Effects of Economic Growth on International Trade | International Economics

Economic growth manifests itself in the accumulation of factors and technical progress. Such changes create impact upon trade through the variations in the pattern of production, consumption and the international terms of trade. In this article we will discuss about the production and consumption effects of growth on trade.

Production Effects of Growth:

As the process of economic growth facilitates the increased supplies of factor inputs, there can be some change in the domestic output of exportable commodities. The increased production of exportable goods brings about an expansion in the volume of trade. The large production of importable goods, on the other hand, causes a contraction in the volume of trade.

Although the effect of factor growth upon production was analysed by Rybczynski in a quite simple manner, a more elaborate analysis on this issue was made by H.G. Johnson. He identified growth as neutral, export-biased, ultra- export biased, import-biased and ultra-import biased.

Growth is said to be neutral, when the output of both exportable and importable goods increases in the same proportion, consequent upon accumulation of factors and growth. Growth is said to be export-biased or pro-trade, if the increase in the output of exportable goods is more than proportionate to an increase in the output of importable goods.

The growth is supposed to be ultra-export-biased or ultra-trade-biased, if the increased production of exportable goods involves some reduction in the output of importable goods. In case, the growth reduces the production of exportable goods, it is said to be ultra-import- biased or ultra-anti-trade biased. When growth results in a more than proportionate increase in the output of importable goods than the exportable goods, it can be regarded as import-biased or anti- trade-biased.

Assumptions:

The varying implications of growth for the international trade can be analysed on the basis of the following assumptions:

(i) The trade exists between two countries— A and B.

(ii) The country A is the home country that experiences steady growth.

(iii) There are two productive factors—labour and capital.

(iv) The quantities of the two factors of production increase over the growth process.

(v) The trade is concerned with two commodities—X and Y.

(vi) The X-commodity is the exportable and Y is the importable commodity of the home country.

(vii) The commodity X is labour-intensive, while Y is capital-intensive.

(viii) There is no change in the techniques of production.

(ix) There is incomplete specialisation.

(x) The international terms of trade, measured by the ratio of price of exportable commodity to the price of importable commodity remain constant.

Given the above assumptions the production effects of growth are expressed through Fig. 11.1.

In Fig. 11.1, the labour-intensive commodity X, which is the exportable commodity, is measured along the horizontal scale. The capital-intensive commodity Y, which is the importable commodity, is measured along the vertical scale. Originally PP₁ is the production possibility curve, given the factor supplies and technology. TT₁ is the term of trade line. The production takes place at R where TT₁ is tangent to the production possibility curve.

As growth occurs, the factor supplies increase and the production possibility curve shifts to the right. The terms of trade line is T₂T₃ which runs parallel to the original terms of trade line TT₁. It signifies that international price ratio of X and Y remains unchanged despite growth. If production equilibrium occurs at S, the growth is neutral because there is equi-proportionate increase in output of two commodities and the two factors grow in the same proportion.

If the production takes place in the range S and N, the growth is export biased. In this range, the proportionate change in the output of exportable commodity X is greater than the proportionate change in the output of importable commodity Y. It also signifies that the use of labour is proportionately more than that of capital.

If the production equilibrium is determined in the range N to T₃, the growth is ultra-export biased because the increased production of exportable commodity X involves a reduced production of the importable commodity Y. In case the production equilibrium is determined in the range S to M, the growth is import-biased.

In this range, the output of importable commodity increases more than proportionately compared with the increase in output of exportable commodity. In this type of growth, the use of capital is proportionately greater than the use of labour. If the production equilibrium gets determined in the range M to T₂, the growth is said to be ultra-import biased or ultra-anti­trade biased.

In this situation, the increased production of the importable commodity Y involves a decline in the production of exportable commodity X. The process of production in this range involves an increased use of capital with possibly no increase in labour. The ultra-export biased and ultra-import biased patterns of growth are the extreme cases in terms of their effects on the self-sufficiency or trade-dependence of a growing country and may exist in very few cases.

