International Trade and Economic Growth | Economics

The classical and neoclassical economists believed that international trade played a vital role in accelerating economic growth of the countries. In fact they called international trade as an ‘engine of economic growth’. The contribution of trade to economic growth, according to them, is determined partly from static and partly from dynamic gains that flow from foreign trade. International trade permits all countries to specialise through reallocation of resources in the production of those goods in which they have comparative advantage and trading with each other will provide them the greater quantity of goods than they could obtain if they do not open up to foreign trade. Specialization and trading will enable them to consume more goods than they could produce.

Commenting on the significance of international trade in increasing welfare of the people Meier writes, “More generally, classical economists considered comparative advantage as determining the pattern of trade. Not the use of surplus resources but resource reallocation allowed trade to benefit a country by producing a more efficient international allocation of resources.

Without any increase in resources or technological change, every trading country is able to enjoy a higher real income by increasing production according to its comparative advantage and trading. The exports have instrumental significance as the intermediate goods used for the “indirect production” of imports; exports allow the country to “buy” imports on more favourable terms than if produced directly at home. The gain from trade is on the import side; and it is significant that the gains are mutually realised by all the trading countries”.

Gains from Trade and Terms of Trade:

Of course, the gains from trade to the countries specialising in production of different goods and trading with each other depend on terms of trade, that is, rate of exchange of goods between any two countries trading with each other. To quote Walter Elkan, “The size of these static gains will depend on the rate of exchange which is such as to produce gains so that in the extreme one could conceive of a situation in which even though a country had a comparative advantage in the production of a good, trade would not take place because the rate of exchange nullified any gains that might have been derived from it.”

Thus static gains from trade can accrue to a trading country if its terms of trade are favourable. It is worth noting that role of trade depending on comparative advantage assumes that the country has a given amount of resources and that they are fully employed. It is through reallocation of resources from goods in the production of which they are relatively inefficient to the production of goods in which they have greater efficiency. This implies that through reallocation of resources they move from one point to another on a given production possibility frontier.

Further, Classical economists, especially Adam Smith, emphasised the role of trade in utilising fully the country’s resources, if they are initially lying idle and unemployed. When such a country enters into foreign trade, it opens up the possibility of a ‘vent for surplus’, that is, using the surplus resources for producing for exports which it can exchange for imports which it cannot produce at home for which it has an unsatisfied demand. This ‘vent for surplus’ implies that a country would be moving from a point within the given production possibility frontier to a point on it. This too is a ‘static gain’.

Trade as Vent for Surplus and Economic Growth:

According to Hla Myint, it is export expansion of the type of “vent for surplus” that occurred in south East Asia and African countries rather than resource reallocation of given resources towards production for primary exports on the basis of comparative advantage. To quote him, “The export expansion of peasant products, particularly South East Asia and from Uganda and West Africa, took place not so much through the reallocation of given and fully employed resources from the domestic to the export sector as through bringing hitherto underutilised land and labour in the subsistence economy into export production.” Thus ‘vent for surplus’ theory assumes more realistically that “a previously isolated country about to enter international trade possesses a surplus productive capacity. In this exports can be raised without reducing domestic production by utilising the surplus productive capacity.”

Hla Myint explained the growth of countries of South East Asia and Africa through ‘primary exports as an engine of growth’ in the colonial period on the basis of ‘vent for surplus’. However, in our view the gain from trade between the colonies and the coloniser countries went mostly to the latter. Further, as Hla Myint has pointed out that growth in underdeveloped colonies remained confined to the export sector and did not spread to the rest of their economies. It is worth quoting Gills, Perkins, Roemer and Snodgrass, “When underutilised land or labour was ‘vented’ as a result of colonisation, as was typical during the nineteenth century, the gains from trade were often purchased at high cost to indigenous population.

Land which may have been idle or utilised at low productivity was frequently alienated from its occupiers, whether these were American Indians, the Kikuyu and other peoples of East Africa or Javanese farmers. Colonisers also used taxation and coercion to keep plantations and mines supplied with low-cost labour in many parts of Africa and Asia, and especially in British India, the movement along a production frontier toward greater production for export resulted in cheap imports to compete with traditional handicraft industries, displacing artisans and workers.

The question about colonisation whether the distribution of gains from trade favoured native populations enough to compensate them for the losses they bore, and whether colonial economies propelled indigenous people toward development or retarded their eventual progress.” Thus while evaluating gains from entering into foreign trade much depends on who gains and who loses.

