Political Economist

3. The Role of Foreign Trade in the Development of the Third World Economies

What is the role of foreign trade in the development of an economy? Does foreign trade increase the wealth of nations? Since Smith and Ricardo, these questions have been among the most critical issues in development economics. Most mainstream economists as well as international monetary organizations such as the IMF and World Bank claim that foreign trade will surely be beneficial to both countries which are engaged in international trade. However, ‘critical’ economists have pointed out that there will be ‘unequal exchange’ between the ‘center’ and ‘peripheral’ countries in the capitalist system, not to mention the huge income inequality among nations.

In order to understand these conflicting notions of the effect of international trade, it seems appropriate to introduce Ricardo’s viewpoint on this issue, because it was Ricardo who originally paved the way of thinking regarding foreign trade, like other economic issues.

In the first place, Ricardo deals with the significant role of foreign trade in the context of the critique of landlords’ unproductive consumption of the wealth which was produced by the employment of capital. According to him, productive capital, which is identified with the wealth of nations and the development of national economy, can be accumulated either by the increase of revenues or by the diminished expenditure of capital. If cheap corn or other subsistence for laborers were imported from other countries through foreign trade, the rents of the landlords and the wages of laborers would fall, and thus the profit of capital would naturally increase. This is why Ricardo argued that the Corn Law, which was preventing import of corn from foreign countries, should be abolished.

However, Ricardo goes one step further, contending that absolute mutual benefits will be achieved from foreign trade. He asserts that it will employ or distribute capital and labor effectively, and increase the variety, and the absolute amount of commodities which will be purchased by laborers. He believes that under the system of free commerce, each country naturally will devote its capital and labor to the employments that are most beneficial to itself, and this pursuit of individual advantage will result in the universal good of the whole.

Of course, Ricardo admits that there might be different production conditions, and thus the natural prices of particular commodities might vary from country to country. But this advocate of the labor theory of value does not pay attention to this kind of ‘unequal exchange.’ He alleges that the rule which has been regulating the relative value of commodities in one country does not “regulate the relative value of the commodities which are exchanged between two or more countries.”(Ricardo 1963: p.70)

Instead, Ricardo introduces the so-called ‘quantity theory of money,’ which is totally different from his previous labor theory of value. According to him, if two countries, e.g. England and Portugal, which have different production conditions, and thus have different prices of two commodities, started to exchange their relatively advantageous commodities, the money would flow from one country (England) into other country (Portugal) which has absolute advantage in both production sectors. This money inflow would, in the long run, raise the general price of all commodities in Portugal. On the other hand, the diminution of money in England would cause the general rise of commodity prices there. If these transactions continued, the increased price level in Portugal would result in its loss of the absolute advantage in both sectors, and simultaneously bring about the gain of absolute advantage in England. With this kind of description, Ricardo claims that even though their initial economic situations were different, both countries would gain benefits from foreign trade.

In this connection, modern orthodox neoclassical economists seem to share Ricardo’s notion when dealing with the issue. They claim that the open market and free trade under ‘globalization’ will bring about various economic opportunities for most new industrializing countries to catch up with the now developed capitalist countries. In order to propagate this kind of belief, they assume that every government in the developing countries engaging in foreign trade would coordinate its ‘factor endowments’ (capital, labor, and natural resources) to an optimal condition. If ‘production possibilities’ and ‘consumption preferences’ were the same in all countries regardless of the economic development stages, they claim that the only difference between them would be the different technology utilization. Thus, if the only problem were the technology, this technological divide would be easily overcome through the technological ‘spill-over effect’ derived from international trade.

However, this Ricardian idea of foreign trade does not explain the antagonistic capital and labor relations inherent in the capitalist production process. Even though we admit that foreign trade would give rise to a certain amount of profits or gains in developing countries, considering the fact that the trade is undertaken by the owner of capital, most of the benefit from international trade will belong to the capitalists, and will not contribute to the general increase of national wealth. Some may argue that the increase in the volume of national capital provides domestic workers with much more employment opportunities than before. However, this employment-generating (‘job creating’) effect has usually been accompanied by the central government’s macro-economic intervention in the resource allocation process, which certainly resulted in brutal oppression of the labor sector, and an authoritarian state-civil society relation as frequently shown under Third World military regimes. These kinds of military dictatorships have been typical phenomena in most Third World countries which became independent from imperialist colonization after the Second World War.

