Although the rate of economic growth and the space and pattern of economic develop­ment depends primarily on internal conditions in developing countries, international trade can make significant contribution to economic development. The traditional theories of trade examine how growth in production capabilities can affect international trade.

Clearly, growth can have a major impact on international trade. There is also likely to be an impact in the other direction—from trade to growth. Exposure to interna­tional trade can have an impact on how fast a country’s economy can grow and how fast its production facilities are growing over time.

The classical economists like Adam Smith and David Ricardo first found interest in the role of trade in economic development. They have sang the praise of free trade based on compara­tive advantage. The principle of comparative advantage holds that each country will benefit if it specialises in the production and export of those goods that it can produce at relatively low cost. Conversely, each country will benefit if it imports those goods which it produces at rela­tively high cost.

The classicists advocated the doctrine of laissez-faire (non-interference by the government) even in international trade (and not just in domestic matters). Such adherence to completely free trade, they thought, would promote the maximisation of welfare for the world and the member countries in the world trading system.

Notwithstanding its limitations, the theory of comparative advantage is one of the deepest in all types of economies. Those countries which disregard comparative advantage ultimately have to pay a heavy price in terms of their living standards and economic growth.

As P. A. Samuelson and W. D. Nordhaus convincingly argue:

“Free trade promotes a mutually benefi­cial division of labour among nations; free and open trade allows each nation to expand its production and consumption possibilities, raising the world’s living standard. Protectionism prevents the forces of comparative advantage from to maximum advantage.”

However, there is dissatisfaction among LDCs as to the virtue of completely free trade and most such countries feel that it is not the ideal policy for them. They feel that they are partners in global trade since the gains from trade are not equally shared by developed and developing countries.

This very feeling gets reflected in the North-South conflict which has created the demand for a new international economic order. Given their level of poverty and some special problems which they have been facing over the years, developing countries often treat the laissez-faire pre­scription as inappropriate.

So, any discussion of the role of international trade in promoting economic development must take into account the special problems faced by the developing countries in international trade and the policy constraints they face in tackling them.

Trade, undoubtedly, has several benefits. It promotes growth and enhances economic wel­fare by stimulating more efficient utilisation of factor endowments of different regions and by enabling people to obtain goods from efficient sources of supply. Trade also makes available to people goods which cannot be produced in their country due to various reasons.

The role of trade in enhancing consumer’s choice (even delight) is tremendous. The foreign trade multi­plier, shows how an injection of income arising out of trade can lead to economic expansion.

According to A.C. Cairn cross:

“As often as not, it is trade that gives birth to the urge to de­velop, the knowledge and experience that make development possible, and the means to ac­complish it.”

An Overview of the Developing Countries:

It may be noted at the outset that LDCs are not a homogeneous group. There are many differences in levels of income, types of industrial structure, degree of participation in inter­national trade (or the degree of economic openness) and types of problems faced in the world economy.

In spite of the diversity among LDCs, a list of Characterizations of these countries is useful for emphasizing that they are very different from the industrialised countries. In general, the LDCs are characterised as having low per capita incomes and a relatively low per cent of their population in urban areas.

In addition, population growth rate, the share of agriculture in GDP, and infant mortality rates are higher and life expectancy is shorter than those in high- income countries. Finally, the share of manufactured exports in total exports tends to be lower in devel­oping countries than in high-income countries.

E. Haberler lists the following benefits of trade to stress the importance of trade to develop­ment of the less developed countries:

1. Trade provides material means (capital goods, machinery, and raw and semi-finished material) indispensable for economic development.

2. Trade is the means and vehicle for the dissemination of technological knowledge, the transmission of ideas, for the importation of know-how, skills, managerial talents and entrepreneurship.

3. Trade is also the vehicle for the international movement of capital, especially from the developed to the underdeveloped countries.

4. Free international trade is the best anti-monopoly policy and the best guarantee for the maintenance of a healthy-degree of free competition.

The Role of Trade in Economic Development:

In discussing the role of trade in fostering economic development, we have to examine various different issues, viz, the static effects of trade, the dynamic effects of trade and export pessimism or secular deterioration of the terms of trade of LDCs. In this context, we have access to discuss trade policies of the developing countries.

1. The Static Effect of Trade on Economic Development:

International trade enables an LDC to get beyond its PPC and improve its welfare. It can consume more than what it is capable of producing through specialisation and exchange. An LDC can improve its well-being by specialising in and exporting the relatively less expensive domestic goods and importing goods which are relatively more expensive. Even if a country’s production does not change at all, there are still gains from exchange if there is a difference between internal relative prices in autarky and those which can be obtained internationally.

In addition, the characteristics of the imported goods either in terms of quantity for custom­ers or productivity in the case of capital and intermediate imports, may improve the economy ‘s ability to meet consumer desires for better quality goods or larger volume of goods made avail­able by improved technology. Imports may also help remove bottlenecks and enable the economy to operate closer to its PPC—that is to say, more efficiency on a consistent basis.

i. Employment Generation:

Due to specialisation there is a relative expansion of the sec­tors using relatively more intensively an LDCs abundant factor—which is labour. For most LDCs, specialisation according to comparative advantage helps to expand labour-intensive production instead of more modern, capital-intensive production.

This means expanding tradi­tional agriculture, primary products, and labour-intensive light manufactures. International trade thus stimulates employment and puts upward pressure on wages as has been suggested by the Heckscher-Ohlin (H-O) theorem. However, most LDCs are labour-surplus countries. So, an increased demand for labour is unlikely to raise the wage rate much.

ii. Export Instability:

Moreover, the relative growth in the production of traditional goods may not be desirable if such growth is at the expense of modern manufacturing. Due to low income and price elasticities of demand for such goods and the instability of supply of agricul­tural and primary products due to natural (weather) conditions, greater specialisation in these goods can result in a greater instability of income even in the short run.

iii. Adverse Terms of Trade:

In addition, since an LDC is a small country (in the sense that it cannot exert any influence on the prices of its exports and imports), expansion of export supply may lead to undesired terms of trade movements that will-reduce the static gains from trade. This may lead to a distribution of gains from trade in favour of the industrially developed countries.

iv. Greater Dependency:

Finally, expanding production of basic labour-intensive goods and relying on the industrialised countries for technology and skill-intensive manufactures and capital goods often leads to excessive economic dependency. It also links the economic health of the developing country to that of the industrialised country.

v. Vent for Surplus:

Both the classical (Ricardian) and the modern (H-O) theories of inter­national trade are based on the assumption that production in each trading country takes place under conditions of full employment. But full employment does not prevail in LDCs. So, trade theories cannot be applied in such countries to predict the impact of trade on production, con­sumption, distribution and social welfare.

Yet, there is another potential gain from trade, as has been pointed out by Hla Myint (1958). According to Myint, due to unemployment on LDCs, actual output is less than its potential output. By utilising its manpower fully an LDC can produce more products and its supply may exceed domestic demand.

This excess supply can be disposed of in the form of export. In this sense a ‘vent for surplus’, i.e., a larger market that will permit a labour surplus country to increase its employment and output, as is shown by a movement from a point such as I (inefficient point), inside the PPC to a point E (effi­cient point) on the PPC in Fig. 1.

Myint suggests that vent for surplus convincingly explains why countries start to trade, while the theory of comparative cost helps to under­stand the types of commodities countries ultimately ex­port and import. No doubt the gains in income, employment and needed imports can render considerable help to the whole process of development.

In short, the static gains from trade for an LDC originates from the traditional gains from exchange and specialisation as will follow from a vent for surplus. However, due to the lack of sufficient flexibility in traditional (largely subsistence) economies and the nature of the traditional labour-intensive exports, the relative gains from trade may be less than those from more flexible and progressive industrial economies and may be further reduced by the undesirable effects of increased economic instability and secular deterioration of the terms of trade. No doubt in the process of economic development we find changes in the economic structure and sectoral distribution of income.

This occurs in response to changes in relative prices brought about by international trade. However, the economic systems of the LDCs tend to be somewhat unresponsive to changing price incentives, at least in the short run.

So, factors of production may not move easily to the expanding low-cost sectors from the contracting higher-cost sectors. In such a situation the process of adjustment assumes the characteristics of the specific-factors model. Consequently, the gains from specialisation are reduced correspondingly.

2. The Dynamic Effects of Trade on Economic Development:

Perhaps the maximum potential impact of trade on development lies in its dynamic effects. As D. Salvatore has put’ it- “While the need for a truly dynamic theory cannot be denied, comparative statics can carry us a long way forward incorporating dynamic changes in the economy into traditional trade theory. As a result, traditional trade theory, with certain qualifications, is of relevance even for devel­oping nations and the development process.”

On the positive side, the expansion of output made possible by access to the wider international markets enables the LDC to exploit econo­mies of scale that would not be possible with a narrow domestic market.

This means that indus­tries which are not internationally competitive in an isolated market may achieve competitive­ness by way of international trade if there are potential economies of scale. If LDCs can take advantage of economies of scale, they can reduce costs of production and sell their products at low prices in international market.

Promotion of Infant Industries:

Moreover, comparative advantage is a dynamic concept. In the real world, we find changing pattern of comparative advantage over time. As a developing nation accumulates capital and improves its technology, its comparative advantage shifts away from primary products to sim­ple manufactured goods first and then to more sophisticated ones.

Thus, with economic devel­opment, international trade can foster the development of infant industries and make them internationally competitive by providing the market size and exposure to products and proc­esses that is unlikely to happen in closed (isolated) economy. This is why the most important argument for protection in LDCs is the infant industry argument. It is essentially an argument in favour of protection to gain comparative advantage.

This is why for protecting infant indus­tries trade policy restraints in most LDCs are used, at least in the early stages to restrict imports or promote exports. To some extent, this has already happened in Brazil, Korea, Taiwan, Mexico and some other developing countries. However, there are various problems with using the policy in practice. Infants never grow adult in some high protected environments and there is need for continuation of protection for ever.

Other Dynamic Influences:

Perhaps the maximum possible impact of trade on development depends on its dynamic ef­fects. Prima facie, the expansion of output brought along by access to the larger international markets permits the LDC to take advantage of economies of scale that do not arise in the limited domestic market.

Thus, industries which are not internationally competitive in a nar­row and isolated domestic market may well gain competitiveness as a wider market created by international trade. Trade creates an opportunity to exploit potential economies of scale. Fur­thermore, comparative advantage keeps on changing over time.

Thus, as economic develop­ment takes place, international trade promotes the growth and ensures the maturity of infant industries which become internationally competitive by being able to exploit the wider market created by trade.

A wider market also exposes an LDCs products and processes in international market and creates pressure on the industries of LDCs to improve product quality and reduce product price so that these are accepted in the rest of the world. In short, international trade makes protected domestic industries internationally competitive.

Other dynamic influences of trade on economic development arise from the positive com­petitive effects of trade, increased investment resulting from changes in the economic environ­ment; the increased dissemination of technology into the LDC (as has been suggested by the product life cycle model), exposure to new and improved products and changes in institutions accompany the increased exposure to different countries, cultures and products. Trade fosters domestic competition and acts as an instrument of controlling monopoly.

Openness to trade can affect the technology that a-country can use. We may now discuss the mechanism in detail. Trade policies give of country access to new and improved products. No doubt capital goods are an important type of input into production that is largely imported by LDCs at lower stages of development. Trade allows a country to import new and improved capital goods, which “embody” better technology that can be used in production to raise total factor productivity.

The foreign exporters can also enhance the process, for instance, by advising the importing firms on the best ways to use the new capital goods. Some empirical studies show that the gains from being able to import unique foreign imports that embody new technology can be larger than the traditional gains from trade, highlighted by the classical theory.

According to T. A. Pugel, in a more general way, openness to international activities leads the firms and people of the country to have more contact with technology developed in other countries. This greater awareness makes it possible for an LDC to gain the use of new technol­ogy—through purchase of capital goods or through licensing or initiation of the technology.

Great economic openness is likely to have a favourable effect on the incentive to innovate. Trade is likely to put additional competitive pressure on the country’s firms. The pressure drives the firms to seek better technology to raise their productivity in order to achieve greater international competitiveness.

Trade also provides a larger market in which to earn returns to innovation. Its sale into foreign markets provides additional returns, then the incentive to inno­vate increases, and firms devote more resources to R & D activities.

Openness thus can enhance the technology that a country can use—both by facilitating the diffusion of imported technology into the country and by accelerating the indigenous develop­ment of technology. Furthermore, these increases in current technology base can be used to develop additional innovations in the future.

The current technology base becomes a potent source of increasing returns over time to ongoing innovation activities. The growth rate for the country’s economy (and for the world as a whole) increases in the long run.

In short, economic openness can accelerate long-run economic growth. This indicates an additional source of gains from international trade (or from openness to international activities more generally). Empirical studies show that there is a strong positive correlation between the growth rate of a country and its international openness. This is not a proof of causation, ‘but it is consistent with the theoretical analysis that suggests why openness can raise growth.

Trade as a Hindrance to Growth:

Critics, however, have pointed out that conditions in developing countries are not very differ­ent from those of industrial countries. So that the application of the static principle of compara­tive advantage may not be helpful in providing appropriate guidelines for trade and specialisa­tion in a dynamic LDC environment. While trade can be beneficial to nations and the world as a whole, it can also have harmful effects on some countries and as also on the world entire.

The international trading system is biased against the developing countries, particularly the poor among them, because of factors like their weak bargaining power vis-a-vis the advanced countries, the participation gap, dependence on the developed countries for various needs, etc.:

The important harmful effects of trade are the following:

1. Trade may lead to indiscriminate exploitation of natural resource, particularly of devel­oping nations. Trade has been resulting in the drain of resources from the developing to devel­oped countries.

2. Trade also causes environmental problems because of the indiscriminate exploitation of resources and location/relocation of polluting and hazardous industries in the developing world for the benefit of the developed world.

3. The deterioration of the terms of trade of the developing countries causes large income transfers from the developing to the developed countries.

International trade may also give rise to demonstration effect in the developing countries. Demonstration effect, a term associated with Nurkse, refers to the tendency of poor people to imitate the life styles of the rich.

In international economics, it refers to the tendency of the people of developing countries to follow the consumption habits of the people of the advanced countries by importing luxury goods. This could have harmful social and economic effects. It could also have some favourable effect if it can encourage the development of the domestic industries of the developing countries.

Another important harmful effect of trade is what is described as the backwash effect. Some of the domestic industries of the developing countries, particularly small scale, which are unable to compete with the well-developed industries of the advanced countries, could be destroyed or damaged by unregulated imports.

India has had a paradoxical policy of reserving many items for the small scale sector but allowing the import of these items. The recent trade liberalisation is adversely affecting the agricultural, often subsistence, sector of many develop­ing countries even as the agricultural sector is heavily protected in the developed world.

Globalisation and free trade are now adversely affecting the developed countries, too be­cause of the edge the developing countries have over the developed ones in the production of many products. Trade also results in the introduction of pep and cola cultures to the developing countries which have important social implications.

Two main reasons for not so remarkable improvement in growth due to trade in LDCs are:

(i) Absence of perfect competition (and the consequent distortion of commodity and factor prices) and

(ii) The absence of full employment (due to existence of not only surplus labour but also surplus productive capacity).

For these reasons, if we are to get a balanced view of the effects of international trade on development we have to refer to some important disadvantages of free trade for an LDC, more so in view of the fact that these problems can have important implications for trade policy.

1. Externalities:

The static theory of comparative advantage ignores the very important fact that most markets in LDCs are imperfect. This implies departure from the Pareto optimality conditions. Market imperfections create an undesirable consequence. Private costs and ben­efits differ from social costs and benefits mainly due to the existence of economic externalities.

Any reliance on market prices in such an environment can lead to the emergence of a pattern of trade which, is largely inconsistent with both relative social costs-and long-term development goals of the country, e.g., if the growth of an industry does considerable damage to the physical environment.

2. Differential Impact of Trade:

In a more general way, the overall effect of growth in exports on the growth and development of the entire economy is likely to vary from commod­ity to commodity. The reason is easy to find out. In a broader dynamic context, the economy- wide production linkages vary among different commodities or sectors.

Industries producing certain strategic inputs like steel, coal and power or oil may act as leading sectors or ‘growth poles’ for the entire economy, while others—such as primary products—will act as the lagging sectors having little or no linkage effect outside their own sectors.

3. Variation in Returns to Scale:

Returns to scale may also vary among commodities. This means that an LDC is unlikely to have a relative cost advantage in a particular product since the domestic market is too narrow to permit cost-efficient production.

However, there might exist a comparative advantage in the same product at a higher level of output. In a like manner, a product may have a relative cost advantage at present but its production is characterised by decreasing returns to scale. So it may have very limited export potential.

4. Market Imperfections and Government Policy:

The domestic supply and demand con­ditions that underlie both current and future comparative advantage is likely to be influenced both by market imperfections and by restrictive, and at times unrealistic, domestic economic policies.

5. Unequal Distribution of Gains from Trade:

Finally, the operation of markets and char­acteristics of traded goods differ between the developing countries and the industrialised coun­tries. Such differences result in a disproportionate share of the benefits of trade being captured by the industrialised countries.

What is worse is that such differences often lead to greater dependence of LDCs on DCs. This is a major source of potential development problems for countries like India, Pakistan and Bangladesh which have a colonial heritage and an enclave economic structure.

As D. Salvatore comments- “With developing nations specialising in pri­mary commodities and developed nations specialising in manufactured products, all or most of the dynamic benefits of industry and trade accrue to developed nations, leaving developing nations poor, undeveloped and dependent.” Two issues related to these differences are export instability and secular (long-run) deterioration of the terms of trade. In this sense, trade acts as hindrance to growth.

It is to this issue that we turn now:

Export Instability:

Exports of LDCs tend to fluctuate more sharply from year to year than are found in industrialised countries. Due to the relatively high degree of openness of many LDCs (i.e., a high ratio of foreign trade to GDP), variability in the export sector leads to fluc­tuations in GDP and the domestic price level. Thus, business cycles get transmitted from devel­oped to developing countries through international trade.

This causes considerable uncertainty to producers and consumers. In addition, export instability makes it more difficult to carry out planning for development. When export earnings are high in ‘good’ years, new projects are started by importing necessary equipment.

