trade strategy in medium-term adjustment

World Development, Vol. 18, No. 6, pp. 879-897, 1990. 030~750x/90 $3.00+0.00 Printed in Great Britain. 0 1990 Pergamon Press plc

Trade Strategy in Medium-Term Adjustment

G. K. HELLEINER* University of Toronto

Summary. - Trade strategy is prominent in current discussions of stabilization and adjustment. The orientation of trade strategy can be categorized according to revealed trade performance, or characteristics of incentive structures, or the nature of the main policy instruments. The record of trade strategy in developing countries has been richer and more complex than currently fashionable dichotomous categorizations in terms of inward or outward orientation suggest. Many trade strategy and policy issues remain unsettled. These include the effects and optimal timing of import liberalization, the appropriate instruments for export promotion, trade policy concomitants of productivity change, and interactions with macroeconomic experience and policies, among others. More country-specific and industry-specific empirical research is necessary.

1. INTRODUCTION

Development strategy normally evolves as the product of a continual process of trial and error - searching, learning, and reacting to exogenous influences. During the turbulent 1970s and 1980s developing countries have sought to maintain developmental momentum in the face of major deteriorations on external account. Terms of trade, capital flow and interest rate shocks early in the 1980s have proven to be of a longer-term nature than was originally expected, and these countries have since been forced to pursue medium-term “adjustment” to the new external realities. Restructuring production toward (and consumption away from) tradable goods and services is the most fundamental medium-term adjustment requirement. Trade strategy is therefore among the central elements of adjustment strategy.

Trade strategy was considered a central element in development strategy long before the current need for adjustment arose. It was not a matter on which a complete professional consensus could be found, although many in the orthodox mainstream appear to believe that their favored “outward orientation” has long since carried the day. (“The question of the wisdom of an outward-oriented (export promoting) strategy may be considered to have been settled,” says Bhagwati, 1987, p. 257. See also Balassa, 1985a.)

Twenty years have now elapsed since the enor- mously influential Little-Scitovsky-Scott project on trade and industrialization (1970) was com- pleted in the Organization for Economic Co- operation and Development (OECD) Devel- opment Centre. Considerable knowledge and

experience have accumulated over the intervening years in a wide variety of countries on the principal issues their project addressed. At the same time, slower global growth and increased macroeconomic instability have raised fresh questions; the deployment of new governmental policy instruments has offered wider possibilities; and new trade theories have stimulated policy controversy among those formerly in agreement. The research community has simultaneously developed its empirical methodology in a variety of directions, generating a certain amount of terminological confusion in the process. The World Bank, in particular, has recently directed major research attention to trade and industrialization policy issues, reporting the gist of its conclusions, favoring outward orientation and liberal trade regimes for all, in the 1987 World Development Report. But this research failed to address many of the most interesting questions; was suspect in many circles from its outset because of the known predilections of its organizers; and has ultimately proven unconvincing.

Old development strategy debates are now being urgently revived as the conditions imposed by self- confident outsiders upon desperate borrowing governments drive them toward trade policies, the short-term and long-term efficacy of which are still subject to considerable professional doubt. Other dimensions of economic openness - in particular, to foreign capital, labor, nonfactor services, and

*I am grateful for comments on the earlier draft to conference participants and to Sidney Dell, Alf Maizels, Paul Streeten and Lance Taylor ~ none of whom is to be implicated in the contents of the current version.

879

880 WORLD DEVELOPMENT

technology ~ are also at issue in the current debate on adjustment strategy; but this paper will focus upon the traditional issues of strategy relating to goods trade.

For the purposes of a survey paper it is necessary to paint with a fairly broad brush. Yet one must resist succumbing to the oversimplifications and generalizations that have too frequently plagued the debates in the sphere of trade strategy. In an insightful assessment of the risks and difficulties of classifying trade regimes too crudely, Keesing highlighted several problems:

(i) any terminology.. is likely to be laden with preconceptions, emotional associations, implicit value judgements, and/or false analytical prem- ises.

(ii) there are multiple dimensions of trade policy. Most writings are based on archetypes or caricatures based on a whole cluster of frequently associated characteristics..

(iii) policies in trade as in other spheres are the result of sequential decision-making under uncertainty, in which most decisions are taken in a piecemeal fashion, sometimes by different sets of people, in response to shifting circumstances..

(Keesing, 1979, pp. 136 137)

Neither the World Bank, for whom his paper was written, nor the economics profession as a whole has noticeably heeded these warnings. (Indeed, neither did he in the latter part of the same

paper.) This survey paper is divided into two main parts.

The first seeks to clarify the terminology and categorization systems employed in recent trade policy debates. The second surveys the recent evidence concerning some of the main questions at issue and highlights areas for further research. It is in the nature of a paper like this one that it does not have much of a conclusion ~ other than the usual one that more research would be very useful. For those who believe that the major questions have been “settled” this may nevertheless come as a surprise.

2. CATEGORIZING TRADE STRATEGY

How can one measure the overall orientation of trade strategy? There have been three main categories of measurement deployed in this connec- tion:

(a) those relating to trade shares, or “revealed” policy,

(b) those relating to incentive structure, (c) those relating to the choice of trade policy

instruments.

In recent research upon the desirability or appro-

priate sequencing of trade liberalization, elements of all three have frequently been mixed together. Consciously attempting to mix them together in a composite measure yields a fourth category.

(a) Trade shares/ “revealed” policy

The most obvious measure of “revealed” trade policy, although it takes no account of the distinction between the consequences of “initial conditions” and those of policy, is the share that exports make up of GDP. Alternatively, although this is more rarely done, one may opt for the import share of GDP. Also sometimes used is the share of exports plus imports in total GDP or total supplies (GDP plus imports).

There are wide variations in these ratios not only across countries but, more important, over time within the same countries. ’ Table 1 presents some illustrative data in these respects for the 41 countries listed in the 1987 World Development Report’s table on trade policy orientation (about which more below). Among the most striking changes in export/GDP ratios over the 1965-85 period are those of the Republic of Korea, from 9% to 36%, and Tanzania from 26% to 7%. Of the 41 countries in this sample, only 12 registered declining export shares over this period; another two experienced no change. The norm thus appears to have been one of increasing openness, even after the global economic setbacks of the 1980s. (Griffin has also noted the fact that export shares of GDP rose in many more developing countries during the 1974 85 period than in the 196674 period, 1988, p. 89.) Some of this change no doubt reflects recent efforts to service foreign debt.

