Capital Market and Trade Liberalization - IMF eLibrary

Occasional Papers of the International Monetary Fund

2. Economic Stabilization and Growth in Portugal, by Hans O. Schmitt. 1981.

5. Trade Policy Developments in Industrial Countries, by S.J. Anjaria, Z. Iqbal, L.L. Perez, andW.S. Tseng. 1981.

6. The Multilateral System of Payments: Keynes, Convertibility, and the International MonetaryFund's Articles of Agreement, by Joseph Gold. 1981.

8. Taxation in Sub-Saharan Africa. Part I: Tax Policy and Administration in Sub-Saharan Africa, byCarlos A. Aguirre, Peter S. Griffith, and M. Zuhtu Yucelik. Part II: A Statistical Evaluation ofTaxation in Sub-Saharan Africa, by Vito Tanzi. 1981.

10. International Comparisons of Government Expenditure, by Alan A. Tait and Peter S. Heller.1982.

11. Payments Arrangements and the Expansion of Trade in Eastern and Southern Africa, byShailendra J. Anjaria, Sena Eken, and John F. Laker. 1982.

12. Effects of Slowdown in Industrial Countries on Growth in Non-Oil Developing Countries, byMorris Goldstein and Mohsin S. Khan. 1982.

13. Currency Convertibility in the Economic Community of West African States, by John B.McLenaghan, Saleh M. Nsouli, and Klaus-Walter Riechel. 1982.

14. International Capital Markets: Developments and Prospects, 1982, by a Staff Team Headed by

Richard C. Williams, with G.G. Johnson. 1982.

15. Hungary: An Economic Survey, by a Staff Team Headed by Patrick de Fontenay. 1982.

16. Developments in International Trade Policy, by S.J. Anjaria, Z. Iqbal, N. Kirmani, andL.L. Perez. 1982.

17. Aspects of the International Banking Safety Net, by G.G. Johnson, with Richard K. Abrams.

1983.

18. Oil Exporters' Economic Development in an Interdependent World, by Jahangir Amuzegar. 1983.

19. The European Monetary System: The Experience, 1979-82, by Horst Ungerer, with Owen Evansand Peter Nyberg. 1983.

20. Alternatives to the Central Bank in the Developing World, by Charles Collyns. 1983.

22. Interest Rate Policies in Developing Countries: A Study by the Research Department of theInternational Monetary Fund. 1983.

24. Government Employment and Pay: Some International Comparisons, by Peter S. Heller andAlan A. Tait. 1983. Revised 1984.

26. The Fund, Commercial Banks, and Member Countries, by Paul Mentre. 1984.

28. Exchange Rate Volatility and World Trade: A Study by the Research Department of theInternational Monetary Fund. 1984.

29. Issues in the Assessment of the Exchange Rates of Industrial Countries: A Study by the ResearchDepartment of the International Monetary Fund. 1984

30. The Exchange Rate System—Lessons of the Past and Options for the Future: A Study by theResearch Department of the International Monetary Fund. 1984

Note: Excludes those titles that are now out of print or that are now included in the series "World Economic andFinancial Surveys."

(Continued on inside back cover)

©International Monetary Fund. Not for Redistribution

Occasional Paper No. 54

Protection and Liberalization:A Review of Analytical Issues

By W. Max Corden

International Monetary FundWashington, D.C.

August 1987


© 1987 International Monetary Fund

Library of Congress Cataloging-in-Publication Data

Corden, W. M. (Warner Max)Protection and liberalization.

(Occasional paper / International Monetary Fund,ISSN 0251-6365 ; no. 54)

"August 1987."Bibliography: p.1. Commercial policy. 2. Free trade and protection.

I. Title. II. Series: Occasional Paper(International Monetary Fund) ; no. 54.HF1411.C5954 1987 382.7 87-16932ISBN 0-939934-95-7

Price: US$7.50(US$4.50 university libraries, faculty members, and students)

Address orders to:External Relations Department, Publication Services

International Monetary Fund, Washington, D.C. 20431


Contents

Page

Prefatory Note v

I. Introduction 1

II. The Facts 3

III. Protection and Macroeconomic Issues 5Impact on Current Account 5Protection and Exchange Rate Instability 7Protection and Macroeconomic Policy Coordination 8Protection, Unemployment, and Recession 8

IV. Current Arguments for Protection 10Infant Industry Argument 10Terms of Trade Argument 11Tariffs and Export Taxes for Revenue 11Political Economy and Protection 12

V. Some Broader Issues 14Rent-Seeking and Other Costs of Protection 14Protection and Growth 14Distribution 15

VI. Developing Countries: Protection, Liberalization, andMacroeconomic Policy 17

Protection, the Exchange Rate, and Real Wage Rigidity 17Short-Run Terms of Trade Effects 19Trade Liberalization: Exchange Rates and Timing 19Liberalization with Fixed Exchange Rates 21Capital Market and Trade Liberalization 22

Protection in Industrial and Developing Countries 23

VII. Summary 26

References 28

iii


The following symbols have been used throughout this paper:

... to indicate that data are not available;

— to indicate that the figure is zero or less than half the final digit shown, orthat the item does not exist;

- between years or months (e.g., 1979-81 or January-June) to indicate theyears or months covered, including the beginning and ending years ormonths;

/ between years (e.g., 1980/81) to indicate a crop or fiscal (financial)year.

"Billion" means a thousand million.

Minor discrepancies between constituent figures and totals are due to rounding.

IV


Prefatory Note

This paper was prepared by W. Max Corden, Senior Advisor in the Fund'sResearch Department. An earlier version was discussed by the Fund's ExecutiveBoard in early 1987. The paper has benefited from comments by staff in the ResearchDepartment, other departments of the Fund, and by members of the Executive Board,and was edited by Mrs. Landell-Mills of the External Relations Department. Theviews expressed are those of the author and do not necessarily represent the views ofthe International Monetary Fund.

It should be noted that the term "country" used in this document does not in allcases refer to a territorial entity that is a state as understood by international law andpractice. The term also covers some territorial entities that are not states but for whichstatistical data are maintained and provided internationally on a separate andindependent basis.

V


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I Introduction

This paper deals with trade policy issues of particularinterest to the Fund. It is motivated both by the revival ofprotectionist attitudes in the industrial countries and theprevalence of liberalization proposals for developingcountries. In view of Fund concerns with the functioningof the international monetary system and with individualcountries' macroeconomic policies, the paper focuses onthe areas where macroeconomic policy, and especiallyexchange rate issues, relate to protection. Thus itsdiscussion of the more standard microeconomic effectsof protection is rather brief. The paper begins with adiscussion of the relationship between protection and thecurrent account, an issue that is particularly relevantcurrently for the United States.

The analysis supplements an earlier Fund publication,Trade Policy Issues and Developments (OccasionalPaper No. 38, July 1985), which contains a comprehen-sive survey of developments in the field up to early 1985.The present paper does not go over the earlier ground andis primarily concerned with policy-relevant analyticalissues, with a heavy emphasis on macroeconomicaspects.

The Fund's position is to favor an open tradingsystem, in general to oppose the use of trade restrictionsfor balance of payments and other purposes, and tosupport trade liberalization. Some Fund programs speci-fically include trade liberalization as an objective. Gov-ernments have also committed themselves to embark onnegotiations for further liberalization in the recent Puntadel Este Declaration of the CONTRACTING PARTIES of theGeneral Agreement on Tariffs and Trade (GATT).Furthermore, there is a wide consensus among profes-sional economists about the benefits of free or freertrade. Nevertheless, protectionist beliefs are widely heldand many arguments for protection persist, even thougha vast theoretical literature has pointed out their weak-nesses. Arguably, it is these beliefs as well as theinfluence of pressure groups, rather than complexitiesof trade negotiations, that underlie the persistenceof protection and the difficulties in bringing aboutliberalization.

The purpose of this paper is to analyze variousprotectionist arguments so that either they can be moreeffectively refuted or any kernel of truth in them can bebetter understood and taken into account in policyproposals.

Protection in this paper refers to all devices that restrictor distort trade, notably tariffs, import quotas and othernontariff barriers, such as voluntary export restraints,preferential procurement arrangements, and exporttaxes. At various points reference will also be made toprotection of industries by subsidization.

The paper is inevitably limited in its coverage.Specifically it does not deal, other than peripherally,with issues of trade discrimination, with measurementproblems (concerned with the satisfactory measurementof the costs or benefits of various protective devices),and it does not deal with details of proposed tradenegotiations and the various negotiating proposals thatare being put forward. These are all large subjects oftheir own.

There are some fundamental and well-known princi-ples justifying the case for an open trading system andexplaining the benefits from free trade—the samearguments that explain why there are gains from freetrade and interchange within the borders of a country.Essentially these rest on the principle of comparativeadvantage as well as the benefits of exploiting economiesof large scale and specialization. These basic argumentsare not restated here, being so well known; the focus israther on various possible qualifications to the basic freetrade approach. In this context, the arguments forprotection that are analyzed in this paper should be seenas no more than suggested modifications of the verygeneral and simple—but nevertheless vitally important—case for free and undistorted international trade. Evenwhen a protectionist argument has some validity it mayonly provide a marginal qualification, applying in somespecial cases. This has to be stressed at the beginning ofthis paper since the arguments for protection that arediscussed here may appear to overwhelm the simple butpowerful case for free trade.

It has to be accepted that in particular cases, if certainassumptions are actually believed to be applicable, someprotectionist arguments can be justified. The theory ofsecond best has been widely applied in this field and hashelped to define more precisely the assumptions requiredto support certain arguments. The theme of this theory isthat—in the presence of market failure or of variouspolicies of governments that distort or override themarket but that cannot be changed—there are someoffsetting policies that address the source of the distor-

1


I • INTRODUCTION

tion and will maximize national income. These are "first-best" solutions, essentially because they tackle theconsequences of the market failure in the most direct waypossible. For instance, if externalities in a given activitycause private costs to be lower than social costs andresult in higher output than would otherwise occur, thefirst-best solution would be for the authorities to tax thatactivity. Other policies have less favorable consequencesbecause they are not as direct and hence have someadverse "by-product" effects, but would still bring aboutan improvement. These are "second-best" policies: pur-suing the same example, a tariff on imports of the goodproduced under domestic distortions would be a second-best approach. Others are still less direct, possibly havemore by-product effects, and are third best, and so on.The distinction between first best, second best, and so onruns right through this paper. l But actual policies are notnecessarily determined by sound first- or second-bestlogic from a national interest point of view. As will benoted below, sectoral pressure groups play a role, often avery important one, and in addition there may be a lack

1The paper, especially Sections IV and V, draws on an extensivetheoretical literature. See Johnson (1965) and Corden (1974 and1984), which also contain further references. There have been recentdevelopments in the theory of trade policy which emphasize imperfectcompetition, oligopoly, and strategic behavior. A recent survey ofthese and other analytical issues is by Deardorff and Stern in Stern(1987).

of understanding of the costs of protection and theeconomic arguments for liberal trade.

Section II of the paper presents a very brief overviewof recent protectionist trends and what the facts show.The main discussion begins with Section III, which dealswith protection and macroeconomics, especially ex-change rate issues, focusing on topics that have beendiscussed primarily with respect to industrial countries.Can protection improve the current account in a floatingrate system, does exchange rate instability justify protec-tion, is there a case for protection when unemployment iscaused by real wages being too high, and so on?

Section IV assesses various popular arguments forprotection in both industrial and developing countriesand also discusses the use of trade taxes for fiscalpurposes, bearing in mind that such taxes may haveprotective effects as by-products. Section V looks atsome broader issues, namely the "rent-seeking" effectsof protection, how protection is likely to affect the rate ofgrowth as distinct from the level of real income, and thedistributional problem in assessing intervention policies.

Section VI is concerned with macroeconomic policy indeveloping countries. What is the role of protection in ashort-term policy package designed to improve thecurrent account? What are the main issues involved intrade liberalization, and how do they relate to capitalmarket liberalization? Finally, a particularly importantquestion is discussed: does protection by industrialcountries justify protection by developing countries?

2


II The Facts

Occasional Paper No. 38 of the International MonetaryFund contains a full review of policies, the facts aboutactual protectionist measures, available evidence on thecosts of protection, and discussion of negotiating issues,all based on information available up to early 1985. Inaddition, it contains extensive further references. Fur-thermore, there is a thorough survey of recent devel-opments, as well as of major protection policy issues, inthe World Bank's World Development Report, 1987.Hence the present paper deals purely with analyticalissues. Nevertheless, before launching into the maindiscussion, something should be said about recentprotectionist trends.2

As usual, the "facts" on their own are rarely conclu-sive. Nevertheless, at the risk of over-simplification, onecan summarize the situation as follows.

1. Protection in industrial countries has increasedsince 1980, the extent of the increase being difficult tomeasure. But a higher proportion of imports is nowcovered by nontariff barriers of some kind and one canidentify particular product areas where there have beenincreases. In trade in manufactures, the most importantand prospectively most adverse development is probablythe 1986 tightening up (through expansion of coverage)of the Multifiber Arrangement. From the point of view ofmany developing countries, including not just actual butalso potential exporters of clothing and textiles, this iscurrently the biggest problem.

