Chapter

3 Trade Liberalization: Policy Options from Inward-Looking to Outward-Oriented

Editor(s):
Saíd El-Naggar
Published Date:
December 1992
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Wilfried P. Thalwitz and Oli Havrylyshyn

I. Introduction

Many countries are currently involved in trade liberalization efforts—at three overlapping levels. First, the members of the General Agreement on Tariffs and Trade (GATT) are concluding the negotiations of the Uruguay Round on multilateral liberalization. Second, customs union, common market, or cooperation agreements are in place or are being expanded at the regional level in many parts of the world. Most of these, such as the three integration schemes among Arab countries—the Gulf Cooperation Council (GCC), the Arab Maghreb Union (AMU), and the Arab Cooperation Council (ACC)—are far less comprehensive than the European Common Market. Third, many liberalization efforts are under way at the country level, some in connection with adjustment programs supported by the IMF and the World Bank (Morocco, Tunisia, the Republic of Korea, and Poland), and others following a policy dialogue with the Bank (Brazil and Peru). In a highly integrated world economy, trade liberalization has become necessary for rapid development, but three important concerns are frequently expressed. First, that liberalizing trade threatens domestic industries and that in developing countries export expansion is constrained by protectionist policies in other countries. Second, that liberalization reduces government control and places undue reliance on the uncertain effects of markets. Third, that it is sometimes unwise for countries to liberalize on their own because this may reduce the incentives for other countries to reciprocate.

This paper addresses these concerns and demonstrates how appropriate policies can help resolve them. The key objectives of policy are

  • balancing and reconciling the goals of export expansion and of domestic industrial development.
  • balancing the roles of government and market forces, both in the domestic process of liberalization and in the international negotiation of reciprocal trade agreements.

Section II briefly summarizes the historical evidence on trade policies and trade performance globally, with an illustrative sketch of the policy-performance link in the Arab countries. Section III then addresses the first policy objective, demonstrating why more liberal, outward-oriented trade policies achieve better results than restrictive inward-looking ones, both in expanding exports and in stimulating domestic industrial development. Section IV considers the second policy objective, describing the need for a reduced but active government role in trade policy, to support market forces domestically and internationally.

II. Link Between Policy and Trade Performance: Historical Evidence

General Findings

There are many trade policy options, from autarky to free trade, and the first role of government is to choose the policy that will best foster a country’s economic development. Traditional economic theory favors positions as close to free trade as possible, while a competing proposition, support for infant industry, favors import substitution at an early stage of development. The historical evidence tells us a great deal about which policies are better.

Within this debate, there is broad agreement on one point:

Sustained rapid export growth is good for economic growth.1

Almost all studies relating exports to economic growth, from Balassa (1978), to Thomas, Martin, and Nash (1990), agree that in general higher growth of exports is associated with higher economic growth. The question for trade policy is what kinds of trade regimes result in good export performance. On this issue, too, there is now wide agreement on the following proposition:

countries that have relied on “outward-oriented” development strategies have done better over the medium and longer run than those countries that have adopted “inward-looking” strategies. (Edwards, 1989, p. 1.)

There is less agreement on the appropriate balance between government intervention and reliance on market mechanisms. Trade liberalization usually involves a movement from too much and the wrong kind of government intervention to more reliance on markets. In particular, it involves two elements: correcting the effect of intervention distortions that protect domestic industry against competition from imports and consequently result in an anti-export bias; and reducing the degree of government intervention, allowing markets and prices a greater role in affecting the economic decisions of producers.2 But while correction of the anti-export bias follows naturally from a substantial reduction in intervention through liberalization of import restrictions and devaluation of the exchange rate, the shift to an outward orientation has often begun with the introduction of new intervention measures to compensate exporters for the high production costs they face as a result of import restrictions. Such measures typically include devaluation, duty-free and easy access to imported materials and components, export subsidies or credits, and assistance in marketing.

Outward orientation can be achieved either by less government intervention or by different government intervention. But in the long run, the evidence shows that very high and continued intervention by governments is damaging to the economy and to trade performance.

