International Economics Policies and their Theoretical Foundations. A Source Book

644 Pages·1982·36.477 MB·English

by  John M. Letiche

INTERNATIONAL ECONOMIC
POLICIES AND THEIR
THEORETICAL FOUNDATIONS
A Source Book
Edited by
JOHN M. LETICHE
Department of Economics
University of California
Berkeley, California
1982
ACADEMIC PRESS
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Library of Congress Cataloging in Publication Data
Letiche, John M., Date
International economic policies.
(Economic theory, econometrics, and mathematical
economics)
1. Commercial policy—Addresses, essays, lectures.
2. Commerce—Addresses, essays, lectures. 3· Inter-
national economic relations--Addresses, essays, lectures.
I. Title. I I. Series.
HF1411.U+54 337 82-1705
ISBN 0-12-444280-3 AACR2
PRINTED IN THE UNITED STATES OF AMERICA
82 83 84 85 9 8 7 6 5 4 3 2 1
Preface
Increasing differentiation of international economic policies among the developed
and developing market economies, as well as among the centrally planned
economies, has been a marked characteristic of contemporary world trade and pay-
ments. In selecting readings for this book, I have endeavored to draw upon works that
take cognizance of this fact without sacrificing the analysis of fundamental principles
of international economics. The objective has been to serve the interests of teachers,
students, and government officials for the long term rather than for the short run.
Cogency, relevance, and basic principles were, therefore, given high degrees of
priority.
An important aim of the book is to provide a complement to textbooks in interna-
tional economics. Sincere acknowledgments are due to authors and publishers for
their generous permission to use materials held in copyright.
I am grateful to a long line of able students who have shared their judgment with
me in the selection of articles: Charles Engel, Charles Marston, and Ronald L.
Solberg gave me not only highly valued advice but also assistance in checking
references and in utilizing libraries. To my wife, Emily Kuyper Letiche, and to my
good friend, Howard S. Ellis, I am indebted for literary criticism and for the inspira-
tion that renders every form of scholarly activity a satisfying experience.
John M. Letiche
IX
INTRODUCTION
JOHN M. LETICHE
This book is composed of nine parts. Part I deals with the evolution of the present
international economic order, the recent experience of developing nations, and the
deep conflicts involved in the North-South debates, culminating in the call for a
new economic order. Part II presents the foundations of terms-of-trade and gains-
from-trade theory underlying key policy issues of economic growth and develop-
ment.
Part III consists of studies in world food production, international trade, and
agriculture. In Chapter 5, Schultz shows economic productivity and human well-
being to be vitally interrelated in both poor and rich countries. Powerful arguments
come to light for rejecting the view that limitations of space, energy, cropland, and
other physical properties are the decisive constraints to human betterment. Instead,
Schultz argues that the acquired characteristics of the peoples of the earth—their
education, experience, skills, and health—are the vital factors in economic prog-
ress. Attention is devoted to attributes of traditional agriculture and to allocative
efficiency, including its implications for commercial policy throughout the world. A
general argument, with supporting evidence, is presented in terms of the increasing
value of human time, a formulation that is applicable to both theory and policy
pertaining to various terms-of-trade concepts.
Because Chapter 5 is taken from a book, and limitations of space have necessi-
tated severe condensation, the broader framework of its context must be examined.1
Schultz explains why even the giants of economics such as Adam Smith, David
Ricardo, and Thomas Malthus could not have foreseen that the economic develop-
ment of Western industrial nations would depend primarily on ' 'population qual-
ity. " A predominant part of their national income (4/5 in the United States) is now
derived from earnings and only a small part from property. Drawing on his expertise
in agriculture, trade, and development, the author provides fresh insights into the
following fundamentals: (1) the process whereby advances in knowledge enhance
both physical and human capital; (2) the underlying reasons economists in rich
countries find it exceedingly difficult to comprehend the implications of the severe
resource constraints on low-income countries; (3) the nature of the performances of
poor people that determine their economic choices; and (4) the implications of the
ample evidence that poor people in developing countries are no less motivated to
work hard, to adapt efficiently to domestic and international market forces (if proper
Theodore W. Schultz, Investing in People: The Economics of Population Quality (Berkeley: Univer-
sity of California Press, 1981), especially Chapters 2, 3, 6, and 7.
International Economic Policies
Copyright © 1982 by Academic Press, Inc.
