Q#10: Give an account of Trade Pessimist arguments.

Trade pessimists tend to focus on four basic themes:

(1) the limited growth of world demand for primary exports,

(2) the secular deterioration in the terms of trade for primary producing nations,
(3) the rise of new protectionism against manufactured and processed agricultural
goods from developing countries.
(4) the presence of market failures that reduce the ability of developing countries to
move up to export higher-value products.

Trade pessimists therefore conclude that trade opportunities are limited and even hurt
developing countries for four reasons:

(1) the traditional exports by developing countries, results in slow growth which means
that expanding exports will only result in lower export prices, causing transfer of
income from poor to rich nations.
(2) If there are no import restrictions, the high elasticity of developing countries'
demand for imports put together with their low elasticity for exports, would mean
that developing countries' must grow slowly to avoid persistent balance of payments
and foreign-exchange crisis.
(3) Since developing nations' comparative advantage lies in trade of primary products,
the 'export-promoting free trade policies' tend to slow down industrialization, which
is a major driver for the accumulation of technical skills and entrepreneurial talents.
(4) Trade pessimists view trade liberalization under the WTO, as limited in actuality,
with developing economies, lacking high powered lawyers and other resources
needed to interfere developed markets open.

Q#11: Give an account of Trade Optimist arguments.

Trade optimists tend to underplay the role of international demand in determining the gains
from trade. Instead, they focus on the relationship between trade policy, export
performance, and economic growth. They argue that trade liberalization, including export
promotion, currency devaluation, removal of trade restrictions, and generally getting prices
right generates rapid export and economic growth because free trade provides a number
of benefits:

(1) It promotes competition, improved resource allocation, and economies of scale in

areas where developing countries have a comparative advantage. Costs of
production are consequently lowered.
(2) It generates pressures for increased efficiencies, product improvement, and
technical change, thus raising factor productivity and further lowering costs of
production.
(3) It accelerates overall economic growth, which raises profits and promotes greater
saving and investment and thus furthers growth.
(4) It attracts foreign capital and expertise, which are in scarce supply in most
developing countries.
(5) It generates needed foreign exchange that can be used to import food if the
agricultural sector lags behind or suffers droughts or other natural catastrophes.
(6) It eliminates costly economic distortions caused by government interventions in
both the export and foreign-exchange markets.
(7) It promotes more equal access to scarce resources, which improves overall resource
allocation.
(8) It enables developing countries to take full advantage of reforms under the WTO.

Q#12: Explain the difference between trade creation and trade diversion with a suitable
example.
Trade diversion is an economic term related to international economics in which trade is
diverted from a more efficient exporter towards a less efficient one by the formation of a
free trade agreement.
When a country applies the same tariff to all nations, it will always import from the most
efficient producer, since the more efficient nation will provide the goods at a lower price.
With the establishment of a free trade agreement, that may not be the case. If the
agreement is signed with a less-efficient nation, it may well be that their products become
cheaper in the importing market than those from the more-efficient nation, since there are
taxes for only one of them. Consequently, after the establishment of the agreement, the
importing country would acquire products from a higher-cost producer, instead of the lowcost producer from which it was importing until then. In other words, this would cause a
trade diversion.
Trade creation is an economic term related to international economics in which trade is
created by the formation of a customs union.
When a customs union is formed, the member nations establish a free trade zone amongst
themselves and a common external tariff on non-member nations. As a result, the member
nations establish greater trading ties between themselves now that protectionist barriers
such as tariffs, quotas, and non-tariff barriers such as subsidies have been eliminated. The
result is an increase in trade among member nations in the good or service of each nation's
comparative advantage.

Examples:
Trade Diversion: An example of trade diversion is the UK's import of lamb. Before Britain
joined the EU, most lamb imports came from New Zealand, the cheapest lamb producer.
However, when Britain joined the EU the common external tariff made it more expensive to
import lamb from New Zealand than from countries inside the union, thus France became
the majority exporter of lamb to the UK. Trade was diverted from New Zealand and created
between France and the UK.
Trade Creation: Hypothetical example: If India is trading woolen fabric for Rs. 100 for a yard,
while Pakistan is trading for Rs. 140/yard and Bangladesh for Rs.80/yard, and if Pakistan and
Bangladesh form a union, the demand for wool from Bangladesh will increase in Pakistan
and production will increase in Bangladesh. These two countries also decide to put a tariff
on India's fabric to a high 130%, which would result in everyone, NOT buying fabric from
India.