Chapter

V Trade Policies of Developing Countries

Author(s):
International Monetary Fund
Published Date:
January 1992
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Since the mid-1980s, there has been a marked shift in the orientation of the trade and industrial policies of most developing countries90 away from a heavy reliance on direct intervention and inward-looking industrial policies toward less controlled and more export-oriented trade regimes. In a selected group of 36 regionally important developing countries that have embarked on trade reform programs since around 1985, 17 have virtually eliminated quantitative restrictions from their restrictive trade systems. Another 8 countries have maintained or further liberalized their open or somewhat open trade systems (Tables 1113).

Table 11.Developing Country Trade Regimes Before Liberalization
CountryYear1Tariffs and Surcharges2Quantitative Restrictions3
Statutory tariff

(In percent)
Charges

(In percent)
Main measureCoverage4

(In percent)
Tight control
Argentina19860–1000–14Nonautomatic licensing60
Bangladesh19840–30015–100 +Prohibitions51
Bolivia19840–600–2Nonautomatic licensing90
Cameroon19880–1005–10Nonautomatic licensing>90
Colombia19846120–18Prohibitions935
Gambia, The19850–600–6Nonautomatic licensing>50
Ghana19880–10010–40Nonautomatic licensing100
India19870–2950–50Nonautomatic licensing>90
Jamaica19840–750–28FX allocation50
Kenya19870–125FX allocation58
Malawi19870–400–35FX allocation85
Morocco19820–4510–45Nonautomatic licensing>90
Nepal19855–1000–105Nonautomatic licensing>90
Nigeria19855–1000–5FX allocation925
Pakistan198810–2256–11Nonautomatic licensing805
Peru19890–1173–147Prohibitions100
Tanzania19876–100FX allocation70
Tunisia19865–2360–50Nonautomatic licensing76
Venezuela19880–802–5FX allocation65
Zaïre19820–50FX allocation>90
Zambia19840–100FX allocation>90
Significant control
Brazil1985812Nonautomatic licensing345
Côte d’Ivoire19832–30Nonautomatic licensing15–50
Ecuador19840–2901–30Nonautomatic licensing385
Indonesia19840–600–40Nonautomatic licensing32
Mexico19840–1003–19Nonautomatic licensing38
Philippines19840–500–25Nonautomatic licensing36
Trinidad and Tobago19885–3510–100FX allocation15–50
Relatively open
Costa Rica19850–22013–1001
Korea1984262155
Malaysia19851420–605
Senegal198515–457–50155
Sri Lanka19860–1000–4513
Thailand19810–1006
Uruguay19820–750–740
Open
Chile19840–355–150
Sources: International Monetary Fund, Annual Report on Exchange Arrangements and Exchange Restrictions; United Nations Conference on Trade and Development; General Agreement on Tariffs and Trade.Note: FX = foreign exchange. Countries are classified based on the following criteria. In regimes with tight and significant control, quantitative restrictions (QRs) cover more than 50 percent or between 15 percent and 50 percent of imports, respectively. Relatively open regimes have QRs covering 5–15 percent of imports or QRs covering less than 5 percent of imports and maximum tariffs and charges that exceed 50 percent. An open regime has tariffs and other import taxes not greater than 50 percent and QRs covering less than 5 percent of imports. No allowance has been made for differences in the administration of QRs or the structure of tariffs that may also affect the degree of restrictiveness of the trade system.
Table 12.Trade Reform Programs in Developing Countries
Year BeganIMF Program1Reform Measures2
Quantitative restrictionsTariff
Reforms in initially restrictive regimes
Major reforms
