This PDF is a selection from an out-of-print volume from the National Bureau of Economic Research

Volume Title: Liberalization Attempts and Consequences

Volume Author/Editor: Anne O. Krueger

Volume Publisher: NBER

Volume ISBN: 0-884-10483-4

Volume URL: http://www.nber.org/books/krue78-1

Publication Date: 1978

Chapter Title: Front matter, Liberalization Attempts and Consequences

Chapter Author: Anne O. Krueger

Chapter URL: http://www.nber.org/chapters/c3849

Chapter pages in book: (p. -22 - 0)

'imes UBERALIZATION ATTEMPTSment: AND CONSEQUENCES

'e Series?egimes by Anne 0. Krueger

:OLUMEX

Ballinger Publishing Company • Cambridge, MassachusettsA Subsidiary of J.B. Lippincott Company

NAT]Arthur F. Burns,James 1. O'Leary,Eli Shapiro, Vice C)Martin S. Feldstein,Victor R. Fuchs,

Palo Alto OfficePhilip J. Sandmaier

NATIONAL BUREAU OF ECONOMIC RESEARCHMoses Abramovitz,Studies in International Economic Relations Atherton Bean,

CorporationAndrew F. Brimmi1. Problems of the United States as World Trader and Banker Inc.

Hal B. Lary Otis F. Brubaker,America

2. Price and Quantity Trends in the Foreign Trade of the United States Arthur F. Burns, AFederal Reserve

E. Lipsey Wallace J. Camp)operative Housi

3. Measuring Transactions Between World Areas Herbert B. Woolley SolomonMartin S. Feldstein

4. Imports of Manufactures from Less Developed Countries Hal B. Lary Eugene P. Foley,York

Edward L. Ginzton5. The Responsiveness of Demand Policies to Balance of Payments: Postwar David L. GrovePatterns Michael Michaely Machines Corp

Walter W. Heller,6. Price Competitiveness in World Trade Irving B. Kravis and DRobert E. Lipsey

Gardner Ackley,7. Money, Financial Flows, and Credit in the Soviet Union G.L. Bach, Stanfi

Charles H. Berry,George Garvy Otto Eckstein,Walter D. Fisher,

8. Foreign Dollar Balances and the International Role of the Dollar John H. Kareken,Raymond F. Mikesell and I. Herbert Furth J. C. LaForce. C

Robert J. Lampn9. Foreign Trade Regimes and Economic Development: Liberalization DIRECTOI

Attempts and Consequences Anne 0. Krueger Richard M. Bird,ciation10. Anatomy and Consequences of Exchange Control Regimes Eugene A. Birnbs

Jagdish N. Bhagwati AssociationsCarl F. Christ, A

lionRobert 0. DederiThis book is printed on recycled paper.Franklin A Lin

Business Econ

nomic DevelojCopyright © 1978 by the National Bureau of Economic Research, Inc. All Paul W. McCn

Associationrights reserved.

Library of Congress Card Number: 77—14401 Percival F. BrundISBN for the series: 0—87014—500—2 Emilio 0. ColladISBN for this volume: 0-88410—483—4 Frank W. Fetter

Thomas D. Flynn\.Printed in the United States of America

Foreign Trade Regimesand Economic Development:LIBERALIZATION ATTEMPTSAND CONSEQUENCES

T

Foreign Trade Regimes iIBER4

and Economic Development: AND

A Special Conference Series b Aron Foreign Trade Regimes Yand Economic Development

VOLUME X

NATIONAL BUREAU OF ECONOMIC RESEARCH- Ballinger Pub

New York 1978 A Subsidiary

Arthur F. Burns, Honorary ChairmanJames J. O'Leary, ChairmanEli Shapiro, Vice ChairmanMartin S. Feldstein, PresidentVictor R. Fuchs, Vice President, Director,

Palo Alto OfficePhilip J. Sandmaier, Jr., Treasurer

Moses Abramovitz, Stanford UniversityAtherton Bean, International Multifoods

CorporationAndrew F. Brimmer, Brimmer & Company,

Inc.Otis F. Brubaker, United Steelworkers of

AmericaArthur F. Burns, Board of Governors of the

Federal Reserve SystemWallace J. Campbell, Foundation for Co-

operative HousingSolomon Fabricant, New York UniversityMartin S. Feldstein, Harvard UniversityEugene P. Foley, Pan American Building,

YorkEdward L. Ginzton, Varian AssociatesDavid L. Grove, International Business

Machines CorporationWalter W. Heller, University of Minnesota

Gardner Ackley, MichiganG.L. Bach, StanfordCharles H. Berry, PrincetonOtto Eckstein, HarvardWalter D. Fisher, NorthwesternJohn H. Kareken, MinnesotaJ. C. LaForce, California Los AngelesRobert J. Lampman, Wisconsin

