative inf'luence on econonric growth.
lf theory suggests that iSI can work weil, why does experience make it look like a bad idea'.) There is no direct contradiction becauie theory only assertecl that ISI r:urtbe better than free trade under certain conditions. It iust so-happens that those conditions have not held since the early 1960s. The theory failed, above all. in the assumption that an informed government tries to nraximize national income. Real-worlcl governments are ill-inforrled, and they lack the power to stop protecting industries that lurn oul to be inefficient. Worse. many govemftents trave fleir o*r self-interesr, which conflicts with the gcal of maximizing national well-being. Embarking on a policy of iSI has so fbr not.turned any economy into a supergrowir iike Soutir Korea. Moie often, the ISI ror:te is the road that turns a South Korea into a North Korea. ISI often results irr industries in which domestic firns have high costs and domestic monopoly power a1d produce products of lorv qualit-v.
Outward-oriented policies encourage domestic firms to make use of the country's abundant resources. zurd the firms can use sales into international rnarkets to achieve scale econor:ries. The efforts to succeed in lbreign markets also nrean that domestic firms t'ace.internatiotral competitive pressure, so that they are driven to raise product quality and resource productivity. The country can use iti rising exports to pay l.or its