Argentina1987SBAGradual virtual elimination.Sharp reduction.
Bolivia1985ESAFVirtual elimination up front.Low tariffs in two-tier range.
Colombia1985SBAGradual reduction, replacement with tariffs.Very gradual reduction of tariffs.
Gambia, The1986ESAFComplete OGL; some state trading elimination.No measures.
Ghana1986ESAFVirtual elimination through FX auction access.Reduction of maximum and rationalization.
Jamaica1985SBAMajor reduction in import licensing.Large offsetting increases.
Kenya1988ESAFGradual replacement with tariffs.Offsetting increases.
Mexico1985EFFGradual virtual elimination.Sharp reduction in rates and dispersion.
Peru1990NoneVirtual elimination up front.Low tariffs in two-tier range.
Venezuela1989EFFVirtual elimination up front, rest by 1992.Reduction of maximum and rationalization.
Zaïre1983SAFVirtual elimination up front.Reduction of maximum and range.
Moderate reforms
Brazil1986NoneGradual virtual elimination.Gradual reduction over 4 years from 1990.
Côte d’Ivoire1984SBASome replacement with surcharges.Tariff increase instead of gradual reduction.
Ecuador1985SBAPhased elimination of QRs.Tariff maximum reduced to 35 percent.
Indonesia1985NoneReduction in QRs, also on competing goods.Reduction of maximum.
Philippines1985SBAGradual replacement with tariffs.Reduction of tariff bands.
Trinidad and Tobago1989SBAGradual replacement with surcharges by 1991.Gradual surcharge reduction by 1993.
Minor reforms
Bangladesh1985SAFSome reduction for intermediate goods.Reduction of maximum tariff.
Cameroon1989SBAGradual replacement with tariffs.Rationalization of tariff structure.
India1988NoneSome net additions to OGL list.Some increases.
Malawi1988ESAFLimitation of FX allocation to a small negative list.Transfer QRs to surtaxes.
Morocco1983SBAReduction in QRs on noncompeting goods.Sharp reduction of maximum; new surcharge.
Nepal1986SAFExpansion of import license auction.Harmonization of tariffs.
Nigeria1986SBAGradual replacement with tariffs.Large offsetting increases in tariffs.
Pakistan1989SAFGradual replacement with tariffs.Reduction of maximum tariff.
Tanzania1988SAFGradual widening of OGL.Reduction of maximum and simplification.
Tunisia1987EFFGradual replacement with surcharges.Tariff reduction; increases in surcharges.
Zambia1990RAP3Gradual increase of OGL and exchange rate unification.Reduction of maximum and range.
Reforms in initially nonrestrictive regimes
Chile1985EFFConstitutional prohibition of QRs.Reduction of uniform rate.
Costa Rica1985SBAElimination of remaining QRs by 1994.Maximum tariffs and charges, 55 percent by 1994.
Korea1984SBARemoval of nonagricultural QRs.Reduction of unweighted average tariff.
Malaysia1986NoneGradual replacement with tariffs.Harmonization of tariffs.
Senegal1986ESAFGradual virtual elimination.Gradual reduction over 3 years.
Sri Lanka1987SAFGradual elimination of most remaining QRs.Reduction of maximum and dispersion.
Thailand1982SBARemoval of nonagricultural QRs.Restructuring later reversed.
Uruguay1983SBANo measures.Sharp reduction in maximum.
Sources: International Monetary Fund (IMF), Annual Report on Exchange Arrangements and Exchange Restrictions; United Nations Conference on Trade and Development; and General Agreement on Tariffs and Trade.Note: EFF = Extended Fund facility; ESAF = enhanced structural adjustment facility; FX = foreign exchange; OGL = open general license; QRs = quantitative restrictions; SAF = structural adjustment facility; SBA = stand-by arrangement.
Table 13.Current Structure of Developing Country Trade Regimes
CountryMost