All rights of reproduction in any form reserved.
ISBN 0-12-444280-3
incentives are adopted), and to improve their lot and that of their children, than are
those with incomparably greater advantages. Schultz pays particular attention to the
consequences of government actions upon national economies and upon their atten-
dant international impacts. The theory developed is robust and applicable to the
following issues bearing on this book: (1) to international economic policies on
basic research in agriculture, (2) to investment in developing and improving domes-
tic and international market structures, (3) to investment in entrepreneurial ability in
developed and developing countries, (4) to economic distortions caused by the
International Donor Community, and (5) to trade discrimination by higher-income
countries. A major economic implication of this discrimination is that free internal
market prices, consistent with international prices in Western European countries,
Japan, and some of the other high-income countries, would not only be a boon for
consumers in high-income countries, but would contribute substantially to the ex-
port opportunities of many low-income countries. ''Gains from such trade,"
Schultz observes, "would probably contribute more to the agricultural development
of low-income countries than foreign aid."2 Systematic research on this issue,
particularly as it pertains to contemporaneous uneconomic and obsolete forms of
overt and covert "tied aid," is likely to yield high returns to both donor and
recipient countries.
Developments in the world food situation is the topic of Chapter 6. Johnson
reveals gross error, exaggeration, and oversimplification in numerous current policy
approaches and government pronouncements. The author calls attention to unsettled
issues and to promising policy research.
Part IV considers the economics of common markets. A key passage from the
modern, classic formulation is given, and subsequent chapters survey the more
recent literature with reference to developed and developing nations. Although a
definitive study on the economic effects of the European common market since its
construction has not yet appeared, a scholarly and provocative synthesis of the
available evidence to date is provided in Chapter 10.3 Under the usual assumptions,
2Ibid., p. 143. Attention has also been directed to the effect of differential growth rates on productiv-
ity in food and manufacturing on trade between tropical and industrial countries. This trade has failed
dramatically as an engine of economic growth. See W. Arthur Lewis "Aspects of Tropical Trade:
1883-1965. Wicksell Lectures, Stockholm, 1969.
3William Wallace, "Economic Divergence in the European Community: Conclusions," Chapter 10 in
this publication. For statistical material on the period 1958-1979 (data for 1980 is estimated) dem-
onstrating that the member states of the community experienced an increase during the 1970s in the
degree of divergence in terms of inflation rates and exchange rates, in comparison with earlier years, see
E. C. Hallett, "Economic Convergence and Divergence in the European Community: A Survey of the
Evidence," Chapter 2, in Economic Divergence in the European Community, edited by Michael Hodges
and William Wallace (London: George Allen and Unwin, 1981), p. 30. While there was no increased
disparity in growth rates, there was increased synchronization of cyclical fluctuations and an emergence
of a two-tier community caused by a convergence within one group of countries (France, Belgium, The
Netherlands, Luxembourg, Denmark, and Germany), "and with current prices and exchange rates
apparently forcing a wedge further between the upper and lower tiers ' ' (ibid., p. 30). The reader may also
wish to consult the expert studies on Economic Policies of the Common Market, edited by Peter Coffey
(London: Macmillan, 1979); and Pierre Maillet, The Construction of a European Community: Achieve-
2 Introduction
it appears that less developed countries (the LDCs) are unlikely to derive economic
gains from the formation of common markets. However, econometric projections
for the 1980s and 1990s show that the growth rates of world output and trade are
more likely to approximate those of the dismal 1970s rather than those of the heady
1960s. In consequence—and because of the failure, to date, to establish a realistic,
gradual, and step-by-step process for the evolution of a North-South expansion in
specified categories of foreign trade—these factors have led to a resurgence of
interest in new forms of economic integration among countries of sub-Saharan
Africa, the Pacific Basin region, and the Caribbean. The analysis of the pertinent
issues needs to be made more operational, especially as it applies to trade among the
more—and the less—rapidly industrializing nations. At present, the industrial
countries of Europe are preoccupied with their domestic economic affairs. Con-
sequently, if leadership in international economic policy is to be provided in this
field, the responsibility then falls on the government of the United States.
