Shane, Mathew

English

Research Papers in Economics

Agriculture  and Trade Analysis Division
Economic Research  Service
United States Department of Agriculture
Staff Report # AGES870928
1988
Trade  and  Development
Shane,  M., ed.
Proceedings of a Meeting  of the
International Agricultural  Trade  Research  Consortium
December,  1986,  CIMMYT,  Mexico City, Mexico
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searc  ConsrtkE ~CitvMexTRADE  AND DEVELOPMENT,
DEVELOPMENT  AND  TRADE
Mathew  Shane  1
There  is an important  relationship  between  trade  and economic  development  and  also  one
between  development  and  trade.  The  first,  highlighted  by  T.  N.  Srinivasan,  focuses  on  the
impact  that trade  has  on  development.  There  is another  analysis,  perhaps  best  put forward  by
John Mellor,  that the  driving force  of trade,  agricultural  trade,  is  income  growth.  I will
briefly  discuss  the  underlying  analysis of each  and  then  their relationship  to each  other.  I
will  only focus  on  the  highlights  of  these issues,  recognizing  that  many details  and
refinements  will  be omitted.  My  objective  is  to  place  this discussion  into  its  overall  context.
Trade  and  Development
Classical  trade  theory  argued  that by using  trade  according  to comparative  advantage  a
country can  achieve  a level of income  in  excess  of what  could be  achieved  with  domestic
resources  alone.  Although  the neoclassical  argument  of  the gains  from  trade  is  clearly  the
source  for  much  of the argument  toward  outward  as  distinct  from inward  orientation  policies,
the  number of simplifying  assumption  underlying  this  analysis  precludes  this from being  more
than  the starting  point  for the  analysis.2
The  most serious  drawback  for our purposes  is  that the  framework  is  static  rather  than
dynamic  and abstracts  away  from  all of the  problems  facing  real  economies  in the  highly
uncertain  real  world  that  we  live  in.  The  discussion  of  the relationship  between  trade  and
development  gets  us  into both issues  of intertemporal  choice  and  the  issues  of market
imperfections  and  uncertainty.
Issues  of Dynamics
Development  is  a dynamic  process,  the core  of  which  is  technical  and  institutional  change
leading  to increases  in standards  of  living  exemplified  by  rising per  capita income.  From  the
classical  model,  static  gains  from trade  can  be  achieved  under certain  conditions.  However,
can trade  be  an  avenue  that induces  a  pattern of development  that leads  to  a higher rate  of
growth  in income  than  would occur  without  trade?  Central  to  this  issue  is  technology  and
information.  Whether  one can  actually  obtain  a new long-run  equlibrium  growth  path  with
higher  per capita income  growth  or just a temporary  path  with  higher  growth  is not really
important  here.  Although  we  are just obtaining  a set of increases  in per  capita income  rather
than  in growth,  the  central  issue  may be  whether  one  can  achieve  clearly superior  levels  of
consumption  (see  report  by  Lucas  (1)).3
Suppose  that an economy  is  faced  with  two  investment  possibilities:  one,  the  traditional
technique  and the  other a  new  technique  available  from  the world  market.  Suppose  further
that there are  scale  factors  associated  with the implementation  of  the  new  technology  such
1The author is an economist  with Agriculture and Trade Analysis  Division,  Economic  Research  Service,  U.S.
Department of Agriculture, Washington,  DC.
2Nonsatiation,  free disposability,  the possibility  of lump sum transfers, and the existence  of a social  welfare
function  are but a few  assumptions.
3Underscored  numbers in parentheses are listed in the References  at the end of this article.
99that  the purchase  of this  technology  in beyond  the means  of  the economy.  If finance  and
trade  is  not available,  an  economy  can  either  borrow  money  to  purchase  the  new  technology
or joint venture  with a group  that has  access  to the new  technology.4  By  obtaining  this
technology,  an economy  can  achieve  a present  discounted  valued  consumption  stream  clearly
superior  to one  without  the prospect  of technical  transfer.
