International Trade And Economic Development Economics Essay

The increasing importance of multinational corporations and associated export for international production has prompted considerable interest in the effects of multinational firms and international trade on host countries and their economic development.(Gorg and Strobl,2004)

Economic development refers to economic growth (economic growth simply may just mean an increase in a countries production or income per capita) accompanied by changes in output distribution and economic structure. These changes might include an improvement in the material well being of the poorer half of the population; a decline in the agricultural share in the gross national product (GNP) marched by a corresponding increase in the GNP share of industry and services; an increase in the education and skill of the labour force; and substantial technical advances originating from within the country. Nafziger (2006:15) Economic development in its simplest form is the creation of economic wealth for all citizens within the diverse layers of society so that all people have access to potential increased quality of life. Job creation, economic output and increase in taxable basis are the most common measurement tools. (Fieldhouse 2000).

From a macroeconomic perspective, export is more stable than other types of capital flows. Equity and short-term debt in particular tend to be highly volatile and speculative, and their role in igniting and deepening financial crises in the 1990s has been closely scrutinized. International trade’s relative stability and long-term character make it the preferred source of foreign capital for many emerging economies. In fact, export has been so stable in tumultuous times that some economists have called it “good cholesterol” for emerging economies (Hausmann and Fernandez-Arias, March 2000)

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Export has the potential to generate employment, raise productivity, transfer skills and technology, enhance exports and contribute to the long-term economic development of the world’s developing countries. More than ever, countries at all levels of development seek to leverage international trade for development. (UNCTAD). I t has been realized that that international trade doesn’t only lead to capital inflow, but that foreign affiliates in the host country can benefit indigenous firms. These benefits can manifest themselves in different forms such as superior marketing , management and production techniques.( Markusen, 2002). New growth literature has laid emphasis on the importance of technological improvement on economic growth. The rate of growth of developing economies is sometimes seen in the extent to which these countries can adopt and implement the technology available in advanced economies. Empirical evidence has shown that multinational firms more often than not fall in to that category of firms which posses advanced knowledge in technology. The ability to make use of this new technology will make the developing country in question to meet up with the level of development in developed economies. This is evident in development models such as the Solow swan development model.

Eminent in the convergence hypothesis by Solow-swan, is the fact that an increase in the level of capital accumulation and improvement in technology in a country specifically a developing economy will lead to an increase in the capital labour ratio of the country. With this the economy will grow relatively faster compared to their developed counterpart. As such capital accumulation and technological transfer which are features of international trade contribute to the growth of an economy hence contributing to the economic development of a region.

International trade has attracted increasing interest from developing countries because of the perceived benefits in terms of the injection of capital, technology and knowledge. International trade could be seen as a measure by which technology could be transferred to developing countries. International trade can increase the production potential or capability of the host country as more advanced technology can and will possibly spread to local firms as multinational firms are at the forefront of technological advancement. They therefore have access to the most advanced technology in place at that moment. Investing therefore in their overseas plants, they will transfer some of this high level technologies.( Findley 1978)

The central question concerning the role of international trade in development is to what extent activities of international trade contribute to the generation of host country economic growth through the realization of externalities whether occurring in the same industry of the multinational firm or elsewhere in upstream industries. (Narula, and Portelli, 2004)

Externalities are the mechanism through which productivity gains by locally based firms occur, leading to the generation of economic growth in the host economy.

Through these externalities, international trade inflows can potentially break the vicious circle of underdevelopment characterized by low savings, low investment and low growth, by easing capital, technology and knowledge into the host economy. (Blomstrom 1990). The major form of externalities of firms through international trade is in technological spillovers. Firms involved in joint ventures tend to acquire new technologies and training programmes more frequently than those without.( Djankov and Hoekman 1999)

In explaining the idea of technological spillovers, most empirical authors have taken the view that the technology gap which may exist between local firms and international affiliates is reflected in the observed differences in the level of total factor productivity (TFP) that is how labour and capital are utilised in host country firms. The effect of technology spillovers can then be captured by changes in the level of total factor productivity observed at the firm level, after controlling the impact of other variables that may influence the firm’s productivity performance. Firms therefore tend to have higher productivity than domestic firms in the same sector. Also as a result of technological spillovers, local firms in the same industry are able to benefit from improved production processes which will boost their out put and contribute positively towards the economic growth of the region in which they are located.( Narula, and Portelli, 2004)

International trade and therefore exports will only however have a positive effect on the economic growth of the country if there is the existence of available absorptive capacity in the host country. Glass and Saggi (1998) view the gap between the home country and the importing country as indicating absorptive capital but the larger the gap according to Glass and Saggi reduces the efficiency with which the home country will be able to absorb spillovers .This is because the home country will lack the necessary human capital and technological know-how. Therefore the lower the gap, the greater the absorptive capacity.

