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References

  • Corden, W. Max, "The Normative Theory of International Trade," in Handbook of International Economics, ed. by P.B. Kenen and R.W. Jones (Amsterdam: North Holland, 1984).

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  • Farhadian-Lorie, Ziba, and Menachem Katz, "Fiscal Dimensions of Trade Policy," IMF Working Paper, WP/88/43 (Washington: International Monetary Fund, 1988).

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  • Krueger, Ann O., Foreign Trade Regimes and Economic Development: Liberalization Attempts and Consequences (Cambridge: Ballinger Publishing Company, 1978).

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  • Papageorgiou, D., M. Michaely, and A. Choksi, Trade Liberalization: The Lessons of Experience, Internal Discussion Paper, Latin America and the Caribbean Regional Series (Washington: The World Bank, April 1988).

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This paper was presented at the 44th Congress of the International Institute of Public Finance held in Istanbul, Turkey on August 21-26, 1988, and will be published in a forthcoming book edited by Vito Tanzi.

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For a summary of evidence, see, for example, Krueger (1978). The theoretical aspects of trade policies are thoroughly reviewed in Corden (1984).

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A very extensive study on the character of the transition following trade liberalization has been carried out under the auspices of the World Bank. For a summary of the evidence, see Papageorgiou, Michaely, and Choksi (1988).

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There are, however, important caveats to this expectation, which are discussed in detail in the next section.

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As mentioned above, if importers are monopolistic, they will capture part of the tariff reduction in their profits. Although this reduces the import tax base, it is likely to raise the income tax base if the windfall profits are properly taxed.

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In theory, the contraction of output and employment should lead to an easing of wage pressures in the public sector. In practice, however, public sector wages tend to be rigid downwards, even in labor-surplus developing countries.

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In a trade model, income share rises because the return to the abundant factor rises as it is turned to more productive use", in most countries that liberalize, there is the added effect of increased employment as output expands, because the protected economy typically will not have enjoyed full employment.

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The most obvious case where a time-lag in capturing revenue potential may be inevitable is when a fixed-period tax holiday has been granted.

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This follows not only because individuals are (on average) better off, but particularly if the sectoral redistribution of income shares the higher national income among a greater number of consumers, and therefore causes the average propensity to consume to rise.

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On the other hand, as the expansion or output brings the economy closer to full employment, there could be generalized upward pressure on wages, which could conceivably offset some of the gain through an increase in the government wage bill.

The Fiscal Implications of Trade Liberalization
Author: International Monetary Fund