Whereas on free trade itself history tells us almost nothing—apart from the experience of Hong Kong, there are no cases to analyze—the phenomenal success of East Asian countries (Japan, the newly industrialized countries, and, more recently, Thailand and perhaps Malaysia) has provoked disagreement on the appropriate role of government in achieving outward orientation.3 Are export expansion measures that merely compensate for still remaining import restrictions sufficient, or must government restrictions and intervention also be reduced? Although it is true that Japan, Korea, and Taiwan Province of China did not immediately reduce their import restrictions when they began their export drives, they did not permanently maintain extensive government intervention but moved gradually to reduce it. All these countries steadily reduced their import regulations—Korea more slowly, and Singapore and Taiwan Province of China more quickly than the others—starting with decreased reliance on quotas and other quantitative controls and greater use of tariffs, and continuing with reductions in these tariffs. Furthermore, the initial levels of protection and distortions caused by government intervention, although high, were much lower in these countries before reform than in most other developing countries.4

Clearly, then, these East Asian success stories are not examples of a movement toward outward orientation through new government intervention alone. Rather, they first moved quickly to outward orientation and then slowly but consistently toward lessened government intervention, and in this respect their experience clearly demonstrates liberalization. Liberalization is a process that evolves over time, involving both a shift to outward orientation and a reduction of government intervention. We return later to the issue of the speed of liberalization, arguing in particular that only a few countries have been able to liberalize as gradually as Korea and without losing momentum.

Another area of wide agreement in the liberalization debate is the need for an appropriate exchange rate policy.5 Devaluation, by increasing the value of exports and the cost of imports, corrects the anti-export bias of an economy and contributes to both export expansion and efficient import substitution.

Some Aspects of Arab Countries’ Trade Policy and Performance

Other papers for this seminar address more explicitly issues relating to the Arab countries as a group and individually, and we will not attempt to do the same here. However, it may be useful to illustrate some of the points made in the discussion so far with selective examples in the Arab country group. El-Naggar (1987) divides Arab countries into three groups: oil exporters, middle-income, and low-income. For an analysis of trade performance, the pattern of exports rather than income levels is a useful basis for grouping countries. This classification results in three groups that are nearly identical to those of El-Naggar, relabeled as oil exporters, diversified exporters, and primary exporters. (Table 1 identifies the countries in each group.) Oil exporters tend to have very low import restrictions, and generally these are tariffs rather than quantitative restrictions. The one exception is Algeria, which may be characterized as having a highly restrictive inward-looking regime.6 However, several countries in this group do have substantial subsidy and support programs for certain sectors, in particular, agriculture and petrochemicals. The agricultural support measures in some GCC countries are similar to those in industrial countries: very limited explicit protection via tariffs or prohibitions, but considerable implicit protection using other measures.

Table 1.Structure of Arab Country Exports by Export Category, 1980 and 1988(Percent of total exports)
Classification19801988
Oil Exporters
Undiversified1(Oil > 90 percent)
Nonfuel primary0.71.3
Manufacturing1.24.0
Nonfactor services1.43.5
Fuel96.691.1
Slight Diversification2(Oil < 90 percent)
Nonfuel primary2.43.6
Manufacturing4.211.7
Nonfactor services17.312.5
Fuel76.172.3
Diversified Exporters3
Nonfuel primary21.618.8
Manufacturing13.124.1
Nonfactor services33.641.8
Fuel31.715.3
Primary Exporters4
Nonfuel primary69.767.0
Manufacturing1.33.4
Nonfactor services27.428.0
Fuel1.61.6
Source: World Bank data.

Algeria, Libya, and Oman.

Bahrain, Kuwait, Qatar, Saudi Arabia, United Arab Emirates, and Repubic of Yemen (formerly the Yemen Arab Republic and the People’s Democratic Republic of Yemen).

Egypt, Jordan, Morocco, Syria, and Tunisia.

Mauritania, Somalia, and Sudan.

Source: World Bank data.

Algeria, Libya, and Oman.

Bahrain, Kuwait, Qatar, Saudi Arabia, United Arab Emirates, and Repubic of Yemen (formerly the Yemen Arab Republic and the People’s Democratic Republic of Yemen).

Egypt, Jordan, Morocco, Syria, and Tunisia.

Mauritania, Somalia, and Sudan.

The second group of countries, diversified exporters, have medium to low levels of restrictions, with Jordan probably lowest on this scale. Jordan has not been strongly inward-oriented or highly interventionist in the recent past, whereas the others have. However, all except Syria have undertaken varying degrees of liberalization or devaluation to correct some of the anti-export bias. The strongest such effort has been the adjustment and liberalization program of Morocco since 1984. Egypt undertook a devaluation in 1987 but has not yet implemented many other liberalization measures.

Finally, of the primary exporters, only Mauritania has undergone some liberalization recently.

A thorough analysis of the link between trade policy and trade performance is not proposed here, since it is particularly difficult to assess the effects of trade policy in oil exporting economies—in particular because large oil exports tend to push up the exchange rate, making other exports less competitive. But some illustrative evidence does yield suggestive conclusions (see Table 2). The apparently high growth rates of manufactured exports of inward-oriented countries (Algeria, Sudan) merely reflect the very low base from which they started.7 It is more notable that all the non-oil exporters that have been outward oriented or have undergone some degree of liberalization have experienced far higher growth rates for nonfuel exports, in particular manufacturing, than the others (Table 2). Perhaps the strongest liberalizer has been Morocco, and its export growth rate has also been the highest. Indeed, if only the period since liberalization (1984) is considered, Morocco’s export growth rate is even higher than shown in Table 2—about 8 percent for nonfuel exports and 16 percent for manufactures.