Trade  can  take  place  in factors  that directly  affect  production  possibilities  as  well  as
commodities.  Thus,  trade  and international  finance  are integral  parts of  the  process  of
technical  change.  We  can,  however,  even  broaden  this further so  that  the  trade  process
involves  not only  elements  of technical  change,  but institutional  change  as  well.  The  setting
up of the  international  research  centers  is but  one  example  of  the transfer  of  institutional
capacity.
The  ability to trade  under unbiased  conditions  not only  allows  for technical  and  institutional
change  underlying  a dynamic  growth  process,  but also  fundamentally  alters  the  dynamic
inducements  toward  future change.  Trade  not only allows  for  increases  in income  and
capacity,  but  it does so  under  a changed  system of relative  prices.  This  change  in relative
prices,  therefore,  induces  a process  of technical  change  that can  be  substantially  different
from that which  would  occur  without  trade.  Furthermore,  the  ability  to  market  internationally
allows  for expanded  production  capacity  beyond  what  could  be  used  in the  domestic  economy
alone,  permitting  the  exploitation  of economies  of scale.
The informational  efficiency,  which  unbiased  price  signals  provides,  should  not  be
underestimated.  Embedded  in world  prices  are signals  about  returns  to  investments  and
production.  An  unbiased  price indicates  possibilities  for returns  based  on  what  the market  is
willing  to accept.  Biased prices,  which  deviate  from free  trade  solution,  imply  investment
returns unrelated  to demand  factors  and  the  possibilities  of surpluses  or  deficits  in  the future.
The  fact  that current prices  reflect  current  expectation  of conditions  and  not  necessarily
those that  will exist  in  the  future  does  not  change  this.  This  only  points  to  the  need  to
develop contingency  markets  to  insure  against changes  in market  conditions.
The  sixties  and  seventies  were  periods  when  trade  by  developing  countries  grew  more  rapidly
than  did their  per capita  incomes.  Growth  in  per capita  exports  grew  at  8-percent  per  annum,
while growth  in per  capita  gross  domestic  product  (GDP)  for developing  countries  grew  at
5-percent  per annum.  Growth  in real  agricultural  trade  per  capita  grew  at  approximately  the
same  rate  as  per  capita GDP.  During  the sixties  and  seventies,  developing  countries  were
increasingly  taking advantage  of  both  the static  and  dynamic  gains  of  trade.  This  pattern  has
not continued  into the  eighties.
Although  developing  countries,  on  average,  pursued  policies  to  increase  their  openness  to
world  markets,  a substantial  number  of them  pursued  policies  resulting  in  reduced  exposure  to
world  markets.  Given  the  advantages  of participating  in  trade,  why  would  such  patterns
persist over  long  periods of time?  The  analysis  of this  issue  takes  us  into  the  subject  area  of
government  intervention.  The  answer  lies  in the  fact that  some individuals  or  groups  view
reduced  exposure  to  the international  market  as  beining  in  their  best  interest.  They pursue  this
because  there  are  rents  to  be obtained  from controling  access  to  these  markets.
By defining  government  intervention  as any  policy  or action taken  by  governments  that
cause  prices  to deviate  from  what  would prevail  in an  unbiased  market,  we  can view  the
consequences  of such intervention  on  the trade  and development  process  in several  ways.  One
type of government  intervention  involves  a movement  of  domestic prices  away  from free  trade
4Vernon  Ruttan has stressed that the contribution  of social  scientists  as distinct form  technical scientists  is that
the former is  concerned  with institutional change,  while  the latter is concerned  with  technical  change  (4).
100solutions.  This  involves  several  possibilities.  One  involves  the movement  of prices  from world
market  toward their  autarky  levels  or beyond.  It is  possible,  and  there  appear  to  be  several
empirical  instances  in  which this  has  occurred,  when  government  intervention  has  actually  led
to  a situation  in which  countries  become  exporters  of their "natural  import good"  and
importers  of their "natural export  good."  It is  also  possible  for governments  to  subsidize
exports  and generate  exports  in excess  of the  free  trade  solution.  Government  interventions
can  clearly  distort  the  trade  mix  away  from  an unbiased  outcome.