Richard M. Bird, Canadian Economics Asso-ciation

Eugene A. Birnbaum, American ManagementAssociations

Carl F. Christ, American Economic Associa-tion

Robert G. Dederick, National Association ofBusiness Economists

Franklin A. Lindsay, Committee for Eco-nomic Development

Paul W. McCracken, American StatisticalAssociation

v.1'OCharles E. McLure, Jr., Executive Director

for ResearchDouglas H. Eldridge, Executive SecretarySam Parker, Director of Finance and Ad-

ministrationRobert E. Lipsey, Director, New York OfficeJoel Popkin, Director, Washington Office

Walter E. Hoadley, Bank of AmericaRoy E. Moor, Becker Securities CorporationGeoffrey H. Moore, National Bureau of Eco-

nomic ResearchJ. Wilson Newman, Dun & Bradstreet Com-

panies, Inc.James J. O'Leary, United States Trust Com-

pany of New YorkPeter 0. Peterson, Lehman BrothersRobert V. Roosa, Brown Brothers Harriman &

Co.Richard N. Rosett, University of ChicagoBert Seidman, American Federation of Labor

and Congress of Industrial OrganizationsEli Shapiro, The Travelers CorporationArnold M. Soloway, Jamaicaway Tower, Bos-

ton, MassachusettsLazare Teper, International Ladies Garment

Workers' Union

Maurice W. Lee, North CarolinaJames L. Pierce, California, BerkeleyAhnarin Phillips, PennsylvaniaLloyd G. Reynolds, YaleRobert M. Solow, Massachusetts Institute of

TechnologyHenri Theil, ChicagoWilliam S. Vickrey, Columbia

Douglass C. North, Economic History Associ-ation

Rudolph A. Oswald, American Federation ofLabor and Congress of Industrial Organi-zations

Philip J. Sandmaier, Jr., American Institute ofCertified Public Accountants

0. Edward Schuh, American AgriculturalEconomics Association

James C. Van Home, American Finance Asso-ciation

-U

DIRECTORS EMERITI

NATIONAL BUREAU OF ECONOMIC RESEARCH

DIRECTORS AT LARGE'CH

er

Lited States

t B. Woolley

Ha/B. Larylents: Postwar

c and

Dollar

Ealization

rch, Inc. All

DIRECTORS BY UNIVERSITY APPOINTMENT

DIRECTORS BY APPOINTMENT OF OTHER ORGANIZATIONS

Percival F. BrundageEmilio G. Collado

Gottfried HaberlerAlbert J. Hettinger Jr.

Boris ShishkinWillard L. Thorp

Frank W. FetterThomas D. Flynn

George B. RobertsMurrary Shields

Joseph H. WillitsTheodore 0. Yntema

RELATION OF THE DIRECTORS TO THEWoRic AND PUBLICATIONS OF THENATIONAL BUREAU OF RESEARCH

1. The object of the National Bureau of Economic Research is to ascertain and to present tothe public important economic facts and their interpretation in a scientific and impartial manner.The Board of Directors is charged with the responsibility of ensuring that the work of the NationalBureau is carried on in strict conformity with this object.

2. The President of the National Bureau shall submit to the Board of Directors, or to its Ex-ecutive Committee, for their formal adoption all specific proposals for research to be instituted.

3. No research report shall be published by the National Bureau until the President has senteach member of the Board a notice that a manuscript is recommended for publication and that inthe President's opinion it is suitable for publication in accordance with the principles of the Na-tional Bureau. Such notification will include an abstract or summary of the manuscript's contentand a response form for use by those Directors who desire a copy of the manuscript for review.Each manuscript shall contain a summary drawing attention to the nature and treatment of theproblem studied, the character of the data and their utilization in the report, and the main conclu-sions reached.

4. For each manuscript so submitted, a special committee of the Directors (including Direc- Forewordtors Emeriti) shall be appointed by majority agreement of the President and Vice Presidents (or by 4.the Executive Committee in case of inability to decide on the part of the President and Vice PrejacePresidents), consisting of three Directors selected as nearly as may be one from each general divi-sion of the Board. The names of the special manuscript committee shall be stated to each Directorwhen notice of the proposed publication is submitted to him. It shall be the duty of each memberof the special manuscript committee to read the manuscript. If each member of the manuscript PAR TI. Intrccommittee signifies his approval within thirty days of the transmittal of the manuscript, the reportmay be published. If at the end of that period any member of the manuscript committee withholds Chapter 1: Thhis approval, the President shall then notify each member of the Board, requesting approval ordisapproval of publication, and thirty days additional shall be granted for this purpose. The The Focmanuscript shall then not be published unless at least a majority of the,entire Board who shall have The Cotvoted on the proposal within the time fixed for the receipt of votes shall have approved. The Pla5. No manuscript may be published, though approved by each member of the specialmanuscript committee, until forty-five days have elapsed from the transmittal of the report inmanuscript form. The interval is allowed for the receipt of any memorandum of dissent or reserva-tion, together with a brief statement of his reasons, that any member may wish to express; andsuch memorandum of dissent or reservation shall be published with the manuscript if he so desires. ChapterPublication does not, however, imply that each member of the Board has read the manuscript, or Payments Reithat either members of the Board in general or the special committee have passed on its validity inevery detail. EconolT

6. Publications of the National Bureau issued for informational purposes concerning the Dehneaiwork of the Bureau and its staff, or issued to inform the public of activities of Bureau staff, and Phasesvolumes issued as a result of various conferences involving the National Bureau shall contain aspecific disclaimer noting that such publication has not passed through the normal review pro-cedures required in this resolution. The Executive Committee of the Board is charged with reviewof all such publications from time to time to ensure that they do not take on the character of for- Chapter 3: CImal research reports of the National Bureau, requiring formal Board approval.

