1. Trade Policy in DevelopingTrade Policy in Developing CountriesCountries
o Import-Substituting Industrialization (ISI)
o Economic Dualism
o Link
Lecture 1

2. Volume of world exports & GDPVolume of world exports & GDP

3. IntroductionIntroduction
• There is a great diversity among the developing
countries in terms of their income per capita.
– the key to economic development was creation of a strong
manufacturing sector.
– The most important economic - infant industry argument.

4. Import-SubstitutingImport-Substituting
IndustrializationIndustrialization
• The Infant Industry Argument
– Potential comparative advantage
Protect and Nurture
• Example: The U.S. and Germany had high tariff rates on
manufacturing in the 19th
century, while Japan had extensive import
controls until the 1970s.

5. Support for Import-SubstitutingSupport for Import-Substituting
Industrialization – Market FailureIndustrialization – Market Failure
Arguments in favor of Infant Industry Protection
– Two market failures are identified as reasons why infant industry
protection may be a good idea:
• Imperfect capital markets justification
– financial institutions: growth of new industries will be restricted.
• Appropriability argument
– Firms in a new industry generate social benefits for which they are not
compensated (e.g. start-up costs of adapting technology).
• Underdevelopment of other adjoining Sectors

6. Didn’t performDidn’t perform
– import-substituting industrialization did not work
the way it was supposed to
– The infant industry argument was not as universally valid
as many people assumed.

7. Against - Import-SubstitutingAgainst - Import-Substituting
IndustrializationIndustrialization
Problems with the Infant Industry Argument
1. Timing
Example: In the 1980s South Korea became an exporter of
automobiles, whereas in the 1960s its capital and skilled
labor were still very scarce
2. Wrong Assumption
Protecting manufacturing does no good
Example: Pakistan and India have protected their heavy
manufacturing sectors for decades and have recently begun to
develop significant exports of light manufactures like textiles.
3. Small Domestic Market (Demand)
Inefficient Scale of production of import competing sector.

8. Import-SubstitutingImport-Substituting
Industrialization ?Industrialization ?
Import-substituting industrialization generated:
• High rates of effective protection
• Inefficient scale of production
• Higher income inequality and unemployment

9. Import-SubstitutingImport-Substituting IndustrializationIndustrialization
Effective Protection of Manufacturing in Some Developing
Countries (percent)

10. Economic DualismEconomic Dualism

11. Problems of the Dual EconomyProblems of the Dual Economy
Development often proceeds unevenly and results in a
dual economy consisting of a modern sector and a
traditional sector.
The Symptoms of Dualism
• The modern/Industrial sector typically differs with a
traditional/Agriculture sector in that it has:
– Higher value of output per worker
– Wage differential: Higher wages
(WM) >(WA).
– Higher capital intensity
– Persistent unemployment (especially in urban areas)

12. Dualism and Trade – The linkDualism and Trade – The link
ISI would ease Dualism
So, if duality exists we should adapt ISI
Dualism is worsened by ISI
So, might actually be a cause for
Severe levels of Dualism.

13. Argument in favor of ISI:Argument in favor of ISI:
Protection/Import substitution Industrialization
would help ease dual economy, by reducing
unemployment/ increasing employment in the
Industrial sector.
ISI would ease Dualism
So, if duality exists we should adapt ISI

14. BUT it didnBUT it didn’t work like that in some’t work like that in some
casescases
The creation of the dual economy (an
economy that is characterized by
economic dualism) has been helped by
import-substitution policies.
Dualism is worsened by ISI
So, might actually be a cause for
Severe levels of Dualism.

15. Let’s see how?Let’s see how?
The Harris-Todaro model
– It links rural-urban migration and unemployment
– undermines the case for favoring manufacturing employment,
even though manufacturing does offer higher wages.
Evidence
• Countries with highly dualistic economies also seem to have
a great deal of urban unemployment.
An increase in the number of manufacturing jobs will
lead to a rural-urban migration so large that urban
unemployment actually rises.

16. Traditional SectorTraditional Sector

17. Problems of the Dual EconomyProblems of the Dual Economy
• Trade Policy as a Cause of Economic
Dualism
– Trade policy has been accused both of:
• Widening the wage differential between manufacturing
and agriculture
• Fostering excessive capital intensity
– Wage differentials are viewed as:
• A natural market response
• The monopoly power of unions whose industries are
sheltered by import quotas from foreign competition

18. Dealing with Economic DualismDealing with Economic Dualism
Solving the problem of Rural-Urban Migration

19. • The National Rural Employment Guarantee Bill goes
beyond describing a set of employment generating
schemes, and goes into the nitty-gritty, listing the broad
responsibilities of the officials at the district, block and
panchayat levels. Tweaked slightly and implemented as an
Act, it can over time evolve into a means of rapid, all-round
infrastructure development in rural India, says Bhanoji Rao.

20. Trade Policy in DevelopingTrade Policy in Developing CountriesCountries
o Import-Substituting Industrialization (ISI)
o Economic Dualism
o Link
Lecture 1