What  is the  impact  of government  intervention  on  growth  and  development?  If  under
competitive  equilibrium  assumptions,  the unbiased  trade  solution  represents  a static  global
optimal  outcome,  any  deviations  from  that solution  will  represent  a  loss and  will  likely  imply  a
slower growth  outcome.  It  is possible,  however,  if there  are market  imperfections  present  or
if the  government  has  a lower discount  of the future  than  does the  private  sector,  that
government  intervention  could  lead  to  higher growth  and  development  outcomes  than  would  be
obtained  by  an unbiased  solution.  One  only  needs  to  reflect  on a  situation  where the  outcome
results  in  higher  rates of efficient  investment.  Higher  growth  will  be  generated,  but at  the
cost of current  consumption.  This  solution  is efficient,  but  not  Pareto  optimal.  It appears
that government  intervention  from the  perspective  of economic  development  does  not
necessarily  generate  an  inferior outcome.
Development  and Trade
Up  to  this  point,  the  discussion  has  focused  on  issues relating  trade  to  development.  These
issues  relate  primarily  to  the  production  side of an  economy.  It  is  argued,  if an  economy
pursues  an outward-oriented  unbiased  trade  policy,  that an  economy  can  use  the gains  from
exporting  commodities  to  increase  income,  consumption,  and  growth.  The  related  issue  looks
at  the  impact that  development  and  growth  has  on  the demand  for imports.  If export  growth
drives  income growth  and development,  then  income  growth  and  development  drive the  demand
for  imports.
How  development  impacts  on  the  import  mix  changes over  the course  of development.  We  can
demonstrate  this  by focusing  on  what  happens  in  the food  and  agricultural  sector.  In  the
early  stages  of development  in  which many  of the  low-income  developing  countries  fall,  the
staples  of consumption  are  largely  confined  to  basic  foodstuffs.  These  would  include  roots  and
tubers,  coarse  grains,  and  food grains  if produced  locally or  provided  on  concessionary  terms.
The  income constraint  is  binding  on  demand,  and  the  technology  constraint  is  binding  on
production.  Very  little  trade  takes  place  during  this  stage.  There  is,  however,  a  very
high-income  elasticity  of demand  for food  which  can  be  greater  than  1 in  some  instances.  It
is  this  very  high-income  elasticity  that  makes  these countries  potential  import  markets.
There  is an  intermediate  stage when  the dynamics  of  development  drive  the dynamics  of trade
growth.  During  this  stage,  large  increases  in per  capita  income  occur  and  driven  by  the  high-
income  elasticities,  and  a  changing  composition  of the  diet from  basic  staples  to  food  grains
to  meat,  demand  for  food  far outstrips  the  increases  in  production.  This  excess  demand  is
met  by increases  in imports.
There  is a final stage  of  development  when  consumption  patterns mature.  In  this  stage,  the
income  elasticity  for  food  can  become  negative.  Furthermore,  an institutional  basis  has  been
developed  for generating  sustained  increases  in  production  through  technical  change.  In this
stage,  import  growth  either levels  off  or declines.  In  a number of  instances,  these countries
can  switch  from  being  importers  to  exporters  when  the  agro-climatic  resource  base  and
political  environment  is correct.
This  pattern  is  reflected  in  the empirical  trends  of developing  and industrial  countries.  The
rapid  growth  in  demand  for food  in the  developing  countries  during  the  past  20  years  has
101generally  exceeded  their  capacity  to accelerate  domestic  production.  The  opposite  is  true  for
the  industrial  countries;  demand  is growing  slower  than  production  (table  1).  Thus,  these  two
groups  are becoming  increasingly  dependent  on  each  other.  The  surpluses  produced  in  the
industrial  countries  are  key  to meeting  the  rapidly  increasing  food needs  of the  developing
countries.
The empirical  patterns  associated  with  development  are striking.  It  is the  middle-  and
upper-income  developing  countries  that are  the growing  markets  for agricultural  products  and
not the  low-income  countries.  Underlying  the serge  in imports  is  the transition  to meat
consumption  from  food  grains.  The underlying  production  and  use  patterns  in developing
countries  implies  a much  higher import  growth  demand  developing  for  coarse  grains  rather
than  for food  grains.  This  is most notably  occurring  in the  upper-income  developing  countries
rather  than the  low-  and middle-income  countries.  The increasing  use  of coarse  grains for
feed  also  supports  this theory.
