Immiserizing Growth

Seems to be a week for International Trade Theory, so today’s topic is “immiserizing growth”, something that can happen when the ‘small country’ argument in the standard Ricardian model doesn’t hold. Two articles appeared in the same edition of the Globe and Mail that illustrate this phenomenon. Both deal with the acquisition of iron ore mining interests in Canada by foreign interests. One is a story about China, and one is a story about India.

A small country is one that is small enough, economically, that they can’t affect the world price of traded goods. When that is true, the world supply of the country’s imports appears to be perfectly elastic, as does the world demand for the country’s exports. For most countries in the world this is an accurate assumption. For large countries, however, an increase in imports and/or exports can alter world prices. Canada, for example, is too small to affect world prices. The United States is not. China has become a large country and India soon will be a large country.

The economic boom in China has caused a global increase in the demand for raw resources such as coal, iron ore, copper and oil. As a result, the global equilibrium price is rising. That is good news for countries like Canada, Brazil and Australia that export these commodities, but bad news for China and India that import them. As input prices rise, the cost of production rises and the price of their exports most rise. This reduces terms of trade in the growing countries and slows the export driven growth. Under extreme circumstances, the increase in input prices can cause economic growth to stop, and ultimately lead to an economic contraction – immiserizing growth.

In an effort to secure supplies of iron ore and thus prevent input prices from rising, both China and India have purchased interests in Canadian producers of iron ore. Watch for more investments in Canada, Australia and Brazil.