A variant on the crude trade ratio takes account of differences in initial conditions, for instance by using, instead, the deviation of this ratio from the “norm” for countries of equivalent size (popu- lation) and per capita income, as measured by Chenery and Syrquin or others. Chenery and Syr- quin have described this as a “trade orientation index” (Chenery, Robinson, and Syrquin, 1986, pp. 114-I 18). One could imagine refining this “norm” via other measures of economic structure such as, for example, agriculture’s share of GDP, to derive a more structure-sensitive “trade orientation” analogue of the International Monetary Fund’s “tax effort” ratios. Similar analyses can be conducted on the structure of trade and deviations from historical and/or cross-sectional norms (McCarthy, Taylor, and Talati, 1987).

Another more influential variant of this measure is the marginal export/GDP (or import/GDP) ratio. Whereas there has been little success with attempts to find statistically significant cor-

TRADE STRATEGY 881

Table 1. Openness measures for all countries characterized by the World Bank

Trade policy orientation

Exports of goods and nonfactor

services as % of GDP

Argentina II II 8 15 Bangladesh II II 10 6 Bolivia I II 21 18 Brazil 0 0 8 14 Burundi II II 10 11 Cameroon 0 I 25 35 Chile II 0 14 29 Colombia 0 I 11 15 Costa Rica 0 I 23 32 Cote d’lvoire 0 I 37 46 Dominican Republic II II 15 28 El Salvador I I 27 23 Ethiopia II II 12 12 Ghana II II 17 13 Guatemala 0 I 17 19 Honduras I I 27 27 Hong Kong 00 00 71 106 India II II 4 6 Indonesia 0 I 5 23 Israel 0 0 19 42 Kenya I I 31 25 Korea 00 00 9 36 Madagascar I II 16 14 Malaysia 0 0 42 55 Mexico I I 9 16 Nicaragua I 1 29 14 Nigeria I II 18 17 Pakistan 11 I 8 11 Peru II II 16 22 Philippines I I 17 22 Senegal I I 24 31 Singapore 00 00 123 na. Sri Lanka II I 38 26 Sudan II II 15 10 Tanzania II II 26 I Thailand 0 0 18 27 Tunisia I 0 19 33 Turkey II 0 6 19 Uruguay II 0 19 25 Yugoslavia I 1 22 30 Zambia II II 49 39

00 = Strongly outward oriented 0 = Moderately outward oriented II = Strongly inward oriented I = Moderately inward oriented

Source: World Bank (1987), pp. 83, 210-211

Country 1963-73 1973-85 1965 1985


relations between export ratios and economic growth (there is even some evidence to suggest that any such correlation may be negative; McCarthy, Taylor, and Talati, 1987) there is evidence of significant positive association, in semi-industrial countries, between marginal export/GDP ratios and growth. Probably the best-known version of this result employs an aggregate production func- tion of the form:

AY AL AK AX X -- = aO- +a,- +a,--m-P fu Y L K x Y

where Y, L and K represent GDP, labor and capital, respectively, and Xrepresents exports. This equation is estimated on the assumption that there are growth-inducing characteristics present in the exporting sector and/or that there was previously an anti-export distortion of domestic allocation, the removal of which generates (once and for all) efficiency gains. Some have sought to separate the (assumed positive) “externality” attributes of exports from the reallocative gains from elim- inating anti-export bias by adding an export growth term to the equation (e.g. Feder, 1983 and 1986).

The association of marginal export shares with growth cannot be obtained for countries below a “threshold” level of per capita income, although one ingenious data-milking exercise managed to find a significant relationship between GDP growth in 18 low-income countries in one (1973- 84) period with the growth in export share in a previous (1965573) period (La1 and Rajapatirana, 1987, p. 195). Feder summarizes his latest econometric investigations: “the export/nonexport dis- equilibrium model seems to provide a suitable framework for analyzing the growth of semi-industrial countries but not of other countries” (1986, p. 277). Cross-sectional regressions, in any case, place heavy demands upon the underlying assumptions, particularly as to structural uniformities across countries. As always, there are also obvious questions with regard to the direction of causality in results of this type. Nor do “Granger-causality” tests, if one takes them seriously, offer much support for the importance of exports to growth in particular countries (Jung and Marshall, 1985).

There have not been equivalent attempts at econometric testing of the correlations between changes in import shares and economic growth, although the logic of the case for liberalization would suggest that this should have been an early proposition to test.

Similar measures of trade policy orientation can also be deployed at the sectoral or industry level. Much of the literature on industrial import substitution has been based upon measurements of the

sources of output growth, that are in turn based on changes in import shares of apparent consumption and are thus of the same genre as these. In Chenery et al.‘s formulation, output growth may be decomposed into the following elements:

(i) domestic demand expansion, (ii) export expansion.

(iii) import substitution of final goods, (iv) import substitution of intermediate goods,

and (v) changes in input-output coefficients.

The first two are measured by assuming constant import shares. The third and fourth terms are measured as the direct and indirect effects of changes in import shares (Chenery et a/., 1986, pp. 121- 147).

Another “revealed” measure of trade policy is based upon constant market share analysis of export performance. In this analysis, export growth may be decomposed into that which is attributable to growth in world markets. that which is attributable to altered share of world markets (“competitiveness”), and that attributable to the development of new, nontraditional exports (“diversification”):

AX= (x, IV’,-x, W,)+(xzW,-x,W,)

+(NTz - NT,)

where W, is the world market for this country’s traditional exports in period t, x, is this country’s share of these world markets in period t, and NT, is the value of nontraditional exports in period t. (A further term may be useful to distinguish changes in world prices for exports from changes in the volume of world trade.) The “competitiveness” and “diversification” components of export performance may be grouped together, and nor- malized (e.g., by the share they make up of changed exports), to derive a “revealed” measure of trade policy orientation. Obviously this measure, like those focusing upon import substitution, can also be deployed at the sectoral or industrial level. Some accounts devote particular attention to the performance of nontraditional exports as an indicator of trade policy orientation.

Another dimension of trade strategy that has been employed relates to the primary or manufacturing (or primary-manufacturing “neutrality”) orientation of exports. Chenery et al. (1986) employ this distinction, among others, to categor- ize countries. The use of the actual primary or manufacturing share of exports to measure trade policy orientation in this sense will obviously incorporate elements of countries’ initial conditions (including natural resource endowments and other elements of comparative advantage, size,

TRADE STRATEGY 883

etc.), and may therefore mislead. On the other hand, the primary vs. manufacturing bias in the structure of export (or other) incentives - which might better characterize trade policy orientation - may be more difficult to measure.

Earlier accounts effectively’distinguished countries on the basis of the composition of imports. Except for the very low-income countries, however, import bills now look broadly similar across a wide range of developing countries, since most have long since accomplished the “easy” elements of (mainly consumer-good) import substitution.

