The Inefficient Side of Trade between DEVELOPING and INDUSTRIALIZED countries

Talking about trade it is an old story, but not always.
-Danilo Avalos

The successful development of industrialized nations today has been possible—at least in most part—thanks to trade. Trade is the invisible tool that allows the voluntary exchange of goods and services for the benefit of the parties involved. In a micro or macro scale, trade in its different forms has allowed diversity and production improvement for the people/nations
that decided to play along the trade rules. This is the reason why trade was used extensively
since remote times and keeps in continuous development. However, after the globalization revolution, trade in its evolved form international trade has become a divided issue between the ones that favor free trade and international policies, and the ones that oppose it. But, if the more we trade, the more we benefit and both parties win. Then, why international trade is such a polemic issue? If trade is a solution for production improvement, why developing nations
involved in any sort of trade agreements are still under-producing and struggling?
There are many reasons for such a disparity in trade, but for reasons of this essay I will focus on the trade between developing and industrialized nations. During my studies of economic models,
I noticed a certain degree of inefficiency in the economic models regarding trade between developing and industrialized nations. The reason for this degree of inefficiency it’s found in the application of the model itself.
The mystery of why this brilliantly designed economic model is inefficient is because
its analogy was thought assuming its effects on both nations, and not in an impartial perspective from both sides of the story. Ronald H. Coase, explains this problem eloquently,
Economics, over the years, has become more and more abstract and divorced from events in the real world. Economists, by and large, do not study the workings of the actual economic system. They theorize about it.
As Ely Devons, an English economist, once said at a meeting, “If economists wished to study the horse, they wouldn’t go and look at horses. They’d sit in their studies and say to themselves, ‘What would I do if I were a horse?’’’ (De Soto, 15)

In the following model, I will explain why its inefficiency comes from its benevolent intent to improve productivity and its effect of free trade and tariffs on price taker nations, as most developing nations are, while failing to consider the developing nation’s environment.


Fig. 4.3. Carbaugh, Robert J., graphic, International Economics, 10ed. Ohio: 2005

It is true that with free trade the amount of autos available in the market of the price-taker nation increases, and that some domestic factories will close. It is also true that there is a nation gain in consumer surplus redistribution after the tariff is imposed. But, did the developing
nation really gained from this transaction? Most developing countries lack the capacity
of producing skilled labor products as machinery and equipment.
Thus, if the small nation is trying to develop its auto industry, opening the economy to free trade will kill its auto production. Thus, resources will be shifted to what the small nation is relatively efficient producing; primary products such as agriculture. Then, what’s wrong with producing potatoes instead? The answer goes with a question, what is wrong with relocating auto manufacturing employees to farms? Obviously, the answer is a bad allocation of labor resources and a destroyed industry. Let’s take Peru for example, a nation of Spanish-Inca culture, which its economic life turns around international trade. Before opening the economy to free trade, small companies as Carrocerias Morillas S.A. was promising a great future in the manufacturing
and assembling of chassis for vehicles. After free trade, a flood of used vehicles coming from the U.S., China, and Europe provided consumers with an incentive to stop domestic consumption
and buy a used imported vehicle. The results, as car assemblers were laid off; the number
of taxi drivers increased.

The Inability of Producing Capital

Another reason why international trade is not boosting the economies of developing nations
as it should hides in the dead capital accumulated by the poor. The poor citizens of developing
nations are currently excluded from the legal market and developing another market quickly, the informal market.
This problem causes a bottle neck effect in those economies. There are billions of dollars of invisible currency and kinetic potential for development in one side, and in the other side the legal system that would put these resources into production. However, they cannot get together due to the jargon of procedures and legal paperwork barriers in such nations. This is the bottle neck that allows only few of the million individuals trapped in the other side to prosper and incorporate in the legal society. De Soto studied the informal market of some developing
countries, concentrating in a measurable dead capital as real estate. He figured it out; there are approximately US $ 453.5 billions of real estate dead capital combined among Philippines, Peru, Haiti, and Egypt. These properties cannot generate capital because nobody can prove it owns it. They possess it, and maybe have a certificate of possession. But as a possessor of the land, the person living on that land cannot sell it or get a loan on it. They are trapped into a dead asset that cannot generate further capital.
In the Peruvian newspaper El Comercio, De Soto describes further problems caused by this inability of rightful ownership. After studying the effect of hurricane Katrina, and the tsunami
that impacted on properties on Indonesia, and Tailandia; De Soto explains the problem,
Cuando el agua se retiró de Nam Khem, Tailandia, un magnate bien conectado se lanzó a apropiarse de la valiosa primera fila de terrenos frente de playa. Los sobrevivientes de las 50 familias que durante una década habian ocupado la orilla protestaron, pero no tenian derechos de propiedad legalmente documentados que respaldaran sus reclamos. (El Comercio, 2)

I will fairly translate his explanation from Spanish to English,
When the water retired of Nam Khem, Thailand, a connected affluent tycoon went to take control of the valuable first row of beach land located in the front. The survivors of the 50 families who during one decade had occupied the border protested, but they didn’t have legally documented property rights that endorsed their reclamations. (El Comercio, 2)

If a nation had all its resources fully incorporated; it would be much easier for developing nations
to become more efficient. As an effect, the incorporation of the poor into the legal market will permit capital to flow freely as it should, commerce will prosper, as well as the modus vivendis of citizenry. But, how this solution reflects on international trade? With more capital among people more trade will be generated, and trade is good.

