0:03 Hello everyone. This is a tutorial about
0:05 trade policies in developing countries
0:07 and mainly dealing with import
0:09 substitution, industrialization and
0:11 economic dualism and link between these
0:14 two. There has been a belief that key to
0:16 economic development is really having a
0:19 strong manufacturing sector and one way
0:21 to have a strong manufacturing sector is
0:24 to really protect your industry at the
0:26 expense of imports. You expect your
0:28 industry to have a potential comparative
0:30 advantage that the industry would reach
0:33 sometime in the future. But right now it
0:35 is in the infancy stage and needs to be
0:38 protected and nurtured. There has been a
0:39 success with infant industry argument
0:41 mainly with US and Germany that adopted
0:44 this in the 19th century. Also, Japan
0:47 had extensive import controls for a long
0:49 time as well. And seeing the success of
0:51 these two countries, a lot of developing
0:53 countries started protecting their
0:56 manufacturing sectors.
0:58 Right. So there have been um arguments
1:00 in favor of infant industry production.
1:03 Uh one such argument is that you know
1:05 there are certain market failures that
1:07 prevents an industry from reaching its
1:11 comparative advantage. A sector has the
1:15 potential to uh reach a uh a high level
1:17 of productivity such that it might have
1:18 a comparative the country might have a
1:20 comparative advantage in the future. But
1:22 at this point in time it is being
1:24 constrained and restricted by other
1:26 sectors and one might be imperfect
1:29 capital markets. It's not easy for this
1:33 exporting sector to uh avail uh capital
1:38 or borrow money uh at uh at a uh at the
1:40 market interest rate and it might just
1:41 be that there are no banks in those
1:43 rural areas where these exporting
1:45 sectors might be now. Because of the
1:47 growth of the industry is might be
1:48 restricted because of imperfect capital
1:51 markets or a probability argument where
1:55 you have certain goods that have a large
1:57 proportion of uh benefits occurring to
1:59 the society not to the private sector
2:01 that might invest in it. So you might
2:03 have low levels of investment in those
2:06 sectors and then other uh adjoining
2:07 sectors as well like transportation
2:09 sector you might not have uh decent
2:12 roads uh for to transport the goods from
2:15 the place where it's being produced to
2:17 where it needs to be shipped to and this
2:19 might just be uh leading to a higher
2:21 cost. You need to protect these
2:23 industries till the other sectors also
2:24 develop and you'll have a competitive
2:27 advantage in the future. If you allow
2:29 for imports to come in at this point in
2:31 time, what's going to happen is that uh
2:34 your own industry will not be able to
2:36 compete with these imports not because
2:38 it is not product but because it has
2:40 other sectors that are pulling it down,
2:43 right? And um but but what we've
2:45 observed is that this import
2:47 substitution utilization has not really
2:49 worked the way it was supposed to, the
2:52 way that it worked for the US uh and for
2:54 Germany. There are some problems with
2:56 the infant industry argument that uh had
2:58 been ignored earlier. One is industry
3:00 might have a comparative advantage in
3:03 the future. But how much further in the
3:05 future do you think you might have that
3:07 advantage and would it make sense to
3:09 protect the industry right now if after
3:10 20 years you might have comparative
3:12 advantage? One example that is offered
3:14 is of South Korea which protected its
3:17 industry for 20 years and it it's only
3:19 now that we see Kia uh trying to compete
3:22 with other uh automobiles. And uh number
3:24 two, some of these industries that these
3:26 countries are trying to protect might
3:28 not really have a competitive advantage
3:29 even in the future. So there might be
3:32 wrong assumption about which industries
3:34 might have a competitive advantage.
3:36 Right? And here we talk about Pakistan
3:38 and India that have had protection for
3:41 its industry for a long time and it's uh
3:45 once uh India had to lower its uh tariff
3:46 rates the protection that it was
3:48 offering its import competing sectors in
3:50 the '90s we observed that the industries
3:52 could not really compete with the
3:54 outside world and it's still the light
3:56 manufacturing sectors that are uh able
3:58 to really compete and we have the
4:01 pharmaceutical sector as well now and uh
4:03 then the third is well what if you do
4:05 protect your industry and the industry
4:08 is producing for the domestic market but
4:12 the domestic demand is too small. It's
4:14 so small that you're actually producing
4:16 at an inefficient scale of production.