Also of interest, as far as the industrial sector is concerned, is another measure of “revealed” policy - the degree of openness in the sense of intraindustry trade (Chenery et al., 1986, pp. 210P211). Standard measures of the importance of intraindustry trade’ and therefore of intraindustry specialization indicate that it increases with per capita income (Havrylyshyn and Civan, 1983; Erzan and Laird, no date). These measures are unfortunately extremely sensitive to the level of disaggregation of the data employed in their construction, and they cannot distinguish intrafirm from arm’s_length intraindustry trade. They may nevertheless be used, with care, in both intercountry comparisons and comparisons over time.

(b) Incentive structure

The principal advocates of more “liberal” trade policies have recently swung from measures of actual trade performance toward measures based upon incentive structures in their efforts to characterize individual countries’ overall trade policies. This approach, while no doubt more sensible, proves much more conceptually complex, and more difficult in terms of empirical application.

The principal question, in the formulation of Bhagwati, Krueger, and others, is the relationship between the (average) effective exchange rate for a country’s exports (EER,) and that for its imports (EE’R,,,), where the effective exchange rates (domestic currency per unit of foreign currency) take into account all duties, taxes, subsidies, etc. “Outward-oriented” trade policies are defined, in this approach, by the neutrality of incentives as between exporting and importing, i.e., EER, = EER,,,. The “normal” incentive structure

within developing countries has been one in which there is an anti-export bias, i.e., EER, < EER,.’ Only in a very few cases has this overall incentive structure leaned in the reverse direction, generating “ultra-export-promotion” (Bhagwati, 1987) or “right-wing deviationist” (Findlay, 1981) policies.

This approach has been enthusiastically adopted

by the World Bank in its 1987 World Development Report (WDR):

For analytical convenience, trade strategies can be broadly divided into two groups, outward oriented and inward oriented. An outward oriented strategy is one in which trade and industrial policies do not discriminate between production for the domestic market and exports, nor between purchases of domestic goods and foreign goods. Because it does not discourage international trade, this nondiscrimi- natory strategy is often (somewhat inaptly) referred to as an export promotion strategy. By contrast, an inward oriented strategy is one in which trade and industrial incentives are biased in favor of production for the domestic over the export market. This approach is well known as the import substitution strategy (World Bank, 1987, p, 78).

Chenery et a/. also allow for an intermediate “neutral” strategy (1986, chapter 4). They also.distinguish outward-oriented policies that are neutral as between tradables and nontradables (as in free trade) from those that f&or both exports and import-competing activities vis-d-vis nontradables (pp. 1655166).

Measurement of these broad averages, whether or not they carry much meaning to individual firms, a matter on which there is room for some doubt, proves to be a difficult and time-consuming task. Where quantitative restrictions and ad hoc tax exemptions. rebates, or surcharges abound, as is usual in developing countries, the formal schedule of import and export duties and subsidies offers scant assistance. There is usually no escape from difficult and costly product-by-product comparisons of domestic and world prices in search of “tariff equivalents”; and even then there are major conceptual problems relating to quality, weighting, timing, etc.

When the World Bank moved to categorization of individual countries according to the degree of inward or outward orientation of their trade incentives, it was quickly driven to the use of qualitative as well as quantitative indicators, and ended up with some highly subjective characterizations and extremely uncertain conclusions as to what difference these orientations made. It is far from evident that the dichotomous categorization of trade strategies to which this approach has led (even allowing for the further qualifications as to “strong” or only “moderate” degrees of outward or inward orientation, which the Bank introduced in its 1987 WDR) effectively discriminates among countries - either in terms of their growth performance, as the WDR would have us believe, or indeed in terms of the overall nature of their trade strategies. Singer (1988) has noted that, statistically speaking, per capita income is a better dis- criminator in respect of growth performance in the WDR tables than purported trade orientation.


There is evidently very little correlation between the empirical record in respect of export shares and the World Bank’s primarily incentive-structure- based characterizations. For example, Argentina and Brazil have identical export shares in 1965 and almost identical ones in 1985; yet the former is characterized as “strongly inward oriented” whereas the latter is described as “moderately outward oriented” in both periods. On the other hand, ull of the 16 countries characterized as “outward oriented” (exclusive of Singapore for which 1985 data are not available) - in either period ~- showed increases in export shares between 1965 and 1985. Of the remaining 24 countries, only 10 registered increasing export shares. All 12 of those with declining export shares were categorized as “inward oriented.” The difficulty of distinguishing “moderately outward-oriented” and “moderately inward-oriented” countries is indicated by the fact that all six of those countries that moved from the former category to the latter simultaneously experienced vising export shares!

Incentive structures have other dimensions. For those who emphasize the degree of neutrality of incentives, what is at issue is not only the neutrality of average exporting or import-substituting incentives but also the degree ofdispersion within both categories and overall. “Liberalization,” as under- stood by trade theoreticians, is at least as much a matter of increasing uniformity (neutrality) of all incentives as it is a matter of merely those relating to export and import-competing averages; moving toward neutrality in the above Bhagwati-Krueger sense is not evidently “liberal” if it is accompanied by increasing overall dispersion of incentives. The circumstances in which special incentives and dis- incentives are or are not appropriate constitute a major area of trade policy debate (about which more below).

Also relevant in much of the debate over incentive structures, although less frequently measured, is their stability over time. There exists some evidence that real exchange rate stability is conducive to more successful export performance. This is an area deserving further investigation.

More generally, the focus on incentive structures highlights the fact that trade strategy cannot be sensibly addressed independently of the question of exchange rate policy. The exchange rate ~ as the most important single price in the typical open developing country - is a key determinant of the overall structure of incentives. The calculation of effective rates of subsidy (protection) for different economic activities rests upon a specified exchange rate with which to translate world prices in international currencies into world prices in domestic currency. Where the domestic currency is “overvalued” (in the sense that its official value is incon-

sistent with medium-term internal and external balance, with an acceptable and practicable degree of governmental intervention in trade), high measured rates of subsidy may simply reflect the fact of an inappropriate official exchange rate. The apparent inefficiency of the subsidized sector may be illusory in the sense that it vanishes with the introduction of a more appropriate exchange rate (Schydlowsky, 1972; Balassa, 1982). Effective rates of subsidy must therefore somehow be exchange- rate-adjusted if they are to be trusted at all.

It is obviously also therefore important to distinguish. where possible, the effects of macroeconomic stabilization and/or exchange rate realignment from the effects of changes in the trade regime in the strict sense (Rodrik, 1988a, p. 28).

It is also important not to forget that other incentives besides those emphasized in the trade literature may be no less important to adjustment, growth and developmental processes - those, for instance, governing relative factor prices, or favoring large firms over small, or local firms over foreign ones. There may be a host of further important, though less directly relevant, ones - affecting management effort, worker morale, location, etc. There is no obvious theoretical basis for the heavy emphasis that so much of the recent writing has placed upon interindustry trade-related incentive structures.

