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Export Pessimism ISI, Inward and Outward Orientation

Export pessimism is the opinion “that” if “developing

countries expand their exports”, it will cause a decrease

in their “terms of trade” due to an unfitness (caused “by

weak demand”) or “unwillingness (expressed via protection)

of developed countries to take these exports”. (Deardorff

2010)

According to the economist, World trade “encourages”

money to “flow” to “poor” countries. When developing

countries lessen their “trade barriers” developed countries

will “invest” their money in those countries. This will add

to the “domestic savings” of the country. These investments

can be in the form of “loans” or “Foreign Direct

Investments (FDIs)”.These investments cause a rise in

“incomes” by increasing “demand for labor” and “making

labor more productive”(The Economist 2001).

In spite of these advantages that occur due to

increased trade, there are several opinions that tend to

differ. The view is known as “export pessimism”. It states

that if all developing countries would “simultaneously”

decide to “grow” through trade by increasing “their

exports”, the “price” of these “exports” would be forced

low by “world markets”. It further clarifies that the

“success of East Asian tigers” using the increasing trade

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model was only fruitful because many other “developing”

countries were not doing so (The Economist 2001).

The Economist also had another claim that increased

trade was not beneficial. It pointed out that the “FDIs”

produced “little or nothing of value” because the money may

be “wasted or stolen” or would just be a “show of

insupportable debt to foreigners if the money was borrowed”

(The Economist 2001).

Also critics say that workers in poor countries do not

have the same conditions as workers in rich countries

because of the lack of “bargaining power” that surrounds

the labor of poor economies. Their “wages” do not rise and

they may have “unhealthy working conditions” (The Economist

2001).

This raises the question as to whether trade is good

for growth or not. The “export pessimism theory” cannot be

fully discredited because we cannot accurately predict what

would really have occurred “over the past decade if all

developing countries” had vigorously increased their “trade

simultaneously because they didn’t”. In spite of this there

are “reasons” why the pessimism theory can be considered as

not valid (The Economist 2001).

One reason is that the total “exports” of all “poor

countries” only represent “5% of global output. Assuming

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that the “global demand for imports” was limited, more

“exporting” from poor countries would not put a “strain on

the global trading system”. But the true fact is that

“demand for imports is not capped”, making “export

pessimism a fallacy of its own” (The Economist 2001).

The “Import- substituting industrialization (ISI)”

strategy also fails to support the “export pessimism”

theory. “ISI” involves the move from “labor-intensive

manufacturing” to “more” advanced methods “of” production.

It is an “inward oriented approach” that makes a gap

“between” global and local “prices that favors production”

for the local market rather than for “exports” (The

Economist 2001).

During the “1950’s” the “East Asian tigers” chose to

encourage and pursue trade while “India, Africa and Latin

America” chose to go for “ISI” thus discouraging “trade”.

For the period till the 1970’s .The countries which pursued

“ISI” experienced never before seen “surges in growth” with

the “East Asian tigers” flourishing. Economists then came

to see the importance of “outward orientation”- the

relationship “between trade and growth” (The Economist

2001).

The problem with “ISI” is that it “produced

inadvertently large and complex distortions in the pattern

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of production that often became self-perpetuating and even

self-reinforcing”. With “investments” being emerged in

projects that were only fruitful due to “tariffs and

quotas”, any attempts to “remove those restrictions were”

greatly opposed (The Economist 2001).

MEXICO AND NAFTA RATE OF RETURN

The North American Free Trade Agreement (NAFTA) is

described as an “agreement” between “United States, Canada

and Mexico” that would lead to the “elimination” of

“tariffs” and other “fees to” promote “trade” among the

“three” countries. It was reached in “1994”. (Radcliffe).

NAFTA has benefited Mexico to a large extent with some

disadvantages also experienced. It was predicted that

participation in NAFTA would reduce the rate of return on

Mexican capital. Several situations led to this scenario

(Kaplan 2002).

After joining NAFTA, the Mexican “peso” was “pegged”

to the American dollar. This led to the stability of the

“peso”, which encouraged “investors” from the United States

to participate in the “Mexican financial and consumer

markets” due to the nullification of “exchange rate risk”.

The result was a high flow of “money through the capital

account”, with most of it purchasing “highly liquid Mexican

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stocks and bonds” which could be disposed “almost

overnight” (Kaplan 2002).

The Mexican population and industries “imported” more

products from the US due to the strong “value” of the “peso

in relation” to the US currency. By maintaining the “peso”

at a high “value” and making imports cheaper, Mexico

encouraged more importation than local “production”. This

caused a current account trade deficit (Kaplan 2002).

The “nominal exchange rate” of the “peso” remained

stable because it was “pegged” but the “real exchange rate”

had increased notably. Also during this period, “relative

inflation rates” in Mexico “were higher” than the US. The

solution to this was to “increase prices” of local products

while having stable prices for US “imports due to the

pegged nominal exchange rate”. With Mexican “incomes”

increasing together with “inflation” and “import prices”

remaining stationary, there was more purchase of US imports

“which were falling in real terms”. This led to an upsurge

“in the current account deficit” (Kaplan 2002).

The Mexican peso/U.S. dollar exchange rate collapsed.

There are several main causes for the peso’s “exchange rate

collapse”. The huge “current account deficit” in Mexico

increased the amount of “currency in foreign exchange

markets, putting downward pressure on the currency's value”.

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The increase in United States interest rates caused an

outflow of money that had gone to Mexico “through the

capital account”. Money was withdrawn from the “Mexican

economy” to fund investments with “higher and more secure

returns” in the US. This depleted the “substantial capital

account surplus” (Kaplan 2002).