7. Unless otherwise determined by the Board or exempted by the terms of paragraph 6, a Phase Icopy of this resolution shall be printed in each National Bureau publication. The Cli

(Resolution adopted October 25, 1926, as revised through September 30, 1974)

and to present to Contentsimpartial manner.rk of the National

:tors, or to its Ex-h to be instituted.President has sentcation and that insciples of the Na-riuscript's contentscript for review.treatment of the

iJ the main conclu-

(including Direc- Foreword0

xiiiPresidents (or byesident and Vice Preface xviieach general divi-

to each Directorof each member

Df the manuscript PAR TI. Introduction 1

uscript, the reportsmittee withholds Chapter 1: The NBER Project 2sting approval orhis purpose. The The Focal Issues 2rd who shall have The Country Studies 7approved.

The Plan of the Work 8of the specialof the report in

Jissent or reserva-to express; and

Pt if he so desires. Chapter 2: The Ten Countries and Theire manuscript, or Payments Regimes 12on its validity in

Economic Characteristics of the Project Countries 12concerning the Delineation of the Phases 22

lureau staff, and Phases in the Project Countries 28u shall Contain armal review pro-rged with reviewcharacter of for- Chapter 3: Characteristics of QR Regimes 42f paragraph 6, a Phase II Controls 43

The Changing Nature of Controls 48tember3O, 1974)

vii

FPAR TII. Phase III Policies 54 Chapter 9: Lo

lntermei

Chapter 4: Devaluation and Related Policy Measures 55 Long-T.

Devaluation Packages 56Devaluation in an Exchange Control Context 61

Chapter 10: IIII Episodes

Chapter 5: Measuring Changes in Exchange Rates 69

Nominal and Effective Exchange Rates 69 MacroecReal Exchange Rate Changes 78 Macroec

Chapter 6: QR-Related Aspects of Phase III 86 PART IV. LiInteraction of Devaluation and the QR Regime Growth

A Framework for Analysis 86 Chapter 11: 1Liberalization during Phase III Episodes 93 GrowthThe Extent of Bias Reduction 99Rationalization of the Regime 111 MicroecReducing Variance 112 Macroe

Chapter 7: Macroeconomic Policies in Phase III Episodes 119 Chapter 12: 1EconomicObjectives of Macro Policies 120

Behavior of Monetary Variables 124 The Br2Fiscal Policy 130Import Liberalization 133 Grow

Conclus

PAR Till. Outcome of Phase III Episodes 143Appendix A

Chapter 8: Short-Run Response to Phase III 144Appendix BPrice Level Behavior 145

The Level of Economic Activity 155Short-Term Balance-of-Payments Response 164Appendix (by Anne 0. Krueger and Salih Neftci) 180

r54

Chapter 9: Longer-Term Response to Phase III 185Intermediate-Term Responses 186

55 Long-Term Response to Phase III 206

5661 Chapter 10: Determinants of the Outcome of Phase

III Episodes 218

69 Successes and Failures 219The Initial Transition Period 220

69 Macroeconomic Difficulties 22978 Macroeconomic Lessons 239

86 PART IV. Liberalized Trade Regimes and EconomicGrowth 245

Chapter 11: Impact of Phase IV and V Regimes on99 Growth 246

111 Microeconomic Effects 247112 Macroeconomic Effects 268

119 Chapter 12: Liberalization, Direction of Bias, and120 Economic Growth 277

124 The Brazilian and South Korean Experiences 278130 Export-Promotion versus Import-Substitution133 Growth Strategies 283

Conclusions 296

143

Appendix A 301144

145 Appendix B 304

155164180

I6-5 Braziliaj

Changes7-1 Percent

before a7-2

Tables ingproduct)

7-3 ImportCountrie

8-1 Rates ofDevaluatwholesal

8-2 Rates ofYears

8-lA Regressiition (dei

9-1 Indexes2-1 Population, Gross Domestic Product, and Per Capita Pro- tries,

duct, 1970 and Real Growth Rates, 1950-1970, Ten Countries 14 9-2 Indices2-2 Sectoral Composition of GDP, Ten Countries, 1960 and 1970 Countrie

