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International Trade and Finance

Notes trade with other Southern economies only if the South innovates and produces its own products. In
these types of models, Southern focus is left ignored because the South has a comparative disadvantage
in the production of these goods.
Where the South concentrates on production of differentiated consumer goods, it does it on a small
scale and potential economies of scale remain partially, if not fully, unexploited. Stewart (1984)
discusses this case in detail by pointing out that a lack of natural comparative advantage in their
production at the primary stages when there are diseconomies of scale and no inefficiency (i.e., under
employment of resources, etc.) compel most of them to produce under heavy protections. As Stewart
recognizes, there is a trade off between efficiency and variety, unless trade can perform the role of
permitting specialization, scale economies and variety to be exploited. As far as intra-industry
specialization and exchange is concerned, it is solely a matter of more efficient deployment of resources
within the South, and it should raise productivity and not direct resources. This is a form of trade
creation. If countries in the South specialized on particular differentiated variety of final products
and then exchanged them each country should be able to use its resources more efficiently, raising
output without resource diversions. As the South moves into 'manufactured exports, as we will see
in the subsequent chapters, the need for analyzing this kind of specialization and gains from exchange
is looming large. The most general conclusion, following Stewart, is that while the theories explain
N-N trade, S-S trade offer a potential way for the South to gain from the trade in products for countries
with identical demand structure, in differentiated products and in intermediate goods. All of the
models discussed in Section II postulate an equivalence between scale economy and IIT in the sense
that for individual product varieties within an industry (e.g., car) having a common technology there
are scale economies (internal to the firm), giving rise to IIT or 'non-comparative' advantage trade.
This equivalence does not necessarily hold for the LDC because for small open economies the
realization of it requires inter-industry trade. It is due to the fact that scale economies apply to large
product lines and also a single scale efficient plant often exceeds the domestic market size of many
LDCs. To take advantage, many industrial complexes will concentrate in a single country giving rise
to IIT and specialization.
Krugman (1988) describes a situation (hypothetical) where scale economies in infrastructure (required
for imports into agriculture) give the overall primary good a definite 'non-comparative advantage 'in
trade pattern. In LDCs exports of manufacturers, there are elements of increasing returns as well as
comparative advantage; hence, the phenomenon of IRS may be applicable to LDCs, even if primarily
in the role of providing necessary infrastructure to get them to world or, in non-traded intermediate
inputs to standard primary productive activity. The economic integration efforts in the developing
world were always motivated more by the "swapping of production for import substituting industries'
enjoying scale economies". Scale economies have mattered much in LDC trade policy. Since the market
structure matters in international exchanges, it is necessary to analyze the imperfections in market
characteristics in such 'regulation-prone' setting for LDCs. Firms and government interact in arriving
at regulations and controls which have a spillover effect on a region's trade pattern. Small number of
private agents and relatively heavy intrusion of government regulation make the traditional
assumption of large, competitive markets, prima facie, less relevant for LDCs than the developed
countries (DCs). For many LDCs these gains do not accrue to the state. Brander and Speneer (1981)
type strategic export subsidies may seem a little far fetched for LDCs as their bargaining ability and
credibility of threats is small. Even if the small country has some major share of the product, the
government will face difficulty of becoming a credible first mover. Another interesting point to note
is the fact that Krugman's 1984 paper "Import protection as export promotion": international
competition in the presence of oligopoly and economies of scale' is a refurbished version of the 'Infant
Industry Argument' for protecting an industry in a small LDCs. Krugman's model is based on IRS--
internal to the firm so that firms in protected domestic market will move down their marginal cost
curves and market shares will go up. The argument was originally pioneered by Hamilton (1791),
List (1841), Mill (1909) and Bastable (1921). This is the model that countries like China, India, Japan
and South Korea adopted and achieved international competitiveness.

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