Trade Policy in Developing Countries

By Edward F. Buffie | Go to book overview

CHAPTER 8
Liberalization and the Transition Problem,
Part II: Credibility and the Balance
of Payments

A certain amount of trade reform can be accomplished by enhancing the incentives for export production, reducing dispersion in effective rates of protection, and loosening quotas on imports of intermediate inputs and capital goods. But after these opportunities have been exploited, it is necessary to get on with the more difficult business of dismantling the high tariffs and restrictive quotas that protect firms in the importcompeting industrial sector. At this stage in the liberalization process, lack of credibility can do serious damage. As we saw in Chapter 6, expectations of a policy reversal weaken the incentive for workers laid off in the import sector to seek jobs in the export sector. The same point applies to physical capital and other inputs that cannot shift costlessly from one sector to another. Thus, even if other policies prevent unemployment from increasing, there is a cost to weak credibility in that the gains from trade on the production side will be slower to materialize.

This chapter focuses on the connection between lack of credibility and another aspect of the transition problem: sudden, large increases in spending on consumer imports. Some increase in consumer imports is expected and desired in liberalization programs that aim for a significant reduction in the level of protection. The problem is that the objective is often greatly overfulfilled. In Chile (1978), Mexico (1987), Turkey (1989), Kenya (1976, 1980, 1988), Tanzania (1984), Zaire (1983–86), Zambia (1986), the Sudan (1979), Uganda (1985), Senegal (1986), Sierre Leone (1988), Cote d'Ivoire (1984), Guinea (1983–86), Vietnam (1989), Ecuador (1990–94), and elsewhere, liberalization was followed by a surge in consumer imports inconsistent with plausible values for price and income elasticities of demand.1 This suggests the private sector did not believe the reform would last — that it viewed liberalization as a one-time opportunity to purchase imports at exceptionally favorable prices.

____________________
1
See the accounts in Loxley (1989), Stein (1992), Zack-Williams (1992), Sepehri (1993), Celasun (1994), Ros (1994), Arulpragasam and del Ninno (1996), Mommen (1996), Reinikka (1996), Truong and Gates (1996), and Larrea (1998).

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