8. ECONOMICS AND SCALE

8.1 INTRODUCTION :

In economics, effects of the increase in the amount of an input on total output

holding all other inputs constant is sometimes studied. This study is called the Law

of Diminishing returns. This law states that less and less extra output is obtained

with the addition of an additional dose of an input while holding other inputs fixed.

In other words, the marginal product of each unit of input will decline as the

amount of that input increases, holding all other inputs constant.

But, what if all the inputs are increased proportionately? Well, this leads to the

introduction of the concept of “scale”.

8.2 MEANING :

“Scale” means “quantity” or “extent”. When scaling up or an increase in all inputs

takes place proportionately, there may be 3 outcomes:

i. Constant returns,

ii Increasing returns,

iii Decreasing returns.

These returns are called returns to scale, because these are the returns or (gains in

output) that occur when an increase in inputs or the quantity(scale) takes place.

Thus, we have following 3 types of returns:

1.Constant Returns to Scale:

It is a situation in which a change in all inputs leads to a proportional change in

output i.e. if factors like labour, demand, etc. are increased by 3 times, the output

increases by 3 times ,also. Handloom operations in a developing country or

haircutting in U.S.A. are prime examples.

2. Increasing returns to scale :

It is a situation in which a change in all inputs leads to a more-than proportional

increase in the level of output. For example, in engineering field many

manufacturing processes get modestly increasing returns to scale for plants upto the

largest size, i.e., an engineer may get more than 15% proportional increase in output

by increasing inputs by 15%.

3.Decreasing returns to scale :

It is a situation in which a proportional increase in all inputs leads to a less than

proportional increase in total output. It may happen due to increased costs of

management or the control. Prime examples are activities like growing wine

grapes, provision of clean drinking water to a city, electricity generation plants.

8.3 ECONOMIES OF SCALE

INTRODUCTION :

As a brief study of the concept of “SCALE” shows clearly, an increase in inputs

leads to an increase in output irrespective of it being just proportional, more than

proportional or less than proportional. This increase in output or production helps

reduce or minimise the cost of production by way of getting especially the fixed

costs spread over a larger number of units produced.

Mass production techniques require factories to be of certain minimum size. With

an increase in output, firms divide production into smaller steps, taking advantage

of specialization and division of labour. It also allows intensive use of specialized

capital equipment, automation and computerized designes and manufacturing to

do simple repetitive jobs easily and quickly. Once Economies of scale has been

achieved especially in terms of constant returns to scale, it can be maintained by

replicating or duplicating elsewhere the existing manufacturing processes

irrespective of the level of output.

8.4 TYPES:

Advantages of large scale production or economies of large scale production may

be grouped into 2 categories:-

(1) Internal Economics

(2) External Economics

8.5 INTERNAL ECONOMIES:

These are advantages of cost reduction of output obtained by a firm from its

own growth. These can further be subdivided as follows :

a) ECONOMIES OF INCREASED DIMENSION:

Increasing of the dimension of the input leads to cost reduction per unit of

output in terms of increased output, i.e. ,use of machine leads to a larger

production.

b) ECONOMIES OF LINKING PROCESSES:

Linking processes give advantages. In large scale production, all the

processes right from beginning to end are linked with each other under single

control, thereby reducing the cost, i.e. , in a Sugar factory, all the processes

right from thrashing to sugar production are linked together under one

control.

c) ECONOMIES OF SUPERIOR TECHNIQUES:

Large-scale production requires use of superior techniques which may be

costly. But these superior techniques help increase production on a large

scale, thereby minimising the possible costs.

d) ECONOMIES OF SPECIALISATION AND DIVISION OF LABOUR:

With increase in production, a firm has to use division of labour and

specialisation. It has to divide or allocate different steps of the specialised

work/job to different workers specialising in their areas of competence.

Machines are employed to do highly specialised job. All this causes large

production leading to lower costs.

1. MANAGERIAL ECONOMIES :

With increase in the size of the production unit, one individual is unable to

look after all the aspects. It leads to delegation of authority and division of

labour. It in turn leads to better management resulting into a higher

efficiency. Higher efficiency generates a larger production.

2. MARKETING ECONOMIES:

A production unit has to incur marketing costs for its finished products

and raw material inventory. With a large market for products, it has to

maintain big stocks of raw materials. This raw material gets available at

lower prices, because it is purchased in bulk or a big quantity. Low price

of raw material helps it to lower the cost of production. Plus, cost of

marketing (like by sample method) gets distributed over the total quantity

produced.

3. FINANCIAL ECONOMIES:

A large firm gets a goodwill in market, amongst financial institutions,

investors, stock exchanges. This all helps in mobilising required capital

from market at lower rates, which helps in increasing the production.

4. ECONOMIES OF RISK BEARING :

A large firm has the advantages of product and market diversification. It

can offer a mix of different products and in different spatial/geographical

markets. It reduces the risk of product failure. If one product fails, its

losses are compensated by profits in other products. Similarly, losses in

one sales territory are sustained by profits in other sales territories. With a

large production, costs of products goes down, too. This minimises the

risk of failure or uncertainty. This practice is called “Putting eggs in

different baskets” .

8.6 EXTERNAL ECONOMIES:

These advantages or the economies are those advantages or economies which a

production unit gets from outside due to concentration of other production units in

the same area.

These are further subdivided as follows:

i. ECONOMIES OF CONCENTRATION :

Concentration of production units in a area gives it a significant independent

industrial identity and standing causing setting up of different facilities in the area

like transportation, financial institutions, etc. This helps in large-scale production

by getting certain required inputs easily, cheaply and quickly like finances.

ii. ECONOMIES OF INFORMATION :

Production units may have advantages in an industrial cluster or belt like some

common platform to discuss their problems and share information.

This helps in large-scale production by getting quickly, easily, cheaply the

requisite information ,i.e. ,Maharatta Chamber of Commerce located at Pune in

Maharashtra is such a forum.

iii. ECONOMIES OF DISINTEGRATION:

Large-scale production is made possible also by getting advantages of

disintegration in terms of existence of supporting or ancillary units. This avoids

wasting time, money and energy on some activities which are done by these

ancillary units. The saved time, money and energy are devoted to increasing the

production.

DISECONOMIES OF LARGE SCALE PRODUCTION :

Large scale production may lead to following disadvantages :

1. Decreasing returns to scale due to need for management and supervision.

2. Problems of management and co-ordination.

3. Ineffective management of increasing product lines and market areas

geographically.

4. Cutting off from the realities of market, etc. due to lesser time available to higher

controlling authorities with an increasing size of the firm involving delegation of

authority and spread of the functions over a large geographical/technical area.

5. Isolation from the reality causes slow responses to changes, i.e., General Motors

lost its much market share to smaller firms in the 1970s oil Prices Rise Crisis.

8.7 SPATIAL VARIATION IN DEMAND

1. INTRODUCTION:

What do we mean by spatial variation in demand? It means that the demand

for a product changes with a change in geographical space or area or

distance. With increasing distance from a market place, the demand for a product

goes on decreasing because the price goes on increasing. Price increases because

of other costs like the increased cost of transporting the products from market area

to the outside areas or the increased cost of transportation involved in travelling

from a place outside to the market area. In simple words, this is the meaning of

the phrase “Spatial Variation in Demand.”

2. GEOGRAPHICAL PERSPECTIVE :

There are various theories to explain the reasons for location in space of various

industries. Some of these theories take demand as constant or unchanged. Such

theories consider the effects of variations in the cost of manufacturing due to

different spatial or geographical locations of factors of production like raw

materials, labour, technology, etc. These theories totally ignore effect of other

factors on the choice/decision /action of locating a particular industrial unit at a

particular geographical location like effect of demand by consumers, behaviors or

psychology of the consumer & so on. Alfred Waber’s theory of location of

manufacturing units (secondary production) is such a prime example.

So, to overcome the shortcomings of such theories considering only factors of

production, some economists/ geographers came up with the idea of location of

industries based on the demand for a particular product. Such theories have come

to be known as Maximum Revenue Theories, because of the tendency of

manufactures to locate their industrial units in such a strategic geographical

location as would maximise their revenue based on optimum demand by

consumers. Demand in turn depends on 3 important factors:

(1) Price of the product

(2) Transport costs

(3) The Possibility of the substitution.