(percent of total GDP in each country) 16 9-3 Value o2-3 Distribution of GDP by Expenditure Categories, Ten Coun- (millions

tries, 1960 and 1970 (percent of GDP) 17 9 Value of2-4 Average Annual Rate of Export Growth, by Decades, (millions

1950-1970, and Composition of Exports, 1970, Ten Countries 19 9-5 Regressi

2-5 Behavior of Wholesale Prices, Ten Countries, 1950-1970 21 Minor E:

2-6 Number of Countries in Each Phase, 1950-1972 (quarterly 9-6 Estimatecount converted to annual basis) 39 Countrie

5-1 Gross and Net Devaluations Accompanying Phase III 9-7 EstimateEpisodes, Ten Countries 73 Real Exc

5-2 Chilean PLD-EERs for Five Commodity Groups for Years 9-8 Changes

Surrounding Phase III Episodes 79 10-1 Exchang

5-3 Net Devaluation and Behavior of the Real Exchange Rate in Peg CouSurrounding Years, Ten Countries 83 10-2 Nominal

6-1 Number of Importable Items in South Korean Semiannual 1955-197

Trade Programs, 1961-1967 98 per U.S.6-2 Bias of Trade Regimes before and after Phase III Episodes, 1l1

Five Countries 102 tries, 195

6-3 Ratio of Import to Export EERs. before and after Phase III = 100)

Episodes, Nine Countries 11-2 Impact

6-4 Black Market Exchange Rates before and after Phase III Growth

Episodes (local currency units per dollar) 108

x

TABLES •xi

6-5 Brazilian Effective Rates of Protection, before and after 1964Changes 114

7-1 Percent Change in Money Supply over Specified Periodsbefore and after Devaluation, Ten Countries 129

7-2 Government Expenditures and Deficits for Years Surround-ing Devaluations, Ten Countries (percent of gross nationalproduct) 134

7-3 Import Flows for Years Surrounding Devaluations, TenCountries 138

8-1 Rates of Inflation over Specified Periods before and afterDevaluations, Ten Countries (percent increase in thewholesale price index) 148

8-2 Rates of Growth of Real GNP and Industrial Output forYears Surrounding Devaluations, Ten Countries 157

8-lA Regression Estimates of the Price Level Impact of Devalua-tion (dependent variable: quarterly observations on P(t)) 183

9-1 Indexes of PLD-EERs for Traditional Exports, Nine Coun-a Pro- tries, 1950-1971 (1958 PLD-EER = 100) 188

intries 14 9-2 Indices of PLD-EERs for Nontraditional Exports, Nined 1970 Countries, 1950-1972 (1958 PLD-EER = 100) 189

16 I 9-3 Value of Traditional Exports, Nine Countries, 1954-1972Coun- (millions of U.S. dollars) 190

17 9-4 Value of Nontraditional Exports, Ten Countries, 1954-1972cades (millions of U.S. dollars) 191

intries 19 9-5 Regression Estimates for Annual Percentage Changes in70 21 Minor Exports, Colombia 193

arterly 9-6 Estimated Coefficients for Export Earnings Model, Ten39 Countries 203

se III 9-7 Estimated Coefficients of Response of Export Earnings to73 Real Exchange Rates and Phases 205

Years 9-8 Changes in Incentives to Brazilian Exporters, 1964-1971 20979 10-1 Exchange Rates, Nominal and Price-Adjusted, Three Sliding-

in Peg Countries (local currency units per U.S. dollar) 23483 10-2 Nominal, Effective, and Real Exchange Rates, Israel,

Lnnual 1955-1971, and South Korea, 1961-1972 (local currency units98 per U.S. dollar) 236

sodes, 11-1 Indicators of Imported Capital Goods, Prices, Five Coun-102 tries, 1954-1971 (index of PLD-EERs for capital goods, 1958

Ise III = 100) 254105 11-2 Impact of Export Growth and Trade Regime upon GNP

se III Growth Rates, Five Countries (1954-1971) 273108

xl'

Figures Forewou

The National2-1 Phases of Exchange Control Regimes, Ten Countries, Economic De'1950-1972 38 Anne 0. Krw.6-1 Components of Devaluation Jagdish N. Bhundertaking nwith internati(economies ofBureau projecfessor Kruegerfinanced undetional Develoj

For manyternal problerraspects of oneas parts of Buitivity, and ateconomic systternational ecLary. AEconomic RdStates as WonTrends in the

Most of Iother develop

Foreword

The National Bureau's comprehensive project on Foreign Trade Regimes andies, Economic Development is completed with the issuance of this synthesis by

38 Anne 0. Krueger and the forthcoming publication of a companion study by90 Jagdish N. Bhagwati, co-director of the project with Professor Krueger. This

undertaking marks a major step in the National Bureau's increasing concernwith international economic problems, foreign economies, and particularly theeconomies of developing nations, and is being followed up by a new NationalBureau project on Alternative Trade Strategies and Employment, under Pro-fessor Krueger's direction. That project, like the one reported on here, is beingfinanced under a research contract with the United States Agency for Interna-tional Development.

