Themes in International Economics

Mats Lundahl

• Publisher: Routledge
• Year: 2018
• ISBN:
  9780429774515
• Edition: 1
• Topic: Business
• Subtopic: Business General
• Index: Business

First published in 1998, this collection of essays deals with four different areas of international economics: the theory of international trade, trade and development, protectionism and factor movements (notably migration and foreign aid). These themes explore the determinants of trade patterns, the relation between these patterns and those of underdevelopment and development, the failure of protectionism to increase welfare and, finally, the impact of emigration on the source country and that of foreign aid on the recipient country.

1 Introduction

This book collects essays within the field of international economics. Four different themes are explored: theories of international trade, trade and development, protectionism and factor movements (notably migration and foreign aid). These themes explore the determinants of trade patterns, the relation between these patterns and those of underdevelopment and development, the failure of protectionism to increase welfare and, finally, the impact of emigration on the source country and that of foreign aid on the recipient country.

The first section centers on three important contributions to the theory of international trade. The first was made by T.M. Rybczynski in 1955. On the surface this contribution may appear a bit trivial, because it simply states that when a certain production factor grows or is accumulated there will be a tendency for lines of production using this factor intensively to grow and for other lines to contract. In reality, this theorem is far from trivial, however. It is one of the most useful in international trade, with wide applicability both in theoretical work and in the investigation of what happens in real economies. The theorem was derived in the standard setting of neoclassical trade theory: two goods, two factors and constant returns to scale. Presently the latter restriction is relaxed and conditions are derived for when the theorem carries over to the case of diminishing returns to scale.

The other two theories are the vent-for-surplus approach, pioneered by Adam Smith, and in the modern context by Hla Myint in 1958, and the staples theory of trade and growth, originated by Harold Innis in the 1930s. In recent years both these theories have gone slightly out of fashion, for reasons that are a bit difficult to understand, as once they are examined closer, their ability to explain the opening of trade and its further consequences in primary-producing economies is striking. Here these theories are surveyed and unified in a common framework that captures a number of historical episodes from economies as diverse as the regions of recent settlement, plantations and peasant economies.

The staples theory is connected with development issues in the second section, where concrete instances of trade and development (or underdevelopment) are examined. The first of these, the opening of trade in Spanish America, turns out to be an episode where conventional approaches have a relevance that is marginal at best. What happened and what the consequences were cannot be properly understood outside the institutional context of the fifteenth and sixteenth centuries. Two other Latin American episodes, Chile from the mid-nineteenth to the mid-twentieth century, and Costa Rica since the 1830s, are easier to relate to the staples approach. Finally, the role of economic integration in a development context is examined, with examples from Asia and Latin America.

The third section examines the consequences of turning inwards – of not making use of international trade. The case is that of Swedish agriculture during the post World War II period. This sector has been subjected to goals which are largely of a non-economic nature, notably that of having to feed the population in case of an emergency resulting in a disruption of normal trade patterns. First the historical causes behind this goal are sketched and thereafter different formulations of the contingency target are compared with respect to what the optimal policy should look like. The results are contrasted with the course followed in practice: protection of the sector against competition from the world market.

The fourth and final section focuses on factor movements. International migration is analyzed in two different settings: one where the emigrants remit some of their income back home, and one where brain drain triggers capital outflows and emigration of unskilled labor as well. The chapters in this section examine the welfare consequences of these migratory currents for various groups. The effectiveness of foreign aid, notably Swedish aid, to Tanzania, Zambia, Nicaragua, and Guinea-Bissau, is examined both in a macroeconomic and in a microeconomic perspective. The connection between policy reform and aid is also investigated. A similar thread is picked up in the last essay, which analyzes the experience of structural adjustment in a number of African economies.

Theories of international trade

Chapter 2, ‘The Rybczynski theorem under decreasing returns to scale’ (written with Göte Hansson), deals with one of the most fundamental and useful theorems of international trade: the so-called Rybczynski theorem. This states that in a model with two goods and two production factors with production functions that are linearly homogeneous (i.e. that do not exhibit any economies or diseconomies of scale), if one of the factors grows, the sector employing the growing factor intensively will increase its output in absolute terms while the output of the other sector will shrink, as long as commodity prices remain constant.