But when export earnings subsequently decline, the planning process receives a severe jolt. The reason is that foreign exchange is not available to complete and to operate the projects. The end result is huge resource waste and, a serious distortion to the planning process.

Causes:

There are three main causes of export instability. There is a common link among the causes since all originate from the fact that many LDCs are relatively more engaged in the export of primary products than of manufactured goods. While the first two reasons pertain to price fluctuations, the third one focuses on variations in total export earnings.

Immeserising Growth:

J. N. Bhagwati has even pointed out that a large country actually could be made worse-off by an improvement in its ability to produce the products it exports. This is known as immeserising growth. By expanding its ability to produce food as its export good the large country increases its supply of exports (expands its willingness to trade). This reduces the relative price of food in world markets. At the same time this causes an increase of the relative price that it must pay for its imports of car.

The decline in the country’s terms of trade is so bad that it outweighs the benefits of the greater ability to produce exportable goods. In short, growth that expands the country’s Willingness to trade can result in such a large decline in the country’s terms of trade that the country is worse off.

No doubt most of the gains from trade in the past have accrued to DCs. But this does not mean that trade is actually harmful. There are cases where a balanced trade may actually have hampered economic development. However, in most cases, it can be expected to provide invaluable assistance to the development process.

Dutch Disease:

Booming primary exports may fail to stimulate development due to deterioration of the terms of trade for a special reason, known as the Dutch Disease. This problem was first detected in Netherlands in the 1960s when major reserves of natural gas were discovered.

The ensuing export boom and the balance of payments surplus pressurized new prosperity. Instead, how­ever, during the 1970s, the Dutch economy suffered from rising inflation, declining export of manufactures, lower rates of income growth, and rising unemployment.

Max Corden and Peter Nearly first described the strange phenomenon of the Dutch Disease, in which a country that receives higher export prices or a larger inflow of foreign capital may be worse-off than with­out the windfall.

Trade Policy and the LDCs:

We may now briefly discuss how trade policy can be used to promote growth and develop­ments, in countries like India. The focus is on three areas: export instability, terms of trade deterioration and inward-versus outward-looking development strategies.

1. Stabilisation of Export Prices and Earnings:

Three main types of policies can stabilise prices of export earnings in LDCs.

These are:

(a) International Buffer Stock Agreement:

This is essentially a means of generating larger benefits for LDCs in the world economy. Under such an agreement, producing nations (often joined by consuming nations) set up an international agency endowed with funds and a stock of the commodity. If the world price of the good falls below the flour the agency will buy it to bring the price up to the flour. On the other hand, if the world price rises above the ceiling, the agency will sell the good to bring the price down to the ceiling. If the agency achieves success, then both producing and consuming nations will gain.

(b) International Export Quota Agreement:

Under an export quota agreement, producing countries choose a target price for the good and make a forecast of world demand for the coming year. They then determine the quantity to be offered for sale which will, in conjunction with estimated world demand, yield the target price. If the forecast of demand is correct and supplying countries adhere to their quotas, then the next year’s price will reach its target level.

The export quota agreement contains a mechanism for keeping prices stable. If the world price falls due to a fall in demand, the export quotas of the supplying countries will be tight­ened and the price will rise to the target level. Likewise, if the world price rises, the quotas will be relaxed and the price will fall to the target level. Thus, this policy provides some degree of stability to export prices.

(c) Compensatory Financing:

Under this scheme, an international agency is provided with necessary funds. It forecasts the growth trend of the export earnings of each participating LDC. The IMF has such a facility since 1963. Where export earnings of an LDC falls, the agency ensures that there is a steady flow of foreign exchange to the LDC for the purchase of develop­ment imports. This method is superior to international consumption agreements (ICAs) since compensatory financing does not interfere with the allocative function of prices.

2. Combatting a Secular Deterioration of the Terms of Trade:

Four broad measures can be adopted for preventing a long-term deterioration of the terms of trade:

(a) Export Diversification:

One strategy adopted to prevent the terms of trade of LDCs from deteriorating is increased diversification into manufactured goods by the LDCs. For making this measure effective, greater education of the labour force is essential. This will enable LDCs to learn to produce manufactured goods by adopting modern technology developed in advanced countries so that the LDCs do not fall behind in the technology growth race.

Moreover, the elasticities of demand for manufactured goods are also much higher than those of primary products. So there is hardly any chance of price fall due to overproduction of manufactured goods. The manufactured goods can be labour-intensive goods in accordance with the factor endowments of LDCs.

(b) Export Cartels:

By forming cartels like the OPEC, LDCs, in general, can organise to obtain a larger share of the gains from trade in the world economy. A cartel will be successful in case of products for which world demand is inelastic—both in the short run and in the long run, as is the case with oil.

There are three other conditions of cartel success:

(i) All exporting countries have to be part of the process,

(ii) Substitutes for the product under consideration should not be readily available at competitive prices,

(iii) Members of the agreement must not cheat on the agreement.

(c) Import and Export Restrictions:

A third policy is the use of restrictions to improve the terms of trade. A country with the ability to influence world prices can improve its welfare level by imposing import tariff (in the absence of retaliation from other countries).

However, to influence the terms of trade, a country has to be large in the economic sense, in one or more of its export commodities. But this is not the case with most LDCs. Furthermore, any reduction in the volume of trade by the use of restrictive policies will not be effective for LDCs.

It is be­cause by imposing such restrictions LDCs will be depriving themselves of necessary develop­mental imports (e.g., machines, transport equipment, components, etc.) from the industrial countries and will create price distortions into their economies. This will do considerable dam­age to development.

(d) Economic Integration:

Finally, developing countries can help themselves through eco­nomic integration by forming free trade areas or common markets. By this the LDCs can avoid the deterioration in their TOT with industrialised countries by having greater participation in regional trade (i.e., trade among themselves having similar factor endowments). Through eco­nomic integration LDCs can have more negotiating and bargaining power in world markets because they will be able to act as a united front.

In addition, the wider market within the region may stimulate investment. The emergence of a strong base for trading manufactured goods and the export diversification is needed to avoid export instability and deterioration of the terms of trade.

Such integration is likely to facilitate the flow of new technology and promote develop­ment in LDCs without locking them into specialising in the production of primary goods. In­stead, LDCs can be enabled to take best advantage of their underlying comparative advantage. However, such a scheme will not be very effective unless its benefits are evenly distributed among the member countries.

3. Trade Strategies for LDCs:

Our study of the relation between international trade and economic development will not be complete unless we are able to identify the appropriate among two competing strategies regarding the trade sector. An inward-looking strategy seeks to withdraw, at least in the short run, from full participation in the world economy.

This strat­egy emphasises import substitution, i.e., the domestic production of goods at home that would otherwise be imported. This will initially lead to considerable foreign exchange saving and, ultimately, generate new manufactured exports without the difficulties associated with the ex­ports of primary products provided two conditions are satisfied. First, if economies of scale are important, second, the infant industry argument applies.

This strategy uses tariffs, import quo­tas, subsidies to import-substitute industries, and similar measures. In contrast, an outward- looking strategy emphasises participation in international trade by encouraging efficient allo­cation of resources without causing price distortions. It does not use policy measures to shift production in an ad hoc (arbitrary) basis serving the domestic market and foreign markets.

It is essentially an application of the principle of comparative advantage in the area of production so as to ‘get prices right’. The focus is primarily on export promotion, whereby policy steps such as export subsidies, encouragement of skill formation in the work force, and the use of more advantageous technology and tax concessions are used to generate more exports, particu­larly labour-intensive manufactured goods in accordance with the H-0 theorem.

Even the World Back has recommended that LDCs adopt more outward-oriented policies. The reason is that sooner or later import substitution policy comes to a halt due to the narrow size of the domestic market for industrial goods. But when a country produces for the export market there is scope for endless expansion as there is no limit for the much wider and ever expanding global market.

Difficulties:

However, the practical application of the outward looking strategy is beset with a number of difficulties:

(i) Protectionist Barriers:

The expansion of manufactured exports, from successful coun­tries such as Hong Kong, South Korea, Taiwan and Singapore (the so-called four Asian Tigers) can run into protectionist barriers in the industrialised countries.

Since, the export of labour- intensive manufactured goods from such countries threaten long-term existing industries in industrialised countries (e.g., shoes and textiles), restrictions such as Multifiber Arrangement in Textiles and apparel may obstruct this development strategy sooner or later.

(ii) Skill Constraint:

Much like the import substitution strategy, the export promotion strat­egy also runs into another difficulty—shortage of skilled labour. The export promotion strategy may require skills in the labour force that are not yet fully developed and will require a huge commitment of resources at the initial stage of development. Most LDCs do not have sufficient resources to follow this path.

(iii) Fallacy of Composition:

There is a fallacy of composition in the outward-looking strategy in the sense that what is good for one country is not beneficial for its trading partners. The reason is that while any one country may be favoured by high price elasticity of demand for its exports of manufactured goods, the demand facing all developing countries is less elastic than that faced by a single country. Substantial price-reductions are likely to occur if all devel­oping countries follow the same escape route from export stagnation.

(iv) Lack of Association between Exports and Industrialisation:

Some empirical studies find lack of any positive correlation between export growth and pace of industrialisation. Some studies even suggest that such positive link, if any, occurs only above some threshold income level.

An over-riding issue in the relation between trade and development is whether there is conflict between the gains from the international trade and development of economy. The en­tire question of the link between ‘trade and growth’ has traditionally been a subject of interest among economists worldwide. Contributing to the understanding of the complex mechanics of growth and trade, interest expanded and theories proliferated.

When economists discuss the role of international trade in the process of economic development, they tend to adopt one of four general views. First view is one what Diaz Alejandro describes the ultra-pro trade biased obiter-dicta of the professional mainstream. The second view is still very much a part of the orthodoxy of trade theory.

Models embodying both traditional free trade assumptions and some market distortions can generate results in which free trade is neither the best policy available nor welfare improving for all the trading countries.

Thirdly, conservative orthodoxy seeks to de­scribe ways in which differences in economic structure b/w countries bias the gains from trade in favour of the developed industrialised economies and against the under-developed, non-industrialised economies. The view is structuralist. Final view is based on a radical perspective which asserts that trade and economic specialisation cause a sharp polarisation of the world into a developed core and an underdeveloped periphery.

The Industrial Revolution of the 18th century gave birth to a new mode of production called ‘capitalism’. Commodification of social relation is a basic principle of capitalism. The development of capitalism comes to depend on the accumulation of capital through the progressive transformation of a part of surplus value into productive capital.

Capitalism as a historical reality has the economic necessity to engulf the hither to untouched backward economies to make itself a global phenomenon. The fallout of capitalism is therefore internationalization of capital and unification of world economy i.e., involvement of different countries in the network of world market.

Let us make a brief review of the stylized facts of international trade, theoretical develop­ments occasioned by the empirical regularities. The 19th century pattern of trade was one in which Britain, followed by other Western countries, exported, manufactures to the rest of the world, the colonies and the ‘regions of recent settlement’ exported raw materials and food with capital exports from Europe financing the creation of the necessary physical infrastructure in the primary exporting regions.

In the 50s Nurkse, Prebisch, Lewis were all pessimistic or at least sceptical about the power of trade to continue to serve as an ‘engine of growth’ in LDCs as it had done up to 1914—when the First World War begun (1914-1918). The 60s and early 70s however saw tremendous expansion of world trade driven by historically unprecedented growth rates in Japan, West Europe and USA.

Can foreign trade have a propulsive role in the development of a country? The issue dates back to the period of economic development when Adam Smith makes an enquiry into the nature and causes of Wealth of Nations (1776). His view is that international trade expands market and facilitates divi­sion of labour. Division of labour is the key to industrial development and thus trade has a beneficial role to eco­nomic development.

If country A has more efficiency in the production of y, it will be mutually advantageous of both the countries to involve in international trade. Coun­try A should specialise in the production of X, while coun­try B should specialise in the production of Y.

The subsequent classical economists considered compara­tive advantage as determining the pattern of trade. Every trading country is able to enjoy higher real income by spe­cialising in production according to its comparative advantage.

The gains from trade arising from comparative advantage may be called static gains from trade. The static gains facilitate the growth to the extent that by efficient reallocation, the NY of the country can group. Classical economists focused attention on the indirect dynamic benefit.

Every extension of the market generates forces which work to improve the processes of production. Mill clearly observes the scope of increasing productivity of an LDC by means of foreign loan finance and capital. Hicks argues that if production is subjected to increasing returns, the total gains from trade will exceed the static gains from a more efficient allocation of resources.

For a small country with no trade there is very limited scope for large scale investment in advanced capital equipment. Specialisation is limited by the extent of the market. The larger the market, the easier capital accumulation becomes if there is 1 Re. foreign trade provides the basis for import of foreign capital in LDC s.

There are some immediate static gains from trade which stem from Pareto optimum reallocation of resources in the trial of international trade. Consumption gain and produc­tion gain collectively lead to an improvement of social welfare. Consumption gain accrues to the economy when the same bundle of commodity is produced under free trade that were produced under autarky.

It is attributed to difference in relative price between pre- trade and post-trade situations. Production gain accrues to the economy over and above the consumption gain as a result of the shift of the production point due to difference between pre-trade and post-trade relative commodity prices. Now we shall illustrate the point diagrammatically.

An autarky price equilibrium occurs at E₀ where PPF touches SIC₀. When trade opens up, there is a separation between consumption point and production point. The economy produces at E’ and consumes at E₂. To isolate the consumption gain, let us assume that the production point is frozen at E₀ but the economy will benefit from trade. It consumption point will move from E₀ to E₁, i.e., the economy will shift from SIC₀ to S/C, which represents consumption gain. The production gain is represented by the movement fromE₁ to E₂ as a result of the change of production pattern from E₀ to E_2.

Corden’s Analysis:

The comparative cost doctrine emphasises the efficiency gains of trade. Corden argues that efficiency gains gradually acquire a dynamic character and involve cumulative impact on a country’s growth potential.

According to him, a coun­try participating in world trade experience five differ­ent and distinct effects:

(a) Impact effect

(b) Capital accumulation effect

(c) Substitution effect

(d) Income distribution effect

(e) Factor weight effect.

These ef­fects are all cumulative and intensify the increase in real income over time as trade breaks open. One important potential gain from trade is the provision of an outlet for a country’s surplus commodities [Export] which would otherwise go unsold representing a waste of resources-Trade Prides an outlet for an underde­veloped country with huge amount of unemployed natural resources and abundant unemployed or semi-employed labour to be utilised gainfully to produce an output even and above the domestic requirement which can then be exchanged for other scarce goods.

This is the so-called vent for surplus. In the vent for surplus theory, the economy has surplus productive capacity which implies an inelastic domestic demand for an exportable commodity and/or a considerable degree of immobility internally and specialise use of resources. Fig. 3 will show that trade will lead to an increase in the production of export sector without reducing the production of for the import sector.

The shift from A (pre-trade situation) to point P (post-trade situation) clearly shows the fact that trade has augmented the production of commodity X but the production of commodity Y has remained unaltered. Mynt has argued that the vent for surplus theory is a much more plausible theory than the comparative cost doctrine in explaining the rapid expansion of export production in most part of the developing world in the 19th century.

Mynt observed that, when parts of Africa and Asia came under European colonisation, the consequent expansion of their international trade ena­bled these areas to utilise their land or labour more intensively to produce tropical foodstuffs such as rice, cocoa and oil palm for exports.

According to J. S. Mill there are indirect effects of foreign trade which must be counted as benefits of high order. The most important indirect dynamic benefit is the tendency of every extension of the market to improve the process of production. Secondly, opening up of trade in a backward country gives its citizens exposure to new commodities and tempting them by easier acquisition of things which they had previously thought not attainable.

Thirdly, through the interaction with the developing countries, the LDCs come to know the art of development. Accumulation of knowledge has a great intellectual effect in trade which acts as the dynamic propelling force behind economic development.

According to Mill, the effect of foreign trade is nothing short of an industrial revolution, seeping to the hitherto underdeveloped regions in the trial of foreign trade. A number of export based modes of growth have been formulated to present a macro-dynamic view of how export performance determines the level of economic growth.

Here we can present different variants of the exports led growth:

(1) The initiation of economic development in an LDC requires the import of certain non­competitive investment goods with negligible substitutability in the production process. The pace of industrialisation crucially depends on the availability of investment goods which in turn depends upon export performance of the country assuming that foreign exchange cannot be obtained either from foreign aid or redirected from consumption of imported finished product

(2) The issues connected with export-led growth can also be examined in the context of celebrated Lewis Model of Economic Development with unlimited supply of labour. We can visualize a traditional sector and an enclave export sector in an LDC, drawn labour from the traditional sector.

We can present a simple model to examine the role of growth in export in the determination of the overall rate of economic growth. Let us assume the entire wage is spent on consumption and saving comes from profit. The rate of growth is proportional inversely to the real wage and directly to the propensity to save and in product-efficiency of the economy.

Now let us establish the direct relationship between the rate of growth and the rate of profit.

Here, y = wL + rk; where w = real wage held constant, and r = rate of profit

We know at equilibrium, I = S …(i)

Since saving is a function of profit,

We can write

S = Sπ where S = mps and π = total profit

.^.. I = Sπ (using i)

Dividing both sides by k, we get

This proves that the rate of growth is directly related to the rate of profit.

Now we shall give diagrammatic representation:

The right side shows the inverse relationship between rate of profit and real wage rate. Left hand side shows the positive relationship between rate of growth and rate of profit. Here FF is the efficiency curve. Product efficiency in the economy is indicated by the height of the FF curve. Higher the FF curve more is the product efficiency.

Let us suppose the real wage rate to be fixed at ɷ. International trade enhances product efficiency curve from FF to F’F’ in Fig. 4. With the wage rate fixed at ɷ, there is an increase in the profit rate from r₀ to r₁ and a corresponding rise in growth rate from g₀ to g₁. In a LDC the real wage rate is very low and, therefore, the country specialises in production process. Capital accumulation by playing back of profit in labour-intensive commodities can eventually lead to a rise in real wages, higher capital intensity and more sophisticated technology.

(3) The term ‘staple’ designates a raw material or a resource intensive commodity occupy­ing a dominant position in the country’s economy. The staple theory postulates that with the discovery of a primary product in which a country has a comparative advantage, there is an expansion of a resource used export commodity, which induces higher rates of growth of ag­gregate and per capita income.