For many years the Bureau's research efforts were concentrated on the in-ternal problems of the American economy. There were some studies of specificaspects of one or another foreign economy or U.S. trade or capital movementsas parts of Bureau programs such as those in business cycles or government ac-tivity, and an occasional look at a specific feature of the internationaleconomic system. Only in the 1960s was a separate program begun on the in-ternational economic relations of the United States, under the direction of HalLary. A separate National Bureau publication series—Studies in InternationalEconomic Relations—began in 1963 with Hal Lary's Problems of the UnitedStates as World Trader and Banker and Robert E. Lipsey's Price and Quantity

• Trends in the Foreign Trade of the United States, and now includes 8 volumes.Most of the Bureau's earlier studies were focused on the United States,

other developed economies, and the relations among them. It was not until

XII'

xiv FOREWORD

Hal Lary's Imports of Manufactures from Less Developed Countries in 1968 The latterand Simon Kuznets' contribution to NBER's 50th Anniversary Colloquia, import licensepublished in 1972, that attention was shifted to the much larger world outside fects of deyajthe developed countries. tion resulted i

This first major venture by the Bureau into studying the economies of gests that mardeveloping countries is directed at one of the most controversial issues of change rate cidevelopment policy: the choice of exchange rate regimes, the implications of the nominalalternative regimes for resource allocation and growth, and alternative policy rate. Where t]instruments for moving from exchange control regimes to regimes in which almost all thequantitative restrictions are unimportant as an instrument for regulating the Anotherbalance of payments. liberalization.

There has been, of course, no shortage of public discussion of the trade shifts from quand exchange rate policies of developing countries. The basis for the Bureau's plc, liberalizeproject was that no single author could examine those policies and their conse- Professor Kruquences in a number of very different countries with the required degree of ex- sion, as ispertise and attention to the difficult problems of measurement involved, and resulted fromthat uncoordinated studies differed so in framework and method that results tant in its owicould not be compared and added up. The co-directors therefore brought With resjtogether a distinguished group of collaborators, each of whom was an expert Krueger findsin the field of trade and development and was also well acquainted with one of monetary polithe countries to be studied. The authors would all work under an agreed corn- ducing paymemon framework and set of instructions, hammered out among them at an ear- offset the effely working party, although they retained their freedom to modify the plans to Among thefit the peculiarities of their particular countries, a minor one.

The result was the series of coordinated studies that Professor Krueger One of tihas drawn on for this synthesis, each of which contains much valuable infor- themselves, armation and analysis of the country beyond what can be summarized here. Nine were often farsuch studies have been issued, covering, in approximate order of publication, intended. One

[ Turkey, Ghana, Israel, Egypt, the Philippines, India, South Korea, Chile, and replaced by/ Colombia. Studies of Brazil and Pakistan had been scheduled and, though not suspects, the gcarried through on the scale envisaged for publication, yielded useful results in been. Anotheunpublished papers. controls, this

L Of course, the country authors and Professor Krueger are well aware that port targets i:trade policy and exchange rate policy are not the sole determinants of the rate direct importof development. It is notable, however, that from the mass of factors affecting earned byeconomic development, including political influences such as the stability of Perhaps tgovernmenis, Professor Krueger is able to discern some striking relations be- is that a bias ttween trade policy and economic growth. stable govern

One point that recurs throughout the study is the importance of looking growth. Stressbeyond the changes in nominal exchange rates (gross) to changes in effective mitment to anexchange rates (net)—that is, the amounts actually paid for foreign currency. ple, changes i

tations about

rThe latter measure takes account of changes in, for example, the premium onimport licenses or the abolition of export subsidies, which could offset the ef-fects of devaluation. In one extreme case, Egypt, a 23 percent gross devalua-'tion resulted in only about a 3 percent net devaluation. Professor Krueger sug-gests that many instances in which exports supposedly failed to respond to cx-change rate changes were in fact cases where there was nothing to respond to:the nominal devaluation was offset by other factors affecting the exchangerate. Where there were changes in real effective exchange rates, she reports,almost all the authors found signficant responses of exports to them.

Another point of importance is the distinction between devaluation andliberalization. The former alters the price of foreign exchange, while the lattershifts from quantitative restrictions to price intervention. One could, in princi-ple, liberalize by substituting tariffs for quotas at an unchanged exchange rate.Professor Krueger denies that devaluation attempts necessarily lead to reces-sion, as is often asserted. When such a juxtaposition occurred, she suggests, itresulted from efforts to curb domestic inflation (a separate objective impor-tant in its own right), not from the devaluation itself.

With respect to the fear that devaluation results in inflation, ProfessorKrueger finds that inflation in such cases is usually the result of expansionarymonetary policy, although Occasionally the success of the deyaluation in pro-ducing payments surpluses and the subsequent failure of some governments tooffset the effect of these surpluses on the money supply did result in inflation.Among the many inflationary forces in developing countries, devaluation wasa minor one.