The selections included in Part V pertain to international cartels, commodity
agreements, and the oil problem. Emphasis centers on the economic analysis and
historical experience of relevant price fluctuations and price trends. The economics
of exhaustible resources and of the world oil outlook is briefly but critically
examined. This appraisal lends itself to comparison with the Link System simula-
tions for 1981-1990, presented in the concluding chapter of this volume, the results
of which furnish a long-term projection of world trade, output, and prices when the
real price of oil remains steady, rises gradually, or rises by way of discontinuous
shocks.4
In Part VI, multinationals and international investment are considered. The
chapters provide a synthesis of the roles of direct foreign investment and foreign
trade under competitive and monopolistic conditions. Original contributions appear
on the "product cycle" and on "uneven development."
Part VII concentrates on commercial policies of developed and developing mar-
ket economies. Salient facts of industry and trade of seven developing countries
have been published by the Organization for Economic Cooperation and Develop-
ment (OECD).5 Basic information is further provided in nine volumes of a special
ments and Prospects for the Future (New York: Praeger, 1977), originally published in French as La
Construction Européenne (Paris: Presses Universitoires de France, 1975), especially Chapters 1 and 3 for
the effects of the common market on Europe, and Chapter 4 on European macroeconomic adjustments.
4See John H. Lichtblau, "Factors Affecting World Oil Prices in the 1980s," Chapter 13 in this
publication; and Lawrence R. Klein, "Some Economic Scenarios for the 1980s," Chapter 31. For a
more extensive treatment, see L. R. Klein, S. Fardoust, V. Filatov, and V. Su, "Simulations of the
World Impact of Oil Price Increases: An exercise in Supply Side Economics," to appear in Lawrence R.
Klein, Supply and Demand Side Economics: Two Blades of the Shears (Berkeley: University of Califor-
nia Press, 1982.). Excellent discussions on some of the theoretical issues involved, with references to
practical problems, are provided by R. M. Solow, "The Economics of Resources or the Resources of
Economics," American Economic Review 64, no. 2 (May 1974), pp. 1-14; and D. M. G. Newbery,
"Oil Prices, Cartels, and the Problem of Dynamic Inconsistency," Economic Journal 91 (September
1981), pp. 617-646.
5See especially I. M. D. Little, T. Scitovsky, and M. Scott, Industry and Trade in Some Developing
Countries: A Comparative Analysis (Paris: OECD, 1970).
Introduction 3
conférence series published by the National Bureau of Economic Research.6 In
addition, two volumes summarize the experience of these foreign trade regimes and
their impact on development. One explains the causes for successes and failures of
economic liberalization attempts, the other outlines the overall results.7 Even the
summaries of these volumes, however, are either too lengthy, or too closely linked
to their context, for feasible inclusion in this book. Nevertheless, for an appraisal of
current commercial policies of the developing market economies, a brief statement
of the core of this research is indispensable.
The evidence appears to be generally consistent with the following conclusions.
The more closed the regime, the lower the growth rate in exports and in GNP.
Furthermore, for the middle-income LDCs, the more closed regimes were usually
associated with the following characteristics:
1. more comprehensive import-substitution programs;
2. greater ' 'bias' ' against exports, denoted by the greater extent to which relative
incentives for domestic production of items not traded and import substitutes were
distorted away from international relative prices;
3. higher variance in price differentials among commodity categories;
4. more distorted relative factor prices and less efficient relative factor use, and
less efficient finished-product markets;
5. larger investment in capital-intensive sectors;
6. lower domestic value added to capital employed;
7. lower real profits;
8. smaller inflow of governmental and private capital, signifying lower gross
investment relative to gross national saving as a percent of GNP;
9. less optimal, and more erratic, composition of imported inventories;
10. greater instability of agricultural and food supplies; and
11. larger excess capacity of plant utilization in manufacturing production.
The first selection in Part VII (taken from a more comprehensive source based on
independent research that is complementary to the summary in the preceding),
succinctly sets forth the lessons and prospects for the choice of a development
strategy.8 Balassa first analyzes the results of inward- and outward-oriented de-
velopment strategies. The lessons of experience—such as the exceedingly high cost
incurred by many developing nations as a consequence of their governments ' im-
plementing erroneous economic policies—stand out clearly. Chapter 18 by Myint,
an important article in the history of economic thought, examines the relevance of
6See "A Special Conference Series on Foreign Trade Regimes and Economic Development," result-
ing from a National Bureau of Economic Research project. The series includes nine country studies:
Turkey, Ghana, Israel, Egypt, The Philippines, India, South Korea, Chile, and Colombia, and synthesis
volumes noted in the following.
