Trade Development I Import Substitution Industrialization International Political

Trade & Development I: Import Substitution Industrialization International Political Economy Prof. Tyson Roberts

Brief history globalization & development • Mercantilism (1500 s-1700 s) – Globalization through empire – Imperial goal: amass the most gold – Subsidize exports, tax imports • Classical liberalism (1800 s– early 1900 s ) – Increasing free trade promoted by Britain hegemon – Continued promotion of trade within empires

How globalization helps developing countries according to classical liberalism 1 st Age of Globalization • Free trade: poor countries specialize in comparative advantage (e. g. , agriculture) & import other products (e. g. , manufactures) • Free flow of labor: workers move from laborabundant to labor-scarce economies => wages • Free flow of capital: capital flows freely from capitalrich to capital scarce countries => investment, development

Example 1: Argentina in 1800 s • Economically backward compared to Britain • Land abundant • Labor scarce What should we predict regarding policy preferences of each group, and the resulting political coalitions?

Commerce and Coalitions 1 st Age of Globalization (increasing free trade) Labor scarce relative to Land Labor abundant relative to Land Capital rich (Developed countries) Capitalists & Landowners for trade Labor against Capital & Labor for trade Landowners against Capital scarce (LDCs) Landowners for trade Labor & Capitalists against Labor for trade Landowners & Capitalists against 5

Commerce and Coalitions 1 st Age of Globalization (increasing free trade) Labor scarce relative to Land Labor abundant relative to Land Capital rich (Developed countries) Capitalists & Landowners for trade Labor against Capital & Labor for trade Landowners against Capital scarce (LDCs) Landowners for trade Labor & Capitalists against Labor for trade Landowners & Capitalists against Argentina 6

In 1800 s, Latin America ruled by landowners; much of Asia & Africa ruled by empires Collective Action Cost High Factors Mobile & Majoritarian Inst. (e. g. , democracy, not oligarchy) Rampant free riding No trade policy coalitions Exit (? ) Low Rogowski Rampant free riding Trade policy coalitions Exit (? ) Class-based coalitions possible, but not necessary for victory Factors Specific & Majoritarian Inst. Individual interest groups unable to affect trade policy Consumer groups inactive Universalistic logroll (? ) Cross sector coalitions (logrolling) or coalitions with labor Consumer groups active Factor Specific & Non-maj. Inst. Standard trade policy Model (Pareto, Olson, etc) Lobbying for protection Consumer groups inactive Cross sector coalitions (logrolling) or coalitions with labor possible, but not necessary for victory Consumer groups active Factors Mobile & Non-maj. Inst. (e. g. , oligarchy)

Brief history globalization & development • Mercantilism (1500 s-1700 s) – Globalization through empire – Imperial goal: amass the most gold – Subsidize exports, tax imports • Classical liberalism (1800 s– early 1900 s ) – Increasing free trade promoted by Britain hegemon – Continued promotion of trade within empires • World Wars & interwar period (1914 -1945) – Breakdown of free trade system, nationalist, fascist & communist movements

Crisis: WWI & Great Depression • War => increased demand for labor => increased power of labor in economics (unions) and politics (votes) (esp. in sovereign nations) • British Navy no longer strong enough to enforce free trade policies in developing countries • Rich and poor countries respond to crisis by imposing controls on trade, capital, immigration • Communists & Fascists extremely protectionist

War => increased demand for labor => increased power of labor in economics and politics (votes) Collective Action Cost High Factors Mobile & Majoritarian Inst. (e. g. , democracy, not oligarchy) Rampant free riding No trade policy coalitions Exit (? ) Low Rogowski Rampant free riding Trade policy coalitions Exit (? ) Class-based coalitions possible, but not necessary for victory Factors Specific & Majoritarian Inst. Individual interest groups unable to affect trade policy Consumer groups inactive Universalistic logroll (? ) Cross sector coalitions (logrolling) or coalitions with labor Consumer groups active Factor Specific & Non-maj. Inst. Standard trade policy Model (Pareto, Olson, etc) Lobbying for protection Consumer groups inactive Cross sector coalitions (logrolling) or coalitions with labor possible, but not necessary for victory Consumer groups active Factors Mobile & Non-maj. Inst. (e. g. , oligarchy)

Example 2: Argentina in 1930 s • Economically backward compared to Britain • Land abundant • Labor scarce What should we predict regarding policy preferences of each group, and the resulting political coalitions?

