By Syed Umair Ali Abid Iqbal

Outward-Looking Development Policies Encourages free trade, free movement of capital, workers, enterprises, media, students etc Inward-Looking Development Policies LDCs should evolve their own styles of development in manufacturing and indigenous technologies appropriate to the nations resources and needs

Primary Commodity Expansion: Limited Demands, Shrinking Markets 1. Income elasticity of demand for agricultural food stuff & raw material are relatively low 2. Developed Countries population growth rates are near replacement level so little expansion can be expected 3. Price elasticity of demand for most primary commodities is relatively low 4. The development of synthetic & other substitutes in the Developed World 5. Limited Production of LDCs due to scarce resources & growth opportunities 6. Biased trade policies in the developed world

First fulfill the domestic needs and then opt for Export Promotion They should cooperate with each other They should press the International community for Trade Agreements (Quotas, Tarrifs etc)

Asian Tigers have been greatly successful in this regard Manufactures items have relatively high elasticity of scale but they were kept out of the market by the developed world Tariff & Quotas are the most common weapons against the LDC manufactured products MFA & GATT negotiations were signed against Quotas, effects are yet to be seen

It attempts to replace commodities that are being imported usually manufactured items with domestic sources of production & supply It can involve joint ventures with foreign companies that are given tax incentives & tariff relief for imports It bears high costs in short run but in the long run establishes strong industries

Tariff protection against the import commodity is needed to give the local industries appr. time to flourish In this way they could achieve economies of scale in production & efficiency etc Foreign products should be kept away from market by tariffs so that local products can be sold on a high price or they ll wipe out them with low prices Alternatively they allow foreign products to compete in the market but with a low tariff rate so that a reasonable price could sustain in the market that would benefit the local producer in the long run aswell

P1
Price

Import price with prohibitive tariff Domestic price without trade

P2 P3

b
D

World Price

Quantity

Standard domestic Demand & Supply for an industry in ABSENCE of International Trade

P1 Pt P2

Price

Pt=P2 (1+to)
World Price

f
D

Q2 Q4 Q5 Q3
Quantity Standard domestic Demand & Supply for an industry in PRESENCE of International Trade

IS industries are inefficient, costly and uncompetitive due to Govt. support Revenue of foreign firms go abroad instead of being spent here! Import Substitution occurs on import of capital & intermediate goods & machineries creating balance of payment problems for the country in the end

Countries artificially overvalue exchange rates (Dollar price decreased) to decrease cost of import & increase that of exports They reduce cost for the imported goods for industry but increase cost & thus loose markets for other items, mainly agricultural abroad, taxing worsens the situation for them Many infants industries never grow up relying on the Govt. They often reduce their own costs by import substitution & increase the price of their goods which if intermediary, becomes costly for the next producer in the chain

Many tariffs and quotas help Govt. restrict unnecessary imports like that of luxury items This prevents companies to indulge in competition For this, Rate of Protection should be determined as to know which rate would be sufficient to protect an industry, beyond which imports should be allowed There are two rates of protection; Nominal & Effective

T=p-p p Where p & p are unit prices of industrys output with & without tariffs e.g. If the domestic price (p) of an imported automobile is $5,000 whereas the CIF price p when the automobile arrives at the port entry is $4,000 & nominal rate of tariff protection t would be 25 %.Referred to as t in the graph

Shows the percentage by which value added at a particular processing rate in a domestic industry can exceed what it would be without protection g= v-v v Where v and v are value added per unit of output with & without protection resp.

g can be defined as the difference b/w the value added (% of output) in domestic prices & value added in prices, expressed as a percentage of the latter

It shows by what %age, the sum of wages, interest, profits & depreciation allowances payable by local firms had can exceed because of protection, exceed what this sum would be in free competition (no tariffs protection) It is greatly useful in ascertaining the degree of protection and encouragement afforded to local manufacturers by a given countrys tariff structure.