One of the purposes of this study was to examine the payments regimesthemselves, and Professor Krueger argues that quantitative restriction regimeswere often far more protective than the governments imposing them knew orintended. One indication of that lack of awareness was that when quotas werereplaced by tariffs, the tariffs provided less protection, partly because, shesuspects, the governments did not realize how high the levels of protection hadbeen. Another indication of lack of awareness of the effects of quantitativecontrols, this time on the export side, was where the imposition of physical ex-port targets in return for import licenses produced cases in. which even thedirect import content of the exports was greater than the foreign exchangeearned by them.

Perhaps the most important conclusion from Professor Krueger's analysisis that a bias toward exports, and particularly a pervasive, well-publicized, andstable government commitment to exports, is most favorable to economicgrowth. Stress is laid a number of times on the importance of the known com-mitment to an export orientation, beyond the measurable effects of, for exam-ple, changes in effective exchange rates. The commitment influences expec-tations about future government actions and encourages export suppliers to

FOREWORD xv

untries in 1968Colloquia,

• world outside

economies ofersial issues ofimplications ofernative policyiimes in whichregulating the

on of the trader the Bureau'snd their conse-

degree of cx-t involved, andiod that resultsrefore brought

was an expertted with one ofan agreed corn-them at an ear-ify the plans to

Kruegervaluable infor-ized here. Nineof publication,rca, Chile, andnd, though not

useful results in

well aware thatants of the rateactors affectingthe stability of

rig relations be-

ince of lookingges in effectivereign currency.

L

Xvi FOREWORD

believe that currently favorable conditions will be maintained and aretherefore worth adapting to. Expectations, unmeasurable but sometimespredictable, can, of course, work against a rational exchange rate policy ifpotential exporters have learned from experience to expect favorable condi-tions to be ephemeral. fThe favorable effects of an export orientation are attributed by Pro-fessor Krueger not only to such traditionally cited factors as economies ofscale or the stimulating effects of foreign competition, but also to the factthat such a policy limits the use of quantitative restrictions and the distor-tions of economic incentives that accompany them. It is a policy that forcesthe recognition and rectification of mistakes that are hidden by an import-substitution policy.

Academic scholars are sometimes accused of ignoring the world's ma-jor problems and concentrating on trivial ones because they are more easilyunderstood and solved. That is a charge that cannot be made against Pro-fessors Bhagwati and Krueger and their collaborators. The result of this col- This volume islaborative effort is, we believe, the most authoritative examination of determines the (developing countries' trade policies ever carried out, and one that will not when they takebe superseded for a long time. We hope and expect that it will be a major restriction of mtcontribution to both academic discussion and to policymaking. tion and growtl

as to reduce orRobert E. Lipsey these questionsDirector, International Studies Both questS

the early 1950s.tions whenrestrictions on tthat importantanalysis was ladevaluation ten

By thecontrol had accanalysis based othe National Buco-directors ofDevelopment"and to investigafirst phase of tanalytical framperience of tenanalysis of the I

suppliaspects of the

itained and arebut sometimes

ige rate policy iffavorable condi-

Prefacetributed by Pro-

economies oft also to the facts and the distor-olicy that forces

en by an import-

This volume is devoted to analyzing two closely related questions: (1) Whatdetermines the outcome of devaluation and its accompanying policy measureswhen they take place in an environment of exchange control and quantitativerestriction of international transactions? (2) How are domestic resource alloca-tion and growth affected when trade and payments regimes are liberalized soas to reduce or eliminate reliance on quantitative restrictions? The analysis ofthese questions is set within the context of developing countries.

Both questions have been the subject of a great deal of discussion sincethe early 1950s. Early analyses generally failed to distinguish between devalua-tions when normal market reactions are being restrained by quantitativerestrictions on trade and those that occur under liberalized regimes. Even afterthat important distinction came to be recognized, a general framework foranalysis was lacking, and empirical investigations of individual episodes ofdevaluation tended to treat each event as unique.

By the late 1960s enough experience with devaluation under exchangecontrol had accumulated so that it seemed feasible to attempt a systematicanalysis based on a number of devaluations. Such a project was undertaken bythe National Bureau of Economic Research, with Jagdish Bhagwati and me asco-directors of the project. "Foreign Trade Regimes and EconomicDevelopment" was designed to provide answers to the two questions aboveand to investigate other issues related to exchange control and its effects. Thefirst phase of the project was the preparation, review, and revision of ananalytical framework; the second phase comprised separate analyses of the ex-perience of ten developing countries;1 the final phase is a comprehensiveanalysis of the findings from the ten country studies.