Recent

Year of

Reform
Tariffs and Surcharges1Quantitative Restrictions2
Statutory tariff

(in percent)
Charges

(in percent)
Main measureCoverage3

(in percent)
Tight control
India19900–2950–78Nonautomatic licensing70
Nepal19895–1000–105Nonautomatic licensing>50
Tanzania19900–600–50FX allocation>50
Significant control
Bangladesh19900–>100Prohibitions244,5
Cameroon19910–1005–10Nonautomatic licensing15–50
Malawi19910–450–85Nonautomatic licensing176
Morocco19890–450–13Nonautomatic licensing224
Nigeria19890–2007Prohibitions214
Pakistan19910–950–15Prohibitions214,7
Tunisia19900–4315–30Nonautomatic licensing30
Zambia199015–500–20FX allocation15–50
Relatively open
Brazil19910–6514
Colombia19910–630–16144
Côte d’Ivoire19875–300–1274
Ecuador19915–35154
Indonesia19900–400–40154
Jamaica19880–607
Kenya19910–1006
Malaysia19895
Peru199115–255
Philippines198910–500–2584
Senegal199115–4510–5064
Sri Lanka19905–5094
Thailand19900–10084,8
Trinidad and Tobago19915–450–6009
Venezuela19910–2010
Zaïre19860–500–238
Open
Argentina19910–220–444
Bolivia19885–101–22
Chile198815105–200
Costa Rica19901–400–181
Gambia, The19910–231
Ghana19880–250–230
Korea19901–504
Mexico19880–202
Uruguay19850–450–50
Sources: International Monetary Fund, Annual Report on Exchange Arrangements and Exchange Restrictions; United Nations Conference on Trade and Development; General Agreement on Tariffs and Trade.Note: FX = foreign exchange. Countries are classified based on the following criteria. In regimes with tight and significant control, quantitative restrictions (QRs) cover more than 50 percent or between 15 percent and 50 percent of imports, respectively. Relatively open regimes have QRs covering 5–15 percent of imports or QRs covering less than 5 percent of imports and maximum tariffs and charges that exceed 50 percent. An open regime has tariffs and other import taxes not greater than 50 percent and QRs covering less than 5 percent of imports. No allowance has been made for differences in the administration of QRs or the structure of tariffs that may also affect the degree of restrictiveness of the trade system.

While most developing countries have made substantial progress in liberalizing their trade and trade-related exchange systems, progress across regions has been uneven. The shift in the orientation of trade policies is most striking in Latin America where almost all of the largest countries have, or are now committed to, open or relatively open trade systems. This contrasts starkly with the strong inward orientation that prevailed as late as 1984. The liberalization policies in these countries have been marked by a rapid elimination of quantitative restrictions and a clear plan for subsequent reductions in tariffs to quite low and uniform levels.91 In contrast, reforms in East and Southeast Asia, where most countries have had relatively open systems since the early 1980s, have tended to be gradual. Their reforms have progressively increased the range of sectors subject to import competition. While some low-income countries have made substantial progress in liberalizing their trade systems, many countries in Africa and South Asia have not yet opened their economies to significant foreign competition; much of the reform has focused on inputs for production, and now they face the more difficult task of liberalizing quantitative restrictions on competing products and reducing very high tariffs. Reforms are continuing and more countries are likely to adopt open trade systems in the near future. A key feature of the latest round of reforms is that they are part of an integrated package of macroeconomic and structural reforms (often supported by multilateral institutions). Trade reforms that are accompanied by appropriate supporting policies are more likely to contribute to improved economic performance and to be sustained over time.

The increased participation of developing countries in the multilateral trade system is an important development linked to recent reforms. Many Latin American countries, for example, have bound 100 percent of their tariff schedules in GATT, in part to secure the trade reforms made so far. To consolidate these achievements, reciprocal liberalization within the framework of the Uruguay Round will be important. Secure access to foreign markets in the areas where developing countries have a comparative advantage is the most beneficial way of fostering genuine trade reforms and ensuring effective use of foreign aid and financing.

Trade Policies Prior to the Mid-1980s

Two important reasons explain the predominance of restrictive regimes prior to the mid-1980s. First, the desire to protect domestic industry to foster import substitution, which was seen as essential for development. Export pessimism, in terms of market access and unfavorable terms of trade, had played an important part in providing the justification for import substitution. Under the infant industry argument, import substitution required the protection of the industrial sector, to enable it to expand and to reduce its costs through economies of scale and learning by doing. Protected manufacturing industries were expected to provide externalities, such as urban employment, a “modern” industry, and diversification of the economy away from traditional exports of primary products. Corden (1987) reviews some of the arguments for protection and Bhagwati (1988) provides a historical perspective on the various reasons for this dirigiste approach.