The export of a primary product also has the effect in the rest of the economy through diminishing underemployment, inducing a higher rate of domestic sav­ing and investment, attracting an inflow of factor inputs into the expanding export sector and establishing linkage with other sectors of the economy.

Albert O. Hirschman coined the phrase ‘backward linkage’ for the situation in which the growth of one industry (such as textiles) stimulates domestic production of an upstream input (such as cotton or dye stuffs). Backward linkages are particularly effective when the using industry becomes so large that supplying industries can achieve economies of scale of their own, become more competitive in domestic or even export markets.

Expanded production of primary products also can stimulate forward linkages by making lower cost primary goods available as inputs into other industries. Consumption linkages develop indirectly as the higher income earned from primary product exports leads to increased demand for a wide range of consumption.

Infrastructure linkages arise when the provision of overhead capital—roads railroads, power, water, telecommunications—for the export industry lower costs and opens new production opportunities for other industries.

Primary export sectors also may stimulate human capital linkages through the development of local entrepreneurs and skilled labourers. The best case for petroleum, mining, and some traditional agricultural crops is the fiscal linkage.

The Relevance of the Solow Model:

Solow growth model is popularly known as Neo-classical exogenous growth model. Economy is a full employment economy and saving determines investment. The single most factor lead­ing to growth is Exogenous Technological Progress. If technological progress is absent, then there is no growth.

The neo-classical economist of the 1950s and 60s recognised that technological improvement provide an escape from diminishing returns. Most reflect purposeful ac- Si research and development, since the amount of resources devoted to development depends on economic condition, the evolution of technology also depends on

We shall now discuss Solow model with technological progress. We introduce labour augmenting technological progress.

Y = F (K, AL), A is an efficiency parameter, growth of A is actually exogenous. It improves productivity of labour. Hence AL: effective labour force. Here function obeys CRS.

Now we shall discuss endogenous growth with production function as Y = AK K is a com­prehensive category which also includes human capital. In Solow model, growth is due to Abut in endogenous model, A is fixed and then we show if growth exists or not

We shall move forward studying arguments by Baldwin and Majumder. Baldwin suggests that increase in real per capita income due to trade is an upward shift of the production function. His arguments have been modified by Majumder. He argues that developing countries import in goods and relative price of capital goods falls one trade opens
up.

This reduces cost of depreciation. Export requires specialisation which in turn promotes learning and innovation. In other words, there is ‘learning by exporting’. Export generates posi­tive technological externality. We construct a simple model of endogenous growth to explain causal relation between trade and growth.

Let the production function be Cobb-Douglas type with CRS.

Exporting makes production functions behave as if it is AK type and, hence, all have endog­enous growth.

We now consider some of the adverse effects of trade which can wipe out the beneficial ones:

(i) Nurkse argues that external forces determine the export performance of a developed country. Trade can no longer operate as an engine of growth in the 20th century because of the easy availability of substitutes of primary commodities which were the prime exports of a LDC to a developed country.

(ii) Levon is attributes the problem of trade as a faltering engine of growth to a general reduction in the rates of growth of income and expenditure in the DCs.

(iii) Even the neoclassical economists point out the possibility of immeserising growth in the wake of technological progress in an open economy.

(iv) P. S. hypothesis of TOT (terms of trade)—a structuralist approach.

(v) Dependency theory as the Neo-Marxist critique of trade.

Raul Prebisch generalized the empirical claim into the assertion that a LR decline in the terms of trade of developing countries is an essential consequence of growth and trade between the North and The south or the centre or the periphery.

Singer contends that opening up of LDCs to foreign trade and investment has tended to inhibit the development. This trade and investment have diverted the LDCs into types of activities offering less scope for technical progress and general and external economies.

It also leads to deterioration of the TOT by the operation of Engle’s Law. The views of Prebisch and Singer regarding secular deterioration of term of trade, however, face severe criticisms. Britain’s TOT should not be treated as the inverse of TOT of the LDCs. The TOT does not always take into account the quality of product and many more. Moreover the thesis has been vindicated by several data published by UWCTAD.

The important question is whether there should be free trade and not whether there should be trade. Those who question the assumption of comparative cost model express the view that the efficiency gained from free trade are unlikely to offset the tendency in a free market for the comparative position of the developing countries to deteriorate vis-a-vis the developed countries.

The success story of the Asian countries like South Korea, Taiwan, Hong Kong and Singa­pore in the field of export have added new dimension to the analysis of relation between trade and development. The experiences of these countries do demonstrate the potential of exports and labour-intensive production.

The international trading system has enhanced competition and nurtured what Joseph Schumpeter a number of decades ago called ‘creative destruction’, the continuous scrapping of old technologies to make way for the new.

Introduction:

Trade policy plays an important role in achieving the objectives of rapid economic growth and self-reliance.

It is on the basis of these static and dynamic gains of trade that case for free trade or liberalisation of trade was bas been built.

When a country specialises on the basis of its comparative cost or production efficiency and export and import accordingly, it enables it to make optimum use and allocation of its resources. As a result, output, income and welfare of its people increase. These gains emanating from trade through improved allocation of given resources of a country are gener­ally described as static gains.

Thus, Professor Haberler writes, “International division of labour and international trade which enable every country to specialise and to export those things which it can produce in exchange for what others can provide at a lower cost have been and still are one of the basic factors promoting economic well-being and increasing national income of every participating country”.

However, importance of trade is not confined to static gains flowing from improved allocation of the given resources. Foreign trade also promotes economic growth of a country. It is the benefi­cial effect of trade on economic growth that is described as dynamic gains. D.H. Robertson, de­scribed foreign trade as “an engine of growth”.

With great income and production made possible by specialisation and trade, greater servings and investment become possible and as a result higher rate of economic growth can be achieved. Through promotion of exports, a developing country can earn valuable foreign exchange which it can use for imports of capital equipment and raw materials which are so essential for economic growth.

To quote Haberler again, “The higher the level of output, the easier it is to escape the ‘vicious circle of poverty and to ‘take off into self-sustained growth’ to use the jargon of modern development theory. Hence, if trade raises the level of income, it also, promotes economic development”.

Elaborating how trade promotes growth he emphasises the following factors:

1. Through foreign trade developing countries can get material resources such as capital equip­ment, machinery and raw materials which are so essential for industrial growth.

2. The developing countries through trade can import and use superior technology which has been invented in advanced developed countries and is embodied in the machines, capital equipment which they import.

3. Foreign trade enables the transmission of technical know how, skills, managerial talents to the developing countries.

India’s Trade Policy of Import Substitution:

As we began our planning for development, the two options were open to us with regarded to our foreign trade policy. First, we should lay stress on export promotion in our strategy of development for accelerating economic growth. The second option was to adopt import-substitution as a major element of our trade policy.

Note that the second policy of import-substitution does not emphasize the role of foreign trade for accelerating economic growth. In fact, the policy of import-substitution was adopted in view of the perceived bleak prospects of raising India’s exports. When exports could not be increased substantially, we could not pay for imports on a large scale.

Therefore, India’s strategy of industrialisation was based on substitution of imports rather than export-oriented trade policy. The policy of import-substitution for promoting growth was also thought to be quite feasible in view of India’s vast domestic market.

It is clear from above that India adopted the policy of import substitution because of what is now called export-pessimism. In fact, in the fifties and sixties export pessimism characterized the thinking of the most development economists. For example, Raul Prebisch postulated that the terms of trade of developing countries have a tendency to deteriorate over time regardless of the policies of developing countries.

Prebisch’s postulate was based on three grounds. First, demand for pri­mary products which under-developed countries were exporting were income inelastic. Second, technological progress that was taking place in developed countries was of the nature that saved the use of raw materials which underdeveloped countries were exporting.

Third, because of the prevail­ing monopolies in the manufacturing industries of the developed countries, the prices of their manu­factured products was relatively higher than the prices of primary and agricultural products whose production and sale were being done under competitive conditions. Thus, according to Prebish, export expansion by developing countries were quite unprofitable.

Similarly, R. Nurkse, another pioneer in development economics believed that for the newly emerging countries like India foreign trade could no longer serve as ‘engine of growth’. Nurkse’s export pessimism arose from his belief that foreign market could not absorb imports on a sufficient scale as developing countries accelerated their process of economic growth.

In view of this external environment, Nurkse concluded that in order to accelerate growth developing countries should un­dertake a balanced pattern of investment in a number of different industries so that they can generate mutual demand for each other’s product leading to the expansion in size of hone market.

To quote Nurkse, “When developing countries face difficulties in exporting both traditional and new exports, import-substitution strategy may be adopted by them as an escape route from stagnation”. Nurkse further writes, “International trade cannot now be an effective engine of ‘economic growth’ and in the strategy of growth, underdeveloped countries have of necessity to lay emphasis on ‘balanced growth’ – a coordinated development of local industries in accordance with the growth and structure of domestic demand”

It is interesting to note here that our present Prime Minister Dr. Manmohan Singh was perhaps the first economist who challenged this export pessimism of early development economists, espe­cially in the context of India. On the basis of his empirical findings about the export-potential of the Indian economy, he concluded that it was not easy to meet the increase in import requirements in raising the rate of economic growth by any other means but export promotion.

Arguing the case for export-orientation of strategy of development he writes, “whatever the development strategy the function of international trade as a supplier of “material means indispensable for development’ is likely to retain its importance for most underdeveloped countries in their quest for higher rates of economic growth…Imports, however, have to be paid for either by current export earnings or by withdrawal from reserves of foreign exchange or by a fresh capital inflows.

The withdrawal from reserves is not unlimited process,..capital inflows ultimately lead to higher service charges and repayment obligations. In the long run, therefore, the import capacity of an economy and its ability to utilize the above mentioned benefits of international trade is crucially dependent on its export capacity.

But Dr. Manmohan Singh not only highlighted the need for export promotion for accelerating economic growth but with his empirical study he demonstrated in India’s case that export promotion to meet the growing needs for imports was in fact possible and that the stagnation of India’s exports 1951-61 was partly a consequence of faulty Indian economic policies.

Commenting on Dr. Manmohan Singh’s work Prof. Amartya Sen writes, “Rapid increase in exports would be impossible if export pessimism prevailing at that time were well-grounded”. And Professor himself answers that “with its very careful and painstaking empirical arguments, Dr. Manmohan Singh demonstrated that it was not so well grounded after all”.

Empirically, the export pessimism of the fifties (post-war period) has been proved to be untrue and unjustified. Word trade in the fifties and sixties grew faster than world income. Several develop­ing countries used export promotion as a means of attaining a fast economic growth.

In the early 1960s Japan was the shining example of using export promotion strategy to achieve a fast rate of economic growth, beginning from a state of underdevelopment. Japanese growth experience is often described as Japanese miracle. In the later period, other success stories of achieving high growth through outward-looking strategy of development have been of Asian countries of South Korea Taiwan, China, Thailand, Singapore and Hong Kong.

Owing to their rapid economic growth in seven­ties and eighties they have been called ‘Asian Tigers. It is also worth mentioning that the expansion in exports of developing countries which have used export-promotion as a strategy of growth has not been confined to primary products such as fuel and agricultural products (food, agricultural raw materials). As a matter of fact, there has been significant change in the composition of exports of developing countries towards manufacturers.

It may be noted that the fifties and early sixties free trade was opposed on political grounds also. Fears were expressed that through free trade industrial developed countries would acquire political domination, as happened in case of India. East India company of Britain which came to India for trading acquired political domination.

It may however be noted such fears of political domination through trade has now receded in the present political context. In fact, the protectionist sentiment is now stronger in the developed countries such as US and EU. There is now huge and cry in USA for protecting American jobs by banning outsourcing of business services (BPO) to India.

The success in export promotion accelerates economic growth in the country. The emergence of Japan and Germany and recently China as major economic powers has shown that their success in export expansion made them economically more independent and strong.

On the other hand, devel­oping countries like India which followed import-substitution strategy had to face recurrent balance of payments crises and the persistence of huge external debt problem which made them more depen­dent on developed countries and international institutions such as IMF and World Bank.

Import-Substitution:

For at least up to 1980, India adopted a trade strategy of import substitu­tion. The choice of this policy was based on export pessimism which led the Indian planners to believe that export earnings of India cannot be increased. The choice of this inward-looking strategy was further strengthened by the vast size of Indian domestic market.

To implement this trade policy of import-substitution the imports of several commodities into India were banned and quantitative restrictions on some other commodities were imposed. Besides, to give protection to the domestic industries, customs duties were levied on a number of commodities to discourage their imports by raising their prices.

The customs duties levied in India on certain commodities were as high as 200 per cent or 150 per cent which were one of the highest in the world. In addition to these. The import- licensing was used so as to regulate the quantities of some essential goods and raw materials that could be imported and accordingly licences for import quotas were issued by the Government.

A scheme of import licensing in case of certain commodities was introduced under which imports were permitted to the extent that domestic production fell short of domestic demand. Further, strin­gent foreign exchange regulations were introduced and foreign exchange was released to the holders of import licences for importing specific commodities.

It may be noted that India’s policy of import substitution was indiscriminate and also continued for quite a long period. This is unlike some other countries such as Japan and South Korea which adopted import substitution only for some period of time and that too in case of selected commodi­ties for which they had potential comparative advantage.

Results of Import-Substitution Policy:

However, it may be noted that policy of import substi­tution contributed significantly to industrial growth between 1956-66. But several weaknesses of the policy of import substitution became evident during the course of time. First, the policy makers- underestimated the possibilities of expansion in exports.

As in the path-breaking study about the trends in exports, Dr. Manmohan Singh found that a lot of export possibilities was lost due to faulty trade policies. As a result, India’s share of world exports declined from about 2 per cent in 1951 to about 0.53 per cent in 1992.

Second, policy of import substitution underestimated the import-intensity of import substitu­tion process itself. Growth of import-substituting industries required large quantities of imports of capital goods machines, raw materials etc.

As a consequence, whereas imports increased substan­tially there was no adequate growth in exports resulting in balance of payment problems. In 1966 we had to devalue the rupee to promote exports and discourage imports in order to solve balance of payments problem. However, 1966 devaluation did not succeed in improving the trade deficit.

It may be noted that deficit in balance of payments which arose mainly due to import-substitution policy forced Indian policy makers to make some changes in attitude towards exports. Accord­ingly, in the third plan period (1961-66) and the fourth plan period (1969-74) several export promo­tion measures (including devaluation of 1966) were taken.

However, as has been correctly pointed out by C. Rangarajan that “Until the end of 1970s, exports were primarily regarded as a source of foreign exchange rather than as an efficient means of allocating resources. Import substitution remained the basic premise of the development strategy”.

Since import-substituting industrialisation was pursued regardless of comparative cost consid­erations, inefficiencies crept into the system resulting in the Indian economy becoming increasingly high-cost economy. This high cost and inefficiency in production was an important reason for poor export performance despite the various incentives and concessions given by the Government for export promotion.

Export-Promotion Measures in the Eighties:

In the early eighties because of the deficits in balance of payments export-promotion measures “acquired great urgency”. A committee headed by P.L. Tandon made a large number of recommen­dations for export-promotion in January 1991.

Promotional measures for exports taken in the eight­ies are:

1. Incentives scheme to promote exports was launched which provided for imports of raw materials, machinery and capital equipment and accessories against exports. This schemes we called Replenishment (Rep.) Scheme which was later replaced by Exim Scrip’s.

Exim scripts:

Exim scripts equivalent to the 30 per cent value of their exports were given to the exporters. These Exim scripts could be even sold in the market at premium. Exim scripts entitled exporters to import a certain amount of materials and machinery for ex­panding exports. Thus, ‘import-liberalisation for export promotion’ became the focus of trade policy.

2. Fiscal concessions for export promotion were given. The important fiscal concession was the introduction of ‘duty drawback scheme’ under which taxes paid on materials used in the manufacture of goods for export were refunded. Besides a good proportion of profits or income earned from exports was exempted from income tax. Further a 5-year tax holiday was provided to the units set up in Special Exporting Zones (SEZ) for financing exports.

3. Liberal credit facilities at concessional rates of interest were given by the commercial banks to exporters.

4. Bilateral Trade Agreements with some countries were made to step up exports.

5. In the later half of eighties the ‘exchange entitlement’ scheme was introduced to enable exporters to utilize a part of their foreign exchange earnings for the purpose of market development.

6. Cash Compensatory Scheme. A scheme of providing cash assistance to the exporters was started. Under this scheme cash assistance was given to the exporters to compensate them for the taxes paid by them on the imported inputs used by them for the production of exported goods. This was in fact a form of export subsidy paid for providing incentives to the exporters.

7. In the later half of eighties quota system in case of several commodities was replaced by tariffs. This liberalised imports further on the one hand and provided revenue to Govern­ment on the other.

It is evident from above that in the eighties, especially in the later half of eighties, a more liberal trade policy was adopted to promote exports on the one hand and to provide for imports of capital goods and technology so as to enable India to obtain benefits from international trade.

It needs to be emphasized that liberalisation of trade policy in the eighties was in view of the mounting deficits in balance of payments as a consequence of pure import substitution policy followed earlier. In 1981 IMF had also advised India to use export promotion and not export restrictions as the strategy for reducing deficit in balance of payments.

India’s Trade Policy since 1991: Import Liberalisation and Export Orientation: A General Review:

There was a severe economic crisis in 1991. This economic crisis had its root in persistent deficits in balance of payments in the last several years. Gulf war of 1990 added to the problem as it resulted in shooting up of oil prices which required enhanced spending in terms of foreign ex­change.

By March 1991, current account deficit in balance of payments reached a record level of about 10 billion US dollars or over 3 per cent of our GDP. Exports were declining. Foreign borrow­ing in last several years raised the ratio of short-term debit to foreign exchange reserves to an extremely high level of 146.5 per cent. Foreign debit reserve ratio rose to a peak of 35.5 per cent.

As result, our foreign exchange reserves dwindled to a merge amount which was hardly adequate to meet only a few weeks imports. A default on payments for the first time in our history became a distinct possibility in June 1991. Foreign capital was flying from India. No one was willing to lend us any more.