Most LDCs have pursued IS to support local industries with emphasis on final consumer good that already has a market, they are also technically less sophisticated. The record has not been good mostly because of preference for final goods & others having less ERPs. Even though Nominal Rates are low in developed countries on imports from LDS but still ERPs can make a vital difference.

In combination with zero tariffs on imported raw materials, low nominal tariffs on processed products can represent substantially higher effective rates of protection

Country

Average ERP (%)

Uruguay Pakistan India Brazil Ivory Coast Thailand Singapore Colombia South Korea

384 356 69 63 41 27 22 19 -1

Duties on trade are the major source of Govt. revenues in most LDCs with easy form of taxation & imposition Import restrictions represent an obvious response to chronic balance f payments & debt problems It fosters economies of scale, positive externalities, industrial self-reliance & lessens economic dependency. FDIs, high profits, low priced imported equipments, established domestic market, competitiveness, saving & growth opportunities are gained.

Official Exchange Rate is the rate at which a countrys central bank is prepared to transact exchanges of its local currency for other currencies in approved foreignexchange markets (US$) It doesnt necessarily represent demand & supply for a foreign currency

1)

2)

3)

Accommodating excess demand by running down own Forex Reserves or by borrowing Forex abroad Pursuing commercial policies & tax measures designed to lessen the demand for imports Regulating & intervening in the foreign by rationing the limited supply of available Forex to preferred customers (Exchange Control)

Free-Market & Controlled Rate of Foreign Exchange

Price of foreign exchange (units of domestic currency per unit of foreign currency)

Pa

Pe

Pb

M M M S D

Quantity of Foreign Exchange

It would reduce the domestic currency price of imports Cheaper imports are needed for industrialization process On the other hand, they also reduce the imports of finished goods & luxury items which LDCs usually avoid. LDCs opt for import controls or set up dual or parallel exchange rate system with one rate, usually highly overvalued & legally fixed applied to capital & intermediary goods while the other, much lower & illegal, for luxury items They reduce the return to local exporters & other import competing industries Less competition in world markets due to high prices They can ultimately exacerbate BoP & foreign debt problems

Abruptly decreasing local currencys value Low price of exports, thus bigger market share & higher profits Improvement in Trade Balance It is also a key component of IMF destabilization policies

Immediate increase in import prices x=(T+d)x Domestic Market will increase prices with increase in wages & salary demands which accepted increase cost & thus increase prices even further A wage-price spiral of domestic inflation is set in motion which could result in even worsening balance of trade. Thus it can simply exacerbate external balance of payment problem while generating increased inflation domestically

They are extremely unpredictable Subject to wide & uncontrollable fluctuations Susceptible to foreign & domestic currency speculation Unfavorable in LDCs with heavy dependence on Exports & Imports

Formally legalized in the IMF Meeting in Jamaica in 1976 & is the present intl. system of floating exchange rates Major international currencies are permitted to fluctuate freely but erratic swings are limited through central bank intervention Most LDCs peg their currencies with that of a Developed Country Some manage a/c to the weighted index of world currencies instead of tying it to a particular currency

Focus
1. Limited growth of world demand for primary exports 2. The secular deterioration in terms of trade for primary producing nations 3. The rise of new protectionism against the exports of LDC manufactured & processed agricultural goods.

i.

ii. iii. iv. v. vi.

Shift in developed countries from low technology, material intensive goods to high technology , skill intensive products which decreases the demand for Third World raw materials Increase in efficiency in industrial uses of raw materials The substitution of synthetics for natural raw materials like rubber , copper and cotton Low income elasticity of demand for primary products & light-manufactured goods Rising agricultural productivity in developed world Rising protectionism for both agriculture & labor intensive industries in developed countries

i.

ii.

Oligopolistic control of factors & commodity markets in developed countries combined with increasing competitive sources of supply of LDC exportables Generally lower level of income elasticity of demand for LDC exports

3.Terms of New Protectionism

i.