2. Industrial country markets for manufactures are,however, still pretty open. A high proportion of con-sumption consists of goods for which there are nonontariff barriers at the borders (in 1983, 84 percent ofmanufactured imports and 64 percent of agricultural

2This summary is based on a number of sources. While the Fund'sOccasional Paper 38 is the starting point, it is supplemented with theFund's Annual Report on Exchange Arrangements and ExchangeRestrictions of 1986 and 1987, and with OECD (1985), Nogues,Olechowski, and Winters (1986), and Finger and Olechowski (1987).The latter three publications provide information on the extent of non-tariff barriers in industrial countries and recent changes. The Bank'sWorld Development Report for 1986 contains an extensive review ofagricultural protection in both developed and developing countries.The World Development Report for 1987 contains a similarlyextensive discussion and review of empirical material on industrialprotectionism, Chapter 8 on "the threat of protectionism" beingparticularly relevant. Finally, there is a thorough analysis of protectionin Japan, especially intangible protection, in Bergsten and Cline(1985).

imports entered freely into industrial countries, althoughthese shares do not allow for subsidies on domesticsubstitutes). Imports from developing countries havecontinued to increase, although there are indications thatthe share of exports from developing countries in non-oilworld trade has declined since 1980. Tariffs are alsogenerally very low, the result of the several GATTrounds of multilateral tariff reductions (though they tendto be relatively higher on developing countries' industrialexports). Protection is concentrated in limited areas,notably agriculture, clothing and textiles, and steel.Preference for home producers in public procurement is aform of protectionism that is hard to measure but isprobably important in all industrial countries. Formalprotection in Japan is low (aside from agriculture) andthere are differences of view about the extent of"informal" protection which is, of course, also hard tomeasure.3

Thus, while there has been some increase in protec-tion, the revival of protectionism in the industrialcountries, notably in the United States, at least outsideclothing, textiles, steel and agriculture, is at presentmore of a threat than an actuality. The current issue, ofcourse, is whether threat will be translated into actuality.

3. There is a special, and possibly increasing, prob-lem of competitive subsidization of agriculture by theEuropean Community and the United States. Agricul-tural protection is also high in a number of otherdeveloped countries, including Japan. This presents aparticular problem for other agricultural exporters at atime of weak commodity markets.

4. Protection in developing countries is generallymuch higher than in developed countries, covering amuch broader range of imports, and is often extremelyhigh by any measure. In almost all cases it is biasedagainst agriculture. On the other hand, there is noevidence of an overall increase in protection in devel-oping countries in general, and in some countries therehave been significant moves to liberalization.

5. Only the roughest estimates can be made of thecost of protection by nontariff barriers. In particularcases (clothing, textiles, agriculture, and motor vehicles)

3On the basis of Bergsten and Cline (1985), one might conclude thatJapan's market is roughly as open as the U.S. market, which makes it(again aside from agriculture) a fairly open market.

3


II • THE FACTS

the cost has sometimes been shown to be very high inrelation to the value of protected output. Since tariffs areno longer the main instrument of protection, the usualmeasures of protection costs are no longer adequate.Most comprehensive measures of nontariff barriers arerather limited, simply measuring either the coverage ofprotection—such as the proportion of imports subject tosome kind of nontariff barrier—or the presumed effectson trade flows.4

6. There is extensive evidence that countries withoutward-looking regimes (which is not the same ascomplete free trade) have higher growth rates. Thisevidence is summarized in Balassa (1985) and in the

4Many calculations are reported in the references listed infootnote 2.

Bank's World Development Report of 1987. In parti-cular, there seems to be some correlation betweenexport growth, following upon a shift toward amore outward-looking regime, and the aggregate growthrate. Of course, growth rates also depend on otherconsiderations.

7. Finally, a hopeful indication is the Punta del EsteDeclaration of the GATT Contracting Parties launchingthe eighth round of multilateral trade negotiations. Thedeclaration, adopted by consensus, states, among otherthings, that negotiations shall aim to "bring about furtherliberalization and expansion of world trade," to"strengthen the role of GATT," and "improve themultilateral trading system based on the principles andrules of the GATT and bring about a wider coverage ofworld trade under agreed, effective and enforceablemultilateral disciplines."

4


III Protection and Macroeconomic Issues

Impact on Current Account

It is a popular misconception that protection in theform of tariffs or import quotas must necessarily improvea country's current account. This view is frequently putin connection with the U.S. current account deficit. Itcould be based on the assumption that exchange rates arefixed or, at least, that the country's exchange rate willnot change endogenously as the result of a change inprotection levels. In the United States, however, theexchange rate is endogenously determined in a floatingrate system. It can be shown that, in due course, it islikely to appreciate when protection is increased, unlessat the same time there are changes in fiscal or monetarypolicy.

The essential point is that, at a constant value ofthe dollar, an increase in protection by the United Stateswould reduce the demand for foreign currencies relativeto the demand for dollars, and so, unless capital flows (orshort-term expectations, as discussed below) change,the dollar would have to appreciate. This appreciationwill increase imports and reduce exports in due course,so that finally the reduction in those imports where thereis protection will be offset by increases in other importsand by reduction of exports. The current account may notchange at all.

Unless official intervention in the foreign exchangemarket leads to a change in foreign exchange reserves,the current account deficit can only improve if there isreduced net capital inflow, since the ex post currentaccount deficit must be equal to the capital accountsurplus. But net capital inflow depends on the balancebetween savings and investment, private and public. Amajor factor influencing this balance is, of course, fiscalpolicy. One must then ask whether there is any reason forsavings or investment to change as a result of an increasein protection.

There are various possibilities. For example, anincrease in protection might stimulate investment inprotected industries more than it discourages investmentin industries that are adversely affected by appreciation,so that overall private investment would rise, and for this

reason the current account might worsen. Of course,overall investment may decline so the current accountcould improve. Similarly, savings might rise or fall,either improving or worsening the current account. Itwill also be noted below that, with the receipt of moretariff revenue, the fiscal position might improve, and thiswould tend to improve the current account. If the overalllevel of demand for home-produced goods increases andthere were initially underutilized labor and capital—sothat real incomes would rise as a result—savings wouldbe likely to increase, and this would also tend to improvethe current account. While protection will indeed nor-mally increase the demand for home-produced goods,appreciation will have the opposite effect, so this effectmight go one way or the other, holding macroeconomicpolicy constant. The conclusion is then that the currentaccount outcome could go either way and must beconsistent with the savings and investment changes thatcan be expected.

There is a qualification to the conclusion that protec-tion must lead to appreciation of the exchange rate. Thisqualification applies purely in the short run, beforeprotection has any sizable effect on imports. Theexchange rate depends in the short run above all onexpectations in asset markets. Indeed, such shifts inexpectations are usually the causes of the exchange rateinstability that may have given rise to the protectionistpressures. An increase in protection, or the prospect ofsuch an increase, could bring about changes in expecta-tions—whether rational or not—which then depreciatethe exchange rate for a time. But in due course thefactors discussed above, bringing about appreciation, arelikely to come into play, and it is surely more likely thatan increase in unilateral protection would lead to theexpectation of appreciation (relative to what might havehappened to the exchange rate otherwise), and hence, inanticipation, to some immediate appreciation. Of course,if protection were expected to lead to foreign retaliationor, for some reason, to a reduced demand for thecountry's bonds and equities relative to foreign claims,the expectation of depreciation, or of lesser appreciation,might be rational.

It has been suggested that a uniform ad valorem tariff(import surcharge) might deal with the U.S. current

5


III • PROTECTION AND MACROECONOMIC ISSUES

account problem.5 The argument is that, because thetariff would be uniform, it would not distort resourceswithin the import-competing sector. It would, of course,favor import replacement relative to exporting, and thisis presumably not denied by the advocates. The centralissues are whether the uniform tariff would improve thecurrent account and whether it would be an efficient wayof doing so. The answer is that it would probablyimprove the current account provided the revenue raisedwere used to reduce the budget deficit rather than leadingto reductions of other taxes or to greater governmentexpenditures. Any measure that reduces the budgetdeficit and does not have offsetting effects on privatesavings or investment would improve the current ac-count. It represents a change in fiscal policy. Withreduced public dissavings, there would be a change inthe national savings-investment balance in the requireddirection. Of course there could be offsetting effects. Forexample, private investment in the protected industriescould rise, and this would tend to worsen the currentaccount.

But the uniform tariff would be a highly inefficientpolicy instrument. First, it would have the disincentiveeffects that are generally associated with taxes, effectsthat cannot be avoided if there is to be a rise in taxes ofsome kind or other. Second, it would distort the patternof resource allocation between import substitution andexporting and hence reduce the gains from internationaltrade.

A more complex consideration is that it would notnecessarily lead to uniform effective protection (protec-tion related to value added) even if all imports werecovered by the tariff, which is unlikely. This is becausedomestically produced inputs that are close substitutesfor exports would still have their prices determined inworld markets, so that effective protection for import-competing activities that use exportables as inputs wouldbe greater than nominal protection. In other words,uniform nominal protection would yield a system ofeffective rates that would not be uniform and that wouldthus lead to misallocation of resources within the import-competing sector. This issue is discussed further belowwith respect to revenue tariffs. If commodity taxes are tobe preferred to increases in income tax rates, then itcould be shown that a given amount of revenue can beraised with less distortion by a general tax on consump-tion or output (such as a uniform value added tax) than auniform tariff.

To all this must be added the important considerationthat a wide-ranging increase in U.S. protection is highlylikely to provoke retaliation from other countries, as wellas setting an undesirable precedent, especially at a time

5The proposal has been put forward at various times in the publicarena, as also by Professor Branson of Princeton University. SeeBranson in Stern (1987). The proposal is analyzed in detail by Klein,Pauly, and Petersen, using Project LINK, in Salvatore (1987).

when a new round of multilateral trade negotiations hasrecently been launched.

It is worth considering the case of implementing aprotectionist policy when the exchange rate is fixed, or atleast is not readily adjusted, though this case will bediscussed more fully in Section VI in connection withbalance of payments policies of developing countries. Inthis case an increase in protection is more likely toimprove the current account even when the fiscal deficitdoes not change. Of course, either an increase insavings, or a reduction in investment or the budget deficitwould be required for a current account improvement toresult.

Since protection switches the pattern of demandtoward home-produced goods, if there is initially excesscapacity and underutilization of labor, aggregate outputand hence incomes would rise. This would, in turn, leadto a rise in savings as well as tax revenues, and if this isnot offset by a rise in investment induced by the greaterprofitability of import-competing industries or by anincrease in government expenditures, it would then leadto a current account improvement. If there is initially noexcess capacity and readily available extra labor supply,excess demand would arise when protection switchesdemand toward home-produced goods. If domesticprices rise as a result there will have been a realappreciation—an increase in the level of domesticrelative to foreign costs—which would offset the effectsof protection on the current account just as in the case ofa flexible nominal exchange rate discussed above.

But it seems more reasonable to suppose that in thesecircumstances macroeconomic policy would prevent theexcess demand or inflation, and that fiscal or monetarypolicies would reduce demand for home-produced goodsto offset the greater demand for home-produced goodsresulting from the increase in protection. As far aspossible, a net rise or fall in the pressure of domesticdemand would be avoided. This might be described asmaintaining the domestic macroeconomic outcome (or"internal balance") unchanged. Aggregate demandwould be reduced either by a fiscal contraction or by amonetary contraction that reduced private investment orconsumption. It follows that there would again have tobe a rise in savings or fall in investment, public orprivate, if the current account were to improve.

Finally, two qualifications to the previous discussionmight be noted. First, tariffs and quotas imposed onimports that are components or materials used in otherindustries will raise the costs of the latter. Thus someexport- and import-competing industries which use theseimports or their close substitutes as inputs will find thattheir costs have increased, and thus their contributions tothe balance of payments will be affected adversely. Thismay, of course, be offset by favorable effects for theindustries that are directly protected. Second, if protec-tion takes the form of voluntary export restraints by

6


Protection and Exchange Rate Instability

suppliers, import quantities will indeed fall, but pricescharged by exporters who obtain the monopoly or cartelprofits are likely to rise (the best known example beingprices of Japanese autos in the United States). Theconclusion is that, even if the exchange rate stayed fixed,the current account may conceivably not improve as aresult of an increase in protection and the exchange ratemay not appreciate in a floating rate system. But thesecomplications are unlikely to have a dominant effect onthe outcome when a widespread system of tariffs andquotas is introduced.

Protection and Exchange Rate Instability

Seen from the narrow point of view of a particularimport-competing or export industry which has lostcompetitiveness as the result of a real appreciationcaused by macroeconomic developments, protectionseems the natural countermeasure. It can indeed offsetthe consequences on this industry of an exchange ratechange. In this way one can to some extent explainrecent protectionist pressures in the United States. But,for reasons discussed above, an increase in protection islikely to cause the exchange rate to appreciate more.

Thus protection provoked by real appreciation willbring about even more real appreciation. Hence thebenefits for particular protected industries will beachieved by making the problem worse for other import-competing or export industries. Protection will concen-trate the adverse effects of the appreciation more onthose tradable industries that do not get protection,usually the export industries. If an industry competesboth with imports and exports, it may gain at one end andlose at the other. In addition, because of the distortion ofresource use caused by protection, there will be a net lossfor the economy as a whole.