(c) Trude policy instruments

A third basis for characterizing trade strategies or regimes in individual countries is the degree of intervention by government, and, more particularly, the mode of its intervention or the policy instruments it employs. The South Korean case makes it abundantly clear that high trade ratios and relatively outward-oriented incentive structures may be accompanied by a highly intcr- vcntionist state. There is no presumption, such as was once naively held, that outward-oriented and “liberal” regimes are synonymous with luissez- .&ire policies, Hong Kong style.4 Bhagwati even argues that the credibility of outward-oriented policies is greater, and hence appropriate investment is more likely to be forthcoming, when they are actively promoted by an interventionist state than when they are simply the outcome of potentially changeable laixwz~faire approaches (I 987, p. 260).

the close association of the governments of the East Asian economies, and indeed of Japan, with the EP [export-promoting] strategy. provides the kq a.w.wance that governments will not behave erraticali,v. changing their minds and their rules. The assurance supplies the lubrication that is essential for the

TRADE STRATEGY 885

“strategic” pursuit of the development strategy in question.. In short, there is indeed an important role for government even in an EP strategy (Bhagwati, 1986, p. 94, emphasis in the original).

This argument for the importance of governmental commitment, consistency and credibility no doubt holds with respect to any government strategies or policies, whether in the sphere of trade or elsewhere.

The degree of reliance upon market as opposed to nonmarket policy instruments in the pursuit of trade (and other) policies thus seems an obvious further element of measurable differences in trade policies, Market instruments include import and export duties, subsidies, exchange rates, and the like; nonmarket instruments include prohibitions, quantitative physical controls and quotas (whether imposed via import licensing arrangement or foreign exchange controls, or both), moral suasion or directives, etc. An alternative or complementary formulation distinguishes instruments according to their transparency, with market instruments typically more transparent than nonmarket ones. How one measures a government’s degree of reliance upon one kind of instrument rather than another is not so clear. Only at the extremes can one clearly distinguish a market-based regime from a control regime.

UNCTAD collects information on the sheer number of nontariff measures employed by individual countries without attempting to weight their relative importance. There is not yet universal agreement even as to what properly belongs on such a list. Others have used the share of import items not subject to quantitative restriction, usually weighted by value, as a measure of a trade policy’s orientation (World Bank, 1987, p. 100). The weighting system in such calculations is subject to the usual problems: prohibited imports or those whose value is restrained can be severely under- weighted. Better measures would have to be developed if this approach to the characterization of trade policies were to be elaborated, and/or efforts made to correlate them with growth performance. But, as a first approximation, at least on the extremes of practice, it may be usable.

There is obviously further potential here for mutual inconsistency in alternative measurements of the direction of change in trade policies. One can easily imagine, for example, the replacement of quantitative import controls by very high (even prohibitive levels of) import tariffs. According to one measure this would register as trade liberalization; according to another, it would be considered increasing protectionism. One suggested classificatory scheme distinguishes among QR [quantitative restriction]-based and market-based,

and pro- and anti-trade regimes, an amalgam of our incentive structure and policy instrument criteria that yields four “boxes” (Keesing, 1979, p. 140; see also Bhagwati, 1978, and Krueger, 1978).

(d) Subjective liberalizution indices

In a recent World Bank study of 37 “liberalization” episodes in 19 countries (Papageorgiou et ul., 1986), the authors constructed subjective indices of liberalization running on a numerical scale of l-20 for each country. These measures are purely ordinal and cannot be used either for intercountry comparisons or for prescription of adjustment policies for the future. They reflect “quantitative indicators, such as levels and .dis- persions of effective exchange rates, the degree of anti-export bias, etc.; and a wide variety of other indicators that include non-tariff elements and qualitative information about the trade regimes”

(P. 4).

3. MAJOR ISSUES

Interrelationships between external trade and economic growth and development have been analyzed at great length in both the theoretical and empirical literature (to which some references have already been made). This is not the place for a full review of the “engines,” “handmaidens,” “immis- erization” and other theses in this discussion. Rather, a much more selective account of some of the key results and issues seems more appropriate. I shall group them under the following headings:

trade regimes and industrialization; import substitution; export promotion; import liberalization; and other issues.

(a) Trade regimes and industrialization

Particular attention has been devoted in recent research and debate to those elements of trade strategy that relate to industrialization. Partly this is because of the important role universally ascribed to industrialization in the development process. Partly it is because industrial activities are usually (except in the lowest-income countries) those most likely to be sensitive to alterations in the trade policy regime.

Chenery et al. (1986) have documented the rela-


tionship between the measured sources of industrial growth - including import substitution and export expansion in particular - and changes in the trade regime in nine semi-industrial countries in the 1950-75 period. Trade policy “episodes” are characterized as import substitution, export promotion and trade liberalization (where both exports and imports are encouraged to rise together); there is a clear link between changing trade regimes (episodes) and the relative importance of measured import substitution and export expansion in industrial growth over time. Simulations of the performance of a Korea-like, semi-industrial economy over a 20-year time horizon, using a CGE [computable general equilibrium] model, also show clearly the logical link between trade strategy and the growth and structure of such economies (Chenery et al., 1986, chapter 11).

There is also an evident typical sequencing: “periods of significant export expansion are almost always preceded by periods of strong import substitution” (p. 178) (see also Teitel and Thoumi, 1986). The determinants of the length of the lag clearly deserve empirical exploration. Another important highlight is the availability of foreign capital (notably in Israel, Korea and Taiwan) at the time when a shift from import substitution to export promotion was successfully taking place. Particularly striking is the fact that the leading industrial sectors remained largely the same (though different in each country) as the switch from import substitution to export expansion policies and performance occurred in Korea, Turkey and Taiwan; this would seem to lend support to infant industry and/or infant economy arguments for industrial protection, especially when it builds technological capacity and interindustry linkages (Chenery et al., 1986, pp. 1788187 and 224).

Others argue, of course, that this sequencing, or at least the duration of the import-substitution phase, imposed unnecessary costs upon the eventually successful industrial exporters. The Hong Kong experience is usually cited in this regard as an

instance of successful outward-orientation policy.

Thus,

It may be conjectured that the establishment of high- cost firms and the lack of sufficient specialization in the production of parts, components, and accessories behind high protection retarded the development of exports, A particular obstacle to export expansion was the lack of efficient industries producing inputs for export production, given the widespread prohibitions on inputs with domestic substitutes.

During the import-substitution phase in Latin American, countries, productivity also rose less rap- idly than in developed countries. It would appear, then, that import substitution behind high protection has been a negative rather than a positive force in the

subsequent development of Latin American exports (Balassa, 1982, p. 49, emphasis mine).

