A smooth transition of an economy from stagnation to progress is thus not inconceivable, particularly when foreign aid supplements the economy’s own efforts. But the conditions making for it are much too hypothetical; it is very much more probable that the transition will be marked by an adverse foreign balance which will need to be met by forced restriction of normal imports.
It will be the contention of this note that the state of unbalance in foreign trade tends to pursue the economy in the entire course of economic growth, in so far as the rate of growth is maintained or accelerated over a given period. Internal maladjustments of an inflationary character, if these take place, as they often do, only reinforce the tendency. These additional complications, however, are not considered here; the assumption is the extreme-most favourable one of equality between aggregate saving and aggregate investment at constant prices.
With the growth of the economy, will the degree of unfavorable-ness in foreign balance be growing, remain constant or be reduced? The answer to this obviously depends upon the rate at which exports will be growing relatively to imports. With an initial trade deficit covered by foreign reserve or aid, the degree of unbalance will be reduced only when the rate of growth of exports substantially exceeds the rate of growth of imports. For even if the rate of growth of exports equals the rate of growth of imports, the absolute amount of deficit will tend to grow over time. More so will be the case if the rate of growth of exports falls behind the rate of growth of imports. So foreign balance is important.
Assume that the ratio between foreign capital and domestic output remains constant. Then the rate of growth of imports depends solely upon the marginal propensity of income earners to import. If this happens to be higher than the average propensity, the rate of growth of imports will tend to exceed the rate of growth of aggregate income. Now in the case of a developing economy of the type we are envisaging, this may well be the case. For one thing, as a person’s income increases he is inclined to shift to superior goods, and since such goods are yet scarce at home, there may be a tendency to turn to imports. The so-called demonstration effect of economic development is an aspect of this tendency.
For another, in the course of economic development at any rate in the earlier stages the distribution of income tends to be more unequal, if only because growth results in the emergence of shortages in skill and entre-preneurship in the economy for which abnormally high rewards need to be paid. An enlightened Government does no doubt take measures to prevent this tendency; but experience suggests that the tendency is too strong to be eliminated altogether. There is thus a strong probability that in a developing economy the marginal propensity to import should be an increasing function of income. So foreign balance is important.
What happens to exports? Is there any tendency for the elasticity of exports necessarily to assume a value higher than or equal to the income elasticity of imports ? Here one does notice a certain lack of symmetry. For, whereas with growing income at home there is a natural tendency for imports to grow, there is no such natural tendency in the case of exports. The behavior of exports is determined very largely by forces outside the economy. It is a function of the rate of growth in the rest of the world, the regional distribution of income and the state of international competition factors which are all external to the economy. If the rate of growth in the rest of the world, particularly in those countries with which our developing economy has special trade ties is less than the rate of growth at home, the elasticity of exports of the economy would tend to be lower than the elasticity of imports. So foreign balance is important.
Further, even if the foreign markets show a favourable growth rate, movements in the pattern of trade and in international competition may be such as to prevent our economy from maintaining its share in world exports. While its own consumers would show a tendency, as their incomes grow, to shift to superior foreign goods, thus raising the country’s marginal propensity to import, there is less reason to expect that, with equal rates of growth in the rest of the world, there should be a commensurate growth in the foreign consumers’ demand for its own exports, especially those that are of a traditional character. A developing economy may thus find itself in a peculiar predicament of having a growing deficit in its balance of trade.
And in so far as such deficits cannot be met by foreign aid, it has therefore to continue with the policy of trade controls. The experience of our own country during the last twelve years of planned economic development seems, to bear this out, although the difficulties inherent in development may have been enhanced here by internal cost inflation. So foreign balance is important.