Table 2.Annual Growth in Arab Country Nonfuel Exports, 1980–88(Annual growth in dollar value)
Group/CountryTotal Value

(Including

Services)1
Manufactures
ValueVolume2
Oil Exporters
Algeria1.015.713.6
Libya−2.78.611.6
Oman7.63.6−39.5
Average2.09.3−4.8
Bahrain8.20.3−2.8
Kuwait−8.7−15.1−18.8
Qatar−0.11.0
Saudi Arabia−2.620.915.3
United Arab Emirates6.815.412.9
Yemen Arab Republic−5.412.610.1
Yemen, People’s Dem. Rep. of1.912.29.7
Average0.16.83.8
Diversified Exporters
Egypt (devaluation only)5.512.68.0
Jordan (liberal)3.88.25.8
Morocco (strong liberalization)6.113.811.9
Syria (some liberalization)4.68.86.4
Tunisia (average liberalization)5.37.68.7
Average5.110.28.2
Primary Exporters
Mauritania (some liberalization)7.712.09.5
Somalia−9.75.33.0
Sudan−1.718.515.5
Average−1.211.29.3
Overall average1.59.54.1

Including exports of services. Because services are an important part of actual and potential exports in several Arab countries, and since data are available only in current prices, the totals including services are calculated in current prices.

Volume rates of growth are in constant 1980 prices.

Including exports of services. Because services are an important part of actual and potential exports in several Arab countries, and since data are available only in current prices, the totals including services are calculated in current prices.

Volume rates of growth are in constant 1980 prices.

Although much more thorough analysis is needed to assess the effects of trade policy on performance in the Arab countries, these indicators point in the same general direction as the historical evidence for other countries: more market-based and more outward-oriented trade policies are better for export growth than more statist, inward-looking ones.

III. Export Growth and Efficient Import Substitution

The Benefits of More Liberal Trade

Less distorted and more outward-oriented regimes with less government control do much more than generate exports that pay for essential imports. They also increase imports, which introduces important competitive effects into the economy. The common perception that exports are good and imports are bad (because they hurt domestic industry) motivated the failed import substitution policies of many countries. In fact, both exports and imports are good. Exports pay for imports, but more important, the openness of trade ensures that competitive forces will push domestic producers to their most efficient levels. Exporters cannot export if they are not competitive, and domestic producers must approximate world costs if they are to compete with imports. Trade openness also increases the use of new technology, both in the products that are imported and among exporters who must use the best applicable technology to be competitive on world markets. Finally, liberalization brings with it a lower price for goods. The removal of import restrictions allows buyers to purchase goods at world prices plus any remaining tariff, which means, for example, not only that consumers in Morocco pay less for automobiles and electronic goods as restrictions on these items are reduced, but also that domestic producers will pay less for their inputs such as metals, chemicals, or plastic components.

Indeed, it is a happy paradox that in the long run liberalization will make domestic producers more competitive than they were under the protected, import substitution regime. It is the lowering of input prices and the competitive push to greater efficiency that give this beneficial result. These benefits come not only from an expansion of exports but also from more openness to and competition from imports. Achieving these benefits does not require a negotiated reciprocal liberalization between a country and its trading partners. A unilateral liberalization (a move toward outward orientation plus reduced quantitative restrictions) in itself improves export performance and increases the competitive effects. This is not to say, however, that reciprocity is irrelevant; far from it. The more countries reduce barriers, the more trade is generated, and the more the efficiency gains of specialization are shared (see Section IV). To get the most from trade, countries need to combine multilateral trade negotiations with unilateral liberalization in much the same way as a merchant seeks better results both by negotiating the best price for a product and by keeping a close eye on production activities, seeking continued cost improvements there as well.

Minimizing the Transition Costs of Liberalization

Liberalization is often said to entail many costs.8 The devaluation that accompanies liberalization raises costs and may add to inflation; workers in formerly protected industries may lose jobs as a result of import competition; and export expansion may be slow as other countries impose barriers and support their own exports. While all of these problems may accompany liberalization, they are not always as severe as feared and they can be managed by appropriate government policies.

