Trade Reform Trade Reform Background and Experiences Elements

Trade Reform

Trade Reform § Background and Experiences § Elements and Formulation of Trade Liberalization § Speed and Sequence

Background § The end of the Golden Years § Experiences of 60’s and 70’s

The End of Golden Years § By 1960, easy substitution had already taken place. – New problems: inflation, debt crisis, agricultural sector, unequal distribution, unemployment 1. IS was expanded from the country sphere to the regional level, and a number of attempts to create regional trading agreements were undertaken. 2. Some governments made attempts to liberalize trade.

Late 60’s and 70’s: - mostly stories of failed liberalization § 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 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 § 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 § Elements § Formulation § Conditions for a successful reform

Trade Liberalization § Unilateral liberalization § Regional integration § Multilateral negotiation

Result of the early efforts § During 1970 s, there were only few successful cases. § In the mid 1980 s, liberalization through the three approaches.

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 § Substitution of quantitative restrictions for tariffs. Why this is 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 § 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 § If import tariff is not zero anti-export bias § Export subsidy can neutralize this effect § But, fiscal burden § Conflict with WTO

Trade Liberalization in Latin America

Average Tariff in Latin America Country Mid 80 s Late 80 s Mid 90 s 2000 -02 Argentina 28. 0 43. 7 14. 0 12. 2 Bolivia 20. 0 18. 6 9. 7 9. 3 Brazil 80. 0 50. 6 12. 3 Chile 36. 0 15. 1 11. 0 7. 0 Colombia 83. 0 47. 6 11. 4 11. 7 Costa Rica 53. 0 - 11. 7 6. 0 Ecuador 50. 0 39. 9 11. 2 11. 3 El Salvador 23. 0 - 9. 2 7. 3 Guatemala 50. 0 - 10. 8 6. 9 Honduras - 41. 9 17. 9 6. 1 Mexico 34. 0 10. 6 13. 7 16. 4 Nicaragua 54. 0 - 17. 4 5. 1 Panama - 33. 0 - 8. 9 Paraguay 71. 7 19. 3 9. 4 10. 7 Peru 64. 0 67. 8 16. 3 13. 5 Uruguay 32. 0 27. 0 9. 6 11. 4 Venezuela 30. 0 33. 8 11. 8 12. 2 LA 49. 98 33. 99 12. 35 10. 43

Exports/GDP in Latin America

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 § Stabilization and Trade Reform § Trade Liberalization and Capital Market Opening

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 § 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 § 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 Import competing rm a b export rx § 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?

§ 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 Eq 1. High credibility high investment high probability of success high credibility Eq 2. Low credibility low investment low probability of success low credibility § Investment and current account § political alliances

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 § 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

§ Fiscal imbalance tends to result in the appreciation of the RER, even if depreciation is required. § In countries with moderates 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

§ 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 § 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.

Washington Consensus

Washington consensus § § § § § Healthy fiscal position Priority in public spending Tax reform Financial liberalization Exchange rate Trade liberalization FDI Privatization Property rights

Sequence of the Reforms § At first stage – Stabilization – Trade liberalization – Financial liberalization § Later (or never) – Privatization – Pension – Labor market

Speed of the reforms § Fast (shock) – Stabilization – Privatization § Gradual – Financial liberalization – Labor market – Pension § Intermediate – Trade liberalization – Tax reform

Performance in the 1990 s § Latin American countries had undertaken extensive macroeconomic reforms during the 1990 s, but the growth rates achieved thereafter were considered to be inadequate with respect to several possible standards of comparison. § Why?

Possible explanations 1. Market-oriented macroeconomic reform has been the wrong policy prescription. 2. There is a lag between the reform and the results. 3. The magnitude of the reform has been insufficient. 4. Reform had a restricted scope, institutional and microeconomic structural reform required. Unbalanced reform may create bottlenecks.

Trade Reform