5 Trade Policy as a Strategy for Structural Adjustment
Author:
SUHADI MANGKUSUWONDO
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Language:
English
Print Publication Date:
15 Mar 1990
Keywords:
BOOK; structural adjustment; export; country; economy; developing country; export orientation; industrializing economy; primary-producing country; ASEAN member country; trade diversion; Exports; Trade policy; Tariffs; Export competitiveness; Asia and Pacific
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Abstract

The decade of the 1970s will be remembered as one of economic turbulence. It caused profound changes in the structure of world trade, the consequences of which were felt by all countries until the end of the 1980s. Starting with the breakdown of the Bretton Woods system of fixed exchange rates in the early 1970s, followed by sharp rises in the prices of oil and most other commodities, inflationary pressures were building toward the end of the 1970s. Economic growth generally slowed down from the high rates of the 1960s.

The decade of the 1970s will be remembered as one of economic turbulence. It caused profound changes in the structure of world trade, the consequences of which were felt by all countries until the end of the 1980s. Starting with the breakdown of the Bretton Woods system of fixed exchange rates in the early 1970s, followed by sharp rises in the prices of oil and most other commodities, inflationary pressures were building toward the end of the 1970s. Economic growth generally slowed down from the high rates of the 1960s.

SLOWDOWN OF ECONOMIC GROWTH IN THE EARLY 1980s

In the early 1980s, as a consequence of the tight fiscal and monetary policies adopted by the major industrial countries in their attempt to stop inflation, the cycle reached its turning point. Recession set in, followed by sharply declining commodity prices, including steep drops in oil prices in 1983, and again in 1986. The situation was particularly burdensome for the developing countries, which depend mostly on exports of commodities. In addition, there was a general decline in the flow of capital from the industrial countries to the developing nations. At the same time, interest rates tended to rise, adding to the burden of those developing countries still in need of large amounts of foreign borrowings.

Before the oil boom, between 1965 and 1973, the developing countries in general succeeded in achieving a postwar, high average economic growth rate of 6.5 percent a year (see Table 1). During the inflationary period of 1973–80, the average annual rate of growth slowed down to 5.4 percent, and declined further to 3.2 percent during the recession of 1980–85.

Table 1.

Growth of Real GDP, 1965–87

(Annual percentage change)

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Source: World Bank, World Development Report 1988 (Washington, 1988), Table 1.3. Note: Data for developing countries are based on a sample of 90 countries.

In spite of the slowing growth of developing countries, during the twenty years from 1965 to 1985, the average growth of these countries as a group exceeded that of the industrial countries. More important is the fact that during the same period the difference in growth rates among the developing countries themselves widened. As shown in Table 1, during 1965–73 the lowest rates of growth took place in the low-income developing countries (3.4 percent), excluding China and India, and the highest in the group of exporters of manufactures (7.4 percent). During 1980–85, the slowest growth was recorded in the highly indebted developing countries (0.1 percent) and the fastest again in the group of exporters of manufactures (5.8 percent), giving a ratio of 58:1. It is this considerable difference in economic performance among the developing countries that needs scrutiny. Many studies have been conducted lately to understand better the factors underlying the apparent failures and successes of different countries to adjust to the rapidly changing international economic environment.

In this paper, we shall look at a selected number of Asian developing countries: the ASEAN-4 (Indonesia, Malaysia, Philippines, and Thailand), three newly industrializing economies (Hong Kong, Korea, and Singapore), and four South Asian countries (Bangladesh, India, Pakistan, and Sri Lanka). These countries differ in size (population and area), level of income, and resource endowments. Nevertheless, we shall look at some common features of their economic development, particularly during the adjustment period of 1980–87, and see if some inferences about the effect of different trade policies can be drawn.

RECENT PERFORMANCE

A convenient way of comparing the relative economic performance of the Asian developing countries during the last two decades is by looking at the average annual growth of per capita income. Table 2 shows that during the period of 1965–87 Hong Kong, Korea, and Singapore achieved the highest average rate of growth of per capita gross national product (GNP) (6–7 percent a year), followed by the ASEAN-4, except the Philippines (4–4.5 percent a year), while the South Asian countries trailed behind the ASEAN-4 (1–3 percent a year). The highest rate of growth was achieved by Singapore (7.2 percent), the lowest by Bangladesh (0.3 percent). The average growth rate for all developing countries was 2.7 percent a year.

Table 2.

GNP Per Capita

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Source: World Bank, “World Development Indicators,” World Development Report 1989 (New York: Oxford University Press, 1989), Table 1.

A difference of 2 to 4 percentage points in growth rates, if maintained over a period of 10 to 25 years means considerable differences in the final level of income. Such differences in growth rates accounted, to a large extent, for the large differences in the levels of per capita GNP in 1987. The figures in Table 2 show significant differences in the level of per capita income, high incomes prevailing in the newly industrializing economies, medium-level incomes in the ASEAN-4 except in the Philippines, and low levels in South Asia. All the South Asian countries have incomes well below the average for all developing countries ($650 per capita), while those of the newly industrializing economies are well above the average level. The initial levels of income at the beginning of the period were different, but the differing rates of growth made the disparity in income levels at the end of the period even more pronounced.

Having looked at the average growth during the last twenty-two years, it would also be interesting to see the picture before and after 1980, the post-1980 years being the time of recession and economic adjustment.