Where devaluation is necessary (and it usually is), it will indeed raise prices, but this effect is offset by the lower prices on imported goods as import restrictions are reduced. (This effect may be blocked where domestic wholesale and retail markets are monopolistic; and therefore other complementary policies are required.) Also, since devaluation is a far less important cause of inflation than overall macroeconomic instability, an even more important complementary policy is to ensure macroeconomic stability, through fiscal and monetary restraint. On the positive side also, devaluation makes domestic producers more able to compete with imports, and, by allowing for more efficient import substitution, reduces the employment effects of increased imports. Finally, one needs to be clear about which prices are increased by devaluation and for whom. If the exchange rate was overvalued before the devaluation, the resulting foreign exchange shortages signified that not everybody could buy the imported goods; whereas some were privileged enough to receive import licenses, some paid a premium price on the black market, and some went without. Devaluation means higher prices only for those who previously had import privileges. Those who were unable to buy certain imports because of shortages may now be able to do so, while those who paid black market prices continue to pay those prices (or lower ones) but can buy the goods openly. To some degree, higher prices after devaluation are an illusion.

Trade liberalization will result in some worker dislocation, which may even be quite high in some localized areas or sectors. But its overall extent throughout the economy has been exaggerated, as a World Bank study of 19 countries demonstrated.9 The study found that two factors minimize the unemployment problem. Of all the liberalization cases studied, only that of Chile in the mid-seventies showed unemployment effects as high as 10 percent. But these effects occurred only for manufactures and were offset by the very rapid employment expansion in processed agricultural exports. As liberalization measures shift the economy toward an outward orientation and reduce anti-export bias, export expansion increases employment, and in developing countries, export activities tend to be much more labor intensive than are import-substituting ones. Also, liberalization has not meant that entire factories and sectors suddenly close down and that new ones start being built up only slowly. Rather, much adjustment occurs within sectors and even within firms. While some closures do occur, the bulk of adjustment takes place by reducing production of some goods and increasing production of others, such as by switching from one kind of steel product to another. Turkey’s steel industry before the liberalization of the eighties was highly inefficient, but Turkey has since become the third leading steel exporter, thanks to a simple switch from large heavy steel products to simpler products such as radiators for the U.K. market.

The concern that export expansion may not come soon enough is valid but again exaggerated. A combination of devaluation and export promotion measures will help this expansion to develop more quickly. Unfortunately, barriers in importing countries are an element of the trading environment, especially for labor-intensive goods and agricultural goods, the main exports of most developing countries. But this is a problem for reciprocal negotiations at the level of the GATT, and this process requires greater and not less involvement by developing countries. No domestic trade policy measures can do much to alleviate the constraint of import barriers in developed countries. However, it is interesting to observe in this connection that as the nontariff restrictions of developed countries have increased, the most outward-oriented and least distorted economies of East Asia still come out best in export performance.

The Pace of Liberalization and Its Phasing

The desirable pace of liberalization is much debated. Any sensible answer must recognize another element besides speed, however, and that is the combination and sequencing of the many concrete policy measures that constitute liberalization.

In general, a pace as fast as the political circumstances permit is desirable, but perhaps more important than speed is to avoid piecemeal experiments in favor of a preannounced, comprehensive, and consistent program phased in over a specified period of time.

A “fast” program of liberalization does not usually mean immediate or overnight, just as, for most proponents, “liberalization” does not mean free trade. But swift implementation is advocated because a slow pace gives opponents of liberalization (those who stand to lose from its immediate impacts, like highly protected capital-intensive industries) time to lobby for political support to reverse the process. The Bank’s study of 19 countries’ experience with trade liberalization shows that most reforms fail and that they fail for two reasons: the liberalization is incomplete and therefore fails to achieve the benefits that would justify it politically; and the liberalization is so gradual that political opponents have time to mount a strong opposition.10 Examples of such failures are Yugoslavia in the sixties, several Latin American countries over the last three decades, and Turkey in the seventies. Starting in 1980, Turkey launched a much more substantial and successful liberalization based on sustained devaluation, a large program of compensatory export promotion measures, advance notification of gradual reductions in import restrictions, and reasonable adherence to the program schedule.

There are a few cases of sustained successful liberalization over a long period, such as Korea, Greece, Spain, and Portugal. For Greece, Spain, and Portugal, the sustained success of liberalization is explained by the legal commitments they made in their accession to the European Community (EC). The anomaly of Korea’s success is often attributed to the political will of its Government and the strength of its commitment to a policy of efficient economic growth based on outward orientation conditions not found in many other countries. But there is another important factor in the Korean case: its strict adherence to sound macroeconomic policies, in particular fiscal and monetary restraint, plus a stable and realistic exchange rate. The Bank study cited above concludes that such complementary policies were the single most important elements distinguishing successful liberalization episodes from unsuccessful ones.11

While this is not the place to elaborate the components of a comprehensive liberalization package (the two Bank studies cited do this quite thoroughly), a few points, based on experience with trade liberalization, can be made. First, trade liberalization requires macroeconomic stability and a realistic exchange rate. If these conditions are not already present, stabilization measures may need to precede liberalization. Trade liberalization steps can be announced simultaneously and can even be initiated, but liberalization can achieve little in a climate of inflation, uncertainty, and soaring public deficits. Second, other nontrade policies must also be right, in particular, regulations governing investment, price controls, and so on.