According to Myint, the contribution of Western entrepreneurs to development of colonies was mainly in the development of transport and communication and development of new mineral resources. “In underdeveloped countries”, he writes, “the surplus labour existed because in the subsistence economies with poor transport and little specialisation, each self-sufficient economic unit could not find any market outlet to dispose of its potential surplus and therefore no incentive to produce more than its requirements. Here then we have a form of Smith’s unproductive labour locked up in a semi- idle state in the underdeveloped economy of a country isolated from outside economic contacts. In most peasant economies this surplus labour was mobilised, however, not by the money wage system of employment but by peasant economic units with their employment of ‘family’ labour moving en bloc into the money economy and export production.”

Trade as an Engine of Economic Growth- Dynamic Gains:

Mention may be made here of dynamic gains which result from a greater degree of degree of division of labour and specialisation when a country is opened to world trade resulting in rise in productivity of their resources and permits a country to reap the benefits of economies of scale. They are dynamic in the sense that unlike static gains which accrue to a nation as a result of reallocation of resources to the production of goods in which a country has a comparative advantage, dynamic gains cause an outward shift in the production possibility frontier.

Explaining these dynamic effects which he calls indirect effect, J. S. Mill, a classical economist, writes, “The tendency of every extension of the market improves the process of production. A country which produces for a larger market than its own can introduce a more extended division of labour and make greater use of machinery and is more likely to make innovations and improvements in the processes of production.”

Besides, classical economists thought that increase in exports and consequent rise in incomes of the people engaged in the export sector will generate demand for the products of other sectors giving boost to them. Thus the gains from export will spread to other sectors of the economy through what Keynes later called multiplier effect and lead to what has been called export-led growth.

Furthermore, for growth of underdeveloped countries J. S. Mill, emphasised the ‘educative effect’ of trade. Thus J. S. Mill writes, “The opening of foreign trade by making them acquainted with new objects by instilling new ideas and breaking the chain of habits and tends to create in them new wants, increased ambition and greater thought for the future.”

To sum up, according to Meier, the gains from trade on development from the viewpoint of underdeveloped countries are mainly of three types:

(1) Those that widen the market, induce innovations and raise productivity;

(2) Those that promote saving and capital formation; and

(3) Those that have an educative effect in instilling new wants and tastes and in transferring technology, skills and entrepreneurship. The emphasis is on the supply side of the development process.

Trade as an Engine of Economic Growth – Historical Experience:

We have explained above the view of traditional theory about the role international trade can play in development of advanced developed countries and poor underdeveloped countries. We will now spell out that historical experience shows that the traditional theory has been mainly proved correct except its conclusion about the gains the poor underdeveloped countries would derive from international trade by specialising in exports of primary goods.

In the eighteenth century Britain had the industrial revolution through technological breakthrough. Joseph E. Stiglitz and Charlton write – “There were many social, political and geographical factors that caused the Industrial Revolution, but Britain’s trade with her neighbours and colonies played a decisive role in fuelling the new industrial activity and spreading prosperity in other countries. Before long British cities became the workshops of the world importing vast quantities of food and raw materials and exporting manufactured goods to America, Asia and Africa.” Thus international trade proved to be engine of economic growth for Britain.

Similarly, Japan under the Meiji rulers in the early twentieth century achieved rapid industrial growth in which, among other things, trading with other countries made an important contribution to its rapid growth. To quote Stiglitz and Charlton again, “It is hard to imagine the Meiji industrialisation occurring if Japan had not been able to import vast quantities of machinery, transport equipment, and other capital goods from the West in exchange for exports of cheap cloth, toys and other labour- intensive consumer products. And this trade would have been impossible if it were not for the steady flow of food and cheap raw materials arriving in Japan from its colonies in Taiwan and Korea”.

Similarly, international trade played a crucial role in the industrial development in North America and Austria. English capital opened up mines and plantations and built railroads in America, Canada and Australia. This led to the development of these countries and as these countries opened up they provided expanding markets for the products of Europe which led to the rapid growth in European countries.

Like classical economists, Marx thought that international trade prevented the occurrence of diminishing returns in Europe. However, Marx emphasised exploitation of the colonies by the colonial powers. He thought governments of England and France worked in the interests of the capitalists of their countries. In trade relations terms of trade were determined to the disadvantage of the underdeveloped colonies. Marx maintained that the form of trade that took place between the industrialised developed countries and underdeveloped countries made it possible for the advanced countries to retain profits from trade.