'Certain supplementary studies were also prepared on topics of particular interest. They coveraspects of the Indonesian, Japanese, and Pakistani experience.

xvii

the world's ma-7r are more easily

against Pro-t of this col-

:aminatiofl ofthat will not

I will be a major

ii Studies

Xviii PREFACE

The country studies undertaken in this project were carried out by outlook for theeconomists well acquainted with their subject countries. The countries includ- not entirelyed and their study authors were: demand will n

Nonetheless, inBrazil Albert Fishlow, University of California, Berkeley sorts of difficulChile Jere R. Behrman, University of Pennsylvania regimes of earliColombia Carlos F. Diaz-Alejandro, Yale University followed in theEgypt Bent Hansen, University of California, Berkeley; and Some of U

Karim Nashashibi, International Monetary Fund have probablyGhana J. Clark Leith, University of Western Ontario policies. OtherIndia Jagdish N. Bhagwati, Massachusetts Institute of the former is th

Technology; and T.N. Srinivasan, Indian Statistical In- rates. Rationalstitute undoubtedly en

Israel Michael Michaely, The Hebrew University of Jerusalem the currency agPhilippines Robert E. Baldwin, University of Wisconsin action should rrSouth Korea Charles R. Frank, Jr., Princeton University and The tam realistic

Brookings Institution; Kwang Suk Kim, Korea Develop- 1960s. While scment Institute, Republic of Korea; and Larry E. difficult as a C(Westphal, Northwestern University cies, there does

Turkey Anne 0. Krueger, University of Minnesota are floating—ailevel of

This volume and a companion study by Jagdish Bhagwati represent the management isresults of the final phase of this project. This phase draws upon the findings of cy is no longeithe country authors in an attempt to provide an analytical framework that relatively simplmight prove useful in studies of other countries. This analysis also represents reserve assets ian effort to generalize—to the extent possible—on the apparent orders of (IMF) records tmagnitude of the parameters that theory predicts to be important. This book (SDRs); alternaaddresses the effects of devaluation and liberalization; the Bhagwati volume expected futureprovides a comparable analysis of exchange control regimes and their effects. trading

The project on Foreign Trade Regimes and Economic Development began of safety againsin 1969, and the period covered in the country studies generally ends with Although t1972. The research on the individual countries was largely completed before spects of thethe changes in the international' economy of the mid-1970s took place. The following the oipresent analysis, therefore, which is based on the country studies, does not crease itself wastake these recent changes into account. A question of some importance is the some other tenextent to which the lessons emerging from the 1950s and 1960s are applicable tries have beento the changed international economic environment in which developing coun- domestic oil retries find themselves. Obviously, judgments will differ, but I do not think the were the onesconclusions and results need alteration in any fundamental regard.

To be sure, faster growth of world demand and rapidly rising levels of in- to altered circu:ternational trade provide a favorable climate for any set of economic policies.The comparative ranking of alternative policies does not, however, shift 2See, for example

cm Needs of Devesimply because conditions are less favorable for any of them. While the Section, Essay in I

1975).

PREFACE X1X

carried out by outlook for the rate of growth of world trade in the latter half of the 1970s isinclud- not entirely clear, it is likely that—in real terms—the rate of growth of world

demand will not be as rapid as in the decade between 1965 and 1975.Nonetheless, interdependence among countries is likely to continue; and the

Berkeley sorts of difficulties that resulted from some of the quantitative restriction (QR)vania regimes of earlier periods are equally likely to result should similar policies beity followed in the present environment.

Berkeley; and Some of the changes that have taken place in the international economyLry Fund have probably made it easier for developing countries to follow rationalntario policies. Other changes may have made the task more difficult. An example ofs Institute of the former is the shift in the world economy to a system of floating exchangen Statistical In- rates. Rational exchange rate. management in most developing countries will

undoubtedly entail the use of one formula or another to adjust the parity ofty of Jerusalem the currency against a market basket of other countries' currencies. Such anflSifl action should make the adoption of a sliding peg, or other policies that main-ersity and The tam realistic real exchange rates, somewhat easier than it was in the 1950s andKoreaDevelop- 1960s. While some have asserted that reserve management has become moreand Larry E. difficult as a consequence of realignments in rates among the major curren-

cies, there does not seem to be any basis for this allegation. The fact that ratesota are floating—and perhaps set at more realistic levels—may reduce the desired

level of reserves and thus reduce the size of the problem. Insofar as reserveti represent the management is concerned, it is true that holding.all reserves in a single curren-the findings of cy is no longer wise, if indeed it ever was. Countries can, however, find

ramework that 7 relatively simple rules that will suffice. For example, a country might hold itsalso represents reserve assets in the same proportions as the International Monetary Fundrent orders of (IMF) records the weighted exchange rates in terms of Special Drawing Rightsant. This book (SDRs); alternatively it could keep its reserves in approximate proportion toagwati volume expected future net liabilities, including debt-service obligations, to its variousLd their effects. trading partners. The composition of reserves would thereby provide a marginlopment began of safety against short-term fluctuations in exchange rates.ally ends with Although floating rates are unlikely to have adverse effects upon the pro-

rnpleted before spects of the developing countries, the impact of terms-of-trade changes)Ok place. The following the oil price increase is far more difficult to assess. The oil price in-idies, does not crease itself was, presumably, a once-and-for-all measure, really not as large asportance the some other terms-of-trade shifts experienced in earlier years. Different coun-are applicable tries have been very differently affected. In general, among countries without

veloping coun- domestic oil resources, those whose trade regimes relied heavily upon QRso not think the were the ones most adversely affected; those with liberalized regimes andard. outward-oriented growth appear to have been much more capable of adaptinging levels of in- to altered circumstances.2nomic policies.