Table 3 shows the growth rate of GDP and the share of trade in the GDP. During the period of 1965–80, the newly industrializing economies grew the fastest (8–10 percent a year), then the ASEAN-4 (5–8 percent), followed by the South Asian countries (2–5 percent). Compared with the average growth for all developing countries (5.9 percent), the growth rates of the newly industrializing economies and the ASEAN-4 were above average, while those of the South Asian group were below average. After 1980 (1980–87), all the newly industrializing economies and the ASEAN-4 recorded slower growth rates, while those of the South Asian countries accelerated, overtaking the average for all developing countries. Thus, while the growth of GDP of the developing countries slowed down generally during 1980–87, in South Asia growth picked up.

Table 3.

Growth Rate of GDP and Share of Exports Plus Imports, 1987

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Source. World Bank, “World Development Indicators.” World Development Report 1989 (New York Oxford University Press. 1989). Tables 2, 3, and 14

Apparently, this had something to do with the degree of exposure of the economy to external influences. The newly industrializing economies and the ASEAN-4 are generally more open to international trade. Table 3 clearly shows that in 1987, except for Sri Lanka, the share of exports plus imports in GDP of the South Asian countries is much smaller than that of the newly industrializing economies and the ASEAN-4. This implies that the South Asian countries have been less affected by the ill effects of the world recession than the other countries under discussion.

On the other hand, there are indications that since 1986, as the world economy recovered from the recession, the newly industrializing economies and the ASEAN-4 have regained their higher growth rates. In 1988, for example, according to some estimates, Korea, Singapore, and Thailand scored double digit rates of growth. Indonesia, Malaysia, and the Philippines also achieved higher growth rates (between 5 percent and 8 percent). In other words, the more open is a country to international trade, the more it will feel the adverse effects of a recession and the more it will benefit from an upturn in world economic activity.

The difference in structure of trade also affected the trade performance of the Asian countries. Since prices of primary commodities declined much more than manufactures, primary-producing countries suffered more during the recession. As shown in Table 4, commodity prices have declined in nominal dollars, as well as in real terms, during 1980–85. In nominal terms, non-oil commodity prices recovered somewhat in 1986 and 1987; in real terms, however, prices continued to decline through 1987. Thus, for seven consecutive years, starting in 1981, prices of primary commodities have been sliding downward. This, obviously, has affected particularly those developing countries that are highly dependent on exports of raw materials.

Table 4.

Commodity Prices, 1980–87

(In average annual rates of change)

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Source: World Bank, Annual Report 1988 (Washington, 1988), Table 2–6. Note: Commodity price indices are weighted by commodity exports of all developing countries.

Deflated by export prices of manufactures of major industrial countries.

Table 5 shows the structure of merchandise exports of the Asian developing countries. For the developing countries as a group, primary commodities still play a major role in total exports, although their share has declined from 85 percent in 1965 to 45 percent in 1987. The table also shows that primary commodities still dominate the exports of the ASEAN-4 (except for the Philippines in 1987). The newly industrializing economies are the least dependent on primary commodities, even though Singapore's share for 1987 is still 28 percent. But this consists mainly of re-exports from Singapore of primary products originating from its neighboring countries (Indonesia, Malaysia, Thailand). South Asia's position lies between the newly industrializing economies and the ASEAN-4. Primary commodities' share in exports exceeds the average (45 percent), for Sri Lanka (60 percent) and Bangladesh (49 percent). From the structure of merchandise exports, one can draw the inference that the ASEAN-4 plus Sri Lanka and Bangladesh must have been hardest hit by the precipitous fall of commodity prices between 1981 and 1987, while the newly industrializing economies have been least affected.

Table 5.

Structure of Merchandise Exports

(In percent)

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Source: World Bank, “World Development Indicators,” World Development Report 1989 (New York: Oxford University Press, 1989), Table 16.

Textiles and clothing is a subgroup of manufactures.

Of all the Asian nations, Indonesia is most heavily dependent on primary commodities: 72 percent of export earnings in 1987 came from commodity exports. Malaysia (61 percent) and Sri Lanka (60 percent) are also still predominantly primary commodity exporters, although the pattern is rapidly changing since exports of manufactures from these countries are increasing rapidly.

For Indonesia, the sharp fall in oil prices in 1983, and again in 1986, was particularly painful, since oil is a dominant export (54 percent of total exports in 1987 consisted of fuels, minerals, and metals). Oil export is also important for Malaysia and Singapore, but to a much lower degree than for Indonesia. Thus, while the fall in oil prices may have been a blessing for the oil importing countries of Asia, for Indonesia it was a serious setback.

Although exports of primary commodities still play a major role, exports of manufactures have increased rapidly in all the Asian developing countries. However, if we look at the composition of manufactures exports, again it is the newly industrializing economies and the ASEAN-4 that are more “advanced,” in the sense that exports from South Asia still consist mostly of textiles and clothing. These are typically “traditional” manufactures exported by developing countries at the early stage of development.

Table 6 shows the imports of manufactures from the Asian developing countries by the Organization for Economic Cooperation and Development (OECD). Bangladesh has the smallest exports ($696 million in 1987) and the highest proportion of textiles and clothing (84 percent). Pakistan and Sri Lanka also have very high proportions of textiles and clothing (76 percent). Even India (46 percent) has a higher proportion than Hong Kong (42 percent), the leading and traditional exporter of textiles and clothing. All the ASEAN countries have a much lower proportion than Bangladesh, Pakistan, and Sri Lanka.

