Effects of Latin America’s Trade with Developed Nations

Introduction

Following the democratization wave and the equal increase of regional ties, Latin American governments trusted that the support extended by Europe would likewise lead to progress of economic relations. These desires were mostly dependent on the presumption that Latin America’s democracy was the only pre-requisite for economic cooperation. Even though this was a vital condition, it was not adequate to boost the countries’ exports.

European interest in the region continued to expand but the old structure of trade did not fundamentally change. Latin America’s main exports to Europe continued to be food, horticultural items, and fuel. This amounted to 52.3% of exports between 1970 and 1989.¹ Additionally, imports from Latin America in the European market fell consistently. European imports from Latin America, which spoke to over 8% in 1970, dropped to 5.9% in 1980 and to 5.5% in 1990.² As the figures show, Latin America’s expectations as far as trade was concerned with Europe were not met.

Professor Raul Prebisch and his group developed a concept which explained the challenges experienced by these nations causing the decrease in the terms of exchange. Their perspective also led them to suggest industrialization as the main remedy.³ The declining terms of exchange are brought about by divergent forces of international demand and supply. Similarly, according to Puyana, the price and income elasticity of demand for Latin America’s exports that is fuel and food is low especially in developed countries hence it’s unlikely they would increase the countries’ GDP ratio.⁴ Subsequently, the low-income elasticity of demand means that imports of developed countries grow at a slow rate.

Reliance on raw minerals and labor-intensive goods during a time of industrialization and automation would inhibit Latin America’s ability to export. They both agree that it is more difficult to increase the export ratio due to the low price and income elasticity for these goods, especially in these countries. Thus, the root of the problem lies herein.

The Central Intuition behind Prebisch’s Arguments Regarding the Gains from International Trade

Prebisch criticizes the neoclassical economic school of thought by arguing that the global economy involves two various arrangements of nations, Center and Periphery characterized by the attributes of their creation structures. The former is advanced and complex, while the latter is particular in a couple of low-tech areas. Such a structure suggests that a large portion of the workforce in the periphery is allotted in subsistence activities or the informal sector.⁵ The former represents developed nations while the latter comprises underdeveloped countries which specialized in primary production to make his case that free trade policy would not serve Latin American development.

Prebisch questions the validity of classical theories assumptions, for example, the global division of labor which should profit both the Center and the Periphery, boosting production, income, and spreading these advantages across the two territories. Additionally, he challenges the assumption of unrestricted rivalry and illustrates how changes in competition in a powerful setting tend to be suitable to developed nations despite occurring in both locales.

He illustrates how the decline in these fringe nation’s terms of exchange is caused by the demand and supply forces in the international market. The consequence of this decrease is viewed as a hindrance to the progress of countries that specialize in agriculture and the exportation of other raw materials. This limits foreign exchange earnings making capital goods costly hence reducing the capacity to import.

The Dynamic Nature of his Argument Concerning Surplus Transfer

In this context, surplus transfer illustrates a certain proportion of excess manpower that is made available for allocation to other forms of work. This is mainly caused by shifts in demand and technical changes in production. Part of this surplus will likely be from the periphery to the centers as an export substitution. This illustrates the persistent tendency of always moving benefits of trade from the fringe nations to the developed ones. The greater the inelasticity of export demand from peripherals, the larger the proportion of surplus transfer to the centers.

The Differences between the Demand and Supply-Side Formulations of his Argument

The supply-side illustrates the pattern of technical advancement and a connected labor market section. The periphery transfers part of its excess labor market to the centers hoping to employ them in the future. The surplus manpower forces the decrease in wages in both locales thus stimulating exports and making new industries attractive. Consequently, this leads to a decrease in prices.

The demand side on the other hand focuses on the income elasticity of sold goods. It illustrates the labor mobility due to the demand for manufactured goods over primary products. Terms of trade are only affected by the supply side while the elasticity of export demand does not affect these terms and industry growth rate.

The Central Features of an Import Substitution Industrialization (ISI) Program and how they Address Prebisch’s Development Concerns Regarding Free Trade

Import substitution industrialization (ISI) is a growth strategy focusing on advancing local production of previously imported goods to encourage industrialization.

The central features of this program are:

Instability of primary commodity prices

The concentration of exports on essential goods is risky since markets are unstable. Great harvests can lead to a sharp decrease in agricultural commodity prices.

Mineral prices are also volatile since demand is highly sensitive to collapse in industrialized markets because metals like copper are utilized in the production of new equipment.