_______________

however, shift for example, the classification of developing countries in Constantine Michalopoulos, Finan-em While the cing Needs of Developing Countries: Proposals for International Action, International Finance

Section, Essay in International Finance No. 110 (Princeton: Princeton University Press, June1975).

xx PREFACE

The evidence from the country studies demonstrates the potential payoff The facilifor development via reliance on international markets. Perhaps the major con- were invaluablclusions that should be drawn from consideration of the altered international vices withouteconomic environment are that developing countries have a major stake in the particularlyrapid expansion of the world economy and that developed countries can make project officera sizable contribution by providing access to their growing markets. also provided I

The development of the present analysis has been closely interrelated with jor financial stthe fortunes of the individual country studies. During the period when final for Internatioirevisions were being made, from September 1975 to March 1976, published Michael Roeiivolumes or galley proofs were available to me for all the country studies but monitors, andthat of Brazil. For that country I used a summary version prepared by Albert the project.Fishlow for use at the Bogota conference. During the spring and summer of Betsy Fre1974, drafts of what are 2, 4, 5, 6, 7, 8, 9, and 10 were prepared. Kaluza bore p:A working party of country authors was held in September 1974, and i and also the fibenefited from the discussion at that time, as well as from numerous written her correctionsuggestions from those present, including Robert Baldwin, Jere Behrman,Jagdish Bhagwati, Carlos Diaz-Alejandro, Albert Fishlow, Charles R. Frank,Jr., Bent Hansen, Hal Lary, Clark Leith and Larry Westphal. Sergio Molinaand Anibal Pinto of the Economic Commission for Latin America were alsopresent at that meeting and made numerous helpful suggestions.

Chapters 4 through 6 were rçvised on the basis of data provided by thecountry authors and the discussion and comments received at the working par-ty. In addition, drafts of the remaining chapters were prepared.In Decemberof 1974 the Asian Development Bank and the National Bureau jointly spon-sored a conference in Manila on the results of the project. In April of 1975 asimilar conference was held in Bogota under the auspices of the Banco de IaRepublica, the Economic Commission for Latin America, and the NationalBureau. Jose Encarnacion of the University of the Philippines, and KiyoshiKojima of the University of Tokyo, made especially useful comments on themanuscript at the Manila conference, and Patricio Meller of the NationalBureau, and Juergen Donges of the Institut fur Weltwirtschaft, Kiel, did so atthe Bogota conference. I am grateful to all the participants in both con-ferences, many of whom should recognize significant changes based upon theircomments and suggestions.

I am especially indebted to Bent Hansen, Michael Michaely, and T.N.Srinivasan, who read the entire manuscript and commented extensively at thatstage. I also benefited from comments from Richard Snape, who read thepenultimate draft. Hal Lary has read and commented upon all drafts of themanuscript, and it is to him that my debt is greatest.

Salih Neftci provided invaluable assistance with the statistical workreported in Chapters 8, 9, and 11, in addition to our joint endeavor in the ap-pendix to Chapter 8. Abraham Hollander served as a research assistant duringthe academic year 1974/75.

PREFACE xxi

otential payoff The facilities and staff of the National Bureau of Economic Researchthe major con- were invaluable in providing the coordination, editing, and administrative ser-

international vices without which a project of this kind could not have been undertaken. Ijor stake in the particularly want to express my gratitude in this regard to Hal Lary, formerlyLtries can make project officer, and to Robert Lipsey, who succeeded him in that capacity andrkets. also provided helpful comments on the final draft of the manuscript. The ma-Lterrelated with jor financial support for the project was provided by the United States Agencyiod when final for International Development, whose assistance is gratefully acknowledged.976, published Michael Roemer and Constantine Michalopoulos, in turn, were projectitry studies but monitors, and they contributed importantly to the intellectual development ofFared by Albert the project.

and summer of Betsy Frederick and Carol Such each typed parts of the manuscript. Patwere prepared. Kaluza bore primary responsibility for typing most of the first complete draftr 1974, and j and also the final revision, and the manuscript is much improved because ofmerous written her corrections and industry.Jere Behrman,aries R. Frank,Sergio Molina Anne 0. Krueger

erica were also Minneapolis, MinnesotaMay 1976

provided by theie working par-d.In Decemberu jointly spon-

April of 1975 ahe Banco de lad the Nationals, and Kiyoshimments on thef the National

, Kiel, did so at'S in both con-ased upon their

aely, and T.N.ensively at that

who read theLi drafts of the

tatistical workavor in the ap-ssistant during

PART I

Introdu