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126
CHAPTER OUTLINE
I. Trade provides low- and middle- income nations with signi cant opportuni-
ties to improve welfare and accelerate growth and development. Open trade
allows producers to have a larger market in which they can sell, and it allows
consumers to have greater choices in purchases of goods and ser vices. There
is much debate about who bene ts most from trade, and there are typically
both winners and losers.
II. Trends of world trade show dramatic expansion over the past 50 years.
High- income economies, which make up nearly 80 percent of the world
GDP, continue to dominate global exchange, but low- and middle- income
economies have shown signi cant growth in international trade. East Asia
experienced the highest rate of growth in GDP per capita over the past 30
years. Most of the countries in this region followed a model in which trade
served as the engine of economic growth. The types of products traded tend
to change as economies grow and the share of trade increases. Many factors,
such as population size, geographic location, and po liti cal agendas, deter-
mine the extent to which a country trades with the rest of the world.
III. Although not all individuals or groups within each country necessarily
experience the bene ts of trade, every country can gain from trade in the
aggregate. The theory of comparative advantage, associated with David
Ricardo, is the premise for this idea. Comparative advantage is often misun-
derstood. The extensive example of trade between Mexico and the United
States clari es the theory of comparative advantage as well as the concepts
of absolute advantage and absolute disadvantage. Comparative advantage
shows that even with winners and losers, the total gains to each country
outweigh the losses.
Trade and Development
CHAPTER 18
Trade and Development | 127
IV. The Mexico– U.S. trade example continues to illustrate the gains from trade.
Gains from trade are made up of gains from exchange plus gains from specu-
lation. Trade also confers four other signi cant bene ts. First, trade exposes
domestic rms to competition. Second, trade often embodies new technolo-
gies that raise productivity. Third, trade increases not only the quantity of
goods available for consumption, but also the quality and variety of goods
obtainable. Fourth, trade brings people into contact with one another.
V. Many low- and middle- income nations have resources that are in high demand
from high- income nations. Focusing on the trade of primary products is an
engine for growth for many nations. Additional factors of production, such
as capital and labor, can be gained from the expansion of primary product
exports. Also, primary product exports present the possibility of stimulating
other, related sectors, which leads to the possibility of forward linkages.
VI. Raul Prebisch, Hans Singer, and other economists generated the idea of
export pessimism, referring to the decrease of primary commodity exports
relative to prices of manufactured goods over the long run. Relative price
movements were traced to structural factors in the global economy, including
Engel’s law, technological changes in manufacturing, and the notion of mar-
ket power and competition in developed countries. In terms of trends, the
decline of prices of nonfuel commodities over the past 50 years and the uc-
tuation in commodity prices are two apparent trends this chapter illustrates.
VII. Problems with primary product exports are often fatal to development aspi-
rations. Dutch disease is the issue that emerging economies could face when
experiencing export booms of primary commodities. Keys to understand-
ing this paradox are the nominal exchange rate, real exchange rate, and the
prices of tradable and nontradable goods. This chapter goes into great detail
on the relationships between these concepts.
VIII. Resource traps are explained in detail with reference to Paul Collier, author
of The Bottom Billion. He identi es several traps that prevent nations from
growing. Problems such as commodity price cycles and macroeconomic
mismanagement are often caused by poor governance and corruption acts
like a tax on economic activity. It is possible to escape these problems and
overcome the resource curse, though. The use of sovereign wealth funds
and adoption of international charters such as the Extractive Industries
Transparency Initiative (EITI) are current approaches being used.
128 | Chapter 18
Boxed Examples
Box 18– 1: Dutch Disease: A Geometric Pre sen ta tion
Box 18–2: Nigeria: A Bad Case of Dutch Disease
Box 18–3: Indonesia: Finding a Cure
The rst boxed study examines the Dutch disease and how it impacts a nation’s
economy. It discusses the implications of growth, primarily in the nontradable
goods sector. When this new sector experiences a boom, it can lead directly to
in ation. A stream of workers will leave the tradables sector for the nontradables
sector, potentially never to return to the former sector once the boom ends. In most
developing countries, the leading example of the lagging sector from which employ-
ees are leaving is the agricultural sector.
The second boxed example takes a look at how Nigeria was severely impacted
by Dutch disease after the oil price boom of the late 1970s and early 1980s. The
Nigerian government reaped windfall pro ts during this period, but much of the
pro t was squandered on wasteful projects or disappeared into offshore bank
accounts. Because the government misdirected its funds, agricultural production
not only remained archaic, but deteriorated even further— all in the face of a rap-
idly rising population to feed. Even with the oil price recovery in the early 2000s,
Nigeria experienced little economic growth while its poverty rate continued to
soar. The Dutch disease is nowhere close to being responsible for Nigeria’s woes
but does factor into the picture at times.
The third box study discusses how the rising price of oil was eventually han-
dled by another oil exporting nation— Indonesia. In this study, the government
rst experienced in ation but then imposed, among other policies, stringent man-
agement of the money supply to protect foreign exchange rates. By the 1990s,
Indonesia was considered an economic miracle.
In the New Edition
This new edition presents an overview of trends and patterns in world trade. It
reviews the theory of comparative advantage, discussing both the bene ts of trade
and its distributional consequences. Special attention is paid to trade in primary
products, including export pessimism and the terms of trade; Dutch disease and
the real exchange rate; and the resource curse and responses to it.
Class Notes
Much of Chapter 18 emphasizes the notion of winners and losers in global trade.