The severe economic crisis of 1991 forced us to make drastic reforms in trade policy. Fortu­nately, Dr. Manmohan Singh was appointed as Finance Minister. Since then many far-reaching reforms in trade policy have been undertaken. Though some liberalisation of trade policy was undertaken in the eighties, a truly liberalized trade policy was adopted from 1991 onward.

The liberalisation of trade policy in India is characterized by two important features:

1. Import liberalisation and

2. Export-orientation of trade policy.

This new trade policy has accelerated India’s transition to a globally oriented economy by stimulating exports and facilitating imports of essential inputs and capital goods. The steps were taken to promote exports by removing anti export bias in the earlier policy.

This policy of import liberalisation and export-orientation was in fact the policy that was recommended by IMF and World Bank the solve the balance of payments problem facing the developing countries and to accelerate rate of economic growth. We explain below this trade policy in some detail.

Import Liberalisation:

The first important reform in India’s trade policy has been the elimination of quantitative re­strictions in a phased manner on most of intermediate and capital goods since 1991. Secondly, prior to 1991 imports were regulated by means of positive list of freely importable items. Instead, since 1992 as a part of trade policy reforms only a short negative list of imports is subject to regulations by Government. Other goods can be imported, subject of course on payment of duty.

Abolition of Licensing:

Prior to 1991 a large number of goods was subject to import-licencing restrictions. Now, most of the items of imports have been put on Open General Licence (OGL). That is, for their imports prior approval or license from any authority is not required. Thus, License – Permit Raj regarding imports has been done away with.

Tariff Reduction:

An important step towards import liberalisation has been reduction in im­port-duties to eliminate protection given to domestic industries from foreign competition. The maxi­mum import duty which was as high as around 150 per cent was reduced to 110 per cent in 1992-93. This was further reduced to 85 per cent in 1993-94, to 65 per cent in 1994-95 and to 50 per cent in 1950-96 Now, in 2004-05 average customs duty has been reduced to 20 per cent only.

Empirical evidence shows reduction in protection increases efficiency and productivity in the domestic industries as it exposes them to foreign competition.

Liberalisation of imports of gold and Silver:

Another significant import liberalisation has been that imports of gold and silver have been liberalized. This has helped in printing smuggling of these metals.

Critique of Import Liberalisation:

It may be noted that fears were expressed about import liberalisation both by certain politicians and economists, especially with leftist leanings. They contended that import liberalisation would kill domestic industries as they would not be able to compete with the cheap foreign products.

This would lead to closure of a large number of industrial units, especially small scale industries, Besides, they claimed that the large-scale imports would require substantial foreign exchange resources. Thus, according to them import liberalisation would worsen the balance of payments problem rather than solving it.

Even a reputed economist. Dr. Bimal Jalan, a former Governor of Reserve Bank of India, expressed reservations about the policy of import liberalisation and pointed out that it would be highly risky for the Indian economy, Writing in 1991, he says, “given the balance of payments constraints operating now, and the financing operations currently available, import- liberalisation as strategy does not seem to be feasible option over the next few years. This pragmatic view is not dependent on the theoretical validity (or otherwise) of the liberalisation argument. By implication, import liberalisation would have the effect of raising, even in the short sun, the ratio of import to GDP. This may not be undesirable in itself, but it would require larger inflows of external capital in the next few years and this is not available on appropriate terms. Past experience shows that further commercial borrowing to finance import liberalisation …would also be undesirable, given the high level of external debt. In this situation, import liberalisation would be unduly risky and could lead a repetition of the unfortunate experiences of several other developing countries.”

However, in actual experience, these fears about import-liberalisation leading to adverse consequences have not proved to be true.

Export-Orientation of Trade Policy:

Along with import liberalization, export-orientation was also given to India’s trade policy pur­sued since 1991. In other words, for the first time greater emphasis was placed on export promotion in our trade policy by removing anti-export bias of our earlier policy.

Some economists describe it out-ward looking strategy was adopted since 1991 in place of inward-looking strategy of import-subtraction followed earlier. We explain below the various export-promotion measures taken to give export-orientation to trade policy.

1. Reduction in customs duties to end anti-export bias:

Prior to 1991 costumes duties of India were the highest in the world and were levied to promote import substitu­tion. These very high customs duties provided a high degree of protection to domestic industries. In actual practice, the high degree of protection lowers efficiency and is not conducive to optimum use and allocation of resources.

In the absence of competition from imported products, the prices of domestic goods were high and this served to induce import substitution but worked against promo­tion for exports. Since prices of products in international markets were lower, it was not profitable to produce for export.

Therefore to remove this anti-export bias and promote the growth of exports, customs duties were reduced and in 2004-05, average rate of customs duties have been reduced to 20 per cent.

Devaluation or Rupee:

Another important step to promote exports was devaluation of rupee by 20 per cent in July 1991. Devaluation lowered the prices of our exports and gave an important boost to them. Prior to 1991 rupee currency was overvalued and to ensure growth in exports to make some foreign exchange earning, export subsidy in the form of cash compensatory scheme was provided to exporters. Therefore, along with devaluation cash compensation scheme was withdrawn.

Market Determined Exchange Rate: Convertibility of Rupee:

After two years, in 1993, exchange rate of rupee was made market determined, that is, exchange rate of rupee with foreign currencies were left to be determined by demand for and supply of rupee and other currencies. This implies that rupee can appreciate or depreciate in terms of other currencies every day depending on demand and supply conditions.

This flexible exchange rate works to some extent to correct disequi­librium in the balance of payments. However, it is worth mentioning that exchange rate though determined by demand for and supply of foreign exchange can be influenced by RBI through buying and selling of dollars or other foreign currencies. Therefore, present exchange rate system is more correctly described as managed float.

It may be noted that over a period of time since 1993, exchange rate of rupee has declined, that is, rupee has depreciated. This has tended to promote exports and discourage imports. In addition to the introduction of market determined exchange rate rupee has been made convertible on current account of balance of payments, that is, importers can now get their rupees converted into dollars and exporters can sell their dollars for rupees at market-determined exchange rate.

Thus, convert­ibility of rupee has facilitated imports and exports and has contributed to the globalization of the Indian economy.

3. Liberalisation of control over exports:

Through continuous review and revisions during the last 12 years controls on exports has been liberalised to the extent that now all goods may be exported without any restriction except the few items mentioned in the negative list of exports.

The items in the negative list of exports are regulated because of strategic considerations, environmental and ecological grounds, essential domestic requirements, employment generation and on account of socio-cultural heritage.

4. Duty-free import of capital goods for use in production for exports:

A significant export- promoting measure is that capital goods meant to be used for production of exportable products can be imported free of customs duty. There are two windows to fulfill export obligation on FOB (free on board) and NFE (net foreign exchange basis).

5. Advance licences for imports against exports:

Advance licences which are used to import specified raw materials without payment of any customs duty against confirmed export order and/or letter of credit have been made transferable after export obligation has been fulfilled.

6. Exemption from tax and credit subsidies:

Profits or incomes from exports are completely exempt from income taxes. Besides, exporters are provided preferential access to credit from banks. Concessional rates of interest are charged for pre-ship and post-ship credit to exporters.

7. The Duty Drawback Scheme:

In this important scheme of providing incentives to export­ers customs duty and excise duty paid on inputs which are used for production of exports are reim­bursed to exporters.

8. Incentive to exports of services:

In an attempt to provide massive thrust to export of services EXIM Policy 2003-04 has introduced duty free import facility for the service sector units having a minimum foreign exchange earnings of Rs. 10 lakes. The scheme is likely to provide a major boost to export of services like health care, entertainment, professional services and tourism.

9. Small-scale industries (SSI) reservations have been withdrawn from a large number of items so that a large-scale producers can produce these terms cheaply and export them.

Case for Export Orientation:

The export orientation of trade policy (or outward-looking growth strategy) is believed to have many advantages and is regarded as superior to import-substitution policy. We explain some of these advantages below.

First, it has been pointed out that export-oriented trade policy is conducive to more efficient use and allocation of resources. Jagdish Bhawati has emphasized the efficiency gain of export promot­ing trade strategy.

He is of view that export orientation and import liberalization trade strategy will ensure domestic resource allocation closer to efficient production of goods in accordance with comparative cost of a country. According to him, such a trade strategy will not lead to profit-seeking unproductive activities.

An important advantage of export-oriented strategy arises from economies of scale which can be reaped more effectively. As a result, cost per unit of output rises which will tend to lower prices of export. Lower export prices will help in significant expansion in exports and enable us to earn more foreign exchange.

As export demand or market size for a good expands this will lead to economies of scale. With adequate size of market even small-scale and medium enterprises can set up plants of optimum size to enjoy the economies of scale.

Export-oriented trade policy makes substantial contribution to economic growth by relaxing the foreign exchange constraints. Export-promoting trade policy places emphasis on industries geared towards earning foreign exchange. This helps to keep the balance of payments in equilibrium.

It has been found that import-substitution trade strategy generally causes shortage of foreign exchange and leads to the balance of payments problem, as happened in case of India in 1991. Shortage of foreign exchange and balance of payments problem lower rate of economic growth.

On the other hand, export-oriented trade policy does not have to face the problem of shortage of foreign exchange and is therefore conducive to higher rate of economic growth. Further, a signifi­cant merit of export-oriented trade policy is that it will help to achieve self-reliance, that is, self sustained growth of the Indian economy.

As a matter of fact, import substitution strategy was adopted in India with the belief that through it we will achieve self reliance. But the policy underestimated the import intensity of import-substitution process. Import-substitution strategy substantially in­creased our import requirements for equipment and raw materials.

This necessitated a large amount of foreign exchange which could not be earned sufficiently through exports. Thus, far from helping to do away with foreign assistance import-substitution strategy increased our dependence on foreign capital inflows.

Export-oriented trade policy coupled with liberalized foreign investment will enable us to earn adequate foreign exchange to solve our balance of payments problem and ensure self-sustained economic growth. Above all, several studies have found a highly positive relation between growth of national income and expansion in export.

However, as Balassa has promoted out that for relation between export-orientation and economic growth initial conditions matter a lot. These initial condi­tions include resource endowment, expansion opportunities of trade, stock of technical knowledge. No doubt, these initial condition are important for determining economic growth.

However, trade policy is certainly important for providing incentives for expansion of exports for availing of the opportunities thrown up by international trade. This will lead to the optimum use and allocation of material resources which will stimulate economic growth.

Foreign Trade Policy, 2004-09:

After every five years Government reviews its export and import policy in view of the changes in international economic situation. The foreign trade policy or what is also called export-import (EXIM) policy relates to promotion of exports and regulation of imports so as note only to overcome trade deficit but also to promote economic growth.

UPA-1 Government announced its foreign trade policy for a five year period (2004-09) on August 31,2004. This new trade policy carries further the process of trade liberalisation. Exemptions and incentives given in the earlier 2002-07, and Mini Exim Policy 2004 have not been changed and new incentives for promotion of exports have been provided.

We explain below the various provisions of this new trade policy. Mr. Kamal Nath, our present Commerce Minister claims that the new trade policy was not just Export-Import (EXIM) policy but it goes beyond that.

According to him, new foreign trade policy is an effective instrument of accelerating economic growth and employment generation through exports. An important feature of new trade policy is that it seeks to eliminate taxes and duties from exports so as to make exports more competitive.

According to it, ‘we have to export goods and services and not taxes’. The Duty Exemption Pass Book scheme which allows exporters to claim exemption from excise duties and relief on customs duties has been continued for now, but it will be replaced with an effective scheme in line with WTO commitments.

Foreign Trade Target: Doubling of India’s Share in World Trade in Five Years (2004-09):

The new foreign trade policy aims to double India’s share of world merchandise trade in the next five years. As shown in Table 26.6 in India’s share in World export was just 0.8 per cent as compared to 5.9 per cent of China. Thus China has surged ahead of India in expanding its share of world trade.

The new trade policy seeks to raise India’s shore in world exports to 1.5 per cent by 2009.In the past the Indian Government had set target of capturing 1 per cent of global exports. So the target of achieving 1.5 per cent shares in five years in world exports is a very ambitious target.

In absolute term this implies raising India’s exports from 61.9 billion US dollars to 195 billion by 2009. This means 21 per cent compound annual growth in exports. This is based on the assumption that world trade will grow at 10 per cent per annum.

Focus on Employment Generation through Export Strategy:

In line with the UPA Government’s priority to employment generation foreign trade policy also focuses on employment generation through an appropriate export Strategy. Employment opportunities will increase as a result of expansion of agricultural exports for which new policy provides special incentives.

Other sectors identified for employment-generation and export-promotion include handlooms, handicrafts, gems and jewellery, and leather and footwear, apart from services. Non-IT service sectors on which the policy focuses are tourism, health care and education. At present, merchandise exports are valued at over $70 billion, while services contribute more than $50 billion.

Focus on Agro-exports to boost export growth:

The new five-year Foreign Trade Policy moots a special package to boost agro-exports by offering fiscal incentives to exporters. It includes launching a special farm produce scheme called Vishesh Krishi Upaj Yojana (VKUY) to promote the export of fruits, vegetables, flowers and minor forest produce and their value-added products and permission for duty-free import of capital goods for installation anywhere in the agri-export
zones (AEZs).

The procedures for the import of seeds, bulbs, tubers and planting material and the export of plant portion, derivatives and extracts have been liberalized. The measure is expected to help facilitate the production of export-worthy agricultural products. It will also help boost the export of medicinal plants and herbal products.

Exemption of Exports from Service Tax:

A significant measure to promote exports is that exports of all goods and services have been exempted from 10 per cent service tax and 2 per cent cess on it. Export Oriented Units (EOUs) have also been given exemption from service tax in proportion of their exported goods and services.

To accelerate services export, the foreign trade policy has also provided sops-in terms of duty free entitlement — to individual service providers (who earn forex of at least Rs. 5 lakh), other service providers (who earn forex of at least Rs. 10 lakh) of 10% of the foreign exchange earned by them.

The foreign trade policy announcement on service tax exemption for all goods and services exported including those from the domestic tariff area (DTA) – will be available on 161 tradable services.

This list of all 161 tradable services covered under the General Agreement on Trade in Services (GATS) where such payment of services is received in free forex, according to the policy document. As of now, the announcement is statement of fact because all payments received by Indian service providers in foreign exchange are currently exempt from service tax.

Promoting Exports of Services:

Recognising the key role of the service sector in the economy, the foreign trade policy has unveiled the ‘Served from India’ scheme to accelerate growth in service exports. The scheme aims at creating a brand instantly recognized and respected world over. The earlier DFEC (Duty Free Entitlement Certificate) scheme has been revamped and recast into the new scheme.

Individual service providers who earn foreign exchange of at least Rs. 5 lakh, and other service providers with forex earnings of at least Rs. 10 lakh, will be eligible for a duty credit entitlement of 10 per cent of total forex earned by them.

Apart from setting up the export promotion council, the policy has announced two other major initiatives to boost services exports. The government would promote establishment of a common facility centres for home-based service providers. To boost exports, a new scheme ‘ Target Plus’ has been introduced. With this exporters who achieve quantum growth would be entitled to substantially higher duty-free credit based on incremental exports.

New Export-Promotion Schemes:

In the new foreign trade policy, three new schemes have been introduced and others revamped to boost exports. No existing export-promotion scheme has been withdrawn. A new scheme named ‘served from India’ has been launched to popularise non-IT services in line with the existing’ Made in India’ scheme to promote export of Indian goods.

Similarly, a Vishesh Krishi Upaj Yojana has been announced to promote export of fruits, vegetables, flowers, minor forest produce and their value-added products. A’ Target Plus’ scheme has also been announced.

Another new scheme ‘Free Trade and Warehousing Zones (FTWZ) has been introduced to improve trade related infrastructure. Foreign direct investment would be permitted up to 100 per cent in the development and establishment of the zones and their infrastructural facilities. Each zone would have a minimum outlay of Rs. 100 crores and five lakh square metres of built-up area. These units will quality for all benefits applicable for special economic zones.

Target Plus Scheme to promote exports:

A new scheme call “Target Plus” has been launched to accelerate export growth. Under this scheme special incentives have been provided to all exporters who exceed the normal export target growth of 16% fixed by the commerce ministry for 2004-05. For instance if a firm shows a 25% growth in exports it will get duty free credit totaling 10% of the value of incremental exports.

The duty free credit entitlement goes up to 15% of incremental exports if exports grow by 100% during the year. This is expected to provide incentives to exporters to achieve a quantum growth in exports. But past experience has shown that such schemes also get misused widely.

Establishment of Bio-Technology Parks:

Taking note of the significance of biotechnology, the new policy has announced the establishment of biotechnology parks, which will get all the facilities of 100 per cent export oriented unit. In this regard sectors with significant export and employment potential in semi-urban and rural areas have been identified.

Restrictions on Imports of Second-Hand Capital Goods Waived:

For the first time all capital goods regardless of age are made freely importable without any actual user condition or requirement of minimum residual life. Free imports of second hand machinery is expected to bring down the cost of investment and strengthening the forces of industrial restructuring. However free imports does not apply to computer and laptops.

Free Transferability of DFECC (Duty Free Entitlement Credit Certificates):

The main improvement in the DFECC scheme is that the portion related to agriculture exports zones is freely transferable. These will make incentive attractive and give push to the AEZs. (Agriculture Export Zones).

The DFECC for normal exports, which varies from 5 to 15% of export value depending upon export growth rate, is a non-stater mainly because of the actual user condition and restriction on transferability of the entitlement. Unless the negotiability of the entitlement is improved, the scheme will not take off.

Evaluation of New Foreign Trade Policy, 2004-09:

Chambers of Commerce and Industry have welcomed the new foreign trade policy. According to CII president Sunil Kant Munjal, “The foreign trade policy is forward looking’. It presents schemes to develop exports across all sectors of the economy, sets a target of doubling India’s share in global trade and presents a vision of India as a ‘global hub’ for manufacturing, trading and services”.

In view of India’s increasing integration with the global market, there is a need for a more integrated approach to foreign trade policy. The chamber said it is looking forward to interacting with the Board of Trade which is expected to play a greater role in developing foreign trade related initiatives.

FICCI president Y.K Modi said, “This policy not only encompasses the entire export chain but takes cognizance of India’s export competitiveness against the background of bilateral and multilateral trade processes that India has entered into.”