Table 6.

OECD's Imports of Manufactures from the Asian Developing Countries, 1987

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Source: World Bank, “World Development Indicators,” World Development Report 1989 (New York: Oxford University Press, 1989), Table 17.

The “nontraditional” items in manufactures exports are chemicals, electrical machinery, electronics, and transport equipment. Malaysia, Singapore, Philippines, and Korea are the leading exporters of these items. The South Asian countries appear slower in developing internationally competitive manufacturing industries.

Another important aspect of the performance of the developing countries of Asia is the varying sizes of their external debts. All the Asian developing countries have increased their external debts, many of them quite substantially, between 1970 and 1987. Table 7 shows that the developing countries as a whole have increased their external public debt from 12.7 percent of GNP in 1970 to 39.2 percent in 1987. The ASEAN-4, except Thailand, have debt ratios well in excess of the average (around 65 percent). Similarly, the South Asian countries, except India and Pakistan, have raised their external debts to a level far above the average figure (50–60 percent). Only the newly industrializing economies managed to keep their external debts low. Even Korea, with quite large external debts, has succeeded in keeping them at managable levels (20.7 percent of GNP in 1987, well below the average for all developing countries).

Table 7.

External Public Debt and Debt/Service Ratios

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Source: World Bank, “World Development Indicators,” World Development Report 1989 (New York: Oxford University Press, 1989), Table 24.

It is worth noting that while most of the Asian developing countries have debt ratios higher than average in 1987, most of them have below average debt-service burdens, measured in percentage of exports of goods and services. This is due mainly to the high proportion of exports to the GDP of the region. In 1987 the average debt/service ratio for all developing countries was 22.0 percent; only four of the Asian countries, Indonesia (27.8 percent), the Philippines (23.2 percent), Bangladesh (24.2 percent), and Pakistan (25.9 percent), have higher ratios. The debt problem which is a most serious issue in Latin America and Africa, is therefore not a major issue in the developing countries in Asia, except perhaps for Indonesia and the Philippines.

EFFECTS OF DIFFERENT TRADE POLICIES

The World Bank's World Development Report 1987 shows that trade strategy has a great influence on economic development. Trade strategy is divided broadly into two kinds, outward-oriented and inward-oriented. The Bank uses a rather unique definition of outward-oriented strategy, namely, one in which trade and industrial policies do not discriminate between production for the domestic market and exports, nor between purchases of domestic goods and foreign goods. Even when this strategy is neutral and is not biased in favor of exports, it is referred to as export promotion strategy. By contrast, an inward-oriented strategy is one in which trade and industrial incentives are biased in favor of production for the domestic over the export market. This approach is usually known as the import-substitution strategy.

The argument in favor of a neutral trade regime is that it avoids distortion in the allocation of resources. An import-substitution regime, characterized by high levels of protection for manufacturing, direct controls on imports and investments, and overvalued exchange rates, is likely to distort the market. Resources will be induced to move from unprotected activities to protected ones. Producers in the unprotected export sector would find that the price of their output has fallen relative to both protected imports and nontradables. The effect of protection is thus similar to a tax on exports. At the same time, domestic demand will tend to switch to the cheaper products, namely, exportables. Hence, exports will be further discouraged.

Many developing countries have taken measures to encourage import substitution in the mistaken belief that they have no adverse impact upon the export sector. In fact, as shown by empirical studies in a number of Latin American and African countries, the “shift parameters” are usually quite high, indicating that more than half of the burden of protection is shifted to the export sector.

It is now generally recognized that export expansion often acts as an engine of economic growth. Countries that fail to expand their exports may soon find it difficult to achieve or maintain a satisfactory growth rate. There are a number of interacting reasons why this should be so. First, exports provide a source of demand for domestic products, resulting in higher incomes for domestic producers, which in turn create demand for domestic consumer goods. Second, exports produce foreign exchange, which will ensure financing of additional imports of intermediate and capital goods. Third, increasing exports gives assurance that the country will not be facing a foreign exchange crisis, thereby encouraging investment. Fourth, exploiting the country's comparative advantage, economies of large-scale production, and higher capacity utilization will enhance efficiency. Last, but not least, competition in foreign markets will provide incentive for technological change.

While there is mounting evidence of the superiority of an outward-looking strategy, the World Bank, as a rule, does not recommend the promotion of exports by creating positive export incentives. Such incentives may take the form of rebates in excess of actual import charges on imported inputs, or excessive “wastage” allowances on imported inputs, export credits at concessional interest rates, or other explicit subsidies. Apart from the market distortive effects, such policies are difficult to administer and require substantial budgetary resources. They tend to be discriminatory and are open to abuse. Furthermore, they are increasingly threatened by countervailing measures by major importing countries.

From the study, the World Bank found that among the 41 developing countries included in the study, those that have adopted an outward-oriented strategy performed better than those with an inward-oriented strategy. For the study, countries were divided into four groups: strongly outward-oriented, moderately outward-oriented, moderately inward-oriented, and strongly inward-oriented economies. The classification of countries was based on policy indicators, both qualitative and quantitative, such as the effective rate of protection and the use of direct controls (for example, quotas and import-licensing schemes, use of export incentives, and the degree of exchange rate overvaluation).

