Institute of Law,

Nirma University

Economics Assignment

Economic Growth and International Trade:

Choice between Welfare and Prosperity

Submitted to:

Prof. Arun Prasad

Submitted By:

Palak Jhalani

18BAL113
 ACKNOWLEDGMENT

On accomplishment of this assignment it is my pleasure to acknowledge my

heartfelt thankfulness and appreciation towards my mentors for their treasured
recommendations and positive criticism. Their dear guidance and remorseless
support kept me on the right path throughout the whole assignement.

I express my sincere gratitude to my teacher Dr. Arun Prasad Sir for his
direction and inspiration in carrying out this project work. I would like to
acknowledge my and friends who have helped me with their valuable
suggestions in various phases of accomplishment of this project. I am also
thankful to the library of my University for providing me a broad range of books
to learn and accomplish this research which helped me in implementation this
project in an effective and efficient manner.
 CONTENTS

Acknowledgment

Certificate

Chapter 1

Introduction
1.1 Aims and Objectives

1.2 Sources of Data

1.3 Research Methodology

1.4 Research Question

1.5 Issues.

Chapter 2
Inter-Relationship between The International Trade and Economic Growth
2.1 International Trade Theory and Economic Growth Theory

2.2 Views of Classical Theorists on International Trade

2.3 Views of Neo-Classical Theorists

2.4 Views of Modern Economists.

Chapter 3
Case Study: Foreign Trade Policy and Growth in India

3.1 Heavy Protection Period

3.2 Semi-liberalized Period

3.3 Trade Liberalization Period.

3.4 Conclusion

Chapter 4
4.1 Conclusion
 CHAPTER 01

Introduction

Economics is the study of the management of scarce resources for satisfying the
basic wants of the society or individual. The basic theme behind this definition is
the assumption that resources are limited whereas needs and wants are unlimited.
This very principle is the basis of international trade. Obviously, no country is
self -sufficient for the production of all the goods and services. Some of the
reasons behind this scarcity:

• Lack of resource finance

• Unlimited needs and wants of the society

• Individuals tend to maximize their gains

In order to fulfill these needs, it becomes mandatory for countries to trade. It

affects the various sections of the economy. Some of these are: BOP’S, GDP,
size of the market, exhaustion of natural resources etc. These sections are the
indicators of the real economic growth of the country.

That’s why economic growth and international trade are two main branches of
economics. The inter-relationship between these two is the main point of
contention between the economists. Classical economists believe that the trade
between the countries has a positive effect on growth. By the later time, Neo-
classical thinkers said that both the theories are somewhat related to each other.
Therefore, the international trade was somewhat restricted till 1960’s.

Modern economists re-investigated the issue, and by the merger of the two
theories arrived at a conclusive result. The modern economists collectively have
arrived at the conclusion that the trade between the countries is dependent upon
the advantage they have against the other.

1.1 Aims and Objectives

The aim of the project is to present a detailed study on the topic of Economic

Growth and International Trade

1.2 Sources of Data

The following secondary sources of data have been used in the project-

1. Articles

2. Books

3. Websites

1.3 Research Methodology

For the purpose of research, the author has relied upon the primary sources to

look for information related to theories, principles and implications of the topic.

The author has aimed at providing an unbiased account of the topic with the help

of the doctrinal method of research. The various library and Internet facilities

available at Institute of law, Nirma University have been utilized for this

purpose.
1.4 Research Questions

1) What is the relation between economic growth and international trade?

2) How changes in the foreign trade policies affected the growth of India?

1.5 Issues

 As stated earlier, growth of a country is affected by the trade it carries out.

The trade undertaken is not the sole factor affecting it, but a crucial

determinant which can’t be ignored. The purpose of this project is to arrive at

a logical conclusion which put forth the dynamism of international trade and

how it affects the welfare and growth of an economy.