Export through international trade therefore thus affects growth directly by increasing the stock of physical capital in the recipient economy as capital is accumulated, and indirectly by promoting human capital development and technological up grade. Robert Solow in his exogenous growth model or neo-classical model as it is also called, places emphasis on the importance of capital accumulation by a nation in a bid to increase the level of economic growth. Differences in countries economic growth can come about as a result of the difference in their levels of technology.

On the whole, international trade plays an important role on economic growth and economic development. De Gregorio( 1992) found out by examining the experience of twelve Latin American countries between 1950 and 1985 that international trade through exports boosted economic growth three times as much as much when compared with aggregate investment. International trade not only has a strong impact on the economic growth of developing economies but its impact is limited to higher income developing economies. (Blomstrom et al, 1992).

Most governments of developing economies now regard attracting international trade opportunities as a priority, particularly in developing and transitional economies. It is given such emphasis not just because it boosts capital formation but because of its potential to enhance the quality of the capital stock. The reason for this is that in general firms are assumed to bring with them best practice or, as a minimum, better practice technology and management. Moreover, it is possible, perhaps even probable, that a given firm will not be able to protect its superior technology and management fully and prevent some elements being absorbed by indigenous firms.(Gorg 1999)

For a country to be able to attract international trade in good quantity, there are certain basic things which should exist within the economy, before a firm engages in investment in a particular country, it takes in to account the level of political stability in the economy. Political stability includes the possibility of a possible outbreak of war, coups , revolutions, and riots. Of particular interest to the investing firm will be the laws and regulations existing with in targeted investing region. These laws and regulations cold be in the form of intellectual property rights, foreign exchange regulations investment advisory processes and issues and laws concerning currency conversion. (Park ,2002). Also in the category are investment restrictions and incentives and trade restrictions amongst other laws and regulations. ( Dunning ,1998)

International traders also pay attention on the possible growth rate and size of the targeted economy. The macroeconomic and industrial policies pursued by the government. One of the most important factors as well to the investor is the business environment. A favourable business environment characterized by a good social infrastructure , existence of energy, good transportation network, and availability of labour amongst others. ( Dunning ,1998)

Some scholars have come up with assertions that instead of international trade stimulating economic growth, economic growth is the bases for international trade. Carkovic and Levine (2002) in their paper used macro economic data and they came up with conclusions that international trade wasn’t important in stimulating economic growth. Saying previous studies which showed a positive relationship between international trade and growth didn’t take into consideration the endogenous problem. If this was taken into consideration, then according to Carkovic and Levine, it was growth that stimulated international trade. This proposition was supported by Li and Liu (2004), who used a large sample of developing and developed countries and come up with the conclusion that the relationship between international trade and economic growth has become largely endogenous.

It could also be important to realise that when firms engage in international trade through exportation and importation, they tend to employ a large number of expatriate managers ensuring that incomes generated are maintained within a relatively small group of people. This may contribute to a widening of the income distribution. It will also not lead to the transfer of management skills. The attraction for these type of firm may be the large supply of cheap manual labour who they can employ at low wages. These large firms engage in transfer pricing where they shift production between countries so as to benefit from lower tax arrangements in certain countries. By doing this they can minimize the tax burden and the tax revenue of national governments. As many of these firms are very large and have considerable power, they can exert influence on governments to gain preferential tax concessions and subsidies and grants, which plays a little negatively on the host economy.

“International trade reduces the productivity of domestic firms through the competition effects, multinational firms have lower marginal costs due to some firm specific advantage, which allows them to attract demand away from domestic firms, forcing them to reduce production and move up their average cost curves”. (Aitken and Harrison 1999). In their paper, they further seem to find no evidence of a positive technological spill over to domestically owned firms. This conclusion was drawn on analysis made with data collected from the Venezuelan economy between 1979 and 1989.