3. EXAMPLE : H. Hotelling has given a classical example of the working of

maximum revenue theory. He tried to find the location that would give

maximum sales to 2 ice-cream sellers on a mile of beach as shown in the

following diagram:

2 Vendors of ice – cream selling the same brand of ice - cream at the same price

would have ideal location at two points A and B, because M divides the beach

into 2 equal parts. One half has point ‘A’ as its centre. The other half has point

‘B’ as its centre. Naturally, both vendors can equally cover all the customers on

A A1

M

B

Beach

the beach. Now, supposing one vendor moves to point A1, here he/she will attract

‘B’ customers also. To avoid this, ‘B’ may move towards M. This may lead to a

situation wherein both A & B stand back to back to retain customers from their

areas and to avoid their customers going to the other vendor. But , it always may

not work. For example, one vendor may be selling superior quality brand to get

which a customer may be willing to travel more distance despite the same prices.

Thus, a location of a manufacturing unit affects and is affected by the location of

other units. This is also called locational interdependence.

4. THEORY:

The best known general theory of location giving more importance to demand

was proposed by August Losch in 1940. He tried to explain the size and shape

of market areas within which a location would command the largest revenue. To

simplify the matters, he assumed :

(1) Isotropic surface ( a flat uniform plain ).

(2) Constant Supply of products.

(3) Decrease in demand for a product within increase in its price.

(4) Decrease in demand with increasing distance owing to increased

transportation costs from the production centre to the market centre.

(5) Existence of monopolistic competition instead of perfect competition unlike

A. Waber.

(6) Non – Existence of economic discriminations amongst population. Open and

uniform career building opportunities to all individuals.

(7) Even distribution of population & self-sufficiency of area in agricultural

production.

(8) Uniformity in tastes, knowledge, andtechnical skill of people.

(9) Uniformity and proportionality of transport costs in all directions.

(10) Limited Number of producers & Consumers.

(11) Satisfactory location to both producer and consumers.

(12) Equal serving of the entire area by factories .

(13) No entry of a new firm.

(14) Confirmity in the range and quantum of profit

A = No demand due to very high price

OP = Price at production point

PQ = Quantity sold at P

AQN = demand Curve

P = Production Point

(i)

(ii)

Demand Curve rotated around production point to get cone AQP

(Source: August Losch ,“ The Economics of Location” ,Yale University Press1954)

As the figure (i) shows, demand decreases with an increase in price. This leads to

demand curve AQN. Now , let us suppose that price increases due to increasing

transportation costs, its clear that at price A, the demand is zero. Now, let us assume that

this price A is at the maximum distance beyond which there is negative demand! In other

words, we can assume PA as the distance from production point P. Now ,lets rotate the

curve around production point P, the shape of the market will be circular and the size of

A

Q P

NO

O Quantity

Price

AO

Q

P

Sales = Volume of Cone

Market area boundary

Distance

the market will be volume of the cone AQP, i.e., 1/3πr2h (volume of a right circular cone)

as shown in Figure (ii).

Further, increasing competition on the plain causeS development of hexagonal market

areas to avoid overlap and under lap. Also, each market shrinks due to eating up of

revenue by competitors. Each product has different market area depending upon the

relative importance of transport costs in its price. Different patterns of market areas

develop. When such patterns are rotated around a common production center point, then

some of these patterns may coincide nearly, thereby giving indications of formation of

points of maximum demand. This in turn should develop as concentrations of industry.

CRITICISM :

Positive:

1) It has successfully explained the effect of demand on industrial locations.

2) It led to further theorising in the field of locational analysis of industries in terms

of demand.

3) Its failure to consider other factors led to emergence of theories like “Spatial

Margins to profitability theory “by D. M. Smith, “Sub – Optimal locations

theories”,Optimiser theory and satisfier theories.

4) He was first person to give importance to influence of demand on industrial

location.

5) Right & correct emphasis upon the role of competition.

6) Simple and easily applicable calculations.

7) Philosophical contributions on the motive of entrepreneur’s role.

8) Introduction of Equilibrium concept.

9) More précised nature of the concept of “profit maximization” in sharp contrast

least cost” concept of A.Waber.

How Market Areas become Hexagonal

(Source : August Losch, “The Economic of Location, , Yales University Press, 1954)

Negative:

1) This theory is too abstract in nature.

2) It does not consider problems of locational interdependence.

3) It gives too much importance to one aspect, that is the demand just as had been

given to supply by Alfred Waber.

4) It fails to consider other factors like human psychology &human behavior .

5) It generalises human behavior in sharp contrast to postmodern geographical theme

of “ heterogeneity, particularity and uniqueness.”

6) It is not universally applicable, when checked against reality.

7) It is too simplified a model of reality. It rarely occurs in actuality.

8) Its more of an intellectual exercise, because his assumptions are hardly present in

the real / decision making world.

9) Ignorance of “Political decision role “ in industrial location.

1 2 3 4

Firms Operate with Circular Market Areas

Competition increases to serve all the potential market

To avoid overlap of Circles and to serve all areas, the market areas become hexagonal

Final pattern of market areas

10) Neglect of factors like variation in the cost of raw materials and labour wages

rate.

11) Arbitrary dichotomy of the role of agriculture and industry.

12) Agriculture may show a play of the abstract and optimum situation, but industrial

location is a far more complex matter. This theory may be more practical in

agriculture rather than in industry.

13) Demand curve must be rotated around production point O, where there is

maximum demand ON. By taking P Production point , he has ignored the

maximum production at point O. The actual size of the market should be the

volume of the right circular cone ANO and not the volume of the right circular

cone AQP!

OTHER IMPORTANT THEORIES:

1. TRANSPORT COST THEORY OF EDGAR M. HOOVER:

It is an extension of A. Waber’s theory. It emphasizes on the role of 4 costs:

Procurement, production, distribution, transport.

2. BEHAVIONRAL THEORY:

It places emphasis on the role of individual behavior or entrepreneurial decisions

as chief determinants of industrial location. Allan Pred’s Matrix theory is the

most well known behavioral theory.

3. MARKET AREAS THEORY:

It emphasizes more on the competition with others as chief determinant of

industrial location . Frank Fetter is the most well known theorist of this

approach.

4. INTEGRAL THEORY:

It emphasizes on the integrated role of both factors supply and demand. Green

hut & Walter Isard are the well-known theorists of this approach.

9. ECONOMIC DEVELOPMENT

9.1 CLASSIFICATION OF COUNTRIES

Countries have variously been classified in economic geography by taking into consideration

different criteria.

Here, we follow the classifications given by T.A. Hartshorne & J. W. Alexander in their

book “Economic geography” and the U.N.O.

1. CLASSIFICATION BY HARTSHORNE & ALEXANDER :

(A) FIRST WORLD COUNTRIES:

Highly developed countries of North American continent and Europe like U.S.A. ,

England excluding the communist block are called first world countries / Nations.

(B) SECOND WORLD COUNTRIES:

Countries having centrally planned economies like China and the erstwhile USSR,

besides other communist countries are called second world countries/ nations.

(C) THIRD WORLD COUNTRIES:

Countries which are developing areas lacking in a modern urban – industrial

structure are generally known as third world countries/Nations. For example, Kenya

,Pakistan etc.

2. CLASSIFICATION BY UNITED NATIONS :

To quote Asha A Bhende and Tara Kanitkar (in “Principles of Population

Studies”) ,

“The United Nations prefers to designate the economically advanced countries as

“more developed” and the economically backward countries as “less developed

countriess.”

Accordingly, following is the classification given by the U.N.O:

a) “More Developed” Countries

1. North America

2. Japan

3. Europe

4. Australia & New Zealand

5. Temperate South America

b) “Less Developed” Countries

All other countries other than more developed countries mentioned above fall

into this category.

9.2 MEASURES OF ECONOMIC DEVELOPMENT

Economic development of a country/region can be measured in various terms called “Measures” .

These measure or indicators broadly include factors like population, gross domestic

product, Adult literacy and life expectancy.

Economically advanced countries have a low population growth rate, low birth and death rates,

high life expectancy and literacy rates besides a higher standard of living. On the other hand ,

less economically developed countries have still not reached the post demographic transition

population growth and these countries have a relatively higher rate of mortality, low life

expectancy ,low literacy and poor standards of living.

Output per worker is indicative of economic development,also. For example, since 1870,

in 16 high income category countries like USA, West European nations , Japan &

Australia, the output per worker grew by 2.4 % per annum ( a factor of 16 over 120

years) closely moving with increasing standard of living.

