Tuesday 15 September 1992

SOUTH ADVISED TO LIBERALISE IMPORTS GRADUALLY AND SEQUENTIALLY

Geneva 14 Sep (Chakravarthi Raghavan) -- Developing countries should undertake import liberalisation only when substantial export success has been guaranteed, and it should be gradual and accompanied by active industrial and agricultural policies, while maintaining some degree of controls on capital flows, according to the UN Conference on Trade and Development.

The UNCTAD advice is in this years Trade and Development Report in a chapter on Reforming Trade Policies.

Since the late 1980s, a large number of developing countries have been liberalizing their trade regimes, generally as part of a more comprehensive set of structural adjustment measures (and trade policy measures pushed on them by the IMF and World Bank) - both as a response to the economic crisis faced by them as well as disenchantment with excessive state intervention in economic affairs.

The TDR has analyzed these experiences.

Referring to various arguments, including the most popularized 'neo-classical' link of recent decades, used to explain why exports are positively correlated with overall economic growth, the TDR said that many of the arguments depend on which sectors of a country's economy generate exports. It is industrial exports, rather than exports in general, that lead to faster growth.

The statistical evidence on the link between exports and growth is strong in some respects but inconclusive in others. The relationship has not been found to be valid for all groups of countries or all sub-periods of the post-war era. Some studies have shown that while the link is strong for manufactured exports, primary-exporting countries have fared poorly. Taken together, they provide support for "an industrial bias in development policy."

On balance, statistical tests on the causal link between exports and economic growth indicate that overall economic growth, by improving supply capabilities, leads to faster export growth, rather than the reverse.

The statistical findings are less conclusive on the association between trade policy and export growth: Hong Kong and Singapore, prototypes of free trade regimes have achieved strong growth; but so have other countries with strong State intervention and maintenance of import protection, sometimes for long periods. Such success stories of the latter include Republic of Korea, Taiwan Province of China, Brazil, Israel, Portugal and Spain.

No link between trade and productivity is also evident, the TDR says. While at macroeconomic level, faster growth of total factor productivity has been found to be generally associated with more rapid economic growth, and latter with faster export growth, the association between productivity and inward or outward orientation does not "necessarily stand out at the sectoral level".

"The performance of total factor productivity in manufacturing has been good in relatively inward-oriented countries in some periods and rather poor in some outward-oriented countries," UNCTAD says, adding "When causal links are taken into account, there is no clear evidence that export orientation has a positive influence on productivity or that greater protection or inward orientation has a negative influence".

Country studies on Brazil, Colombia and Mexico have failed to find consistent association between greater openness and faster productivity growth. Chile has so far failed to show a strong productivity performance despite massive liberalization and domestic adjustment since mid-70s.

And despite high protection, Brazil up to late 70s was one of the best productivity performers in the developing world. A study of India showed that while (at an earlier period) import substitution had adverse effects on productivity, the first half of 1980s -- a period of not only high but rising tariff protection and moderately falling non-tariff barriers -- "was the period of fastest productivity growth in manufacturing."

While data for a sample of 34 developing countries for the 1980s shows a strong positive correlation between export growth and GDP growth, when the period 1973-1979 as a whole is considered, the association is much weaker and strongly affected by a few exceptional cases. Export growth during this period explains 40 percent of GDP growth for the 34 countries, but when the two extremely successful cases (Hong Kong and Korea) and a strong failure (Trinidad and Tobago) are excluded, the proportion falls to 15 percent.

The association between growth of GDP and exports on the one hand, and protectionist measures on the other, is unclear, UNCTAD concludes, adding "The data suggest that export performance in the 1980s was not associated in any simple way with either low tariffs or non-tariff barriers or any combination of them."

Analysing performance of four groups of countries, differentiated by their trade policy regimes, UNCTAD notes that variations among countries with similar trade-policy regimes have been greater than those with different regimes and "implies that it is not trade policies in general, but rather how specific countries manage them that really determines economic performance."

Taken as a whole, the results indicate that "rapid export growth was crucial to economic performance in the past decade, but that there is no simple link between protection and export success."

Countries under very different export regimes have been able to perform well in international markets. Also, there is not necessarily any incompatibility between domestic protection and export promotion, and the two have been important complements in many cases.

"Indeed, the highly varied economic performance within each of the four groups of countries indicates that export success is probably associated more with individual country experiences than with general characteristics of trade policy," the TDR says and adds: "International trade theories, economic history and the most recent experiences of developing countries indicate that no generalization can be made on the universal virtues of either inward or outward orientation."

"Protection and export promotion are not incompatible strategies," the TDR says. "There are intermediate mixed strategies which can successfully combine elements of both, as the experience of successful export development in the 1980s indicate...it might be inappropriate to judge the anti-export bias of a trade regime simply by levels of protection or the extent to which there is a difference in incentives to produce for domestic markets and for exports...the analysis of export success or failure associated with specific trade regimes is thus more complex than simply measuring the extent of deviation from a uniform system of incentives."

