“An excellent idea. This is the kind of book that many students of international political economy, who often feel uncomfortable with the more technical aspects of the subject, will want to consult.”–Andrew Walter, London School of Economics and Political Science

“The Princeton Encyclopedia of the World Economy has a good scope–not too much to be overwhelming but broad enough to cover important topics.”–Douglas Irwin, Dartmouth College

“An excellent idea. This is the kind of book that many students of international political economy, who often feel uncomfortable with the more technical aspects of the subject, will want to consult.”–Andrew Walter, London School of Economics and Political Science

“The Princeton Encyclopedia of the World Economy has a good scope–not too much to be overwhelming but broad enough to cover important topics.”–Douglas Irwin, Dartmouth College

Kenneth A. Reinert is professor of public policy at George Mason University, where he directs the International Commerce and Policy Program. He is the author of Windows on the World Economy and the coauthor of Globalization for Development. Ramkishen S. Rajan is associate professor of public policy at George Mason University and the author of Economic Globalization and Asia. Amy Jocelyn Glass is associate professor of economics at Texas A&M University. Lewis S. Davis is assistant professor of economics at Union College.

The Princeton Encyclopedia of the World Economy

Volume I

PRINCETON UNIVERSITY PRESS

Copyright © 2009 Princeton University Press
All right reserved.
ISBN: 978-0-691-12812-2

Contents

Introduction……………………………….viiAlphabetical List of Entries…………………xiiiTopical List of Entries……………………..xixDirectory of Contributors……………………xxvEntries A-H………………………………..1

Chapter One

A

absolute advantage

A country is said to have an absolute advantage over another country in the production of a good or service if it can produce that good or service (the “output”) using fewer real resources (like capital or labor, the “inputs”). Equivalently, using the same inputs, the country can produce more output. The concept of absolute advantage can also be applied to other economic entities, such as regions, cities, or firms, but we will focus attention on countries, specifically in relation to their production decisions and international trade flows. The fallacy of equating absolute advantages with cost advantages is a never-ending source of confusion. Deviations between the two are caused by the fact that real resources may receive different remunerations in different countries.

In reaction to the mercantilist literature of the 17th century (which advocated state regulation of trade to promote wealth and growth), a doctrine of free trade emerged at the end of the 18th century, culminating in 1776 in Adam Smith’s masterpiece, An Inquiry into the Nature and Causes of the Wealth of Nations. Drawing on the work of others, Smith was able to put many different arguments and elements together in a coherent and systematic framework, organized using a few general principles, and thus providing a new way of thinking about political economy (Irwin 1996). Smith thus provided the first analysis of economic reasons for advocating a policy of free trade and, according to Joseph A. Schumpeter (1954, 374), “seems to have believed that under free trade all goods would be produced where their absolute costs in terms of labor are lowest.”

Smith’s arguments can be summarized as follows. First, he points out that regulations favoring one industry draw away real resources from another industry, where they might have been more advantageously employed (opportunity costs). Second, he applies the opportunity cost principle to individuals in a society-for example, by pointing out that the tailor does not make his own shoes (which would cost him a lot of time) but buys them from the shoemaker (who can produce them more efficiently). Each individual is therefore specializing in the production of those goods and services in which he or she has some advantage. Third, Smith applies the same principles of opportunity costs and specialization to international commercial policy and nations. It is better to import goods from abroad where they can be produced more efficiently, because this allows the importing country to focus production on the goods it can itself produce efficiently. The primary (classical) reason for international trade flows is therefore a difference of technology between exporter and importer.

Principle of Absolute Advantage To illustrate the principle of absolute advantage, suppose that there are two countries (the United States and Japan) producing two goods (food and cars), using labor as the only input. Assume that goods can be traded without costs and workers are immobile between the two countries, but mobile between the two sectors within a country. All workers in a country are equally productive. Production technology in Japan differs from that in the United States (see table 1). We assume that Japan requires three units of labor to produce one unit of food, whereas the United States requires only two units of labor. Similarly, Japan needs six units of labor to produce one car, whereas the United States needs eight units of labor. Since Japan is more efficient in the production of cars and the United States is more efficient in the production of food, Japan has an absolute advantage in the production of cars and the United States has an absolute advantage in the production of food.

To show that specialization of production, coupled with international trade flows according to absolute advantage, can be advantageous, in our example suppose that the United States produces one car less. This frees up eight units of labor, which can now be used to produce 8/2 = 4 units of food (opportunity cost of car production in the United States). The United States has now produced one car less and four units of food more. Suppose that the United States wants to consume the same number of cars as before. It must then import one car from Japan. To produce this car Japan needs six units of labor. These laborers must come from the food sector, where production therefore drops by 6/3 = 2 units of food (opportunity costs of car production in Japan). Now note that the total production of cars has been unchanged (one car less in the United States and one car more in Japan), while the total production of food has increased by two units (four units more in the United States and two units less in Japan). These extra units of food reflect the potential gains from specialization if both countries concentrate in the production of the good they produce most efficiently. In principle, both countries can gain: for example, if they exchange three units of food for one car.

