How important international trade is for the less developed nations is indicated by the fact that it frequently accounts for 20 percent or more of their total economy as against 8 percent for the economy of the United States. Indeed, trade is much more important to them than aid. Total exports of the less developed areas amounted to $31 billion in 1960, while the total flow of financial assistance from the industrial nations (including private foreign investment) amounted to $8 billion.

Despite these facts, very little is being done either within the less developed nations or through various aid programs to encourage their exports. Indeed, there is a disturbing trend toward policies which actively work in the opposite direction. The failure to stress the importance of international trade is serious, since unless these nations can expand it they cannot achieve their aspirations for accelerated development and for a rapid growth in living standards.

Consequently, it is pertinent to: (1) review the role which exports have played in the development process; (2) examine critically the argument that a developing nation should now concentrate its efforts on local industrialization and play down its traditional trade in food and industrial raw materials; and (3) consider what could be done through commodity agreements or other policies to promote exports from the less developed nations.

In recent years there has been a significant change in the composition of the trade between the industrial and less developed nations. The traditional pattern, and the dominant one until the end of World War II, involved an exchange of primary products (food and industrial raw materials) from the less developed nations for manufactured consumer products from the industrial nations. The United Kingdom, many continental European nations and Japan supported their industrial development by trading textiles, flour, shoes and other consumer products for such primary products as cotton, cocoa, sugar, hides, copper and jute. In such a trading system, it was difficult for local manufacturing to get under way in the less developed nations, though a start was made in the 1920s and 1930s.

The growth of light consumer industries in these nations accelerated during World War II and the early postwar period, when the industrial nations could not meet the world-wide demand for consumer manufactured products and export earnings were high. These facts, plus the natural development of an entrepreneurial class and the spread of various forms of protection, led to a considerable growth of light consumer industries in many less developed nations during the past two decades. Private foreign investment has played an important part in this development, with the emphasis changing from primary-products industries before 1950 to investment in local manufacturing and distribution in recent years. Private investment has also helped to develop local technical and managerial competence.

The result has been a significant shift in the composition of international trade. A major part of the export earnings of the less developed nations now goes to buy the capital goods needed to support their industrialization and general economic development. This process can work to the benefit of all trading nations. The industrial nations gain through the expansion of markets for their capital goods and other manufactured products, as well as through an expanding inflow of primary products which can be produced more efficiently in the less developed areas. These latter gain through their ability to import not only capital goods but the techniques necessary for modernization.

The growing industrialization of the less developed nations through this two-way trade can lead to an expansion in world trade. Experience shows that the greatest and fastest-growing volume of trade takes place among nations where internal development is proceeding most rapidly. The very number of products used by developing nations multiplies geometrically, so that through the process of specialization every nation is able to find exports which can be sold competitively on world markets.

For all these reasons, it would appear that one of the major economic objectives of free-world nations should be to promote an expanding volume of trade between the industrial and less developed nations.

II

Our progress toward this objective in the past decade can hardly be termed satisfactory. There are, to be sure, some exceptions (most of them associated with petroleum); but as a general rule the trade of the less developed areas has lagged in recent years. Their share in world exports has declined steadily, from 31.5 percent of the total in 1953 to 24.7 percent in 1960. Since 1956, total exports of less developed areas have been growing only 2 percent per annum as against 6.5 percent for the industrial areas. The lag has been particularly severe in the case of Latin America, where, excluding Venezuela, exports have been rising only half of 1 percent per year.

This slow growth in export earnings of the less developed areas reflects a leveling off in the volume of most food and raw-material exports (there have been actual declines in a few, such as wool and nitrates) and a general weakness in prices. In many cases, the decline in export earnings has more than offset the increase in financial assistance from the industrial nations. Coffee surpluses plague Brazil, Colombia, Central America and many African nations. Prices of nonferrous metals, cocoa, cotton and wheat have been weakening. Virtually all of the less developed nations have found that their export earnings are insufficient to finance the imports they feel are needed to support their development.