 With the help of case study, study the three main phases of Indian economy so

as to find out how foreign trade polices has affected the growth in India.
 CHAPTER 2

INTER-RELATIONSHIP BETWEEN THE INTERNATIONAL TRADE AND

ECONOMIC GROWTH

It is very well recognized that throughout the economic evolution, there is an existing
relationship between foreign trade and economic growth1 This is evident in both
imports and exports equally.2 Exports help in the realization of the economies as a
whole.3 Moreover, exports help to gain foreign money for procuring imported goods. In
turn, imports according to their particular need, give positive results and helps in growth
and development. The important imports help to cover the needs of those goods that are
not available in the local market; they help to cover the important factors of demand and
supply, which would have otherwise remained unsatisfied by the local goods. The
alternative and substitutive imports cover the goods that could use for their own
production but in low efficacy conditions. It also helps in the distribution of internal
production factors to more profitable activities. It also boosts the development of a
country by when it is consumption goods which increases standard of living.

Economic growth can be thus reflected on exports of a country. In varying degrees, the
increase of the national output can generate an additional export offer and a
supplementary import demand.4 Therefore, the inter-relationship between Economic
growth and the International trade can be taken into consideration to study both the
sides of their co-relation. On one hand the growth process and economic development

2.1 International Trade Theory and Economic Growth Theory

Though the inter relation between economic growth and international trade is obvious,
but in macroeconomics these two terms are studied separately. Thus, economic
development theory and international trade theory emerged. The second theory mainly

1
Charles P. Kindleberger, “International Trade and National Prosperity”, Cato Journal, Vol. 3 No. 3. at
https://object.cato.org/sites/cato.org/files/serials/files/cato-journal/1984/1/cj3n3-1.pdf.

2
Id at 625
3
Id at 627
4
World Trade Organization, Making trade work for the environment, prosperity and resilience, edn. 2018. at
https://www.wto.org/english/res_e/publications_e/unereport2018_e.pdf.
deals with the study of international specialization, by evaluating the various benefits of
foreign trade, and the explanation of the distribution of benefit between the exchange
partners and the trade policy substantiation which ensure their maximisation.5 The first
theory deals with the determinants of the economic growth and development, deals
mainly in: equipment with outputs, physical capital and infrastructure investment,
technological progress, education and training introduced in economic analysis by the
generic term of human capital, etc.5

The interference between these two was looked from very initial time and they
generated what we call “the new foreign trade and economic growth theories”.

2.2 Views of Classical Theorists on International Trade

The inter relation between international trade and the economic growth, not in an exact
form, appears very clearly in the work of predecessors for whom the idea of economic
growth means increasing wealth or the inventory of precious metals a country have.

Accordingly, they think that by this way outside the extraction, the only way in which
exports are in surplus against the imports is by the way of foreign trade.6 Going beyond
the narrow mercantilist concept of wealth and to expand the analysis in the production
category, the founders of the classical theory preserve the idea of the binomial foreign
trade economic development relation7 For this point, Adam Smith offers a whole
argument about the contribution given by the international division of labor on absolute
cost differences for increasing the “wealth of nations”. Now, David Recardio by his
deep analysis, sees the limited amount of the resources and he try to generalizes the
specialization criteria according to his own version of “comparative costs”. International
specialization is based upon the comparative costs condition of the participation in
foreign trades so as to broaden the limits of economic growth in a country. “In a system
with a perfect freedom of trade”, said Ricardo two centuries ago, the distribution of the
production factors on the principle of the comparative advantage is able “to increase the
overall weight of the products, to spread the general benefit and to bound through a
common fabric of interests and relations the universal society of nations from one end
to the other one of the civilized worlds”.8

5
J. Allister McGregor, Nicky Pouw, “Towards an economics of well-being”, Cambridge Journal of Economics, Vol. 41, No.
6
Will Kenton, Classical Growth Theory, April 17, 2018. at https://www.investopedia.com/terms/c/classical- growth-theory.asp
7
Ibid
8
Ricardo, 1959, p. 126
2.3 Views of Neo-Classical Theorists

Neoclassical theorists try to retain and deepens upon the Ricardian analysis with a
thorough manifestation on different areas of concerns on the fine line between trade and
growth.9