Following chart, quoted from “Economics” by Samuelson Nordhaus, illustrates it

amply:

Average growth rate (%)

Period GDP GDP/Person –Hours Labour Force Total Hours worked

1870 – 1913 2.5 1.6 1.2 0.9

1913 – 1950 1.9 1.8 0.8 0.1

1950 – 1973 4.9 4.5 1.0 0.3

1973 – 1990 2.5 2.7 1.1 - 0.1

WORLD DEVELOPMENT REPORT 1997 (world bank ,WASHINGTON 1997):

Nation states or countries are grouped by the world bank into 4 main groups based upon

their per capita incomes. Each includes important indicators of economic development

like , Adult illiteracy and life expectancy.

GDP

Total Per Capita Per Capita

Country

/Group/

ECONOMIE

S

Population

In 1995

( in millions) Total

1995

($ billion)

Level 1995

($ billion)

Growth

(1985-95)

% per year

Adult

Illiterac

y

1995

( %)

Life

Expectancy

at birth

(Years)

Low income

China/India

others

2130

1050

1035

317

499

290

6.1

-1.4

32

46

66

56

LOWER

MIDDLE

INCOME

ECONOMIE

S

(Philippines,

Thailand)

1153

2026

1670

-1.3

20

67

UPPER

MIDDLE

INCOME

ECONOMIE

S

(Brazil,

Malaysia

etc.)

438

1982

4260

0.2

14

69

HIGH

INCOME

GROUP

ECONOMIE

S

(USA, Japan,

France, etc.)

902

22486

32039

1.9

<5

77

Broadly speaking aforesaid discussion is enough to understand the measures of economic

development. Of course, one may enumerate a large number of other variables or

indicators, too as follows:

1. Gross national product/Net National product

2. Per Capita income

3. Per Capita Consumption of iron & steel

4. Population growth rate

5. Infant mortality rate

6. Birth rate

7. Death rate

8. Literacy rate

9. Occupational structures

a) Commercial activities – Developed countries

b) Substantive activities – Less Developed countries

10. Technological Levels

11. Migration trends

12. Religious influences

13. Food availability (malnutrition, etc.)

14. Health (good, poor, etc.)

15. Use of family planning devices

16. Proportion of Urban population

17. International trade.

For example, in 1995, the per capita GNP of USA was $ 26980, Germany $27,510 ,India-

$340, Bangladesh - $ 240, Ethiopia - $ 100.

FOLLOWING INFORMATION AMPLY ILLUSTRATES VARIOUS MEASURES

OF ECONOMIC DEVELOPMENT:

(A) World as a whole had a population of 5840 million in mid 1997, with more

developed countries having a share of 1175 million and the less developed

countries a share of 4666 millions (including china). World in mid 1997 had a

birth rate of 24, death rate of 9, an annual natural increase rate of 1.5 % in

population, population doubling time of 47 years, infant mortality rate of 59, total

fertility rate of 3.0 , life expectancy of 64 years (males) 68 years (females), 32 %

below 15 years and 7 % above 65 years of age population, 43 % urban

population, 56 % of married women using contraception of all kinds and only 50

% of married women using modern methods of contraception, and world per

capita GNP (1995) of US $ 4920.

(B) Comparatively, More developed countries had a population of 1175 millions,

Birth rate of 11 per 1000 population, death rate of 10 per 1000 population, 0.1 %

of annual natural increase in population, 564 years of population doubling time,

infant mortality rate of 9 per 1000 population, total fertility rate of 1.6 % , 20 %

of < 15 years and 14 % of > 65 years of age population , life expectancy at birth

of 71 years for males and 78 year for females, 74 % of population as urban, 66 %

of married women using contraception of all methods and only 60 % of married

women using contraception of only modern methods, and per capita GNP of US $

19,310 ( as in 1995).

(C) Less developed countries ( including China) had a mid 1997 population of 4666

million, a birth rate of 27 pr 1000 population , a death rate of 9 per 1000

population , an annual increase of 1.8% in population growth, a population

doubling time of 38 years, infant mortality rate of 64 per 1000 population , total

fertility rate of 3.4 % , 35% of < 15 years and 5 % of above 65 years population,

life expectancy at birth of 62 years for males and 65 yeas for females, 36 % of

population as urban, 54 % of the married women using contraceptives of all kinds

and only 49 % of married women using modern methods of contraceptives, and a

per capita GNP of US$ 11,20 (as in 1995)

[Source: 1997 World Population Data Sheet, Population, Reference Bureau

Washington D.C.]

9.3 GEOGRAPHICAL ACCOUNT OF W.ROSTOW’S NON-SPATIAL MODEL

1. INTRODUCTION:

The non-spatial model formulated by W. Rostow in 1955 identifies five

stages of economic development. This model was formulated to explain varying

economic development without reference to spatial (geographical) aspect. It is

called The Rostow Model of economic development ,also.

2. PRINCIPLE:

Economic development takes place in five stages, with take-off into self

sustaining growth coming about as one sector of the economy develops rapidly

and encourages the growth of other sectors.This way , the whole region develops.

The Classical Economic theory is the basis of this model. This theory assumes

existence of uniform costs, perfect competition, perfect mobility of capital and

labour in a given region. Further , it assumes that these assumed conditions shall

produce equilibrating forces to maintain inter-regional equality.

For example, excess labour migrate out from a region which has no employment

opportunities- thus, the given region loses labour to outside region-but, low labour

costs in the given region attracts new industry which helps develop economically

the given region – therefore, inter-regional equality is maintained.

3. EXAMPLES:

The great Industrial Revolution in U.K. was led by the cotton industry, which in

turn encouraged the textile machinery industry, transport improvements, service

industries in the expanding towns and so on.

4. CRITICISM:

i. Positive:

a) It is the best-known non-spatial model formulated to explain the

process of economic development.

b) It is easy to understand.

ii. Negative:

a) The model is too simplistic overlooking complex spatial variation.

b) It does not specify time required to move from one stage to the next.

c) It does not tell any mechanism to find out the stage in which a

particular economy is.

d) Its not necessary that an economy has to go through the sequence

suggested by W.Rostow.

e) It is totally incorrect to assume existence of uniform costs, perfect

competition, perfect mobility of capital and labour in a given region.

Further , it is incorrect to assume that these assumed conditions shall

produce equilibrating forces to maintain inter-regional equality.

f) Regional inequalities is a global feature.

g) To quote KNOWLES & WAREING ,

“ If economic development affects the structure of the economy by

producing leading sectors, it may be inferred from Rostow Model that

the distribution of economic activity will be similarly affected, with

the emergence of leading regions.”

For example, in 19th century Britain, the leading sectors of the economy

such as cotton and iron were certainly characterised by regional

specialisation and concentration.

h) It is suggested by many economists that economic development

actually encourages regional inequalities.

i) Costs are never uniform, competition is never perfect, and capital and

labour are not perfectly mobile. These forces don’t maintain inter

regional equality.

The ages of high mass Consumption

5

The drive to Maturity

4

Take - Off 3

The Preconditions for take - off

2

The Traditional Society

1

Decades

THE ROSTOW MODEL OF ECONOMIC DEVELOPMENT

1.

9.4 G.MYRDAL’S SPATIAL MODEL OF ECONOMIC

DEVELOPMENT

INTRODUCTION :

The most important model attempting to explain spatial variations in economic prosperity

by G. Myrdal in 1956 is called Myrdal’s model of economic development.This is a

spatial model or a geographical model.

2. PRINCIPLE :

Contrary to classical theory, economic market forces increase regional differences rather

than decrease them. Two associated processes cause unequal growth. These are :

i. Cumulative Causation

ii. Spatial Interaction

i. Cumulative Causation: Economic development takes place in a region initially

because of the natural advantages offered by it, like raw materials, and presence

of power. Then, once such a region moves forward and ahead of others, a process

of cumulative causation takes place, as acquired advantages are developed to

reinforce the status of the region and ensure that it continues to grow and stay

ahead of others. One development leads to another development.

ii. Spatial Interaction: It occurs with movement of labour, capital and commodities

into the growing region. Such growth produces a backwash effect in the other

regions in that the other regions lose skilled labour and capital to the growth

region and their markets are flooded with goods, thereby preventing local

development.