Even if an exchange rate is in some sense wrong or"misaligned" (perhaps because the market has misjudgedthe implications of macroeconomic policies) it does notjustify protection. If the real exchange rate is tooappreciated, the supply of nontradables is favored undulyrelative to tradables, and that can be described as adistortion or wrong price signal. A tariff or a set ofimport quotas similarly favors the protected industriesrelative to other industries within the tradable sector,notably the export industries, and creates further distor-tions. Under certain circumstances a tariff could offsetsome of the distortionary effects of the misalignment (asecond-best argument), but broadly one can say that anoptimal or nondistorted allocation of resources within thetradable sector as a whole (which combines export andimport-competing industries) is still desirable even whenthe sector as a whole is too small or too large because ofa "misaligned" exchange rate.

The various arguments for or against protection are notreally affected by exchange rate misalignment or by

medium-term real exchange rate instability. For anygiven current account balance and average price oftradables relative to nontradables there is still an optimalallocation of resources within the tradables sector and,subject to various qualifications to be discussed later inthis paper, this will be attained by free trade.Specifically, the real appreciation of the dollar in 1980-85, which reduced the competitiveness of U.S. industriesand which can be explained by the interaction ofmacroeconomic policies in the United States with thoseof other industrial countries, does not appear to havegenerated valid new arguments for protection.

The conclusion is thus that neither real exchange rate"misalignment" nor medium-term instability justifiesprotection. Nevertheless, they may well generate protec-tionist pressures. Indeed, it has been pointed out thatwhenever the dollar appreciates, especially relative to theyen, there is an increase in protectionist pressure (and, tosome extent, in actual protection) in the United States.6

There have been three occasions when the United Stateshas lost competitiveness, namely 1969-71, 1976-77,and since 1981. The argument is that large real exchangerate fluctuations raise the average protection level over alonger period owing to an asymmetry or ratchet effect, asprotection increases when the dollar appreciates, and thisis not reversed when the dollar depreciates later.

Apart from the asymmetry, it is clear enough that theappreciation up to 1985, and possibly also the currentaccount imbalance itself, has been an element in therevival of protectionist pressures in the United States.The explanation lies not with short-term exchange ratefluctuations but with medium-term real exchange rateinstability. From this connection between exchange rateinstability and protectionist pressures follows a frequentjustification for macroeconomic policies to stabilize realexchange rates, and in the conditions of 1985 andpossibly later, to bring down the dollar. This is quiteapart from all the other reasons for seeking to reducemedium-term real exchange rate instability. But it has tobe repeated here that from a national (though notsectoral) point of view protection of particular industriesor even of all import-competing industries is an irrationalresponse to real appreciation.

The question also arises what it is that really generatesprotectionist pressures. Is it truly the real appreciation oris it rather the current account imbalance, as is some-times asserted? The two do not necessarily go together.Alternatively the main explanation could be the level ofimport penetration (share of imports in domestic absorp-tion) either overall or in specific sectors only. This couldincrease even when current account balance is beingmaintained provided exports expand at the same time.

If the Japanese economy grows fast relative to othercountries but Japan maintains current account balance (or

6Bergsten and Williamson (1983).

7


III • PROTECTION AND MACROECONOMIC ISSUES

something near that), the growth in Japanese exports,possibly induced by real depreciation of the yen, mayalso generate resistance in other countries in the form ofprotectionism. It has done so in the past. Industries in theUnited States and elsewhere that compete with Japan'sexporters are adversely affected even when Japaneseimports grow at the same time. The resistance toJapanese export expansion is not a new phenomenon andpredates the large Japanese current account surpluses.

Protection and Macroeconomic PolicyCoordination

It is clearly not necessary to solve the world's macro-economic problems in order to liberalize world trade orto prevent a protectionist resurgence. But, for the reasonsgiven above, avoidance of medium-term real exchangerate instability would help. The more that severe realappreciations can be avoided in the short run, the lesspressure will exist for protection. One important role ofmacroeconomic policy coordination is to moderate oreven avoid such medium-term real exchange rate insta-bility. Furthermore, for reasons discussed below, highemployment levels and high growth rates in the industrialcountries will also help, and macroeconomic policycoordination should also contribute to these objectives.

Conversely, it is not necessary to have world free tradeor even liberalization in order to have successful macro-economic policy coordination. Nevertheless, there is animportant relationship between protection and exchangerate fluctuations and hence possibly the need for coordi-nation. Widespread protection by means of quantitativemeasures (as distinct from tariffs, export taxes, or exportsubsidies) will make trade less responsive to exchangerate changes because the impact of relative price changeswill be reduced. Bigger exchange rate changes thanotherwise would be needed to achieve any particulardesired or required effect on trade volumes. If a countrymoves into budgetary deficit and this then requires anincreased current account deficit to avoid crowding-outof domestic investment, the exchange rate appreciationthat will be needed will be greater when there arewidespread quotas than when the effects of a relativeprice change are allowed full reign. Any given diver-gence in fiscal policies between countries will thus leadto more real exchange rate instability than would resultfrom a nonrestrictionist regime. Hence the need forpolicy coordination to avoid fiscal policy divergencesbecomes greater.

Protection, Unemployment, and Recession

High employment and growth make widespread liber-alization much easier and more acceptable. This is

widely recognized. It seems reasonable to conclude thatpostwar prosperity in Western Europe was not onlyhelped by the gradual internal liberalization in manufac-turing trade associated with the establishment of theEuropean Community but was also a precondition for itspolitical acceptability. The same applies to the liberaliza-tion embracing the larger world industrial communityassociated with the various tariff reduction rounds underthe auspices of GATT. High employment and growth arebeneficial in any case, but the opportunities they allowfor liberalization represent a bonus.

The reverse also applies and is borne out by manyhistorical episodes. Unemployment and recessionsgive rise to protection or pressures for protection.The question then arises whether proposals for protec-tion can be justified by the existence of widespreadunemployment.

If a recession is caused by a domestic contraction ofdemand and the recession is not desired, the obviousremedy is to expand demand by macroeconomic policy.This would be the first best approach because it is themost direct approach to the problem. Protectionistmeasures are inappropriate. With flexible real wages anda fixed exchange rate, an increase in protection—whichwould switch demand away from foreign and towarddomestic goods—would normally moderate the domesticeffects of a recession, but it would be a second-best (orworse) device because it would engender further distor-tions by favoring import-competing relative to exportindustries, as well as generating the other costs ofprotection to be discussed later.

General unemployment may be caused by a deliberatepolicy of demand contraction designed to reduce the rateof inflation, as occurred after 1979 in the industrialcountries. If this is so, it does not make sense forparticular industries to be protected or subsidized inorder to shelter them from the consequences of ma-croeconomic policies. The demand contraction may bedesigned to moderate wage increases, the aim possiblybeing to lower real wages. Protection will then defeatthis objective in the protected industries. One aspect ofpolicy will be obstructing the objective of another aspect,and in the process a new distortion will be imposed.While the contractionary macroeconomic policy is likelyto be only short term, once imposed, protection isdifficult to remove, so that the distortion cost may belong term.

A recession may be imported from abroad through adecline in export demand, leading also to a currentaccount deficit. The appropriate policy response is likelyto involve real depreciation. The role, if any, ofincreases in protection in these circumstances will bediscussed below in connection with developing coun-tries, bearing in mind that in the 1930s many countriesdid respond to the decline in demand for their exportswith increased protection.

8


Protection, Unemployment, and Recession

Unemployment may be caused by real wages that aretoo high. This is "classical" unemployment. It is wellaccepted that it cannot be overcome by demand manage-ment policies unless these actually manage to reduce realwages. Similarly, it cannot be overcome by protectionexcept in special cases. Tariffs or quotas would increaseemployment in protected industries but would also raisecosts in industries using protected goods as inputs, andhence reduce employment there. More important, theywould raise the cost of living. If indexation policies arein effect there would then be an increase in nominalwages so as to maintain the original level of real wages,and the rise in wage costs, in turn, would loweremployment in those industries where protection has notincreased.

Thus both positive and negative employment effectswould result from protection. On balance, overall em-ployment could rise or fall. If the protection or subsidiza-tion were primarily for labor-intensive industries a netemployment gain would be likely. But even in that case,the indirectness of the subsidization process (via tariffsor quotas) would still impose distortion costs that mustbe set against these gains. Furthermore, it is possible thatthe real wages sought and obtained by trade unionswould rise if employment increased, so that some of thepossible employment benefits of protection or subsidiza-tion in particular industries would disappear.

On balance, protection designed to increase employ-ment when unemployment is caused by real wagerigidity is hardly justified. Protection may not succeed inincreasing overall employment even if it does increase orpreserve employment in protected industries. And if itdoes increase overall employment, it is normally an

inappropriate way of achieving this outcome. It alsofollows that trade liberalization should not necessarily bepostponed because there is classical unemployment.Policy should concentrate on the first-best method ofreducing real wages, at least in the short run. In thelonger run the growth of the capital stock will makehigher real wages compatible with growing employment.

Finally, a related question might be considered. Canhigher protection cause a depression? The coincidence ofthe world depression with the highly protectionistSmoot-Hawley tariff in the United States in the 1930s—and the increases in protection which it provoked by wayof retaliation in other countries—suggests the possibilitythat a resurgence of protection can indeed cause adepression.

Depressions depend on aggregate demand contraction,and explanations in these terms are probably sufficientfor explaining the Great Depression. It is likely that thevast increases in protection in the 1930s had adverseeffects on confidence and also stimulated defaults ofsome commodity exporters. Furthermore, declines inreal incomes were exacerbated. This was particularly soin the commodity-exporting countries. To some extentthe increase in protection was already in the pipelinewhen the Depression started, and to some extent itresulted from the Depression. Both the Depression andthe protectionist surge of course greatly reduced worldtrade, essentially a symptom of two distinct and highlyadverse developments where the Depression probablycaused higher protection, at least outside the UnitedStates, more than the other way around.7

7 A fuller discussion of this issue is in Eichengreen (1986).

9


IV Current Arguments for Protection

Numerous arguments for protection have been putforward at various times. Some have already beendiscussed, namely those resting on the belief thatprotection improves the current account, that exchangerate instability or misalignment justifies protection, andthat protection increases employment.

An argument that goes right back to the nineteenthcentury in the United States and that has had a recentrevival is one based on "fairness" or a "level playing-field." It used to be argued that it is unfair to importproducts from cheap-labor countries because producersin high-wage countries are put at a disadvantage by theirhigh labor costs and because such imports support the"exploitation" of labor in poor countries. This was calledthe "pauper-labor argument for protection." It is falla-cious since it ignores the principle of comparativeadvantage. Countries with cheap unskilled or semi-skilled labor have a comparative advantage in labor-intensive products just as more developed countries havea comparative advantage in industries that are skill orcapital intensive. This type of trade provides a principalbasis for the gains from international trade. Furthermore,it has to be remembered that if protection by developedcountries reduces the demand for the products of cheap-labor industries in developing countries, it will reduceemployment in these industries and is thus likely to bringabout further declines in the wages they pay. If theconcern is humanitarian, it is contradictory to advocatepolicies that reduce employment and wages in cheap-labor countries.

Currently, however, the fairness argument is moreconcerned with protection by other industrial countries,where labor costs may be similar or even higher. Thisraises the question whether one country's protection canbe justified by the protection policies of its tradingpartners. This subject will be discussed more fully at theend of this paper in connection with protection bydeveloping countries. The broad answer is that, asidefrom negotiating or bargaining considerations, protectionby one country damages not just its trading partners butalso itself, and this is true even when the other countrypractices protection.

One might consider many other protectionist argu-ments. The "antidumping" argument is well known, andhas some validity when the dumping is "predatory" (that

is, when it is designed to kill competition, after whichprices are raised again) but not when it just means that aforeign supplier's exports are subsidized on a long-termbasis. In the latter case the net effect is to cheapen thecost of imports and hence improve the terms of trade ofthe importing country. Three further arguments whichare particularly relevant for developing countries willnow be considered in some more detail.

Infant Industry Argument

This is the classic argument for temporary protectionin developing countries. A major objection is thatprotection once provided is often not removed. Leavingthat aside, this argument can rest on either of two bases.

First it could be based on imperfections of the localcapital market—resulting in an inability to raise capitalto finance initial losses for an enterprise or industry thatwill eventually be profitable. Such imperfections do existin developing countries, but hardly apply to the sub-sidiaries of multinational companies which can financetheir initial losses from profits elsewhere in their compa-nies or on the world capital market. In any case, apreferable and more direct policy when these capitalmarket inadequacies cannot be removed would be sub-sidized loans. Of course, a first-best policy is clearly toimprove the capital market and especially to removeimperfections resulting from specific governmentpolicies.

