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Research Paper No. 992
\‘
THEORETICAL ISSUES CONCERNING THE HISTORY OF
INTERNATIONAL TRADE AND ECONOMIC DEVELOPMENT
Gerald M. Meier
Delivered at the Free University, Berlin, May 6, 1988.
IAnalyses of the contribution of international trade to economic development
display a curious tension between pessimistic and optimistic conclusions. If a
nation follows its comparative advantage and realizes the gains from trade will it
also be on its optimal development path? Or, in contrast, should the nation
abandon comparative advantage and relinquish the gains from trade the better to
secure the gains from growth? Theoretical perspectives on this issue can come from
classical trade theory, neo classical trade theory, and recent theories of international
trade. Historical perspectives can be derived from even before the industrial
revolution; subsequent papers will illuminate the historical experience of a number
of countries. This paper focuses on the theoretical issues, with concentration on the
pessimistic optimistic strand in the history of thought.
A colleague’s Festschrift is a stimulating occasion for one’s own retrospection,
and perhaps a bit of autobiography can sharpen the central issue that I want to
discuss. When I first studied international trade in the early 1950s at Harvard with
Professor Gottfried Haberler, the theory of international trade theory took resources,
technology, and tastes as given. The following year at the University of Oxford, Hia
Myint introduced me to problems of economic development, and I studied the
macrodynamic models of Roy Harrod and John Hicks. I then read the pioneering
works of Ragnar Nurkse and Arthur Lewis. Both Nurkse and Lewis were
pessimistic about the power of international trade to act as an “engine of growth” (in
D. H. Robertson’s phrase)l for the late developing nations of Asia, Africa and Latin
America. And Harrod and Hicks were stressing the importance of dating variables
that are changing. The problem for me thus became how to relate the great
tradition of Ricardo, Marshall, and Edgeworth on comparative advantage and the
1
D. H. Robertson, “The Future of International Trade,” reprinted in American Economic Association,
Readings in the Theory of International Trade, (1949), p. 501.
2static gains from trade with the development issues raised by Nurkse and Lewis and
with the dynamic theory introduced by Harrod and Hicks.
I want to pursue that problem again here. I shall, however, offer a necessarily
highly condensed statement of the relationship between international trade and
economic development from different theoretical perspectives, and I shall
concentrate on only these limited issues in trade pessimism theory: the stimulus
from exports in an open dualistic economy, and import substituting
industrialization versus export promotion strategies.
1. Classical Trade Theory and Growth
Extremely simple but justly celebrated, Ricardo’s model of England and
Portugal and cloth and wine establishes a basis for international specialization
according to comparative differences in real cost. In his 2 country2 commodity 1
factor (labor) model, Ricardo demonstrated that under conditions of free trade, a
country will specialize in the production and export of those commodities for which
its costs are comparatively lowest, and will import commodities it can produce only
at high relative cost. The cost of “indirectly producing” imports through
specialization on exports is less than if the country directly produced the importables
at home. In following its comparative advantage, each country maximizes output
(imports) per unit of input (exports). The welfare result, according to Ricardo, is that
“the extension of foreign trade. . . will very powerfully contribute to increase the
2mass of commodities, and therefore, the sum of enjoyments.” And these gains
from trade will accrue to each trading nation: trade is symmetrically beneficial. We
would now phrase Ricardo’s conclusion on the merits of free trade in terms of an
2
David Ricardo, Principles of Political Economy, (1817).
3increase in real national income attained by an optimal allocation of resources on a
worldwide basis theattainment of Pareto international efficiency, with trade as a
positive sum game.
Perhaps of even more significance for developing countries are two earlier
versions of trade theory in classical thought a“vent for surplus” theory and a
3dynamic “productivity” theory. These two theories are clearly expressed in Adam
Smith’s Wealth of Nations:
Between whatever places foreign trade is carried on, they all of them derive
two distinct benefits from it. It carries out that surplus part of the produce of their
land and labour for which there is no demand among them, and brings back in
return for it something else for which there is a demand. It gives a value to their
superfluities, by exchanging them for something else, which may satisfy a part of
their wants, and increase their enjoyments. By means of it, the narrowness of the
home market does not hinder the division of labour in any particular branch of art
or manufacture from being carried to the highest perfection. By opening a more
extensive market for whatever part of the produce of their labour may exceed the
home consumption, it encourages them to improve its productive powers, and to
augment its annual produce to the utmost, and thereby to increase the real revenue
and wealth of society (Vol. I, Cannan ed., p. 413).
Smith’s “vent for surplus” theory of international trade contrasts with
Ricardo’s comparative cost theory in two ways: 1) the comparative cost theory
assumes that a nation’s resources are given and fully employed before the nation
enters into international trade. After being opened to trade, the country faces a new
set of relative prices on world markets, and reallocates its given resources more
3
For more detailed exposition, see HIa Myint, “The ‘Classical Theory’ of International trade and the
Underdeveloped Countries,” Economic Journal, June 1958, PP. 317 337. The term “ventfor surplus” was
first used by John H. Williams.