However, the classical and neoclassical theories of free trade were proved correct as rubber plantations of Malaya developed, coffee plantations of Brazil registered rapid growth, Australia’s sheep flock and Argentina’s cattle herd grew, Indonesian oil reserves were developed by Dutch, Artesian wells were sunk in Sahara by the French. English capital developed mines and plantations, and built railroads in India and its other colonies and their products were taken away to feed their manufactured industries. Besides, India, Brazil and Burma provided expanding markets to the British products.

Although trade with Britain contributed to the development of mines, plantations, railroads and to some extent agriculture, its benefits were however derived more by Great Britain due to the unfavourable terms of trade for the underdeveloped colonies. Besides, the imports of cheap manufactured products from Britain did not permit the industrialisation of the underdeveloped colonies. In fact, there was a decline of handicraft industries as a result of cheap imports from Britain.

Though in the nineteenth century the free trade and capital movements contributed a good deal to the industrial growth of the nations of Western Europe and, during this period, the countries of Western Europe, North America and Australia became rich, the underdeveloped countries remained poor despite some growth in the primary sector.

As has been pointed out by Myint, the growth of the export sector in underdeveloped countries could not transmit growth to the rest of their economies. Importantly, stagnation of the underdeveloped countries from 1913 to 1939 occurred because of strangled international trade due to various restrictions that were imposed by the developed countries and worldwide depression and World Wars.

Many economic historians believe that “in the 19th century international trade acted as an engine of growth not only in that it contributed to a more efficient allocation of resources within countries but also because it transmitted growth from one part of the world to another. The demand for Europe and for Britain in particular, for new materials brought prosperity to such countries as Canada, Argentina, South Africa, Australia and New Zealand. As the demand for their commodities increased, investment in these countries also increased. Trade was therefore mutually profitable”. However, all economists would not agree to this view of trade under colonial rule. Marx’s prediction about disastrous effects of colonialism on underdeveloped countries seems to be substantially correct as despite growth of primary exports, they remained in a state of backwardness and poverty.

It is evident from above that whereas for industrialised developed countries international trade proved to be an engine of growth, for underdeveloped countries under the colonial rule exports of primary products in exchange for industrial goods from developed countries did not lead to the overall growth of their countries. In fact they remained backward and poor.

Trade after the Post-Second World War Period:

The situation significantly changed after the post- Second World War period with the attainment of independence from the colonial rule by the underdeveloped countries. Now they were free to make their own choices. Having been suffered from the exports of primary products for the exchange of manufactured goods India and Latin American countries adopted import-substitution policy to accelerate their industrial growth.

On the other hand, Korea and East Asian countries such as Taiwan, Malaysia, Indonesia, Hong Kong and Singapore adopted export-substitution policy and accordingly developed their industries and exported manufactured products instead of relying exclusively on exports of primary products. They also succeeded in achieving rapid industrial growth. The growth of East Asian countries during the period from mid-sixties to mid-nineties was so high that they were called Asian Tigers.

The success of export-led growth strategy in East Asia began with Japan which within a few decades after World War II through its rapid growth became the second largest economy of the world. It achieved sustained growth through export promotion of manufactured products. Japan’s success was followed by South Korea successfully. Again East Asian countries such as Taiwan, Hong Kong, Singapore, Thailand, Indonesia and Malaysia which are generally called Asian Tigers achieved a higher economic growth through international trade by promoting their exports of industrial products. After 1991 India also gave importance to the expansion of exports in the economic reforms and structural adjustment policy initiated in 1991. India’s export of software services also grew rapidly.

Since 1950 there has been liberalisation of world trade on a large scale, first under GATT established in 1947 and then under WTO which replaced GATT in 1995. Barriers to trade such as tariffs and non-tariff barriers and quantitative restrictions such as quota, licenses were brought down significantly to promote world trade. However, Doha Round talks to address to the problems of developing countries under the auspices of WTO have not succeeded so far to help in growth and poverty eradication in the developing countries.

The developed countries of the US and EU which have been the strong advocates of free trade have adopted a selfish and duplicitous attitude towards trading with developing countries. Mentioning about this selfish attitude of the developed countries, Stiglitz and Charlton write, “They have negotiated the reduction of tariffs and elimination of subsidies for the goods in which they have a comparative advantage, but are more reluctant to open up their own markets and to eliminate their own subsidies in other areas where the developing countries have an advantage. As a result we now have an international trade regime which, in many ways is disadvantageous to the developing countries. In a world in which many see global poverty by some estimates there are more than 2 billion living on less than a dollar a day as the world’s most pressing problem, this is especially disturbing. It seems obvious that if the developed countries truly wanted to promote developments in Doha Round they would have reduced their tariffs and subsidies on the goods of interest to the developing countries.”