Generally we tend to have disagreements on whether international trade affects the growth of an economy positively or negatively, we tend to realise however that a greater proportion of scholars accept that international trade at some point will have a positive effect on the growth of the economy however the disparity comes in when they think of the factors necessary for the growth to spring from. As such it could be said that international trade directly or indirectly has a positive relationship with the growth of an economy, most especially developing economies.

Export promotion programs

Export promotion programs are initiatives that are set up by governments to stimulate exports in any country. Export promotion can be seen or described as an alternative development strategy to import protection. Import protective give an opportunity for home grown infant industries to grow, export programs give them as access to international markets. Due to the limited size of domestics markets, and the need to achieve economies of scale, it is always essential for industries to have access to the external markets. Paul Krugman (1984) put forward an argument which said that taking into consideration increasing returning to scale if government pursue the route of import protection, it might act as a form of export protection. The reason for this is that protection allows for considerable gains in the form of productivity that allows the possibility of exportation. To policy makers and academicians over the years, export promotion or export oriented industrialization serves as an alternative to an import substitute development program.

Each and every country usually has it own group of export incentives. Therefore every country has its own reason for pursuing its own export promotion strategy

(Pointon, 2001). There is no universal agreement as to the extent to which a governemt should engage in export promotion programs. As such each government advances towards investment in and promotion of services that influence export isn’t based of apparent economic needs buts but it is also influenced by the social structure and the nature of the industry or nature (Pointon, 2001).

Export promotion programs by government are designed to aim at two different levels , the country market or companies. The first objective is to guarantee that the financial

Incentives provide frims in the country with the most prospect for infiltration of the international market and secondly to provide financial support to those firms that have the best export potential and need assistance to enhance their exports.

The strengths of export promotion can be classified at both a country and a company level.

Benefits of export promotion programs

The positive effect of promoting export in a country can be seen in the flow of foreign currency and in the long run will strengthen the countries currency. An increase in export can influence the value of currency as well as better the fiscal and monetary policies of the government. The government of a country can shape its public perception of competiveness and determine the level of imports that a country is able to purchase. (Czinkota, 1996).

Secondly export promotion can lead to economic development in an economy. The promotion of exportation and technical assistance programs, as part of export-led growth strategy, they are generally created to attend to both internal and external limitations to exportation and to promote economic growth and development. (Cavusgil, 1982, 1983). An example of the success of export led growth strategies can be seen in the Chinese economy, the economic growth witnessed in the late 1990’s attest to the benefits of export extension programs.

Other benefits of export expansion strategies involves economies of scales to firms operating in the country. According to Czinkota (1996) export expansion gives a company the chance to produce more, and by so doing it will produce more efficiently, it broaden the companies market and gives it the chance to reach and serve customers abroad. As a result of serving the international market t can lead home firms to improve their products as well as develop new products to meet the exact needs of the international market..

Nextly, being able to diversify the market and take advantage of different growth rates in different markets as well as gain strength by not relying excessively on one single market are the other benefits of a company engaging in exportation.. it gives a company the chance to be sensitive to different demand structures and cultural differences.

Also through its interaction with the companies’ export involvement behaviour, Genctürk and Kotabe (2001)

“With the help of government export promotion programs there is is an imperative determinant for companies’ export performance in a direct manner.” (Genctürk and Kotabe , 2001)

Profit tends to be main driver of business activity, it can be said that the profit opportunities available to exporters can be considered enough reason to motivate companies to export. Export promotion programs are used as a strategy to motivate countries to engage in export activities plus if profits are the main drivers of export, then export incentives then play an important part in supporting such activities.

Weaknesses of export led growth programs

Opponents to the export led growth program argue that the competitive position of firms should be left to the forces of demand and supply in the market and not to government promotion programs plus clamis of improvement in export performance which are credited to these programs are considered self-serving post hoc rationalizations by many critics (Nothdurft, 1992) other weaknesses involve a lack of information about what services are needed by specific groups, and insufficient financial resources.

Emperical evidence on the export led growth hypothesis.

Over the years, the effects of imports and exports on economic growth has been studied in previous studies in development of the economy and international trade.(Darrat, 1986) Even though a lot of studies do fail to provide evidence of support of a relationship between export and economic growth there is evidence of a casual linkage between economic growth and export. Castro -zuniga (2004) studied a vast amount of literature covering the export led growth hypothesis in developed and developing countries.