7Anne O. Krueger, Liberalization Attempts and Consequences (Cambridge, Mass.: Ballinger Pub-
lishing Company, 1978); and Jagdish N. Bhagwati, Anatomy and Consequences of Exchange Control
Regimes (Cambridge, Mass.: Ballinger Publishing Company, 1978).
8Bela Balassa, The Process of Industrial Development and Alternative Development Strategies, Es-
says in International Finance (Princeton: Princeton University Press, 1980).
4 introduction
classical international trade theory as a guide to commercial policy and to the
economic growth of underdeveloped countries.
Chapter 19 by Prebisch deals with the global system of capitalism in Latin
America.9 Because this chapter is a résumé of a critically important book published
in Spanish that is not yet translated into English, the book itself needs to be placed in
perspective.
Since World War II, Prebisch has not only raised the key economic issues facing
Latin America, and proffered solutions for dealing with them, but has perceptively
and provocatively altered some of his fundamental approaches and recommenda-
tions in the light of new evidence and superior analysis. Prebisch has had a greater
influence on Latin American international development policy than any other
economist, and his influence on government officials and academic economists in
other newly industrializing countries (NICs) has also been marked. This is under-
standable, for the fundamental issue facing Latin America—the struggle for orderly
development in an epoch of revolutionary change, characterized by massive migra-
tions from rural to urban areas, often aggravating the spread of urban decay and the
mounting unemployment in the major cities—has plagued other industrializing
nations no less than those of Latin America. With the projections of lowered growth
rates in world GNP and international trade for the 1980s, the "interior concept" of
economic development has undergone a resurgence (though a moderate one) and the
author has once again drawn attention to fundamental, emerging issues.
Four developments in Prebisch's writings readily can be distinguished:
1. the emphasis in the late 1950s on strengthening the Latin-American indus-
trialization process through differential tariff protection, import substitution, and the
creation of a common market for trade and investment integration;10
2. The recognition by the mid-1960s that the "first," or "easy," stage of sub-
stitution of domestic manufacturing production for imports has passed, and that
Latin American exports should be promoted through the removal by industrial
countries of their trade barriers to imports of manufactures from Latin America;11
3. the call in the late 1960s for tariff preferences with respect to Latin American
exports of manufactures to the United States and other industrial nations, as well as
for more effective economic integration among the major Latin American nations
through the use of Special Drawing Rights (SDRs) and the elimination of their
overvalued exchange rates12; and
9Raul Prebisch, Chapter 19 in this publication.
10Raul Prebisch, "Commercial Policy in the Underdeveloped Countries," American Economic Re-
view 49 (May 1959), pp. 251-273.
11 Raul Prebisch, Towards a Dynamic Development Policy for Latin America (New York: United
Nations, 1963); Towards a New Trade Policy for Development (New York: United Nations, 1964), pp.
20-25.
12Cf. United Nations Economic Commission for Latin America, Economic Bulletin for Latin America
(New York: United Nations, 1967), vol. 12, no. 1, pp. 35-55; also vol. 12, no. 2, pp. 146-147.
Prebisch also expressed similar views at a conference on the 25th anniversary of Bretton Woods held at
Queen's University, Kingston, Ontario, Canada, June 2-3, 1967.