Consumption Effects of Growth:

The process of growth in a given country denoted by the factor growth can bring about changes in its consumption pattern. If there is an increased consumption of the importable commodity, the volume of trade is likely to get enlarged. On the opposite, if the consumption of exportable commodity registers an increase, there is likely to be decline in the volume of trade. As in the case of production, Johnson has classified the consumption effects of factor growth as neutral, export-biased, ultra-export-biased, import-biased and ultra-import-biased.

The process of growth in a country, expressed through increased factor supplies, can bring about an increase in real income. This can result in changes in the consumption of exportable and importable commodities in varying quantities. The relative changes in the quantities consumed of these commodities determine the nature of growth process having varying implications for international trade.

The growth process is said to be neutral, if the increase in the demand for exportable commodity (X) takes place in the same proportion in which the demand for importable commodity (Y) increases. Growth is import-biased or anti-trade-biased, if the increase in demand for importable good is less than proportionate compared with the increase in demand for exportable good.

The process of growth can be regarded as ultra-import biased or ultra- anti-trade-biased, if the demand for importable commodity decreases in absolute terms. There is export-biased or pro-trade-biased growth, when the demand for importable commodity increases more than proportionately compared with the increased demand for the exportable commodity. When the demand for exportable commodity decreases in absolute terms, the growth process is said to be ultra-export biased or ultra-pro-trade biased.

H.G. Johnson pointed out that the output elasticity of demand for importables can measure the nature of growth in relation to trade. The growth process is import-biased, neutral or export- biased, if the output-elasticity of demand for importable commodity is less than, equal to or greater than unity respectively. If the output-elasticity of demand for importable commodity is negative, the growth process is ultra-import-biased. On the opposite, if the output elasticity of demand for exportable commodity is negative, the process of growth is ultra-export-biased.

The consumption effect of growth, given the constancy of tastes, terms of trade and distribution of income can be shown through Fig. 11.2.

In Fig. 11.2, the original position of production and consumption equilibrium is determined at R. At this point, the terms of trade line TT₁ is tangent to the production possibility curve PP₁, on the one hand, and tangent to the community indifference curve I, on the other. If growth takes place, the production equilibrium shifts to S. It is assumed that terms of trade remain unchanged so that the terms of trade line T₂T₃ is parallel to TT₁.

The consumption equilibrium may get determined at any position on T₂T₃ where it becomes tangent to some higher commodity indifference curve. If the consumption takes place at S, and there are proportionate increases in the consumption of two commodities, growth is neutral. If consumption takes place in the range S to M, the growth is export-biased as the demand for importable commodity Y increases at a proportionately greater rate than the demand for exportable commodity.

If consumption takes place in the range M to T₂, the consumption effect of growth is ultra-export-biased. In case, if consumption occurs in the range S to N, there is an import-biased consumption effect. When the consumption takes place in the range N to T₃, the consumption effect of growth is ultra-import- biased.

The output or income elasticity of demand for imports can determine the implication of growth on trade, if the growth results from some factor other than population growth. In this connection, H.G. Johnon writes, “If growth is due to some other cause than population change, income per hand will rise, and the type of growth will depend on the average income elasticity of demand for imports. If imports are luxury goods, growth will be pro-trade-biased; if they are necessary goods, growth will be anti-trade-biased; if imports are inferior goods, growth will be ultra-anti-trade- biased and if exports are inferior goods, growth will be ultra-pro-trade-biased.”

So far in this analysis, it was supposed that the tastes pattern and distribution of income remain the same. With the expansion in income, subsequent to growth, there can be change in tastes pattern and income distribution. These factors can bring about significant change in the relative demand for the two commodities.

Combined Production and Consumption Effects of Growth:

In a growing country, the total effect of growth represents the combined result of its effects on production and consumption.