4efficiently between expansion of export production and contraction of domestic
production. In contrast, according to the vent for surplus theory, the country enters
into international trade with surplus productive capacity over domestic
consumption requirem~ents. The function of international trade then is not to
reallocate given resources but rather to provide the new effective demand for the
output of surplus resources that would have remained unutilized without trade.
Export production can thus be increased without reducing domestic production;
exports become a virtually costless means of acquiring imports and expanding
domestic activity. This was how Smith used the theory to support free trade.
J. S. Mill thought this theory crude and “a surviving relic of the mercantile
4theory.” Modern economists may also consider it crude for its deficiencies in
technical analysis. The theory, however, has helped to illuminate some historical
episodes of 19th century development. Myint, for instance, has applied the theory to
the opening up of the primary exporting countries in Southeast Asia, Latin
America, and Africa during the 19th century. When brought into world markets in
the 19th century, these underdeveloped countries began with a sparse population in
relation to natural resources. At this time the economies were essentially
subsistence economies and a well developed price mechanism and high degree of
factor mobility did not exist to equilibrate away the disproportion between land and
labor. As Myint observes, given the genuine historical setting of an isolated
economy, the initial disproportion between its resources, techniques, tastes, and
population showed itself in the form of surplus productive capacity.
Once the opening up process got into its stride, the export production of these
countries expanded very rapidly along a typical growth curve, rising very sharply to
begin with and tapering off afterwards. Peasant export production of a traditional
4
Principles of Political Economy (1848), p. 579.
5crop (for example rice in Southeast Asia) expanded by using underemployed labor
and by bringing more land under cultivation with the same traditional methods of
cultivation. Even where new peasant export crops were introduced (for example
palm oil and ground nut exports in West Africa), they could be produced by fairly
simple methods that involved no radical change from the traditional techniques of
agricultural production. While peasant export crops expanded by extension of
cultivation using the traditional methods of production, the mining and plantation
sectors of the economy expanded through the inflow of large movements of cheap
labor from India and China and by western enterprise improving transport and
communications and discovering new mineral resources (the “unlocking of the
tropics” in Professor L. C. A. Knowles’ phrase). Rather than making a given
volume of resources more productive, these external influences increased the total
volume of that could be drawn into export production.
Myint concludes that “instead of a process of economic growth based on
continuous improvements in skills, more productive recombinations of factors and
increasing returns, the 19th century expansion of international trade in the
underdeveloped countries seems to approximate to a simpler process based on
constant returns and fairly rigid combinations of factors. Such a process of
expansion could continue smoothly only if it could feed on additional supplies of
5factors in the required proportions.”
5
1 lla Myint, “The Classical Theory of International Trade and the Underdeveloped Countries,”
Economic Journal vol. L)(VIII, June 1958, pp. 317 320
6Some similarities to the Smithian vent for surplus theory also exist in the
6staple theory and in Lewis’ dual sector model of development with unlimited
7supplies of labor.
The term ‘staple’ designates a raw material or resource intensive commodity
occupying a dominant position in the country’s exports. It has a structural )
similarity to the vent for surplusview in so far as “surplus” resources initially exist
and are subsequently exported. It also has some affinity with Lewis’ model when
the surplus to be vented through trade is one of labour and not natural resources.
The staple theory postulates that with the discovery of a primary product in
which the country has a comparative advantage, or with an increase in the demand
for its comparative advantage commodity, there is an expansion of a resource based
export commodity; this in turn induces higher rates of growth of aggregate and per
capita income. Previously idle or undiscovered resources are brought into use,
creating a return to these resources and being consistent with venting a surplus
through trade. The export of a primary product also has effects on the rest of the
economy through diminishing underemployment or unemployment, inducing a
higher rate of domestic saving and investment, attracting an inflow of factor inputs
into the expanding export sector and establishing linkages with other sectors of the
economy. Although the rise in exports is induced by greater demand, there are
supply responses within the economy that increase the productivity of the exporting
economy.
The staple theory also has some relation to Rostow’s leading sector analysis
in so far as the staple exportsector may be the leading sector of the economy,
6Richard E. Caves, “Vent for Surplus’ Models of Trade and Growth, in R. E. Baldwin, et al, Trade
Growth, a~ih~ Balance ~ Payments (Amsterdam: North Holland, 1965), p. 103.
7
W. A. Lewis, “Economic Development with Unlimited Supplies of Labor,” Manchester SchooL vol 21
(1954), pp. 139 191. In Myint’s analysis, as given above, the staple and unlimited labor models are
combined.
7growing more rapidly and propelling the rest of the economy along with its growth.
In Rostow’s analysis, however, a primary producingsector can be a leading sector
only if it also involves processing of the primary product.
8Since the pioneering studies of Harold Innis, the staple theory of economic
growth has often been used to relate the pace of development in Canada to Canada’s
9resource intensive exports. It has also been applied to several other countries.