Complications and Limitations There are several caveats to the foregoing analysis, some of which we discuss now.

Absence of absolute advantage: The example discusses a situation where one country has an absolute advantage in the production of one good and the other country in the production of another good. It is frequently argued that developing countries may lack the technology to gain an absolute advantage in the production of any good, such that they cannot possibly compete on the global market and benefit from free trade (in table 1, for example, if the United States needs four laborers to produce one unit of food). This conclusion is wrong, however, according to David Ricardo’s model of comparative advantage (which emphasizes labor as the primary production factor and attributes the costs and benefits of trade to the differences in opportunity costs among countries), since technologically disadvantaged countries can compete on the global market by paying lower wages. It turns out that absolute advantage is neither a necessary nor a sufficient condition for exporting a certain good and gaining from international trade.

More factors of production: In reality, goods are produced using several factors of production simultaneously, such as capital, land, and various types of labor. Usually, goods then cannot be ranked according to absolute advantage as their production in one country requires more of one input and simultaneously less of another input than in another country. These issues are analyzed in the Heckscher-Ohlin (factor abundance) theory of international trade.

Intra- versus interindustry trade: The example discusses interindustry trade, which is the exchange of one type of good (cars) for another type of good (food). Many countries engage in intraindustry trade, the exchange of similar types of goods (e.g., simultaneously exporting and importing car parts). This type of trade is becoming evermore important. It can be based on market power and economies of scale, as analyzed in New Trade Theory.

Absolute Advantage, Income, and Wages Despite the limitations and complications just discussed, absolute advantages (as reflected by differences in technology) are important for explaining current international trade flows and differences between countries in terms of income levels and wage rates. Daniel Trefler (1995) systematically analyzes these issues by combining the Heckscher-Ohlin model with technology differences, while taking into consideration the empirically observed home country bias (a consumer preference for domestically produced goods over otherwise identical imports). This combination explains about 93 percent of international trade flows. It also shows that technology differences are largely responsible for the deviations in income levels (and wage rates) between, say, the African countries and the high-income countries of the Organisation for Economic Co-operation and Development. For this reason absolute advantage does retain relevance for understanding the modern world economy.

See also comparative advantage; economies of scale; gains from trade; Heckscher-Ohlin model; intraindustry trade; newtrade theory; revealed comparative advantage; Ricardian model; trade and wages

* access to medicines

The term access to medicines encompasses the array of problems faced by the world’s lowest-income inhabitants, who often cannot afford, or do not have access to, medications that could greatly reduce the disease burden under which they suffer. The problems include deficient medical infrastructure, imbalances between prices and ability to pay, and the lack of incentive to develop medicines that would treat diseases endemic to low-income nations.

During the 20th century, numerous technological breakthroughs in pharmaceutical therapy made it possible to cure or at least alleviate most of the diseases that have killed or debilitated millions of people each year. But the ability to purchase those medicines is concentrated in relatively affluent nations, where the vast majority of pharmaceutical sales occur. At the other extreme, roughly 60 percent of the world’s population live in nations defined by the United Nations in 2000 as “low income,” with per-capita gross national product averaging less than $530 (at prevailing exchange rates) a year in 1998. The World Health Organization (WHO) (2004, 61) estimates that in 1999 those nations made only 2.9 percent of the world’s pharmaceutical purchases. The WHO has predicted that by expanding access to available health interventions, and especially essential medicines, 10.5 million lives could be saved annually by the year 2015. Lack of access to medicines and complementary health care in turn perpetuates a vicious spiral: poor health impairs productivity and economic development, while low productivity keeps the citizens of the least-developed nations too poor to afford appropriate health care.

Affordability The medicine access problem has several facets. The overriding problem is inability of individuals to afford medicines. Health insurance is an absent corrective; an estimated 90 percent of the people in developing nations lack such insurance. Inability to pay restricts not only the demand for medicines but also the supply of physicians able to diagnose diseases and recommend appropriate therapies. Nations classified as low income in 1998 by the United Nations had 70 physicians per 100,000 population; those classified as high income, 252. In many instances, the only advice available comes from traditional practitioners whose herbal remedies may work for some indications, but with at best erratic success due to the lack of evidence from controlled experiments. For diseases such as AIDS, malaria, and tuberculosis, carefully administered therapy regimens must be maintained to inhibit the emergence of resistant strains. Counterfeit versions of first-world drugs continue to be a significant problem, in part because third-world health-care authorities lack systematic testing and approval institutions.