If there is complete specialisation in production, the country does not at all produce the importable commodity and the total effect of growth is determined entirely by the shift in consumption equilibrium due to the expansion of income. In such a situation, the overall effects of growth can again be neutral, export-biased, ultra-export biased, import-biased and ultra-import-biased depending upon the relative changes in the demand for imports and supply of exports.

If there is incomplete specialisation, and the given country produces both the commodities, the demand for her imports is measured by the excess of total demand for and the domestic supply of the concerned commodity. The total growth effect on the demand for imports is, therefore, the net effect of the production and consumption effects of the importable commodity.

This total effect determines the extent or direction of shift in the offer curve of the growing country. As shift takes place in the offer curve of the given country, it becomes possible to ascertain its impact on the volume and terms of international trade.

If both consumption and production effects are neutral, the overall growth effect in the growing country, say A, is also neutral. But the domestic supply of importable commodity being a smaller proportion of the total production than the proportion of consumption of imports to the total consumption, the price of importable commodity is likely to be relatively higher than before. As a result, the terms of trade are likely to become worse, despite neutral overall growth.

The overall effect of growth will be export- biased, if any one of the following possibilities exists:

(i) The production effect is export-biased and consumption effect is neutral,

(ii) The production effect is neutral and consumption effect is export- biased,

(iii) Both consumption and production effects are export-biased.

The overall or total effect of growth will be import-biased, if:

(i) The production effect is import-biased and consumption effect is neutral,

(ii) The production effect is neutral and consumption effect is import-biased, and

(iii) Both production and consumption effects are import- biased.

The overall effect of growth is ultra- export-biased when the production effect is ultra- export-biased. In such a situation, the absolute demand for imports increases by more than the entire increase in national income and the supply of exports rises more than its rise in case of export- biased growth. In this situation, the volume of trade gets enlarged but the deterioration in the terms of trade of the home country is more than that occurs in case of the export-biased growth.

The overall effect of growth is ultra-import-biased, if there is an absolute increase in the domestic output of importable and there is an ultra-import bias in production. In this situation, there is an absolute decline in the demand for imports and the supply of exports. If the exportable commodity is not inferior, there will be an improvement in the terms of trade of the home country in this case. The overall or total growth effect is shown through Fig. 11.3.

In Fig. 11.3, OA is the offer curve of home country A and OB is the offer curve of foreign country B. Originally the equilibrium takes place at R. OQ quantity of X is exported and RQ quantity of Y is imported. The terms of trade are determined by the slope of the line OR. As growth takes place in country A, its offer curve will undergo shifts while the offer curve of country B, not experiencing growth, will remain unchanged.

If the overall or total effect of growth is neutral, the offer curve of country A shifts to the right to OA₁ and the equilibrium takes place at R₁. It shows an increase in the volume of trade but there is worsening of terms of trade for country A. It means the neutral growth bias results in the transfer of gain from country A increasingly to the foreign country. If the offer curve of country A shifts to the right to OA₂, the equilibrium takes place at R₂.

The increase in export is proportionately more than that of imports. The volume of trade increases and the terms of trade for country A get worsened. If the growth is ultra-export-biased, the absolute demand for imports increases by more than the increase in national income and the exports increase by more than the rise in imports. As the offer curve shifts to the right of OA₂, say OA₃, there is an increase in the absolute volume of trade and the terms of trade get further worsened for the home country A.

If the growth is import-biased, the offer curve of A shifts to the left of OA₁ say OA₄, but to the right of original offer curve OA. In this case the demand for imports and supply of exports increase less than proportionately to the total output. The volume of trade increases, although there is anti­trade bias in respect of production or consumption or both.

The terms of trade may still get worsened for country A. If the growth is ultra-import-biased, the offer curve of country A may shift to the left of OA, say OA₅. There is absolute reduction in the demand for imports and supply of exports resulting in the absolute reduction in the volume of trade but the terms of trade go in favour of the home country.