Third, the trade measures themselves should preferably begin by eliminating quotas and similar quantitative restrictions, which can at first be replaced by tariffs. This step of creating transparency in protection has several immediate benefits. Tariffs make explicit who benefits from protection and by how much; quantitative restrictions hide this fact. This transparency makes it harder for the beneficiaries of protection to win political battles at the expense of the rest of society. Further, this switch often brings about an increase in fiscal revenues, as the implicit profit premiums arising from protection are transferred from those who hold import licenses to the government via tariffs. While reductions in tariff levels need not come at the same time, they should follow soon thereafter.

Fourth, before tariff levels are reduced, it is important to introduce export expansion measures, as defined earlier in this paper. These measures, along with devaluation, can provide early gains from liberalization by increasing exports, production, and employment, and by demonstrating that liberalization results in benefits that can offset any costs observed. A fifth important finding on which there is broad agreement is that liberalization of international financial transactions should preferably occur after most other liberalization measures to avoid speculative capital flight.

The experience with trade liberalization efforts suggests the following general proposition:

Successful liberalization requires that the government maintain momentum and credibility.

“He who does not move forward falls backward,” goes an old saying; taking small hesitant steps toward liberalization and waiting to see the results before taking the next step is a sure recipe for reversal and failure. Bold initial steps (a comprehensive preannounced program) and a reasonably fast pace both help to sustain momentum and to lend credibility to the government’s intentions. Hesitation, drawn-out programs, with reversals of some measures, quickly undermine credibility and lead to a loss of momentum. The process is self-reinforcing in both directions.

What, finally, does this say about the pace of trade liberalization? In principle, if momentum and therefore credibility can be assured, the process can be very gradual. In practice, we have no cases except Korea that demonstrate that such an approach is possible.

IV. The Role of Government

We turn in this last section to the question: what does a government have to do if the objective of liberalization is to reduce government intervention? The government has a substantial role to play in the process of liberalization, in the transition from inward-looking, restrictive policies to outward-oriented, liberal ones. But even after liberalization is well under way, several critical functions remain for government in supporting a market-oriented, open, and competitive economy.

Role of Government in Managing Liberalization Process

The government’s first action is to identify the objective of liberalization: given the country’s current trade regime, where does it want to go? Once this goal has been identified, as well as the degree of liberalization needed to achieve it, the government’s role is to formulate a program—its timing, sequencing of components, and intensity.

A second role for government is to ease the transition. This role consists of three types of activities. First, it may be appropriate to compensate those who are hurt by liberalization. True, the losers are usually those who greatly benefited from the high protection of the previous, inefficient trade regime, but they benefited because they were following the existing rules of the game, not because of malice to the rest of society. Once the rules are changed, there is some justification for assisting the new losers. The argument is particularly strong for displaced workers, who will require a safety net of unemployment compensation and similar measures. But it may even be appropriate to compensate owners of capital, by providing credit for new investments in other product lines. However, this course of action entails the risk of excessive government intervention and the temptation to try to “pick winners” in industry, a task for which economists and bureaucrats are generally not well suited. As Lieberman (1990) writes, such measures ought to be undertaken “only as a complement to policies that promote efficient, competitive supply responses by industry,” such as market pricing, an increase in competition internally or through imports, or elimination of subsidies.

Another role for government in the transition is to reduce the constraints to the smooth reallocation of resources. New investments need to be made in new places, and workers have to be trained and shifted to other sectors or other parts of the country. The government should certainly not attempt to direct all these shifts—the former socialist bloc countries have demonstrated clearly the failure of such planning. But only the government can make certain improvements, and it may be able to perform some activities better than the private sector. One is to simplify customs and tax procedures. Another is to improve infrastructure, including roads, ports, and telecommunications. Also important are improvements in the education system, particularly during the transition, in areas that quickly begin to demonstrate dynamism (such as textile engineering at a higher level and vocational and technical training in labor-intensive sectors of export strength).

Finally, during the transition, governments should engage in reciprocal negotiations in the international arena, in particular, through the GATT. While unilateral liberalization can yield significant benefits, reciprocal negotiations will certainly increase the gains from liberalization. Multilateral negotiations not only lower external barriers, allowing greater export expansion, but they also can serve an important purpose internally. Reciprocal negotiations help the government to be perceived as an arbiter balancing the interests of those who will be temporarily hurt by import competition with the interests of those who will gain from exports. While everyone gains from liberalization in the long run (import competition stimulates efficiency, export expansion creates new jobs), during the transition it helps to show that efforts are being made to ensure that no one is hurt unfairly.