Consequently, growing and stagnating regions are born. On the other hand, with the

expansion of economy, the benefits of growth begin to affect all regions and the spread

effect of an expanding economy may encourage the process of cumulative causation to

occur and self – sustaining growth to take place in other regions.

Provision of better infrastructure for population and industrial development – roads, factory, sites, public utilities, etc.

Development of external economies for former’s development

Development of ancilliary industry to supply former with inputs, etc.

Expansion of local government funds through increased local tax yield.

Expansion of general wealth of Community

Expansion of service Industries and others serving local market.

Attraction of capital and enterprise to exploit expanding demands for locally produced goods and services.

Increase in local pool of trained industrial labour.

Expansion of local employment and population

Location of new Industry

3. STAGES OF REGIONAL DIFFERENTIATION:

A region passes through 3 stages of regional differentiation in the Myrdal Model :

i. Pre-industrial : There are few regional inequalities.

iii. Second : Great inequalities are produced by cumulative causation and its

backwash effect as the economy “takes off” and expands rapidly.

ii. Third : The spread effect of growth operates to reduce regional

imbalances or differences.

4. CRITICISM :

A. Positive :

a. It successfully explains the development processes in the underdeveloped countries.

B. Negative :

1. To quote KNOWLES AND WAREING “…the forces

producing regional inequalities are much more powerful than

the spread effects operating to reduce them” .

For example, despite government action ,regional inequality

persists in U.K.

2. It does not fully explain the process of development in more developed

economies for which other theories like export base theory, regional

multiplier (input-output analysis), growth poles ,etc. have been advanced.

10. INTERNATIONAL TRADE

10.1 INTRODUCTION

1.) MEANING :

The trade carried on an international level is called international trade.It can be

bilateral(BETWEEN TWO COUNTRIES) or multilateral(AMONGST MORE THAN

TWO COUNTRIES).

2.) BACKGROUND :

International trade has been going on since ancient times. For example, condiments and

pepper were exported from India to cold temperature European countries to make the

meat tasty there. Similarly, silk route was famous for trade between countries of west and

the Far East china. Presently, big multinational companies are involved in international

trade besides local national players.

Examples : Bilateral Trade

India and china – US $ 3 billion (2000 A.D.)

Foreign Exchange Reserves

India reported foreign exchange reserves of US $ 50 billion (2002 A.D.)

The value of goods in world trade since 1938 (Exports in million of US $)

Economics 1938 1950 1960 1970 1980

Developed market 15,100 37,026 85,845 224,908 1,270,323

Developing market 6,000 19,163 27,067 55,684 5,40,353

OPEC 1,000 4,014 7,792 18,032 296,376

Centrally planned 1,600 4,596 15,363 33,2786 177,329

World Total 22,700 60,785 128,275 313,868 1,988,005

SOURCE : UN STATISTICAL YEARBOOK

CERTAIN FACTS AND FIGURES ABOUT

INTERNATIONAL TRADE/GLOBAL ECONOMY:

1. In a single day all over the world, 40%

of the goods and services produced is

traded and nearly 1.5 trillion US $ gets

exchanged in the world exchange

markets.

2. World trade stood at US $ 3.4 trillion

in 1999 and 6.2 trillion in 2000.

3. Value of world output was US $ 24.4

trillion in 1994 and 31.4 trillion in

2000(Source:IMF).

4. Following table gives trend in growth

of the world output:

PERIOD AVERAGE VALUE (US $ trillion ) GROWTH RATE

1983-1992 18 3.4 %

1993-2000 29.6 3.6 %

5. USA was the largest importer and

exporte with imports and exports

worth $ 1060 billion and $ 695 billion .

15 member EU had exports worth US $

799 billion , but its imports were of less

value than USA’s .China ranked 10th in

exports.India ranked 30th in

exports.Indian exports were primarily

directed to USA(21%) and EU(20-

25%).Figures given here are for the

year 2000.

6. World trade grew at the rate of 5.4%

in 1980s and 7.5% in 1990s. As per

W.T.O. , this growth was 12.5% in the

year 2000.

7. Increase in the world trade was more

than the increase in world GDP at the

rate of 5.4% in 1980s and 7.5% in

1990s.

8. Indian exports grew from US $ 32366

million in 2000 (April-Dec.) to US $

32572 million in 2001 ( April-

Dec.).Indian imports rose from US $

38242 million in 2000( April-Dec.) to(

April-Dec.) US $ 38362 million in 2001(

April-Dec.).Thus,exports showed a

growth of 0.64% and imports

0.31%.During the same period , Indian

IT software and services exports rose

by 25% in value.

9. Export of cashew held the third

position with a contribution of 0.93%

(Rs.1882.23 crore)of the total export

earnings of India in 2000-01.

10. Bilateral trade between India and China

during January-Novembar period of 2001

amounted to 3.27 billion US $ ,up 26% over

the same period in 2000.Indian exports to

China during 2001 was 1.56 billion dollars

and China’s exports to India was 1.71 billion

dollars .

11. Following table gives the yearwise value in

indian rupees (crores) of Indian Imports and

Exports since 1950-51:

Year imports exports total value balance of trade

1950-51 581,17 606,81 1187,98 + 25,64

1960-61 1121,62 642,39 1764,01 - 479,23

1970-71 1634,20 1535,16 3169,36 - 99,04

1980-81 12,549,15 6710,71 19,259,86 - 5838,44

1986-87 20,083,53 12,566,62 32,650,15 - 7516,91

1990-91

2000-01

As the above table shows, Indian imports and exports grew by

27 times in value from 1950-51 to 1986-87. However, imports

grew by 34 times and exports by 20 times during this period.

India had a trade deficit of 100 crore rupees in 1970-71 and

7516 crore rupees in 1986-87.Such unfavourable trade is a

cause of concern to India.

Indian exported mainly raw materials and imported

manufactured products before 1951. But, after independence,

this trend has got changed.The following 6 commodities

formed main items exported from India in 1951:

1. Cotton thread and

apparels.

2. Jute products.

3. Tea.

4. Vegetable oil and

products made from it.

5. Leather and skins.

6. Tobacco and products

made from it.

The following 6 new commodities formed main items exported

from India in 1983-84,1984-85,1985-86:

1.Precious jems and jewellery.

2.Cotton apparels , readymade garments.

3.Tea.

4.Machines and transport equipments.

5.Iron ore.

6.Leather, leather products and shoes.

TREND: Since 1980s , Indian trade has shown a tremendous change

in its structure.Now, the items mainly exported are no more raw

materials or semi-manufactured products. The products being exported

are mainly those which have value addition through excellent Indian

craftsmanship and skill ,i.e.,jems and jewellery, readymade cotton

garments, leather products and shoes,etc.Other main export items are:

ores and engineering products.India imports certain items like Cashew

and Jems and exports these items after increasing their value through

excellent Indian craftsmanship and skill .Thus, Indian exports consist of

services ,also. Recently, Information Technology exports has become a

major item of Indian exports.

India saw a growth of 20% in exports in 2000-2001.The value of Indian

exports was 44.1 billion US dollars in 2000-2001 and 36.8 billion US

dollars in 1999-2001. The value of indian imports was 49.8 billion US

dollars in 2000-2001.The Indian imports were higher due to higher

priced oil imports ,i.e., 15.6 billion US dollars against 9.6 billion US

dollars in 1999-2000.It was estimated to rise to 18-19 billion US dollars

in 2001-2002 due to growing demand for petroleum products and rising

level of dependence on crude oil imports to nearly 70% of the nation’s

requirements.Non-oil imports in 2000-2001 had a much lower growth.

The Indian trade deficit came down to 5.8 billion US dollars in 2000-

2001 from the 12.9 billion Us dollars in 1999-2000.

The Commerce Ministry had set an export groth target of 18% for

2001-2002.But, this target could not be achieved due to the overall

depressed global growth in 2001-2002.

