Model Answer on Trade & Development

June 2004; unit 5; question 2(a) : With reference to extract 1 assess the importance of openess to international trade to a developing country's economic growth. 20 marks

Plan : 20 marks = 4 points plus 2/3 evaluation points

1)gains from comaprative adv EVAL - assumes other richer nations are trading fairly
2) increase in X leads to increase in GDP plus multiplier EVAL dependency on exports menas vulnerable to global falls in demand eg Asai in 2001 when demand for high tech goods fell
3)Devaluation of currency will lead to increase in X and fall in M so being open gives another macro tool eg Brazil is closed and so devaluing the Real had no effect.
4)source of foreign currency for external debt servicing EVAL: a better way would be debt forgiveness
Big Finish
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By being open to foreign trade a developing country will be able to gain a comparative advantage in production of certain goods. This happened in the Far East when they became specialised in the production of high-tech goods. There is a static gain from this specialisation and trade, which is the growth of a new industry whcih will not only boost GDP but also employment and income levels. This will be particulalry important for developing countries such as Brazil where the domestic market is not very big. Dynamic gains may take the form of economies of scale over time and the development of expertise, training and capital from foreign firms investing in these economies.However, one drawback of depending on trade is that the gains frm trade can only be enjoyed if the developing coutnries' richer trading partners are not distorting the rules of trade by subsidising industries or using protectionist measures. An example of this is agriculture: there would be little point in Brazil trying to gain a competitive advantage in the production of beef, say, when EU and USA farmers are being heavily subsidised.

An increase in exports will lead to an an increase in aggregate demand. Given that developing countries are not anywhere near a level of full employment, this boost to aggregate demand - and the further boosts from the multiplier effect - will lead to an increase in GDP and there will be economic growth. With weak domestic demand, this boost could be significant and dramatically increase economic growth. This can be seen in modern day China, which has managed to lift millions out of poverty through a reliance on export-led growth. However there is a real danger in such a strategy. In the Far East the Asian economies, which were reliant on the export sales of high-tech goods, suffered badly when there was a fall in global demand for such goods because of a world-wide recession. Fortunately their econnomies were responsive and flexible enoughto adapt and survue, showing how important it is to use the gains from buoyant times to train and develop a flexible workforce.

Another reason why being open to foreign trade is highlighted in the extract. Owing to its open-ness to trade, the Far Eastern economies had a rise in the value of exports and a fall in the vlaue of imports when there was a devaluation. It meant that essentially they had another macroeconomic tool which they could use to boost GDP when they needed to . In Brazil the devalutation of the Real had no discernible effect on the state of the macroeconomy.

Lastly and probably most pertintnetly for developing economies is that an increase in exports will bring in foreign currency for a developing economy. This is importnat especially when a developing country needs to pay off external debt. The crisis in Brazil and other latin American countries, who have defaulted on debt repayments has come aboutpartly becasue of a lack of dollars. By exporting more, they would be able to more readily pay off their debts. This gets me vex. Debt should be forgiven; it is outrageous that struggling, developing countries should have to use foreign currency to pay off very old and very expensive debts to much richer nations when these dollars could be building better hospitals, better schools, better ports and better roads.

In conclusion, being open to trade is one way in which a developing country can grow its economy. It leads to an inrease in GDP and hopefully living standards and brings in foreign currency to either pay off debts or pay for social infrastrucutres; the latter would be better. However, being open to foreign trade also menas being vulnerable to unscrupulous richer nations who distort trade 'rules' and to external shocks such as global recessions.