The chamber has appreciated the commerce minister’s statement that Indian exports can be competitive only if the current practice of exporting local taxes is put to an end. The proposed Service Export Promotion Council and the ‘Served from India’ scheme will help even non-IT services like entertainment, medical tourism, accounting services, financial services to realise their greater potential.

Assocham president Mahendra K Sanghi said it is a good idea to set up free trade warehouse zones through which service exports will be encouraged. The duty free import of capital goods for agriculture exporters and permitting 100% FDI in the Free Trade Zones are good measures to boost India’s agricultural exports.

According to S.S.H Rehman, chairman, CII tourism council, “We welcome the maintenance of the duty free entitlement scheme of imports of professional equipment and consumables including liquor, amounting to the average of the previous 3 years +earnings in foreign exchange, in respect of hotels”.

The step of enhancing the entitlement for stand alone restaurants to 20% is also positive. PHDCCI president Ravi Wig said the emphasis on a partnership approach between industry and government for doubling India’s merchandise exports in the next five years is a positive step. Further, the thrust on promotion of agri-products would lead to substantial foreign exchange earnings as well as employment generation.

The new foreign trade policy seeks to double India’s share of global exports from today’s 0.8% to 1.5% in the next five years. To do that, the policy exempts all exports from the new service tax, allows unlimited foreign investment in free trade and warehousing zones, provides incentives for biotech parks and scrapped restrictions on imports of used capital goods.

To boost exports, some imported inputs necessary for exporting industries have been made duty-free. There is a scheme to boost foreign sales of value-added farm products, fruits and flowers. None of this is earthshaking; they’re workmanlike ideas which could speed up exports to some extent.

Though services exports are growing at a scorching rate and are expected to continue at this pace for many years, India needs to boost manufacture exports. To do that the entire structure of indirect taxes, which penalizes manufacturing, has to be overhauled.

Instead of taxing manufactures with a host of Central and State-level taxes like excise, octroi, sales tax and so on, whose fiscal impact cascades into high prices and loss of competitiveness. There is urgent need for replacing this with a single-rate value-added tax (VAT).

Further, instead of charging different tariff rates for different imports at relatively high rates compared to global standards, the government should shift to a single reasonable tariff rate for all imports. This has two important benefits. First, it will cut out all procedural complications and most of the red tape that goes with trade.

It will also minimise the graft, rent-seeking and policing, inevitable in a multiple-rate system. Finally, the key to a competitive economy is its investment regime. There’s no reason why India cannot implement a liberal foreign investment policy that allows 100% investment in most sectors, and curbs it in a few areas that are deemed too sensitive for foreign funding.

The growth of trade is linked intimately with the health of the economy. History shows that countries with clear, investor-friendly policies do better than those that cripple businesses with red tape and taxes.

In our view the prime driver of exports in a globalizing economy has to be competitiveness and not promotion. And competitiveness is created by a range of factors, very few of which are in the commerce minister’s control. True, promotion of exports is not irrelevant and to that extent, the new thrust given to export of agriculture, handicrafts, leather, gems and jewellery, and services is welcome.

However, it is inexplicable that the one sector in which India’s export opportunity is going to zoom in the near future, that is textiles, has been virtually ignored, except for some leftover concessions for garments. Besides, in our view the lifting of restrictions on imports of second hand capital goods will have an adverse effect on the domestic capital goods industries.

Annual Supplement (2006) to Foreign Trade Policy:

In its annual supplement in April, 2006 to foreign trade policy, 2004-09, the Commerce Minister proposed a series of important trade initiatives to put India’s exports on a trajectory of quantum growth and create two million new jobs in the export sector by 2009-10.

India’s merchandise exports crossed 100 billion US dollars and touched 101 billion US $ in the fiscal year 2005-06, that is, 25 per cent growth on the top of 26 per cent growth achieved last year (2004-05). The target for the current year, 2006-07 is the achieve 20 per cent growth rate in exports. If our exports continue to maintain this 20 per cent or above growth rate, then the export target of 150 billion US dollars in 2008-09 is quite achievable.

In the fiscal year 2005-06, as against the exports of 101 billion US dollars, merchandise imports have been estimated at 140 billion US $ (which includes imports of 43 billion US $ of petroleum oil alone).

In this annual supplement to foreign trade policy the two new schemes namely, Focus Product Scheme and Focus Market Scheme have been announced, especially for the objective of creating employment opportunities in semi urban and rural areas. These two schemes will replace the Target Plus Scheme which has been abolished.

Some details of these two schemes are:

Focus Product Scheme:

Under the focus product scheme a duty-free credit facility at 2.5 per cent of FOB (Free on Board) value of exports will be provided on 50 per cent of the export turnover of notified products such as fish and leather, stationery items, sports goods, toys and handlooms and handicrafts. This will encourage exports and since these products are labour-intensive, their growth will generate a large number of employment opportunities.

Focus Market Scheme:

This focus market scheme offers a similar incentive for all products exported to notified countries which may include Africa and Latin America.

It has been estimated that above two schemes would not involve much loss of revenue for the government.

Stimulus to Exports of Gem and Jewelry:

In this annual supplement to foreign trade policy, favourable policy measures have been announced that will not only help boost exports by 20-25 per cent but will also pave the way for increased FDI in India. An important policy measure in this regard has been the reduction in value-addition norms of exports of gold and silver which have been brought down from 7 per cent to 4.5 per cent. Increase of gold and silver prices over the past few years had made the present value-addition criteria on exports of gold and silver jewellery unrealistic.

Further, the foreign trade policy has allowed re-import of rejected jewellery subject to refund of duty exemption benefits on inputs only not the duty on entire jewellery. On several occasions exporters used to face the dilemma of unsold jewellery in foreign markets because of changing designs and other such factors. The new initiative well help exporters to overcome this problem as now jewellery export would be possible on consignment basis.

Beside, the permission to export cut and polished precious and semi-precious stones for treatment and subsequent re-import within a period of 120 days has been given. This will enhance the quality of these products and afford higher value in the international market. The idea behind these steps is to prevent India’s gems and jewellery business from shifting to Dubai. Boosting the gems and jewellery sector would create more jobs in smaller centres such as Surat.

Boost to Auto Sector:

To provide stimulus to the auto sector, foreign trade policy seeks to promote India as an auto component hub, import of cars for R & D purposes will be allowed without going the expensive homologation. This will enable import of new model cars for testing components.

The Videsh Krishi Upaj and Gram Yojana (VKUGY):

In the new foreign trade policy, the Videsh Krishi Upaj Yojana (VKUY) has been replaced by the Videsh Krishi Upaj and Gram Yojana (VKUGY) under which gram udyog products will also be entitled for a customs duty credit of 5 per cent of free- on-board (FOB) value of exports made after April 2006.

Duty Free Authorisation Scheme:

Besides, in the new foreign trade policy a new duty free authorisation scheme has been introduced with effect from May 1, 2006 with combined features of Advance License Scheme (ALS) and Duty Free Replenishment Certificate (DFRC). DFRC scheme has been discontinued with effect from April 30, 2006 while the advance.

Duty Drawback and DEPB Rates:

It has been decided to include service tax and fringe benefit tax (FBT) under the export promotion schemes such as Duty Drawback and Duty Entitlement Pass Book Scheme (DEPB) which will be notified later in year 2006. Revenue loss to the government on this count will be around Rs. 800 crores.

EPCG Scheme Made Flexible:

The Export Promotion Capital Goods Scheme which allows import of capital goods at a concessional customs duty of 5 per cent has been made more flexible. In this regard export obligation period has been extended to a maximum of 12 years. These changes would help genuine exporters who were unable to fulfill the export obligation due to changed market conditions.

Evaluation of Annual Foreign Trade Policy (2006):

It has been claimed by the Commerce Minister that the growth of exports at the rate of 26 per cent in 2004-05 and 25 per cent in 2005-06 shows the success of foreign trade policy, 2004-09. As a matter of fact, our exports have grown at more than 20 per cent in the last four years (2002-06).

Of course, foreign trade policy to promote exports pursued in the past some years has contributed to such robust growth in exports. However, many other things account for such robust growth in our exports, apart from the trade policy. Macroeconomic stability, gradual elimination of the anti-export bias in our economic policy built up by huge tariff barriers in the past, increasing confidence of India producers, availability of imported inputs at nearly global prices, availability of relatively cheap finance are some other factors that that have boosted the competitiveness of Indian exports. The ability of Indian goods and services to gain market-share abroad is ultimately a function of the competitiveness of Indian producers.

If momentum of export growth of over 20 per cent per annum is maintained, then India’s aim to double its share in global trade from 0.8 per cent to 1.5 per cent by the end of present foreign trade policy period (i.e. by 2008-09) appears to be achievable.

For expanding production of goods and services for export, producers need efficient infrastructure, flexible and less restrictive labour laws, and reforms in the complicated tax structure. Thus, in addition to efficient infrastructure Indian exporters urgently need a full fledged goods and service tax and abolition of all cascading, non VAT commodity taxes like Octoi, entry tax and turnover tax if export target of 150 billion US $ by 2008-09 is to be achieved. The more difficult goal is the generation of an additional two million jobs in the export sector. Trade Policy measures by Government in 2008-09.

Foreign Trade Policy, 2009-14:

Against the fall in exports for the last 10 months, (October 2008 to July 2009) the Government announced its foreign trade policy for 2009-14 on August 27, 2009. Due to the global slowdown, some countries have resorted to protectionist measures posing barrier to free trade which has aggravated the problem for Indian exporters.

The Government’s short-term goal through this foreign trade was to reverse the declining trend of exports and provide support to the export sectors that have been hit badly by recession in the developed world. The Government does not expect immediate outlook for exports to improve and pegged export growth for the year 2009-10 at 3 per cent.

But for 2010-11 it has set the target of 15 per cent growth in exports and an ambitious $ 200 billion target for exports to be achieved by March 2011. In the remaining three years 2011-14 it expected to return to high growth path for exports at 25 per cent per annum. It set the target of doubling our exports of goods and services by March 2014.

Its long-term aim is to double India’s share of global goods and services exports by 2020, that is from 1.64 per cent in 2008-09 to 3.28 per cent in 2019-20. By and large the new foreign trade policy is similar to the previous one for the period 2004-09 and has the same promotion measures, but with some additional incentives.

Duty free imports for labour-intensive sectors:

An import measure of the new foreign trade policy is allowing duty-free imports of capital goods required for the manufacture of export goods as against the existing 3 per cent duty. These labour intensive sectors include engineering, electronics, basic chemicals and pharmaceuticals, apparel and textiles, plastics as well as leather and leather products.

This incentive under the Export Promotion Capital Goods (EPCG) scheme will be applicable until-March 31, 2010. Besides, the period of export obligation for importing capital goods free of import duty has been extended to 12 years.

Further, the other sectors in addition to the above have also been allowed to import capital goods under EPCG scheme at a concessional duty of 3 per cent. In their case too the period of export obligation has been expended to 12 years.

The objective has been to increase the productivity of the export-industries through technological up-gradation by importing required capital goods. This will help our exporters to increase the share of world exports.

Extension of Duty Entitlement Passbook Scheme (DEPBS):

Foreign trade policy for 2009- 14 has also extended the Duty Entitlement Passbook Scheme (DEPBS) until December 2010. Under this scheme exporters obtain a refund on a proportion of indirect taxes paid by them. Since this scheme is not WTO compliant alternative scheme is being worked out.

Expansion of Focus Markets Scheme (FMS):

As India’s existing export markets are reeling under recession, the new foreign trade policy has expanded its Focus Market Scheme (FMS) to 26 more markets, 16 in Latin America and 10 in Africa and IS countries (Common Wealth of Independent States). The new policy has also increased the incentive under this scheme to the exporters from 2.5 per cent to 3 per cent of the value of the exports if they cater to these markets.

Explaining the policy the commerce Minister, Mr. Anand Sharma said, “We cannot remain oblivious to declining demand in the developed world and we need to set in motion strategies and policy measures which will catalyze the growth of exports.”

At present, exports to Europe, US and Japan amount to 36%, 18% and 16%, respectively, of India’s total exports of $ 168 billion in 2008-09. Due to global recession, India’s exports have declined by almost 30% in the last 10 months. This forced the government to induce exporters to sell in new markets.

More Incentives and Greater Coverage for Focus Product Scheme (FPS):

While the incentive available under the Focus Market Scheme (MS) has been raised from 2.5 to 3 per cent, that under the Focus Products Scheme (FPS) has been raised from 1.25 to 2 per cent. Engineering products such as agricultural machinery, parts of trailers, sewing machines, hand tools, garden tools, musical instruments, clocks and watches and railway locomotives, value-added plastic products, jute and sisal products, technical textiles, green technology products such as wind mills and wind turbines, electrically operated vehicles, project goods, and certain electronic items have been included in Focus Product Scheme (FPS).

Export of products like pharmaceuticals, synthetic textile fabrics, value-added rubber products, value-added plastic goods, textile made-ups, knitted and crocheted fabrics, glass products, certain iron and steel products and certain articles of aluminum would be eligible for FMS if exports are made to 13 identified markets (Algeria, Egypt, Kenya, Nigeria, South Africa, Tanzania, Brazil, Mexico, Ukraine, Vietnam, Cambodia, Australia and New Zealand).

Market-linked FPS benefits have also been extended for export to more new markets for certain products. These products include auto components, motor cars, bicycles and parts, and apparel, among others.

Extension of other Export Booster Schemes:

The other booster schemes, which were announced earlier, will also continue under the new foreign trade policy. Some of the such schemes are 2 percentage points interest subvention on pre-shipment credit and enhanced insurance coverage through Export Credit Guarantee Corporation (ECGC). These measures will now continue till March 31,2010.

ECGC provides a range of credit risks insurance cover to exporters against loss in exports of goods and services. It also provides guarantees to banks and financial institutions to enable exporters to obtain better facilities from them.

Incentives to Gems and Jewellery:

The $ 27 billion Indian gems and jewellery sector which contributes 13% to India total exports, has received a host of incentives, including input duty refunds (under duty drawback scheme) on gold jewellery export and setting up of diamond bourses to make the country diamond-trading hub.

“It shall be our endevaour to make India an international diamond- trading hub and we plan to establish diamond bourses in the coming years,” commerce minister Anand Sharma said unveiling the new Foreign Trade Policy.

The Rs. 80,000 crore diamond cutting & polishing industry that has an 80% global market share has suffered heavily because of the recession in the world’s largest diamond markets, the US and Europe. Surat, the diamond city, saw more than 3,000 units shutting down with around 4 lakh workers losing jobs in Gujarat alone.

Relief for Export-oriented Units (EOUs):

EOUs can sell 90% of the output in domestic market instead of 75%. But over a period of 75% of the production has to be exported.

Measures to Reduce Transaction Costs:

With a view to boost exports, the government initiated several measures to rationalise procedures and reduce transaction costs in its new foreign trade policy (FIP), announced today. Following the demand of industry, the application and redemption forms under the Export Promotion Capital Goods (EPCG) scheme have been simplified.

The maximum fee charged on authorisation or licence applications on schemes like focus product, focus market, market access initiative and market development assistance, has been slashed to Rs. 1 lakh from Rs. 1.5 lakh (manual applications) and to Rs. 50,000 from Rs. 75,000 (for electronic applications). No fee shall now be charged for granting incentives under the schemes which deals with export incentives of foreign trade policy.

The government has extended the time within which exporters can convert shipping bills from one export scheme to another, from one month to three months. An inter-ministerial committee would also be formed to resolve issues of exporters.

In order to reduce transaction costs, dispatch of imported goods directly from the port to the site has been allowed under the Advance Authorisation Scheme for deemed supplies. At present, duty-free imported goods could be taken only to the manufacturing unit of the authorisation holder or its supporting manufacturer.

To facilitate duty-free import of samples by exporters, number of samples or pieces has been increased from the existing 15 to 50. Customs clearance of such samples shall be based on declarations given by the importers with regard to the limit of value and quantity of samples.

The government has also allowed disposal of manufacturing wastes, after payment of the excise duty. Besides, automobile firms, which have their own R&D centres, would be allowed free import of petrol and diesel up to 5 kl.

The commerce and industry ministry is also promoting the use of electronic systems with initiatives like electronic data interface (EDI) ports, electronic message exchange between Customs and the Directorate General of Foreign Trade.

Evaluation of Foreign Trade Policy, 2009-14:

The various sops and incentives to the exporters in the new foreign trade policy is expected to arrest shrinking exports. The dynamic policy initiatives announced by the Government in the new foreign trade policy towards expansion and diversification of export markets, technological upgrade increased flexibility and procedural simplifications will help our exporters retain market share, and will hopefully reverse the declining trend in our exports.

The extension of the DEPB (Duty Entitlement Passbook) scheme, expansion of the focus market scheme (FMS) to 26 new countries, extension of interest subvention and zero duty on capital goods imports under the Export Promotion Credit Guarantee (EPCG) scheme are measures which will help revive exports and protect employment.

The emphasis on reducing transaction costs and simplifying trade and tax procedures in the new foreign trade policy would help enhance the competitiveness of Indian exports and would specially benefit small and medium sized exporters. The micro, small and medium enterprises, or MSMEs, are in need of technological upgrade in order to be cost-effective and competitive in international markets.

The technological up-gradation Scheme, by providing imports of capital goods for certain sectors under EPCG at zero per cent duty will help. The new policy initiatives relating to import of capital goods are, indeed, timely. The EPCG (Export Promotion Capital Goods) scheme has really been benefiting the upgrade and modernisation of India’s export manufacturing sector and the new incentive of giving access at zero duty would certainly help the beneficiary sectors such as engineering and electronic products, pharmaceuticals and chemicals, apparels and textiles, leather and leather products.

These are sectors where India enjoys a comparative advantage and the zero-duty capital goods import facility should go a long way in speeding up the process of technology upgrade.

The new foreign trade policy has taken important measures to diversify our export market and offset the inherent disadvantage for our exporters in the emerging markets of Africa, Latin America, Oceania such as credit risk, higher transaction costs etc. through appropriate policy instruments.

The policy focuses on the immediate objective of reversing the decline in exports and for that purpose provides support and incentives to the exporters. But in our view, the new foreign trade policy lacks the long-term strategic vision and does not provide any new approach on how India’s share of world trade can double by 2020, given the competition that India faces from China which has already raised its share of total world trade to 10 per cent while India’s share is still only 1.6 per cent.