A second argument for protecting an infant industryrests on the presumed existence of external economies ofa dynamic kind applying to a group of firms, perhapsthrough the mutual creation of an "atmosphere" favor-able to new kinds of activities, usually thought of asmanufacturing. This version of the argument needs to betreated with some skepticism. Protection of one industryis always at the expense of others (through generalequilibrium effects to be discussed below), and it has tobe asked not just whether the firms or potential firms inthe industry generate external economies, but whetherthey generate more than some other enterprises might. Indeveloping countries the infant industry argument isusually used to justify protection of manufacturingindustry. But it is hard to see why the possibilities of

10


Tariffs and Export Taxes for Revenue

spill-over effects through learning by doing should begreater in manufacturing than in agriculture.

The infant industry argument is also used to justifyprotection of high-technology or other new industries inindustrial countries. While it is undeniable that suchindustries—or, more precisely, the development ofparticular products—may need to incur losses for pro-longed periods before becoming firmly established andearning the returns required to justify the investment, it isdifficult to defend subsidization by consumers or fromthe public purse in such cases. After all, capital marketsin industrial countries are highly developed, and, inaddition, large companies can finance losses of newactivities out of profits from their other activities. Theremay conceivably be externalities, but it would have to beshown that they are greater than when similar publicfunds are applied to other uses.

Finally, modern analysis has added an importantqualification to the use of tariffs or quotas for infantindustry protection. If an infant industry is to beprotected (or, a better word, "promoted") it should beprotected not just for sales to the home market but alsofor exporting. Most developing countries have verysmall home markets so that if production is to be atadequate levels it should eventually, even if not at thevery beginning, aim for the world market. Thus assist-ance, if it is to be provided, should not be by tariffs orquotas but rather by other forms of assistance that do notdiscriminate between home and foreign sales (for exam-ple by the provision of subsidized infrastructure orexpenditures on education to build up a suitable workforce).

Terms of Trade Argument

The restriction of the supply of exports to the worldmarket may raise the prices of these exports and thereduction of demand for imports may reduce their prices.Hence the restriction of trade by a country may improveits terms of trade. This is the basis for another classicargument for protection that is sometimes used. Therestriction of trade may be brought about by export taxesor export controls or by import tariffs or quotas. Thegains to one country are then clearly achieved at theexpense of other countries. It is important to stress thatthe large economies need to take the possibility ofretaliation into account when directing such protectionagainst each other. As major actors and trend setters inthe world economy, they must also bear in mind theadverse effects on the world trading system.

The major objection is that small economies—andalmost all developing countries are relatively small inworld trade—can hardly affect their terms of trade bysupply or demand restriction, other than in the very shortrun. Of course, there are possibilities of concerted

restriction of supply by a group of countries and the gainsmay last for some time. But eventually the benefits areusually eroded as alternative sources of foreign supplyemerge in response to the higher prices and as consumersmove towards cheaper substitutes. But the application ofthe terms of trade argument for restriction of trade whenapplied to short-term policies of developing countriesand to the question of "export pessimism" will bereturned to later.

The modern version of export restrictions whichimprove the terms of trade is the acceptance of voluntaryexport restraints by exporting countries such as Japanand various developing countries that export clothing andtextiles. These restraints raise the prices that they cancharge to consumers in their export markets, and so tendto improve the exporters' terms of trade. This isparticularly so if the alternative that is avoided byvoluntary export restraints is the imposition of importquotas imposed by some importing countries, whichwould force the exporters to unload their products at lowprices in other markets.

Tariffs and Export Taxes for Revenue

Taxes on trade that are imposed for fiscal purposesmay have protective side effects. This is particularlyrelevant for the design of Fund programs. In many of thelow-income developing countries, especially in Africa,and also in some of the middle-income ones, tariffs orexport taxes are important sources of government reve-nue. Collection costs of taxes on trade are often lowcompared with other kinds of taxes. Historically (as inthe nineteenth century in the United States) raisingrevenue was also the primary role of tariffs in countriesthat are now developed.

From a short-run fiscal point of view it may well beconvenient to maintain or even raise such taxes. Indeed,this is often a concern when the immediate macro-economic problem hinges on an excessive budget deficit.But there are likely to be long-term adverse effectsthrough encouraging uneconomic import-competing pro-duction and discouraging more socially efficient exportproduction. There are important issues here because it isa matter of balancing the short-term versus the long-terminterest.

The imports on which tariffs for revenue purposes arelevied may be luxury consumption goods of which thereis initially little or no local production. In the absence ofadequate income taxes such import taxes may have afavorable distributional effect. But local production ofsimilar, if not identical, goods is likely to be encouraged,so that protection of local industries that produceconsumption goods for high-income earners would be anundesired by-product of tariffs designed for revenue.Furthermore, the revenue itself would gradually declineas import substitution progresses. The desirable policy is

11


IV • CURRENT ARGUMENTS FOR PROTECTION

then to supplement the tariffs with taxes on localproducers at the same rate, the net result being to converttariffs into consumption or sales taxes. There will then beno special or distorting incentive for import-substitutingproduction of these kinds of goods.

The taxation of exports is similar in its effect to a tariffon imports. Production for exports becomes lessprofitable, and is discouraged. Indirectly, through anexchange rate or general equilibrium adjustment, import-competing production will be stimulated. Reduced ex-ports resulting from export taxes may require theexchange rate to be more depreciated than it wouldotherwise be in order to maintain balance of paymentsequilibrium, and this depreciation will then stimulateimport-competing production; alternatively, wages andother factor costs may fall (or rise less than theyotherwise would) as export production becomes lessprofitable, and the lower costs and readier availability oflabor will then stimulate import-competing production.

A general equilibrium adjustment designed to maintainemployment is, of course, desirable, given that exporttaxes have been imposed. But the net result is to reducethe volume of trade and to replace economic exportproduction with less economic import-competing output.

The adverse effects on long-term resource allocation,and hence possibly on growth, of such taxes on importsor exports must thus be borne in mind. Tariffs should besupplemented by taxes at the same rate on domesticproduction of similar goods (converting the tariff, ineffect, into a nondiscriminatory consumption tax), ormodest levels of export taxes should be supplemented bytaxes on domestic output of all kinds sold at home. Butthe qualification has to be noted here that in somecountries there may be obstacles, at least in the short run,to the efficient collection of sales taxes or taxes ondomestic production.

Numerous considerations enter into the construction ofan optimal taxation system, notably effects on incomedistribution and relative collection costs of various kindsof taxes. Here attention is drawn to the distorting effectson resource allocation of trade taxes, and that consump-tion taxes (of which import tariffs may be a component)are likely to be preferable to tariffs on their own.

It should be noted that tariffs that were imposedprimarily to raise revenue and that appear to be at modestlevels may actually represent high degrees of protectionand thus have marked protective effects eventually. Thisfollows from the distinction between the nominal rate oftariff protection and the effective rate of protection. Thelatter refers to protection provided for value added.

It is common for inputs or components to enter at lowrates of duty, or possibly not to pay any tariffs at all,while final goods or goods at later stages of processingpay a revenue tariff. In that case the effective rate ofprotection will be considerably greater than the nominalrate. For example, if the nominal rate is 20 percent, if the

share in cost of an imported input at free trade prices is50 percent and if this input is not required to pay anytariff, then the effective rate of protection is 40 percent.The same applies if the input is produced locally and ispotentially exportable, so that its domestic price isdetermined by the world market price. Since the sharesof imported inputs in the cost of production of localproducts are likely to vary a great deal, a uniform rate ofnominal tariff designed for revenue may yield veryuneven rates of effective protection. For example,producers of two products that both obtain 20 percentnominal tariff protection may both use as inputs variousother products which are all obtained without any dutyhaving to be paid. If the share in cost of these inputs atworld prices is 50 percent for one product and 75 percentfor another, the effective protection for the first is 40 per-cent and for the second 80 percent. The result of auniform tariff is thus to create uneven incentives not onlyrelative to exporting but also between protectedindustries.

Political Economy and Protection

There are obviously numerous possible reasons fortrade policy measures, and some of the most commonlyused arguments for protection have just been discussed.But often the arguments given are couched in terms ofthe national interest when better explanations for variousmeasures can be found in a concern for sectoral interests,possibly a response to particular political pressures.While economic theory can be useful in analyzing theconsequences of protection, explanations of why protec-tion comes about, why it takes particular forms, and whyit continues, would often appear to be more in the realmof political economy.

In mature industrial countries the principal explanationfor recent protectionist pressures and for actual increasesin protection appears to be a concern to preserveindustries that would otherwise decline or, at least, toslow up or ease the decline. The motivation is essentially"conservative." The potential decline of an industry maybe caused by shifts in comparative advantage or by otherstructural factors, or (in the United States for severalyears recently) by real appreciation induced by ma-croeconomic policies. The objective of protectionistproposals is to preserve regional or industry-specificincomes, even though this would be at the cost of a lossof national income overall from the loss in nationalefficiency.

One might say that trade policy is, to some extent,used as a system of social insurance, the idea being tohelp industries in trouble at the cost of the rest of thecommunity. The implication is that investors and em-ployees in other industries who bear the current loss

12


from protection would also get some help if they neededit. This reason for protection no doubt also applies insome developing countries.

Sometimes the original explanation for protection lieselsewhere—in a balance of payments crisis or an infantindustry argument—but the original justification hasdisappeared and the continuance of protection is causedby a concern for sectoral income maintenance. Onecould argue that it is simply the result of sectoralpressures combined with a general failure to appreciatethe costs of protection, especially the long-term costs, inthe form of a loss of aggregate national output. Alterna-tively, it could be given a "social insurance" rationale.

When the objective is to prevent severe declines insectoral incomes, owing possibly to exogenous shocks,adjustment assistance would be preferable to tradeprotection. The latter is clearly not first best both becauseit has various ancillary distortionary effects that lower

Political Economy and Protection

national income and because it is rarely temporary. Atthe same time, aside from political considerations, thereis little justification for adjustment assistance that dealsonly or specifically with trade-related shocks. Presum-ably unemployment benefits, assistance in retraining,education, and so on, can be justified irrespective of thesource of the shocks. Another obvious difficulty is thefiscal cost of adjustment assistance. On the other handthere is the political factor: if adjustment assistance canavoid protection, or make possible a liberalization thatwould not otherwise take place, there is likely to be a netbenefit from trade-related adjustment assistance.8

8This view, with respect to the current protectionist threat in theUnited States, is put in Lawrence and Litan (1986).

13


V Some Broader Issues

Rent-Seeking and Other Costs of Protection

The orthodox costs of protection result both from thedistortions it generates in the pattern of production andthe use of inputs into production, and from the distor-tions it causes in the pattern of consumption, broughtabout by price signals that do not correctly reflect thetrading opportunities open to a country. Mostly theeffect of protection is, as noted earlier, to lead toexcess production of import-competing relative to exportproduction as well as to distortions within the import-competing sector from uneven effective rates of protec-tion. The net result is then to reduce national income.Such costs result even from a system of fixed and well-defined tariffs. But the actual costs of protection areusually much greater than these "orthodox" costs, essen-tially because trade interventions are often very com-plicated and are frequently altered, responding to pres-sures of various kinds. In particular, they involvelicensing of imports and ad hoc bureaucratic decisionmaking.

Three kinds of costs in addition to the orthodox costsof protection then arise. These are (1) costs of adminis-tration and compliance, (2) "rent-seeking" costs, and(3) disincentive costs of made-to-measure systems.

Administration and compliance costs can be very highwhen there is an elaborate licensing system. This is aparticularly important argument for preferring firmlyfixed tariffs to import quotas in developing countries.The complexities and inequities in quota (and exchangecontrol) systems multiply, and scarce administrativetalent in government and industry is diverted intononproductive channels. Such activities are unproductivefor society and create a particular problem in developingcountries where there is often a scarcity of trainedpersonnel.

Rent-seeking costs (which have received much atten-tion in recent analyses) result from efforts devoted toobtaining scarce import or foreign exchange licenses,and from lobbying legislators to obtain or to reduceprotective tariffs or quotas. Rent seeking does not referto pure redistribution effects (which result from bribery)but rather refers to actual resource costs—principallylabor costs—involved in the various activities, notablylobbying. The scope for rent seeking is particularly great

with import quotas (unless they are auctioned) andprovides another argument for preferring tariffs to quotasif there is to be protection.

Protection systems are made to measure, or attempt tobe so, when they are frequently adjusted to reflect theprofitability of import-competing activities. In systemsthat try to be made to measure the more profitable localproduction is, the more protection would be reduced,while a rise in domestic costs for whatever reason—causing local industry to become less competitive—leadsin such a system to an increase in protection. Systemsthat are based on quantitative targets for imports (forexample, when there is a provision that a given share oflocal absorption should be imported) have this effect.Such systems involve high administrative costs andstimulate rent seeking. Even more important, theyreduce, or possibly even eliminate, the incentives toimprove efficiency and to cut costs, and are thus clearlyundesirable.

Protection and Growth

The provision of protection for a particular industry orcategory of industries may well, for a time, lead tohigher growth of these industries. Thus a country thatprovides infant industry protection for manufacturing isquite likely to find that the rate of growth of manufactur-ing does accelerate as a result. But such protection is atthe expense of other industries (perhaps agriculture)which are likely to grow less fast; hence there is nopresumption that growth in the economy as a wholewould be higher. A correlation between sectoral growthand protection rates tells one nothing about the overallgrowth effects.

