On the Search for Well-Being

CHAPTER 7 Foreign Transactions

CHAPTER 7 Foreign Transactions From the very beginning of interest in the status of low-income countries, foreign trade, international capital movements, aid, technology transfer, and foreign training have all occupied a great deal of attention. The initial argument was that the the low-income countries should industrialize, should change their economies from agricultural or mineral based to industry based. The most influential of all early ideas of development-the dual economy models of Arthur Lewis and Fei and Ranis-rested specifically on the idea that the presently low-income countries should expand their modem sector as rapidly as possible and allow their traditional sector to die off. Both Lewis and Fei and Ranis were careful not to equate "modem" with industry, but industrialization soon became widely equated with modem, and traditional often with agriculture. This way of thinking was the origin of the notion that development meant replicating the North. Modem meant "North," and hence great emphasis was placed on the capacity to import physical capital goods and technology from the North. To achieve this, the dominating strategy that evolved was to replace imports-initially of consumer goods only-with their domestic production, a strategy usually identified as import substitution . 1 Import substitution became, during the 1950s and 1960s, the most widely practiced approach to development. Its dominant role continued until the early 1970s when the great success of Korea and Taiwan became increasingly evident to the world. The most evident feature of this success was the remarkable growth of exports of the two countries. A strategy, alternative to import substitution, then emerged, usually identified as an export or outwardlooking strategy. I begin this chapter with abrief review of the import substitution, outward -oriented debate. I want, however, to spend most of the chapter on the way the foreign sector can affect productivity growth. I conclude that some l. The article by Arthur Lewis (1954) and later the book of John Fei and Gustav Ranis (1964) were the earliest statements of the labor-surplus, dual-economy model. Of course there have been numerous books and articles on these topics since the 1950s, but these early works were enormously influential in terms of both policy and theoretical formulations. So far as I can determine John Power (1963) was the first author to study import substitution as an approach to development. 133 134 On the Search for Well-Being kind of protection is likely to be necessary in most countries to put an indigenously grounded growth process in place. An exact form of protection that is most suitable for this purpose is discussed in the following chapter. I end the present chapter with some quick comments on a few other foreign sector issues that are illuminated a bit by the discussion of productivity growth and protection. The basic notions on which this chapter builds may be stated in the following way: International trade in commodities results in greater availability of goods and services for a country than is possible without such trade. Such trade however cannot provide continuing growth of goods and services for a country. To achieve that, the process that I have examined in the preceding chapters must be in place in each trading country. More precisely, the absence of productivity growth in one country cannot be offset by commodity trade with another country in which productivity is growing. To say the same thing again: Commodity trade is not a substitute for internal productivity growth. In the context of growth of output and of development in general, gains from trade are in the form of contributions to learning and inducements to search. I want now to study how international trade, and international transactions in general, can contribute to the growth of productivity directly and to the growth of well-being.2 Development Strategies: Import Substitution and Outward Orientation The central idea of import substitution3 was very simple. Production in all low-income countries of the late 1940s was largely agricultural or mineral. Manufactured products, capital and consumer, were imported. The dual-economy models were interpreted to imply that this structure had to be changed. Given this widespread way of thinking, the idea of replacing imports with domestic production seemed obvious. Thus various forms of protection were installed, behind which a wide range of manufacturing activities (producing mainly consumer goods) sprang up in many countries. The presumption, mainly implicit, was that, at some point in the not-too-distant future, these activities would be able to survive without protection. Thus...