The reason for this is that, with linearly homogeneous production functions, there is a one-to-one correspondence between relative commodity prices, relative factor prices, and factor intensities in the two sectors. If we know something about the commodity prices we are also in the position where we can predict the techniques used by each sector. Thus, if commodity prices are to remain constant, factor intensities may not be altered. Let us allocate the entire addition to the factor endowment to the sector that uses this particular factor intensively. This, however, will violate the constant techniques requirement unless the same sector receives enough of the other factor to restore the original factor proportions. Hence, this sector will increase its output. The addition of the non-growing factor could come only from the other sector, but if the constant factor proportions requirement is not to be violated in that sector either, the sector must release some of the other factor as well. Its output hence must shrink.

The Rybczynski theorem is eminently applicable in general equilibrium analysis. It often enters in the intermediate stage in comparative statics, between one full equilibrium and the next. The factor endowment changes; the population and labor force increases and capital is accumulated. This, in turn, will affect both production, consumption, and factor use and change relative prices, and with that also the incomes of different groups in the economy. The comparative static analysis of these changes usually proceeds in two steps. First, prices are held constant, and the Rybczynski effects are derived. Thereafter, the system is solved for the changes in relative commodity prices that results from the changes in demand (incomes) and supply that take place at given prices. Finally, the effects on factor prices and incomes of these price changes are traced.

The Rybczynski theorem is of great practical applicability as well. One case in point is land erosion. Agricultural economies in the less developed world can often be modeled in terms of land and labor only, since the use of capital is negligible. Thus, we may think of peasant societies as producing two types of goods, food crops and export crops, with the aid of land and labor. Assume furthermore that food crops are labor-intensive and exports land-intensive, and that the production of labor intensive goods tends to lead to erosion, while production of export goods does not. The latter may be perennial, like coffee, meaning that they tend to bind and protect the soil, while food crops could be annual or harvested several times per year, i.e. they require that the soil has to be laid bare when the time to sow and plant comes, which in the tropics normally is during the rainy season. Finally, we may assume that the terrain in which agriculture takes place is hilly or mountainous.

With these assumptions, population growth will produce soil destruction. The Rybczynski theorem states that the increase in the labor force will lead to increased output of food crops and reduced output of export crops. Annual crops are substituted for perennial ones. The extent of erosion increases, meaning that the land area that may be used for agriculture shrinks. Then the Rybczynski theorem may be applied ‘backwards’. A shrinking land area will have the same effect as a growing population, i.e. it will increase the man-land ratio. Again, the output of foodstuffs will increase and that of export goods decrease, etc. The process will feed back on itself, even in the absence of further population growth, and if the population continues to grow, it will become cumulative, unless relative commodity prices change enough to reverse the chain of events.

Like other standard theories of international trade, the Rybczynski theorem was originally developed for the case of linearly homogeneous production functions. It makes use of one of the characteristics of such functions: that constant relative commodity prices imply constant relative factor prices and factor proportions as well. One may perhaps suspect that the theorem would not carry over to situations where one or both sectors exhibit decreasing or increasing returns to scale. Chapter 2 deals with the case of decreasing returns. The chapter demonstrates that the Rybczynski theorem does indeed carry over to the case of decreasing returns to scale in one or both sectors as well, provided that the difference between the factor intensities of the two sectors exceeds a certain minimum value.