The central question is whether the various protection-ist devices improve or worsen the overall efficiency ofthe economy both in terms of the orthodox resourceallocation concept and the other considerations (such asrent seeking) just discussed. The general presumptionwhich follows from the discussion so far is that theyworsen efficiency. In that case, growth is also likely todecline because the efficiency of investment will decline.A given amount of savings when invested will yieldlower output gains. The capital output ratio rises. Thus

14


Distribution

the growth effect is a by-product of the static efficiencyeffects.

While the principal implication for growth of variousmicroeconomic interventions is through capital accumu-lation—which becomes more productive the moreefficient the economy becomes—there are other growthimplications of protection. Five might be noted here.

First, any change in efficiency is likely to developgradually. For example, removal or simplification of asystem of protection will raise the efficiency of theeconomy by increasing the productivity of given factorinputs. This may take place over a period of years andduring this period, though not indefinitely, the rate ofgrowth will be higher than otherwise.

Second, protection policy may affect the relativeprices of investment goods, and this could affect thegrowth rate. If protection raises the domestic cost ofinvestment goods, or forces local industries to usedomestically produced equipment of lower quality, thegrowth rate is likely to be reduced as a result.

Third, "made-to-measure" systems of intervention,which compensate industries in trouble by providingmore tariffs or subsidies when their profits fall, andwhich reduce protection when the industries are suc-cessful, reduce the incentive to innovate and are thuslikely to lower the growth rate.

Fourth, rent seeking, referred to above, can lead to aserious diversion of entrepreneurial effort and hencereduce the rate of growth.

Fifth, the overall growth rate will decline if protectionpreserves old-established industries which have rela-tively low rates of technological progress at the expenseof potential high-growth industries.

Extensive research on the relationship between growthrates and outward-looking policies versus inward-looking policies has been done at the World Bank andelsewhere. Outward-looking policies can be defined aspolicies that do not discriminate significantly againstexports and allow market forces to determine (to areasonable extent) the degree of openness, while inward-looking policies are those that create a bias in favor ofimport substitution. More and more evidence seems to beemerging that developing countries which have beenoutward looking have also enjoyed high growth rates.9

Higher export growth resulting from some trade liberali-zation combined with appropriate exchange rate adjust-ment has been associated on average with higher overallgrowth. Outstanding examples here are Korea, and, for alimited period from about 1966, Brazil. There are alsoexamples from the earlier history of now-developed

9The large literature analyzing this issue and giving strong supportto this conclusion is surveyed in Balassa (1985), Balassa (1986), andWorld Bank (1987).

countries, such as Sweden. Of course other factors, suchas investment ratios, have also been important inexplaining relative growth rates.

Outward-looking countries have never had completelyfree trade, and governments have usually played animportant role in development policy, but the bias inincentive systems has not been against exports duringtheir high growth periods. In some cases there has simplybeen some reduction in the import-substitution bias ofthe incentive system. This has stimulated export growth,and in turn an increase in overall growth seems to haveresulted.

Distribution

Intervention policies usually benefit some sections ofthe community at the expense of others. Trade liberaliza-tion in industrial countries would, for example, reduceprofits and employment in the clothing and textileindustries while benefiting consumers at large as well asother industries (through the exchange rate depreciationor labor cost adjustment with which it might beassociated).

Some of the benefits to the gainers spill over fairlydirectly to the losers, so providing partial compensation,especially if there is an effective taxation and socialwelfare system. Thus, if trade liberalization has the neteffect of raising aggregate national income it will raisethe tax base, and some of the revenue may be spent ontransfers or extra public facilities that benefit present andformer employees in the losing industries.

Nevertheless, on balance there are likely to be somenet losers since full compensation rarely takes place. Ithas been frequently calculated that the potential gainsfrom removing protection on particular industries, no-tably clothing and textiles, are so large that it wouldactually be possible to compensate most generouslyemployees in those industries, and yet still leave con-sumers better off. 10 But in practice full compensationrarely takes place, primarily because it is difficult toidentify losers precisely. Further, if compensation poli-cies became customary and hence rationally expected,there would be an incentive for protected industries tostay in existence and even expand, even if they knew thattheir protection is unlikely to last.

Given that there will be gainers and losers fromliberalization or protection, can anything really be saidabout "national" gains or losses? There are three possibleapproaches:

1. The traditional answer of economic theory has been10Cost of protection figures and further references can be found in

the Fund's Occasional Paper 38, OECD (1985), Balassa andMichalopoulos (1985), and World Bank (1987). A detailed calcula-tion for the United States has been made by Tarr and Morkre,summarized in their contribution to Salvatore (1987). Figures onclothing and textile protection in the United States will appear in Cline(1987).

15


V • SOME BROADER ISSUES

to focus on the concept of potential welfare, whichallows for the possibility of compensation. If gainerscould compensate losers and yet have something leftover, there would be a national gain as the policy changewould represent an improvement in national efficiency.It is accepted that actual compensation may not takeplace, but the potential exists, and if nations choose notto compensate fully, then, they must be satisfied with theincome distribution that has resulted.

2. One can argue that there is a presumption in favorof trying to foster national efficiency, but that particularmeasures that have well-defined distributional effectswhich are thought to be adverse should be accompaniedby appropriate compensating measures. Various calcula-tions have shown that the potential efficiency gains fromliberalization are often very great. There is then a strongargument for pursuing liberalization combined withcompensation of losers, if only to make the liberalizationpolitically acceptable. Various methods of compensationwhich might also improve efficiency are available, forexample, retraining and relocation grants.

3. Finally, there is the "long-term mutual gain ap-proach," which probably represents more closely theviews of those who advocate efficiency-oriented pol-

icies. The argument is that policies which consistentlyfoster national efficiency will eventually make everyonebetter off. There is a long-term mutual gain, or at least itis probable that there would be. While particular indi-vidual steps that improve national efficiency may makesome parts of a population worse off, other furthersteps will make them better off, and so finally all will bebetter off.

It must be emphasized that this distributional prob-lem—almost a philosophical problem—does notcreatany presumption in favor of protection even if onedismisses the "long-term mutual gain" approach. Itwould still have to be shown that protectionist regimes inpractice actually have farable distributional effects whenjudged by some kind of objective criterion. In manydeveloping countries, protection benefits the urban popu-lation relative to the rural one and average incomes in thelatter are usually lower, so that the overall distributionaleffect would normally be regarded as adverse. Further-more, when protection takes the form of quantitativerestrictions, which inevitably involve the issue oflicenses, there is scope for the benefits in the form ofmonopoly profits going to privileged persons withcontacts and influence, and also for direct corruption.Poor people are unlikely to be the beneficiaries.

16


VI Developing Countries: Protection, Liberalization,and Macroeconomic Policy

Protection, the Exchange Rate, andReal Wage Rigidity

A central issue in the design of policies (and of Fund-supported adjustment programs) is to deal with balanceof payments problems. In view of the importance of thissubject it will be dealt with at some length here eventhough there is some repetition of analysis presentedearlier.

What, if any, is the role of trade restrictions when acurrent account deficit needs to be reduced? When theexchange rate is fixed but adjustable, are trade restric-tions ever to be preferred to real devaluation? TheFund's position is clear: restrictions should not beincreased and, if possible, should be reduced. Theexchange rate should be used as the required device thatswitches the pattern of demand away from foreign on tohome-produced goods, supplementing the necessaryreduction in real expenditures.

But others often do not agree. Many of the issuesdiscussed earlier enter here. One might accept theproposition that for maximization of national efficiencyin the medium and long run the best policy is liberal trade(with perhaps some exceptions on infant industry andother grounds discussed earlier). But is such a liberalpolicy also best for the short run? The former Cambridgegroup in Britain, for example, did not agree, and similarviews have been propounded in Latin America andelsewhere. 11

It is worth analyzing in some detail the case for short-run protectionism when the current account has to beimproved. Such a protectionist argument comes oftenalmost instinctively to policymakers and others. It isexplicitly or implicitly an argument against devaluation,or at least against sufficient devaluation. Hence one isreally concerned with import restrictions (or, morerarely, tariffs) versus devaluation as switching devices toaccompany the necessary and inevitable reduction in realexpenditure.

11 The Cambridge Economic Policy Group produced their argumentfor protection when a country has a current account problem inCambridge Economic Policy Group (1976) and elsewhere, and theargument is analyzed in detail in Corden (1985), on which thisdiscussion is based.

The familiar "orthodox" analysis is that a devaluationraises domestic currency prices of imports and exports.This will switch the pattern of domestic demand awayfrom imports and increase profitability of import-competing and export industries, provided nominalwages do not rise, or do not rise much. This higherprofitability will then, in due course, lead to expansion oftradable goods output, which is the desired objective. Atthe same time, if output was at full capacity initially,demand for nontradables should decline—absorptionshould fall—to free resources for extra production oftradables.

A short-term argument for using import restrictions inpreference to devaluation at a time of balance ofpayments crisis is that the effects of devaluation workwith a lag, so that initially very high devaluation (to anextent that cannot be calculated in advance) may berequired to achieve a desired reduction in imports.Temporary quantitative restrictions may then be neededas well.

Here it has to be borne in mind that quantitativerestrictions also take time to implement and createadministrative problems. If they are associated with pricecontrols on restricted imports, excess demand will begenerated and powerful pressures can build up to ease therestrictions. If there is no effective price control, therestrictions will yield the familiar monopoly profits forimport license holders (who may be local manufacturersusing imported inputs). In both cases vigorous rentseeking may result.

Nevertheless, the validity of such a short-run casecannot be completely denied. The main objection is thatrestrictions once imposed are not readily removed. Therewould then be medium- and long-run adverse effectsthrough failure to stimulate exports (hence producing toomuch import compression), as well as distortions in thepattern of imports as the result of using a nonmarketmethod of discriminating among imports to be restricted.

In fact, it makes an important difference not onlywhether the import restrictions are in fact temporary orpermanent but also whether they are expected to betemporary or permanent at the time they are imposed. Ifa country devalues at a time of balance of payments crisisand supplements this with import restrictions that are

17


VI • DEVELOPING COUNTRIES: PROTECTION, LIBERALIZATION, AND MACROECONOMIC POLICY

widely accepted as being temporary, longer-term re-source allocation decisions will be influenced by thedevaluation and not very much by the restrictions. Themain role of the restrictions will be to bring about a rapidreduction in imports (in association with the necessaryreduction in real expenditure). This may be desirable ifreserves are low or short-term loans cannot be easilyobtained. An excessive expansion of import-competingproduction relative to exporting will then be avoided.But a belief that the restrictions will only be retained fora short period is hard to establish—naturally so on thebasis of experience in many countries. Furthermore, ifthe balance of payments problem is really known to betemporary, one has to ask why it is not possible to drawon reserves, the capital market or, indeed, the Fund.

Leaving aside this very short-run argument for importrestrictions at a time of balance of payments crisis adeeper, more sophisticated argument (the Cambridgeargument) should now be considered. It hinges on thepossibility that there is a tendency to real wage rigiditybrought about by formal or informal wage indexation. Itis highly likely that for a nominal devaluation to succeedin improving the competitiveness of tradable goodsindustries and so bringing about real devaluation, realwages must fall. With given nominal wages, the averageprice level would rise. And this creates the problem thatthe rise in the domestic price brought about by devalua-tion would cause nominal wages to rise to restore theinitial level of real wages and the benefits of the nominaldevaluation might be destroyed completely. The requiredswitching of the pattern of output from nontradables totradables, and the switching of the pattern of expenditurefrom foreign to domestic goods, would then not takeplace.

At this point the suggestion is made that importrestrictions or tariffs might be used instead on thegrounds that they do not require declines in real wages.But these devices will also raise the domestic price levelby creating shortages. The element of validity in theargument is that tariffs might raise the price level lessthan devaluation if there is domestic consumption ofexportables, and even less if the revenue raised wereoffset by equivalent reductions in indirect taxes. In thatcase the initial real wage declines and hence thesubsequent increases in nominal wages would be less.

The essential feature of a devaluation compared withthe other devices is that it increases the profitability ofexporting, which should in due course—as supplyexpands and foreign markets are exploited—bear fruit inhigher export income (in terms of foreign currency). Ameasure that makes exporting more profitable might tendto reduce real wages more—and so in due course bringabout more compensating rises in nominal wages—thanmeasures that are purely import compressing.

In the medium and long run, export promotion throughexchange rate adjustment is clearly what is needed.

Tradable goods production should expand both on theimport-competing and the export front if the nondis-criminatory signals of the market are to be accepted as aguide to resource allocation, and if excessive importcompression is to be avoided. But in the short run exportsupply is often quite inelastic, especially if exports areprimary products or if new manufactured products haveto be developed. Hence the rise in export profits resultingfrom devaluation can be regarded as a windfall whichcould be dispensed with for the sake of reducing theadverse effect of the switching policy in causing nominalwages to rise.

Compared with the free market solution of devalua-tion, the use of import restrictions is thus a way of taxingprofits of exporters so as to sustain real wage levelswhen, in the short run, real wages really need to fall.Alternatively, one might argue that tariffs and devalua-tion have the same or similar effects on the cost ofliving and real wages, as well as on profits of import-competing industries, but that tariffs bring in revenue tothe government (which it may or may not offset with thereduction of other taxes) while devaluation brings in theequivalent revenue to exporters.

