The Trade Policy Debate
In this chapter I try to provide a balanced, dispassionate critique of the various arguments that have been advanced for export promotion and against protection.1 The chapter begins with a brief overview of LDC trade policy that introduces some basic concepts and discusses the main features of import-substituting industrialization (ISI). Following this, Section 3.2 examines at length the argument that the first-best remedy for most types of market failure is to combine free trade with an appropriate tax or subsidy. The argument is powerful but subject to the qualifications that the most direct tax/subsidy intervention (i) not involve greater administrative costs than the comparable trade tax, and (ii) not adversely affect the strategic environment in which policy makers operate. If these qualifications matter, trade taxes may have a place in the optimal policy package.
The second half of the chapter deals with more specific aspects of the policy debate. Section 3.3.1 appraises the infant industry argument, the oldest and most common defense of protection. In Section 3.3.2, I discuss the nature of factor market distortions in LDCs and the claim that ISI exacerbates the underemployment problem. Sections 3.3.3 and 3.3.4 examine the theory and empirical evidence bearing on the connection between trade policy, production and prices in oligopolistic markets, scale economies, and productivity growth.
The distinguishing characteristic of trade policy in countries pursuing ISI is that consumer goods are subject to much higher tariffs and more restrictive quotas than imports of intermediate inputs and capital equipment. Because the price of intermediates affects industry costs, there is no simple formula relating trade taxes to the sectoral pattern of output.____________________