Role of Government in a Liberal Economy

What role remains for the government as we approach the liberal range of policy options? First, on the role of government in an economy, what makes some economies more successful than others? In simple terms, the same things that make some individuals more successful than others: working hard, working smart, and working for the future. For the economy as a whole, this means expanding employment, investing in capital and education, striving to increase efficiency and productivity, and saving and reinvesting (wisely) a large part of GNP. But how it is done is also important. The appropriate economic role of governments is not to decide, direct, or command, but rather to create an environment in which individuals are free and motivated to work hard, smart, and for the future, taking a direct hand only in the economic activities for which governments are better suited than individuals. That line is not easy to draw, but the burden of proof should be on governments to show why they are undertaking a given economic activity.

This very simple notion that the primary locus of economic activity is the individual acting in (and being disciplined by) the marketplace is well expressed in recent documents of the Government of Morocco, such as the “Lettre Royale du 14 Juin” of His Majesty the King. On the international aspect of economic policy, this document implies an economy open to the world market and based primarily on private initiative and the discipline of the market-place, complemented by four types of government undertaking:12

  • Assurance of a stable, clear, and credible legal framework for the enforcement of commercial contractual obligations in a system of justice, with recourse and access by all parties.
  • Maintenance of a stable macroeconomic environment, including a realistic and stable exchange rate and fiscal and monetary stability.
  • Readiness to act, if needed, after liberalization to assist those seriously hurt by any unforeseen changes (including the effects of policy).
  • Direct government actions to develop the physical, human, and social infrastructure needed to spur economic growth and to increase productivity, but only in areas in which the government clearly has a comparative advantage over individual initiative.

Does this mean free trade—that is, no tariffs, no customs regulations, and no laws against dumping by foreigners? It may mean that if that is the social consensus and the government reflects that view, but it need not. A moderate level of tariffs,13 some rules of operation on safeguards and antidumping, or similar measures are not necessarily very harmful. What are to be avoided are high tariffs, extensive use of quotas and licensing, and highly distorted patterns of protection that largely benefit some favored infant industries at a great cost to others.

In other words, what matters is that the governments perform well the four functions noted above and that any remaining trade regulations are low, clear, simple, transparent, limited, and fair in the sense that no sectors or industries enjoy greater favors than others. This means, simply, very limited and nondiscriminatory government intervention.

V. Conclusion

A country’s choice of trade policy is not just a matter of selecting free trade or autarky, for there are many options in between as well. Two key aspects characterize a trade policy: the degree and type of government intervention, and the effect of this intervention on inward or outward orientation. The historical evidence on what kind of trade policy leads to the best performance, although not entirely unambiguous, does point consistently toward freer, more liberal trade.

The strongest agreement—by now virtually universal—is with the conclusion that outward-oriented regimes outperform inward-looking ones. Agreement is not as strong on how best to achieve outward orientation, whether with less, or with different kinds of, government intervention. While export expansion measures alone, even with highly restrictive import regulations, can—in theory and in fact—shift the trade regime from inward-oriented to outward-looking, two important qualifications are readily acknowledged.

First, the measures used for imports and exports should be the simplest and clearest price-related measures available, such as tariffs, taxes, or tax exemptions for exporters; quantity control measures such as quotas or government production planning directives are to be avoided. The second, and perhaps more important, qualification is that intervention should be temporary and that the government should move consistently toward increased liberality. Thus, for example, if it starts with a highly restrictive, inward-oriented policy, its actions on the export side, such as exemptions from import regulations for exporters, are an acceptable first step, but only a first step.

If we think of liberalization as a process over time, combining a shift from inward-oriented to outward-looking policies plus a reduction in the degree of government intervention, the differences in interpretation lessen. Then not only is a quick leap to free trade a liberalization, but so also is a relatively quick change in orientation and reduced intervention or a slower two-step movement, first shifting to outward orientation and then reducing intervention. The main difference is in the timing and sequencing.

However, although the more gradual, two-step liberalization is feasible, it is difficult to implement without a loss of momentum and credibility in the drive toward the goal of more liberal trade. The very few countries that have achieved liberalization in this way and their special circumstances are a testimony to the difficulty of very gradual liberalization. That a much larger number of countries have tried gradualism and failed further emphasizes this point. This does not mean that only a strong, overnight liberalization will work. It does mean that the period of reform needs to be relatively short, and that the program needs to be announced in advance and followed as planned.