Thus sometimes, with rigid real wages, trade restric-tions of particular kinds could make the short-runproblem easier. This would be so particularly if therestrictions were focused on goods not consumed bywage earners, and if the distributional shift implied bythe particular pattern of restrictions (for example, onimports of so-called luxury goods) were thoughtdesirable.

This is a sympathetic summary of the Cambridgeargument for import restrictions as part of a policypackage to deal with a current account problem. Such apackage would involve damaging medium- and long-runprospects for the sake of possible short-run gains,though this trade-off is not usually pointed out by theproponents. The source of the long-term damage isthat inadequate incentives are provided for exportexpansion. Relatively uneconomic import-competingproduction will be fostered in preference to moreeconomic export production. Furthermore, in the med-ium and long run protection by developing countries islikely to reduce growth in employment as well as slow upreal wage increases. The reason is that developingcountries have a comparative advantage in labor-intensive products, so that export expansion resultingfrom outward-looking policies would tend to be in labor-intensive industries. Growth of labor-intensive industriesrelative to capital- and resource-intensive industries willtend to raise real wages by increasing demand for labor,and may also increase overall employment. The experi-ences of the newly industrializing countries of East Asiabear this out.

The distributional effects of the policy choices mustalso be considered. A rise in the domestic prices of

18


Trade Liberalization: Exchange Rates and Timing

exports brought about by devaluation (but avoided bytariffs or import restrictions) may increase incomes of thepoorest sections of the community if exports are pro-duced by peasants. The distributional effects of thechoice of "switching" device depend on the particularstructure of the economy, and in countries with peasantexport sectors proposals for preferring import restrictionsover devaluation imply unfavorable income redistribu-tion. With real wage rigidity in the urban sector, importrestrictions have then an equivalent effect to a combina-tion of devaluation and taxation of rural incomes tosubsidize urban employment. In addition, it is almostinevitable that a system of import quotas will haveunfavorable distributional effects through the privilegedallocation of licenses.

Short-Run Terms of Trade Effects

So far it has been assumed that if exporting were mademore profitable by devaluation, supply might not in-crease much in the short run, even though it wouldincrease in the long run. Thus in the short run the extraprofits in the export industries resulting from devaluationwould simply be rents which could be taxed away orforgone by avoiding devaluation and using instead thealternative device of import restrictions.

Even if supply did increase, world demand may beinelastic, possibly because of restrictions (includingimposition of "voluntary" export restraints) abroad.Extra exports may be excluded from some industrialcountry markets by protection, and hence would have tobe unloaded at substantially lower prices elsewhere.Hence the country's terms of trade would deteriorate as aresult. Even without protection abroad, short-run de-mand elasticities are often low, so that increased exportsupply may well lead to declines rather than increases inthe value of exports.

Looking purely at the short run, and even without anywage indexation, there appears then to be a case forpreferring tariffs or import quotas to devaluation, thisbeing simply a version of the terms of trade argument forprotection. It hinges completely on estimates, implicit orexplicit, of elasticities of demand for exports. In the1950s and 1960s elasticity and export pessimism wereone basis for the import substitution bias of developmentpolicies in Latin America, India, and elsewhere (but notin East Asia) and this view can still be encountered.

The element of justification is that if voluntary exportrestraints are imposed upon a country then, in effect, itsown optimal policy is to impose export taxes or quotason the particular products affected when directed to theparticular markets concerned. But, apart from that, thereare two objections to this line of approach as an argumentfor conventional protection.

First, insofar as it has some validity, it might justifyexport taxes or restrictions, the rates of tax being higherwhere the demand elasticities are believed to be lower. Inother words, the first-best short-term policy (ignoring themedium and long run) is to impose export taxes orrestrictions differentially between different exports.Some exports, especially of manufactures, may face veryhigh elasticities of demand and no foreign restrictions, sothat even significant expansion of exports by manydeveloping countries at the same time would require onlytaking up a small share of a very large industrial countrymarket. In these cases there would be no need for pricesto be reduced much, if at all, in order to expand sales inworld markets, and hence there would be no significantterms of trade effect. The optimal export tax would thenbe zero. In other cases, where a country is a significantworld supplier of a product, there might be some short-run benefit from export restriction.

It might be noted here that the current weakening ofcommodity prices, explained to some extent by expan-sion of supply in earlier years, suggests, at least withhindsight, that world market prospects have not alwaysbeen adequately foreseen, whether by governments or byprivate decision makers. In particular cases less supplyexpansion than actually took place would clearly havebeen desirable. But this was more a question of thedifficulty or inadequacy of forecasting than of a diver-gence of private and social interests justifying exporttaxes or restrictions.

The second objection concerns the application of theargument to actual and prospective exports of manufac-tures in general. Whatever the short-run case, theevidence has shown that elasticities in world marketstend to be high in the medium and long run. Thus therehas been a very significant expansion of exports ofmanufactures from developing to industrial countriesduring the 1960s and continuing after the first oil shock.This has not just been a volume but also a real valueexpansion. Hence medium-run elasticity pessimism forexports of manufactures is not justified on the basis ofrecent experience. 12

It is then a matter of balancing possible short-run gainsfrom import restrictions against the medium- and long-term losses that result from failure to seize exportopportunities. If fundamental or structural improvementsare sought it is clearly necessary to bear in mind adversemedium-run effects of policies.

Trade Liberalization: Exchange Ratesand Timing

The most important point about large-scale unilateraltrade liberalization is that it must be associated with realdevaluation if the current account is not to deteriorate

12See Balassa (1985), Balassa and Michalopoulos (1985) and WorldBank (1987).

19



and if the employment losses in protected import-substituting industries are to be compensated by employ-ment gains elsewhere, especially in export industries.Normally nominal devaluation will be needed to bringabout the required real devaluation. A liberalizationprogram must, therefore, be part of a policy packagewhich includes exchange rate adjustment. The appropri-ate exchange rate adjustment will be hard to judge inadvance, but it is important to bear in mind that thelonger-run equilibrium real exchange rate does dependon the degree of trade liberalization.

The question is often asked where the extra jobs wouldcome from when liberalization brings about employmentlosses in highly protected import-competing industries.In a general context of growth, liberalization may leadnot to absolute losses in employment in these industriesbut rather to a reduced rate of growth. But the question isrelevant even in that case.

In the main, the extra jobs will be generated by the realdepreciation which is part of the policy package. It willmake exporting more profitable and also improve thecompetitiveness of import-competing industries. Someimport substitution may become economic that waspreviously uneconomic—and hence generate extra em-ployment. Those import-competing industries which hadreceived low protection, or none at all, will benefit.

Industries that use imported inputs that were notreadily available before liberalization or that used inputsproduced locally at high cost owing to protection willfind that their costs have fallen and may expandemployment. Against this must be set the higher costs ofimports resulting from the devaluation, which will affectsome industries adversely. In addition, the improvementin resource allocation in the tradable sector as a whole islikely to increase real national income, leading to moreconsumption spending and hence employment genera-tion in domestic industries producing for the homemarket. The higher real incomes will yield more taxrevenue and so improve the fiscal balance. If tax rates arereduced to restore the initial fiscal balance, increasedprivate consumption or investment will generate extrajobs, or alternatively, increased government expenditurefinanced by the higher tax revenue would do so.

The sequencing of liberalization and the associatedexchange rate adjustment is also a matter of somecomplexity. A choice, essentially political, has to bemade between gradualism and sudden measures, andhow much advance announcement there should be. Thelonger the period between the announcement of acredible program of liberalization and the actual changesin tariffs and quotas, the easier it is for protectedindustries to make the necessary adjustments and forpotential gainers—notably export industries—to gear upfor expansion. But the announcement has to be credible.On the other hand, it has been argued that the longer thelag between the formal commitment to a program and its

actual implementation, the greater the opportunity forinterest groups to slow up or even halt liberalization andthe more likely it is that expectations about the credibilityof the authorities' intentions will be undermined. 13

The exchange rate should be adjusted early even at thecost of generating temporarily excess profits in exportindustries and in import-competing industries that are notprotected. The beneficial effects of depreciation onexports are likely to develop with a lag, while an increasein imports resulting from liberalization could be quitequick. A firm, credible assurance that a program ofliberalization will be followed should discourage theflow of resources out of nontradables into highly-protected industries during the transitional period whenthe protected industries are excessively profitable be-cause the exchange rate has already been devalued whilethe liberalization process is not complete.

Is a time of balance of payments difficulties the righttime to liberalize trade? This important issue arisescurrently and needs to be considered in relation to Fundprograms. It is, of course, not possible to resolve thisissue here or arrive at conclusions appropriate for allcountries but some considerations can be set out.

From the narrow but popular partial view it certainlyappears to be the wrong time. Traditionally, a balance ofpayments crisis has led to the imposition or tightening ofimport restrictions since it is noneconomists' commonsense that when imports are too high in relation toexports the proper policy is to restrict imports.

Two immediate answers can be given. Firstly, liberali-zation will allow, possibly for the first time, the readyavailability of cheap imported inputs required for ex-ports. This aspect of liberalization would improve thebalance of payments by raising exports even if theexchange rate stayed constant. There may be a lag beforeall the benefits come through since it takes time toexpand exports, find new markets, and so on, but at leastthere is a favorable and direct balance of paymentseffect.

The more important answer is that the alternative toimport restrictions is not to do nothing but to depreciatethe exchange rate. Hence one is back to the choicealready highlighted several times in this paper betweentwo "switching" devices, one of which discriminatesbetween imports and in favor of import substitutionrelative to export expansion, while the other—exchangerate adjustment—is nondiscriminatory. The improve-ment in the current account requires both a reduction inaggregate spending and depreciation of the exchange rateto switch demand from foreign toward home-producedgoods and, within the latter, toward tradables. If there is

13The issue of the process of trade liberalization and how it relates tomacroeconomic and other policies is currently being researched in aWorld Bank project involving the study of 37 liberalization episodes in19 countries. For a preliminary report, see Papageorgiou, Michaelyand Choksi (1986). Many of the liberalization issues are discussed incontributions to Choksi and Papageorgiou (1986).

20


simultaneously some liberalization of imports, evenmore depreciation is required.

Restrictions may be so widespread, complex, anddislocating that their removal can have fairly immediatebeneficial effects on incentives and output. This wouldparticularly be so when imported inputs for manufactur-ing production with export potential are subject tolicensing. It would then also become easier to solve thebalance of payments problem, because an increase insupply would modify the extent of the reduction inaggregate demand required, and hence reduce the pain-fulness of the required adjustment.

In other cases the beneficial effects of removingrestrictions combined with adequate devaluation wouldonly show up in the medium run, as new investment isdirected into more productive channels, rent seekingdeclines, and so on. In the short run, liberalizationassociated with exchange rate adjustment may give riseto dislocations and to localized or industry-specificunemployment as profitability of some industries de-clines while that of others improves. The question thenarises whether the short-run problems of liberalizationshould be added to the problems involved in bringingabout the reduction in real expenditures needed forrestoring macroeconomic stability.

In considering whether to liberalize at a time ofbalance of payments crisis it is then a matter of tradingoff additional short-term problems against medium- orlong-run benefits; there may be short-run adjustmentcosts, and the short-run problems these engender may beharder to bear when at the same time the needs of thebalance of payments call for a major reduction inaggregate spending. Liberalization may also risk beingunjustly blamed for the many problems—including oftenunemployment—caused by the need to reduce spendingin order to improve the balance of payments. On theother hand, some countries seem to have continuousbalance of payments difficulties which have underlyingstructural causes and call for longer-term measures toincrease output, as well as appropriate adjustment ofdemand to available resources, domestic and foreign. Inthese cases it may be best to focus on supply-sidemeasures—including liberalization designed to improveresource allocation, reduce rent seeking and so on.

Finally, trade liberalization might be attempted when acountry suffers from high inflation. Countries maycertainly have balance of payments problems without atthe same time suffering from high inflation, and mayalso, though less commonly, suffer from high inflationwithout having a balance of payments problem. For acountry to sustain inflation higher than that of its tradingpartners without a balance of payments problem emerg-ing, the nominal exchange rate would need to becontinuously or frequently depreciated. Normally highinflation is associated with many distortions, notably anexchange rate that is not adjusted sufficiently so that it

Liberalization with Fixed Exchange Rates

becomes overvalued, nominal interest rates that are toolow owing to controls of various kinds, and importcontrols designed to compensate for the failure to adjustthe exchange rate sufficiently.

The question arises whether trade liberalization ispossible if the fundamental factors causing high inflation(usually a high budget deficit financed by money crea-tion) are not eliminated. The answer has to be that it istechnically possible provided the nominal exchange rateis depreciated even more than it needs to be to compen-sate for the inflation. If there is continued high inflation,as well as a current account deficit that has to be reduced,the addition of trade liberalization to the policy programwill require continuous nominal depreciation to compen-sate for continuous inflation, and in addition nominaldepreciation to bring about sufficient real devaluation.The real devaluation must be large enough both toimprove the current account as required (to switchexpenditure from foreign towards home-produced goodsand to switch the pattern of output from nontradablestoward tradables) and to compensate for the employmentand current account effects of trade liberalization. Inaddition, real expenditure must, of course, be reduced.

