Chapter 10
International Trade and
Economic Growth
This chapter concludes our treatment of the pure theory of international trade by considering the
interactions between international trade and economic growth. The first part of the chapter discusses
economic development and, in particular, various trade policy strategies pursued by developing countries.
The discussion then turns to an analysis of models involving growth of factors of production under
◼ Chapter Outline
Introduction
Trade and Development
Primary-Export-Led Development Policies
Import-Substitution Development Policies
Outward-Looking Development Policies
Trade and Growth
Trade and Growth: Some Additional Comments
Technological Change
Chapter 10 International Trade and Economic Growth 45
◼ Suggested Answers for the End-of-Chapter Exercises
1. Compare and contrast the types of trade policy actions taken by governments that pursue import–
substitution substitution policies versus those that pursue outward-looking strategies.
2. Many Latin American countries have followed import-substitution policies. Many of these same
countries have also experienced long periods of high inflation. Explain some of the possible linkages
between import-substitution policies and high inflation.
Inflation is caused by rapid expansion of the domestic money supply. Money creation, in turn, is
often the means by which governments faced with high expenditures and low revenues finance their
3. According to Table 10.1, many developing countries have begun to replace quotas with tariffs as they
adopt more outward-looking strategies. Discuss some possible motives for these changes.
Tariffs are more consistent with the basic goals of an outward looking development strategy. For
4. Describe how import-substitution policies can encourage the escalation of tariffs by stages of
processing.
5. Explain carefully how international trade can affect the rate of growth of an economy.
In an economy with unemployed factors, increased trade (via export sales) can bring about an overall
expansion in production and an accompanying fall in the unemployment rate. The magnitude of the
6. Suppose that in country A the income elasticity of demand for good S is less than 1 and the income
elasticity of demand for T is greater than 1. Suppose also that A exports good S and imports good T,
and the S is relatively capital intensive in its production and that A is relatively capital abundant.
What would happen to A’s trade pattern if alternatively,
a. A were to experience equiproportionate growth in K and L
b. A were to experience a relative increase in K versus L
c. A were to experience a relative increase in L versus K
This is a situation where the capital abundant country exports the capital intensive good, with the
added twist that as its income increases, it tends to like the labor intensive good (which it imports)
more than the good it exports. This last part means that CR, the consumption ray in Figures 10.5 and
10.6, won’t be a straight line but rather will curve towards the T axis. It also means that any increase
in income will be pro-trade biased.
a. Equiproportionate growth will result in increased production in the same proportions, but
consumption of S (the import) will grow more than consumption of T (the export). This is pro-
7. Compare the costs of a MNC operating in a foreign country with the cost of domestic firms operating
in that country. Explain how a MNC can compete under these circumstances.
An MNC faces an enormous number of additional costs that domestic firms do not. Foreign firms
often must receive permission from numerous government agencies before they are even allowed to
begin business activities. Then they must negotiate the costly international transfer of financial or
8. Suppose that A is a small open economy that takes world prices as given. What would be the effect on
wages and rents in A if it were to experience an inflow of foreign capital. Use a diagram to explain
your answer. Which groups would favor this capital inflow? Which would oppose it? Explain.
9. What is immizerizing growth? Do you think it is likely to occur in the real world? Explain.
Immizerizing growth results when a country grows and, as a result, becomes worse off. At constant
prices, growth will shift a country’s price line out as its PPF moves outward, thereby increasing its