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Trade deficits in LDCs Ruth Tarrant The Open University and Peter Symonds College

Trade deficits in LDCs

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Trade deficits in LDCs. Ruth Tarrant The Open University and Peter Symonds College . Outline . Issues facing (African)LDCs post WW2 Independence and its implications for development The size and funding of trade deficits for LDCs Focus on Tanzania African LDCs today . - PowerPoint PPT Presentation

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Page 1: Trade deficits in LDCs

Trade deficits in LDCs

Ruth TarrantThe Open University and Peter Symonds College

Page 2: Trade deficits in LDCs

Outline

• Issues facing (African)LDCs post WW2• Independence and its implications for

development• The size and funding of trade deficits for LDCs– Focus on Tanzania

• African LDCs today

Page 3: Trade deficits in LDCs

The (African) colonies post WW2

Page 4: Trade deficits in LDCs

Exploitation of primary products for reconstruction

Page 5: Trade deficits in LDCs

Foreign exchange generated by exports kept by colonial powers

Page 6: Trade deficits in LDCs

No import-substitution measures allowed. Colonies = markets for colonial powers

Page 7: Trade deficits in LDCs

Allied victory / creation of UN led to social pressure for independence and progress

Page 8: Trade deficits in LDCs

Colonial powers prevented secondary / tertiary education

Page 10: Trade deficits in LDCs

Independence

Neo-colonialism

Nation building / gain

authorityKeynesian

Aid / trade dependent

Diplomatic pressure

‘removal’ of ‘hostile’ leaders

Heavy state intervention:

banking, education,

infrastructure‘developmentalism’

ideology led to authoritarian governance Mimic USSR:

achieve growth

Page 11: Trade deficits in LDCs

BUT

INEQUALITY• basic needs not met• focus on capital intensive industry• rate of urbanisation > rate of wage growth

PRIMARY PRODUCT DEPENDENCY• No manufactured X• decline in terms of trade = vulnerability• World Bank!

NO TRANSFORMATION OF AGRICULTURE• urban – rural income gap• need to import food• no growth

FAILURE TO ENCOURAGE ENTERPRISE• ideological aversion to entrepreneurship• education still lacking

RENT-SEEKING GOVERNMENTS• short-termism• inability to consider longer-term growth/development

Page 12: Trade deficits in LDCs

The ‘crisis years’, 1974-early 1980s

• 1975-1983: only 3 years saw any positive growth, on average, in Africa

• 1983: African economies’ GDP per capita fell on average by 5%

• Why?– Falling commodity prices and falling demand

• Recession in the developed world

• Consequences– Balance of payments crises– Economic stagnation and decline

Page 13: Trade deficits in LDCs

The ‘crisis years’ – available policies

• Option 1– Accept BoP crisis as

structural & long-term

– Restructure economy

– Change the development model

• Option 2– See BoP crisis as

temporary– Borrow from abroad

to finance the deficit– Advice and pressure

from external lenders e.g. World Bank / IMF

Page 14: Trade deficits in LDCs

The adjustment years, early 1980s to mid 1990s

• Option 2 ‘chosen’– Copy East Asian model• Rely on markets, not gov’t intervention• Export orientation rather than import substitution is

key– Slash public sector spending– Focus on primary product comparative advantage

Page 15: Trade deficits in LDCs

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Page 16: Trade deficits in LDCs

“While some aspects of this [Asian] model (for instance, greater political insulation of economic policy makers) could reasonable be achieved in African countries, the extensive co-ordinated economic interventions of the East Asian states are well beyond the administrative

faculties of most African governments”Lewis, 1996

“...no major expansion occurred in the diversity of products exported by most of the sub-Saharan African countries, although there one or two exceptions like

Madagascar and Kenya. Indeed, the product composition of some of the African countries’ exports

may have become more concentrated”Ng and Yeats, 2000

Page 17: Trade deficits in LDCs

Far from supporting a minimalist approach to the state, these examples have shown that development requires an effective state, one that plays a catalytic, facilitating role, encouraging and complementing the activities of

private businesses and individuals...History has repeatedly shown that good government is not a

luxury but a vital necessity. Without an effective state, sustainable development, both economic and social is

impossible”Wolfensohn, 1997

Page 18: Trade deficits in LDCs
Page 19: Trade deficits in LDCs

A familiar macroeconomic framework

GDP = C + I + G + X – M GDP = (C + I + G) + X – M GDP = Domestic Absorption + X – M GDP + M – X = Domestic Absorption GDP + trade gap = Domestic Absorption