The economic explanation of the decreasing returns case is the following. Let us assume that the labor force increases while the capital stock remains constant. Then, first of all, the output of the labor-intensive good must increase and that of the capital-intensive good must contract. This is the standard Rybczynski effect. However, once we allow for decreasing returns to scale, profits will emerge in the contracting sector and losses in the expanding one. Thus, the scale effect will neutralize the Rybczynski effect and the entire addition to the labor force will be unemployed. The solution to this dilemma is that factor prices must change at given commodity prices. The relative and absolute price of labor must fall and that of capital rise. Both sectors will employ more labor-intensive methods. The labor-intensive sector will expand since costs will be reduced there. What happens with the capital-intensive sector is uncertain. If the wage reduction is large enough to outweigh the cost-raising effect stemming from the increasing cost of capital, its output will increase, but if factor intensities differ enough, the stimulus to labor-intensive production exerted by the falling wage may be strong enough to make the former sector expand so much that it pulls factors away from the latter, aided by the cost rise emanating from the rise of the price of capital. Thus, relative factor intensities play a crucial role here.

It is easy to think of applications of the Rybczynski theorem in the case of decreasing returns. For example, agriculture is likely to display disadvantages to scale. Adding capital and labor in equal proportions to a given land area will produce this result. Then, if wages are inflexible downwards and/or a ceiling on interest rates exists, the labor market may not clear and unemployment will arise. This is a typical situation in many developing countries with minimum wage legislation and strong unions on the one hand, and anti-usury legislation or subsidized interest rates on the other. Mining would be another case in point, with decreasing returns to scale as increasingly lower-grade ores are mined.

In Chapters 3 and 4, attention is turned to the so-called staples theory of international trade. A staple is a product that has a large natural resource content. It is in high, and preferably increasing, demand in the international market and its value per unit of weight or volume is large enough to make transportation over long distances of the unprocessed product commercially viable. Staples are typically either agricultural goods or minerals. They enter the international market either as a result of increased demand, discovery, or development of new technologies and their production entails linkage effects with other sectors of the economy in the sense of Albert Hirschman, i.e. they may serve as inputs for other sectors or use other sectors’ output as inputs. Furthermore they generate incomes that may be spent domestically, either by the income earners themselves or by the government, after taxation, and which hence generate further demand and incomes. The staples theory is not only a theory of international trade but in addition a theory of how trade may generate growth.

Chapter 3, ‘Staples trade and economic development’, surveys the staples theory: how trade is opened, the short-run effects of trade, linkage and income effects in the somewhat longer perspective, and, finally, the issue of to what extent a staple-led economy can transform and become less dependent on staples. Before the opening of trade, the economy to which the staples theory applies should be thought of as a sparsely populated one, but with abundant natural resources of some kind – resources that have so far not been exploited other than marginally, for one or more of the reasons given above. Once the demand is present, the resource is discovered, or the technology required for its exploitation becomes available, exports begin, either in a Heckscher-Ohlin fashion, with increasing specialization on the production possibility curve, or by moving the economy from production somewhere inside the curve, putting hitherto unutilized resources to work. Transportation facilities are devised that allow the product to leave the country.

The staples theory of trade and growth differs from the standard Heckscher-Ohlin framework in that it involves mobility of production factors across national boundaries. Typically, the capital needed to exploit the natural resource comes from abroad, along with the technology and the skilled labor required, and, if the population is small, unskilled workers as well may have to be acquired through immigration from more densely populated areas. The opening of trade introduces a new sector in the economy: resource-intensive goods produced with the aid of some new production factors. To this corresponds the shrinking of the traditional handicraft sector which, if industrially produced goods and handicrafts are close substitutes, runs the risk of being completely destroyed by cheaper imports of manufactures from overseas nations.

What will happen in the staple-led economy in the long run is not clear. The crucial issue is whether the staple sector will transmit growth impulses to other parts of the economy as well. One distinct possibility is that the export sector will form an enclave without much contact with the rest of the economy, with most of the production factors coming from abroad and with most of the incomes generated being spent on imports or outside the country. The alternative is that growth and development will spread, and what to a large extent will determine the outcome is the production function of the staple. Thus, plantation crops, like sugar, as well as mining, have characteristics that make the emergence of an enclave likely. They entail substantial economies of scale. Large amounts of capital are used together with unskilled labor whereas relatively few people are involved in supervisory and managerial functions. The possibilities for substituting labor for capital are limited. It is hence difficult to set up similar undertakings for domestic entrepreneurs who lack capital on the necessary scale. Also, the income distribution produced by these units will be highly uneven, with the labor force being seasonally unemployed, generally working on subsistence-like small farms in the meantime. Both these facts tend to make it very difficult for the staple sector to generate linkages with other parts of the economy.