Economic performance was measured in terms of average annual growth rates of real GDP and per capita income, the gross domestic savings ratio, the average incremental capital/output ratio, the average annual growth rate of real manufactures export, and the average annual rates of inflation. As stated earlier, the available data suggest that the economic performance of the outward-oriented economies has been broadly superior to that of the inward-oriented economies in almost all respects.

Of the Asian developing countries, the newly industrializing economies, Hong Kong, Korea, and Singapore, consistently fall under the category of strongly outward oriented, for the periods 1963–73 and 1973–85 covered by the study. Malaysia and Thailand fall under the category of moderately outward oriented for both time periods; Indonesia falls under the same category for 1963–73 but moves to the category of moderately inward oriented for 1973–85 owing to the introduction of import substitution policies in the early 1980s. It should be noted, however, that since 1983 Indonesia has embarked on a deregulation program covering a wide range of areas, such as banking, investment, industry, trade, and transportation. Apparently these liberalization measures have not been taken into account because of the time frame of the study. The Philippines remains in the category of moderately inward oriented for both periods. As in Indonesia, the Philippines has adopted significant liberalization policies since the Aquino administration took office in 1986. Pakistan and Sri Lanka, belong to the category of strongly inward oriented for 1963–73, but move to the category of moderately inward oriented for 1973–85 when they introduced some liberalization measures; Bangladesh and India fall under the category of strongly inward oriented for both periods.

As we have seen earlier, the conclusion of the Bank's study is generally consistent with the data in Table 2 above, which shows that during the period of 1965–87 the Asian newly industrializing economies achieved 6–7 percent average growth of per capital GNP, followed by the ASEAN-4, except the Philippines, with 4–4.5 percent growth, and then the South Asian countries with 1–3 percent annual growth.

As also stated earlier, an inward-oriented strategy, by adhering to policies biased in favor of production for the domestic market, tends to discourage exports. Therefore, inward-oriented countries are low exporters as well as low importers. The data in Table 3 seem consistent with this hypothesis. The newly industrializing economies, with strong outward-looking policies, have high ratios of trade to GDP, ranging from 72.6 percent for Korea to 306.9 percent for Singapore. The small size of the domestic market of Hong Kong and Singapore accounts for the high ratios, but Korea with a population of 42 million is not particularly small; yet the trade ratio is high.

The ASEAN-4, with the exception of the Philippines, also have high trade ratios, ranging from 46.1 percent for Indonesia to 97.2 percent for Malaysia. But even for the Philippines, the ratio (37 percent) is still higher than the average (34.5 percent) for all developing countries. The more inward-oriented South Asian countries, with the exception of Sri Lanka, have lower trade ratios, ranging from 14.3 percent for India to 31.6 percent for Pakistan. As we have seen earlier, Pakistan and Sri Lanka have lately taken steps to liberalize their trade regime, which moved them from the category of strongly inward oriented to that of moderately inward oriented. This explains their relatively high trade ratios; the lowest ratios are found in India and Bangladesh (14.3 percent and 21.0 percent, respectively), both strongly inward-oriented countries.

LESSONS FROM EXPERIENCE IN TRADE REFORM

One of the most important lessons we can get from the experience of many developing countries that have embarked on the road to structural adjustment is that trade reform seldom stands on its own; it usually goes hand in hand with a program of controlling inflation. Trade reform is normally part of a larger package, including fiscal and monetary policies, to restore or maintain the stability of an economy that has been subjected to destabilizing internal or external shocks.

Export promotion is likely to fail, or is difficult to sustain, if inflation is not under control. This has been demonstrated in many Latin American and African countries that for some reasons were unable to keep inflation at sustainable levels. If inflation goes on for an extended time at a rate substantially above the world rate, exports will suffer, unless prompt and continuous adjustments are made in the exchange rate. High inflation thus creates, among other things, difficult exchange rate management problems.

In this respect, the record of the Asian developing countries is much better than many other countries. The Asian countries have been rather successful in containing inflation, although notable differences exist among individual countries.

During the last two decades, when the average rate of inflation of the developing countries showed an upward trend, inflation in the Asian developing countries, except in the Philippines and Sri Lanka, slowed down (see Table 8). In India, the inflation rate was more or less constant at 7.7 percent a year. During 1980–87, the average inflation rate for all the developing countries was 43.9 percent a year, while in Asia, the average for individual countries was much lower (ranging from 1.1 percent to 16.7 percent). Even in the Philippines, where the highest rate prevails among the Asian countries during that period, the inflation rate (16.7 percent) was less than half the overall average. Compared with some Latin American countries, such as Brazil, where the rate was 166.3 percent, and Argentina, 298.7 percent, the Asian economies are stable.

Table 8.

Average Annual Rate of Inflation as Measured by the GDP Deflator

(In percent)

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Source: World Bank, “World Development Indicators,” World Development Report 1989 (New York: Oxford University Press, 1989), Table 1.

Nevertheless, one can notice that inflation in South Asia has been generally higher than in the newly industrializing economies and the ASEAN-4, with one or two exceptions. One can thus surmise that in South Asia export promotion has been more difficult, because rising domestic prices have given exporters less incentive to expand exports.