12. Following table gives the structure of world

economy in the year 2000:

ECONOMIES % SHARE IN GLOBAL

OUTPUT TRADE

1.DEVELOPED 57.1 75.7

2.DEVELOPING 37.0 20.0

3.CENTRALLY PLANNED 5.9 4.3

WORLD 100.0 100.0

4. USA $ 6 other big nations 45.4 47.7

5.Asia 21.6 9.2

6.China 11.6 3.7

7.India 4.6 0.8

1. Global economy witnessed 4.8% growth in

2000 and it weakened in 2001 mainly due to a

slow down of USA’s economy which grew at

the rate of 1-2% in the first half 2001 against

5% in 2000.The USA SLOW DOWN hit

several East and South East Asian countries

dependent on the American market for their

exports of electronics and computer

products.In a 10 years’ period , the year 2000

was the peak of growth.Industrial countries

had an average growth of 4.1% and developing

countries 5.8% during this period.IMF

projected a global economic growth of 3.2% in

2001 in the hope of USA economic recovery in

the second half of 2001 and emerging of Japan

out of its longest recessionary period.Though

there have been many cuts in interest rates by

US Federal Reserve Bank , yet 11th September ,

2001 event of collapsing of the World Trade

Centres in Newyork by terrorists adversely

affected the whole global economy including

the American economy.The only beneficiary

was Pakistani economy which saw huge inflow

of American Aid meant to wipe out AFGHANI

TALIBANS , besides remittances by Pakistanis

settled abroad anxious to avoid getting their

financial assets frozen due to any suspicion on

them by USA for their any possible role in the

11th September 2001 Tragedy! “The World

Economic Situation and Prospects for 2002”

report released by the United Nations says that

the terrorist attacks in New York and

Washington caused the lowest growth in Gross

World Product ( GDP ) in a decade.The GWP

fell from decade high of 4% in 2000 to 1.3% in

2001.The report foresees a gradual recovery in

2002 with GWP expected to grow by 1.5% and

world trade by 3%.It means limited growth in

2002 with no growth in per capita world output

for 2 consecutive years.

ADVANTAGES OF INTERNATIONAL TRADE :

1. John Stuart Mill says ,“ the benefit of international trade – a more efficient

employment of the productive forces of the world. ”

2. Mc Kinsey Study (Mc Kinsey Global Institute) 1990 identified following benefits

a. Competitiveness leads to increased real income.

b. Globalization increases productivity by improvement through introduction of

leading cutting edge technologies and stimulating competition.

c. High productivity leads to high living standards in terms of trade, capital, and ideas

from advanced countries and consequent competition.

d. The so called much hyped economies of scale/manufacturing techniques and

workers’ skill level/education are of little significance. Large differences exist

within firms in the same industry.

3.) CAUSE OF INTERNATIONAL TRADE :

International trade is carried on due to demand and supply factors involved in

goods and services produced, exchanged and consumed with reference to spatial

aspect on the earth. Countries deficit in certain goods and services import them.

Simultaneously, countries having surplus export them. This is the basic primary

cause generating international trade. However, there are other compelling reasons,

too like the need to earn foreign exchange or repay for goods and services purchased

from other countries.

10.2 BASIC CONCEPTS

1. TRADE :

Exchange of goods, services or information.

2. TRADE BALANCE :

The part of a nation’s balance of payments that deals with merchandise (or

visible) imports or exports, including such items as foodstuffs, capital goods,

and automobiles.

3. BALANCE ON TRADE ACCOUNT :

When services and other current items are included in a nation’s balance of

payments, this measures the balance on trade account.

4. BALANCE OF INTERNATONAL PAYMENTS :

A statement showing all of a nation’s transactions with the rest of the world

for a given period. It includes purchases and sales of goods and services,

gifts, government transactions, and capital movements.

5. BARTER :

The direct exchange of one good for another without using anything as

money or as a medium of exchange.

6. OPEN ECONOMY :

An economy that engages in international trade is called an open economy.

7. FOREIGN EXCHANGE RATE :

It is the price of one currency in terms of another currency.

8. FOREIGN EXCHANE MARKET :

A market in which currencies of different countries are traded and foreign

exchange rates are determined.

9. FLEXIBLE EXCHANGE RATES :

A system when exchange rates are completely flexible and move purely

under the influence of supply and demand.

10. FIXED EXCHANGE RATES :

A system when governments specify the rate at which their currency will be

converted into other currencies.

11. DEPRECIATION :

A fall in the price of one currency in terms of one or all other currencies.

12. APPRECIATION :

A rise in the price of a currency in terms of another currency.

13. DEVALUATION :

A situation in which a country has officially set or, “pegged” its exchange

rate relative to one or more other currencies and the pegged rate or parity is

changed by lowering the price of the currency.

14. REVALUATION :

When the pegged rate or parity is changed by raising the price of the

currency.

15. CREDIT :

If a transaction earns foreign exchange currency for the country, it is called a

credit and is recorded as a plus item.

16. DEBIT :

If a transaction makes a nation loose foreign exchange currency, it is called a

Debit and is recorded as a negative item.

17. BILATERAL TRADE :

Trade between two countries which is generally unbalanced.

18. MULTILATERAL TRADE :

Trade amongst more than two countries, which is generally beneficial.

19. TARIFF :

It is a tax levied on imports.

20. QUOTA :

It is a limit on the quantity of imports.

21. PROHIBITIVE TARIFF :

A tariff so high that it chokes off all imports.

22. NON PROHIBITIVE TARIFF :

A tariff which is so low as to injure but not kill off trade.

23.TERMS OF TRADE: -

It is the ratio of export prices to import prices.

24. OPTIMAL TARIFF :-

The set of tariffs that maximizes domestic real incomes is called the optimal

tariff.

25. PROTECTIONISM :-

Any policy adopted by a country to protect domestic industries against

competition from import (most commonly, a tariff or quota imposed on such

imports ).

26 ECONOMIES OF SCALE :-

Increase in productivity, or decreases in average cost of production, that

arises from increasing all factors of production in the same proportion.

27. MONETARY UNION :-

Adoption of a common currency by a groups of nations ,i.e.,,”Euro” by

European countries under the maastricht Treaty of 1991.

28. GLOBALIZATION :-

Exposure of a region/country to competition with the world leader in a

particular industry.

29. COMPETITIVENESS :-

The extent to which a nation’s goods can compete in the world market place.

30. PRODUCTIVITY :-

It is the output per unit of input.

31. REAL NET EXPORTS :-

The quantity of exports minus the quantity of imports, both measured in

constant prices.

32. OVERVALUED CURRENCY :-

A currency whose value is high relative to its long run or sustainable level.

33. IMPORT :-

Bringing in of a product, services or information on payment from a foreign

country.

34. EXPORT :-

Selling to another country on payment products, services or information.

35. FAVOURABLE TRADE :-

When Exports are more than imports.

36. UNFAVOURABLE TRADE :-

When Exports are less than imports.

10.3 FACTORS INFLUENCING THE INTERNATIONAL TRADE :

A combination of different GEOGRAPHICAL AND NON- GEOGRAPHICAL

factors Influence international trade. These factors may act as encouraging

or discouraging one from time to time and may vary in degree of

importance spatially.GEOGRAPHICAL FACTORS SHOW PRIMACY IN THE

SHORT RUN.HOWEVER, NON-GEOGRAPHICAL FACTORS BECOME MOST

IMPORTANT IN THE LONG RUN.

International trade is totally dependent on transport Network or systems. Without

transportation , no movement or flow of goods and services can take place. 2 important

theories/ models have been advanced to explain this flow of goods and services system or

transport network:

1. FLOW THEORY :

E.L.Ullman has identified 3 basic factors influencing interaction between

regions: Complementarily, intervening opportunity and transferability.

(a) COMPLIMENTARITY :

First, there has to be a demand in one region that can be met from other region.

Secondly, the area of demand must be able to pay for the supply of goods and services to

generate a two- way movement of the same. This demand and supply region develops a

complimentary relationship. Earlier, tropical regions would supply primary goods to

temperate regions in exchange for manufactured goods. Regional specialization

strengthens complimentarity. Of course, buyers and sellers may have alternative options.

So, it’s just one of the factors.

(b) INTERVENING OPPORTUNITIES :

With the development of synthetic rubber, interaction between tropics and temperate

regions has decreased due to decrease in demand for natural rubber. Likewise, depletion

of lake superior iron ore deposits has resulted in the use of South American and African

ores in the U.S.A. Thus, the principle of intervening opportunity in economic context,

determines/influences international trade.

(c) TRANSFERABILITY :

Interaction between complimentary regions can take place only if the

products/services/informations are transferable. Transferability decreases as economic

distance increases and any intervening opportunity will be taken , if it reduces this

distance. Transferability changes from time to time since intervening opportunity and

economic distance are not constants.