Growing no. of primary products industries in LDCs prompt the same commodity producers in Developed Countries to give them protection from low-cost LDC products by means of Tariffs, Quotas or even Bans.

1.

2.

3.

Slow growth in demand for their traditional exports means that export expansion results in lower export prices and a transfer of income form poor to rich nations Without import restrictions, the high elasticity of the LDC import demand & low elasticity of exports means a slower growth in order to avoid chronic BoP & Forex Crisis Export-promoting free trade policies tend to inhibit industrialization

Trade liberalization generates rapid export & economic growth because 1. It promotes competition, improved resource allocation & economies of scale in areas where LDCs have a comparative advantage, Costs of production are consequently lowered 2. It generates pressure for increased efficiencies, product improvement & technical change, thus raising factor productivity and further lowering costs of production 3. It accelerates overall economic growth, which raises profits & promotes greater saving & investment & thus furthers growth 4. It attracts foreign capital & expertise

5. It generates needed foreign exchange that can be used to import food if the agricultural sector lags behind or it suffers from catastrophes etc 6. It eliminates costly economic distortion caused by government interventions in both export & Forex markets & substitutes market allocation for the corruption & rent-seeking activities that usually results from an overactive Govt. sector 7. It promotes more equal access to scarce resources which improves overall resource allocation

It occurs when a group of nations in the same region join together to form an economic union or trading bloc This is done by raising a common tariff wall against the products of non-member countries while freeing internal trade among members Common internal tariff unions are termed as customs union & those whose members differ in it are called a free-trade are A common market not only posses attributes of Customs Union but also has free movement of labor, capital etc

The static resource & production reallocation effects within highly flexible & industrialized nations is of limited value to contemporary LDCs intent on building up their industrial base

Integration provides the opportunity for industries that have not yet been established as well as for those that have to take advantage of large scale production made possible by expanded markets In its absence, each separate country may not enjoy the fruits of large markets to achieve lower costs of production & economies of scale for their industries In such case IS will result in inefficient, high cost local industries By removing barriers among member nations, possibility of coordinated industrial planning & trade development cooperation is created However, in such cases industries are assigned to member country, creating inter-dependence & a political union too

Trade Creation is said to occur when common external barriers & internal free trade lead to a shift in production from high-to-low cost member states

Trade Diversion
Trade Diversion is said to occur when common

external barriers & consumption of one or more member states to shift from lower cost nonmember sources of supply (e.g. a developed country to higher-cost member producers

European Union NAFTA SAFTA

LDCs cannot escape the effects of the Developed Countries Policies which is esp. seen in three major areas
1. Tariff & non-tariff barrier to LDC exports 2. Adjustment assistance for displaced workers in developed country industries hurt by free access of labor-intensive, low cost LDC exports 3. The general impact of rich-country domestic economic policies on developing economics

Developed Countries will cut tariffs on manufacturers by avg. 40% in 5 annual reductions in 10 major sectors, LDCs in return will not raise tariffs by binding in trade reforms Trade in agricultural products will come under WTO & will be progressively liberalized. Developed Country non-tariff barriers will be converted into tariff & reduced to 36%, agricultural subsidies to be removed by 21% For textiles & apparel, MFA quotas will be phased out by 2005. Tariffs on textile imports to be reduced by only 12%

Manufacturers in rich countries resist trade barriers to avoid competition from their low-cost LDC counterparts This can be solved by moving labor to capital intensive industries where comparative advantage exists Many Adjustment assistance schemes have been proposed but no one has truly been effective

The economy of export oriented LDCs depend largely on fiscal policies of the Developed World When Intl. economic disruption occurs, LDCs feel the effect much sooner & more substantially As long as LDCs will keep their economies closely linked with policies of the Developed World, theyll remain volatile, under pressure & might never come out of the developing stage

Though not denying their interdependence with Developed World, LDCs should realize that in absence of major reforms of the International economic order, a concerted effort at reducing their current economic dependence & vulnerability is essential to any successful development strategy