Experience in Latin America and Africa indicates that a major cause for inflationary pressures has been the inability of governments to keep government budget deficits under firm control. In Asia, the fiscal deficits have not been excessive overall, but they are generally higher in the South Asian countries (more than 8 percent of GNP in 1987, except for Bangladesh) than in the newly industrializing economies and the ASEAN-4 (5 percent of GNP or less, except for Malaysia, see Table 9). The ability of the Asian governments to keep budget deficits within reasonable limits is perhaps a reflection of the relative political stability in these countries. Under such conditions price stability is easier to control, and this in turn is an important condition for any trade liberalization effort.

Table 9.

Overall Fiscal Deficits

(In percent of GDP)

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Source: World Bank, “World Development Indicators,” World Development Report 1989 (New York: Oxford University Press, 1989), Table 11.

Inflation calls for flexible exchange rates, otherwise the balance of payments will be under constant pressure. High inflation rates need to be compensated for by a corresponding depreciation of the currency to maintain the real effective rate of exchange. If we look now at the movement of the real effective exchange rate in the Asian developing countries, it seems that on the whole the countries have managed to keep the real rate of exchange stable (see Table 10). Nevertheless, it seems that the higher rate of inflation in South Asia has led to some real appreciation of their currencies against the U.S. dollar during the period 1981–1987 (with the exception of Pakistan). On the other hand, the ASEAN-4 have depreciated their currencies, except for Malaysia. This implies that inflation and foreign exchange policy in South Asia have been less conducive to export promotion than in the other Asian countries.

Table 10.

Real Effective Exchange Rate

(National currency per U.S. dollar, deflated by the consumer price index, 1981 = 100)

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Source: International Monetary Fund. International Financial Statistics (Washington, January 1989).

Trade policy reform is not something that comes easily. Once a country has adopted an inward-looking policy and once protective walls have been erected for domestic producers, it is not easy to start tearing down those walls. There must be compelling reasons for a country to reverse its policy, particularly in such an important area as trade and finance. Usually it happens when a crisis emerges that needs drastic measures to overcome. Most often the crisis takes the form of a balance of payments crisis or an acute inflation, or both.

Take, for example, the case of Indonesia. Loose monetary and fiscal policies in the early 1960s led to mounting inflationary pressures, culminating in the runaway inflation of 1965 and 1966 (more than a 600 percent rate of inflation in 1966). After a short political upheaval, a new government came into power that quickly reversed all economic policies of the previous government, including trade policies. The new policies were mostly outward oriented, and the economy moved in the direction of a more open system.

This course was not maintained for very long. The oil boom, which started in 1973, brought very substantial foreign exchange and revenues to the Indonesian Government. Gradually trade policies turned inward, aimed at developing domestic industries rapidly, as part of a catch-up program with other countries that were one or two steps ahead on the road toward industrialization. Manufacturing industries grew rapidly during this period of import substitution, supported by ever-widening protective trade policies.

It took another crisis to stop and reverse these policies. This time it was the collapse of oil prices, in 1983 and again in 1986, which led to a serious balance of payments problem. A very large current account deficit in 1983 (7.6 percent of GDP) convinced the government that Indonesia needed to diversify its exports quickly, meaning that non-oil exports needed to be stimulated. Thus, trade and investment policies were again reversed, this time becoming more outward oriented, as the only way to boost exports of agricultural and non-oil manufactured products.

In retrospect, the sharp drop of oil prices in 1983 and 1986 may have been a blessing in disguise for the Asian oil exporting countries, like Indonesia and Malaysia, because the balance of payments crisis created by the collapse of oil prices forced these countries to undertake the necessary trade reforms. Similarly, the oil booms of 1973 and 1979 may have been a blessing in disguise for the Asian oil importing countries, like Thailand and the Philippines, because the steep rise in the trade deficits, owing to sharp increases in oil prices, forced these countries to adopt an aggressive export promotion strategy, which in the longer run turned out to pay very handsomely.

On the other hand, one could argue that the less open character of the economies of South Asia has saved them from serious internal and external imbalances, but by the same token, since no crisis emerged, there were also no compelling reasons to change their trade policies. This may explain, at least partly, why countries like India and Bangladesh have not made any significant change in their essentially inward-oriented policies.

Devaluation is often a vital step toward trade policy reform. Many of the Asian developing countries have had, at one time or another, to go ahead with the painful process of devaluation as part of a package of trade reform. Devaluation will not solve the balance of payments problem, however, if inflation is not kept under control, as has been so often demonstrated by the Latin American experience. A program of trade reform, in order to succeed, must show concrete results as soon as possible, in the form of increased exports and improved balance of payments. If tangible results are slow in coming, resistance to the reform may gain strength, mostly from industries that are losing their protected status. The situation, of course, becomes worse if inflation continues unchecked and undermines the trade liberalization efforts.

Another important issue is whether, and to what extent, trade liberalization should be accompanied by liberalization of the financial sector. In principle, the two should go hand in hand, the one reinforcing the other. Many capital transactions are linked to trade. Restrictions in financial and capital transactions may inhibit the free flow of goods and services. Experience in some Latin American countries seems to indicate that the sequence of policies taken is important. Liberalization of the capital account of the balance of payments should come after liberalization of the current account and not the other way around. The reason is that under the present international monetary system of flexible exchange rates, very large amounts of capital are moving across national borders, therefore, a premature introduction of a free foreign exchange regime may destabilize the fragile economy and undermine the trade promotion effort.

