International Trade: Theory and Evidence Growth in world exports: 1960 68 7.3% 1968 73 9.7% 1973 80 3.3% 1980 85 2.3% 1985 90 4.5% 1990 03 6.0% LDC export growth:, rapidinasia, highly variable in Latin America, slow in Africa.
- 10-2600 Figure 1. Growth of Merchandise Exports, 1970-2000 1 index (1980=100) 2100 1600 1100 600 Other Developing Countries World Sub-Saharan Africa 100 1970 1975 1980 1985 1990 1995 2000 Source: IMF World Economic Outlook (WEO). 1 Excluding oil exports. Least Developed Countries 45 40 35 Minerals Agriculture Manufactures Total Figure 2. Developing Countries: Share of Exports Going to Other Developing Countries, 1965-98 30 percent 25 20 15 10 5 0 1965 1970 1975 1980 1985 1990 1995 1998 Source: Global Trade Analysis Project (GTAP) database, version 5. Figure 3. World: Product Composition of Merchandise Exports, 1965-98 percent 100 90 80 70 60 50 40 30 20 10 Minerals Agriculture Manufactures 0 1965 1970 1975 1980 1985 1990 1995 1998 Source: GTAP database, version 5.
Developing countries share of world trade:, 20% in 1980, 30% in 2005., BUT decline in share of sub saharan Africa (1% 0.5%) Composition of LDC exports has shifted towards manufacturing, now about 70% of total exports, mostlyduetoeastasia(esp.china), often a result of deliberate policies
Figure 4. Developing Countries: Composition of Merchandise Exports, 1965-98 100 90 80 70 Minerals percent 60 50 40 30 Agriculture 20 10 Manufactures 0 1965 1970 1975 1980 1985 1990 1995 1998 Source: GTAP database, version 5.
Figure 6. Sub-Saharan Africa: Composition of Merchandise Exports, 1965-95 100 90 80 70 Minerals 60 percent 50 40 30 Agriculture 20 10 Manufactures 0 1965 1970 1975 1980 1985 1990 1995 Source: GTAP database, version 5.
Standard hypothesis of trade patterns: DCs Primary goods Manufactures LDCs, LDCs export proportionately more primary goods, BUT developed countries do not import proportionately more primary goods Why?, large fraction of DC trade is within DCs and is in manufactured goods
Actual World trade ßows DCs Primary Manu. Manufactures DCs Primary Manu. LDCs LDCs However, trade between LDCs has increased recently to about 10% of world trade
Why Do Countries Trade? 1. Comparative Advantage Ricardian Trade Theory Example:, 2 countries: North and South, 2 goods: Computers and Rice, 1 factor: labour 600 workers each
Technological assumptions: Labour One One sack Required Computer of Rice in North 10 15 in South 40 20, North has an absolute advantage in both goods,, but a comparative advantage in computers., South has a comparative advantage in rice.
Production possibilities frontier In North: 10C N +15R N = 600, canbewrittenas R N =40 2 3 C N In South, canbewrittenas 40C S +20R S = 600 R S =30 2C S
Rice Rice 40 North South 30 2/3 2 0 60 Computers 15 Computers 1.Production Possibilities
Autarky If both goods are consumed in North: p N c = 10 p N r 15 = 2 3. Why?, Competition p N c =10w c and p N r =15w r If pn c 10 >pn r 15, then w c >w r, all workers flow into computers.
If pn c 10 < pn r 15, then w c <w r, all workers flow into rice For both goods to be produced, we need w c = w r Similarly, if both goods are consumed in South: p S c p S r = 40 20 =2.
Free Trade If both goods are going to be produced: 2 3 < p c p r < 2. Why? if p c p r < 2 3 < 2, both countries specialize in rice if p c p r > 2 > 2 3, both countries specialize in computers if 2 3 < p c p r < 2,, North specializes in computers, South specializes in rice.
If it is cheaper to produce rice in North, why don t people buy rice there?, market wages adjust so that rice is not cheaper in the North., as we move from autarky to free trade so that p N c p N r p S c p S r North : p N c 10 = wn > pn r 15 specialize in C South : p S c 40 <ws = ps r 20 specialize in C, effectively nullifies S s advantage in rice production.
