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The author wishes to acknowledge helpful comments on a previous draft of the paper received from G.E. Gondwe, Mohsin Khan, Atsushi Miyauchi, Peter Montiel, Roger Nord, and Waleed Taha.
For an illustration of the application of the Dornbusch model to the issue of protection and export performance in Sub-Saharan African countries, see DeRosa (1990). For a description of the theory and measurement of illegal trade transactions, see Bhagwati and Hansen (1973) and Bhagwati (1974).
In Tanzania, imports are administered under nine different “windows.” In addition to the own-funds facility, the most important other facilities are (a) “free” resources, reflecting imports funded from Tanzania’s own foreign exchange receipts; (b) loans, grants and other import support funded directly by foreign donors and creditors; and (c) OGL imports, which are funded mainly by resources from the World Bank. In 1989/90, own-funds imports accounted for about 30 percent of the total value of imports, whereas imports under the three other major facilities accounted for about 60 percent.
The price of importables relative to nontraded goods is eP*.
This premium is identical to the parallel market premium computed with respect to nominal exchange rates. Assuming the law of one price holds for tradable goods, it is possible to write r/e = (RPx*/Pn)/(EPx*/Pn) = R/E; where R and E are parallel and official nominal exchange rates respectively, and Px* and Pn are prices of exportables and nontraded goods expressed in foreign and domestic currency terms respectively.
The porousness of import controls refers to the ability of national authorities to enforce quantitative restrictions on imports. The economic costs of smuggling, on the other hand, refer to the added costs of transportation and marketing typically thought to be associated with illegal international trade transactions, as well as the potential cost of penalties for (unsuccessful) smuggling. For further discussion, see especially Bhagwati and Hansen (1973).
The dead-weight loss is comprised of losses in both consumer and producer surpluses that result from the reduction in trade caused by the official imposition of restrictions on imports. The dead-weight loss concept and the underlying assumptions of applied welfare analysis are discussed in Harberger (1971).
This conclusion is an important one, but seems to be at some odds with the recent analysis of Kaufmann and O’Connell (1990), which suggests that establishment of the own-funds facility contributed to an increase in the parallel market premium. An explanation for this difference in conclusions may be that Kaufmann and O’Connell do not take into sufficient account the simultaneous adjustment in the official and parallel exchange rates implied by the simple model depicted in Figure 3. Instead, their focus may be simply upon the implications for adjustment in the parallel market premium given solely by the supply schedule for illegal exports, without demand entering into the picture.
If, simultaneously, the enforcement (through customs surveillance and legal penalties) of restrictions against imports, or export smuggling, were also relaxed, the CX” schedule in Figure 3 would become more elastic, thereby increasing the effective speed at which point A” would approach point A along the import demand schedule in the figure.
Unrecorded remittances and private transfers as well as false invoicing of official trade flows are also sources of financing for own-funds imports. Like unofficial exports, however, these sources of financing arise mainly in response to the existence of the parallel market premium. Therefore, the implications of the analytical model would not be substantially altered by more comprehensive specification of the sources of sustainable financing for own-funds imports.
The supply functions for total exports, smuggled exports and official exports in the model are derived from a mutually consistent profit-maximizing framework. See Appendix for details.
In reality, of course, the continued maintenance by Tanzania of controls on capital flows, especially capital outflows, would imply that a parallel exchange market supported by unofficial exports will persist, albeit at a substantially reduced parallel market premium.
The algorithm used to solve the comparative statics exercise for the free - trade equilibrium is discussed in the Appendix. Essentially, it involves determining the responsiveness of the official and parallel exchange rates to changes in the level of administered imports, and then determining the change in the level of these imports that is consistent with the elimination of both the parallel premium and export smuggling.
Problems of accurately measuring trade flows, associated mainly with over-invoicing imports and under-invoicing exports, are not considered in the present analysis. Such problems, however, are important in the came of most African countries, including Tanzania. For further discussion, see Yeats (1990).
The conditions underlying the derivation the model’s export supply relationships also indicate that the price elasticity of supply for official exports is somewhat greater in value than the price elasticity of supply for total exports. This elasticity value, however, cannot be determined arbitrarily; accordingly, it is determined on the basis of the values selected for the model’s other parameters, particularly the other supply elasticity parameters and the baseline value of official exports to total exports. See Appendix for further discussion and details.
See Currency Alert (International Currency Analysis, Inc., New York.) and Africa Analysis (Africa Analysis, Ltd., London).
The estimated magnitude of the adjustment in the parallel market premium, r/e, is dependent solely upon the assumed value of the price elasticity of supply for total exports. This is because the bounds of the adjustment in the premium, in response to liberalization of the OGL facility, are circumscribed by the supply relationships for total exports and export smuggling in the model, and not by the relationship for import demand.
The parallel premium is expressed here in difference form. For greater analytical convenience in the main text it is represented in the ratio form r/e.