Econ3004: International trade

Dr. Parama Chaudhury

University College London
Term 1, 2017-18
 International Trade : The Verdict

What have we learned so far?

• Free trade lowers prices, thereby increasing a country’s total

welfare.
• Small countries benefit more from trade
• There may be distributional effects within a country
• Migration can theoretically reduce native wages, but data
shows that migrants are often imperfect substitutes for natives,
so little effect on wages
• Recent migrants to the UK improve fiscal balance
 Trade Liberalisation in LDCs
Import-substituting industrialization was a trade policy adopted by many
low- and middle-income countries before the 1980s.
The policy aimed to encourage domestic industries by limiting
competing imports (infant industry argument)
 Trade Liberalisation in LDCs
• Import-substituting industrialization in Latin American countries
worked to encourage manufacturing industries in the 1950s and
1960s.
• Did import-substituting industrialization promote economic
development?
o No, countries adopting these policies grew more slowly than others.
• Some low- and middle-income countries that had relatively free trade
had higher average economic growth than those that followed
import substitution.
• By the mid-1980s, many governments had lost faith in import
substitution and began to liberalize trade.
o Dramatic fall in tariff rates in India and Brazil, and less drastic reductions in many
other developing countries.
 Trade Liberalization in LDCs
Has trade liberalization promoted development?
• Growth rates in Brazil and other Latin American countries have
been slower since trade liberalization than they were during
import-substituting industrialization.
o But unstable macroeconomic policies and financial crises contributed to
slower growth since the 1980s.

• Other countries like India have grown rapidly since liberalizing

trade in the 1980s, but it is unclear to what degree liberalized
trade contributed to growth.
• Some economists also argue that trade liberalization has
contributed to income inequality (but the Heckscher-Ohlin
model predicts this should fall in labour-abundant countries).
The East Asian Miracle
The East Asian Miracle - The Role of Trade
 The East Asian Miracle
• These countries have experienced average growth rates of 8-
9% from the mid 60s until today
• They are also particularly open to international trade in terms
of trade over GDP
• However in terms of policy, they did engage in protection
through tariffs, import quotas and export subsidies
• They also engaged in a variety of different levels of
government activism in industrial policy subsidized loans for
industries and subsidized R&D

• Are high exports a consequence of growth rather than a

cause of growth in these countries?
Is trade liberalization in LDCs sustainable?

A typical scenario in the 1980s/1990s:

“The country concerned is hit by a terms of trade deterioration, a

reduction in foreign capital inflows, and capital flight. Inflation
accelerates to new heights, while the economy comes to a
standstill. The central bank runs out of reserves. Enter the IMF
and the World Bank with the promise of structural adjustment
loans, which would unlock additional funds from other creditors,
provided that the government undertakes a number of reforms,
including the rationalization of the commercial regime. The
government has few alternatives but to accept.”

Source: Rodrik, JEP 1992

Is there a conflict between trade liberalization
in LDCs and macroeconomic stability?

• Standard economic theory does not imply any direct link

between the two.
• However, e.g. converting quotas or subsidies to tariffs earns
much-needed government revenues and helps the fiscal
balance. (in some developing countries, tariffs have accounted
for 15-20% of government revenue). The move away from
other trade barriers also increases efficiency.
• Lowering tariff rates may also increase official trade by
reducing activity on the black market.

Source: Rodrik, JEP 1992

 Trade Liberalization in LDCs

What are the consequences of trade liberalization in the

imperfectly competitive market environments that are prevalent
in LDCs?

If there are untapped economies of scale in an import-

competing sector, and this sector is squeezed by the removal of
protection, there may be welfare losses. But under imperfect
competition, it is also possible for import-competing sectors to
produce more under free trade (e.g. because demand becomes
more elastic and prices fall)

Free trade could lead to increase in technical efficiency, but there

is mixed theoretical and empirical support for this.
Source: Rodrik, JEP 1992
 The TPP and growth
Developing countries:
• IPR encourage innovation
• Labour regulations increase productivity
• Environmental regulations

Developed countries:
• Open borders encourage innovation
• Similar labour regulations in LDCs encourage higher standards
and productivity
• Environmental regulations
IPRs, technological progress and LDCs