Although it should not be interpreted as a general theory about the growth of export
oriented economies, it does have illuminating applications to the case of a new
country. It is significant in relating a country’s development not only to its export
revenue, but also to the spread effects of its export sector i.e.,the impact of export
activity on the domestic economy and society.
This emphasis on spread effects brings us back to our more general question
of the contribution of international trade to the pace and pattern of a country’s
development and to the policy implications regarding alternative trade regimes.
Lewis’ dual sector model provides some relationships that should be
considered. Lewis analyzes the process of economic expansion in a dual economy
composed of a “capitalist” sector and a”non capitalist” sector. The capitalist sector is
defined as that part of the economy using reproducible capital, paying capitalists for
the use thereof, and employing wage labor for profit makingpurposes. The
subsistence sector is that part of the economy that does not use reproducible capital
and does not hire labor for profit theindigenous traditional sector or the self
employment sector. In this sector, output per head is much lower than in the
8
Melville H. Watkins, “A Staple Theory of EconomicsGrowth,” Canadian Journal of Economics and
Political Science, vol. xxix, no. 2, May 1963, pp. 141 158. There is also a close relation of the staple
• thesis to Hirschman’s linkage approach; see Albert 0. Hirschman, “A Generalized Linkage Approach
to Development, with Special Reference to Staples,” in Manning Nash (ed.), Essays on Economic
Development and Cultural Change in Honor of Bert F. Hoselitz, (Chicago: University of Chicago Press,
1977), pp. 67 98.
9
Forbibliographical references and a good survey, see Watkins, op. cit.
8capitalist sector; given the available techniques, the marginal productivity of labor
in agricultural production is very low and possibly zero as a limiting case. As a •
result of institutional arrangements, such as the family farm or communal holdings
of land, members of the farm labor force consume essentially the average product of
the farm’s output even though the marginal product of some farm laborers may be
well below the average product. The fundamental relationship between the two
sectors is that when the capitalist sector expands, it draws labor from the reservoir in
the non capitalistsector. Labor is “unlimited” in the sense that when the capitalist
sector offers additional employment opportunities at the existing wage rate, the
numbers willing to work at the existing wage will be greater than the demand: the
supply curve of labor is infinitely elastic at the ruling wage. )
Lewis’ account of how he postulated this fundamental relationship is of
interest. He states that he was concerned with what were the sources of capital
formation in a developing economy. It was clear to him that in the 19th century for
Europe the bulk of finance came from a rising share of profits in the national
income. “And what caused this rise in the share of profits? Neo classical economics
was no help. Keynes’ model provided for the profit share to rise in a cyclical
upswing. The evidence showed, however, that profits share and the saving share
were more or less constant in the long run after 1870, in both Britain and the United
States. What we were getting from the neo classicists. . . were demonstrations of
how to combine long run savings constancy with short run savings volatility. This
was of no use to us, since what we were trying to understand was a long term rise in
the savings propensity.
“As I was walking down a road in Bangkok one morning in August 1952, it
suddenly occurred to me that all one needed to do was to drop the assumption then
usually (but not necessarily) made by neo classical macroeconomists thatthe supply
of labor was fixed. Assume instead that it was infinitely elastic, add that
9productivity was increasing in the capitalist sector, and one got a rising profits share.
It also occurred to me that this model would solve another problem that had
bothered me since undergraduate days: What determined the relative prices of steel
and coffee? I had been taught that marginal utility was the answer to this question.
But this answer made no sense to me. If, however, one assumed an infinite
elasticity of labor in terms of food to the coffee industry, and an infinite elasticity
also in terms of food to the steel industry, then the factoral terms of trade between
steel and coffee were fixed, and marginal utility was out the window. So in three
minutes I had solved two of my problems with one change of assumptions.”lO
Thus Lewis made the driving force in the system the reinvestment of the
surplus in the capitalist sector. As the capitalist sector expands, and the wage price
ratio remains constant, the share of profits in national income increases. And since
the major source of savings is profits, savings and capital formation also increase as
a proportion of the national income. Barring a hitch in the process, the capitalist
sector can expand until the absorption of surplus labor is complete and the supply
function of labor becomes less than perfectly elastic. Capital accumulation has then
caught up with the excess supply of labor; beyond this point, real wages no longer
remain constant but instead rise as capital formation occurs, so that the share of
profits in the national income will not necessarily continue to increase, and
investment will no longer necessarily grow relative to the national income. What
is essential for savings to rise as a fraction of national income is that the internal
terms of trade between agriculture and industry not turn against the modern
capitalist industrial sector: if real wages rise, profits will fall and so will savings.
We may now relate Ricardo to Lewis. Ricardo did not formulate his model as
mere abstraction, but wanted to provide a persuasive case for free trade in order to
10
Arthur Lewis, “Development Economics in the 1950s”, in C. M. Meier and Dudley Seers (eds.) Pioneers
in Development, (New York: Oxford University Press), 1984, pp. 132 133.
10