In cross sectional approach studies the export led hypothesis was tested using either estimations of a regression model or the rank correlation coefficient. Various definations of export are considered in cross sectional studies. That is, real export good, manufacturing a mechandise real export, export shells GDP. Below an analyses will be made of both types of cross sectional approaches.

Regression Approach.

The regression approach generally involves a set of explanatory variables being regress against a growth variable in this case exports can regress against GDP. The export led growth hypothesis is said to be accepted when the coefficient of exports is positive and statistically significant. Some academicians accepts that, by applying this procedure to less developed countries with favourable export goods, a higher rate of economy growth can be achieved. They are other studies who do not how ever support the idea of exportation leading to increased levels o gross domestic production and economic development and they therefore concluded that in the case of different countries, specific needs of country needs to be considered. Various regression studies have therefore confirmed that ELG changes over time. The main problem with regression analysis as studies have found is the fact that it is hard to determine from the results of the regression which is statistical causation and statistical association. Previous studies give very little knowledge about the various ways by which gross domestic product is affected by exogenous variables and the efficient incentive behavior portrayed in other countries. It is implicitly assumed that the parameters used in the regression are the same across countries and it does not allow for any variations between countries.

Ram (1985 and 1987) are two of the most widely used studies of regression analysis.. His analysis and studies depicted a transition to casualty that could be gained through regression analysis from the original correlation approach. Ram (1985) made use of a production function carrying out regressions of output on capital, export , and labour to be able test the export led growth hypothesis on different countries. In his analysis, he used various countries ranging from developed to developing economies and he found out that international trade, specifically the performance of export was particularly important for economic development and growth in both developed and developing economies. The approach, which has been taken in this study, was a better analysis than previous studies because it involved lower income countries and included a larger sample of less developed countries.

Rank Correlation

With rank correlation coeeficient, the export led growth hypothesis can be accepted when the correlation coefficient gross domestic product and exportation is positively and statistically significant. (Darrat, 1986). Short comings linked to this process include the presence of plausible but false correlation which results in the necessity for the least development before any association can exists; however, any noticed correlation can show an existing relationship between other economic variables for example gross domestic product and export. (Darrat, 1986).

Findlay (1984) and Krueger (1985) carried out studies using the rank correlation coefficient and In their work, they tested the export led growth hypothesis for four countries of the Asian region. These included Singapore, Taiwan, Korea and hong kong. He did this using yearly data for 1960-1982 (Darrat, 1986). They came to the conclusion that export promotion strategies in all of these economies helped to drive up economic growth in these countries. The limitation they however faced for using the rank correlation coefficient for this study was that it didn’t consider the possibility that simple correlations where not sufficient enough to test for casualty as high correlation between other variables in the regression analysis can also show an increase in gross domestic product resulting from export

Time Series Approach

This approach solves for some of the short coming presented in other cross sectional studies.it is common for the following three steps to be followed in most time series studies.

1. Firstly, we will be testing for the unit roots in the stationary or non stationary series using the Phillip-Perron tests
2. Secondly, we test for co-integration, using Johansen and Juselius’s (1990) procedures, and/or Engle-Granger co- integration approach
3. Thirdly, using the wildly applied causality approach used by Granger (1969), we will test for causality

In his casuality procedure he has made very little effort in trying to bring in economic theory in order to put any limitations on the links between that exist between any variables that are of interest to the study

For the last couple of decades, to be able to estimate the vector autoregressive models (VAR) as well as the structural VAR models are two procedures which are used commonly in empirical studies, they have also been applied to a lot of export led growth studies in a dynamic time series setting. The two most valuable indicators of the vector autoregressive models analysis are Impulse Response Functions (IRFs) and Variance Decompositions (VDCs). These indicators show the ever changing nature of empirical models.

Even though time series approaches test for causality gross domestic product or economic development and exportation using analytical econometric models, they still show a few problems in predicting their results.

1. The first problem will be able to define the variables with a particular period of times leads to problems in an export led study using Granger-causality tests,
2. Secondly, A limitation, which has been realized, is the aggregation of data, Researchers have come up with different findings for specific countries by using different data sets.