These recent trends in markets for primary products have lent support to economic theories which argue that developing nations should turn away from the export of primary products and emphasize local industrialization. The thesis, as advanced by economic theorists in many of the less developed countries, is that the industrial nations have managed to get all of the advantages from the world-wide rise in productivity and have deprived the areas producing primary products of their share; that long-term price trends show much greater increases in prices of manufactured products than in prices of foods and industrial raw materials; and that because the terms of trade go steadily against them in this manner, the less developed areas do not share in world-wide development, and cannot import enough to meet their aspirations.

In addition, it is argued that commodity prices have been widely unstable; hence commodity exports cannot provide a reliable basis for economic development. Out of this line of argument come a number of policy recommendations: (1) developing nations must stress industrialization, since they can find little nourishment in developing commodity exports; (2) the industrial nations have an obligation to share the fruits of progress with the less developed areas through aid and commodity stabilization schemes; (3) investment even in inefficient domestic industries will benefit a developing nation more than would the same investment in commodity export lines.

The argument that the terms of trade go against the less developed areas in an inexorable manner has been shot to pieces by many analysts. The price indexes on which it rests are faulty in many ways; they do not properly allow for the improvement in the quality of manufactured exports, nor for the substantial reduction in the costs of transportation. Experience shows that many nations have successfully supported their industrial development by pushing food and industrial raw-material exports-among them the United States, Canada, Mexico, Australia (and even the United Kingdom depended heavily on coal exports for a century or more).

Nevertheless, the thesis of declining terms of trade dies hard. It fits into a superficial interpretation of recent economic history and provides a perfect rationalization for politicians of all parties: they can lay the blame for low living standards and slow progress on world markets.

While there is no evidence of a long-term deterioration in prices of primary products relative to those of manufactures, there are two features of trade in primary products which are significant. Many individual products display: (1) a lower-than-average growth trend over the long term; and (2) wide fluctuations in prices. Exports of many food products are linked chiefly to the growth in population in consuming areas, since there is little evidence of a major upward trend in consumption per person. Since population in the industrial areas grows less rapidly than total incomes, this means that demand for many imported food products lags behind the general growth of the industrial economies. In addition, trade in temperate- zone farm products has been limited by government measures to support uneconomic local production in Western Europe.

Exports of many industrial raw materials are influenced by the tendency of industrial economies to use steadily smaller volumes of raw materials per dollar of output. Measured in constant prices, the United States used 22½ cents worth of raw materials for each dollar of gross national product in 1900. In 1960 we used only 11½ cents of raw materials per $1 of gross national product. This trend has accelerated in the past 20 years. We economized in the use of raw materials at a rate of .1 percent per annum from 1900 to 1940, and at a rate of 1.8 percent per annum since 1940.

Two factors underlie our ability to get more final production per unit of raw materials. One is the growing importance of service industries, which use fewer raw materials per unit of output than is the case in manufacturing and building. This increase in services is reflected in the fact that only 35 percent of workers are now employed in manufacturing and construction, as compared with 43 percent in 1919.

A much more important factor in recent years has been the increasing efficiency with which raw materials are used. This shows up in many ways: electric utilities produce steadily more kilowatts of power per pound of coal or per b.t.u. of other fuels; auto tires last longer, requiring less rubber per mile; less steel is used per tin can, or per given unit of capacity of a highway bridge. In addition, scrap is used more effectively, and synthetics are replacing natural products in some lines.

While all these factors point to a slower growth in consumption of primary products than in gross national product in the industrial nations, over-all prospects for food and industrial raw-materials exports from the less developed nations are not at all bleak. Consumption of some primary products will rise more rapidly than the average-for example, petroleum, bauxite, aluminum and the newer metals.

Moreover, the price weakness which followed the Korean War boom in commodity prices is gradually being corrected. The major exception appears to be coffee, where production continued to expand even with sharply lower prices. In other markets, the continuing growth in demand, together with measures to restrain the increase in productive capacity, could bring a better balance in the years ahead and reasonable levels of prices for producers.

A second broad characteristic of most commodity markets is the fact that prices fluctuate widely. Demand is not very sensitive to price changes in the short run, and therefore a shortage leads to a more than proportionate increase in price. As an example, the 1949 freeze in Brazil reduced the world output of coffee only moderately, but prices doubled. On the other side, the supply of many commodities is relatively inelastic, so that severe price declines have relatively little effect on the volume produced in the short run.