4:18 That means you're producing such a small
4:20 amount that you can't really avail of
4:22 economies of scale that might exist in the
4:23 the
4:25 industry. Right? And in that sense
4:27 you'll never really drive down the
4:30 average cost. you never bring down the
4:33 cost of producing the good because of uh
4:35 the the restricted demand that exists in
4:37 your uh country. So in that case you'll
4:39 never have the comparative advantage
4:41 because you'll never ever produce at a
4:45 scale uh to bring down your cost right
4:48 now. So what has been the result of
4:50 adopting import substitution
4:52 industrialization in these countries?
4:55 Well, there has been higher rates of uh
4:57 effective production and inefficient
4:59 scale of production in these
5:02 industries. And the main one that we'll
5:04 discuss uh in this lecture is high in
5:07 income inequality and
5:09 unemployment in these
5:13 countries. Um this is a table which
5:15 shows the effective rate of protection
5:17 for various countries at various points
5:19 in time. And what we we you see for
5:21 Pakistan uh
5:24 271% of tariffs being imposed on imports
5:28 whereas for Mexico you see only 26%. So
5:31 really different countries were are um
5:32 adopting different kinds of uh trade
5:34 policies. Some very protective measures,
5:36 some not so protective measures and
5:39 India hovers around 300% as
5:43 well, right? Um so where are we going
5:44 with this? Well, we want to look at
5:46 economic dualism. What is economic
5:48 dualism? It's exactly what this picture
5:51 shows you. There is a modern sector that
5:55 exists exists with a whole slum area
5:57 around it. Right? So you have high
6:01 levels of unemployment in the city and this
6:02 this
6:05 unemployment is arising because you have
6:08 a traditional sector which is offering
6:11 them a very lower wage compared to the
6:13 modern sector and people are migrating
6:16 from rural areas to urban areas. Right?
6:18 So you see a slum right next to a big city
6:20 city
6:25 here and really all
6:28 countries while while they develop go
6:31 through this period of duality. Okay.
6:32 Because development really proceeds
6:36 unevenly and you have dual economy where
6:37 modern sector starts performing much
6:38 better than a traditional sector.
6:41 traditional sector lags behind and you
6:45 have dualism and then countries develop
6:47 further and this duality disappears.
6:50 Right? Now the what is what are the
6:51 symptoms of dualism? How do you define
6:53 or how do you characterize uh economic
6:57 duality? Well, you have two sectors
7:00 coexisting with very different uh
7:02 characteristics. You have a modern
7:05 industrial sector which has a higher
7:07 high value of output per worker. So
7:08 productivity, labor productivity is
7:10 really high in these sectors compared to
7:12 agriculture sector. There's a huge wage
7:14 differential. Wages are much higher in
7:16 the modern sector compared to the
7:19 agriculture or the traditional sector.
7:21 higher capital intensity in the
7:23 manufacturing se in the modern sector
7:24 further increasing the labor
7:27 productivity and and then you have
7:29 persistent unemployment around the urban
7:31 areas that those were the slums that we
7:35 saw in that picture and this is the high
7:37 level of unemployment that exists in the
7:40 urban areas right now how are how are
7:42 import substitution industization
7:45 economic tourism linked well if you have
7:48 this high levels of unemployment around
7:50 your urban areas That means the modern
7:51 sector is not able
7:54 to absorb these people that are
7:56 migrating from rural to urban areas.
7:59 Right? Uh so the believers in ISI really
8:03 think that the ISI can ease dualism.