Introduction 5
4. the synthesis of his views in the early 1980s, the essence of which is an
enhanced rate of capital accumulation; this is to be achieved via a reduced propor-
tion of GNP devoted to profligate government expenditures and class-conscious
conspicuous consumption, and an enlarged proportion (directed by government)
devoted to more productive investment through the greater use of private entre-
preneurial capacity and improved market structures, supported by preferences on
exports of manufactures and selective import substitution.13
Prebisch has had much practical experience in guiding and evaluating the process
of Latin American economic development. With reference to his earlier views, he
believes that after World War II, an import-substitution strategy was essential for
Latin America because imports were "undercutting" the development of "nas-
cent" industries. To overcome this handicap, trade barriers had to be erected but
they were to be temporary—not permanent. Prebisch also recommended policies
for Latin American economic integration, which were to help achieve essential
internal and external economies of scale. But, he now maintains, the trade barriers
against the outside world were to be moderate, whereas most Latin American coun-
tries pushed them to the extreme. Furthermore, he had advocated North-South
economic cooperation, which, in his judgment, the industrial countries failed to
implement: "The centres," Prebisch writes in Chapter 19 of this volume, "have by
no means encouraged this process through changes in their production structure; and
by failing to open their doors to manufacturing imports from the periphery, they
force the latter to continue with import substitution."14
Prebisch appears to concur, however, in the general consensus that has arisen
regarding the effects of the tariff and of the quantitative restrictions imposed by
most Latin American governments in the 1950s and 1960s. They had inordinately
reduced foreign competition. Domestic firms became relatively more inefficient as
they expanded production of substandard commodities for highly priced and com-
paratively small, internal markets. These factors, he points out, contributed to his
focusing attention on the markets of the "centre countries"—the United States,
Western Europe, and Japan. But Latin American manufacturers could not compete
in these markets without preferential tariff treatment. Consequently, the United
Nations Commission on Trade and Development (UNCTAD) was formed in 1963 to
help Latin American countries compete. As its first secretary general, a post he held
for 6 years, he made this organization the focal point of the North-South dialogue.
In effect, the concepts developed by UNCTAD induced the United Nations General
Assembly in 1974 to pass the unattainable, even if desirable, comprehensive reso-
lutions for a "new international economic order."
The more promising paradigm that Prebisch now advocates appears to have taken
account of the serious errors made both by the industrializing and the industrial
countries in recent decades. The extreme trade restrictions of the NICs not only
,3Raul Prebisch, Chapter 19 in this publication.
14Ibid.
6 Introduction
hindered competition from imports, but also had the effect of discriminating against
their exports. Explicitly, this was brought about by high taxes on exportables and
implicitly, by overvalued exchange rates that resulted from the cost-price raising
tendencies of the immoderate trade restrictions. It was the combination of ill-
advised economic policies and the movement from the first stage of import substitu-
tion to the second stage that resulted in the vast and costly economic distortions. The
first stage usually entailed the replacement by domestic production of imports of
nondurable consumer goods (e.g., clothing, shoes, and household wares), and of
their inputs (e.g., textiles, leather, and wood products). Characteristically, the NICs
had a dynamic comparative advantage in these industries. They are usually labor
intensive, and do not require highly skilled workers and sophisticated technologies
or a network of suppliers of parts and components for the attainment and mainte-
nance of international competitiveness. Their efficient scale of output is relatively
low and their expansion tends to generate an increasing supply of entrepreneurial
ability, improved labor training, and technology.15
The second stage of import substitution involved, however, the replacement of
imports of consumer and producer durables (as well as intermediate inputs) by
domestic production. The intermediate inputs were composed of goods such as steel
products and petrochemicals. The required conditions for efficient production, un-
derstandably, were converse to those prevailing in industries referred to as appro-
priate for the first stage of import substitution. Propelled by exorbitantly high rates
of effective tariff protection, these products generated exceedingly high domestic
resource costs relative to foreign exchange earnings, because the need to import key
materials and machinery virtually always was enlarged. Furthermore, the neglect of
intraindustry relationships resulted in enormous economic waste, with the over-
pricing of industrialization to be matched only by the underpricing of agriculture.
The result was an uneconomic relative contraction of output in food and agriculture,
aggravating inflationary pressures and external deficits. Since nominal rates of
interest usually lagged behind the rise of domestic prices, much wasteful private and
public investment was undertaken, and credit rationing by the banks and/or gov-
ernment was imposed.
Not surprisingly, Prebisch regards the immense economic waste in the policies of
overextended governments of the NICs and in the new consumption patterns of the
elite and middle classes—especially in his native Latin America—as basic factors
in their distorted economic structures. Nevertheless, he contends that market forces
are not and cannot be ' 'the supreme regulator of the development of the periphery
and its relations with the centre. "16 Notwithstanding their satisfactory growth rates
in the 1960s and 1970s, he points out, income distribution in Latin America remains
15For an extensive analysis, see Bela Balassa, The Process of Industrial Development, pp. 4-9; and
the sources cited therein. This essay retains the format of the Frank D. Graham Memorial Lecture
delivered by the author at Princeton University. It eschews footnote references, but a list of the author's
publications from which the empirical evidence cited in the essay (and in Chapter 17 of this publication)
is derived, is contained in an appendix. Ibid., pp. 29-30.
Introduction 7