The opposite pole is represented by staple production in the setting of the family farm, producing, for example, wheat, where the optimum scale is lower and the elasticity of substitution between labor and capital higher. No specialized managerial or supervisory staff is needed but the family farm setting provides better incentives for education of the work force because of the comparative ease of setting up independent production units, which in turn to a large extent is a result of the more equal income distribution generated and of the fact that the items produced are more likely to be consumed domestically as well. These farms are more likely to use domestically produced inputs than plantations and the incomes generated are to a much larger extent spent on domestic goods and services.

In the very long run, the staple-led economy usually faces the problem of transformation into other activities as the demand for the staple tends to weaken over time, as tastes change, substitutes are developed, new producers appear, or technological progress allows less of the good in question to be used as an input. If so, the economy must move into other lines of production if the growth rate is not to decline. There is, however, no guarantee that this will take place. Plantation economies, not least, are likely to experience substantial problems in this respect because they have created a per capita income level, an income distribution, and an educational level that do not facilitate a move into manufacturing, which is where the economy would have to go unless it is fortunate enough to develop new staple products that can take the place of the old ones. The overall flexibility of the economy is limited.

Chapter 4, ‘Natural resources, “vent-for-surplus” and the staples theory’ (co-authored with Ronald Findlay), develops the staple theory of trade and growth formally. The point of departure is the obvious relationship between the staples setting and the vent-for-surplus approach originated by Adam Smith and resurrected by Hla Myint in 1958, and the chapter sketches a theory of trade and growth that employs and unifies concepts from both the vent-for-surplus and the staples settings.

The chapter first accounts for a number of real-world instances of staples trade in agriculture-based economies in three different institutional contexts: the so-called ‘regions of recent settlement’, i.e. the temperate zones of European settlement in Australia, New Zealand, and the Americas, the tropical plantation economies, and, finally, ‘peasant export economies’, in Africa and Asia. The regions of recent settlement are represented by Canada, the United States, Argentina, and Australia. The well-known staples story of Canada deals with furs, cod fisheries, and wheat, spurred by increasing demand and prices in the world market and inflows of both capital and labor from abroad. Wheat cultivation served to move the frontier on the prairie and substantial linkages were created, not least by the development of the transportation network, and a manufacturing industry developed.

The United States story is similar. The expansion of cotton in the antebellum South generated linkages to the Northeast, notably in manufactures, but also in finance, transportation, and services, and the West, and supplied the South with grain. In the process the frontier moved west and canals and railroads developed in the process. This continued after the Civil War, but at that point new staples – wheat, livestock, and minerals – had developed, and industrialization was in full swing in the East. All this was fomented by a steady inflow of capital and workers from Europe.

From the late nineteenth century until the beginning of the depression in 1929 Argentina embarked on a staples export path with rising incomes being fueled by animal products and grains, produced by European immigrants and financed by European and North American capital. Transportation developed and the land frontier in the Pampa expanded steadily, concentrating the land in the hands of a powerful oligarchy that was to dominate politics during the period. Little by little a domestic consumer goods industry was established that would be protected by tariffs as staples-led prosperity came to an end with the world depression of the 1930s. Developments in Australia had much in common with Argentina: the open range and the inflows of both labor and capital during the nineteenth century. Gold and wool provided the impetus.

Two plantation ec...

Table of contents

• Cover
• Half Title
• Title Page
• Copyright Page
• Table of Contents
• List of tables and figures
• Acknowledgements
• Preface
• 1 Introduction
• I Theories of International Trade
• II Trade and Development
• III Protectionism
• IV Factor Movements and Structural Adjustment
• Index