In the theory of opportunity costs propounded by Alfred Marshall and Gottfried von
Haberler, it could be said that though the geometric and algebraic neoclassical ways
helps to analyses them, investigation in that directions are dimmed as far as the merits
generated by the foreign trade are expressed by the shift in the consumption indifference
curves, while the possibilities curves stay in the passive place.10

The second neoclassical theory which was proposed by the Swedish school, Heckscher
and Ohlin, shows new perspectives for showing the theoretical binomial foreign trade-
development. The reason why this happened because the Swedish authors aimed “to
demonstrate that the international division of labor is explained by the inputs
endowment of each country”.11Therefore, the comparative advantage sources are
identified with the endowment of inputs that constitutes the fundamental reasons for
growth. Then the neo-classists analyses the trade-growth inter-relation. Although it
remains the same, but it is more extended than the Ricardian perspective with the whole
new issue of foreign trade contribution to the equalization of the development
conditions by equalizing the input prices.

2.4 Views of Modern Economists

For modern economists, the theory of foreign trade and economic growth came into
picture in the late 70‟s. It is not a single body theory, instead a series of theories and
models that arose from the post-war theories of the traditional, classical and the
neoclassical economists, who said that most of the critics were in favor of the theory of
the H- O model and less from the Ricardian theory.

9
Supra note 7
10
Heller, 1972, pp. 29-50
11
Ohlin, 1967, p. IX.
The challenges posed by the traditional theories’ assumptions as well as the new ideas
as a response to the relations between foreign trade and the economic growth were
drawn from two different perspectives: some of them from the offer perspectives, and
others from the demand perspectives which mainly helped to find out trade as an
important factor for economic development. On the other side, many contemporary
theorists, such as H. Johnson, Tadeusz Rybczynski, Jagdish Bhagwati, Gerald Meir,
challenged the static characteristic of the traditional theory based on the restrictive
condition of the invariability supply factors. This prevents from analyzing the evolution
of the international division of labor during the economic growth and development.12
The dynamic approach taken resulted, mainly, in the study of comparative advantages,
variations that generated by changes in size, structure and quality of the endowment of
factors, including: capital accumulation, growth in population, increasing productivity
and improving technology. But all of these represent the sources of economic growth.
Therefore, the dynamic theory of international trade has helped in the study of how
economic growth affects trade.

12
Esteban Ortiz-Ospina, Is globalization an engine of economic development, August 01, 2017. at
https://ourworldindata.org/is-globalization-an-engine-of-economic-development.
 CHAPTER: 03

CASE STUDY: FOREIGN TRADE POLICY AND GROWTH IN INDIA

The trade policies adopted in India have often been at contradiction with those that are

derived from the models of either protection or free trade. From the last four and a half

decades India has been experimenting with the import substitution strategies and export

strategies. However, India is considered as one of the heavily inward-oriented

developing countries. However, in the time period of 1955-56 to 1995-96 there is a

huge shift in the trade policies. Considering policy shifts and structural shifts in the

Indian economy, policy period can be divided into three categories:

1. Heavy protection period (1955-56 to 1976-77),

2. Semi-liberalized period (1977-78 to onwards).

3. Trade liberalization period (1990-91 to onwards)

During the time of heavy protection period, in India trade system was progressively
more restrict and complex. After 1976-77 the import sector has been gradually
liberalized and measures for promotion of exports have been increased. After the years
1990-91, India has initiated numerous trade liberalization measures in the form of
liberalization of import and Support towards export led-growth economy. The policy
shifts mentioned above have been checked and documented in most of the studies
including the World Bank studies.13 Some policies undertaken are discussed below:

3.1 Heavy Protection Period

India had not revealed its trade strategy of development in the First Plan Period (1951-
56). Import regime were quite liberal. From the Second Plan (1956-61) time period, the
country adopted highly intensive import substitution strategy to achieve
industrialization-led development.14 Areas of Manufacturing and capital goods was
given the main priority during the second-plan. In early stages of development, India
had to import capital goods. Thus, the main idea was to replace these goods with
domestic production. The factors like the promotion of newbie and key industries,
change in the composition of trade and GDP, export pessimism, the spirit of nationalism
have enforced India to convert into an import competing industry. To minimize these
trade distortions and to promote principle of self-reliance in production, India had
injected all heavy dose of policies by enforcing all types of physical and non-physical
interventionist policies. This policy includes import and industrial licensing system with
high level of tariffs.