It would not be easy for our exporters to be weaned off the Western developed countries (where little can be done till demand there revives) by diversifying exports to Africa and Latin America where purchasing power of the people is quite small. In our view Asia itself presents a long opportunity for our exports. Therefore, the bilateral agreements made by our Government with Asian and South Korea are appropriate steps to expand our exports.

To revive exports in the immediate future, the new foreign trade policy has rightly increased the incentives under the time tested export-promotion schemes which in the past contributed to export growth and has made an attempt to diversify markets for our exports. But long-term strategy to double our share of world export by 2020 is lacking in our foreign trade policy for 2010-14.

Trade Policy Measures in 2009-10 and 2010-11 to Check Inflation:

Trade policy measures taken by the Government and the RBI in 2009-10 and 2010-11 focused on reviving exports and export-related employment. The Government followed a mix of policy measures including fiscal incentives, institutional changes, procedural rationalization and enhanced market access to the world and diversification of export markets, improvement in infrastructure related to exports; bringing down transaction costs and providing full refund of all indirect taxes and levies were there major areas of focus.

Some of the trade policy measures to check inflation during 2009-10 and 2010-11 in the country are the following:

1. Import duties reduced to zero for rice, wheat, pulses, edible oils (crude), butter and ghee to 7.8 per cent for refined and hydrogenated oils and vegetable oils.

2. Import of raw sugar allowed at zero duty under open general licence (OGL).

3. Import of white/refined sugar allowed. The facility was extended up to 31 December 2010 without any quantitative,

4. Levy obligation in respect of raw sugar and white/refined sugar removed.

5. Export of basmati rice, edible oils, except coconut oil and forest-based oil and pulses (Kabuli Chana), banned.

6. Minimum export price (MEP) used to regulate exports of onions (at $ 1200 per tonne for Dec. 2010) and Basmati rice ($ 900 PMT) were fixed.

7. Export of onions (all varieties) including Bangalore rose onions and Krishna puram onions, fresh or chilled, frozen, provisionally prepared or dried (but excluding onion-cut and sliced or broken in powder form) not permitted with effect from 22 December 2010 and until further orders.

8. Full exemption from basic customs duty provided to onions and shallots with effect from 21^st December 2010. Consequently these items are exempt from special duty of 4 per cent and education cess. The exemption is open-ended and does not carry a validity clause prescribing a terminal date, and secondary and higher education cess.

The Important Foreign Trade Policy Measures, 2012-13:

Budget Related:

1. Imports of equipment for initial setting up or substantial expansion of fertilizer projects fully exempted from basic customs duty of 5 per cent for a period of three years up to 31 March 2015; and basic customs duty on some water- soluble fertilizers and liquid fertilizers other than urea reduced from 7.5 per cent to 5 per cent and from 5 per cent to 2.5 percent.

2. Concessional import duty available for installation of mechanized Handling Systems and Pallet Racking Systems in mandis or warehouses extended for horticulture produce.

3. Full exemption from basic customs duty for coal-mining projects.

4. Basic customs duty on plant and machinery imported for setting up or substantial expansion of iron ore pellet plants or iron are beneficiation plants reduced from 7.5 per cent to 2.5 per cent.

5. Full exemption from basic customs duty of 5 per cent for automatic shuttle-less looms and reduction in basic customs duty on wool waste and wool tops from 15 per cent to 5 per cent.

6. Basic customs duty increased on standard gold bars; gold coins of purity exceeding 99.5 per cent and platinum from 2 per cent to 4 per cent and on non-standard gold from 5 per cent to 10 per cent.

Credit Related:

1. In November 2011, the RBI increased the all-in cost ceilings for External Commercial Borrowings (ECBs) increased to 350 basis points (bps) over 6-months Libor/Euro Libor/Euribor for a maturity period between three and five years and 500 bps over 6 Months Libor/Euro Libor/Euribor for a maturity period more than five years. Accordingly, the all-in cost ceiling on trade credits has also been increased to 350 bps over 6-months Libor/Euro Libor/Euribor until 31 March 2013.

2. With effect from 5 May 2012, banks were allowed to determine their interest rates on export credit in foreign currency with the objective of increasing the availability of funds to exporters.

3. On 18 June 2012, the RBI enhanced the eligible limit of the export credit refinance (ECR) facility for scheduled banks (excluding regional rural banks [RRB]) from 15 per cent of the outstanding export credit eligible for refinance to 50 per cent, with effect from 30 June 2012.

The objective was to provide additional liquidity support to banks of over Rs. 300 billion. The rate of interest charged on the ECR facility was retained at the prevailing repo rate under the liquidity adjustment facility (LAF).

The 2 per cent Interest Subvention Scheme, earlier meant only for handlooms, handicrafts, carpets, and SMEs, was extended on 1 April 2012 to 31 March 2013 for labour-intensive sectors also, viz. toys, sports goods, processed agricultural products, and readymade garments. This was further extended up-to 31 March 2014and 134 tariff lines of engineering goods were also included in the scheme.

Foreign Trade Policy Measures in 2012-13:

1. Incentive on Incremental Exports:

Incentives to be granted on incremental exports made during the period January- March 2013 over the base period January-March 2012. The incentive to be granted to an Importer and Exporter Code (IEC) holder at the rate of 2 per cent on incremental growth of exports made to the USA, Europe, and Asian countries during this particular quarter, i.e. January-March 2013.

2. Export Promotion Capital Goods (EPCG) Scheme:

Zero Duty EPCG Scheme extended up to 31^st March 2013 and its scope enlarged. Export obligation under this scheme to be 25 per cent of the normal export obligation for export of products from north-eastern states and export of specified products through notified Land Customs Stations of the north­eastern region provided additional incentive to the extent of 1 per cent of Free on Board (FOB) value of exports.

3. Support for Export of Green Technology Products:

To promote exports of 16 identified green technology products, export obligation for manufacturing of these products under the EPCG Scheme reduced to 75 per cent of the normal export obligation.

4. Support for Infrastructure for the Agriculture Sector:

Status holders exporting products under ITC (HS) (both inclusive) are getting Duty Credit Scrip equivalent to 10 per cent of FOB value of agricultural products so exported. Import of 14 specified equipment’s had been notified for setting up of pack- houses besides import of capital goods and equipment for cold storage units, pack-houses, etc.

5. Incentives for Promoting Investment in Labour-intensive Sectors:

Status holders issued status holders incentive scrip (SHIS) to import capital goods for promoting investment in up-gradation of technology of some specified labour- intensive sectors like leather, textile and jute, handicrafts, engineering, plastics and basic chemicals. Up to 10 per cent of the value of these scrip’s will be allowed to be utilized to import components and spares of capital goods imported

6. Market and Product Diversification:

Seven new markets have been added to the Focus Market Scheme (FMS) and seven to the Special Focus Market Scheme (Special FMS). Forty-six new items have been added to the Market Linked Focus Product Scheme (MLFPS). The MLFPS has been extended till 31 March 2013 for exports to the USA and EU in respect of items falling under.

Around 100 new items have been added to the Focus Product Scheme (FPS) list. Three new items have been added to the Vishesh Krishi and Gram Udyog Yojana (VK.GUY). Additional measures announced as trade facilitation measures by widening and deepening of export incentives, 2012 to be made effective from 01.01.2013. These include addition of 5 new markets to FMS, one new market to Special FMS, 62 new items to MLFPS and 102 new items to FPS.

7. Simplification of Procedures:

Import under advance authorization (AA) permitted at any of the Electronic Data Interchange (EDI) ports, irrespective of the EDI port in which the AA has been registered. There would be no requirement of Telegraphic Release Advice (TT{A). Export shipments from Delhi and Mumbai through post, courier, or e-Commerce to be entitled for export benefits under the FTP.

8. New ‘e-BRC’ Initiative:

A major EDI initiative the ‘e-BRC’ launched which would herald electronic transmission of foreign exchange realization from the respective banks to the Directorate General of Foreign Trade (DGFT) server on a daily basis. The exporter will not be required to make any request to the bank for issuance of a bank export and realization certificate (BRC).

Exports Policy Changes in 2013-14:

To give boost to exports which contracted by 1.76 per cent in 2012-13 to $ 300.6 billion, the government in its annual exports policy for 2013-14 announced several incentives. These include easier land requirement norms, simpler exit options, cheaper credit and tax breaks for import of machinery.

The highlights of the export policy changes for SEZs in 2013-14 are the following:

1. The new rules for SEZs will allow IT firms to claim tax breaks by moving offshore work to such duty-free enclaves. The earlier requirement of minimum 10-hectares for such campuses has been done away with

2. IT SEZs can now be set up if the these are spread across at least 100,000 square metres in seven major cities including Mumbai, Delhi and NCR, Chennai, Hyderabad, Bangalore, Pune and Kolkata.

3. For category B cities, IT companies can set up SEZs even in a smaller built-up area of 50,000 square metres and for remaining cities in only 25,000 square metres. IT firms allowed to set up SEZs in campuses as small as 2500 square metres.

4. Minimum land area requirement halved to 500 hectares for multipurpose SEZs and to 50 hectares for sector-specific ones.

5. Ownership transfer of SEZ unit sales has been permitted.

6. Export Promotion Capital Goods scheme, which allows exporters to import machinery and capital goods at zero duty, was extended beyond March 2013 and would be applicable to all sectors.

It follows from above the package of export-policy reforms was meant to revive investor incentives for SEZs. It has been realised that SEZs have not realised their full potential.

IT industry body Nasscom welcomed these reforms in export policy and was delighted to note that the government has recognized that IT exports as a key growth driver for India’s exports.

Export-led growth (ELG) is an economic development strategy where a country aims to achieve sustainable economic growth by emphasizing and expanding its exports. This strategy has been particularly associated with developing countries seeking to accelerate their economic development.

1. Definition of Export-Led Growth (ELG):

Export-led growth refers to a strategy where a country focuses on increasing its exports as a primary driver of economic development. The idea is that by expanding exports, a nation can attract foreign exchange, stimulate domestic industries, promote efficiency, and ultimately achieve sustained economic growth.

2. Historical Context:

• Post-War Period: The concept gained prominence in the post-World War II era when many developing countries gained independence and sought strategies for economic development.

• East Asian Tigers: Notable success stories of export-led growth include the East Asian Tigers (South Korea, Taiwan, Hong Kong, and Singapore) during the latter half of the 20th century. These countries achieved rapid industrialization and economic development by heavily relying on exports.

3. Theoretical Underpinnings:

i. Comparative Advantage:

Export-led growth often aligns with the principle of comparative advantage, emphasizing a country’s ability to produce certain goods or services more efficiently than others.

ii. Economies of Scale:

ELG leverages economies of scale, as increased production for export markets can lead to lower average costs and increased efficiency.

iii. Foreign Exchange Accumulation:

By focusing on exports, countries can accumulate foreign exchange reserves, which can be used to finance imports of critical goods, reduce external debt, and stabilize the domestic currency.

4. Advantages of Export-Led Growth:

i. Diversification of the Economy:

ELG encourages diversification of the economy, reducing dependence on a narrow range of industries and markets.

ii. Technology Transfer and Learning:

Engaging in international trade often exposes domestic industries to new technologies and management practices, fostering learning and innovation.

iii. Increased Employment:

Growing export-oriented industries can lead to increased employment opportunities, contributing to poverty reduction and social development.

iv. Foreign Direct Investment (FDI):

A successful ELG strategy can attract foreign direct investment, bringing in capital, technology, and managerial expertise.

5. Challenges and Criticisms:

i. Vulnerability to External Shocks:

Overreliance on exports makes countries vulnerable to external shocks, such as changes in global demand or commodity price fluctuations.

ii. Income Inequality:

ELG may exacerbate income inequality, especially if the benefits are not distributed equitably across the population.

iii. Environmental Concerns:

Rapid industrialization driven by export-oriented growth may lead to environmental degradation and sustainability challenges.

iv. Global Competition:

Intensified global competition may result in “race-to-the-bottom” dynamics, where countries compete by lowering labor and environmental standards.

6. Examples of Export-Led Growth:

i. East Asian Tigers:

As mentioned earlier, countries like South Korea, Taiwan, Hong Kong, and Singapore are often cited as successful examples of export-led growth, transforming from agrarian economies to industrial powerhouses.

ii. China:

China’s economic rise since the late 20th century is a prominent example of export-led growth. China leveraged its abundant labor force to become the “world’s factory,” focusing on exports to drive economic development.

iii. Mexico:

Mexico adopted an export-oriented strategy, particularly in manufacturing, aiming to attract foreign investment and boost exports to the United States and other markets.

Conclusion:

Export-led growth has been a significant strategy for many developing countries, offering both opportunities and challenges. While success stories demonstrate its potential to drive rapid economic development, the approach is not without risks. The effectiveness of export-led growth depends on various factors, including a country’s institutional framework, policy environment, and ability to adapt to changing global economic conditions. As countries navigate the complexities of the global economy, export-led growth remains a dynamic and evolving strategy for fostering development.

Gains from Trade and Terms of Trade:

How the gain from international trade would be shared by the participating countries depends upon the terms of trade. The terms of trade refer to the rate at which one country exchanges its goods for the goods of other countries. Thus, terms of trade determine the international values of commodities. Obviously, the terms of trade depend upon the prices of exports a country and the prices of its imports.

When the prices of exports of a country are higher as compared to those of its imports, it would be able to obtain greater quantity of imports for a given amount of its exports. In this case terms of trade are said to be favourable for the country as its share of gain from trade would be relatively larger.

On the contrary, if the prices of its exports are relatively lower than those of its imports, it would get smaller quantity of imported goods for a given quantity of its exports. There­fore, in this case, terms of trade are said to be unfavourable to the country as its share of gain from trade would be relatively smaller. In what follows we first explain the various concepts of the terms of trade and then explain how they are determined.

Concepts of Terms of Trade:

Net Barter Terms of Trade:

The most widely used concept of the terms of trade is what has been caned the net barker terms of trade which refers to the relation between prices of exports and prices of imports. In symbolic terms:

T_n = P_x/P_m

Where

T_n stands for net barter terms of trade.

P_x stands for price of exports (x),

P_m stands for price of imports (m).

When we want to know the changes in net barter tends of trade over a period of time, we prepare the price index numbers of exports and imports by choosing a certain appropriate base year and obtain the following ratio:

Px₁/ Pm₁ : Px₀/ Pm₀

. Px„ Pm„

where Px_o and Pm₀ stand for price index numbers of exports and imports in the base year re­spectively, and Px₁) and Pm₁) denote price index numbers of exports and imports respectively in the current year.

Since the prices of both exports and imports in the base year are taken as 100, the terms of trade in the base year would be equal to one

Px₀/ Pm₀ = 100/100 = 1

Suppose in the current period the price index number of exports has gone upto 165, and the price index number of imports has risen to 110, then terms of trade in the current period would be:

165/110: 100/100 = 1.5:1

Thus, in the current period, terms of trade have improved by 50 pa’ cent as compared to the base period. Further, it implies that if the prices of exports of a country rise relatively greater than those of its imports, terms of trade for it would improve or become favourable.

On the other hand, if the prices of imports rise relatively greater than those of its exports, terms of trade for it would deterio­rate or become unfavourable. Thus, net barter terms of trade is an important concept which can be applied to measure changes in the capacity of exports of a country to buy the imported products. Obviously, if the net barter terms of trade of a country improve over a period of time, it can buy more quantity of imported products for a given volume of its exports.

But the concept of net barter terms of trade suffers from some important limitations in that it shows nothing about the changes in the volume of trade. If the prices of exports rise relatively to those of its imports but due to this rise in prices, the volume of exports falls substantially, then the gain from rise in export prices may be offset or even more than offset by the decline in exports.

This has been well described by saying, “We make a big profit on every sale but we don’t sell much”. In order to overcome this drawback, the net barter terms of trade are weighted by the volume of exports. This has led to the development of another concept of terms of trade known as the income terms of trade which shall be explained later. Even so, the net barter terms of trade is most widely used concept to measure the power of the exports of a country to buy imports.

Gross Barter Terms of Trade:

This concept of the gross terms of trade was introduced by F.W. Taussig and in his view this is an improvement over the concept of net barter terms of trade as it directly takes into account the volume of trade. Accordingly, the gross barter terms of trade refer to the relation of the volume of imports to the volume of exports. Thus,

T_g = Om/Qx

Where

Tg = gross barter terms of trade, Qm = quantity of imports

Qx = quantity of exports

To compare the change in the trade situation over a period of time, the following ratio is employed:

Om₁/Qx₁ : Qm₀/Qx₀

Where the subscript 0 denotes the base year and the subscript I denotes the current year.

It is obvious that the gross barter tenns of trade for a country will rise (i.e., will improve) if more imports can be obtained for a given volume of exports. It is important to note that when the balance of trade is in equilibrium (that is, when value of exports is equal to the value of imports), the gross barter terms of trade amount to the same thing as net barter terms of trade.

This can be shown as under:

Value of imports = price of imports x quantity of imports = Pm. Qm

Value of exports = Price of exports x quantity of exports = Px. Qx

Therefore, when balance of trade is in equilibrium.

Px . Qx = Pm. Qm

Px .Qm = Pm Qx

However, when balance of trade is not it equilibrium, the gross barter terms of trade would differ from net barter terms of trade.

Income Terms of Trade:

In order to improve upon the net barter terms of trade G.S. Dorrance developed the concept of income terms of trade which is obtained by weighting net barter terms of trade by the volume of exports. Income terms of trade therefore refer to the index of the value of exports divided by the price of imports. Symbolically, income terms of trade can be written as

Ty = Px.Qx/Pm

Where

T_y = Income terms of trade

P_x = Price of exports

Q_x = Volume of exports

P_m= Price of imports

Income terms of trade yields a better index of the capacity to import of a country and is, indeed, sometimes called ‘capacity to import. This is because in the long run balance of payments must be in equilibrium the value of exports would be equal to the value of imports.

Thus, in the long run:

Pm, Qm = Px, Qx

Qm = Px.Qx/Pm

It follows from above that the volume of imports (Qm) which a country can buy (that is, capacity to import) depends upon the income terms of trade i.e., Px.Qx/Pm. Since income terms of trade is a better indicator of the capacity to import and since the developing countries are unable to change Px and Pm. Kindleberger’ thinks it to be superior to the net barter terms of trade for these countries, However, it may be mentioned once again that it is the concept of net barter terms of trade that is usually employed.