Chenery et al.‘s CGE model simulations suggest that import-substitution policies (defined in terms of the structure of incentives) reduce longer-term growth rates in semi-industrial economies below those attainable via export promotion or more “balanced” strategies. The main elements of the characteristics and/or assumptions of their three postulated strategies and key simulated results are reproduced in Table 2. What is perhaps most striking about their results, however, is the remarkably small difference in the GDP growth rates - a range of only 0.8%, or 12-14% of the growth rates themselves ~ associated with the three different strategies. This relatively small difference is associated with quite major differences in the measured demand-side sources of growth (as between export expansion and import substitution), and export and import shares of GDP. These results are, of course, consistent with the usual empirical finding of fairly small overall welfare effects (in the sense of Harberger triangles) associated with major trade policy changes. They suggest that trade policy orientation, while important, may not be a domi- nant determinant of growth and may not therefore deserve the attention that the World Bank and others have given it.

Chenery et ~1. are admirably careful to emphasize the susceptibility of their results to the model structure and to crucial assumptions regarding substitution possibilities in production, demand and trade. Not only arc the results ungeneralizable, but they are also highly dependent upon the work- ings of market incentives about which economists, in their present state of their art, think they know the most. Missing from the model are such potentially important issues as the determinants of total factor productivity (TFP) growth, the development of indigenous “technological mastery” in import-substituting activities, and the marketing and other institutional prerequisites of successful export performance (Chenery et al., 1986, pp. 339- 340).

The evidence on the relationship between TFP growth and the trade regime remains inconclusive. Comparisons across countries are unpersuasive since there are so many other influences for which it is difficult to control. There is some evidence suggesting that, within countries, periods of protectionism and foreign exchange controls coincided with periods of only limited TFP growth (World Bank, 1987, p. 92). Total factor productivity growth has been associated more with export expansion than with import substitution in Korea, Turkey, Yugoslavia and Japan. (These results are themselves somewhat mixed -- those

TRADE STRATEGY 887

Table 2. Representative trade strategies and simulated macroeconomic results

Components

A. Trade strategy

Trade policy Sectoral trends

Main policy instruments Trade bias Trade shares

Borrowing policy

Indirect effects Productivity growth Capital goods

Examples (I 960s)

B. Macroeconomic indicators Average ratio of capital inflow

to GDP Ratio of imports to GDP,

terminal period Incremental capital-output ratio,

terminal period Export growth rate Import growth rate GDP growth rate

Import substitution Balanced Export promotion (IS) (R) (EP)

Import reduction Import reduction

Tariffs/import rationing Inward Low/falling

Limited by low exports

Real exchange rate Neutral Constant

Maintain neutrality Sustain trade liberalization

Low/intermediate High cost

Turkey Mexico Philippines Colombia Argentina Brazil

4.5

10.7 18.1 24.0

3.26 3.02 2.95

7.9 10.3 14.1 4.5 6.4 9.3 5.7 6.2 6.5

Intermediate World prices

Israel Thailand Tunisia Greece

4.4

Export penetration/ import liberalization

Real exchange rate Outward Rising

High World prices

Korea Taiwan Singapore Malaysia

4.1

Source: Chenery et al. (1986), pp. 321-322

for Japan are quite different from the rest - and subject to alternative interpretations as to causality. See Nishimizu and Robinson, 1984; Pack, 1988b.) On the other hand, productivity growth in Latin America was frequently higher in the “protected” wartime years than it was there- after (Bruton, 1967). On the face of it, productivity growth in import-substituting Latin American countries was also relatively high during the 1930s. The samples thus far are small and the nature, even the direction, of causality is unclear. This is an area in which more careful historical assessments are needed. Industry-level analyses of the correlates of rapid TFP growth are also obviously potentially fruitful. (Pack’s recent survey reaches the same conclusion, 1988b.)

Further study such as that of Chenery and col- leagues of the concomitants and consequences of changes in trade regime, both in the industrial sector and economy-wide, with particular attention to the sequencing of structural changes and the

role of foreign exchange availability therein, would certainly be fruitful. It seems remarkable, in light of the subsequent accumulation of experience and debate, that there has been so little detailed further study of these issues after the Little, Scitovsky and Scott (1970) Bhagwati (1978), Krueger (1978) and Balassa (1982) contributions. Even these useful earlier analyses were based on limited samples of countries and historical experience.

(b) Import substitution

Import substitution has been the natural first stage of industrialization, accounting for the vast bulk of recorded industrial expansion in the developing countries in the 20th century (Maizels, 1963; Batchelor et al., 1982). Some of this has been the product of natural evolution, periodically offered a fillip by wars or balance-of-payments crises. That portion which has been achieved via conscious


governmental “import-substitution strategy,” particularly in the post World War II period, has been the object of severe criticism. Properly interpreted and implemented, however, the strategy made and continues to make considerable economic sense in terms of efforts to create ‘Lan economy that is sufficiently flexible, diversified, and responsive that it can weather shocks, can respond to and indeed create opportunities for growth, and can, on its own, generate continually increasing welfare for its people” (Bruton, 1989, p. 1602). Virtually all successful exporters of manufactures except Hong Kong began their industrialization with import substitution under significant protection. Pro- tection in support of import substitution may be usefully thought of as a temporary, and obviously costly, device to assist in the restructuring and development of an infant economy. Its costs are unfortunately, in practice, more certain than its ultimate benefits.

Protection is a means of inducing diversification and the learning upon which development is based. More accurately, perhaps, it is a means of creating a process of development that builds on search and learning. The goal is to create an economy with the capacity to move in various directions as opportunities are provided and new knowledge is accumulated. When such capacity exists, the economy can then seek to concentrate or specialize, because with such capacity it can more readily opt out of a declining sector into one that is recognized to be expanding. If that capacity is lacking, rapid, unanticipated changes are likely to impose major costs on the community (Bruton, 1989 pp. 160551606).

protection generally imposes short run costs on the economy.. The shorter the period of import substitution as a development strategy.. the less its cost and the higher the return on the investment. This means that the ending or phasing out of import substitutes is an essential part of the strategy itself (Bruton, 1989, p. 1607).

Import-substitution policies clearly should therefore avoid needless distortions and defiance of traditional static allocation criteria, and should promote learning processes. The simple replication of foreign productive processes on domestic soil under heavy protection is unlikely to be fruitful. That policy makers typically know little about scale economies, externalities, or the prospects for learning and productivity growth in particular industries is frequently taken as an argument for uniform incentives for all. Moreover, first-best policy would involve targeting subsidies directly toward the sources of social gain. But some knowledge does exist in autonomous and well-run government bureaucracies in some countries; and first-best policies may be fiscally or otherwise difficult. The interindustry dispersion of incentives

in the “successful” East Asian industrializing countries has been high; industrial policies have been both selective and successful (Westphal, 1982; Pack and Westphal, 1986; Wade, 1985 and 1988). Have all other countries so little hope of doing as well? and, if so, precisely why? What have been the most (and least) cost-effective instruments of such import-substitution policies in specific industry and country cases?