Second, in the context of inappropriate macro-economic policies and real exchange rate appreciation, discretionary import licensing and foreign exchange restrictions were used to limit the demand for, and allocate the supply of, foreign exchange to cope with chronic balance of payments pressures.92 In some cases this was done on an ad hoc basis; in others it was done in the context of annual import plans (e.g., India, Pakistan, and Bangladesh).93Whalley (1989) has argued that external sector controls in many developing countries were imposed cyclically to absorb some of the fluctuations in export receipts and capital flows. For example, the external regimes of many developing countries became more restrictive in response to the first oil crisis and the collapse of commodity prices in 1973, and the subsequent 1974–75 recession, after having been liberal in the 1960s and the early 1970s. Similarly, many developing countries responded to the debt crisis and recession starting in the early 1980s by initially tightening trade and exchange restrictions.

In this connection, some 80 percent of quantitative restrictions notified to the GATT by developing countries were justified for balance of payments reasons under Article XVIII:B. In addition, a number of countries employed foreign exchange restrictions on current account transactions, particularly those with tightly controlled regimes. In many of these countries, the restrictive measures used to shelter the import-competing sector had the important indirect effect of biasing the incentive structure against agriculture as well as exports.94

A number of developing countries nevertheless undertook trade reforms before the mid-1980s, with varying intensities and with mixed results. An extensive review of some of the main cases of trade liberalization prior to the mid-1980s is contained in Michaely, Papageorgiou, and Choksi (1991). An important conclusion of this study is that the strong reforms were likely to be sustained and the weak reforms were likely to be reversed. The single most important reason for the reversal of reforms was inadequate macroeconomic policies, which led to the reimposition of licensing or exchange controls to protect the balance of payments. In many cases where first attempts at reform were weak and failed, subsequent reforms were likely to succeed if they were strong. Some of the strong reforms that succeeded were those in Chile (1974–81), Indonesia (1966–72), Sri Lanka (1977–79), and Turkey (1980–84). Korea (with reforms in 1965–67 and 1978–79) is the only developing country with reforms classified as weak that succeeded. Two important and contrasting cases in the 1970s and 1980s are Chile and Korea. Their goals of high export growth were achieved through different strategies of trade liberalization. Chile adopted a strong and rapid liberalization program and became an open economy in the late 1970s. Korea adopted gradual, sustained reforms and became a partially open economy only in the mid-1980s. In both countries, generally prudent macroeconomic policies that stressed low inflation and a realistic exchange rate were, despite some slippages, the foundation of their success.

In the sample of 36 developing countries referred to earlier, most of the countries with nonrestrictive trade systems during the early to mid-1980s performed well in the 1980s in terms of real growth of exports and output. Five of the eight countries in this category had better export growth and six had better output growth than the average for developing countries in 1983–90. Two of the countries with weak performance, Costa Rica and Uruguay, had very high tariffs to foster import substitution, yet still performed close to the Western Hemisphere average. Senegal experienced export growth well below the average for sub-Saharan Africa. It is a member of the franc zone and is relatively free of quantitative restrictions, but it had a complex system of taxes on imports that resulted in very high tax rates, and used high reference prices for a large range of imports.

Trade Policies Since the Mid-1980s

Extent of Reforms

In recent years, many developing countries pursuing structural reforms have included some trade liberalization measures. In order to assess the extent and quality of trade reforms in these countries, a review was made of trade policies in 36 countries that have implemented trade reform programs since the mid-1980s (Box 2). In all but five of the programs reviewed, trade liberalization was supported by arrangements with the Fund and in many cases by World Bank adjustment loans. Of the 36 developing countries reviewed, 28 had either a tightly controlled (21) or a significantly controlled (7) trade regime, while only 8 had either a relatively open (7) or an open (1) regime (Table 11).

Box 2Methodology Used in Trade Review

Coverage

A review of the major countries in each geographic region based on the size of trade or gross domestic product (GDP) was undertaken to assess the extent and quality of trade reforms undertaken since the mid-1980s. All but five of the countries (Brazil, India, Indonesia, Malaysia, Peru)—had Fund-supported trade reform programs after the mid-1980s, Brazil, India, and Peru have recently concluded agreements with the IMF. Indonesia’s trade reforms have been supported by World Bank loans and technical assistance from the Fund to introduce a value-added tax. The Eastern European countries are not included in this sample, but their trade reform programs are reviewed in Section IV. Comprehensive reform of their trade and payments systems is a key element of their reform programs.