Determination of Terms of Trade: Theory of Reciprocal Demand:

As seen above, the share of a country from the gain in international trade depends on the terms of trade. The terms of trade at which the foreign trade would take place is determined by reciprocal demand of each country for the product of the other countries.

The theory of reciprocal demand was put forward by JS. Mill and is thought to be still valid and true even today. By reciprocal demand we mean the relative strength and elasticity of the demand of the two trading countries for each other’s product.

Let us take two countries and B which on the basis of their comparative costs specialise in the production of cloth and wheat respectively. Obviously, country would export cloth to country B, and in exchange import wheat from it. Reciprocal demand means the strength and elasticity of demand of country A for wheat of country B, and the intensity and elasticity of country B’s demand for cloth from country A If the country has inelastic demand for wheat of country B, she will be prepared to give more of cloth for a given amount of wheat. In this case terms of trade will be unfavourable to it and consequently its share of gain from trade will be relatively smaller.

On the contrary, if country A’s demand for import of wheat is elastic, it will be willing to offer a smaller quantity of its cloth for a given quantity of the imports of wheat. In this case terms of trade would be favourable to country A and its share of gain from trade will be relatively larger. The equilibrium terms of trade would settle at a level at which its reciprocal demand, that is, quantity of its exports which it will be willing to give for a given quantity of its imports is equal to the reciprocal demand of the other country.

Note that the equilibrium terms of trade are determined by the intensity of reciprocal demand of the two trading countries but they will lie in between the comparative costs (i.e., domestic exchange ratios) of the two countries. This is because no country would be willing to trade at a price which is lower than at which it can produce at home.

Let us return to the example of the two countries A and B which specialise in the production of two commodities cloth and wheat respectively, and exchange them with each other. Production conditions in the two countries are given below:

Table 45.1: Production of one man per week

It will be seen from above table that before trade production conditions in country B are such that 12 bushels of wheat would be exchanged for 20 yards of cloth, in it, that is, the domestic ex­change ratio is 12: 20 (or 3: 5). On the other hand, in country A production conditions are such that 4 bushels of wheat would be exchanged for 12, yards of cloth, that is, the domestic exchange ratio is 4: 12 or 1: 3. Obviously, after trade, terms of trade will be settled within these domestic exchange ratios of the two countries.

The domestic exchange ratios of the two countries set the limits beyond which terms of trade would not settle after trade. It is evident that country B will be unwill­ing to offer more than 12 bushels of wheat for 20 yards of cloth since by sacrificing 12 bushels of wheat it can produce 20 yards of cloth at home.

Likewise, country A would not accept less than 6.66 bushels of wheat for 20 yards of cloth, for this is the domestic exchange rate cloth of wheat for(l :3) determined by production or cost conditions at home in country A.

It is within these limits that terms of trade will be settled between the two countries as determined by the strength of reciprocal demand of the trading countries. It also follows that it is not mere demand but also the comparative produc­tion costs (i.e., the supply conditions) that go to determine the terms of trade. Indeed, the law of reciprocal demand, if properly understood, considers both the forces of demand and supply as deter­minants of the terms of trade.

Critical Evaluation of the Reciprocal Demand Theory:

The reciprocal demand theory of the terms of trade is based upon two countries, two commodi­ties model. It assumes that full-employment conditions prevail in the economy and also that there is perfect competition in both the product and factor markets in the economies of the various countries.

It also assumes the governments of the various countries follow free trade policy and impose no restrictions on foreign trade by imposing tariffs or adopting other means to restrict imports. Further, this theory grants that there is free mobility of factors domestically within the economies of the two countries. To the extent these assumptions do not hold in the real world, the terms of trade would not conform to those determined by the reciprocal demand.

However, as stated above; every theory makes some simplifying assumptions. The soundness of a theory depends upon whether the deduc­tive logic it employs is flawless and the conclusions it draws about the impact of economic forces on the subject investigated are correct or not. On this test the reciprocal demand theory fares very well as reciprocal demand is undoubtedly an important factor which influences terms of trade.

F.D. Graham criticized this theory by pointing out that it is applicable only to trade in antiques and old masters which are found in fixed supplies and therefore in their case demand plays a crucial role in the determination of terms of trade.

He stressed that the theory of reciprocal demand was not relevant in case of goods produced currently since their international values (i.e., terms of trade) were determined by comparative production costs (i.e., the supply conditions). In his view, recipro­cal demand theory grossly exaggerates the role of reciprocal demand and neglects the importance of comparative cost conditions.

However, Graham’s criticism is not valid. The reciprocal demand or offer curve embodies both demand and production costs. In reply to Graham’s criticism, Viner writes that “The terms of trade can be directly influenced by the reciprocal demands and by nothing else. The reciprocal demands in turn are ultimately determined by the cost conditions together with the basic utility function.”

We therefore, conclude that terms of trade are determined by reciprocal demands of the trading countries. Reciprocal demands in turn are governed by both the demand and supply (cost) condi­tions. Thus, the intensity of demand by others for exports of a country and the intensity of its demand for imports from the other country are the important factors that determine the terms of trade. Be­sides, comparative cost conditions of the products exported and those imported have also an impor­tant role in the determination of terms of trade.

Determination of Terms of Trade and Offer Curves:

The theory of reciprocal demand has been explained graphically with the help of the concept of offer curves developed by Edgeworth and Marshall. The offer curve of a country shows the amounts of a commodity it offers at various prices for a given quantity of the commodity produced by the other country.

To understand how offer curves are derived and how with their help determination of the terms of trade is explained, we shall first explain how a country reaches its equilibrium position about the amounts of goods to be produced and consumed.

For this purpose, modern economists usually employ the tools of production possibility curve and the community indifference curves. The production possibility curve represents the combinations of two commodities which a country, given its resources and technology, can produce.

A community indifference curve shows the combinations of two goods which provide same satisfaction to the community as a whole. A map of community indifference curves portrays the tastes and demand pattern of a community for the two goods. A production possibility curve TT’ and a set of community indifference curves IC₁IC₂ and IC₃ of coun­try A have been drawn in Fig. 45.1.

The country reaches its equilibrium position with regard to production and consumption of cloth and wheat at the point Q where the production possibility curve TT’ is tangent to the highest possible indifference curve IC₂ at which marginal rate of transfor­mation of cloth for wheat (MRT_CW) equals marginal rate of substitution of cloth for wheat (MRS_CW) as well as the price ratio of the two commodities Pc/Pw as shown by the slope of the price line P₁P₁.

Thus, tangency point Q in Fig. 45.1 depicts the equilibrium position of country in the absence of trade. Suppose country A enters into trade relation with country B and price of cloth rises relative to wheat so that new price-ratio line becomes P₂P₂.

It will be observed from Fig. 45.1 that with price- ratio line P₂P₂ production equilibrium of country is at point M, its consumption equilibrium is at point R. This shows that with price-ratio line PP₂ country A will offer or export MN of cloth for RN imports of wheat.

Similarly, if price of cloth further rises relative to wheat, price-ratio line will become more steep, then for the same quantity offered of export of cloth, the or import of wheat will increase. With such information gathered from Fig. 45.1, we can derive offer curve of country A in Fig. 45.2.

The tangent line in Fig. 45.1 shows the domestic price ratio of the two commodities and has a negative slope. In the analysis of the offer curve, the price line is drawn with a positive slope from the origin. This is because in the drawing of an offer curve we are interested only in knowing the quantity of one commodity which can be exchanged for a certain quantity of another commodity.

In other words, in the analysis of terms of trade what we are really interested is the absolute slope of the curve, i.e., the price ratio. In Fig. 45.2 the positively sloping price line OP₁ from the origin, which in absolute terms, has the same slope as P₁P₁ of Fig. 45.1 has been drawn. In Fig. 45.2 at price ratio line O₁P₁ no trade occurs.

When price of cloth rises and price ratio line shifts to OP₂ as will be from Fig. 45.2, country A offers ON₁ of cloth (exports) for RN₁ of wheat (imports). (Note that at a given price ratio how much quantity of a commodity, a country will offer for imports from the other country is determined by production possibility curve and community’s indifference curves as illustrated in Fig. 45.1).

Suppose the price of cloth further rises relatively to that of wheat causing the price line to shift to the position OP₃. It will be seen that with the price line OP₃, country A is willing to offer for export ON₂ quantity of cloth for SN₂ of wheat.

Likewise, Fig. 45.2 portrays the exports and imports of the country A as price of cloth in terms of wheat increases further and consequently price line shifts further above to OP₄ and OP and the new of­fers of export of cloth for import of wheat are determined by equilibrium points T and U. If points such as R, S, T and U representing the country A’s offers of cloth for wheat are joined we get its offer curve.

It is important to note that the offer curve may be regarded as the supply curve in the international trade as it shows amounts of cloth which the country A is willing to offer for cer­tain amounts of imports of wheat at various price ratios.

Another important point to be noted is that the offer curve cannot go below the price line OP, which represents the domestic exchange ratio determined by the tangency point Q of pro­duction possibility curve and community indif­ference curve of country A as shown in Fig. 45.1. This is because, as stated above, no country will be willing to export its product for the quantity of the imported product which is smaller than that it can produce at home.

Likewise, we can derive the offer curve of country B. Figure 45.3 portrays the derivation of the offer curve of country B. representing quantities of wheat which it is willing to exchange for certain quantities of cloth from country A at various prices.

Note that so long as country B is importing a smaller quantity of cloth, it will be willing to offer relatively more wheat for cloth. But as the quan­tity of imported cloth is increased, it would be prepared to offer relatively less wheat for the given quantity of imports of cloth.

In Fig. 45.3 whose Y-axis represents wheat, the origin for indifference curves of country B will be the North-West Comer Price lines. OP₇, OP₆, OP₅, OP₄ etc., express successively higher price ratios of wheat for cloth. Price line OP₁ represents the domestic price ratio in country B in the absence of trade. The points C, D, E, F, G which has been obtained from the equilibrium or tangency points between the community indifference curves of country B and the various price-ratio lines show the equilibrium offers of wheat by country B for cloth of country A at various prices. By joining together points, C. D, E, F and G we obtain the offer curve of country B indicating its demand for cloth of country A in terms of its own product wheat.

It would be observed from Fig. 45.2 and 45.3 that offer curves OA and OB of the two countries have been drawn with the same origin O (i.e., South-West Corner) as the basis. These offer curves represent reciprocal demand of the two countries for each other’s product in terms of their own product. The offer curves OA and OB of the two countries have been brought together in Fig. 45.4.

The intersection of the offer curves of the two countries determines the equilibrium terms of trade. It will be seen from Fig. 45.4 that the offer curves of two countries cross at point T. By joining point T with the origin we get the price-ratio line OT whose slope represents the equilibrium terms of trade which will be finally settled between the two countries.

At any other price-ratio line the offer of a product by country A in exchange for the product of the other would not be equal to the reciprocal offer and demand of the other country B. For instance, at price-ratio line OP¹, country B would offer OM wheat for MH or ON of cloth from country A (H lies on B’s offer curve correspond­ing to price-ratio line OP₅).

But at this price-ratio line OP country A would demand much greater quantity of wheat UW for OU of cloth as determined by point W at which the offer curve of country A intersects the price ratio line OP. This will result in rise in price of wheat and the price-ratio line will shift to the right until it reaches the equilibrium position OT or OP₄.

On the other hand, if price ratio line lies to the right of Or (for instance, if it is OP,), then, as will be observed from Fig. 45.4, it cuts the offer curve of country A at point L implying thereby that the country A would offer OR of cloth in exchange for RL of wheat. However, with terms of trade implied by the price ratio line OP₄, the country B would demand OZ of cloth for ZS quantity of wheat as determined by point S.

It therefore follows that only at the terms of trade implied by the price ratio line OT (i.e., OP₄) that the offer of a product by one country will be equal to its demand by the other. We therefore conclude that the intersection of the offer curves of the two countries determines the equilibrium terms of trade.

As explained above, the offer curves of the two countries are determined by their reciprocal demand. Any change in the strength and elasticity of reciprocal demand would cause a change in the offer curves and hence in the equilibrium terms of trade.

It is worthwhile to note that terms of trade must settle within the price lines OP₁ and OP₇ representing the domestic rates of exchange between the two commodities in the two countries respectively as determined on the basis of production cost and s demand conditions existing in them.

When the terms of trade are settled within these limits set by these price lines OP₁ and OP₇, both countries would gain from trade, though one may gain relatively more than the other depending on the position of terms of trade line.

As explained above, the terms of trade cannot settle beyond these domes­tic prices ratio lines because in case of terms of trade line lying beyond these price lines, it will be advantageous for a country to produce both the goods (wheat and cloth) domestically rather than entering into foreign trade.

Effect of Tariff on Terms of Trade:

The various countries of the world have imposed tariffs (i.e., import duties) to protect their domestic industries. It has been said in favour of tariffs that through them a country can provide not only protection to its industries but under appropriate circumstances it can also improve its terms of trade, that is, tariffs under favourable circumstances enable a country to get its imports cheaper.

These favourable circumstances are:

(1) The demand for the exports of the tariff-imposing countries is both large and inelastic

(2) The demand for the imports by the country is quite elastic. Under these circumstances, as a result of the imposition of tariff by that country, the imports of the country will decline since the price of the imported commodity will rise. But this is not the end of the story.

The decline in imports of the tariff-imposing country would reduce the export earnings of its trading partner as it will lead to the decrease in demand for it exported commodity. The decrease in demand for the exported commodity in the trading partner would result in lowering its domestic price.

As a result of the fall in the domestic price of the exported commodity and in order to maintain its export earnings the exporting country is likely to reduce the price of its exports. This means that the tariff- imposing country would now be able to get its imports at a relatively lower price than before.

Given the demand and price of its exports, the fall in its prices of imports of the tariff- imposing country would imply the improvement in its terms of trade. It is worth mentioning that the improvement in the terms of trade through tariff depends upon the changes in price and resultant changes in quantity demanded of imports and exports of the trading countries which in turn depends upon the elasticity’s of their reciprocal demand.

The effect of tariff on the terms of trade can be explained through the geometrical device of offer curves. In Fig. 45.5 the offer curves OA and OB respectively of the two countries A and B are shown. These offer curves intersect at T implying thereby that terms of trade equal to the slope of OT are determined between them.

Now, suppose that country A imposes import duty on wheat from country B. As a result of this imposition of tariff, the offer curve of country A will shift to a new position OA ‘(dotted). This implies, for instance, that, before tariff, country was prepared to offer ON of cloth for NQ of wheat, but after imposition of tariff it requires NT’ of wheat for ON of cloth and collects QT ‘ as import duty.

It will be noticed from Fig. 45.5 that the new offer curve OA ‘(dotted) of country A intersects the offer curve OB of country B at point T and thereby the terms of trade changes from OT to OT’. Note that the slope of the terms of trade line OT’ is greater than that of OT’.

Thus terms of trade for country A have improved consequent upon the imposition of tariff by country A. For instance, whereas according to terms of trade line OT country A was exchanging ON of cloth for N L imports of wheat, it is now exchanging ON of cloth for NT’ of wheat.

The following three things are worth nothing about the impact of tariffs on terms of trade:

1. The gain in terms of trade from imposing a tariff depends on the elasticity of the offer curve of the opposite trading country. If the offer curve of the opposite trading country is perfectly elastic, that is, when it has constant costs so that offer curve is the straight line OB from the origin with slope equal to that of OT as shown in Fig. 45.6, the imposition of tariff would reduce the volume of trade between them, the terms of trade remaining the same.

For example, if in the situation depicted in Fig. 45.6 country A imposes a tariff on imports of a wheat from the country B and as a result the offer curve of A shifts upward to the new position OA’ (dotted), the terms of trade remain constant as measured by the slope of the terms of trade line OT. It will be seen from Fig. 45.6 that in this case only volume of trade has declined from ON to OM

2. The gain in terms of trade from imposing a tariff will finally accrue to a country only in the absence of retaliation from the trading country B. But when one country can play a game to improve its position, the other can retaliate and play the same game.

That is, on country A imposing a tariff on its imports from country B in a bid to improve its terms of trade, the latter can also impose a tariff on the imports from the former and thereby cancels out the original gain by country A. Such competition in imposing tariffs on each other’s product would greatly reduce the volume of trade and leave the terms of trade between them unchanged.

As a result of the reduction in volume of trade, both countries would suffer a loss. “The imposi­tion of tariffs to improve the terms of trade, followed by retaliation, ensures that both countries lose. The reciprocal removal of tariffs, on the other hand, will enable both countries to gain. That is why different countries enter into bilateral agreements to reduce tariffs on each other’s products.” Fur­ther, there is now World Trade Organisation (WTO) which requires the member countries to reduce tariffs so that the volume of international trade expands.

The relationship between trade and economic development is a complex and multifaceted subject in international economics. Trade plays a crucial role in the economic development of nations, influencing growth, poverty alleviation, technological progress, and the overall well-being of societies.  

1. Theoretical Perspectives:

i. Classical and Neo-Classical Theories:

• Absolute Advantage (Adam Smith): Smith’s theory suggests that countries should specialize in the production of goods in which they have an absolute advantage and engage in trade to maximize efficiency.
• Comparative Advantage (David Ricardo): Ricardo’s theory argues that even if a country has an absolute disadvantage in producing all goods, it can benefit from specializing in the production of goods in which it has a comparative advantage.

ii. Heckscher-Ohlin Model:

• This model, developed by Eli Heckscher and Bertil Ohlin, emphasizes factor endowments (such as labor and capital) as determinants of comparative advantage. Countries are expected to export goods that intensively use their abundant factors.

iii. New Trade Theory:

• Developed by economists like Paul Krugman, the New Trade Theory incorporates economies of scale and product differentiation to explain the pattern of trade. It suggests that specialization and trade can arise due to increasing returns to scale and product differentiation.

iv. Global Value Chains:

• The rise of global value chains (GVCs) reflects the increasing fragmentation of production processes across borders. Countries participating in GVCs can benefit from specialized tasks, technology transfer, and access to global markets.