Import-substitution (or self-sufficiency) objectives seem to have been much more respectable in orthodox circles in the food and energy sectors than in manufacturing. In part, this may be attributable to a recognition of the important, and relatively increasing, role of transport costs and thus the prospect of a continuing rise in the gap between f.o.b. export and c.i.f. import prices in these sectors. More fundamentally, it probably reflects recognition that risk aversion or, more properly, national security is a legitimate element in development planners’ objective functions, at least with respect to some sectors.

(c) Export promotion

The principal point of export expansion in medium-term adjustment programs is to earn foreign exchange for import-strangled economies. Obvi- ously, efficient import substitution also achieves that objective, and thus may contribute equally to the bottleneck-breaking and increased capacity utilization that exporting can engender. The theoretical reason for such association as has been found between export growth and overall growth thus remains rather mysterious (Krueger, 1981). Export enthusiasts properly emphasize the potential for scale economies (especially in small countries); and, more controversially, the positive productivity effects of exposure or access to international tastes, technology and competition. Such explanations relate primarily to manufactured exports. On the face of it, an indigenous capital goods sector, broadly defined (to include even human capital), seems more likely to contribute to learning processes and the development of an indigenous technological capacity than exports quu exports (Bruton, 1989). On the other hand, in many cases and particularly in small countries, exports may constitute the only reasonably efficient means of shifting the sectoral composition of output away from traditional primary activities and thus deriving “dynamic” benefits from industrialization.

Certainly, the development implications of expanded exports of one kind are unlikely to be identical to those of another. Conventional advice typically fixes upon the extra desirability of “nontraditional” exports. Part of this stems from the

TRADE STRATEGY 889

frequent desirability of export diversification. (Where all are diversifying into one another’s “traditional” products, however, the gains from such “nontraditional” export expansion may be quite limited. For an excellent survey of the recent record of export diversification and the issues it raises, see Bond and Mime, 1987.)

Ultimately more important are the kinds of considerations emphasized in an earlier literature on the “staple theory” (Watkins, 1963). As has been seen in the discussion of import substitution, some economic activities may be more “developmentally nutritious” than others - in terms of the gen- eration of positive externalities, learning effects, equitable income distribution, and the like. If exports are to be expanded, and if there is room for policy choice, better some export activities than others. Unfortunately, knowledge either of the choice set in particular countries or of the developmental attributes of particular activities is fairly limited. It would undoubtedly be useful nonetheless for country studies (and policy makers) to attempt to search out the broader or longer-run implications of contemplated or newly expanding nontraditional exports. Such investigations would ideally seek to move well beyond such obvious and traditional considerations as the unskilled labor- intensity of exporting industries and firms.

Also of concern in current medium-term adjustment discussion is the “adding-up” or “fallacy of composition” problem. It is certainly true that world prices are “given” to small countries, and since they can do nothing about them, they must respond to current ones as best they can. But they must also use information other than current prices when they seek to forecast market prospects. Particularly must they worry when investments involve heavy fixed costs and long gestation periods. The prospect of several developing countries simultaneously expanding export volume in similar products, whether primary or manufactured, particularly during a period in which OECD growth is expected to be slow, is one that must be analyzed in detail. Primary product prices may suffer and protectionist barriers to manufactures increase in consequence of widespread and uncoordinated efforts at export growth. Even Bhagwati, among the most enthusiastic and influential of trade liberalizers, acknowledges that the international economic environment may be an important determinant of the efficacy of outward- oriented policies (1987, pp. 260 and 269-283) although he believes modern “export pessimism” to be unjustified. (A little inconsistently, he also argues that export subsidies cannot be employed by developing countries because of the ubiquity of antidumping and countervailing duties in the industrialized countries.) There is recent econo-

metric evidence that the positive growth effects with which export expansion had previously been associated were significantly damped in the post- 1973 period (Rana, 1988; Singer and Gray, 1988; Kavoussi, 1985). Export strategy must therefore be carefully constructed; and global-level information about market prospects coordinated and made more widely available.

Entry into “new” world markets can be difficult. Unfortunately, one cannot always assume that products sold on domestic markets are readily tradable on international ones. Tastes, quality standards, and marketing requirements may be quite different in the two markets. The institutional and nonprice requirements for effective world market penetration can therefore be quite stringent (Keesing and Lall, 1988). There appear to be systematic relationships between firm size (and thus domestic market structure) and the composition of the manufactured export bill. South Korea’s large firms have been more effective selling high quality exports than Taiwan’s small firms, though both countries have been highly successful exporters overall (Rodrik, 1988~; Levy, 1988).

The keys to successful expansion of exports seem so far to have been realistic and stable real exchange rates and sustained governmental support, not import liberalization and laissez faire. That even appropriate exchange rates have not, of themselves, been sufficient for good export performance is an important recent empirical finding (Fishlow, 1987). As is by now widely recognized, the export- promotion policies of Korea were successfully undertaken by a thoroughly dirigiste government simultaneously employing tight import controls and a tightly regulated capital market. “The Asian experience.. suggest(s). . that successful development might be helped as much by raising the quality of public sector management as by pri- vatizing public enterprises or liberalizing markets” (Sachs, 1987, p. 294).

Domestic protection may make it easier for firms to penetrate export markets (even to start up for export when there is no prior production) by creating profits with which to meet fixed costs and permitting, at least until antidumping laws are deployed against them, export sales at prices below average costs (Krugman, 1984; Rodrik, 1988a, pp. 2628). Further,

To achieve an open development strategy with strong reliance on manufactured exports calls for more than an appropriate choice of policies. Initial conditions are important, and more than just trade policy is involved. an open development strategy if successful, demands a difficult balancing of forces and careful timing. The gains from success are great, but the difficulties of managing the required structural changes and concomitant pressures on the balance of


trade are also great (Chenery et al., 1986, pp. 224- 225).

The efficacy of export subsidies as an important weapon of trade policy clearly has emerged as an important new area for debate. Granting the greater administrative ease of currency devaluation for the purpose of rectifying anti-export bias, and always allowing for the possibility of optimal export tariffs on some traditional products, there may nonetheless be an important case for targeted/selective export subsidies, either explicit or indirect, for infant industry export promotion. Such selective export promotion was an important element in Korean penetration of overseas markets for its manufactured exports (Westphal, 1982). Research on alternative stabilization programs has also highlighted the efficacy of targeted export subsidies as an important short-term stabilization policy instrument (Taylor, 1988).