The explanation lies in the tremendous devaluation of

the peso in relation to the dollar. The United States

already had low tariffs on most of its goods. It therefore

did not need to liberalize its markets much.

Although NAFTA took things further, cutting tariffs on

American goods, trade between Mexico and the United States

was booming for long (Kaplan 2002).

By promoting trade between the U.S., Mexico and Canada,

NAFTA did help boost Mexico's exports in the region,

providing a silver lining during the Mexican recession.

Soon after NAFTA, Mexico had a current account surplus

(Kaplan 2002).

TRADE INTERVENTION

“Tariffs” are one of the major types of government

trade intervention restrictions. They are “taxes” imposed

on “imported goods” that leads to an increase in their

“cost”. The main reasons why tariffs are used are to

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“protect domestic employment, infant industries and

consumers”. By imposing taxes on imports, the prices of

goods are increased, minimizing competition and reducing

“threat” to domestic industries. This measure secures

“domestic employment” since “domestic industries” do not

have to close shop and lay off workers or offshore their

production abroad so as to remain competitive. Developing

nations impose “tariffs” on imported goods in “infant

industries” it wants to “foster growth”. This creates a

local market for locally produced “goods” and enables a

shift from “agricultural products to finished goods by the

“Import Substitution Industrialization (ISI) strategy”.

“Tariffs” are also imposed to protect consumers from

products deemed to be potentially harmful to the

“population”. The inefficiency of tariffs stems from the

fact that it is only advantageous to the “government” and

“domestic industries”, leaving fewer benefits to the

consumers. “Governments” profit by collecting taxes and

“domestic industries” profit through less competition from

foreign goods which have higher prices. The cost of this to

the “individual” and “business consumer” is higher prices

for foreign goods caused by taxes. In the long run industry

may also experience “inefficiency” through lack of

sufficient “competition” and decline in revenue because of

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the rise of “substitutes for their products”. The

“government” may also suffer in the long run due to more

“demand for public services” because the population has

less “disposable income” due to price increases in goods

(Radcliffe).

A “quota” is a limit on the amount of goods that can

be imported. Quotas create a shortage which cause the price

of the good to rise and allows domestic producers to raise

their prices and to expand their production. Licensing is a

form restriction which grants businesses permission to

import a certain good. This creates less competition and

increase in prices (Radcliffe).

Subsidies are money given to local producers to

encourage exports. They can be used to pay production costs

thus charge less for their goods than foreign producers.

Subsidies are paid for by taxpayers who may or may not use

the good.

“Figure 1 shows trade without tariffs.DS is Domestic

Supply and DD is Domestic Demand. The price of goods is P,

and the world price is P*. At a lower price, consumers will

consume Qw worth of goods, but because the home country can

only produce up to Qd, it must import Qw-Qd worth of goods”.

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Figure 1. Price without the

influence of a tariff

“A tariff imposition increase prices and limits the

volume of imports. In Figure 2, price increases from P* to

P'. Local companies produce more, so Qd moves right and Qw

left. The overall

effect is a reduction

in imports, increased

domestic production

and higher consumer

prices”

Figure 2. Price under the

effects of a tariff
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Effect of subsidies on milk importing nations

For a large milk producing and milk importing country,

it is necessary to use subsidies so as to protect its

domestic milk industries and give lower prices to

consumers. Subsidies can be thought of as tariffs in

reverse. Instead of taxing the foreign milk imports, the

government gives grants of money to domestic producers to

encourage milk production. Those who receive such subsidies

can use them to pay production costs and can charge less

for their goods than foreign producers. Subsidies are paid

for by taxpayers who may or may not use the milk. Subsidies

encourage shifting from effective exporting producers to

less effective domestic producers. They also ensure that

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domestic farmers can earn enough profits to continue

farming.

In spite of its important advantages, subsidies have

several downside effects. Subsidies will lead to lower

production costs and therefore lower price for the milk.

The domestic milk prices will be cheaper than the imports.

Due to lack of foreign competition there might be a poorer

quality of domestically processed milk. Lower prices will

increase demand for the milk. This coupled with poorer

quality will encourage more milk imports so as to supply

this need. Therefore it can lead to further imports of milk

and be damaging to domestic milk producers.

Euphoria and Paranoia

x= 12.0-p+0.5 q

y= 10.0+0.5p-2.0q

S= 2.0p- 12.0

a) Given that price of paranoia chariots, q=6

x= 12.0-p+0.5(6)

x= 15-p

And y= 10.0+0.5p-2.0(6)

y= 0.5p-2

At equilibrium x=y and thus

15-p=0.5p-2

P+0.5p= 15+2
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P=11.333…. (Equilibrium price-thousands of francs)

For domestic supply S, we substitute p,

S= 2.0(11.333)-12

S=10.666 (domestic supply at equilibrium-millions of

chariots)

At equilibrium price 11.333, demand for domestic

euphoric chariots is

x= 12-11.333+3

x=3.666 (millions of chariots)

But since the supply for domestic chariots is 10.666, the

imports of paranoia chariots will be

10.666-3.666=7 (millions of chariots)

References

Deardorff, A. (2010).Deardorff’s Glossary of

International Economics. Retrieved from http://www-

personal.umich.edu/~alandear/glossary/e.html

Kaplan, J. (2002). The macro economy and exchange

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rates Retrieved from

http://www.colorado.edu/Economics/courses/econ2020/section1

3/section13-main.html

Radcliffe, B. The Basics of Tariffs and Trade Barriers

Investopedia Retrieved from

http://.investopedia.com/articles/economics/08/tariff-

trade-barrier-basics.asp

The Economist (2001, September 27th) Grinding the poor

Economist.com Retrieved from

http://dipeco.economia.unimib.it/persone/Colombo/econinter-

a/economist/poor.htm