8:06 uh and if there is economic duality then
8:08 maybe what uh policies developing
8:10 countries should be following is one of
8:13 protection import subs industalization
8:16 they protect their manufacturing sector
8:18 or the modern sector from
8:21 imports the prices in these sectors
8:24 rise and production would increase and
8:27 hence employment increases and you deal
8:29 with a decreasing unemployment right so
8:31 that's really what their argument is in
8:37 favor of ISI. Now the other argument the
8:38 counterargument is that actually you
8:40 know what the dualism has been worsened
8:43 by import substitution industization. So
8:45 it's actually a cause of these severe
8:47 levels of dualism found in developing
8:50 countries these days not a solution. So
8:52 these are the arguments and the counter
8:55 arguments for whether you should use ISI
8:57 when you have economic dualism. So let's
9:00 look at the first argument. Um as uh I mentioned
9:01 mentioned
9:03 earlier import substitute
9:05 industalization can ease
9:08 rism by reducing
9:11 unemployment. You protect the import
9:15 substitution substit uh import competing
9:17 sectors your manufacturing sectors your
9:20 modern sectors from imports. You block
9:22 out imports. The production takes place
9:24 at home. There's increase in production.
9:27 There's increase in uh manufacturing
9:30 goods. employment increases and you can
9:32 deal with these slum areas these high
9:36 levels of unemployment in urban
9:39 areas. The second the counter argument
9:41 is well not
9:43 really what has been observed in some
9:46 developing countries is that there has
9:49 been an increase in economic duality as
9:51 a result of import substitution
9:53 industalization. Right? So it's actually
9:56 causing it not
9:59 helping. And uh the ones to come up with
10:01 were Harris and Daro. They came up with
10:04 this model which links they explain this
10:07 um counterargument by linking the rural
10:10 to urban migration and unemployment in urban
10:11 urban
10:15 cities. And the it undermines the
10:17 migration undermines the case of
10:19 favoring manufacturing
10:23 employment. Right? So really what we are
10:26 what they were suggesting is that right
10:28 you do if you protect the manufacturing
10:30 sectors and the prices are increasing
10:32 these sectors the wages are also
10:34 increasing these sectors. So increasing
10:36 this wage disparity between traditional
10:39 sector and the urban sector and their
10:41 argument is really based on this
10:44 evidence that we uh see that highly
10:46 dualistic economies also have a high
10:50 level of urban unemployment. Right? And
10:52 so the main link that they are making is
10:55 between the rural to urban migration uh
10:57 which is so large that the increase in
10:59 urban employment cannot keep up with
11:02 this migration and urban unemployment
11:05 actually rises. Now that that would
11:06 happen because you're protecting the
11:09 manufacturing sector, the modern sector,
11:11 right? The prices are going up, the
11:13 wages are going up, it has higher
11:16 returns and so you see capital moving
11:19 more towards uh the modern sector is
11:21 becoming more productive. The wages are
11:22 increasing. At the same time, the
11:24 traditional sector is lagging behind.
11:26 The productivity isn't increasing at the
11:29 same pace. The wages aren't going up. Uh
11:32 there is a huge disparity now that wage
11:33 disparity between modern sector and
11:35 traditional sector. So more people are
11:37 going to be dissatisfied in the rural
11:39 areas and move towards urban areas. So
11:42 really the problem is your uh
11:44 traditional sector that is not really
11:46 able to increase productivity. Okay. So
11:48 these are pictures of um some
11:49 traditional sectors in India and what we
11:51 see here is really that uh there hasn't
11:53 been any improvement in technology being
11:54 used in the agriculture sector. The
11:56 labor productivity is really low. As a
11:58 result you see the wages lower uh in
11:59 these traditional sectors and modern
12:02 sectors. Trade policy has really been
12:03 accused of widening this wage
12:06 differential as well as fostering excess
12:08 capital intensity in the capital in the
12:10 modern sector. By uh imposing high
12:12 tariffs, you're keeping the prices in
12:14 the manufacturing sectors artificially
12:17 high which then increases the capital
12:18 intensity in these sectors because it's
12:20 more profitable to invest in these
12:21 sectors because of higher prices. Is
12:23 resources moving away from agriculture
12:25 towards a modern sector? To deal with
12:27 economic dualism, you really have to
12:29 attack the problem the problem of rural
12:32 to urban migration. You have to deal
12:34 with this wage inequality by increasing
12:36 the labor productivity in the