Predictions of Ricardian Theory Each country specializes in the production of the goods in which it has a comparative advantage and exports them in return for other goods. All households in both countries are unambiguously better off with free trade than in autarky., the wage in both countries rises, consumption possibilities lie outside the production possibilities frontier Caveats only one factor of production labour is perfectly mobile across sectors competitive markets
Rice Rice p c /p r North South Consumption X Consumption M Production p c /p r 0 X Computers M Computers 2.Gains From Trade
2. Factor Endowments Neoclassical Trade Theory (Eli Heckscher and Bertil Ohlin) Example, 2 countries: North and South, 2 goods: Cars and Textiles, 2 factors: Capital (K) and Labour (L), identical preferences across countries North is relatively well endowed with K : K N L N > KS L S
Car production is capital intensive and textile production is labour intensive., given the same w/r. production isoquants are such that K/L for cars exceeds textiles Capital K c / L c Cars K T / L T w/r Textiles isocost line Labour 3.Capital Intensity
0 T C B Capital A 0 C Labour 4.Edgeworth box for North
Textiles A B C Cars 5.Production Possibilities Frontier for North
0 T E F Capital D 0 C Labour 6.Edgeworth Box for South
Textiles D E F Cars 7.PPF for South
Textiles N N p C /p T C Excess Demand P Excess Supply Cars 8.Disequilibrium in Autarky
Textiles T* E N N p C /p T C * Cars 9.Equilibrium under Autarky
S S p C /p T N N p C /p T 10.Autarky in North and South
p C /p T North p C /p T South C N M X P N C S P N X M 11.Free Trade Equilibrium
Implications of Neoclassical Trade Theory Under free trade the price ratio settles at a level between the two autarkic price ratios Incomplete specialization both countries produce both goods A country will tend to export the commodities that are intensive in factors that are possessed by that country in relative abundance., consistent with the standard hypothsis of DC LDC trade,, does not explain trade flows amongst OECD countries, model predicts a lot of trade between DCs and LDCs Households in both countries are potentially better off with free trade BUT there are distributional consequences
3. Differences in Preferences How do preferences differ between LDCs and DCs?, one hypothesis: DCs spend proportionately more on manufactured goods (luxuries), drives down relative price of primary goods as DCs get richer
Textiles Textiles p C /p T M X p C /p T X Cars M Cars 12.Trade due to differences in preferences
4. Economies of Scale Trade allows concentration of production in some coutries to maximize the effects of economies of scale Example:, 2 identical countries East and West, 2 goods ships and aircraft
$ $ Autarky AC AC A C Aircraft B D Ships 13.Trade and Specialization with Economies of Scale
The Gains and Losses from Trade Distributional Consequences of Trade Neoclassical theory potential gains due to increased goods/services BUT not necessarily actual gains to all members of society. Example (from earlier): Move toward free trade in North, increased (capital intensive) car production, reduced (labour intensive) textile production w/r falls, i.e. labour loses, capital gains Distribution of gains depends on distribution of factor ownership
Static vs. Dynamic Gains/Losses from Trade Comparative advantage is a static concept, but technologies and factor endowments change over time LDCs could allow trade patterns to change as they accumulate physical / human capital, natural shift from primary to manufacturing BUT may get stuck as primary producer and never invest enough to get beyond this stage
Why? Prebisch Singer Hypothesis, as world gets richer, fraction of income spent on primary products declines, long term deterioration in the terms of trade faced by many LDCs: T.o.T. = Export Price Index Import Price Index real incomes grow less rapidly, less capital accumulation / infrastructure Policy implication: need to protect / promote domestic manufacturing, may lower current income by distorting the gains from trade, but this is an investment which will raise future incomes.
Does this hypothesis make any sense? not necessary that world demand will go against primary products (e.g. coffee beans), BUT slow recovery from 60% decline in early 1980s, policy implication assumes that capital markets are not working properly, in a functioning capital market, high future returns in manfacturing should induce investment flow into it and away from primary production.