In their efforts to combat the burden of disease, health authorities at the WHO and in individual less-developed nations have since 1977 published “model lists” of so-called essential drugs. Drugs have been included on the list in part because of their proven efficacy and partly because of their relatively low-cost. Low cost in turn has been achieved by emphasizing generic drugs, that is, those on which patent rights restricting supply to a single firm have expired. Historically, more than 90 percent of drugs on the WHO’s model lists have been generics. However, this emphasis was threatened by the emerging epidemics of HIV/AIDS and related opportunistic diseases such as resistant tuberculosis and cryptococcal meningitis. Virtually all of the drugs effective against those diseases were patented and, at least initially, available only at costs for a year’s treatment exceeding total average incomes of citizens in low-income nations.

The Trade-Related Aspects of Intellectual Property (TRIPS) agreement culminating the World Trade Organization’s (WTO) Uruguay Round Treaty, signed at Marrakech in April 1994 and implemented in 1995, exacerbated this situation. Up to that time, many less-developed nations, emulating some more prosperous countries, were able either to produce or, more likely, import patented drugs because they granted no patent rights on pharmaceutical product inventions. TRIPS required that signatories to the Marrakech treaty begin awarding such patents-within one year for the wealthiest nations, five years for middle-income countries, and ten years (later extended to the year 2015) for the least-developed nations. Transitional provisions also required grants of marketing exclusivity for post-1994 inventions on which initial patent applications were filed. Especially for AIDS and AIDS-related diseases, this posed special problems. Up to that time, the newest and most effective drugs might be available generically from India and other nations that had not awarded pharmaceutical product patents. But as the TRIPS provisions began to bind on India, Brazil, South Africa, and other nations, their ability to continue supplying low-cost generics atrophied.

The combination of TRIPS and the AIDS epidemic precipitated a crisis. Two main solutions emerged. First, at a joint WHO-WTO conference in Hsbjr, Norway, in April 2001, a consensus emerged encouraging the world’s leading research-oriented pharmaceutical companies to practice “differential” or “Ramsey” pricing. The companies would charge high prices in rich nations and make life-saving drugs available to consumers in low-income nations at prices approaching marginal cost. From what had been near parity of AIDS drug prices across rich and poor nations (Scherer and Watal 2002),wholesale prices were shown by Lucchini et al. (2003) and the UK Department for International Development (2005, 22) to have plummeted in the least-developed nations, in some cases by as much as 98 percent. One consequence of such discriminatory pricing was the reexport of low-price drugs to high-price nations, but steps to suppress this “parallel trade” were quickly implemented. Donations from multinational pharmaceutical firms to organizations providing health care in less-developed nations-in effect, sales at a zero price-also helped increase access to essential medicines.

Second, because of exceptions written into the original TRIPS agreement, nations were able to threaten or actually implement compulsory licensing of existing or new patents on AIDS and other epidemic disease drugs in order to authorize generic production. Threats of compulsory licensing induced multinational patent holders to reduce sharply the prices of their branded drugs in the third world and enter into voluntary agreements with such nations as Brazil and South Africa to permit generic supply. A limitation in the original TRIPS text was that production under a compulsory license was to be “predominantly for the supply of the [Member’s] domestic market.” However, many of the world’s least-developed nations lacked both the technological know-how and sufficient market scale to produce generics for their own use. A permissive amendment to the TRIPS agreement accepted in August 2003 following a mandate issued at the Doha Round of international trade negotiations in 2002 alleviated this problem. The TRIPS agreement does not require nations formally to report compulsory licensing decrees, and as of 2006, only an AIDS drug license by Thailand to a government entity, minimally controversial under TRIPS, had come to light publicly. The existence of other unreported cases cannot be ruled out. Alternatively, post-2000 price and voluntary license developments may have been sufficient to satisfy the limited ability of low-income nations to distribute drugs effectively.

Incentives for Drug Development Another fundamental problem preventing access to medicines is the lack of innovative drugs targeted specifically toward diseases prevalent only in the third world, for instance, sleeping sickness, Chagas disease, and leishmanisais. Because low-income nations have limited purchasing power, multinational pharmaceutical firms lack demand-based incentives for research and testing on drugs targeted toward the so-called tropical diseases and the resistant strains that continue to evolve. A study for Medicins sans Frontires (2001) revealed that among 1,393 new drug chemical entities introduced into world markets between 1975 and 1999, only 13 (or 15 counting tuberculosis) drugs were indicated for tropical diseases. Also deficient has been the development of vaccines that could prevent diseases curable using modern medicines, but at costs too high to be sustained by overstressed third-world medical care providers.

(Continues…)

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