Some important roles remain for the government. For one, the government is the arbiter of society’s sometimes competing interests, deciding on the policy option to be chosen and the path to be followed. For another, it may need to provide a safety net during the transition to a more liberal regime for those displaced by the reallocation of economic activity that constitutes adjustment. It also needs to act as an arbiter in the reciprocal negotiation process of the multilateral trade negotiations in the GATT. Whatever the criticisms brought against this process (and there are many), it has had useful results. Finally, in the more liberal environment, the government retains key responsibilities to support and work with a market economy based primarily on private initiative: ensuring a system of just laws and commercial security, a sound macroeconomic environment, a system of support for the unemployed and for related assistance during unforeseen shocks, and the provision of infrastructure where the private sector does not easily operate, particularly in education, transport, and communications. In the words used so often by foreign investors—the government should do only as much as is needed to improve the investment climate, and stop short of the point where its actions undermine it.

Comment Rasheed O. Khalid

It is difficult to comment on a well-written paper with which you agree on all or most of its contents. So what do you do? You underline certain important aspects of the paper and point out some issues that might need elaboration and then proceed to talk about what it does not contain and perhaps should have. This is what I intend to do.

From a long-run perspective everyone would agree with the central thesis of the paper, which is that everyone gains from liberalization. This happens because import competition stimulates efficiency and export expansion creates jobs. The real issue is the path to be taken toward this objective. In other words, what is the best way to achieve this goal? The World Bank paper can profitably be expanded in that direction. I shall come to that point later. At the moment I wish to offer specific comments on certain points mentioned in the paper.

Some distinction needs to be made between the concept of “liberalization” and the idea of a strategy of outward orientation based on a vigorous pursuit of export expansion. The broad objective of economic liberalization is to allow for a more efficient and better use of resources through increased reliance on market forces. Heavy government intervention in economic matters in the former socialist countries of Eastern Europe and elsewhere in the developing world has failed to deliver the promise of economic growth and improvements in living standards of the vast majority of the populations of those countries. Accordingly, and in a process unprecedented in its scale, a large number of countries are currently engaged in comprehensive liberalization programs.

These liberalization programs are much broader than the pursuit of export expansion as a strategy for rapid economic growth. The strategy has become fashionable because of the impressive economic performance of the newly industrialized countries of East Asia, which, relatively speaking, enjoy low resource endowment levels. The experience of these countries (the Republic of Korea, Taiwan Province of China, and, before that, Japan) has shown that a process of gradual liberalization can be successfully embarked upon after a successful export expansion drive.

Although the paper refers to the benefits of the removal of trade barriers worldwide, and to the relevance of reciprocal trade negotiations, its analysis of the gains from trade liberalization seems to be conducted largely within a unilateral context. Thus, the significance of the multilateral dimension to trade liberalization efforts in individual countries was not, I think, emphasized in a manner commensurate with its importance. While it is correct to argue that liberalization, insofar as it leads to the removal of domestic distortions, will result in efficiency gains for the country concerned, trade issues are inherently multilateral in character.

The success and continuation of trade liberalization programs currently being undertaken in a number of countries will to a great extent hinge on the presence of an international environment conducive to more open trade. One has only to look again at the experience of the newly industrialized countries of East Asia to realize how vital was the growth and expansion of world trade in the three previous decades to their remarkable success. The present calls for protectionism in industrial countries and their grouping into three major trading blocs is a cause for great concern. It is regrettable that countries that are commendably trying to open up their economies and trade—thereby risking great political and social challenges at home—are faced with an international environment in which the commitment of rich powerful countries to an open trading system appears to be waning.

The statement that “large oil exports tend to push up the exchange rate, making other exports less competitive” may require further elaboration. The exchange arrangements in the countries of the Gulf Cooperation Council, with the exception of Kuwait, are such that national currencies maintain, in practice, an unchanged relationship with the U.S. dollar. The Kuwaiti dinar is pegged to a basket of currencies that reflects Kuwait’s external trade and financial relations. Over the years, however, the value of the dinar in terms of the dollar has remained relatively stable. Perhaps an analysis of the movements of the real effective exchange rate in these countries would throw more light on this question.

Finally, there is an implicit and unstated assumption throughout the paper that an adequate, skilled, and versatile work force exists in developing countries that can be retrained and reconverted with ease. Furthermore, the impact of prolonged external shocks on liberalization reform efforts has not been explicitly recognized in the paper.

I return now to the central issue of the appropriate path for the transition to outward-oriented policies. This aspect is largely ignored in the paper; yet it is extremely important. It is a formidable task for latecomers to industrialization to break into world markets of manufactured goods. There is a strong case for granting developing countries more trade concessions, compared with what they actually face at present: a trade environment in which protectionist measures are toughest on goods in which they enjoy a comparative advantage (such as textiles). The case rests on the following assumptions: First, a fundamental asymmetric trade relation exists between these two groups of countries. The industrialized countries buy much more from among themselves than from the developing countries, and the developing countries do just the reverse. That means that a certain amount of exports from the developing countries have much greater importance for their economies than they have, in the form of imports, for the economies of industrialized countries.