Latin American countries have seen their markets in capital goods dissolve because of innovation. Technical changes also crash markets for manufactured goods.

Terms of exchange decreasing

There is a tendency for the terms of exchange of these developing nations to decrease because they concentrate only on exporting primary products.

Prebisch’s concerns on free trade argued that the ISI strategies created a distortion in capital allocation and prevented industrial nations from seeking their comparative advantages in the international market. Nations grow by exporting products that intensively utilize their abundant factors. In this case, the main exports for Latin America are natural resources and labor. Since developing countries are poor, it means they will concentrate on labor-intensive exports which would trap workers in low-wage industries.

Where to Look and Tell a Particular Country was Pursuing Such a National Strategy

Import Substitution Industrialization is significant to the economic performance of some nations. If I were to look for countries pursuing such a strategy, I would start with those that have growing economies. These countries are identified as BRICS and include Brazil, Russia, India, China, and South Africa.⁶ Their economies have grown over the years and their key exercises are based on ISI strategies that include high tariffs, directed import control, government subsidies, and eventually, export strategies. These countries are characterized by a growing middle class, fast-growing economies, and favorable markets.

Challenges of Doing Business under Such a Regime

One of the major challenges of doing business in such an economy would be less competition due to the corporate state mentality. This is where manufacturers and workers expected the government to shield them from market uncertainties hence the low capacity to transform and innovate. This system creates quasi-monopolies which hampers new exports.

Another challenge would be having to buy costly inputs from inefficient government industries since importation is controlled. Lastly, due to low-interest rates industries become capital intensive hence low saving rates making it less profitable. There is a limited possibility for long term growth in such an economy.

Errors to Expect from Public Policymakers

One of the errors would be ignoring the agricultural sector by directing all their attention to funding industries. Thus it becomes difficult for farmers to finance seasonal crops or innovate in better crop production techniques like irrigation. Little effort to integrate farming subsequently leads to the slow collapse of this sector hence overdependence on imported food in the long run.

Secondly, heavy involvement by the government through constant subsidies to failing sectors leads to budget deficits. Lack of easy borrowing from abroad would prompt them to print more money to solve this public deficit which leads to inflation. Also, high government intervention means more corruption while subsidies made producers neglect innovation.

Opportunities and Threats Associated with a National Campaign for Economic Liberalization

Economic liberalization is the removal of barriers to the free exchange of goods between countries. These restrictions include tariffs such as duties and non-tariff barriers for example licensing. Some of the advantages of this strategy include the promotion of free trade. Reducing regulation decreases costs for countries to trade with each other which ultimately results in low consumer prices. Increased competition from abroad encourages efficiency and innovation in the local industries making countries transfer resources to businesses that put them at a competitive advantage.

However, trade liberalization can adversely influence certain industries in a nation due to great competition from its foreign counterparts resulting in less local support. This can stifle local industries and may lead to the failure of newly established ones. Nations with cutting-edge education frameworks will in general adjust quickly to a free-trade economy since they have a work market that can conform to changing requests and industries that can shift their focus to additional in-demand products. Underdeveloped countries may struggle to adjust to a changing economic environment.

Reference List

Adewale, A.R., ‘Import Substitution Industrialisation and Economic Growth: Evidence from the Group of BRICS Countries’, Future Business Journal, vol. 3, 2017, p.138-158.

Baer, W., ‘The Economics of Prebisch and ECLA’, Economic Development and Cultural Change, 2015.

Prebisch, R., Commercial Policy in the Underdeveloped Countries: American Economic Review, vol. 49, 1958.

Puyana, A., ‘The External Sector and the Latin American Economy in the 1990s: Is There Hope for Sustainable Growth?’ 1994, p.51.

Footnotes

1. A. Puyana, ‘The External Sector and the Latin American Economy in the 1990s: Is There Hope for Sustainable Growth?’ 1994, p51.
2. ibid.
3. W. Baer, ‘The Economics of Prebisch and ECLA’ Economic Development and Cultural Change, 2015. Web.
4. Puyana (n 1).
5. R. Prebisch, ‘Commercial Policy in the Underdeveloped Countries’, American Economic Review, vol 49, 1958, p.251-273.
6. A.R. Adewale, ‘Import Substitution Industrialisation and Economic Growth: Evidence from the Group of BRICS Countries’, Future Business Journal, vol. 3, 2017, p.138-158.