The gap between import and export had been widened, at the latter half of the Second
Plan due to the neutral response of the export sector to the IS policy. Therefore, export
promotion was inducted along with the heavy regime of the trade policies during the
third plan (1961-66) and it continued till the subsequent three annual plan periods.15 A
new dimension to export promotion efforts was given in the form by creating a number
of organizations and by providing some export incentives and other services to
exporters through Cash Compensatory Support (CCS), Duty Drawbacks (DD),
Replenishment and Import licenses are the primary additives within the basket of export
incentives India devalued her foreign money on the price of 57.Five according to cent
towards Dollars in 1966 to promote export. As an end result of these, export has been
picked up all through the fourth plan seventy-six (1969-74).

Along with incentive measures, export controls and export taxes also are levied on sure
commodities to protect the interest of the nation. Meanwhile, some of committees and
Task Forces have been set up through Government of India and Reserve Bank of India
13
Supra note 4
14
Shodhganga, Foreign Trade and Economic in India: A review of Trade Literature and Policies. at
http://shodhganga.inflibnet.ac.in/bitstream/10603/96053/9/09_chapter%203.pdf.

15
Id at 72.
(RBI) at some point of 1975-85 to look at the functioning of present change rules and to
indicate remedial measures to make it greater powerful in promoting change-led
improvement. Among them, the most vital committees had been Dr. Alexander
Committee (1978), Tandon Committee (1980) and Abid Hussain Committee (1984).16
These committees reviewed the operation of diverse policies and its implications on
trade in addition to improvement and endorsed a number of innovative measures to
rationalize the change policies. They also entreated the Government of India to do so to
promote export and to liberalize import policy.

3.1 Semi-liberalized Period

Export promotion acquired a new urgency during late 70's due to the increased demand
for import, stagnant export earnings and industrial stagnation. This forced the
government of India to mitigate the negative effects of high protection and to reduce
anti-export bias. Therefore, Government of India initiated a new approach of
liberalization in its regime with more export promotion measures. The important policy
changes related to import sector since 1978, are expansions of OGL lists, shift in goods
from more to less restrictive list, swifter and less restrictive, administrative judgements,
concessional duties and reduction in scope of canalization. There has been greater
degree of simplifying and intermediate import. But import of consumer goods are
continued to be banned. A number of direct incentives were given to export sector in the
form of simplified export procedure, reduction in export taxes, more advanced and
special license for import, promotion of export-oriented industries and Foreign Trade
Zones, concessional finance, tax rebate and unified exchange rate. Due to change in the
policy measures, there has been a steady increase in the number of capital goods in the
OGL lists from 79 in 1976 to 1170 in April 1988. The process of import liberalization
has gathered considerable momentum following the introduction of the long term
import-export (EXIM) policies covering the period 1985-86 to 1990-91. Import of raw
materials and technical know- how required by manufacturing sector were almost made
free from licensing formalities. The license issued to registered exporters out of total
licenses was 26.6 per cent in 1981 which was increased to 68.4 per cent in 1991. As a
result of this, there existed an import-led export growth in India. The sorrowful story in
external sector starts from 1987. Though export growth during the period was not bad,
export did not pick up at the level of import. The current account of the balance of

16
Ibid.
payment deteriorated in late 80's. A continuous increase in budgetary and fiscal deficit
from mid-80's created more pressure on external payment. Along with the frequent
depreciation of Rupees in late 80's, tariff levels were increased which pushed up the cost
push inflation and downed the export. India's historically low inflation exceeded to 17
per cent in August 1991. At the USA Dollar of 10 billion in 1991 (3.5 per cent of GDP),
the current account deficit of balance of payment (BOP) was unsustainable. This long
run failure of macroeconomic management provoked by Gulf crisis of 1990-91, ended
with crisis of foreign exchange in 1991. At the time, India had reserves for just a week
import. This has put down industrial growth at the negative level followed by the burst
of import. So, India had shifted her policy towards Outward-oriented strategy after
1990-91