Second, the developing countries will continue to provide expanding markets for imports from developed countries, especially for their capital goods. The import patterns of developing countries are distinctly biased in favor of those goods that are the main exports of industrialized countries.

Third, the potential import demand of developing countries is much greater than their actual imports. The gap arises from a general shortage of foreign exchange resources, which, admittedly, could be attributed in part to the long adherence to inward-looking policies. Thus, any degree of export expansion permitted to developing countries would lead to almost the same degree of import increase, which is in the interest of their trading partners and of world trade expansion.

Some progress—albeit at a certain cost—has no doubt been made in the past in the field of import substitution aided by import control policy. However, since the scope for import substitution is gradually reduced as development reaches more advanced stages, further progress on the foreign trade front points to the need for the expansion of manufactured exports and the opportunities inherent therein. In this connection, it is worth mentioning that regional trade arrangements and cooperation will undoubtedly contribute toward a larger market for all the countries involved. However, even if regional trade cooperation can succeed, it will solve only a small part of the problem, for it is with the developed industrialized countries that developing nations trade most.

In this context, a more liberal trade policy by industrialized countries toward exports from developing countries cannot be overemphasized. This is as important as regional trade and economic cooperation among developing countries. For it is from the developed industrialized countries that the developing countries obtain the bulk of their capital goods.

It goes without saying that an increase in the flow of external capital in the form of both loans and direct investment will be of great help. But unless external loans are provided largely in a concessionary form (a source currently tending to decrease), they cannot provide an answer to the problem for they have to be serviced and amortized or, in other words, eventually paid back by goods and services. On the other hand, direct investment could play a crucial role in the development process, by providing external finance, as well as the opportunity to benefit from advanced technology and management techniques. However, a great deal has be done, in terms of domestic economic reforms and liberalization measures, in the majority of developing countries before private foreign capital can actually be attracted. Hence, a more realistic solution would seem to rest with trade: that is, export expansion and import substitution.

It is difficult, however, to weigh the relative importance of these two elements (export expansion and import substitution) in the development process in any particular country. Historically, the United Kingdom and Japan are examples of exported growth. But Germany and the United States are examples of protected industrialization.

A more pragmatic approach to the issue of import substitution and export expansion is to try to consolidate the existing policies in an individual country and to make them more consistent and more rational to serve the purpose of development. This is not a simple task because many countries have adopted more than one kind of control—usually a combination of two or three or even more of such measures as tariffs, subsidies, multiple exchange rates, quantitative restrictions, and tax and credit incentives. In searching for a rational solution, one first has to examine the impact of these individual measures, one by one.

In concluding, I would like to say that the authors presented persuasively and clearly, but in a condensed and general form, an issue that is highly relevant to the problems currently being faced by a large and increasing number of countries around the globe. Considering who the authors are, the paper may be pointing us in the direction that World Bank thinking is fortunately being led. The impact of the paper would, I think, be greatly enhanced by an attempt to think through and to work out in some detail the optimal path to free markets and to outward-oriented economic policies.

References

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1

Short bursts of exports, owing to either fortuitous circumstances of high demand for a country’s raw materials or heavy subsidization of exports, are not in themselves enough to sustain the growth impetus.

3

See Sachs (1987) and Lal and Rajapatirana (1987) for different interpretations, and Edwards (1989) for a reconciliation of the two.

5

See Michaely, Choksi, and Papageorgiou (1989) and Thomas, Martin, and Nash (1990) for discussions of how important appropriate devaluations are in explaining successful trade liberalization experiences.

6

Algeria is categorized as an oil exporter because oil accounts for 90 percent of its exports.

7

In 1990, Algeria had manufactured exports of $3 million and Sudan less than $1 million, compared with over $100 million in Egypt and Jordan, nearly $500 million in Morocco, and over $900 million in Tunisia.

8

The following discussion draws heavily on the World Bank report by Thomas, Martin, and Nash (1990).

9

Michaely, Choksi, and Papageorgiou (1989).

10

Michaely, Choksi, and Papageorgiou (1989).

11

Sachs (1987) also emphasizes the importance of macro policies in sustaining the export and growth performance of Korea.

12

The concrete measures that may follow from these fundamental principles in a particular case are elaborated in Havrylyshyn and others (1990).

13

The industrial country average is less than 5 percent, but their level of protection is higher than tariff rates alone suggest, given the substantial increase in their use of nontariff restrictions, which is in effect a step backward in liberalization that deserves the criticism it gets. Liberalization measures in developing countries should include all possible efforts to reduce these barriers, including reciprocal negotiations and political-diplomatic pressures that publicize the extent of this “New Protectionism.”

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