"This is more so in economies in transition - from more inward to more outward-oriented strategies," UNCTAD argues. "In the short run, using an economy's existing stock of capital, labour skills and technical abilities to generate additional exports is better than developing totally new sectors.. temporary incentives (either protection or subsidies) may serve as a mechanism to maintain production and earning levels while firms improve production processes and accumulate skills.

"Reducing protection too quickly may generate irreversible losses, as firms are unable to adapt rapidly to the new circumstances. The larger the role of fixed capital accumulation of all sorts, including skills and technology, and the larger the role of scale economies in contracting sectors, the greater the losses are likely to be."

The experience of the varied groups of countries support the view that macro-economic stability (reflected in particular in only moderate inflation) is a necessary condition for structural change and economic growth. The experience of many Latin American and African countries show that growth is unlikely to be resumed without guarantee of macroeconomic stability. But the latter while necessary is not a sufficient condition either.

Due to the frustrating experiences, policy recommendations have increasingly favoured ultra-shock treatment, in which major stabilization policies and structural reforms are adopted simultaneously, thus breaking the traditional sequence that used to be suggested in the past, UNCTAD notes.

"This 'big bang' approach has been defended on three main grounds: overall credibility is enhanced, conditions for sustained growth is laid down early in the process, and an open trade regime imposes discipline on economic agents and thus supports stabilization efforts.

"But experiences with the 'big bang' approach are not encouraging," UNCTAD says and cites the experiences of Chile in the mid-70s (when growth remained moderate and unstable for a long period), Bolivia (in 1985) when hyperinflation was stopped but growth remained under an annual three percent during 1986- 1991. More recent experiences of Latin America also point to some of the "more dangerous effects" where the countries that used the big bang approach to stop hyperinflation experienced massive overvaluation of domestic currencies. The resulting expectations of devaluation fuelled inflation and made structural adjustments extremely painful.

The tendency to mix structural adjustment policies with anti- inflationary policies were more general than the 'big bang' episodes, the TDR says, citing the experiences of Mexico, Turkey and Colombia.

"In all these countries, rapid export growth slowed down after the stabilization-cum-trade reform programme was adopted. The more traditional prescription, which would recommend increasing the incentive to export in order to facilitate overall structural adjustment in the face of contracting import substitution activities, would seem more appropriate."

"Political consensus," UNCTAD argues, "is perhaps the major requirement for long-term credibility, and thus for stability of reforms. A major disadvantage of shock treatment is that it increases both the contractionary and adverse balance of payments (bop) effects of reforms, and increases both short-term political resistance to reforms and the likelihood that policies will be reversed as a result of foreign exchange constraints - making the 'credibility' and 'political economy' arguments in favour of shock treatment intrinsically contradictory."

UNCTAD also suggests that trade reforms should precede liberalization of internal capital flows and should not be simultaneous. In some countries, such liberalization might result in capital flight, thereby endangering the fragile BOP situation which accompanies the liberalization process.

The high costs of adjustment and rapid liberalization that might lead to an irreversible loss of capital, labour skills and technological capabilities, argue in favour of gradualism in trade policy.

On the specifics of trade liberalization, and the arguments against quantitative restrictions (QRs) on imports, the TDR lists three reasons why this argument may be invalid.

QRs, it notes, are a very useful temporary bop device recognized in GATT and may be useful in reducing short-term inflationary and contractionary effects of devaluation and be a temporary complement to gradual devaluation and demand policies. QRs function as a 'hard' signal to economic agents and may be useful if complemented by other 'hard' signals (like export targets) in order to generate adjustment when marginal price signals do not influence the desired outcome.

And, under imperfect competition, price rigidities and uncertainties, tariffs and QRs are not equivalent and 'tariffication' of QRs is not always a real alternative. Also, in practice, many tariff items include a heterogenous group of goods and it is impossible to tariffy them without generating adverse effects.

But generalised, permanent QRs (practised in many developing countries) could generate monopoly profits, corruption and other adverse effects, and hence their virtues have to be considered in the light of specific economic and political circumstances.

"Overall," UNCTAD concludes, "a more traditional sequencing is preferable to the current inclination to mix together stabilization and structural reforms...import liberalization should be adopted only when substantial export success has been guaranteed. It should also be gradual...and accompanied by active industrial and agricultural policies. Some degree of control on capital flows should also be maintained. The speed of reforms, the relative weights to be given to tariff and non-tariff measures, the alternative forms of industrial policy adopted, the different mechanisms to control capital inflows and the resulting importance of interventionism in the overall programme have all to be evaluated on the basis of specific domestic conditions."