In practice high-inflation countries have often failedto depreciate their currencies sufficiently, and high in-flation gives rise to the distortions mentioned above.These are caused essentially by attempts to deal withsymptoms rather than causes—to control interest rates,prices, imports and so on. It is then important to tacklethe fundamental causes, and either to associate liberal-ization with a credible and adequate inflation stabi-lization program or even to make the attainment ofreasonable stabilization a precondition for substantialtrade liberalization.

Liberalization with Fixed Exchange Rates

A special problem arises with countries that are part ofa currency zone and where, therefore, the nominalexchange rate cannot be unilaterally devalued. Suchcountries are short of a policy instrument. It is assumedhere that even a once-for-all exchange rate adjustment isruled out. Trade liberalization will still require realdevaluation, but this cannot be brought about by nominaldevaluation.

There are, then, two possible approaches to theproblem. The first is to rely on gradual liberalization,keeping the domestic rate of inflation below the inflationrate in trading partner countries. Liberalization would, inthe first instance, reduce demand for domestically pro-duced goods, and the moderation of increases in domes-tic wages and prices that might result would then restorecompetitiveness, bringing about the required real devalu-ation. To avoid significant output losses it would benecessary for the liberalization to be gradual.

21



This approach is likely to work if there is significantinflation abroad. Without this, some downward flexibil-ity of domestic nominal wages and prices would beneeded.

The second approach is to reduce or eliminate distor-tions not by removing trade restrictions but rather byestablishing a uniform ad valorem tariff combined with auniform ad valorem export subsidy at the same rate. Thispackage of policies would have effects similar to that of adevaluation, at least on trade and output of goods (giventhat usually it cannot be applied to services). But it mayalso present administrative problems, and it might bedifficult to attain complete uniformity and to resistpressures from sectoral interests to provide lower orhigher tariffs in particular cases.

Quantitative restrictions might at first be replaced bytariffs and then the tariffs might be adjusted eitherquickly or slowly in the direction of uniformity. At thesame time, export subsidies would be necessary to avoidan import substitution bias. The revenue from tariffswould finance the export subsidies and, if there is a tradedeficit, there would still be a net revenue yield from thetax-subsidy system. If the system could not be applied toservices, some distortion would remain. Possibly thewhole level of tariffs and subsidies could be graduallyreduced in time, and even eliminated eventually, if thereis reasonable flexibility of domestic wages and prices.

Capital Market and Trade Liberalization

For the more usual cases, where exchange rates can bealtered, a matter that has been much discussed has beenthe relationship between trade liberalization and capitalmarket liberalization. This discussion has been stimu-lated by the experiences of Argentina, Chile, andUruguay where some liberalization of both kinds tookplace in various orders. In Argentina capital marketliberalization (for a limited period) came first and inChile trade liberalization. 14

It is clear that one kind of liberalization is possiblewithout the other. Some countries have very open capitalmarkets but restrictive trade regimes while others haveextensive international capital controls but relatively freetrade. Among industrial countries during the BrettonWoods era controls on international capital movementswere the norm while trade was progressively liberalized,and this has also been true until very recently within theEuropean Community. It is striking that in recent yearsthe tendency to increased protection or protectionistpressures in some major industrial countries has coin-cided with the rapid growth of the international capitalmarket and a general tendency to capital marketliberalization.

14See Edwards (1984).

There are three important links between the two kindsof liberalization.

First, capital market liberalization involving the free-ing of domestic interest rates and the removal of controlson inward and outward capital flows may lead to greatercapital inflows than before. Not only would removal ofcontrols on inflows, including direct investment, encour-age this, but removal of controls on outflows (providedthe liberalization is expected to last and economicconditions support the policy thrust) might also, since itwould reduce the risk that capital cannot be repatriated.With more foreign capital available domestically it isthen particularly desirable that the relative profitability ofdomestic industries gives a true indication of socialprofitability, so that investment is directed in optimaldirections. Hence some trade liberalization shouldideally precede capital market liberalization if the exist-ing protection system is very distorting.

The need to get the signals right also applies when newinvestment is wholly domestically financed, but theargument is strengthened when major capital inflows arein prospect. It is unfortunate if foreign capital flowsprimarily into heavily protected industries so that lowbenefits to the country result, and possibly there could bea social loss, the local consumers of the protectedproducts in effect subsidizing foreign capital. In addi-tion, foreign companies become yet another interestgroup in support of maintaining protection.

Second, the process of capital market liberalization islikely to affect the real exchange rate, possibly quitesharply for a limited period, as a portfolio adjustmenttakes place. If domestic interest rates had been helddown by controls and are now raised, capital will flowin, or at least there will be pressures in that direction.This effect will be strengthened if investors' perceptionsof the security (and opportunity to repatriate) of invest-ment in the country improve. The nominal exchange rateand, with it, the real rate may then appreciate. Theexchange rate may, of course, depreciate if the portfolioadjustment involves net capital outflow, which mightoccur if controls on outflows were initially severe or ifdecontrol were expected to be temporary. But the morecommon experience has been for the exchange rate toappreciate consequent upon financial liberalization.

If the real exchange rate appreciates, this will maketrade liberalization inconsistent with current accountbalance. The adverse effects of appreciation on import-competing industries will intensify the effect of the tradeliberalization. Of course the real appreciation caused bycapital market liberalization will be temporary, but itdoes create problems. Furthermore, the appreciation willrender exporting less instead of more profitable.

If capital tends to flow out after financial liberaliza-tion, the exchange rate will move in the right directionfor the current account (by depreciating) but it willovershoot, since the extent of depreciation required for

22


Protection in Industrial and Developing Countries

the current account to be maintained with trade liberali-zation is less than that required for a temporary currentaccount surplus to accommodate capital outflow.

Third, if the capital market has already beenliberalized, trade liberalization, or even just the expecta-tion of it, may give rise to capital movements which thenaffect the exchange rate.

One possibility is that depreciation comes to beexpected—since, as noted earlier, it would eventually berequired if the current account is not to change once tradeliberalization takes place. Hence the exchange ratedepreciates in advance of actual trade liberalization. Asalso noted above, this might be desirable, bearing inmind that export expansion will be required and is likelyto take time. But the opposite possibility must also beallowed for.

The acceptance of proposals for trade liberalization,possibly combined with other structural reforms, maymake local and foreign investors more "bullish" aboutthe economy, expecting higher and more secure profits.Hence the tendency will be for capital to flow in and forthe exchange rate to appreciate. This is similar to theeffect discussed above where the capital inflow and theappreciation were caused by capital market liberaliza-tion. In the present case the capital market is alreadyliberalized and the same effect results from expectationsstimulated by trade liberalization and other structuralreforms. In both cases the appreciation can createproblems by making industries producing tradable goodsin general less profitable at a time when industries thatare losing their protection will suffer a loss of pro-fitability in any case while export industries need tobecome more profitable.

To sum up, opening the domestic capital market to theworld market is likely to make it more difficult tomanage the exchange rate. The rate will be put undercapital-market-determined pressures, and this presentsproblems if it is desired to fine tune the exchange rate aspart of a major trade liberalization exercise. On the otherhand, there seems little reason to slow down capitalmarket liberalization if trade liberalization is piecemealand gradual. Furthermore, sometimes capital marketliberalization may be inevitable because of the break-down or high administrative costs of controls.

One might also note the case where the nominalexchange rate is kept fixed or, at least, the more commoncase where there is some degree of intervention designedto moderate exchange rate changes. If capital marketliberalization or trade liberalization stimulates capitalinflow, as seems quite possible, there will then be abuildup of reserves and, if the effects are not sterilized, adomestic monetary expansion, and hence domestic in-flationary effects. In the latter case there would be a realappreciation with the same kinds of adverse effectsalready discussed. If the capital movements are short

term it will clearly be desirable for the monetary effectsto be sterilized.

The problem would be greater if the net effect ofcapital market liberalization and of the expectation oftrade liberalization (and hence of eventual devaluation)were for capital to flow out rather than in. The reserveswill then decline, and—if the exchange rate regime is notchanged—the balance of payments situation may theninhibit the trade liberalization process.

A similar difficulty can arise when an import liberali-zation is not expected to last—when a government hasnot succeeded in making the program credible to privatetraders. Imports may then flood in, in expectation of thereimposition of quotas. An immediate, though tempo-rary, balance of payments problem will then be created.If depreciation of the exchange rate is ruled out, atightening-up of monetary policy may be needed in allthese cases.

Protection in Industrial and DevelopingCountries

The argument is often heard in developing countriesthat the recent revival of protectionism in the industrialcountries justifies a reluctance to liberalize by thedeveloping countries. Does protection in the industrialcountries, combined with the need to improve currentaccounts because of the debt situation, call for inward-looking policies by the developing countries? Thisinvolves the general question whether protection in onegroup of countries can justify or even necessitate theprotection policies of another group.

In very broad terms, protection overall is much higherin almost all developing countries than in industrialcountries. On the other hand, again in broad terms,protection in industrial countries has been increasing, atleast since 1980, and the threat is of further increases,while protection in developing countries has on thewhole not changed much (with some exceptions, wherethere has been liberalization) and all the proposals, if notprospects, are for further liberalization.

The question has then been raised whether there are orwill be "inequities in global liberalization." Why shouldone part of the world move in one direction—a directionthat is favorable for the world system—when anotherpart (the source of most of the preaching) is moving inthe opposite direction?

One approach to this question focuses on prospectivecurrent accounts. It is said that industrial countriesas a group are not willing to live with current accountdeficits (excluding interest payments) especially if theUnited States eliminates its deficit; hence the develop-ing countries cannot have or sustain the non interestsurpluses required to meet their interest obligationsand eventually even repay some of their debts. So

23



there is no point in developing countries pushing ex-ports, and growth will have to be associated with importsubstitution.

The argument is fallacious on the basis of thediscussion earlier: once the possibility of exchange rateadjustment is allowed for, current accounts do notdepend on protection; rather, protection determineswhether a given current account outcome is obtainedwith more or less import substitution relative to exportexpansion.

If industrial countries do not allow developing coun-tries to improve their current accounts, a choice still hasto be made by developing countries between expandingexports and hence also being able to import more, or(taking a particular case) keeping exports and then alsoimports constant, hence lowering the ratio of imports toGNP in the process of growth. And this choice raises thefamiliar protection issues that have nothing to do withcurrent accounts. For any given current account balance,choices can still be made between inward-looking andoutward-looking growth, and, as noted earlier, theempirical evidence as well as economic analysis suggestthat outward-looking growth is generally better fordeveloping countries.

It should also be borne in mind that industrial countrymarkets are still quite open for most products. So far,their protectionism has not in fact stopped a steady rise inthe share of developing countries' exports of manufac-tures in total consumption of manufactures in industrialcountries (even in clothing and textiles). Furthermore,except in clothing, the share is generally quite small, sothat the scope for expansion is considerable. In 1983 inthe United States the share was only 3 percent for allmanufactures and 15 percent for clothing. In 1973the percentages were respectively 1.1 and 5.6 (Balassaand Michalopoulos, 1985).

The morality argument (as it might be called) shouldalso be dismissed. Liberalization by developing coun-tries would benefit industrial countries and the worldsystem, just as liberalization by industrial countrieswould benefit developing countries and the world sys-tem. It is then asked why developing countries shouldgenerate these benefits when the industrial countries arefailing to do so, and, in fact, are moving in the oppositedirection. The answer is that liberalization by developingcountries would also benefit the developing countriesthemselves, and most debates, like the discussion in thispaper, are concerned with defining these benefits.

The broad point can be put as follows. Protection byindustrial (developed) countries reduces the gains fromtrade in both parts of the world. It damages both theresidents of the industrial countries in the aggregate(though particular sectors may benefit) and it damagesthe developing countries, especially when the protectiondiscriminates against their exports. Adding protection bydeveloping countries further reduces the gains from trade

in both parts. It is this broad point that is the key one:even if protection in industrial countries does increase, abad example being set and the interests of the developingcountries being damaged as a result, it would not be inthe developing countries' interests to forgo their ownliberalization for that reason.

The adverse effects on developing countries of asignificant increase in protection by the industrial coun-tries need hardly be restated. The developing countries'terms of trade would deteriorate as a result. With exportrevenue lower than otherwise and real incomes reduced,the tax base would decline and hence the task of attainingfiscal balance would become more burdensome. Acurrent account improvement would require more importcompression than otherwise. If there is some rigidity ofreal wages, unemployment would probably increase.

For any given level of protection or liberalization indeveloping countries, an increase in protection by indus-trial countries, if directed against the exports of thedeveloping countries, will shift the relative profitabilityof exporting and import substitution in developingcountries in a trade-compressing direction. It will makeexporting relatively less profitable and import-substitu-tion relatively more profitable. Thus development willtend to become more inward looking. This would be anappropriate response for the developing countries whichwould result even if all resource allocation decisionswere based on the market signals facing them—includingthe signals distorted by the protection of the industrialcountries. Protection by the developing countries them-selves does not have to increase for this result.