Measurement of Trade and Trade-Related Measures

Tariffs and other import charges are measured in this study by the predominant maximum and minimum rates. The range of tariff rates provides information on the dispersion compared with average or effective tariff rates. Effective rates of protection would have been a preferable measurement, but are not available for most countries or for recent years. High tariff rates that applied only to a few items have been excluded and if exemptions are widespread, a zero minimum tariff rate has been used, even if there was no statutory zero rate.

Nontariff barriers are measured in terms of their coverage of import values. The import values generally relate to the pattern of imports in the measured year. It would be preferable to measure the coverage in terms of import patterns that would exist in the absence of restrictions, as otherwise the items subject to the most severe restrictions would receive the least weight. In the limit, items which are prohibited or for which no licenses are issued have a zero weight. Where this problem is quite extensive the proportion of tariff code items subjected to quantitative restrictions is provided as an alternative measure.

There are other shortcomings with the use of the coverage of quantitative restrictions in terms of import values or tariff code items as an indicator of the restrictiveness of quantitative trade measures. First, although this indicator is a measure of the existence of controls, it is not a good measure of the protective impact of quantitative restrictions, given the difference in size and diversification of the domestic industries of countries. In a small country, quantitative restrictions applied to a relatively small range of import values can protect a large proportion of domestic production. Tunisia, for example, had liberalized quantitative restrictions on 70 percent of import values by early 1991; however, 70 percent of domestic production remains sheltered by quantitative restrictions. In smaller, lower-income countries, the same proportion of domestic production is likely to be protected by an even smaller import coverage of quantitative restrictions. This problem can be overcome by weighing the coverage in terms of the shares of domestic production protected by them, but this measure is not available in most countries. Second, the coverage of quantitative restrictions indicates only the existence of one or more restrictions but not the scarcity value they imply.

Trade Liberalization

Trade liberalization covers decontrol—the elimination of nontariff measures—as well as policies that shift the trade regime toward neutrality—a reduction in the bias toward a particular activity, especially the production of import substitutes.

Neutrality is defined as a situation in which the effective exchange rate for a country’s exports—nominal exchange rate adjusted for export taxes and export subsidies and tax credits—is equal to the effective exchange rate for imports-nominal exchange rate adjusted for duties and premiums resulting from quantitative restrictions (Bhagwati (1988)). An incentive system that is approximately neutral is preferable in that it fosters an efficient use of resources. Export rebates or duty-drawbacks may improve neutrality because they offset the bias against exports created by the protective system. However, export subsidies could imply a shift away from neutrality and lead to an inefficient use of resources.

Decontrol does not necessarily imply a shift toward neutrality. An example of decontrol without a move toward neutrality is the replacement of quantitative restrictions with equivalent tariffs. However, the elimination of quantitative restrictions makes trade regimes more transparent, helps to reduce rent-seeking activities, increases the price sensitivity of the trade system, and serves as the basis for subsequent tariff reductions. Another example of decontrol without a more neutral incentive structure is the removal of quantitative restrictions on inputs to import-substituting sectors without the decontrol of the final goods. This encourages the expansion of protected production and may increase the effective rate of protection for final import-competing goods.

Criteria Used to Classify Trade Regimes

For the purposes of the review of trade reforms, the following criteria were used to classify countries’ trade regimes. In regimes with tight and significant control, quantitative restrictions (QRs) cover more than 50 percent or between 15 percent and 50 percent of imports, respectively. Relatively open regimes have QRs covering 5–15 percent of imports or QRs covering less than 5 percent of imports and maximum tariffs and charges that exceed 50 percent. An open regime has tariffs and other import taxes not greater than 50 percent and QRs covering less than 5 percent of imports. No allowance has been made for differences in the administration of QRs or the structure of tariffs that may also affect the degree of restrictiveness of the trade system.