Recent ELG studies

In the last couple of decades different academicians have researched the usefulness of the ELG hypothesis in either a multi variate or bi variate setting. An argumental neo classical function has always been used in these studies. Monthly quarterly and annual data sets were used to test the different properties of a time series. The newest and relevance of studies have been reported in castro -zuniga’s thesis ( 2004)

Marshall and jung(1985) have examined the export led growth hypothesis by testing for auto correlation and casualty on a bi- variate auto regressive process for thirty seven countries. They found out that the export led growth hypothesis was not supported in many of the thirty seven countries they tested. The export led hypothesis was supported only in four of the countries, Egypt , Indonesia, Ecuador and costa Rica. On the other hand export reduction hypothesis was supported in the other countries which signifies that it is not always true that an increase in export will lead to an increase in the level of growth in the country. The authors did however find unidirectional causation from growth in only three countries which supports the export led growth hypothesis.

The export led growth hypothesis was reexamined across Taiwan Singapore, Korea and Hong Kong by Darrat (1986) making use of the same time period 1960-1982 . Beach- Mackinnon maximum-likelihood method correcting for serial correlation were used to estimate the equations. Granger- causality tests were used to find out what the directional causation between gross domestic product or economic development and exportation. From the results of their findings, they discovered that exports didn’t cause economic growth and economic growth didn’t cause exports in Hong Kong. In effect, they found that there was no relationship between export and economic growth. Overall , their study didn’t support the evidence for export led growth. Another scholar Jin (1995) looked at the significance of the export led growth hypothesis in four Asian countries using data from 1973-1976. He made use of 5-variable VAR model and the VDCs, and the IRF the relationship between export and economic growth were tested. Stationary and co integration test on the series will be also used. This study showed that there was a positive significant relationship between gross domestic product or economic development and exportation using the VDC’s in all of the four countries examined. An effect of growth on export was also found in three of the countries. In the IRFs, bidirectional causation was discovered between gross domestic product or economic development and exportation and from economic development or gross domestic product to exportation in all of the countries examined. For all four countries the ELG hypothesis was found to be true

Ekanayake (1999) made an analysis of the causal relationship between gross domestic product or economic development and exportation in eight developing countries in the Asian continent using data from 1960-1997. Ekanayake tested for unit roots in the series, co- integration between the variables, and causality. (Sinoha-Lopete,2004)The author used these techniques in a bi- variate model rather than making using of them in a multi variate model as generally always applied in various time series studies. (Sinoha-Lopete,2004) These models have also been utilized to ensure stationarity and help provide more connections by which Granger-causality can be seen if variables are co- integrated. (Sinoha-Lopete,2004)

Ekanayake (1999) carried out test for the unit roots and he did this making use of the ADF test. The results , show that the two variables in all the countries analysed where found to be stationary. (Sinoha-Lopete,2004) He estimated the optimum lag-length. (Sinoha-Lopete,2004) The author tested for co-integration between exports and economic growth using two co- integration tests for each country: (Sinoha-Lopete,2004) Engle-Granger’s and Johansen-Juselius’s methods. Bidirectional causality was present between economic development, gross domestic products and exportation in seven countries. (Sinoha-Lopete,2004) There was evidence of causality in the short-run from economic development, gross domestic product to exportation in allthe countries used, except in Sri Lanka. There was Strong evidence of long-run causality between gross domestic product or economic development and exportation in all countries. (Sinoha-Lopete,2004)

A study was carried out in sixteen industrialized countries, by Afxentiou and Serletis (1991) to find out the significance of the export led growth hypothesis using data for the period 1950-1985. The variate auto regressive model was used to test for causality and time series properties were tested. In the study, the authors found that there was no co-integration between gross domestic product and export. From their studies only two of the industrialized countries showed evidence of growth led

The export led growth hypothesis was examined in the united states by Jin and Yu (1996) with the use of an expanded 6- variable VAR model using quarterly data for time period 1959 to 1992. This study was looked at to be an extension and synthesis of Sharma et al. (1991) and Marin’s (1992) studies. The variables which were used in this study were exports, output, real exchange rates, foreign output shocks, capital, and labor. Sharma et al. (1991) and Marin’s (1992) stated that increases in foreign income and foreign direct investment and depreciation of United States currency may increase the nation’s exports. They checked their models for unit roots and stationarity using the ADF test. They then conducted a co-integration test using Engle-Granger’s co-integration procedure and Hansen’s two stage test, and the results found no evidence of co-integration. They further examined the dynamic effects the two variables on each other with the help of computing two functions (VDCs and IRFs). The Monte C