So, if an economy spends more on final goods and services than it can produce, its imports will exceed its exports by the value of the excess expenditure over GDP. This ‘trade deficit’

must be financed i.e. paid for

Tanzania persistently has a trade gap about 10% - 18% above GDP, although now shrinking

Page 20: Trade deficits in LDCs

LDCs and trade deficits

• Very common in 1980s and 1990s!– Dramatic fall in commodity prices– Global recessions of 1981-82 and 1991-93– Increased protectionism in developed world

against LDC exports

Page 21: Trade deficits in LDCs

Financing trade deficits using current flows

• Factor payments• Wages, rent, interest and profit

• Transfer payment• Payments not made in return for providing factors of

production– Official grants from govt’s, NGOs or international institutions– Money received from permanent overseas factors

Tanzanian factor payments have a negative balance, and transfer payments historically fund around a

quarter of the trade deficit

Page 22: Trade deficits in LDCs

Other methods

• Draw on official foreign exchange reserves• Capital account transactions– Dealing in financial assets (public and/or private)– FDI from abroad• Requires good rates of interest!

LDCs such as Tanzania hold very limited foreign exchange reserves. Small, low income countries also

tend to have limited access to capital markets, as their economies are vulnerable. Historically, Tanzania found it difficult to attract FDI but rising tourism and demand

for commodities from China is helping.

Page 23: Trade deficits in LDCs

Remaining options?GDP + trade gap = domestic absorption

Now subtract Consumption (public + private)from both sides

Savings + trade gap = Investment

Rearranging, gives:

Trade gap (i.e. M – X) = Investment - Savings

This is the key relationship for many macro policy makers in LDCs

Page 24: Trade deficits in LDCs

Mean African current account deficit (% GDP)1960 to 2000

Page 25: Trade deficits in LDCs

Implications for LDCsLow income

Low savings ratio Low absolute savings

Investment cannot be funded domestically

Aid is an essential source of finance for investment

Page 26: Trade deficits in LDCs

Aid used for investment in:- Import-substituting industry- Capital-intensive industry

Investment managed by donors

Foreign aid ‘matched’ by domestic spending

- Gov’t had to print money!- Rising inflation

- Falling real incomes- More aid = more inflation = more

poverty

Page 27: Trade deficits in LDCs

Consequences

Falling real income, overly rapid urbanisation, mass unemployment due to investment in capital-intensive

industries, internal political strife

Increasing trade deficit

Even more aid!

Worsened by falling terms of trade!

Page 28: Trade deficits in LDCs

1987 - 20011. Export volumes increased

by 9.9% p.a.2. Exports of services

(tourism) grew most quickly, and agricultural exports least quickly

3. Rate of increase in export volumes not matched by rate of increase in purchasing power of exports – negative for agricultural exports!

Page 29: Trade deficits in LDCs

‘Reversion to the mean’

Shocks aside, most African current account deficits now appear to be stable

(exceptions are Burkina Faso, Ghana, Lesotho, Mauritania and Senegal, which will become more reliant on international transfers)

Attempts to reduce deficits (e.g. devaluation) will only have short-run, temporary effects – no difference to

long run deficit

Page 30: Trade deficits in LDCs

Chinese FDI

Rising terms of trade

Rising purchasing

power

Shelter from financial crisis

Debt relief

Political stability

Chinese FDI

Incredible growth

Sound economic

management

Page 31: Trade deficits in LDCs

Recent Tanzanian key economic data

1998 2007

Gov’t spending as % of GDP 12.4% 20.8%

Investment as % of GDP 14.6% 45%

Consumption as % of GDP 82.8% 72.3%

GDP (2001 = 100) 80.5 152

Value of Exports (2001 = 100) 82 183

Value of Imports (2001 = 100) 95 178

Page 32: Trade deficits in LDCs
Page 33: Trade deficits in LDCs

• Shrinking trade gap• Reduced reliance on aid• Productive investment

Conclusions

Hope!

Page 34: Trade deficits in LDCs

Thanks to...

• Mark Holmes, Loughborough University• Thandika Mkandawire, the UN, the Open

University, DfiD and the LSE• Marc Wuyts and Sam Wangwe, the OU