Of the 28 countries with restrictive trade systems, 17 undertook comprehensive trade reforms that resulted in relatively open or open trade regimes, while 11 implemented only partial reforms that left their domestic sectors substantially protected by quantitative restrictions (Table 12).95 The 17 countries that introduced comprehensive reforms virtually eliminated trade and payments restrictions, usually within a two-year period, leaving tariffs and surcharges as the principal means of protection; 12 countries narrowed the range of tariffs, but 5 raised tariffs or surcharges when quantitative restrictions were lifted. In the partially open countries, tariffs remained high and widely dispersed, but the initial reforms greatly improved the transparency and price sensitivity of the trade regime. Thus by the end of the period under review, 60 percent of the countries with initially restrictive trade regimes had succeeded in removing the most distorting trade barriers (Table 13). In the 11 countries that implemented minor reforms, the quality of reforms varied, but in most cases the removal of quantitative restrictions was gradual and partial, with inputs for production or noncompeting imports decontrolled first, leaving quantitative restrictions on many final products and potentially raising their effective levels of protection. Such partial reforms may increase the level of effective protection on final import-competing products, rather than reduce it.

The main instruments used to promote export growth and diversification in the programs reviewed have been adjustments to exchange rates and producer prices and tariff reforms to reduce the anti-export bias in the structure of import protection. In countries with extensive foreign exchange controls, foreign exchange retention schemes for exporters were sometimes introduced; and in some cases, special licenses were provided to exporters to import inputs or duty drawback systems were used. In general, such schemes have not effectively addressed the anti-export bias facing export industries in restrictive systems and have proved difficult to administer. In more neutral regimes, however, duty exemption schemes can play an important role.

Overall, while most countries reviewed made considerable progress in substantially eliminating quantitative restrictions on trade and payments, tariff protection still remains high in most of them. Only nine have achieved an open trade regime with few quantitative restrictions and low tariff rates. Most others continue to maintain high and widely dispersed tariff structures that hinder the efficiency of resource use and growth prospects. A high tariff level results in inefficient import substitution and raises the cost structure of the economy; the resulting higher equilibrium value of the currency acts as a general tax on the export sector. A wide dispersion in the structure of tariff rates provides greater protection for those industries with the higher tariffs, attracting scarce resources from more efficient sectors.

Issues in the Design and Implementation of Trade Reforms

Compared with trade reform programs undertaken in earlier periods,96 the programs reviewed were more frequently designed and implemented in the context of comprehensive macroeconomic and structural adjustment programs that introduced complementary measures to deregulate domestic product and factor markets and improve the efficiency of the public sector. In addition to appropriate financial and exchange rate policies, structural measures that accompanied trade liberalization commonly included measures to improve public expenditure and tax programs, reform public enterprises and marketing boards, decontrol domestic prices and financial markets, attract foreign direct investment, and reduce labor market rigidities. These measures aimed to improve the responsiveness of economic agents to relative price changes and the climate for private sector investment and thereby reduce the costs of adjustment. In turn, the liberalization of trade and payments has supported macroeconomic adjustment by fostering greater competition in the domestic market and alleviating the foreign exchange constraint; it also eliminates distortions facing many developing countries and thereby stimulates production based on comparative advantage.

There is broad agreement, which is confirmed by experience under the programs reviewed, that credible and balanced macroeconomic policies are essential to reap the benefits from trade liberalization. Where macroeconomic policies lack credibility, the need for frequent changes in policies and nominal exchange rates have led to inflationary expectations, speculative imports, and the reimposition of import restrictions (the Philippines, Zambia). In some other cases, inadequate fiscal adjustment has placed too great a burden on monetary policy, putting upward pressure on real interest rates and exchange rates and penalizing the productive sector (Argentina and other Southern Cone countries in the 1970s; and Argentina, Brazil, Jamaica, and Peru in the 1980s and early 1990s).97

In the context of comprehensive programs, an important issue is the proper sequencing of trade reforms in relation to other policies. Views differ about whether macroeconomic stabilization needs to precede trade liberalization or whether the two go hand in hand. The review of experience indicates that trade liberalization has succeeded both after (Ghana, Korea) and during macroeconomic stabilization programs (Chile, Mexico, Venezuela).98 While the choice in sequencing depends on the initial conditions in the country concerned, the international economic environment, and the overall program design, there is a growing consensus that high priority should be given to trade reform at an early stage in the adjustment effort (Table 14). Financial, exchange rate, and wage policies are essential to the adjustment process, but when these policies are complemented by the liberalization of the trade and payments regime, a more efficient framework for restoring a viable external position can be achieved.