The wide fluctuation in commodity prices is illustrated by three principal Latin American exports over the past decade: The highest coffee price was 75 percent above the average and the lowest 50 percent below it; the highest cocoa price was almost double the average and the lowest almost half the average; the highest sugar price was 50 percent above average and the low 25 percent below the average. Obviously, then, a nation heavily dependent on exports of one or two commodities will find earnings fluctuating widely (except where the commodity is oil). Sixteen of the Latin American republics derive more than half their export earnings from one or two commodities.

There has been so much emphasis on the fluctuating nature of commodity prices that it is worth examining the problem in several dimensions.

First, it should be noted that prices fluctuate upward as well as downward.[i] Over the past 60 years the less developed areas have gained more from the upward fluctuations than they have lost in periods of declining prices. In other words, if at any time in that period-except in the 1930s and the late 1950s-a bargain had been worked out to stabilize commodity prices at their average relationship to industrial prices, the less developed areas would have been the losers.

The record shows that export earnings from individual manufactured products have been just about as unstable as those from individual commodity exports. The fact is that foreign trade is a fluctuating business, and apart from the hazards of weather in the case of farm products, there appears to be little to choose as between manufactured and primary-products exports on the grounds of stability. Most of the complaints about commodity prices by suppliers relate to the failure of prices to hold at, or move ahead from, historic highs. It appears to be a natural attribute of sellers to regard the most recent high as a norm.

Secondly, it is frequently overlooked that, while the demand for and the supply of commodities are relatively insensitive to price changes, they are not absolutely insensitive. More coffee will be sold at a lower rather than at a higher price, and declining prices will sooner or later lead to a reduction in supply. Many of the mistakes in dealing with commodity problems stem from a failure to understand the simple economic truth that the law of supply and demand is a peculiarly inexorable law even in the hands of government. This is important, for although it would be possible and even useful to devise a workable mechanism to reduce wide fluctuations in commodity prices-through a buffer-stock mechanism or by an international agreement to limit price fluctuations in any year within a range around the previous year's average-any attempt to hold the price of a commodity above that dictated by supply and demand will be very costly and probably ineffective.

A third point about the instability of commodity prices is that prices of individual products seldom move up and down in unison. Thus, diversification of commodity production and exports can contribute greatly to stability and growth in a nation's export earnings. Mexico, Peru and Canada provide examples of nations with diversified export lists and with both stability and growth in export earnings.

A final point is that misguided domestic economic policies frequently do more damage to export earnings than changes in world market conditions. The most direct way to discourage exports is to tax them-as, for instance, Mexico, while encouraging other exports, taxes exports of most minerals. Multiple exchange rates can also have the same effect as a tax on exports; Brazil's exchange system discouraged cotton and cocoa exports until about a year ago. Of all domestic policies, however, inflation is perhaps the most effective in deterring exports. When domestic prices rise more rapidly than the exchange rates depreciate, domestic costs rise faster than export receipts, exports become less profitable and their volume declines. The best remedy is, of course, price stability. If that is not achieved, a nation must be willing to devalue promptly and repeatedly to maintain a realistic relationship between domestic and foreign prices.

III

What does all this mean for United States foreign economic policy? Our broad objective continues to be that of supporting the sound development and growth of the less developed areas. The burden of the foregoing argument is that one of the most important steps we can take toward this objective is to promote the growth of trade between the industrial and less developed areas. Thus, it is important to evaluate a number of policies which have been advanced in the trade field to see if they would contribute to an expanding volume of trade.

The most immediate question concerns the attitude of the United States toward international commodity agreements. These agreements seek to stabilize prices through the coöperation either of producing nations alone or of both consuming and producing nations. In some cases, they operate through a buffer-stock mechanism under which supplies are purchased for the stock when prices are below a minimum figure and sold from the stock when the price goes above a maximum figure. In other cases, export quotas, or a combination of export and import quotas, are used in an attempt to control the supplies reaching markets, hence the price.

