Should LDCs Liberalize Their Trade?
...ct on exports with an import duty drawback system and/or export subsidies (usually through subsidized credit on exports), and (2) Export Processing Zones (EPZs). Activities inside EPZs are not subject to the normal protective regime and in some cases other regulations. III. Relationship between development and trade policy The relationships between trade policy and growth have long been a subject of considerable controversy among economists. From historical perspective, the use of trade policy protecting economic development is not a recent innovation. The latest research has shown that, throughout their history, those countries which today are the most developed have not hesitated to resort to protective tariff s or import controls in order to support their infant industries (Chang, 2002). In Britain, restrictive trade policies were implemented as early as the 15th century in order to support the wool industry. At that time, raw wool was exported to Holland, where it was processed in Dutch factories. At that time, heavy customs duties were imposed on raw wool exports in order to force producers to process the wool locally; prohibitive tariff s were also imposed on the import of finished products. These restrictive trade practices were still in force until the repeal of the Corn Laws in 1846, an event which historians see as the United Kingdom’s real free-trade milestone. The competitiveness of British industries was considerably helped by that country’s restrictive trade practices, and external openness did not begin until Britain emerged in the mid-19th century as the world’s most developed nation. The U.S has also made use of trade policies and protected its infant industries in order to build up their competitiveness (Chang, 2002). From 1830 until the end of the Second World War, the United States applied the world’s highest customs duties on imports of industrial products. In addition, transport costs were very high until the late 19th century; consequently, American industry enjoyed the world’s highest levels of protection. In 1930, the average tariffs imposed by the U.S on imports of industrial products were estimated at 48 percent. Only after the war did the U.S, now the world’s greatest economic power, open up more to foreign trade. Other countries which are now among the developed economies, such as France and Germany, used various instruments of trade policy, such as customs duties and export subsidies, to promote the growth of industrial development and close the gap between themselves and Britain. Japan also followed the example of the other developed countries in the early years of the 1868 Meiji revolution, using restrictive trade policies in support of its efforts to modernize its economic structures. Recent development experiences in South-East Asia have shown that the countries of the subregion are no exception to the rule. In addition to the protection afforded to local industry, they have granted considerable direct and indirect subsidies to their exports. These policies have helped those countries’ enterprises to strengthen their competitiveness in new sectors such as electronics, shipbuilding and semiconductors. In the early post-World War II period, many LDCs leaders concluded that protective trade policies stimulated growth, and import substitution policies were widely adopted. By the 1980s, however, country-specific and general cross-country analyses had demonstrated the failure of the import substitution approach, and consequently outward-oriented policies were widely adopted (Balassa, 1989). In the same period, the emergence of the Washington Consensus led to the unanimous agreement on the beneficial effects on growth and development of trade liberalization. The Consensus emerged in response to the economic crisis affecting most developing countries at the time, triggered by the debt crisis (Nayyar, 1997). While subsequent cross-country studies have generally indicated the growth effectiveness of outward-oriented policies, recent criticisms of these studies (by Rodriguez and Rodrik, 2000, in particular) have called this conclusion into question. Rodriguez and Rodrik in this article attack the main studies suggesting a strong positive correlation between external openness and economic growth in developing countries. They suggest that the methodological choices and empirical series used have had a preponderant influence on the nature of results and particularly on the conclusion of a positive relationship between external openness and growth. They emphasize the limitations of the methods used, and postulate that that relationship is not that clear. They state that it is difficult to show that trade liberalization leads to any increase in rates of growth and development. The possible benefits of trade liberalization By the early 1980s, LDCs had come to realize that state failures were at least as common as market failures and the state not a reliable substitute for well- functioning markets. All the world took in the East Asian Miracle, wherein a group of heretofore very poor economies managed to break out of their inward-orientations and indeed succeed in exports on a rather massive scale. Indeed, such countries as Taiwan, Korea and to a lesser extent several other countries of Asia, have become star performers in growth over the last thirty years and without increasing income inequality which has remained low (Chang, 2002). Beginning in the mid-1980s and continuing to the present, many other LDCs have gradually chosen to follow the lead of Taiwan and Korea in transforming their policy orientations through policies of trade liberalization. The theoretical rationale for trade liberalization is also extremely strong. Trade liberalization is believed to yield both static and dynamic benefits. Among the former are the ability of the country (1) to make better use of the resources in which it is well endowed (Dornbusch, 1992); (2) to emphasize those sectors in which it can produce more efficiently than other countries, (3) to increase competition and thereby reduce the losses associated with monopoly (World Bank, 1987); and (4) to decrease the scope for corruption and thereby allow time and resources to be spent more productive rather than rent-seeking activities(Dornbusch, 1992). Among the latter are (1) the dynamic effects of competition on technological change, (2) the effects of increased trade flows in domestic and foreign investment, (3) the effects of the agents that trade on the supply of international market information and the demand for other market friendly institutions and policies (Evans, 1993), and (4) the inequality-reducing effects derived from the factor price equalization effect of trade. The possible costs of trade liberalization There are also some potential costs associated with trade liberalization in the developing countries. (1) The removal of all of the rich countries’ barriers to the merchandise exports of developing countries—including agriculture, textiles, and other manufactured goods—would result in very little additional income for the exporting countries ( Hakim, 2003). (2) Some of the most widely used economic models show that many developing countries will actually lose from trade liberalization in important sectors, such as agriculture and textiles. There are three reasons for this outcome. First, some countries will be hurt by the elimination of quotas that now allow them to sell a fixed amount of exports at a price that exceeds the competitive market price. Second, trade liberalization changes the relative prices of various goods, and some countries will find that their export prices fall relative to the price of imports—the ‘terms-of-trade’ effect. Third, some developing countries currently benefit from access to cheap, subsidized agricultural exports from the rich countries (Balassa, 1989). (3) Developing countries incur substantial problems from reducing their trade barriers. In many developing countries, tar...