Table 14.Trade Liberalization, Stabilization, or Both
A.Liberalize Trade First
1.If foreign funds are available, tariffs can be reduced without an accompanying real depreciation, helping the stabilization effort by providing an anchor for (many) domestic prices, Krueger (1978).
B.Implement Both Policies Simultaneously
2.Trade reforms complement fiscal adjustment, Papageorgiou, Choksi, and Michaely (1990).
3.In theory there is very little connection between the determinants of inflation and the orientation of the trade regime. It is possible to attack both problems at the same time as long as we avoid overvaluation, Krueger (1981).
4.Postponement of liberalization implies prolonging inefficiency costs. Do it simultaneously following crawling peg and assuming that government will not resort to controls to curb inflation, Krueger (1984).
5.Liberalization will only succeed with depreciated real exchange rate. This requires solving fiscal deficit pressures simultaneously, Michaely (1987).
6.As long as overvaluation is avoided, it is possible to carry on both policies at the same time, Corden (1987).
7.A variety of trade reforms complement fiscal adjustment, such as the conversion of quantitative restrictions to tariffs and reduction of tariff dispersion, Thomas, Matin, and Nash (1990).
C.Stabilize the Economy First
8.Liberalizations will have a better chance of succeeding if undertaken with a fiscal surplus. In this way we can assure that we will maintain a depreciated real exchange rate, McKinnon and Mathieson (1981).
9.Main problem with aborted liberalizations is that they have been accompanied with massive capital inflows resulting in real appreciation. Need for foreign funds can be avoided by achieving fiscal surplus before liberalizing, McKinnon (1984).
10.Since inflation generates serious distortions, liberalization will take place under inappropriate signals. Thus, inflation should be brought down first, Fischer (1986, 1987).
11.Both policies result in a “competition for instruments,” where what is required to succeed on one front is the opposite of what is needed to succeed on the other. Historical evidence from successful Asian exporters suggests that stabilization should be consolidated before attempting trade reforms. In countries with high inflation where stabilization requires the use of exchange rate as a nominal anchor, it is preferable to postpone trade reform until the economy is stabilized, Sachs (1987, 1988).
12.Reduction in tariffs to low levels has a direct revenue impact and an indirect budgetary impact because of lower activity and employment and the payment of safety net benefits. Thus fiscal consolidation and reform need to come before complete liberalization, Blejer and Cheasty (1990).
13.Despite their complementary nature, trade reforms may have to be delayed in high inflation situations, Thomas, Matin, and Nash (1990).
Source: Based on Table 4.1 in Operations Evaluation Departments, World Bank Support for Trade Policy Reform, Report No. 9527 (Washington: World Bank, 1991).

The interaction between the government budget and the various stages of trade reform needs to be considered when a trade liberalization program is designed. This includes both the direct fiscal impact of changes in trade-related taxes and the indirect effects of changes in budgetary receipts and payments owing to a possible initial contraction in economic activity and employment and the provision of safety net benefits.99 The initial stages of trade reform, when quantitative restrictions are replaced by tariffs and tariff exemptions are eliminated, can complement fiscal adjustment. However, in countries that depend heavily on import taxes, a reform of the domestic tax system is required before tariffs can be brought down to a sustainable basis. Of the countries reviewed, a number that have successfully liberalized have introduced value-added tax systems to broaden the domestic tax base (Indonesia, Mexico). Some others have delayed tariff reductions (Bolivia, Pakistan, Sri Lanka, Thailand) or introduced surcharges (Chile and Morocco) for revenue reasons.

Appropriate exchange rate policies are also essential to ensure that trade reforms are consistent with balance of payments objectives. Because the equilibrium exchange rate is partly determined by the degree of import restrictiveness, major reform programs often involve an exchange rate adjustment; ultimately, the choice of exchange rate policy will depend on initial conditions and the other elements of the macroeconomic program. In the sample reviewed, all but two of the programs that resulted in relatively neutral trade regimes with low tariffs were associated with a substantial devaluation of the nominal exchange rate at about the time trade reforms were initiated, which resulted in a real effective depreciation that was sustained by policies thereafter. Korea’s trade reform program, which was gradual and preannounced, was not associated with a major exchange rate adjustment.