It is quite possible that the experience of some countries has confirmed the above hypothesis. But the experience of Indonesia proved otherwise. The foreign exchange regime in Indonesia has been liberalized since the early 1970s, well before trade liberalization was introduced. It is true that occasionally large capital movements in and out of the country have caused considerable instability in the financial sector. But so far it has not posed an obstacle to the liberalization of the trade regime. On the contrary, the very liberal foreign exchange regime has contributed positively to the achievement of rapid export growth when trade was liberalized.

Still another lesson that we can draw from the experience of the Asian newly industrializing economies that have succeeded in achieving high economic growth during the past two decades is that high export growth is associated with high rates of domestic saving. This is important because in order to maintain a high rate of growth of exports, large and sustained levels of investment in export industries and in economic infrastructure are necessary. At the initial stage of export expansion, foreign investment, particularly multinational companies, usually play a major role. But as the country prepares to take off, domestic saving must be available in larger volumes to ensure that no supply bottlenecks develop owing to lack of investment. The success of the export promotion efforts, in the longer run, will thus be determined by the country's ability to generate the necessary domestic saving.

If we look at the situation in the region, the available figures show that gross domestic savings have generally increased during the last two decades, in line with the average for all developing countries, which have increased from 20 percent of GNP in 1965 to 25 percent in 1987 (see Table 11). Only in three countries, the Philippines, Bangladesh, and Pakistan, were the saving rates lower in 1987 than in 1965. But what is noteworthy is that in all the South Asian countries the rate of gross domestic savings is relatively low. Even India (22 percent in 1987) shows a saving rate below the average of all developing countries (25 percent). Bangladesh has an extremely low saving rate, namely 2 percent of GDP in 1987. The high levels of saving in the newly industrializing economies in 1987 (ranging from 31 percent for Hong Kong to 40 percent for Singapore) are particularly striking. The ASEAN-4, except for the Philippines, also show high saving rates in 1987 (ranging from 26 percent for Thailand to 37 percent for Malaysia). The data on domestic saving rates, thus, confirm the earlier observation that among the Asian developing countries the South Asian countries are the least export oriented, and therefore least able to generate sufficient domestic saving.

Table 11.

Gross Domestic Savings

(In percent of GDP)

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Source: World Bank, “World Development Indicators,” World Development Report 1989 (New York: Oxford University Press, 1989), Table 9.

EFFECT OF TRADE POLICIES OF INDUSTRIAL COUNTRIES

In this final section we shall look at the impact of restrictive trade policies of industrial countries on the developing economies of Asia, and how these countries react to those policies. The countries of the Organization for Economic Cooperation and Development (OECD) have now become more protectionist than in the past. They have roughly similar trade policies, with all emphasizing restrictions on imports of labor-intensive consumer goods, such as textiles, clothing, footwear, and leatherware. These are manufactures in which the developing countries have a natural comparative advantage. The European Community's (EC) wider protectionist policies have increased sharply its trade diversion impact on the rest of the world. Japan puts a universal emphasis on restricting imports of agricultural goods. Japan also uses nontariff measures to restrict imports of high-tech goods. The United States has strong restrictions on imports of consumer goods in general, with particular emphasis on limiting imports of textiles and garments.

It is true that tariff rates in the industrial countries have been reduced substantially as a result of the Tokyo Round of trade negotiations among the members of the General Agreement on Tariffs and Trade (GATT). Since then, however, more and more trade restrictions have been introduced in the form of nontariff barriers. In effect, import restrictions have not diminished since the Tokyo Round. Moreover, the industrial countries were the beneficiaries of the tariff cuts and not the developing countries. For example, the EC reduced tariffs on total imports of finished and semifinished manufactures with a weighted average of 28 percent. Tariffs on the imports from developing countries, however, have been on average reduced only 25 percent. The figures for Japan are 46 percent and 32 percent respectively. While for the United States the figures are 30 percent and 24 percent.1 The total impact of the tariff reductions, therefore, have not improved the competitiveness of the developing countries with the industrial countries.

Another policy of the industrial countries that makes industrialization more difficult for the developing countries is tariff escalation. Most industrial countries levy higher tariffs on manufactures than on the raw materials used to make them. The tariff reductions of the Tokyo Round did not change the escalation of tariffs, because tariffs on manufactures have been reduced more or less at the same rate as tariffs on raw materials. According to some estimates, owing to higher tariff rates on finished goods than on parts, components, or raw materials, the average effective rates in the OECD countries are considerably higher than their average nominal tariffs. In the United States, after the Tokyo Round, the average nominal protective tariffs for manufactures are 7.26 percent, but the average effective protective tariff, owing to the escalation of tariffs, is 11.5 percent. In Japan the nominal rate is 9.60 percent, but the effective rate is 15.91 percent. The figures for the EC are 7.85 percent and 15.20 percent respectively, and for Canada 11.35 percent and 20.63 percent.2 These high effective rates of protective tariffs continue to obstruct the industrialization of many developing countries.