More recently, strategic considerations have also been introduced into the debate over export subsidies. Under certain assumptions - oligopoly, Cournot behavior (assuming other firms’ output behavior parametric), fixed number of firms, constant marginal costs, etc. - export subsidies may generate higher market shares and thereby increased social welfare (Brander and Spencer, 1985; Krugman, 1986). While these theoretical results have not proven very robust to variation in assumptions, others, more descriptive of developing countries’ circumstances, e.g., individual countries’ quest for textile and other quota rents, may be more so; and the empirical relevance of these arguments has not yet been adequately explored. (For some recent explorations of these issues in the context of Brazilian civil aircraft and Korean semiconductors see, respectively, Baldwin, 1988, and Yoon, 1988.)

Still at issue as well is the appropriate international legal regime concerning export subsidies. Abuse of antidumping and countervailing provisions under the GATT and/or evasion of their provisions via “voluntary export restraints” have been costly to many developing countries. The fact of costly “process protection” in major markets, not only via GATT-illegal measures but via others as well, and the prospect of continuing uncertainty regarding market access constitute important dis- incentives to the encouragement of exports.

(d) Import liberalization

Current Western orthodox orientations and the dominance of the World Bank and International Monetary Fund have ensured that the principal trade strategy issue in current adjustment debates,

whether or not it is objectively the most important, concerns the efficacy and/or timing of import liberalization. The World Bank’s missions typically rec- ommend the ealiest and fullest possible import liberalization, beginning with the replacement of quantitative import restrictions by tariffs, thereby creating both government revenue and greater transparency of incentives. Following the phasing- out of controls, reduction in the levels and dispersion of tariffs is urged. Balassa used to rec- ommend a desirable sequence for semi-industrial economies running from

First, a partially compensated devaluation, invrlving the imposition of optimal export taxes, togethc. :+h a reduction of differences in incentives between mar,“- facturing and primary activities and between sales in domestic and foreign markets. This would be fol- lowed by the replacement of quantitative restrictions by import tariffs, reductions in the level and the dispersion of tariffs, and eventually the equalization of tariff and subsidy rates (Balassa, 1982, p. 77).

The timing of these moves and the duration of the entire sequence remained unspecified in this formulation. In more recent writings, many orthodox analysts have moved toward less gradual and more compressed liberalization programs. Grad- ual liberalization via pre-announcement of forthcoming policy change is still sometimes rec- ommended, but there have been too few actual instances of such policies for any firm conclusions to be drawn about their efficiency (Papageorgiou et al., 1986, p. 11).

Many have noted the critical importance of fav- orable macroeconomic conditions (e.g., capital inflow, terms of trade), weather, etc. in the timing of successful major policy changes such as import liberalization or currency devaluation. The World Bank itself has recently argued:

The more ambitious and long-lasting liber- alizations - in Portugal, Greece, Spain, Israel, Chile and Turkey ~ all started with macroeconomic stabilization. The countries which have tried to liberalize trade in the midst of macroeconomic crisis have failed The evidence also stresses the importance of balance of payments equilibrium once trade liberalization is under way. A large deficit involving a substantial loss of foreign exchange reserves is almost sure to undermine trade reform.. what seems to matter most to successful liberalization is export performance (World Bank, 1987, p. 109; see also Papa- georgiou et al., 1986, p. 15).

The link between export expansion and import liberalization, however, is one that remains controversial - even within the Bank. Some of the protagonists in this debate have altered their views over time. Advocates of “shock” treatment for the trade regime - as well as other reforms - are at present in the ascendancy. A prominent Bank

TRADE STRATEGY 891

economist recently put the case:

Experience. suggests that future reforms ensure that export expansion programs be accompanied by import liberalization.. Experience.. does nof in our view suggest that import liberalization should be undertaken only after export reforms have increased the supply of foreign exchange. This kind of sequencing is likely to be self-defeating, since it is extremely difficult to reorient producers toward export markets as long as heavily sheltered domestic markets offer them assured profits (Michalopoulos, 1987, p. 45).

There appears to be agreement, in principle,

at least within World Bank headquarters, that stabilization, if not necessarily improved export performance, needs to precede such structural adjustment if the latter is to succeed. In practice, however, countries are typically pressed for maximum policy reform packages at the earliest

possible time. Despite much research and rhetoric regarding the appropriate phasing of policy changes, the Bank’s missions have frequently sought shortcuts through normal stabilization and development experience. Sachs has noted that the “lessons” from East Asian experience in respect of the transition from stabilization to liberalization, if they are transferable at all, are quite to the con- trary:

(i) there is likely to be a long time interval between stabilization and successful exporting or liberalization effort;

(ii) substantial external financial assistance is likely to be an essential element in successful transition;

(iii) import liberalization is likely to follow successful exporting with a fairly long time lag, and is not an essential or typical part of successful export-promotion efforts;

(iv) the public sector is likely to play an important role in the shift into successful industrial exporting (Sachs, 1987, pp. 303-3 10).

In the short run it may be more productive in many countries to assist in streamlining and increasing the efficiency of foreign exchange control and management systems (however faulty they may remain) than to promote overall decontrol. Import decontrol is likely to be both easier to sell and more productive at later stages of a medium-term adjustment and recovery program. At such stages, legitimate debate about the longer-run (“normal”) role of administrative as against market-oriented policy instruments can be expected; and its outcome will vary from country to country. To advocate decontrol and liberalization during periods of foreign exchange crisis is to risk the imposition of even

greater economic costs and increased popular unrest upon an economy already operating under stress and below capacity. Even if their relative importance in the import bill is small, the reappear- ance of luxury consumer goods as a consequence of liberalization or the introduction of foreign exchange auctions may constitute important sym- bols and carry important political consequences.

Beyond “tariffication” of quantitative restrictions, on which many can agree because of the quasi-rents and corruption often engendered by controls and the build-up of stock demand for imports causing potential future problems, further efforts toward “liberalization” or laissez faire are considerably more controversial. There exist respectable arguments for non-uniform incentive structures as second-best policies for a second- best world (Diaz-Alejandro, 1975; Krueger, 1984). Modern trade theory has by now knocked the struts from under the conventional arguments for the uniformity of treatment that free trade achieves.

To the extent that there are lessons from recent historical experience, they certainly do not include the efficacy of neutral incentives. About as far as one could go in the liberals’ direction is to note the heavy costs of significantly overvalued currencies and excessive levels of protection. Moreover, in poor countries where import tariffs are an important source of government revenue and fiscal con- straints are daunting, one cannot easily con- template major across-the-board tariff cuts unless one has first found alternative sources of revenue.