3.2 Trade Liberalization Period

India officially started out liberalization reform with the external zone reform within the
balance of payment crisis in 1991. The initiation become was taken in the measures;
devaluation of the domestic foreign money, discount in tariff costs, removal of
restriction on import quota, capital inflows and FDI, and abolition of import licensing
device. Indian currency devaluated by way of approximately 22.8 percent in July 1991
relative to a basket of currencies, meanwhile custom tariff price lists have been
decreased with the aid of extra more than 40 percentage, a liberal policy become
followed for FDI with a mechanism of Foreign Investment Promotion Board (FIPB) to
approve the FDI suggestion, and virtually it was made extra open in 2001. Public-region
reform became made by means of casting off the protection and with the involvement of
private sector, private and economic region additionally were made more competitive
disposing of the forms of the protections and regulations. Trade reform initiated getting
rid of quota regulations and tariff fee were decreased notably; and license raj device
become removed in different segments of liberalization reform.

Notably, tariff coefficients are decreased drastically, decrease level until 2008; however,
these coefficients are reducing after early 1980's as defined within the Figure 1. The
sharp reduction is discovered in 1991-1993 and 2004 to 2007. Similarly, figure 2
indicates the fashion of customs tariff costs discount considering the fact that reform
policy adopted; price lists were decreased to 10% in 2008 while the rate turned into
150% in 1991. More sharp reduction inside the tariffs become made until 1995.
 Source: Pursell, Kishor & Gupta (2000)

Source: Handbook of Industrial Policy and Statistics, India

Despite the heavy reduction in tariff rate coefficients and customs tariff shape inside the
reform era, Indian exports accounts only 1 % of world wide’s export share in 2008,
coincidentally equal to the criteria of 1965 as explained in Table 1, which explores
every other important fact that Indian export performance became very susceptible
notwithstanding the attention turned into given to export merchandising in past due
1960's.
Figure 3 explains the overall trade state of affairs of India for the period of 1960-2009
covering the facts for exports to gross domestic product (GDP) percentage, import trade
to GDP percent and merchandise trade to GDP percentage. Until 1980, Indian
merchandised exchange to contribution remained approximately 10% of GDP then it
began to boom until 2008 and Global financial crisis (GFC) pressured it to show down
in 2009. Indian import trade is nicely above than export change on since 1978 and this
example has not been changed even considering that 1960, however the gap is different
through the years. Both import and export alternate have been restrained almost 7% of
GDP until late 1980's, and then import expanded to about 25% of GDP while export
expanded to approximately 20 % of GDP in 2008 displaying the broader gap of trade
balance since 2003.

3.3 Conclusion

The experience of past trade policy of India indicates that the stagnation of export
quarter has caused imbalance in balance of payment. Though the response of financial
system and export area to contemporary reforms has been generally fine,
macroeconomic stresses raised by using reforms posed a brand-new challenge for the
future reform system. During the last one and half years, effect of liberalization isn't so
constructive for the economy. There is a signal of deceleration in boom of import,
export, industrial output and the net invisible receipts. Hence, these problems required
urgent empirical verification. India has done commendable achievements in certain
fields through trade policies. Nevertheless, the policy environment did enable India to
grow to be a large production zone. Its share of GDP has been elevated from 11.5% on
1950-51 to 17.4 % in 1994-95. The positive change caused in composition of import,
Export and GDP over the period is largely because of the IS policy. It is also noticed
that India ought to sustain her economic system from external shocks pretty higher than
other developing countries, particularly at some point of oil disaster (Joshi and Little
1994) A rapid development of technology and industrialization is the wonderful
contribution of IS policy for the Indian economy. Thus, resultants and reversals of the
change coverage of India monitor 83 that India could acquire further higher
development if policies have been properly implemented. Therefore, any failure of trade
policy arises out of incorrect notions and isolation of economic system from the external
zone. The structural transformation in Indian financial system at some point of the time
during the last four and half of decades has furnished enough enjoy to make it feasible
to evaluate the relative function of trade in the process of economic growth. Underlining
the above observations, the project makes a try to measure the long-term link among
trade and economic growth. While quantifying change and growth relationship, effect of
policy shifts is recognized. In adopting time series techniques trade liberalization period
is protected in the semi-liberalized periods as strategies require sufficient wide variety
of observations. Thus, present take a look at specifically taken into consideration policy
length 1) Heavy protection period (1955-56 to 1976-77), 2) Semi-liberalized period
(1977-seventy-eight to 1995- ninety-six). However, Trade liberalization period (1991-
96) is separately considered.
 CONCLUSION