Figure 1. Evolution of non-oil commodity terms of trade Indices 1980 = 100; prices deflated by the unit value of manufactures exports from the G-5 countries to developing countries 100 80 Developing countries 60 40 Sub-Saharan Africa 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 Table 1 World Bank commodity price indices for low and middle income countries (1990 =100) 1970 1980 1990 2000 Jan-Dec 2002 Jan-Dec 2003 Jan-May 2004 Agriculture 163.3 175.2 100.0 93.0 86.4 94.7 107.1 Beverages 202.8 230.2 100.0 90.9 84.6 87.1 90.3 Food 166.5 176.7 100.0 87.0 90.1 96.4 116.0 Fats and Oils 229.5 188.6 100.0 99.0 101.2 120.6 157.5 Grains 166.6 170.4 100.0 81.8 88.1 90.2 104.2 Other Food 114.9 170.5 100.0 80.0 82.1 80.1 88.7 Source: 1970-2000: World Bank Global Economic Prospects 2004 (Appendix 2) 2002-2004: World Bank Commodity Price Data Pinksheet - June 2004
Figure 1.21 Commodity prices continued gains through 2007 led by metals Figure 1.22 Copper, zinc, and aluminum prices sharply affected by China Commodity price indexes (January 2003 100) 350 300 250 200 150 100 50 Jan. 1, 2000 Jan. 1, 2001 Jan. 1, 2002 Metals Crude oil Agriculture Jan. 1, 2003 Jan. 1, 2004 Jan. 1, 2005 Jan. 1, 2006 Jan. 1, 2007 $/metric ton 9,000 Copper 8,000 7,000 6,000 5,000 4,000 3,000 2,000 Aluminum 1,000 Zinc 0 Jan. 3, 2000 Jan. 3, 2001 Jan. 3, 2002 Jan. 3, 2003 Jan. 3, 2004 Jan. 3, 2005 Jan. 3, 2006 Jan. 3, 2007 Source: World Bank. Sources: London Mercantile Exchange and World Bank.
Figure 1.25 Agricultural prices surge over 2006 7 Commodity price indexes (2003 100) 175 Raw materials 150 125 100 75 50 Jan. 1, 2000 Figure 1.26 A rise in food price led by a ramp-up of the prices of fats, oils, and grains Commodity price indexes (1990 100) 200 175 150 125 100 75 50 Jan. 1, 2000 Jan. 1, 2001 Jan. 1, 2001 Jan. 1, 2002 Source: World Bank. Jan. 1, 2002 Source: World Bank. Jan. 1, 2003 Grains Jan. 1, 2003 Beverages Food Jan. 1, 2004 Jan. 1, 2004 Jan. 1, 2005 Fats and oils Other foods Jan. 1, 2005 Jan. 1, 2006 Jan. 1, 2006 Jan. 1, 2007 Jan. 1, 2007 growing conditions in India, Pakistan, and Thailand improved, and new plantings and favorable weather boosted Brazilian production. Food prices have risen nearly 75 percent since their lows of 2000. The increases stem partly from the stepped-up use of food crops for biofuels and partly from other more fundamental factors, such as rapid income growth in developing countries, high fertilizer prices, low stocks, and droughts. Biofuels are playing an increasingly important role in agricultural commodity markets as their share of global production and trade increases. In 2006, biofuels accounted for 5 10 percent of the global production of the primary biofuel feedstocks and up to 77 percent of the volume of trade. Among the largest biofuel producers, the United States used 20 percent of its maize production for biofuels; Brazil used 50 percent of its sugarcane for biofuels; and the EU used 68 percent of its vegetable oil production, primarily rapeseed, and also imported additional vegetable oils. Such large usage reduces supplies of these crops for food and feed and has contributed to substantial price gains (box 1.2). The anticipated spike in grains prices, identified as a concern in the World Bank s Global Development Finance report published in May 2007 (World Bank 2007a), has largely materialized. Monthly wheat prices have increased 90 percent since mid-2007. Wheat stocks are expected to fall to record lows relative to consumption, and prices may increase further in 2008 before production recoups enough to rebuild stocks. In the meantime, a large number of food-importing countries may suffer substantial terms-of-trade losses over the course of 2007 and into 2008 (box 1.3). Price increases for vegetable oils and grains primarily affect low-income countries, with the rise in prices since the end of 2004 leading to a terms-of-trade loss equivalent to 0.5 percent of GDP. This represents 1 percent of GDP in 29 countries, and nearly 5 percent of GDP for the most affected country, Eritrea. The impact on middle- and high-income countries is considerably less because imports of these commodities represent a smaller share of trade, and higher prices on other commodity exports tends to offset terms-of-trade losses resulting from higher food prices. Agricultural prices are expected to remain nearly flat at high levels in 2008, as biofuels production continues to ramp up in response to consumption mandates and production subsidies, drawing resources from other crops.
BUT there are many market failures, imperfect capital markets create bias against future benefits relative to current costs., dynamic gains from investment may involve positive externalities, distribution of wealth, large country tariff argument may justify government intervention in the form of trade policy.