Experience with commodity agreements extends over many decades; one of the earliest was a whale-oil agreement almost a century ago. In more recent years, arrangements have been set up in such fields as wheat, sugar, coffee and tin. None of these agreements has been notably successful. Those consisting of producer groups usually try to hold prices at a high level, thereby providing substantial incentives for nations to stay out of the agreement. Some agreements have broken down because producing and consuming nations have been unable to agree on prices, while in the case of farm products, where supply is difficult to control, the attempt to prop up prices can lead only to mounting surpluses.

None the less, I believe the United States should coöperate with less developed areas to see whether workable commodity agreements can be negotiated. If such efforts are directed at limiting short-term price fluctuations while allowing long-term forces of supply and demand to operate, they may serve a useful purpose. In the process, the mechanism of international study groups may help spread an understanding of the mutual problem of supplying and consuming nations, and may perform valuable educational services.

However, the United States should seek to orient commodity agreements in a generally liberal direction in the sense that they should be directed at expanding world trade instead of developing into tight international cartels. The objective should be to facilitate the adjustments required by free markets rather than to replace free markets with rigid controls and high prices.

The International Coffee Agreement, which was signed by the United Nations coffee conference last September, may serve to bring the issues involved in commodity agreements into sharp focus. Coffee is in massive oversupply, with carry-over stocks equal to about two years' consumption and with estimated production for the crop year 1962-63 almost 20 percent above world consumption. While the details have not been fully spelled out, the coffee agreement is essentially an attempt to hold up, or increase, prices by imposing quotas on coffee exports from producing nations. The five-year agreement places export quotas for the first year at 45.6 million bags, slightly higher than shipments in recent years. Importing countries are required to hold purchases from non-members at the average level of the past three years. The export quotas are to be enforced by requiring a certificate of origin for each coffee shipment. The agreement also contains provisions calling on producing nations to reduce coffee production to bring it in line with export quotas.

While the agreement may bring stability to coffee markets in the short run, it remains to be seen whether it can work to the advantage of producing nations in the longer run. If the idea that it should be used to raise coffee prices is pursued, the agreement is likely to break down, because prices which are well above the costs of efficient producers will provide a very strong incentive to increase coffee production and exports. The agreement's mechanism for restricting production appears to be weak, as is likely to be the case with a farm product turned out by a great many farmers. If the export-quota mechanism should break down, it might be possible to set up a series of import quotas in consuming nations as a means of bolstering prices. If, as has been the case in sugar, major consuming nations will control imports tightly, prices can be maintained at levels well above those which would prevail in free markets. However, even if the coffee agreement can be made to work in one way or another, a number of basic problems will remain. An obvious one is that of dealing with existing surplus stocks and present surplus productive capacity. Ultimately, exporting nations must take steps to shift from coffee to more useful pursuits.

This highlights the basic problem. If commodity agreements can be used as a device to ease the transition from over-production of certain primary products to expanding production of other things which are in demand, then commodity agreements can serve a constructive purpose. But if they serve merely to pile up surpluses, then commodity agreements will either break down or divert productive resources to unproductive ends. The experience of the United States with its extremely costly farm price support programs should be studied by all those who propose to prop up prices through international commodity agreements.

In stressing the problems involved in commodity agreements, I do not wish to leave the impression that nothing can be done. Where supply can be controlled, they may work to the general advantage, provided consuming and producing nations can agree on an orderly development of the world's resources. Where the control of supply is more difficult, as is generally the case in farm products, commodity agreements might still ease the transition from oversupply to a more balanced situation.

However, there is another approach which maybe more promising than commodity agreements in certain situations. This is to compensate less developed nations for sharp reductions in exchange earnings due to a drop in the price or export volume of commodities. Our real objective is to maintain the ability of these nations to import, and thus support their domestic development. It seems to me better to do this directly by lending them money to minimize the impact of fluctuating export earnings than to go into the indirect and exceedingly difficult process of stabilizing commodity prices.

A number of schemes for insuring export earnings have been worked out. One would provide long-term loans whenever a nation's earnings from exports of primary products fell more than 5 percent short of the previous three years' average. The loans would cover 50 percent of the export short-fall and would be repayable when export earnings rose above the three-year moving average. Without necessarily endorsing this particular scheme, I think that efforts along these lines would be much more constructive than those devoted to commodity agreements. For one thing, it would allow the laws of supply and demand to operate more effectively in commodity fields.

