Trade Policy Note Final-rev08 - Development

Section IV – Exports and Poverty
Section V - Agriculture
Section VI - Trade in Services
Section VII - Investment
Section VIII - Movement of Natural Persons
Section IX - Intellectual Property for the Poor
Section X - The FTA Option
Section XI – Sectoral Annexes
II.
POLICY SPACE FOR FUTURE NATIONAL
DEVELOPMENT STRATEGIES
Theoretical Context
The purpose of this Policy Note is not to discuss or focus on trade theory.
Nevertheless, some theoretical context is nevertheless useful to anchor the policy
discussion elaborated in this paper. A brief theoretical context is, therefore,
summarized below. 1
Few branches of the literature on economics are richer or more controversial than that
on international trade. There has been little consensus on the relationship between
trade and short- to medium -term economic growth—and even less on its role in longterm
economic development.
The principle of comparative advantage, first described by David Ricardo, forms the
theoretical basis for tradit ional trade theory and provides the rationale for free trade.
The principle states that even if a country produced all goods more cheaply than other
countries, it would benefit by specializing in the export of its relatively cheapest good
(or the good in which it has a comparative advantage).
Some classical economists believed that comparative advantage was driven by
differences in production techniques. Later theoretical developments identified
differences in factor endowments as the principal basis for comparative advantage.
Traditional trade analysis acknowledged the argument for policy intervention
(protectionism) if market failures created a need for temporary protection of infant
industries—though direct subsidies were still considered preferable. Intervention was
also justifiable, though still discouraged, if it could improve a nation’s terms of trade
by deploying market power. But these were exceptions to the general principle that
free trade is best.
Traditional trade theory has been challenged beca use it often cannot explain actual
trade patterns. Careful empirical investigations show that many of the theory’s basic
assumptions - perfect competition, full employment, perfect factor mobility within
countries, immobile factors between countries—are unrealistic and do not conform to
theoretical predictions. When these assumptions are relaxed, welfare and other
1 See UNDP et al., Making Global Trade Work for People (London and US: Earthscan, 2003)
(www.earthscan.co.uk), p.25.
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