Criticism surrounding the potential losers is reconciled through concepts like
comparative advantage, which illustrate that the aggregate gains typically out-
weigh the losses at an individual level. Discussing the criticism of global trade will
be useful for students to fully understand the effects it has on nations.
Trade and Development | 129
The examples pertaining to success in East Asia are excellent topics for discus-
sion. The chapter clearly explains how the nations of that region focused on trade,
and their success is evident. China would be a great topic to continue the discus-
sion as it has followed this trade- focused model since the 1970s and had remark-
able growth since then. Recent history of the use of successful trade models will
be excellent for conversation.
The trade relationship between Mexico and the United States is examined
throughout much of the chapter, and this relationship is used to explain several
concepts and terms. The consistency of this example will certainly help students
understand how the topics connect to one another. The concept of primary prod-
ucts lls a signi cant portion of this chapter. A lot of emphasis should be brought
to this type of product.
The “Resource Trap” section of this chapter features contributions from British
economist and author Paul Collier. He identi es several problems that nations face
in terms of trade, as well as causes and solutions. The questions from the Ques-
tion Bank will be great conversational topics.
QUESTION BANK
Concept Map
Trade Trends and Patterns
Comparative Advantage
The Bene ts of Trade
Trading Primary Products
Export Pessimism
Dutch Disease
The Resource Trap
Breaking the Resource Curse
Multiple- Choice Questions
1. The bulk of world trade originates and is exchanged between ________
economies.
a. high- income
b. low- income
c. developing
d. closed
2. Which country is the largest trading partner of the United States?
a. Mexico
b. Canada
c. China
d. Japan
3. In 2009, which nation replaced Germany as the world’s largest exporter
ofgoods?
a. United States
b. Japan
c. Rus sia
d. China
4. Almost half of Asia’s exports today are sent to:
a. North America.
b. Eu rope.
c. other Asian countries.
d. the Middle East.
5. ________ prices are domestic prices without trade.
a. Autarky
b. Commodity
c. Absolute
d. National
6. A nation will have a(n) ________ of a good when its production of that good
is relatively more productive than that of another nation.
a. absolute advantage
b. comparative advantage
c. relative advantage
d. trade advantage
7. ________ is the ratio of the prices a nation receives for the goods it exports
relative to the prices it receives for the goods it imports.
a. Exchange equilibrium
b. International terms of trade
c. Balance of trade
d. Net exports
8. Gains from trade are made up of the gains from ________ plus the gains
from ________.
a. population size; diversi cation
b. exchange; diversi cation
c. technology; education
d. exchange; specialization
9. Most world trade involves manufactured goods, but ________ still represent
about one-third of the value of all traded goods.
a. primary products
b. secondary products
c. intermediate materials
d. pro cessed materials
10. Adam Smith’s term for the situation in which a country has the capacity to
produce more than it can sell in the domestic market is known as:
a. safety stock.
b. leftover goods.
c. capacity maximization.
d. vent for surplus.
11. Expanded production of primary products can stimulate ________ by mak-
ing lower- cost primary goods available as inputs to other industries.
a. backward linkages
b. forward linkages
c. horizontal linkages
d. vertical linkages
12. Tariff escalation makes it harder for developing nations to move up the
value- added ladder by imposing higher tariffs on imports of ________ than
on ________.
a. raw materials; pro cessed goods
b. pro cessed goods; raw materials
c. primary goods; secondary goods
d. natural resources; nished products
13. Raul Prebisch, Hans Singer, and other economists argued that, over the long
run, prices for primary commodity exports on the world markets tend to fall
relative to prices of manufactured goods. This concept is known as:
a. export pessimism.
b. import optimism.
c. export cynicism.
d. trade con dence.
14. Which term labels the problem that emerging economies could face when
experiencing export booms of primary commodities?
a. Holland sickness
b. Dutch disease
c. Netherlands syndrome
d. Dutch illness
15. Which of the following is the price at which anyone holding foreign exchange
can convert it into local currency?
a. real exchange rate
b. nominal exchange rate
c. foreign exchange rate
d. national exchange rate
16. An increase in nontradables prices causes the real exchange rate (RER) to:
a. appreciate.
b. depreciate.
c. remain unchanged.
d. equal the nominal exchange rate.
17. The best prevention for Dutch disease effects is to avoid or reverse the initial
real ________ of the currency.
a. appreciation
b. depreciation
c. devaluation
d. purchasing power
18. ________ acts like a tax on economic activity and encourages rent- seeking
behavior rather than productive investment.
a. Fraud
b. Bribery
c. Lobbying
d. Corruption
19. According to British economist Paul Collier, which of the following signi -
cantly increases the probability that a nation will experience a civil war?
a. low income
b. slow growth
c. dependence on primary commodity exports
d. all of the above
20. Which of the following refers to the accumulation of foreign assets, usually
nanced by primary product export earnings?
a. offshore bank account
b. foreign investment
c. sovereign wealth fund
d. international hedge fund
IDs and Paired- Concept Questions
These terms can be used individually as short- answer identi cation questions, or
they can be used in pairs. In the latter case, ask students to explain (1) the meaning
and signi cance of each of the two terms and (2) the relationship between them.
1. Open trade, winners and losers
3. Openness to trade, rate of growth in GDP per capita
5. Absolute advantage, comparative advantage
7. Exporting primary products, forward linkages
9. Dutch disease, exchange rates
11. Politics, resource traps
