Published on May 8, 2008
Trade Reform: Trade Reform Trade Reform: Trade Reform Background and Experiences Elements and Formulation of Trade Liberalization Speed and Sequence Background: Background The end of the Golden Years Experiences of 60’s and 70’s The End of Golden Years: The End of Golden Years By 1960, easy substitution had already taken place. New problems: inflation, debt crisis, agricultural sector, unequal distribution, unemployment IS was expanded from the country sphere to the regional level, and a number of attempts to create regional trading agreements were undertaken. Some governments made attempts to liberalize trade. Late 60’s and 70’s: Late 60’s and 70’s Programs to expand exports Brazil’s aggressive industrial policy: export subsidies + tax allowances, subsidized credit to selected industries + crawling peg exchange rate system Some success, not very much Export didn’t relax the required foreign exchange constraint Heavy borrowing 1982 crisis Why different with East Asia? East Asian countries rewarded export in general Macroeconomic instability, real exchange rate Other examples: Other examples Chile 1974-79: Eliminate QRs, tariff reduction. Trade policies suffered from some adjustment between 1962 to 1988, but the rules established after 1974, in essence, have not been altered. Uruguay: reform 1978, reversal 1983, resume 1986 Argentina: 1976-82: a frustrated move Trade Liberalization: Trade Liberalization Elements Formulation Conditions for a successful reform Trade Liberalization: Trade Liberalization Unilateral liberalization Regional integration Multilateral negotiation Result of the early efforts: Result of the early efforts During 1970s, there were only few successful cases. In the mid 1980s, liberalization through the three approaches. Elements of trade liberalization: Elements of trade liberalization Reduction of NTBs Reduction of the average level of tariffs Reduction of the degree of dispersion of the tariff structure Reduction of export taxes Formulation: Formulation Substitution of quantitative restrictions for tariffs. Why is this a liberalization? Tariffs protects less than quantitative restrictions, more transparent Tariffs affects price, not quantity. International price change is reflected more quickly In many cases, this substitution have been a fundamental element in the first stage of trade reform, sometimes the unique element. It was observed that with this small change only, the production grew due to a more transparent and less restrictive regime. Tariff reform: Tariff reform Two dimensions Reduction in the average tariff Reduction in the dispersion or variance Ways to reduce the average and dispersion Reduction equiproportional to all tariffs Reduction equiproportional to the excess of each tariff to the targeted level prefixed Higher reductions in proportion for the higher tariffs “De Concertina” Incentives to export: Incentives to export If import tariff is not zero anti-export bias Export subsidy can neutralize this effect But, fiscal burden Conflict with WTO Conditions for successful reform: Conditions for successful reform Export expands. Productivity grows. Trade balance does not exhibit unreasonable deficits. Low unemployment is maintained. Real wage increases. Speed and Sequence: Speed and Sequence Speed Stabilization and Trade Reform Trade Liberalization and Capital Market Opening Speed of trade liberalization: Speed of trade liberalization Gradual liberalization This would give firms time for restructuring their productive processes and, thus, would result in low dislocation costs in the form of unemployment and bankruptcies. Low adjustment cost provide the needed political support for reform. Some authors contend that adjustment cost can be reduced by relying on foreign capital during the transition Slower reform tend to lack credibility, inhibiting firms from actually engaging in serious restructuring Faster reforms: Faster reforms More credible Empirical work shows that even in the short-run, the cost of reform can be small. Expanding sectors tend to create a large number of employment positions and absorb workers from contracting sectors. Consequences of lack of credibility: Consequences of lack of credibility Reduce adjustment incentive Make it more difficult for the reform to be sustained Consumer expect that the reform will be reversed sometime Perceives that important goods are temporarily cheaper Leads to intertemporal substitution in consumption to the present (lower saving rate and lower investment) Increase in current account deficit reversal Low investment in export sector: Low investment in export sector Discount rate d, initially rm = rx Trade reform increases rx rm + s Is s enough for the capitalist to switch from import competing to export sector? Capital relocation take place if rm+ s – d*a > rm But if investors attach probability of p that the reform will be aborted? Import competing export a b rm rx Slide20: The investor will have to pay an additional relocation cost of p(a+b) to move back to import competing sector. rm+ s – d*a – p(a+b) > rm s > d*a + p(a+b) must be satisfied p(a+b) can be viewed as a tax on investment in export sector imposed by incomplete credibility. Multiple equilibria: Multiple equilibria Eq1. High credibilityhigh investmenthigh probability of successhigh credibility Eq2. Low credibilitylow investmentlow probability of successlow credibility Investment and current account political alliances How to enhance the credibility: How to enhance the credibility Consistency of the policy package Ex. Fiscal spending, exchange rate… In case of time inconsistency problem Build reputation and mechanism of commitment In case of asymmetric information With World Bank assistance, the redistributer may choose to mimic the liberalizer for a while to have access to World Bank resources. Signaling Stabilization and trade liberalization: Stabilization and trade liberalization Resolving the fiscal imbalance is a priority in implementing trade liberalization Uncertainty associated with very high inflation, including high relative price variability, would reduce the effectiveness of market oriented structural reforms Low investment, investment in the wrong sector More relevant to the small countries that relies heavily on import tariffs Slide24: Fiscal imbalance tends to result in the appreciation of the RER, even if depreciation is required. In countries with moderate rates of inflation, trade liberalization and macro stabilization will tend to reinforce themselves Price discipline, productivity increase offset RER appreciation But most countries embarked on trade reform first or simultaneous stabilization and reform Slide25: A large devaluation constitutes the first step in a trade reform process, in order to maintain a depreciated and competitive RER. Reduction in protection may generate a rapid and immediate surge in imports. On the other hand, the expansion of exports usually takes some time. Trade balance disequilibrium Many countries failed to maintain depreciated RER Capital Market opening and trade liberalization: Capital Market opening and trade liberalization Trade liberalization first Prevent large capital inflows that may result in real appreciation Chile’s superior performance was due to having maintained the capital account closed while tariffs were reduced. Instantaneous adjustment of capital market and slow adjustment of the goods market Simultaneous liberalization Use foreign capital to reduce the adjustment cost.