“ The development of transport systems must be seen as a process in which

complementarity operating to encourage movement between regions, is balanced

against intervening opportunity and transferability, which operate to discourage

movement.”

2. GRAVITY MODEL :

Applying gravity model, one may conclude that the amount of economic

interaction/international trade depends on the product of the economic size (purchasing

power) of the two regions divided by the result of the economic distance between them.

Or in other words, it’s the operation of distance decay theory, meaning that the

interaction decreases with increasing economic distance.

3. NETWORK REVOLUTION :

The network revolution that began in the great age of discovery in Europe

influenced international trade. Europeans were originally marginalised due to fall of

Constantinople to the Turks in 1453 and the venetian monopoly of eastern trade.

However ,during the renaissance period, revival of Greek ideas of a spherical earth,

navigational aides like compass, improvements in ship design encouraged the search

for alternative routes to bypass the Mediterranean. Discovery of India in 1498,

America in 1492, China in 1513 through sea and Magellan’s expedition around the

world in 1519-22 changed Europe’s position from relative isolation to being centre

of the world trade.

New patterns of trade emerged. Trade Winds helped trade leading to development

of a triangular or quadrangular Atlantic trade in manufacturing goods from Britain

to West Africa in exchange for slaves to the West Indies or American Colonies in

Exchange for sugar, rum, Cotton & Tobacco back to Britain. Cargo changed,also .

Tea, Sugar & Tobacco entered World Trade, yet it was essentially in high value low

bulk goods.

4. THE CARGO REVOLUTION:

The process of industrialization using steam power and mechanical methods of

manufacturing to increase production, creating a demand for large quantities of

raw materials and a supply of manufactured goods caused cargo revolution leading

to the large scale transfer of bulk cargoes. Increased complimentarity ,growing

population ,increased urbanization ,high demand for food staffs leading to new

methods of finance like extension of credit by the new commercial banks, free trade

philosophy ,improved methods of transport, settling of Europeans in Americas and

Australia, creating new sources of supply and demand ; the scramble for Africa in later

19th century led to a search for materials and market. All this influenced nature and

structure of World Trade.

5. WARS AND ECONOMIC SCENARIOS:

Wars and prevailing economic scenario influenced world ,too, i.e, two world wars and the

great depression of the 1930’s have greatly changed the structure and direction of world

trade especially since 1945.

6. POPULATION GROWTH :-

Growth in population since 1945 especially great “baby boom” of 1950s has greatly

stimulated demand for international products services and information.

7. EMERGENCE OF ECONOMIC BLOCKS :-

Emergence of syndicates or blocks amongst countries influences world trade.

Generally, countries of a block encourage trade amongst its members only and

discourage trading activities with outsiders by way of reduced and increased tariffs

respectively.

8. DIVERSITY IN NATURAL RESOURCES :-

Noted economist Samuelson Nordhams says ,

“ Trade may take place because of the diversity in productive possibilities among

countries”.

These productive possibilities in part reflect endowment of natural resources ,i.e.,

Saudi Arabia is blessed with Petroleum, whereas India has a fertile land producing

enough food grains to spare for trade.

To quote Knowles & Wareing,

“Trade arises mainly from regional economic difference and serves to balance

production and consumption by moving goods and services from areas of surplus to

areas of deficiency”.

9. DIFFERENCES IN TASTES :-

Even if conditions of production were identical in all regions , countries might still

engage in trade if their tastes for goods were different , i.e , Indians and Pakistanis

produce sugar and movies. But ,lets say Indians have fondness for sugar more than

cotton and Pakistanis for movies than the sugar. In such a situation both can

maximise happiness by mutually exchanging sugar and movies.

10. ECONOMIES OF SCALE OR THE DECREASING COSTS :-

To quote Samuelson Nordhaus (Economics) ,

“Perhaps the most important reason for trade is difference amo ng countries in

production costs”.

The economies of scale gives a country high volume- low cost products in the areas of its

cumulative acqusitions advantages of a headstart. It gives it a comparative advantage

over the other country in terms of cost effectiveness. Thus, David Ricardo’s (1817) law

of comparative advantages comes into play. This factor influences trade.

11. FOREIGN EXHANGE REGIME :-

If the exchange rate of a currency goes higher relative to other currencies , it

encourages imports by making them cheaper & discourages exports by making

them costly to buyers abroad. Reverse happens with a decrease in the value of a

currency, i.e,depreciation or devaluation. This factor affects the composition of the

trade, its structure and flow of commodities , services and information.

10.4 STRUCTURE OF INTERNATIONAL TRADE

Structure of International trade can be approached from 2 perspectives:

1. Volume of Trade

2. Composition of commodity flows

1. Volume of trade :

a) World trade has been growing at a rate of 8% per annum since 1950. It has

increased almost 50 times since 1938 ,i.e. ,to 1,988005 million US $ (1980)

from US $ 22,700 millions (in 1938). Its still 6 fold increase after allowing for

currency inflation.

b) Period since 1945 has seen rapid economic growth.

c) Despite destruction of productive capacities of much of Europe, USSR &

Japan in 2 world wars, these regions have witnessed rapid economic growth at

a level higher than 1938s due to economic upsurge sweeping all advanced

economies.

d) There is a reduction in Tariff barrier since 1945.

e) High population growth, increased standard of living and enhanced demand

for materialistic comforts has stimulated volumes.

f) Increase in volumes of trade is not uniform.

Following chart shows it :

% SHARE OF WORLD TRADE

Countries/Economics 1938 1972 1980 2000

Developed 69.6 - 75.1 75.7

Developing 23.0 - 12.3

OPEC - 6.6 14.9

20.00

Centrally paired 7.4 - 8.9 4.3

World 100.00 100.00 100.00

2. COMPOSITION:

1938 1980 2000

Primary 50% 33%

Secondary 46% 63%

Tertiary and Others 4% 4%

100% 100% 100%

a) The above table shows decreasing importance of primary products in the world trade.

Type of commodity has changed. In 1980, Wool, Rubber, Fruit dropped out from

top 20 commodities. Tin, Lead, Zinc have increased in importance. Petroleum has

constituted 50% of total tonnage of the world trade since 1960.

Primary reasons for decrease in the importance of primary products are:

1.Development of synthetic for rubber silk and cotton.

2.Application of scientific methods to agriculture in the developed countries

increasing their primary production.

3.Population increase in food exporting countries leading to less availability of

surplus food for trade.

4.Protection of agriculture by tariffs on imports despite the GATT (1947).

5.Decreased irrigation in agricultural sector in developed countries due

to comparatively higher price of water diversion for irrigation leading to a drop in the

agricultural products.

3. TRENDS/DIRECTION:

A. Direction of commodity flows from the pattern established in the 19th

century has changed. Earlier in the 19th century, manufactured goods from

developed countries were exchanged for the food stuffs and raw materials

from the less developed countries.

To quote KNOWLES &WAREING (Economic & Social Geography),

“Now most trade is in manufactured goods between developed

countries and 60% of trade takes place between 2 leading areas,

Anglo-America and Western Europe, although there are important

traders such as Japan elsewhere.”

B. Britain,s share of exports has declined, especially to Latin America,

Commonwealth countries like Australia and New Zealand. This has

reduced London’s role as the hub of trade.

A. Other exporters have developed to fill up the gap left by Britain’s ouster :

1. USA is now the world’s leading exporter with extensive markets in

Europe, Japan & Canada.

2. Germany has been able to increase its exports due to removal of tariff

barriers in the EEC.

3. Japan has carried out aggressive policies in USA & Europe.

4. Asian Dragons are a force to reckon with.

B. Trade has increased between Erstwhile USSR & its European allies/satellites with

smaller increases to Western Europe and developing countries.

C. There is a small increase in the trade of a few small number of primary products,

largely restricted to minerals.

D. Role of the 3rd world countries has decreased due to developing economies

increasingly trading among themselves.

E. Formation of several duty free areas made up of several countries too has altered

the direction of trade . Following are some of the most important trading blocs

mentioned against their year of formation:

i. 1957 – EEC

ii. 1959 – European free trade Area (EFTA)

iii. 1959 – Central American Common Market (CAMT)

iv. 1960 – Latin American free trade Association (LAFTA)

v. 1960 - Organisation of Petroleum Exporting Countries (OPEC)

These areas/unions increase trade between members, restrict trade between

members and non-members and encourage trade between non-members ,i.e.,

Britain’s entry into the EEC in 1972 increased its food imports from Europe and

decreased the same from traditional suppliers like New Zealand. New Zealand in

turn directed its exports to new markets like Japan.

