Bridging 10/24/2010
Inequality: the Gap
Questions for this week
How do we bridge the gap between
rich and poor countries?
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10/24/2010
How do we reduce inequality
between countries?
What can the countries do?
Import substitution
Export promotion
How can rich countries help poor
countries?
Foreign Aid
Trade
Import Substitution
Import substitution involves:
State guided development
State owned enterprises
Geared at replacing imports with goods
produced in the country
Promoting/subsidizing local industry
Raising tariffs on imports
Putting up non-tariff barriers
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10/24/2010
Advantages and Disadvantages of
Import Substitution
Advantages
Protects nascent industries from competition that they may not be able to survive.
Especially useful in early stages of development.
In larger countries such as India or Brazil, they are able to make good use of local
resources to fulfill local needs.
Helps make the country self -sufficient and less susceptible to highs and lows in
the global economy (think of the Asian crisis where this was a huge problem for
countries like Thailand)
Disadvantages
In later stages of development, monopoly public enterprises in particular (state
owned steel or energy plants for instance) are found to be less efficient, more
corrupt and over -dependent on government subsidies. Competition leads to better
e fficiency and weeds out low performers. Without this competitions, firms have
little incentive for efficiency.
In smaller countries, this policy could conversely be disastrous as smaller
countries are less likely to have the diversity of resources available to them to be
a ble to meet all local needs for goods and services.
In order to create some goods, importing parts may be essential. High import
duties on these parts make the end product far more expensive and less
a ffordable for everyone including industries that manufacture these products.
Export promotion
Export promotion policies include the state doing
the following:
Encourage labor intensive manufacturing
exports
Makes capital easily available
Import duties decreased
Exporters given income tax concessions
Responsible monetary policies -- contain
inflation
Advantages and disadvantages of
export promotion
Why was export promotion more successf ul?
The countries were able to create economies of scale (sell large volumes of
r easonable goods).
They were able to specialize in a f ew products that they could produce well
and cheaply creating a comparative advantage.
Examples: Brazil and Colombia switched in 1960s to export promotion and
doubled growth rate.
Disadvantages
Countries become intricately linked the to global economy. Dips in the
economy of a trading partner af f ect it deeply. Think of the Asian f inancial
crisis.
Developing countries may get exploited by f irms f rom developed countries
through poor terms of trade.
See the trade section - resources such as skilled and educated labor is
essential to build a comparative advantage. This is a long process.
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10/24/2010
Should rich countries use aid or
trade to help poor countries?
What are the advantages of using aid?
Fast delivery
Can be given directly to those who need it the
most
Can be directed to particular sectors such as
health or education
What are the disadvantages to using aid?
Problems with Aid:
1. Often politically motivated
2. Commercially motivated (tied aid) donors force developing
country recipients to buy expensive goods or goods they dont
need from the donors
3. Subject to budgetary pressures in donor countries. If the U.S.
C ongress cuts budget allocatio n for foreign aid, then these
recipient countries may be severely affected. This dependence
is dangerous.
4. Promotes corruption in receiving countries (Poor people in the
rich countries giving to the rich people in the countries) gets
directed to the wrong sectors.
5. Aid is unrelated to growth. Most of the aid has gone to Africa but
Africa hasnt grown very much.
6. Eventually aid is a short term fix and not a long term solution.
Alternative: Trade
What are the advantages of using trade?
Longer term solution
Spillage effects as developing of comparative
advantage in a few areas leads to the need for
new industries (goods and services)
Less dependence on individual donors economic
performance and whims of political leaders.
What are the disadvantages to using trade?
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10/24/2010
Problems with trade
Barriers f rom developed countries. Developed countries set up tarif f and
non-tarif f barriers to reduce the inf low of goods f rom developing countries.
An example of non-tarif f barriers is labor standards which are set high so
that f ew developing countries can meet those.
Time lag to develop strong exports. This cannot happen overnight. It takes
time to develop the skills and specialization to create a comparative
advantage in an industry (to be able to produce goods at better prices than
competitors) to build a strong economy. Aid is a much quicker f ix.
Need resources (natural, skilled and unskilled labor)
It takes money to educate and train the labor.
Depends on State to
provide incentives
provide education and training
build comparative advantage in a diverse range of areas
Do all developing states have the capacity to provide this type of support?
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