It is often said that the effect of protection in industrial countries has been mostly exaggerated, since in fact exports of manufactures from developing countries have increased quite rapidly. Look at the share of developing countries in world exports of manufactures: in 1963 the share was 4.3 percent (the share of industrial countries was 82.3 percent), but in 1985 the developing countries increased their share to 12.4 percent (that of the industrial countries dropped to 78.8 percent). It is quite likely that protection in the industrial countries has not been entirely effective. There are numerous ways in which developing countries (in particular the newly industrializing economies) can avoid the protective obstacles, first by producing products not subject to restriction and second by moving to higher quality products that enjoy higher prices, thereby increasing the value of exports.

Nevertheless, the trade diversion effect of protection can be substantial. For example, textiles and clothing exports into the United States between 1980 and 1985, originating from OECD countries (excluding Japan) have increased by 269 percent, while imports from restricted suppliers increased only by 104 percent. Imports from Japan (restricted) increased only by 55 percent, and from the Asian newly industrializing economies by 71 percent.3 Little doubt remains that without discriminatory trade restrictions, exports of textiles and clothing, as well as other restricted products from the developing countries, would have increased much faster.

Another effect of protection in the industrial countries is that, together with the slowdown of world demand owing to the recession, it may have discouraged many developing countries from adopting an export promotion strategy. Restrictive trade policies, especially those directed toward imports from developing countries, may have induced the emergence of a new export pessimism among some developing countries, and encouraged them to turn more inward in their development policies.

This seems to have taken place in India and Bangladesh, two of the Asian developing countries that consistently leaned toward inward-oriented policies. That policy choice may have been reinforced by the existence of a sizable domestic market. The evidence during the years 1980–87, when GDP growth in South Asia was quite impressive (see Table 3), seems to vindicate the adopted strategy. However, as we have seen from the available evidence, these countries have also forgone the many advantages of an outward-looking strategy.

The reaction of the Asian newly industrializing economies and the ASEAN-4 to the restrictive policies of the industrial countries was to adopt a more aggressive trade policy, particularly export policy. One reason is, perhaps, that these countries, except Indonesia, have small domestic markets. There is no way for them to get rapid industrial development by relying mainly on the internal market. And, unlike the major industrial countries, these countries have no credible retaliatory powers to protect themselves. The EC, for example, may react by limiting its imports from the United States, or from Japan, if it feels that these countries with their protective policies have damaged the EC's interest. The small developing countries of Asia do not have that option.

Regional cooperation among the ASEAN countries, at one time, was expected to offer the possibility of adopting a strategy of retaliation against the industrial countries. Since ASEAN together forms a sizable market, by acting together they might have the bargaining strength to face the threat of protectionism. Based on the experience so far, however, the ASEAN member countries seem to realize that, in their own long-run interest, they will be better off by adopting the alternative strategy, namely, an outward-looking strategy to gain maximum benefit from international trade. In the ongoing GATT Uruguay Round, ASEAN is fighting for the preservation and strengthening of an open, nondiscriminatory, multilateral trading system.

For the moment, this seems to be a more realistic attitude. Although the ASEAN countries have more than 300 million people, their purchasing power, although growing, is still limited. ASEAN also still needs lots of capital and technology from outside. Therefore, it seems rational for ASEAN to look outward, and try to get the utmost benefit from the international division of labor, by concentrating on improving their own efficiency and competitive strength.

Comment

MOHAMED ARIFF ABDUL KAREEM

The paper by Suhadi Mangkusuwondo is extremely interesting and refreshing. Its empirical content and analytical treatment of the subject matter render the paper a useful addition to the trade and development literature. I have little criticism, as I am in sympathy with the author's line of reasoning and am generally in agreement with his main conclusions. As such, my comments will serve mainly to reinforce some of the points made in the paper and underscore some of my own reservations.

The author's choice of countries and the typology used have been particularly helpful in bringing the issues relating to trade strategies into sharper focus. The growth performance of countries of differing size, per capita income, resource endowments and factor proportions, and at various stages of development is explained mainly in terms of trade policies and strategies.

Mangkusuwondo's analysis of 1965–87 data shows that countries which have pursued an outward-looking industrialization strategy have performed better than those which had chosen the inward-looking strategy. His analysis also suggests that during 1980–87, the inward-looking South Asian countries tended to fare better than the export-oriented East and Southeast Asian countries. Needless to say, there is much more to this than meets the eye. There is no denying that industrialization strategies and trade policies do matter, but, one needs to go behind these strategies and policies and discover why some countries opt for certain strategies and why some policies work better in some countries than in others. It would be erroneous to chart an outward-looking industrialization path for all countries. Export-oriented industrialization cannot be a policy prescription for all countries, just because it has worked well in some countries.

This, of course, begs the question: what is export-orientation? Mangkusuwondo addresses this conceptual issue and draws on the World Bank definition according to which “export promotion” does not necessarily entail a bias in favor of exports. He points out that, according to the World Bank, an outward-oriented strategy can imply a neutral trade regime.

A pertinent question to ask in this context would be, Do the Asian newly industrializing economies and the ASEAN-4 really fit this definition of outward orientation? The kind of export orientation pursued by Korea and Taiwan Province of China was distinctly different from that of Hong Kong and Singapore. Korea and Taiwan Province of China have followed highly protectionist policies. They have fanatically protected their domestic industries and at the same time vigorously promoted their exports. As a result, import-substituting and export-oriented industries have coexisted in these economies. Until quite recently, their trade regimes were truly mercantalist in character. It is only Hong Kong and Singapore that can fit fairly comfortably into the World Bank description of a neutral trade regime that is truly outward looking.