Commerce and Coalitions Depression of the 1930 s (increasing protectionism) Labor scarce relative to Land Labor abundant relative to Land Capital rich (Developed countries) Capitalists & Landowners for trade Labor against Capital & Labor for trade Landowners against Capital scarce (LDCs) Landowners for trade Labor & Capitalists against Labor for trade Landowners & Capitalists against 12

Commerce and Coalitions Depression of the 1930 s (increasing protectionism) W. European Fasicism United States: New Deal Labor scarce relative to Land Labor abundant relative to Land Capital rich (Developed countries) Capitalists & Landowners for trade Labor against Capital & Labor for trade Landowners against Capital scarce (LDCs) Landowners for trade Labor & Capitalists against Labor for trade Landowners & Capitalists against South American Populism Asian & East European Fascism 13

Argentina 1940 s-1950 s • Juan Peron rises to power with support of labor, industrialists (import competing sectors) and military • Implements import substitution industrialization policies

• http: //www. youtube. com/watch? v=Wxna. Z 0 S ANr 8

Structuralist Critique of Economic Liberalism • Market imperfections in developing countries – Industrialization in modern era requires coordination • Complementary demand: need critical mass of wage workers to buy manufactured products • Pecuniary external demand: need related industries to invest simultaneously

Coordination Problem Electricity Firm Manufacturer Invest in factory Don’t invest Invest in Dam Don’t invest 10, 10 -5, 0 0, -5 0, 0

Solution to coordination problem: “Big Push” by Government Volta Dam, Ghana Major electricity producer Valco aluminum smelter Major electricity user

Structuralist Critique of Economic Liberalism • Market imperfections in developing countries – Industrialization in modern era requires coordination – Declining terms of trade • Imported manufactures prices rise • Export commodity prices fall • Result: core country real incomes rise, periphery country real incomes fall

Solution to Declining Terms of Trade Problem: ISI 1. Easy ISI: – Promote local production of consumer goods • Sufficient local demand to enable economies of scale • Sufficient local labor for labor intensive production • Necessary technology available for import (in part in form of foreign capital: machines, etc. ) • Benefits: wage-based employment, human capital

Solution to Declining Terms of Trade Problem: ISI 1. Easy ISI 2. Second step options – Secondary ISI • • Move up to consumer durables (cars, etc. ), intermediate inputs (steel, etc. ), and capital goods (machines, etc. ) Common in Latin America, South Asia, etc. – Export substitution • • Expand consumer good production for export Common in some East Asian countries

ISI Policies • Government planning (5 -year plans, etc. ) • Government investment – Roads, rail, electricity, telecom, etc. – State-owned & mixed-ownership enterprises • Trade barriers – Tariffs (on manufactured goods) – Import quotas (on manufactured goods) – Overvalued and/or multitiered exchange rates to enable import of capital goods

Sources of funds for investment • Foreign aid • Foreign borrowing • Taxes on agricultural exports (marketing boards) • Tariffs on imports

$2 $1 $1

Winners & Losers from ISI Policies Winners Losers • Workers & firms in importcompeting industries • Export-oriented farmers – Higher market share & prices for produced goods • Government – Jobs, opportunities for rentseeking • Urban residents – Subsidized government services – Lower producer prices => reduced production • Consumers – Higher prices for manufactured goods • Manufacturers in exportoriented industries (if any) – Overvalued exchange rates increase price of exports, etc.

Assume the world equilibrium price for cocoa is $2. How much would Ghana cocoa farmers be willing to produce? Price of cocoa 3 SC 2 DC 1 2 4 6 Quantity of Ghanaian Cocoa

How would cocoa farmers respond if the government sets the producer price at $1? Price of cocoa 3 SC 2 DC 1 2 4 6 Quantity of Cocoa

ISI policies successfully promoted industrialization & GDP growth in 60 s & 70 s GDP/capita growth 1960 s & 70 s Latin America 2. 3% Sub-Saharan Africa 1. 4% Middle East & N. Africa 3. 7% East Asia 5. 2 % South Asia 1. 2% Southeast Asia 3. 1% But for most countries (all but East Asia), those growth rates would not prove sustainable…

Conclusions • International and domestic developments and new belief systems => ISI Policies – World Wars & Depression strengthened relatively scarce factor owners – Political changes strengthened workers, domestic industrialists, urban voters, etc. – Marxism, Structuralist critique of economic liberalism, etc.

Conclusions • ISI policies increased industrialization & GDP growth, but … • Urban workers & industrialists benefitted to detriment of export-oriented farmers • Governments (esp. in “weak states”) took advantage of rent-seeking opportunities to overextend protection of inefficient manufacturers • Budget & trade deficits left countries exposed to global downturn