Factors  related  to food  demand  and  its components  are driving the  system.  By  using  results
from cross-section  time  series  data,  we  found the  income-elasticity  patterns  that  generated  the
import  patterns  (3).  The elasticity  for the  food  grains (wheat and  rice)  rises  rapidly  until
incomes  reach approimately  $1,000,  and then declines  throughout  its  range,  becoming  negative
at about $3,500.  The income  elasitcity  of meat  rises  more  slowly  and  has  a  plateau  at
approximately  0.8  between  incomes  of  $1,000  and  $4,000  and slowly  accelerates  its  decline  so
that when  incomes  reach  $7,000,  it becomes  negative.  This elasticity  for the  components  of
food  translates  into nonlinear  patterns  of  food consumption  per  capita,  which have  increasing
and then  decreasing  per capita patterns  for food  grains  and  meats and  an  overall  declining
pattern  for coarse  grains.
Table 1--Consumption and production changes  in  developing
and industrial  countries
Change 1961-63  to 1980-82
Item  Developing  Industrial
Percent
Consumption per capita:
Food grains  23  1
Coarse groins  20  35
Oi lseeds
1   10  127
Production per  capita:
Food grains  14  44
Coarse grains  4  74 Oi  lseeds  66  140
1/  Oilseeds  inctude  only soybeans,  soybean  oi l,  soybean
meal,  peanuts,  peanut  oi  ,  and  peanut  meal.
Source:  (2)
102Conclusions
The  changing  composition  of demand  as  a  driving  force for  import  demand  extends  far  beyond
the  food sector.  Development  creates  demands  for  an expanded  consumption  bundle  that  will
outstrip  the  capacity  of an  economy  to  respond,  at least  in the  short run.  The  relationship
between  trade  and  development  and  development  and  trade  is thus  a  complementary  one.  The
ability to  export  and respond  to  world  demand  in a way  consistent  with  comparative  advantage
allows  low-  and middle-income  countries  to  accelerate  their  growth  and  development  far
beyond  what  could  be  obtained  in a self-sufficient  autarky  state.  The  resulting  income  growth
provides  consumption  demands  that  exceed domestic  capacity.  Since  exports  are  a  lead  sector,
the foreign  exchange  necessary  to  respond  to changing  demand  is  available.  Exports  drive
development,  which  drives  import demand.  It  is,  therefore,  not  surprising  that  the single  most
important  variable  in import  demand  is  foreign  exchange  availability  and  not income.  Income
growth,  as  we  have  seen,  can  have both  positive and  negative  effects  on  import  demand,
depending  on the  development  stage  of a country.
The  current  world  environment  in  which both  trade  and income  growth  are  lagging  is  a  very
poor environment  to stimulate  development.  Many  developing  countries,  saddled  with
substantial  international  debt,  are faced  with  declining  per capita  incomes  for  the  foreseeable
future.  Considering  the  interdependence  of the  developing  and  industrial  world,  solutions  must
be  sought that  will  allow  us  to  break  out of the  current  low-level  world  equilibrium.
REFERENCES
(1)  Lucas, R. E.  "Mechanics of Economic  Development,"  unpublished manuscript,  Univ.  of Chicago,  Dept.  of Economics,
1986.
(2)  Marks,  Susanne Marie,  and  Mervin J.  Yetley.  Global Food Demand Patterns Over Changing Levels of Economic
Development.  Staff Report  No. AGES870910.  U.S. Dept. Agr.,  Econ.  Res.  Serv.,  Oct.  1987.
(3)  Roe,  Terry, Mathew  Shane,  and De Huu  Vo.  Price Responsiveness  of World Grain Markets:  The Influence of
Government  Intervention  on Import Price Elasticity.  TB-1720.  U.S. Dept. Agr.,  Econ.  Res.  Serv.,  June  1986.
(4)  Ruttan, Vernon.  "Social  Science  Knowledge  and Institutional  Change, "American  Journal of Agricultural  Economics,
Vol.  66, No.  5,  Dec.  1984,  pp.  549-559.
103

Trade and Development, Development and Trade

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