Secondly, neoclassical economists’ notion of the mutually beneficial effect of international trade fails to explain the problem of the high rate of foreign debt in Third World countries. They are suffering from chronic international debt directly originating from international trade. The Third World countries, which have traditionally been engaged in agriculture, have to export their raw materials such as crude oil, cotton and wood, and various kinds of primary products in order to earn international standard currency.

Sometimes, governments in the periphery of the world capitalist system have tried to borrow huge amounts of money from international monetary organizations such as the IMF (International Monetary Fund), World Bank and ADB (Asia Development Bank) in order to invest in domestic industrial sectors. However, the more they export their primary products, the more they have to face the cold economic reality, i.e., a chronic trade deficit and a huge economic development divide. Sometimes, they have adopted to issue their domestic currency much more than necessary as a last resort in the hope of paying foreign debt because if they maintained expensive domestic currency compared to the dollar or pound sterling, they could buy dollars or pounds sterling with the increased volume of their domestic currency. However, this policy has resulted in the hyper-inflation and low investment rates instead of reducing foreign debt. This circulatory movement between huge foreign debts and domestic financial catastrophe has been among the most typical aspects of most Latin American countries especially after the 1970s’ oil shock. Thus, unlike the rosy fantasy of neo-liberal globalization, the optimal endowment of production factors, namely the effective employment of capital and labor, and the specialization of industry, remains far remote from reality.

Finally, although foreign direct/indirect capital investment can provide developing countries with opportunities to modernize their management skills and to follow up new technologies, these processes can only be achieved at the huge expense of destroying national industries, undermining the potential of endogenous development of production and thus increasing the rate of the ‘industrial reserve army’ (high unemployment rate). Furthermore, recent experiences of financial crisis in Latin America and East Asian countries showed that drastic financial capital volatility seeking short-term arbitrage on the stock market and the international junk bond market would devastate national economies.

Even though there are a lot of theoretical debates on the real causes of cyclic financial crises in Latin America and Asian countries, and even though I admit that many non-Western countries are suffering from non-transparent corporate governance and underdeveloped financial market system, cyclic financial crises cannot be attributed to those problems. As most Western scholars and economists asserted until the Asian Financial Crisis of 1997-98, the secret of East Asian ‘economic miracle’ was mainly due to an effective bureaucratic resource allocation mechanism in both government and corporations. Then how and why can the same economic pattern or system be the fundamental reason for an economic miracle in the one hand, and be designated as the typical chronic mal-functional tradition in the corporate management on the other? In short, the real causes behind the financial crises in the Third World countries lie in the drastic financial capital flight seeking temporary interests and profit-gain. Thus, international trade, in this case unregulated financial capital movements, would not reduce the economic inequality among regions but generate chronic instability of economic ‘fundamentals.’

In conclusion, unlike the Ricardian perspectives, I believe that so-called ‘trade balance’ and ‘optimal allocation of resources’ cannot be achieved naturally from international trade. Foreign trade, in most cases, is accompanied by huge amount of trade deficit, unequal and uneven development, and domestic income inequality. Thus contrast to the dominant notion of neo-liberal orthodox economists, I maintain that we should still pay due attention to the proper role of government or other non-market systems such as NGOs in civil society in order to develop sustainable economic patterns and reduce prevailing poverty in the Third World countries. While doing so, it seems necessary for us to examine concrete economic developmental processes and strategies of individual countries in historical and comparative perspective.

References

Ha-Joon, Chang. Kicking Away the Ladder: Development Strategy in Historical

Perspective, Cambridge: Anthem Press, 2002

Ricardo, David. The Principles of Political Economy and Taxation, ed. by R.D. Irwin,

Illinois: Homewood Press, 1963, pp.67-76.

Shaikh, Anwar. “Foreign Trade and the Law of Value: Part Ⅰ.” Science and Society,

Fall 1979, pp.281-302.

----------------. “Foreign Trade and the Law of Value: Part Ⅱ.” Science and Society,

Spring 1980, pp.47-57.

Vernengo, Martias. “Globalization and endogenous fiscal crisis: theory and

experience of Latin America.” Nov. 11th 2004. Center for Economic Policy Analysis

conference paper.