If simultaneously there is actually some liberalizationby developing countries, the reduction in trade and theshift to inward-looking development would be modifiedand possibly offset. Their own policies would havebecome more outward-looking but because of the shift inthe opposite direction in the policies of the industrialcountries, their development pattern—governed by therelative prices facing domestic producers—would notnecessarily, on balance, shift in an outward-lookingdirection.

The question remains as to how the benefits to thedeveloping countries of liberalization (or possibly ofprotection) by the developing countries themselves areaffected by the protection policies of the industrialcountries.

First, protection by developing countries can conceiv-ably be used as a bargaining device to reduce industrialcountry protection. Sometimes it may then be justified topostpone unilateral liberalization if there is a chance thata good reciprocal bargain can be struck. The developingcountry would gain from unilateral liberalization, but itwould gain even more if, as a result of its ownwillingness to liberalize, developed countries engaged insome reciprocal liberalization of their own restrictionsagainst the developing country's exports. Nevertheless,

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the possibility of using a system of protection as abargaining chip is a doubtful argument for providingprotection in the first place. Protection generates domes-tic interest groups that will oppose liberalization and thatwill not be happy to see the basis of their profits andemployment transformed into a bargaining chip, even ifscope for such bargaining exists.

Second, the threat of import restrictions by industrialcountries can justify the governments of developingcountries imposing voluntary export restraints. These arethemselves a form of trade-restricting intervention. Suchrestraints are acceptable to developing countries eitherbecause they provide a means of improving their terms oftrade or—more commonly—because the alternative isthe imposition of import restrictions by the importingcountries themselves. The objective of the industrialcountries in seeking these restraints from foreign sup-pliers is to protect their own producers, and this couldalternatively be achieved by imposing tariffs or importquotas. The revenue from tariffs goes to the treasury ofthe industrial country and that from quotas goes to thelicense-holder, who is usually a local trader or producer(unless quota rights are sold). By contrast, excess profitsfrom voluntary export restraints at least go to thedeveloping countries' exporters or, alternatively, to their

Protection in Industrial and Developing Countires

governments in the form of revenue from export taxes orthe sale of quota rights.

As noted earlier, there is no argument here for theimposition of general restrictions on imports by devel-oping countries. Nor is there an argument for generalrestriction of exports to all destinations. The argument isfor export restraints only in particular cases where thereis a threat of import restrictions by developed countries.

Returning to the main issue and leaving aside thevoluntary export restraint cases which apply only to alimited group of products, if tariffs and import restric-tions in industrial countries are given and unaffected byhow much protection there is in developing countries,they do not alter the case for liberalization by developingcountries.

This conclusion ignores terms of trade effects, whichmay produce some gains for one group at the expense ofthe other group. But such gains for developing countrieswould only be short term, since developing countries arerelatively small in supplying total world consumption,other than in the case of a limited number of primaryproducts. The major exception, of course, is oil. Henceone should not expect much medium-term gain in theterms of trade to result from their intervention policies.

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VII Summary

It was pointed out at the beginning of this OccasionalPaper that the Fund position is to favor an open tradingsystem and to oppose the use of trade restrictions forbaJance of payments purposes. Protectionism in indus-trial countries appears to have increased, and there arepressures for further increases, even though the initiationof a new round of multilateral trade negotiations is ahopeful sign. In the case of developing countries,protection tends to be higher and more widespread thanfor industrial countries, but there have been proposals forliberalization, and in some countries actual moves in thatdirection.

The paper opened with a discussion of several macro-economic issues. An increase in protection does notnecessarily improve the current account. It all dependson what happens to savings and investment, private andpublic, and this depends on macroeconomic policies andthe way policy responds to the increase in protection.When the exchange rate floats there is no presumptionthat protection would improve the current account. Auniform import surcharge in the United States, forexample, would only be likely to improve the currentaccount if it improved the fiscal situation, but it wouldnot be an efficient way of doing so. Exchange rateinstability may well have given rise to protectionistmeasures, but it provides no justification for protection.Similarly, the existence of unemployment does notjustify protection. Devaluation, or macroeconomic poli-cies that bring about depreciation, would normally bepreferable to import restrictions if the balance of pay-ments is to be improved at a constant level of overallemployment, or if overall employment is to be increasedwhite avoiding a balance of payments deterioration. Inthe case of real wage rigidity and hence classicalunemployment neither method may be able to deal withan unemployment problem. The employment gains byprotected industries would be offset by losses in otherindustries.

Various arguments for protection have been analyzed,notably the infant industry argument, the terms of tradeargument and the case for using tariffs and export taxesto raise revenue. In all cases it is possible to make validarguments for protection applying in particular (but notnecessarily common) circumstances. Usually they arearguments only for the short term, so that possible short-term gains have to be weighed against long-term losses.

It has been pointed out that one of the main reasons forprotection in practice is the maintenance of incomes ofparticular sectors in response to adverse shocks, thisbeing brought about at a cost in national income as awhole.

Reference has been made to rent seeking and to thespecial problems created by import quotas as comparedwith tariffs. There is a strong case, at the minimum, forreplacing quotas with tariffs, preferably fairly uniformand not "made to measure." Protection is likely to affectgrowth adversely through various channels, includingthe effects on the productivity of investment. There isconsiderable evidence that out ward-looking policies—defined as policies which avoid a bias in the incentivesystem against exports—have led to higher growth rates.

A key issue for developing countries and for the designof Fund programs is whether import restrictions shouldbe used at a time of balance of payments crisis, andwhether, by contrast, it is appropriate to liberalizeimports when a country still has a current accountproblem. This is a complex issue, but it has been notedthat any case for import restrictions can only be shortterm and it may be a matter of balancing possible short-term gains against long-term losses, essentially the lossesfrom providing inadequate incentives for exports, quiteapart from all the other costs of distorting and licensingsystems.

In general, trade liberalization requires devaluation. Jtis thus particularly important to think of trade liberaliza-tion and exchange rate adjustment as representing apolicy package. The relationship between trade liberali-zation and capital market liberalization has also beendiscussed. It has been noted that capital movements canpresent problems for large-scale trade liberalizationthrough their effects on the real exchange rate.

Finally, protection by industrial countries does notjustify protection by developing countries (or viceversa), the central point being that protection in bothparts of the world reduces the gains from trade and hencereal incomes of both. Industrial country markets for themanufactured exports of developing countries are stillfairly open, though there is a special and serious problemfor clothing and textiles, and the developing countriesare certainly damaged by protection in industrial coun-tries, both in agriculture and in manufacturing, espe-

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27

cially when, as in the case of clothing and textiles, suchprotection actually discriminates against the developingcountries.

Subject to various qualifications noted in the paper, thegeneral conclusion follows that, both from the point ofview of countries imposing protection—that is, from the

Summary

point of view of their national interests—and from thepoint of view of their trading partners and the worldsystem, increases in protection are rarely justified and areundesirable. This conclusion also applies to existingprotection and hence justifies moves to trade liberaliza-tion, preferably multilateral but also unilateral.


References

Anjaria, S.J., N. Kirmani, and A.B. Petersen, Trade PolicyIssues and Developments, International Monetary FundOccasional Paper 38 (Washington: IMF, 1985).

Balassa, Bela, "Outward Orientation," World Bank DiscussionPaper (Washington: World Bank, 1985).

, "The Importance of Trade for Developing Countries,"World Bank Discussion Paper (Washington: World Bank,1986).

, and Constantine Michalopoulos, "Liberalizing WorldTrade," Development Policy Issues Series Report (Wash-ington: World Bank, 1985).

Bergsten, C. Fred and William R. Cline, The United States-Japan Economic Problem, Policy Analyses in Interna-tional Economics 13 (Washington: Institute for Interna-tional Economics, 1985).

, and John Williamson, "Exchange Rates and TradePolicy," in Trade Policy in the 1980s, ed. by C. FredBergsten and William R. Cline (Washington: Institute forInternational Economics, 1983).

Cambridge Economic Policy Group, Economic Policy Review(Cambridge: Cambridge University Press, 1976).

Choksi, Armeane M. and Demetris Papageorgiou (eds.),Economic Liberalization in Developing Countries (Ox-ford: Basil Blackwell, 1986).

Cline, William R. (ed.), Trade Policy in the 1980s (Washing-ton: Institute for International Economics, 1983).

, The Future of World Trade in Textiles and Apparel(Washington: Institute for International Economics,1987).

Corden, W. Max, Trade Policy and Economic Welfare(London: Oxford University Press, 1974).

, "The Normative Theory of International Trade," inHandbook of International Economics, ed. by P.B. Kenenand R.W. Jones (Amsterdam: North-Holland, 1984).

, Protection, Growth and Trade: Essays in InternationalEconomics (Oxford: Basil Blackwell, 1985).

Edwards, Sebastian, The Order of Liberalization of theExternal Sector in Developing Countries, Essay in Inter-national Finance 156 (Princeton: Princeton University,1984).

Eichengreen, Barry, The Political Economy of the Smoot-Hawley Tariff, National Bureau of Economic ResearchWorking Paper 2001 (Cambridge, Massachusetts: NBER,1986).

Finger, J.M. and Andrzej Olechowski, "Trade Barriers: WhoDoes What To Whom," in Free Trade in the WorldEconomy, ed. by Herbert Giersch (Tubingen: J.C.B.Mohr, 1987).

International Monetary Fund, Annual Report on ExchangeArrangements and Exchange Restrictions (Washington:IMF, various issues).

Johnson, Harry G., "Optimal Trade Intervention in thePresence of Domestic Distortions," in Trade, Growth andthe Balance of Payments, ed. by Robert E. Baldwin et al.(Amsterdam: North-Holland, 1965).

Lawrence, Robert Z. and Robert E. Litan, Saving Free Trade:A Pragmatic Approach (Washington: The BrookingsInstitution, 1986).

Nogues, Julio J., Andrzej Olechowski, and L. Alan Winters,"The Extent of Nontariff Barriers to Imports of IndustrialCountries," World Bank Economic Review (Washington),Vol. 1 (September 1986).

Organization of Economic Cooperation and Development,Costs and Benefits of Protection (Paris: OECD, 1985).

Papageorgiou, Demetris, Michael Michaely, and ArmeaneChoksi, "The Phasing of a Trade Liberalization Policy:Preliminary Evidence," World Bank Discussion Paper(Washington: World Bank, 1987).

Salvatore, Dominick (ed.), The New Protectionist Threat toWorld Welfare (Amsterdam: North-Holland, 1987).

Stern, Robert M. (ed.), U.S. Trade Policies in a ChangingWorld Economy (Cambridge: MIT Press, 1987).

World Bank, World Development Report (Washington: WorldBank, various issues).

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Occasional Papers of the International Monetary Fund(Continued from inside front cover)

33. Foreign Private Investment in Developing Countries: A Study by the Research Department of theInternational Monetary Fund. 1985.

34. Adjustment Programs in Africa: The Recent Experience, by Justin B. Zulu and Saleh M. Nsouli.1985.

35. The West African Monetary Union: An Analytical Review, by Rattan J. Bhatia. 1985.

36. Formulation of Exchange Rate Policies in Adjustment Programs, by a Staff Team Headed byG.G. Johnson. 1985.

38. Trade Policy Issues and Developments, by Shailendra J. Anjaria, Naheed Kirmani, and Arne B.Petersen. 1985.

39. A Case of Successful Adjustment: Korea's Experience During 1980-84, by Bijan B. Aghevli andJorge Marquez-Ruarte. 1985.

41. Fund-Supported Adjustment Programs and Economic Growth, by Mohsin S. Khan and Malcolm

D. Knight. 1985.

42. Global Effects of Fund-Supported Adjustment Programs, by Morris Goldstein. 1986.

44. A Review of the Fiscal Impulse Measure, by Peter S. Heller, Richard D. Haas, and Ahsan H.

Mansur. 1986.

45. Switzerland's Role as an International Financial Center, by Benedicte Vibe Christensen. 1986.

46. Fund-Supported Programs, Fiscal Policy, and Income Distribution: A Study by the Fiscal AffairsDepartment of the International Monetary Fund. 1986.

47. Aging and Social Expenditure in the Major Industrial Countries, 1980-2025, by Peter S. Heller,Richard Hemming, Peter W. Kohnert, and a Staff Team from the Fiscal Affairs Department.1986.

48. The European Monetary System: Recent Developments, by Horst Ungerer, Owen Evans, Thomas

Mayer, and Philip Young. 1986.

49. Islamic Banking, by Zubair Iqbal and Abbas Mirakhor. 1987.

50. Strengthening the International Monetary System: Exchange Rates, Surveillance, and ObjectiveIndicators, by Andrew Crockett and Morris Goldstein. 1987.

51. The Role of the SDR in the International Monetary System, by the Research and Treasurer'sDepartments of the International Monetary Fund. 1987.

52. Structural Reform, Stabilization, and Growth in Turkey, by George Kopits. 1987.

53. Floating Exchange Rates in Developing Countries: Experience with Auction and InterbankMarkets, by Peter J. Quirk, Benedicte Vibe Christensen, Kyung-Mo Huh, and ToshihikoSasaki. 1987.

54. Protection and Liberalization: A Review of Analytical Issues, by W. Max Corden. 1987.

International Monetary Fund, Washington, D.C. 20431, U.S.A.Telephone number 202 623-7430

Cable address: Interfund


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