F. To quote KNOWLES & WAREING, “Flows of international trade are therefore

large and complex and are constantly growing and changing and this is reflected

in the complex transport networks that have been built to make these exchanges

possible.”

10.5 PROBLEMS OF INTERNATIONAL TRADE :

Following are the problems related to International trade :

1. PAST 2. PRESENT 3. FUTURE

Despite temporal or time veriation aspect, most of these problems remain the same

whether we study contemporary international trade, past trade or the future trade.

PROBLEMS :

1.Imbalance in the volume of trade amongst countries.

2.Imbalance in terms of composition of commodity flows.

3.Imbalance in terms of direction of commodity flows.

4.Prohibitions, restrictions.

5.High import tariff rates /protection.

6.Foreign Exchange Problem.

7.Balance of International payments.

8.Non-Tariff Barriers.

9.Subsidies to domestic production areas like agriculture.

10. Wars and bad diplomatic ties amongst countries.

1.Foreign Exchange Rate Problem.

To avoid a repetition of the Great Depression of 1929,the noted

economist John Maynard Keynes & others made conceted efforts. Their efforts led

to the setting up of Bretton Woods system(1944) at New Hampshire. Under this

system, each currency was linked to Gold or Dollar terms or both. Later on,

International Monetary Fund (IMF) was established as a central bank to solve the

problem of Balance of payments faced by member nation states so as to mitigate

/discourage inflation and attendant problems. It administers International

monetary system. The World Bank was established to finance economically sound

projects & it disbursed loans worth US $ 21 billion in 1996. However, Presently,

Hybrid System is in vogue which consists of

1.Free floating currencies

2.Managed but flexible currencies

3.Pegging to basket currencies (gliding /crawling peg)

4.Currency-bloc currencies

5.Intervention by countries.

2.Balance of Payment Crisis :

India had to face this crisis in 1990 when it had to mortgage to London 250 tonne of

Gold!

PROBLEMS OF INTERNATIONAL TRADE

OR

THE FACTORS INFLUENCING INTERNATIONAL TRADE

1.INTRODUCTION :-

International trade has faced several problems in the past. It is facing problems

even presently. It shall continue facing one or the other problem in future ,too,

Thus,problems are a part and parcel of international trade.

2) PROBLEMS :-

Problems of international trade can broadly be classified in the following two categories:

i.) General ii) special or immediate

i) GENERAL :-

These problems generally exist at all points of time in varying degrees of

importance. These may be summarised as follows:

1) HISTORICAL:

Historicity acts as a problem, sometimes. For example, African countries over a fairly

long period of history have been drained of their precious human resources by

European countries. Consequently, Agricultural and other developments in Africa

suffered. Comparatively, European countries with their historical stock of financial,

technological and other resources experienced a higher stage of economic growth and

came to dictate terms of trade in the international market. This has created problems

for smaller and less developed countries of Africa which can’t compete on an equal

footing with European Nations due to later’s superiority in technology, management,

finances, etc.

2) POLITICAL:

World politics creates problems ,too. For example, the creation of trade blocks

encourages trade amongst member countries and discourages trade with non members

countries. European Nations (EU), a trade block comprising of 15 European nations,

experiences intratrade to the tune 61% and only 39% of its trade takes place with non

member countries.The following table gives a clear idea about % of intra -block

exports(exports within the block members)as in 2000 A.D.:

TRADE BLOCKS PERCENTAGE OF INTRA-BLOCK EXPORTS

NAFTA 52.0

ASEAN 20.6

SAARC 4.5

In world politics, enemy nation state tries to protect its enlightened national self

interests through various means like diplomacy, war, negotiations, trade restrictions,

high import tariff rates, etc. This creates problems. For example, World War I and II

adversely affected world trade from 1919 to1950. On the other hand, existence of peace

encourages international trade, because traders are able to carry out trade activities

without fearing any losses due to war or armed clashes.

3) ECONOMIC: -

Certain economic factors create problems . For example ,poor means of transportation

and communication; poor demand and supply of goods, services and information;

recession; lack of goodwill in the market; poor financial conditions; Lack of foreign

exchange resources to pay for imports, fluctuation in the foreign currency exchange

rates, Economic Distance, existence of same selling price of a product, etc. we can get

an idea of the significance of this factor by discussing the impact of recession on

trade. During recession , supply outstrips the demand leading to a piling up of a huge

inventory/stocks. This causes loss of employment because manufacturers try to cut

down on costs by retrenching the workers on all levels. This triggers a chain reaction

by restricting the purchasing power of the general public, which in turn causes a drop

in the demand for products whether indigenously manufactured or imported from

outside. This drop in the demand causes a drop in the volume and value of

international trade, because no one would like to incur losses by trading in products

which have no demand! Great Depression of 1929 in U.S.A is a classic example.

Even as recently as 2001, South Asian and East Asian Countries supplying computers

related products to U.S.A could not do much trading of these items due to a poor

demand in U.S.A owing to a slow down of U.S.A domestic economy.

4) GEOGRAPHICAL / PHYSICAL :-

Physical or natural factors like geographical location, relief features, climate, soil, etc.

hampers trade, too. For example, Nepal, Bhutan, Mangolia and Afghanistan are land

locked countries with no direct access to cheap sea routes. Consequently, these

nations have to incurr heavy transportation costs in moving their cargoes through

land routes of neighbouring countries for further onward shipping through seas!

Alternatively, transportation by air becomes costly, thereby reducing their

competitiveness in international markets. This in turn may sometimes discourage

them from undertaking trade activities on an international trade.

5) CULTURAL :-

Cultural factors like race, religion, caste, creed, language, etc. may hinder

international trade. For example, in medieval India, it was forbidden and considered

a sin to travel across the seas to other lands inhabited by the so-called “Malechhas”.

Consequently, Indians could not take advantage of contemporary international trade.

Whereas foreigners like Arabs and Europeans with no such social / religious

restrictions indulged in international trade and reaped the benefits. Islam enjoins upon

its practitioners to travel far and wide. Consequently, Arabian Muslims travelled far

and wide which encouraged trading activities in the Middle East and other Muslim

dominated regions. Till the beginning of Renaissance in Europe, the church

discouraged international trade indirectly by disapproving material comforts of life.

One can’t trade in pork with Muslim countries and in beef with Hindu country like

Nepal because pork and beef eating are forbidden in their respective

religions/regions.

6) TECHNOLOGICAL :

Non-availability of appropriate scientific and technological aides hampers

international trade, too. For example, it was only after the introduction of

freezing/cold storage facilities aboard ships that beef could be exported to

European countries from Argentina. Highly perishable and delicate items

require a high degree of sophistication in packing and handling.Availability of

such facilities has made it possible to export to the gulf countries from

Maharashtra in India the highly perishable items like grapes and “Hapus

7) NATURAL HAZARDS:

Sometimes, natural hazards block the carrying out of trade

Activities. The Great Bubonic plague of 1348 wiped out a large

number of European population leaving little scope for

international trade to prosper due to reduced demand for products.

Famines and Epidermic cause vast devastation and loss of life,

thereby reducing the population having requisite purchasing

power. Low purchasing power and a lower number of people mean

a lower demand for goods, services and information.

(ii) SPECIAL OR IMMEDIATE FACTOR:

Although the general factors mentioned above go on affecting international trade all

the time in varying degree, yet their impact may not vary dramatically. From the point

of view of the present time, it is the immediate factor which makes the most powerful

impact on international trade. This special or immediate factor varies from time to

time. For example, the division of the world into communist and capitalist blocks

during cold war era was the most important factor which inhibited the growth of trade

amongst countries of these two blocks. This factor has lost its importance with the

disintegration of the erstwhile USSR and the emergence of U.S.A. as the global super

power. The year 2001 saw the emergence of threats by international terrorism as the

immediate factor, which hampered the recovery of U.S.A. and the global economy

and consequently the international trade. The collapse of the “North” and “South

Towers” of World Trade Center (WTC) at New York on 11th September 2001 by

terrorists through hijacked aeroplanes caused a loss of thousand of billions US

Dollars in terms of economic growth and trade by sending the whole global economy

into a panic, because WTC was the nerve centre of the World Financial Market.