The International Trade Shock of Developing Economies

Before the United States get together into the great nation it is. There was a different
environment surrounding its economic future. There was resentment for the English crown laws that didn’t quite fit into the colonies reality. The abuse and corruption angered the Americans,
and a revolution gave the American colonies its independence.
As independent colonies, they realized that in order to fully prosper; they must diminish
the burdensome of interstate commerce. They were indeed a bunch of states competing against each other. So, they wanted to get together in order to efficiently boost the economies of all estates; and they did. Further on, the independent colonies became the United States of America. As the U.S. no longer they sell Texas cars or Idaho potatoes to the international community independently. They negotiate U.S. cars and equipment, U.S. agriculture products, and so on. U.S. infrastructure developed through years of continuous improvement that allowed commerce to freely flow within its boundaries, and as a result; a capital abundant economy smiles to most of its population.
The lesson I learned of this story it’s quite complex. In order to efficiently engage into international trade a nation must fully develop from the inside out, just as any corporation
does before pursuing international business. However, most of developing nations doesn’t have good infrastructure and its internal commerce doesn’t flow as quick as it should to be able to compete efficiently. The developing countries lack the tools for an efficient international trade, but they engaged into the global market without being able—in most cases—to supply efficiently its internal market. Once economies were open to free trade agreements, there was a shock caused by such aggressive competence and its industries were damaged intensively. I remember seeing flourished industries in a place called Parke Industrial in Trujillo, Peru. Now, those industries are nothing but empty buildings like a mausoleum to dead productivity. Seventeen years has passed and no other industries replaced the exiting industry and as a result there is no enough money to buy the cheap imported product. (see the figure)

The Importance of being Unimportant Revisited

There is an old concept going around the economic school that states that during trade between a big and small nation; the small nation takes more of the benefits. The statement is true indeed, but incomplete. A small nation is a price taker, and causes no major influence in the market. Then, how this disparity can be reduced? The answer flows in a synergetic perspective.
I will reintroduce the concept. In trade taking place between a big and small nation; the small nation take most of the benefits. However, when a big nation trade with small nations as a group; the benefits equalize. Thus, it is in the big nation advantage to promote trade among small nations. Hutchison P. Kenneth show the numbers, Trade seems to have had its predicted effect. Krugman dismisses this possibility by nothing that the organization for Economic Cooperation and Developments trade with the Third World amounts to approximately 1% of its GDP. But, since the United States alone has seen the development of the large wage gap, it is the U.S. trade figures that matter. In 1992, U.S. imports from developing countries were 3.8% of GDP, and over 10.9% of manufacturing value added. (Hutchison, 1)
Dealing with Trade Disparities and Learning from Mistakes Several leaders of developing nations have seen these disparities and inefficiencies as a heavy cost for its citizens, and as a result they had taken—in such a hurry—harmful decisions that now are haunting them. Remembering Peruvian experiences, the actual president Alan Garcia during the years 1985, in his first period, closed the doors abruptly to international trade and a hyperinflation followed,
“which reached 7,649 % in 1990”. (Wikipedia) Now as current president of Peru for its second time, Alan Garcia showed he learned from the past when he refused president’s Hugo Chavez invitation to fight against the “American Imperialism”. The current Bolivian’s president Evo Morales nationalized without remuneration industries belonging to foreign investors. There are several other examples I could cite to illustrate how getting into isolation could harm the fragile economies of developing nations, but what is the lesson learned from such decisions? It is a bad choice to get isolated from the international community and foreign investment. It would be like trying to cover the sun with one finger. Dissolving what has been gained through years of negotiation and trade should not be undone to solve internal problems. Developing nations must learn to deal with its weaknesses, and point key industries to push for development.
Just like Japan did after the war, Japanese government pointed its finger to specific industries
and helped them with industrial policies to become the efficient industries of today. “Japanese government’s targeted industries—such as semiconductors, steel, shipbuilding, and machine tools—are probably more competitive than they had been in the absence of government
assistance.” (Carbaugh, 83)
The next step for developing nations should be to join efforts in reducing poverty within its borders as well as the creation of a decentralized market on the internet which could provide easy entry and exit to small producers. Small producers are like babies, so nations must protect them until they are ready to stand for themselves into a real comparative advantage. South America is following the example of the European Union, and looking forward for unionizing.
This union could bring more opportunities for improvements among Latin American countries, and a more stable currency. A closer look into the economies of poor nations revealed severe problems to be attended. But the job did not end. There is a lot of stuff to be done, so more studies should be conducted to keep analyzing other factors affecting development of the crippled economies of developing nations. But, what do industrialized nations have to learn from this lesson? I believe, industrialized nations as well as private investors should learn to negotiate
efficiently with Third World governments, so both can benefit public and private sector.
Most of the times conflicts have come from the inability of negotiators to understand the demands of governments and its politic environment. Wells, Louis explains in his article on the Harvard Business Review, Many of the managers involved have found that they did not have the skills they needed to arrive at satisfactory agreements to cover the operation of new plants or to deal with request from governments for changes in the terms that govern projects already in place. (Wells, 1)
If trade is a both sided equation, it is imperative to reduce inefficiencies that are the source of the economic disparities in a world everybody lives in. Economic does not solve all the problems, but it surely can improve economic deficiencies. Third World countries can do better, and the benefits will be shared among future generations of people worldwide.

Works Cited

1.- De Soto, Hernando. The mystery of capital: why capitalism triumphs in the west and fails everywhere else. New York: Basic Books, 2000.
2.- Wells, Louis T. “Negotiating with Third World governments.” Harvard Business Review (2000).
3.- Carbaugh, Robert J., graphic, International Economics, 10ed. Ohio: 2005
4.- Hutchison, Kenneth P. “Creating the Agile Enterprise: Models,
Metrics and Pilots.” Harvard Business Review (1994)
5.- De Soto, Hernando. “¿Qué sucede si no puede demostrar que tenía una casa?.” El Comercio 22 Jan. 2006.


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