Trade policies of the United States also have an important impact on the less developed nations. We have tariffs and quotas on a number of primary products which we produce, and we subsidize a number of farm products which are exported in competition with less developed areas. The list of products under some form of restriction includes grains, cotton, wool, tobacco, meats, copper, lead, zinc and petroleum. In many cases, the restrictions on imports of primary products into Western Europe are even more constrictive. We should work to reduce such restrictions as rapidly as possible, for they interfere both with domestic objectives of growth and prosperity and with the flow of trade with the less developed areas. The importance of such action is shown by a study of the National Planning Association estimating that removal of U.S. restrictions against primary products coming from Latin America alone would result in increased export earnings for that area of from $850 million to $ 1.7 billion a year.

The development of the European Economic Community poses new and difficult problems, particularly for Latin America and other less developed areas not associated with Europe. As presently oriented, the E.E.C. would discriminate against outsiders in favor of associated territories, among which the less developed nations of the British Commonwealth seem unlikely to be included. It seems to me that we have a major responsibility to persuade the E.E.C. to eliminate discriminatory arrangements for trade in primary products.

IV

Up to this point, the convenient assumption has been that the less developed areas export only primary products. However, India and Hong Kong are already significant exporters of textiles and apparel. An inevitable result of the modernization process is that the less developed nations will increasingly become able to sell more and more manufactured products to the industrial nations on a very competitive basis. To absorb these products will pose difficult problems of adjustment on the part of the industrial countries.

In dealing with such problems, it has been proposed that the industrial nations should offer what has been termed "one-way free trade" to the less developed areas.[ii] The industrial nations should be prepared to accept without tariff or other restrictions both the primary and industrial products offered by the developing nations, at the same time allowing them to set up tariffs and other devices to protect their infant industries. Such actions might provide the most significant support to international development which the industrial nations can offer.

In return for such great generosity, the industrial nations should seek agreement from the less developed areas on two points:

The industrial nations should not be flooded by exports from the less developed areas. They should be allowed time to adjust to the increased ability of the less developed areas to export a specific product so that the impact is not unbearably heavy.

On the other side, the less developed areas should not discriminate against industrial products forever. In their own interests, there should be some incentive to make infant industries grow up to the point where they can compete in world markets. I would allow plenty of time for the process to work, say, 15 to 20 years, or possibly longer in certain cases. But I believe it is very important that the United States use its influence to bring about an eventual reduction in tariffs in the less developed areas. Otherwise we face the prospect of a world economy split into autarchic trading blocs.

In advocating one-way free trade, I am fully aware of the opposition it will meet. The recent textile agreement, which quite effectively restricts the growth of exports from certain low-cost producers in the less developed areas, illustrates the problem. If the textile agreement were designed to spread over time the adjustment to increased imports of low-cost products from the less developed areas, it would be satisfactory. However, it proposes to freeze a past pattern of trade, thus insulating producers in the industrial areas from international competition.

While the textile agreement was framed in response to very powerful political pressures which are not easy to resist, I believe we must continue to press for one-way free trade. In the long run, the industrial nations must learn to accommodate the exports of the developing nations, even at the cost of awkward problems of adjustment. Painful though they may be, such adjustments work in the long-run interests of the industrial nations, which will be able to obtain consumer goods at lower costs, while shifting their production to the more highly technical products where their international advantage is greater.

Paradoxically enough, one-way free trade can operate in a two-way fashion. The greater the export earnings of the less developed nations, the more they will buy from the industrial nations. By opening up avenues for the export trade of the developing nations, and making the adjustments required in the process, the industrial nations can advance their own well-being and at the same time provide the support needed to enable the less developed nations to achieve self-sustaining economic growth. In the final analysis, an expanding world trade is the only way to provide markets for the products of both industrial and developing nations, and to support the economic development needed to achieve the broad objectives which the free world seeks.

[i] Many of the ideas in this section were developed by Stacy May in "Folklore and Fact About Underdeveloped Areas," Foreign Affairs, January 1955.

[ii] See Alfred C. Neal, "New Economic Policies for the West," Foreign Affairs, January 1961.

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