• Solow-type growth model implies that long run growth is not

possible without technical progress
• Intellectual property rights (IPRs): A patent gives an inventor
the exclusive rights to an invention for a period of time
• This encourages innovation, by allowing inventors to capture
the returns to their innovations
• The downside is that (at least for a period of time) it restricts
the benefit to society as a whole from the invention
• Until recently, protection of intellectual property rights in the
developing world has been weak
 TRIPs
• The final (Uruguay) round of the GATT explicitly linked trade to
IPRs through an agreement known as TRIPs (Trade Related aspects
of International Property rights)
• In order to become members of the WTO, countries also had to
subscribe to TRIPs
• TRIPs requires patent protection for at least 20 years for almost all
types of technology (including drugs)
• It also requires enforcement of this protection
• Developing countries had 10 years (until 2005) to put these
conditions in place
• TRIPs has been quite controversial, particularly the pharmaceuticals
clause
Evidence on the Effect of IPRs
• Several economists have tried to quantify the effect of
enforcement of IPRs on the developing world, and come to
variable conclusions
• It is clear that the price effects/reduction of competition
effects are substantial (e.g. Chaudhuri, Goldberg and Jia on
antibiotics in India)
• The effects on innovation are less obvious
o IPR reform in Japan in 1988 did not have an effect on innovation
(Branstetter and Sakakibara 2001)
Evidence on the Effect of IPRs

• Regarding the diffusion of products, the evidence is also

mixed:
o Hollywood movies are released faster in countries with an intermediate
level of IPR protection than in countries with high or low levels

• There is some evidence that stronger IPRs lead to increased

FDI (Branstetter, Fisman, Foley and Saggi)
o Developing countries that strengthen IPRs see an increase in
employment and output through foreign firms (especially for patent-
intensive firms)
Labour Regulations and Trade
• Anti-globalization activists in the developed world often
emphasize the “exploitation” of workers in the developing
world
• The Stolper-Samuelson theorem implies that workers in
developing (labour-abundant) countries should be better off
with trade.
• Another claim often made is that trade liberalization may lead
to reduced compliance with labour standards in developing
countries (due to competitive pressures) and hence to
increased poverty
• As a result, some labour activists want to include labour
standards in trade negotiations
Labour Regulations and Trade: The Evidence
• Harrison and Scorse (AER) show for Indonesia in the 1990s
that, controlling for worker and plant characteristics, foreign-
owned firms are more likely to be in compliance with the
legislated minimum wage
• For exporters, this is more true at the end of the 1990s than at
the beginning, possibly due to human rights activism
• This may be offset by increased use of outsourcing (arms-
length relationships with domestic firms) and shifting
production from countries with high enforcement to low
enforcement of labour standards
Source: Labour and Social Policy Components in Current Trade Agreements in Asia and the Pacific, ILO
ACT/EMP Research Note, March 2015
 Child Labour and Trade

• Anti-globalization activists have also claimed that trade liberalization

leads to higher use of child labour because of increased demand for
goods produced by children
• Child labour is held not only to be bad in and of itself, but also
harmful to development since it reduces human capital accumulation
through lower participation in formal schooling
• Again, there is a potentially offsetting effect of trade on welfare
(standard real income gains), and all the evidence suggests that as
household incomes increase, child labour falls
• The cross-country data (Pavcnik and Edmonds) indicates a negative
correlation between trade and child labour that is driven by income
• However there is not much evidence on the direct effects of trade
liberalization on the use of child labour
 The Environment and Trade

• Compared to rich country standards, environmental standards

in low and middle income countries are lax
o Some have opposed free trade because of this fact
o Pollution haven hypothesis

• But we cannot conclude that trade hurts the environment,

since in the absence of trade, government policies have
degraded the environment

• Some environmental activists want to include environmental

standards in trade negotiations
So how does Free Trade affect Welfare?

• Free trade lowers prices and therefore increases welfare

• There are some exceptions, where protection (at least
temporarily) increases welfare
• But these are often better addressed using domestic policies
• There is little evidence however that trade increases growth rates
(only a one-off rise in welfare)
• Trade (outsourcing) might be thought of as a way to facilitating
violations of labour, environmental or other regulations
• Here too, the issue is really about domestic institutions
• Could trade be used as a way to change domestic institutions?
External Media Slide
The Globalisation Trilemma
 Where to from here?
• Some backward steps away from “hyper”-
globalization”

• “Democracy” flexing its muscle in the name of

globalization

• Is there a way to reform global governance to

align it with democratic ideals and the spread of
globalization?
External Media Slide