Price increases can also be problematic!
From 2005 until recently, the market for primary commodities including oil, metals and agricultural products has experienced a boom resulting in higher prices and consequently, higher national incomes for producing countries (cf Brazil).
While this clearly benefits some less developed countries by reducing balance of payments and debt problems and providing funds for investment in infrastructure and poverty reduction, such booms can also create problems:
- Leads to further dependence on the primary products as it removes the incentive to diversify into areas, such as manufacturing, which have higher potential for valued added production in the long-run.
- Puts an upward pressure on a country's exchange rate and disadvantages those non commodity export sectors of the economy that find themselves less competitive on the world market. This phenomenon is sometimes called the 'Dutch effect'.
- Leads to AD Pull inflationary pressures within the economy reducing the real wages and incomes of many of the poorer member of society adding to the levels of poverty.
- Worsens corruption as those individuals benefiting from the boom in prices find ways of avoiding governments attempts to manage the economic effects of the boom. Indeed some of the corruption may very well involve members of the government who attempt to gain personally from supporting illegal activities.
Inability to access international markets
Developing countries often face barriers to entry in international markets.
One major barrier is when introducing a new brand into an existing market there is often a perceived quality issue. The international car market is a strong example of this: Kia and Jac are perceived by potential customers as low quality and therefore can only command a relaticely low price. It often takes decades (eg Fiat before new brands are accepted into the international markets.
Made in Japan (in the 1960s), Made in Hong Kong (1970s), Made in S. Korea (1980s) have all signalled low quality mass production. Japanese cars now, however are recognised for their high quality (Toyota, Honda etc) and a major success story in a different markst is Samsung (S. Korea).
Developing countries may say they promote free trade but then use protectionist policies aimed at increasing employment at home (see Page 114 for the USA Cotton Subsidies case brought up by Brazil at the WTO)
- Long-term changes in the terms of trade (Higher Level Only)
The formula for calculating the ToT is:
If the ToT ratio were to increase then either Px has increased (more imports per unit of exports) or Pm has decreased (more imports per unit of exports again) or both: this is called a favourable movement
If the ToT ratio were to decrease then either Px has decreased (less imports per unit of exports) or Pm has increased (less imports per unit of exports again) or both: this is called an unfavourable movement
The price of anything is determined by Supply and Demand in markets and the prices of Exports and Imports are the same. In the long term demand for commodities is income inelastic. As economic growth and therefore higher income occurs for countries that import commodities the demand for those commodities does not increase at the same rate. Developing economies therefore tend to see the growth in demand for their exports decrease (remember it is the growth in demand that decreases not that demand decreases). The gap between economic growth in developing countries and developing counties widens.
If export prices increase it could be that more imports are gained with each unit of exports: However the demand for exports could alos fall - this is ok if PEDx is inelastic but not so if PEDx is elastic.
It is crucial then that you consult the actual Case Study text to find out the particular circumstances facing the country in question.