International trade and economic growth are somewhat inter-related. Both of the
concepts are inter-related and very-well affects a country’s economy as a whole. No
country is self-sufficient to produce all the goods and services. Therefore, so as to meet
the demand of goods and services, it becomes necessary for a country to trade.

The very basis of trade is administered by the unequal distribution of the resources
between the trading countries. Classical economists are of the belief that a country who
is equipped with better resources and have sources to extract those resources have a
trading advantage over other countries, as supply is more than demand. But this notion
was only partly true. However, modern economists criticized the same and gave the
concept of dynamic theory of international trade. Therefore, trade and procedure are
modified over time to time. However, the “if” factor governs the whole very basis of
international trade which is that there is no hard and fast rule for international trade.
International trade depends upon the contemporary resources, relation between the
countries, technological availability, balance of payments etc. All these factors are
variable and changing in nature. Therefore, before, the countries have to look upon the
“what if” scenario, so that they are aware of all the dimensions go the trade taking
place. International trade affects the imports and exports, which in turn affects the
income generated by an economy. Net output or Income is an important factor for
determination of economic growth of in an economy. If the receipts of the net exports
are higher, then the trade lays a positive effect on the country’s economy. Similarly, if
the receipts of net imports are higher, then the trade lays a negative effect upon the
country’s economy. The receipts of exports and imports is dependent upon the
conditions and terms of trade, resources employed, available technology etc. If a
country wants to be a part of the international trade, then it advocates the free trade
policy regime. The free trade policies help the trade to take place smoothly. On the
other hand, if a country thinks of the international trade as a threat to its own economy,
it imposes the protectionist policies. Protectionist policy regime puts a check and
balances upon the trade to protect the domestic market of an economy. It imposes
restrictions in the form of tariff, geographical restrictions, quotas etc.
In order to have a clear understanding of the dynamism of the international trade and its
connection with the economic growth, the author did a case study on the foreign trade
policies and how it affects economic growth in India. It revolves around three phases of
India’s foreign policy: It helps to understand the reasons of shift from one policy to the
other one. India, earlier being one of the strict protectionist economies changed into a
liberal economy in 90s. However, Indian economy has faced both the extremes. As a
result, Indian economy work as a blend of both. Not only does it take into account the of
the welfare of the economy and its people, but it also takes into account the prosperity
of the country
 BIBLIOGRAPHY

1) Books Referred:

i. M.L. Jhingan, International economics, Universal Law

Publishing Co. Pvt. Ltd., Delhi, 2005.

ii. World Trade Organization, Making trade work for the

environment

2) Articles Referred

i. Charles P. Kindleberger, “International Trade and National

Prosperity”,

ii. J. Allister McGregor, Nicky Pouw, “Towards an economics

of well- being”, Cambridge Journal of Economics, Vol. 41,
No. 4, July 2017, pp. 1123–1142,
https://doi.org/10.1093/cje/bew044.

iii. Will Kenton, Classical Growth Theory, April 17, 2018. at

https://www.investopedia.com/terms/c/classical-growth-
theory.asp

iv. Esteban Ortiz-Ospina, Is globalization an engine of

economic development, August 01, 2017. at
https://ourworldindata.org/is- globalization-an-engine-of-
economic-development.

v. Shodhganga, Foreign Trade and Economic in India: A

review of Trade Literature and Policies at
http://shodhganga.inflibnet.ac.in/bitstream/10603/96053/9/
09_chapter%203.pdf.