The ASEAN-4 lie in between, although there are considerable variations among them. Like Korea and Taiwan Province of China, the ASEAN-4 have also pursued, in a paradoxical fashion, import substitution and export promotion simultaneously. But, the degree of protection, in both nominal and effective terms, for manufactures in the ASEAN-4, especially Malaysia and Thailand, has been significantly less than that in Korea or Taiwan Province of China.

In those countries where import-substituting and export-oriented industries have coexisted, the anti-export bias present in the structure of protection has been offset by all sorts of export promotion incentives. These countries have seemingly adopted a “neutral” trade regime by “neutralizing” the distortions caused by their structure of protection.

To be sure, export incentives cause distortions just like tariffs. Therefore, each is as objectionable as the other. And, one may say a lot against the principle and practice of offsetting one set of distortions with another set in the opposite direction. Of course, the first-best solution would be to eliminate the distortions at the source and not to offset them with others. There is also the danger of export incentives more than offsetting the bias against exports. In fact, there is evidence of exports being subsidized in some cases. It is no secret that Korea and Taiwan Province of China have been subjected to U.S. countervailing duties many a time.

Although the trade regimes in most of the high-growth countries in the paper are not truly “neutral,” they have all tended to adopt somewhat liberal policies. Export orientation in these countries has necessitated decontrol and deregulation to a considerable extent. All this can lead to both static and dynamic gains. Seen in this perspective, it is not hard to understand why export expansion has tended to act as an “engine of growth.”

Another feature common to all these high-growth economies is the extent and role of foreign investment, which reflect the fairly liberal policies toward foreign investors. All these countries have also had reasonably sound macroeconomic policies. In short, one cannot single out trade policies to explain the success or failure of groups of countries.

The point is that it is not export orientation per se but the other things that go with it (e.g., deregulation) that really matter. It is quite possible for a country to do these “other things” without having to resort to export orientation. The latter is critical and crucial only for small economies like Singapore and Hong Kong, given their domestic market constraints. For big countries like India and Pakistan, where such constraints are not severe, an inward-oriented strategy with fairly liberal economic policies and minimum government intervention can facilitate rapid growth.

Data presented by Mangkusuwondo support this view. He observes that during 1980–87, the newly industrializing economies and the ASEAN-4 recorded slower growth rates, while the South Asian countries accelerated theirs. The disparity, he attributes to the degree of exposure of these economies to external influences. One cannot deny that outward orientation renders the economy vulnerable to external fluctuations, while inward orientation tends to insulate the economy from external vagaries. It is not difficult, therefore, to understand why the world recession of the early 1980s was particularly painful for the newly industrializing economies and the ASEAN-4 but not for the South Asian group. Be that as it may, we must not lose sight of the fact that the South Asian countries had undertaken bold policy liberalizations in the 1980s. I would argue that the better economic performance of these countries during the decade was primarily due to their domestic policy reforms.

I do not intend to downplay the significance of trade policies. Far from it. I do recognize how important trade policies are and am in favor of trade liberalization, as it can help allocate resources efficiently. But, having a liberal trade regime is one thing; aggressively pursuing export orientation is quite another. There is always the danger of going overboard. For excessive export promotion is just as bad as excessive import substitution. It is a well-known theoretical proposition that ultra-pro-trade bias can lead to immiserizing growth. My stance, which admittedly is very neoclassical, calls for liberal policies that would allow market forces to determine the pattern of industrialization in a country consistent with its resource and factor endowments.

Structural adjustments in a country should reflect the changes taking place in the country's comparative advantage. Industrial transformation is never-ending and ongoing in a dynamic setting. Policies should facilitate, not frustrate, the process. This means that aging industries should be allowed to die without being put on a life-support system. As Mangkusuwondo has observed, traditional manufactures already play a more important role in the South Asian countries than in the ASEAN-4. The latter may soon lose their comparative advantage in some nontraditional activities, such as electronics assembly operations, to their South Asian neighbours. It would be wrong for the ASEAN-4 to obstruct such migration of industries. Instead, they should move away from sunset activities and upgrade themselves as Japan has been doing quite successfully.

With respect to the protectionist trade policies of the developed countries, I do agree with the author that it is nontariff measures, and not tariffs, that really affect the market penetration of developing country products. Although tariffs have become less important as barriers over the years, the degree of tariff escalation seems to have increased, discriminating even more strongly against the products of developing countries.

As Mangkusuwondo has observed, the share of developing countries in the developed country markets has increased, despite such protectionist measures. He conjectures that protection in the industrial countries has not been entirely effective. This may have been the case, as many newly industrializing economies have been able to circumvent the barriers quite successfully. It is also important to highlight the fact that many of them have managed to respond to the protectionist threats positively through structural adjustments and market diversification.

I hasten to reiterate that trade policies cannot be considered in isolation and to underline that trade policy reforms cannot always be equated with export orientation.

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1

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3

World Bank (1987), Table 8.9.

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Cover Strategies for Structural Adjustment
Strategies for Structural Adjustment
The Experience of Southeast Asia, papers presented at a seminar held in Kuala Lumpur, Malaysia, June 28-July 1, 1989
ISBN:
9781557751478
Publication Date:
15 Mar 1990
Publisher:
International Monetary Fund
DOI:
https://doi.org/10.5089/9781557751478.071
Pages:
214