As discussed above, the scope and pace of liberalization programs has varied significantly across geographic regions. Recent trade reform programs in Latin America and Eastern Europe have been comprehensive and relatively quick, while those in Southeast Asia have been gradual and most reforms in Africa and South Asia are not yet complete. It is difficult to assess at this stage whether the “big bang” or the gradual approach will be more enduring; however, an important measure of success has been achieved by countries that have substantially completed the liberalization process using either approach. Bolivia, Chile, and Venezuela in Latin America, and the dynamic Asian economies have all had considerable success in sustaining their earlier reforms.

There are strong indications that the completeness and the credibility of a reform program are the most important factors for success. Elements of trade reform programs that have contributed to sustained liberalization include the preannouncement of the timing and scope of reforms, the early removal of quantitative restrictions, the reduction of tariff levels and dispersion, and complementary domestic price, tax, and public enterprise reforms. Locking in reforms in various ways also enhances credibility. Many countries in Latin America have bound their entire tariff schedules in the GATT; Chile introduced an amendment to its constitution forbidding the use of quantitative import restrictions; and countries that adopt a relatively uniform tariff schedule may find it easier to resist pressures for protection from special interest groups.

The economic effects of trade liberalization are difficult to disentangle from the effects of other policies, but the evidence from a number of comprehensive studies indicates that the long-run effects of trade liberalization on output and employment growth, trade expansion, and the balance of payments were beneficial.100 A recent comparison by the IMF of the trade orientation and growth performance of 41 developing countries showed that during 1975–89, the outward-oriented countries achieved, on average, significantly higher growth rates of potential GDP and of total factor productivity than the inward-oriented countries.101 The review of countries’ trade reform programs also indicates that most of the countries that had open or relatively open trade regimes in the early 1980s have performed well in terms of the growth of output and exports and have avoided serious balance of payments problems.

Although trade liberalization has been shown to be beneficial in the longer run, shorter-run adjustment costs are likely to be incurred when formerly protected sectors are exposed to import competition. The elimination of price controls and rationing, which frequently accompanies trade reforms, can also put basic necessities out of reach of the poorest segments of the population. In these circumstances, public support for reforms can be enhanced and transition costs reduced by policies that improve external competitiveness, facilitate adjustment in labor markets, and target safety net benefits to the most needy.

Trade Liberalization Versus Export Promotion and Selective Intervention

Trade liberalization is now considered a more efficient instrument for promoting export diversification than some of the earlier schemes used for this purpose. These included export subsidies for nontraditional exports, including cash subsidies and income rebates, which were common in Latin America before the recent reforms, or duty relief schemes, which have assisted a large range of exports in Korea and relatively open countries, such as Indonesia and Malaysia. In the absence of a relatively open trade system, these schemes have not generally been successful in that by and large such countries did not reduce their reliance on traditional exports during the 1960s and 1970s. Export processing zones have been set up in a large range of countries to enable certain export production to avoid domestic taxes and restrictions altogether; however, their contribution to exports has been significant in only a few cases.

Competition provided by the liberalization of imports of final products can serve as part of an anti-inflation policy and can promote the adjustment of real wages needed to strengthen export competitiveness. In a protected industry, enterprises often give wage increases to workers to compensate for devaluation-induced price increases, rather than face industrial unrest. Competition from imports can induce greater restraint on the part of firms and workers. This objective has been an important part of the trade liberalization programs in Latin America as well as in Eastern Europe.

Despite the widespread shift to more market-oriented policies some development economists and governments advocate selective intervention in the economy through trade and industrial policies. The economic reform programs supported by the Fund and the World Bank envisage a strong and active role for governments in creating an environment for efficient economic activities, rather than the government intervening in the economy to “pick winners.”102 Proponents of selective intervention justify it on the basis of market failures or strategic needs. They envisage protection of a few sectors via planning, directed credit, or import allocation to create internationally competitive industries.103 Many of the arguments in favor of intervention are simply variations of the infant industry argument. Counterarguments stress that the choice of which industry to support requires a great deal of information as well as impartial and nonpolitical decision making. Since market prospects can change rapidly, such decisions have to be taken quickly while avoiding the temptation to prolong support to industries that are unprofitable. The possible gains from the few industries that may succeed have to be weighed against the large potential looses from incorrect decisions.

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