10.6 PROSPECTS OF INTERNATIONAL TRADE: 1. Taking into consideration contemporary development in the world, it seems

reasonably well to see bright prospects on the horizon for international trade, since the

world is inching towards integrated global dynamic spatial economy by slowly removing

tariff barriers in the direction of a perfectly balanced world economic landscape.

2. The period from 1950 to 2000 has witnessed a mixed picture, with some successes and

some failures. However, an overall impartial assessment would show that international

trade has grown faster than output for every major country.

Having learned the dangers of protectionism in the 1930’s ,nations have now joined

together in multinational trade treaties and agreements to overcome the temptation to

impose trade restrictions, i.e. ,1993 Uruguay round which extended the principle of free

and open trade to new sectors and new nations.

3. MAASTRIHT TREATY (1991) which usheredd in “Euro ” currency and the resultant

1992 crisis have shown that :-

A country can’t have simultaneously :-

1. a fixed but adjustable exchange rate.

2. Open capital market.

3. Independent domestic monetary policy.

10.7 DAVID RICARD’S CLASSICAL THEORY

1. INTRODUCTION :

David Ricardo, the British Economist in 1817 gave the law of comparative

advantages. This law shows that international specialization benefits a nation. In

other words, international trade benefits all trading nations.

2. BACKGROUND :

Around 1800, questions were raised whether nations should import nothing and

‘protect’ their markets with tariffs or quotas. For example, will America import

nothing if its labour (or resources) is absolutely more productive than European

Labour? Is it economically wise for Europe to “protect” its markets with tariffs or

quotas? David Ricardo answered these questions by his classical theory of

comparative advantages.

3. EXPLANATIONS :

David Ricardo considered two types of advantages :

i. Absolute

ii. Comparative

For simplicity, he took two regions and only two goods. He chose to measure all

production costs in terms of labour-hours. He analysed food and clothing for

Europe and America.

In America, it takes 1 hour of labour to produce a unit of food and 2 hours of

labour to produce a unit of clothing. In Europe, it takes 4 hours of labours to

produce a unit of food and 3 hours of labour to produce a unit of clothing.

Clearly, America has absolute advantage in both goods, because it takes less time to

produce these in America compared to in Europe. However, America has comparative

advantage in food compared to clothing because it takes less time to produce food than

the clothing. Europe has comparative advantage in clothing, because it takes less time to

produce clothing than the food. From these facts, Ricardo proved that both regions will

benefit, if they specialize in their areas of comparative advantage, i.e., if America

specializes in the production of food and Europe specializes in the production of clothing.

Thus, America will export food to pay for European clothing and Europe will export

clothing to pay for American food.

American and European Labour Requirements for Production

Necessary Labour for production

(labour-hours)

Product In America In Europe

1 unit of food 1 4

1 unit of clothing 2 3

Comparative Advantages Depends only on Relative Costs. In a hypothetical example,

America has lower labour costs in both food and clothing. American Labour productivity

is between 1½ and 4 times Europe’s (1½ times in clothing and 4 times in food).

Now, there are two situations :

i. Before trade

ii. After trade

i. Before trade : The real wage of the American worker for an hour’s work is 1

unit of food or 1/2 unit of clothing. The real wage of the European worker for an

hour’s work is 1/4 unit of food and 1/3 unit of clothing per hour work. With

perfect competition, in America clothing will be 2 times as expensive as food

,because it takes twice as much labour to produce a unit of clothing as it does to

produce a unit of food. In Europe, clothing will be only 3/4ths as expensive as

food.

ii. After trade : After trade, the relative prices of food and clothing must be

somewhere between the European Price Ratio (4/3 = food to clothing ratio) and

the American Price Ratio (1/2 = food to clothing ratio) which is assumed to be

2/3. So, 2 units of clothing trade for 3 units of food, because it takes more hours

to produce clothing than food (i.e. 3 hours) : In one hour, only 1/2 unit of food is

available. In one hour, only 1/3 unit of clothing is available. 1 unit of clothing is

completed in three hours as follows :

1/3 +1/3+1/3=3/3 = 1 unit

In three hours, following unit of food is ready =

1/2+1/2+1/2=3/2 units

Thus, to get 1 unit of clothing prepared in 3 hours ,the other one has to give 3 hours of

food which is 3/2 units of food. Or to get 2 units of clothing , 2 times the 3/2 units of food

have to be exchanged. Therefore

3/2 * 2 = 3 units of food

2 units of clothing = 3 units of food

ECONOMIC GAINS FROM TRADE:

Initially American worker was required to work for 3 hours and European 7 hours to get

one unit each of food and clothing.

After opening of trade, the American has still to produce food (within 1 hour) and has to

work for another 1 ½ hour to get a unit of clothing (assuming that price of food is $2 per

unit and $3 for clothing per unit) Thus, he has to work only for 2 ½ work, thereby

saving ½ hour or gaining real wage by 20%. Similarly, European worker has still to work

for 3 hours to produce one unit of clothing. However, he has to work to get one unit of

food. Since food cost is $ 2 and his each hour’s work is equal to $ 1, he has to work for

another 2 hours. Thus, he has to work only for 3+2=5 hours, thereby saving 2 hours. It

means an increase of 40% in the real wages.

Then workers and consumers can obtain a large quantity of consumer goods for the same

amount of work, when they specialize in the areas of comparative advantage and trade

their own production for goods in which they have relative disadvantage.

4. IMPORTANCE :

This theory can be applied to trade between and amongst countries. When countries

produce products in which they have comparative advantage, then they are better off.

Free trade allows the world to move to its production – possibility frontier as shown

below :

Bilateral, multilateral trade in numerous commodities benefit from operation of

the law of comparative advantages. Bilateral balancing of trade leads to severely

reduced economic gains. Trade between a single country and “the rest of the

world” stands to gain numerous benefits for its operators.

Following Figure shows it:

Production Possibility Frontier

Food Z

E

Before Trade

After Trade

500

X

Clothing

Consumer Electronics Machinery

Developing Countries

Japan

America

Oil

500

Or

Following example:

India ‘s Pakistan’s

Comparative wheat engineering products sugar Comparative

Advantage Advantage

5. CRITICISM :

i. Positive : It clearly shows the importance/significance/advantages of

International trade. Other sectors will gain more than the injured sectors

will lose. Over long periods of time, those displaced from low-wage

sectors will move towards higher-wage jobs.

ii. Negative :

a)Classical assumption : Classical assumption of a smoothly working

competitive economy with flexible prices and wages and voluntary

unemployment is quite wrong. Imports may lead to unemployment of

workers in that particular sector due to cheaper imports compared to

domestic products.Overvalued foreign exchange rate may reduce demand

for workers who may not find comparable jobs in other sectors. Nation

may be pushed inside its PPF with rising unemployment and falling GDP.

1930s depression led to Tariff walls inU.S.A.

To quote Samuelson Nordhaus (in Economics),

“The classical theory of comparative advantage is strictly valid only

when exchange rates, prices, and wages are at appropriate levels and

when macro economic policies banish major business cycles and trade

dislocations from the economic scene.”

c) Income distribution : People, sectors or factors of production or regions

may get harmed due to substitution of people, sectors or factors of high

income countries by low-wage developing countries or regions. This

leads to loss of wages in the receiving country due to availability of cheap

foreign products rendering local labour or factors incompetitive.

d) Those who are temporarily injured by international trade are genuinely

harmed and are vocal advocates for protection and trade barriers.

6. CONCLUSION:

To quote Samuelson Nordhaus,

“Notwithstanding its limitations, the theory of comparative advantage is one

of the deepest truths in all economics. Nations that disregard comparative

advantage pay a heavy price in terms of their living standards and economic

growth.”

“Petition of the Candle Makers,”Written by French economist/Satarist Frederic

Bastat aptly sums up the whole truth of comparative advantage and protectionism

in the following paragraph,

“To the chamber of Deputies:We are subject to the intolerable competition of a

foreign rival, who enjoys such superior facilities for the production of light that

he can inundate our national market at reduced price. This rival is no other than

the sun. Our petition is to pass a law shutting up all windows, openings, and

fissures through which the light of the sun is used to penetrate our dwellings, to

the prejudice of the profitable manufacture we have been enabled to bestow on

the country.

Signed : The Candle Makers,”

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