2. Empirical Evidence:

i. Historical Examples:

• The Industrial Revolution in Europe and the economic development of East Asian Tigers (South Korea, Taiwan, Singapore) are historical examples where trade played a pivotal role in driving economic development.

ii. China’s Economic Rise:

• China’s rapid economic development since the late 20th century is often attributed to its export-oriented growth strategy. Trade openness has facilitated technology transfer, industrialization, and job creation.

iii. Globalization and Developing Countries:

• Empirical evidence suggests that developing countries that have integrated into the global economy have experienced higher growth rates, increased income levels, and reduced poverty compared to those with closed economies.

3. Policy Implications:

i. Trade Liberalization:

• Policies that promote trade liberalization, including the reduction of tariffs and non-tariff barriers, are often advocated to enhance economic development by fostering efficient resource allocation and promoting competitiveness.

ii. Infrastructure Development:

• Investing in infrastructure, such as transportation and communication networks, is crucial for facilitating trade. Efficient logistics and connectivity contribute to a country’s competitiveness in the global market.

iii. Institutional Reforms:

• Sound institutional frameworks, including property rights protection, contract enforcement, and the rule of law, are essential for creating an environment conducive to international trade and investment.

4. Challenges and Criticisms:

i. Inequality and Distributional Effects:

• Critics argue that the benefits of trade are not always evenly distributed, leading to income inequality within countries. Some segments of the population may face job displacement or wage stagnation.

ii. Vulnerability to External Shocks:

• Open economies are susceptible to external shocks such as changes in global demand, commodity price fluctuations, or financial crises, which can negatively impact economic development.

iii. Environmental Concerns:

• The environmental impact of increased trade, including resource depletion and pollution, raises concerns about the sustainability of certain development strategies.

5. Globalization and Trade:

i. Multilateral Trade Agreements:

• Multilateral agreements, such as the General Agreement on Tariffs and Trade (GATT) and its successor, the World Trade Organization (WTO), aim to facilitate global trade by reducing barriers and establishing rules.

ii. Trade and Technology Transfer:

• Global trade facilitates the transfer of technology, knowledge, and best practices across borders, contributing to technological progress and innovation.

iii. Role of Multinational Corporations (MNCs):

• MNCs play a significant role in global trade by investing in foreign markets, transferring technology, and integrating production processes across different countries.

Conclusion:

The relationship between trade and economic development is dynamic and multifaceted. While theories such as comparative advantage provide a foundation for understanding the potential benefits of trade, the real-world impact depends on a variety of factors, including institutional quality, policy choices, and the global economic environment. In navigating the complexities of international economics, policymakers must carefully consider the trade-offs and design strategies that harness the positive aspects of trade while addressing its challenges to foster sustainable and inclusive economic development.

Meaning and Measurement of Gains from Trade:

Just as two traders in the same country enter into exchange for the consideration of making some gain, in the same way two countries get engaged into transactions for deriving some gain. The economists have viewed the gains from trade from different angles. The classical theorists believed that gains from trade resulted from increased production and specialisation.

Jacob Viner pointed out that the gains from trade were measured by the classical economists in terms of:

(i) Increase in national income,

(ii) Differences in comparative costs, and

(iii) Terms of trade.

The modern theorists considered the gains from trade as the gains resulting from exchange and specialisation.

Some approaches to the concept of gains from trade and their measurement are discussed below:

(i) Adam Smith’s Approach:

In the opinion of Adam Smith, the gains from international trade are in the form of the increased value of product and improvement in the productive capacity of each trading country. The international trade leads to export of the commodity which is less in demand in the home market, and import of the commodity which is strong in demand. It enables each trading country to derive the maximum welfare and obtain maximum possible export earnings.

When each country specialises in the production of the commodity in which it has cost advantage, there is optimum allocation of productive resources. Coupled with increased division of labour, specialisation reduces the cost structure and enlarges the size of market for each trading country. As a consequence, the world production and welfare gets maximized through international trade.

(ii) Ricardo-Malthus Approach:

Ricardo viewed the gain from trade as an objective entity. According to him, the specialisation in production and trade on the basis of the principle of comparative costs results in saving of resources or costs. Through the cheaper availability of commodities required by each country from abroad, every country can increase the ‘sum of enjoyments’ and also increase the ‘mass of commodities’.

In the words of David Ricardo, “The advantage to both places is not that they have any increase in value but with the same amount of value they are both able to consume and enjoy an increased quantity of commodities.” Malthus had expressed in this regard views similar to those of Adam Smith. The gain from trade, according to him, consists of “the increased value, which results from exchanging what is wanted less for what is wanted more.” The international exchange on this basis increases “exchangeable value of our possession, our means of enjoyment and our wealth.”

The Ricardo-Malthus approach to gains from trade was illustrated by Ronald Findlay in terms of Fig. 13.1.

In Fig. 13.1., the production possibility curve under constant cost conditions is AB before trade. The production, let us suppose, takes place at E. If this country enters into trade, the international exchange ratio line shifts to A₁B and production of two commodities X and Y now takes place at C. The production at point C will be possible if the labour input increases to such a large extent that the production possibility curve shifts to A₂B₂. The gain from trade will be measured by BB₂/OB.

Malthus criticized this measure of gain from trade as exaggerated. According to him, if the production possibility curve shifts to A₂B₂, the point C cannot be the point of equilibrium. The relative prices along A₂B₂ are more favourable to the export good X than along the line A₁B. Some point to the right of C rather than C itself would be preferable to the community. Hence the gain from trade along the line A₁B cannot be measured by an increase in the input of labour in the ratio BB₂/OB. It tends only to overstate the gain from trade.

Ronald Findlay attempted a modification over the Ricardian measure of gain from trade by introducing in this analysis the community indifference curve. Given the community indifference curve I, the equilibrium does not take place at the Ricardian trade equilibrium position C but at D where the production possibility curve A₃B₃ became tangent to the community indifference curve I.

At point D each individual in the community is better off than at C. The gain from trade in this situation is BB₃/OB rather than BB₂/OB. The measure of gain from trade BB₃/OB vindicates the Malthusian criticism that Ricardian measure of gain from trade was an over- estimation.

(iii) J.S. Mill’s Approach:

A serious deficiency in the Ricardian approach was that it could not explain the distribution of gains from trade among the trading countries. J.S. Mill attempted to analyse both the gains from trade and distribution thereof among the trading countries. He emphasised upon the concept of reciprocal demand that determines terms of trade, which is a ratio of quantity imported to the quantity exported by a given country. The terms of trade decide how the gain from trade is distributed between the trading partners.

Suppose in country A, 2 units of labour can produce 20 units of X and 20 units of Y so that the domestic exchange ratio in country A is : 1 unit of X = 1 unit of Y. In country B, 2 units of labour can produce 12 units of X and 18 units of Y so that the domestic exchange ratio in this country is : 1 unit of X = 1.5 unit of Y. The domestic exchange ratios set the limits within which the actual exchange ratio or terms of trade will get determined.

The reciprocal demand or the strength of the elasticity of demand of the two trading countries for the products of each other will decide the actual rate of exchange of two commodities. If A’s demand for commodity Y is less elastic, the terms of trade will be closer to its domestic exchange ratio: 1 unit of X = 1 unit of Y. In this case the terms of trade will be favourable for country B and against country A.

The gain will be more for B than for A. On the contrary, if B’s demand for X commodity is less elastic, the terms of trade will be closer to the domestic exchange ratio of country B: 1 unit of X = 1.5 unit of Y. The terms of trade, in this situation, will be favourable for A and against B. Country A will have a larger share out of the gains from trade than country B.

The distribution of gains from trade can be explained in terms of Marshall-Edgeworth offer curve through Fig. 13.2.

In Fig. 13.2., OC and OD are the domestic exchange ratio lines of countries A and B respectively. OA is the offer curve of country A and OB is the offer curve of country B. The exchange takes place at P where the two offer curves cut each other. Country A imports PQ quantity of Y and exports OQ quantity of X.

The terms of trade for country A at P = (Q_M/Q_X) = (PQ/OQ) = Slope of Line OP. If the line OP gets closer to OD, the terms of trade become favourable to country A and unfavourable to country B. On the opposite, if the line OP gets closer to the line OC, the domestic exchange ratio line of country A, the terms of trade turn against country A and become favourable to country B.

Country A was willing to exchange before trade SQ units of Y for OQ units of X. After trade, it gets PQ units of Y for OQ units of X. Therefore, the gain from trade for country A, out of the total trade gain of RS, amounts to PQ – SQ = PS units of Y. In case of country B, RQ units of Y were being exchanged for OQ units of X before trade.

However, after trade it has to part with only PQ units of Y to import OQ units of X. Therefore, the gain from trade for this country amounts to RQ – PQ = RP units of Y. As the point of exchange P gets closer to the line OD, the share of country A in the gain from trade will rise and that of country B will fall and vice-versa.

(iv) Taussig’s Approach:

Taussig maintained that the gains from international trade can accrue to the trading country in the form of a rise in income. As trade brings about an expansion of the export industry, the employers start offering higher wages in order to absorb more labour in this industry. This leads to a rise in the money wages in other industries otherwise there will be accumulation of inefficiency in them. It signifies a general rise in money incomes. A higher level of income due to trade enables the people of a country to make larger purchases of both domestically produced and imported goods and reach a higher level of welfare.

(v) Modern Approach:

The modern approach stresses that the introduction of international trade brings two types of gains—gain from exchange and gains from specialisation. These two gains together constitute the gains from international trade. When trade commences, consumers enjoy a higher level of satisfaction, partly because of improvement in terms of trade and partly on account of greater specialisation in the use of economic resources of the country. These two types of gains from trade can be shown through Fig. 13.3.

In Fig. 13.3., X-commodity is measured along the horizontal scale and Y-commodity is measured along the vertical scale. AA₁ is the production possibility curve. P₀P₀ is the domestic price ratio line. It is tangent to the production possibility’ curve at E. Thus E is the point of production equilibrium in the absence of trade.

E is also the point of consumption equilibrium because P₀P₀ is tangent to the community indifference curve I₁ at this point. When trade commences, P₁P₁ is the international exchange ratio line, which is tangent to the production possibility curve at F and to the community indifference curve I₃ at C₁.

Thus F is the point of production and C₁ is the point of consumption. After trade takes place, D₁F of X-commodity is exported and C₁D₁ quantity of Y-commodity is imported. The trade causes two types of shifts in the country. First, the production point shifts from E to F. It occurs because of specialisation in the production of X-commodity and specialisation in factor use. This can be called as the production effect. Second, the point of consumption shifts from E at I₁ to C₁ at the higher community indifference curve I₃. It means an increase in the satisfaction of the commodity. This can be called as the consumption effect. Both together signify the gain from international trade.

If a line P₂E is drawn parallel to P₁P₁ from the original equilibrium situation E, it signifies that there is no change in production but the consumption equilibrium shifts from E to C at a higher community indifference curve I₂. In this situation, CD quantity of Y is imported at lower international price of Y. The quantity of X-commodity exported in exchange of CD quantity of Y is DE. Although production is the same as at point E but the consumption equilibrium shifting from E to C signifies the gain from trade. This is the trade gain from exchange.

After trade, as the specialisation in production and optimum factor use takes place, the production equilibrium shifts from E to F along the same production possibility curve and consumption equilibrium shifts to C₁. In this situation, C₁D₁ quantity of Y is imported and D₁F quantity of X is exported. As a result of specialisation in production after trade, the shift in consumption equilibrium from C to C₁ reflects the trade gain from specialisation.

To sum up, the total gain from trade is comprised of gain from exchange and the gain from specialization. The total gain from trade can be measured by the movement from E to C₁. This movement takes place in two steps—the movement from E to C is the gain from exchange and the movement from C to C₁ is the gain from specialization.

Gains from Trade for Large and Small Country:

H.R. Heller discussed that under the conditions of constant opportunity cost and unchanged terms of trade, the large country receives no gain from trade and the entire trade gain goes to the small country. This case can be explained through Fig. 13.4.

In Fig. 13.4. (i) For a large country A, the production possibility curve under the conditions of constant costs is AA₁. In the absence of trade, consumption and production takes place at R where the community indifference curve I is tangent to the production possibility curve. After trade takes place, there is no change in terms of trade for country A so that the international price ratio line remains AA₁. This country will, however, modify its production pattern in such a way that some imports are made from country B. It may decide to move to P where it exports PS quantity of X commodity and imports SR quantity of Y. Since the terms of trade remain unchanged for country A, it fails to make any gain from trade.

In Fig. 13.4. (ii), for the small country B, the production possibility curve or domestic price ratio line under constant cost conditions is BB₁. Its tangency with the community indifference curve I₁ shows that production and consumption equilibrium in this country, in the absence of trade, takes place at R₁. As trade commences, this country specialises completely in the production of Y commodity. The international price ratio line is BB₂, which is parallel to AA₁. This country produces at B. The consumption equilibrium occurs at R₁.

So after trade it exports TR₂ (= SR) of Y commodity to country A and imports BT (= PS) quantity of X from country A. The movement from R₁ to R₂ in country B reflects the gain from specialisation and exchange to the small country B from the international trade. Since this country is able to import X-commodity at the lower international price, the terms of trade turn in favour of it. That also shows that the gains from trade go to small country B alone and large country goes without any gain from trade.

Potential and Actual Gain from Trade:

The potential gain from trade for the two trading countries A and B is determined technically on the basis of the difference in domestic cost ratios of producing two commodities, say X and Y.

Thus,

Thus the equalisation of actual gain and potential gain takes place when there is an absence of tariff and other trade restrictions. However, if there is imperfect competition and tariff or other trade restrictions are present, there arise differences in cost ratio and price ratio in each trading country. As the price ratio (P_X/P_Y) is more than the cost ratio (C_X/C_Y), the actual gain from trade exceeds the potential trade gain (G_a > G_P).

Free Trade vs. No Trade:

Free trade is a trade situation in which no tariff or any other restriction is placed upon trade.

Assumptions:

In such a situation, there is a tendency for the domestic factor and product prices to get equalised with international prices.

The proposition that free trade is superior to no trade is proved on the basis of the following assumptions:

(i) There is a state of perfect competition in the market.

(ii) The government does not interfere in trade through tariffs, quotas and subsidies.

(iii) The given country has no monopoly power in trade.

(iv) The factors of production are fixed in supply.

(v) The technology is such that the production possibility curve is concave to the origin.

(vi) The country is small.

(vii) Transport costs are absent.

On the basis of the assumptions given above, it is possible to show that the free international trade is much superior to autarchy (absence of trade). The diagram, to demonstrate it, is adapted from the diagram given by Jagdish Bhagwati.

In Fig. 13.5., X commodity is measured along X axis and Y commodity along the Y arise. AB is the production possibility curve of the home country. In the absence of trade, the domestic price ratio is given by the line DD. C is the point of production and consumption equilibrium. As the trade commences and there is no restriction on trade, the international price ratio is given by the slope of the line EE which runs parallel to DD. The line EE represent consumption possibility curve.

This determines the new availability frontier in the country. The point R, where the consumption possibility curve is tangent to the production possibility curve, represents the most efficient production point.

Consumption point on the other hand is determined at C₁ where the international price ratio line EE is tangent to the higher community indifference curve I₂. Since after free trade, the production is optimised at R and consumption is optimised at C₁, it follows that the free trade is definitely superior to no trade.

Static and Dynamic Gains from Trade:

The gains from international trade are of two types:

1. Static Gains from Trade:

The static gains from trade are as under:

(i) Expansion in Production:

International trade based on the principle of comparative cost advantage, according to classical economists, assures the benefits of international specialisation and division of labour. All the available productive resources in the trading countries get optimally utilized resulting in the maximisation of production not only for the individual trading countries but also for the whole world.

(ii) Increase in Welfare:

International trade results in the increased production of consumable goods in both home country and foreign country due to large world demand for products. Specialization also leads to improvement in the .quality of consumer products. As cheaper consumer products of superior varieties become easily available, there is definite rise in welfare of the people. “The extension of international trade”, opined Ricardo, “very powerfully contributes to increase the mass commodities and, therefore, the sum of enjoyments.”

(iii) Rise in National Income:

International specialisation results in expansion of production in the trading countries. More and more employment opportunities become available to the people. The expansion of production and employment leads to a rise in national income of the trading countries.

(iv) Vent for Surplus:

According to Adam Smith, international trade leads to the fullest utilisation of productive resources of the country. It becomes capable of creating a surplus of goods, which can be easily disposed of in the foreign market. Thus, the vent for surplus also constitutes a gain from international trade.

2. Dynamic Gains from Trade:

The major dynamic gains from international trade are as follows:

(i) Technological Development:

The international trade stimulates technical and scientific inventions and innovations as the producers in all the counties attempt to develop such techniques of production through which costs can be minimised and the speed of production can be accelerated. Trade facilitates the transfer of advanced technology from the developed to less developed countries. New ways of producing and organising production are spread to local economies through trade.

(ii) Increased Competition:

Trade stimulates competition, which makes the producers in all the countries to improve the quality of products and secure production at the least costs. The international competition promotes efficiency of all the industries in the trading countries.

(iii) Widening of Market:

International trade enlarges the size of market. It induces the producers to expand the scale of production, volume of investment and employment. Consequently, the production frontiers in the trading countries can continuously be expanded.

(iv) Increase in Investment:

As the demand for the home produced goods increases due to international trade, there is strong impetus to investment. The growth of export sector leads to the expansion of several allied ancillary industries creating more and more opportunities for investment. There is also substantial increase in foreign direct investments in the export sector of the economy.

(v) Efficient Use of Resources:

International trade paves the way for more efficient use of productive resources. The exploitation and use of the resources, previously considered economically non-viable, becomes economically viable due to increased demand in the foreign markets.

(vi) Stimulus to Growth:

Production for exports and increased imports of goods bring about a series of adjustments within the economic system that ultimately have stimulating effect upon the overall growth in the trading countries. Trade not only induces the growth of export industries, but also promotes the growth of infrastructure and services sector.

Ellsworth and Clark Leith summed up the dynamic gain from trade in these words, “Trade is a dynamic force that stimulates innovation. New ways of producing and organising production are spread to the local economy through trade and the competitive force of trade stimulates adoption of cost saving techniques. Trade also makes possible economical local production of many goods that would be prohibitive to produce locally.”