Krugman has recently put a new and more theoretically sophisticated case for liberal (free) trade. Abandoning the traditional comparative advantage arguments based upon the assumption of efficient markets, he posits instead a world in which the sophisticated trade (and other) interventions for which “the new trade theories” call are likely to be difficult to implement, low in their returns, and subject to hijacking by special interests. Simple policy rules are best “in a world whose politics are as imperfect as its markets” (Krugman, 1987, p. 143). This stands previously conventional approaches on their head. Whereas political influences used to be blamed for the inability of governments to pursue rational free trade policies, now political factors are deployed to defend free trade policies against the rational economic arguments for sophisticated intervention. But his advocacy of simple policy rules would also seem to permit, say, 30% across-the-board industrial tariff protection.

The effects of liberalization on overall output and welfare, according to orthodox trade theory, are primarily the product of improved allocative efficiency and are once andfor all in their nature. When measured in the conventional manner -


via “Harberger triangles” - they are typically remarkably small, rarely as much as 5% of GNP. Technical efficiency and scale effects may easily dominate those relating to allocative efficiency. Even allowing for reduced general equilibrium “distortion” effects and reduced costs of rent-seek- ing activities leaves the allocative efficiency effects limited. Rodrik convincingly demonstrates the crucial significance of freedom of exit and entry to the potential for industry rationalization from trade liberalization (1988a, 1988b). Simulations of the effects of liberalization where there is frictionless entry and exit can generate quite large productivity improvements. But, he concludes, “There is as yet no convincing empirical evidence for developing countries that shows liberalization to be conducive to industry rationalization” (Rodrik, 1988a, p. 26). Nor is macroeconomic stability, which may also be conducive to productivity improvement, obviously related to the trade regime.

The impact of liberalization upon ongoing technical change - the principal element in measured economic growth over longer periods - is theoretically ambiguous and empirically uncertain. “ to date there is no clear cut confirmation of the hypothesis that countries with an external orientation benefit from greater growth in technical efficiency in the component sectors of manufacturing” (Pack, 1988a, p. 38; see also Bhagwati, 1988, pp. 3940).

Schumpeterian approaches might even suggest that protected monopolies innovate the most. Only when import-competing entrepreneurs can be assumed to “satisfice” rather than optimize, or to have backward-bending labor supply curves, are x- efficiency improvements from import liberalization theoretically plausible; and, even then, parallel exporter behavior would severely damage the overall case for it (Rodrik, 1988b). Scale economy effects from import liberalization may, similarly, go in either direction. Those deriving from export expansion can be achieved via appropriate exchange.rates (unified or dual) or export subsidies, and are not necessarily related to the import regime.

The costs of adjustment to liberalized trade policies have always been a matter of policy concern, even though their size - like those of the welfare triangles - is generally measured as small. They are likely to be concentrated in particular industries and regions, and borne primarily by displaced labor. The results of the World Bank’s research on relatively mild liberalization episodes suggest that liberalization-related unemployment has not normally been significant in reversing trade liberalization policies; far more important have been balance of payments and macroeconomic policies and performance (Papageorgiou et al., 1986, pp.

14-15). Nor have labor shares of GDP or of manufacturing value added necessarily altered in one direction or another. The Chilean experience of the late 1970s suggests, however, that a rapid change in the trade regime can generate heavy (gross) unemployment in the manufacturing sector.

There is evidence that small-scale producers are typically hurt more by liberalization than are large-scale producers. There are also indications that, where import-competing producers possess domestic market power (at least in the short to medium run), liberalization may transform them into importers, leaving domestic prices unchanged. Income distributional consequences of liberahz- ation measures may thus be more complex to un- ravel than oversimplified models suggest. More empirical investigation would certainly be helpful.

The appropriate place of trade “liberalization,” however defined, within a sequence of policy reforms aimed at the overall “liberalization” of economies more generally, has been the object of considerable recent research attention, particularly in the World Bank and particularly on the Southern Cone countries. The emerging consensus from those engaged in this research seems to be that the appropriate sequence of liberalizing policy reforms, in order of implementation, is: (I) fiscal discipline; (2) “freeing” the labor market (i.e., allowing real wages to fall); (3) “liberalizing” goods trade, including external trade; (4) “liberalizing” domestic financial markets; and (5) “liberalizing” the external capital account (see, for instance, Choksi and Papageorgiou, 1986). Im- plicit in this sequence are caveats with respect to import liberalization. prior to the restoration of internal balance. For those who take merely as hypothesis the premise of these researchers that overall liberalization best promotes economic growth and development, there does not appear to be much more that can be drawn from these results.

Where import penetration has increased (for the economy as a whole or for particular sectors), or import controls relaxed, or incentives unified, it is important to attempt to assess the short- to medium-term effects on (i) real output and employment; (ii) total factor productivity, firm exit, entry and restructuring, and market structure in the liberalized sectors; (iii) price levels in the liberalized sectors and the overall rate of price inflation; (iv) income distribution, notably the disposition of former quota rents. One should also assess the role of the speed of policy change, concomitant or prior policy changes, country characteristics, and/or exogenous influences upon these outcomes. There is urgent need for case study materials of a comparative kind that may be able to shed more light on controversies that at present feed mainly on theory and selected anecdotes.

TRADE STRATEGY 893

(e) Other issues

(i) Distributional effects The orthodox presumption is that increased out-

ward orientation will shift resources toward more labor-intensive activities in which developing countries have comparative advantage, thus con- tributing to greater formal sector employment and improved distributional equity (Krueger, 1983). In many low-income countries, resource shifts toward smallholder exporters can be expected, with similarly beneficial distributional consequences. But export sectors may instead be dominated by land- owning elites or large (frequently foreign-owned) firms, so that these presumptions are subject to serious challenge in particular countries. Since nontradables are typically labor intensive, restructuring toward tradables (even if particularly directed at more labor-intensive exports) may reduce employment and labor incomes. Moreover, labor-intensive informal sectors are found both in tradable and nontradable sectors. Simulation of similar policies in different types of economy have shown the danger of simplistic generalizations in this sphere (de Melo and Robinson, 1982; see also Addison and Demery, 1986).

(ii) Optimal transitions “Shock” alteration of trade strategy is con-

trasted in the literature with gradual change. Those who have dominated recent decision making in the International Monetary Fund and World Bank argue that the credibility and therefore the sus- tainability of policy reform is enhanced by strong action at the outset. Smaller, more gradual, changes are likely, in this view, to be easily rolled back and indicate a lack of governmental commitment. This view is purportedly supported by still unpublished research on 39 liberalization episodes (Papageorgiou et al., 1986). It can equally be argued, however, that targets and policy changes that are modest, but firm and realistic, are likely to be more credible and sustainable than large changes that are, to a degree, “leaps into the unknown.” Moreover, cutbacks in the “liberalized” sectors are easier to accommodate when growth in other sectors is already underway rather than merely devoutly hoped for. Attempts at “forced marches” toward large-scale policy change may strain governmental capacity and strengthen the impression, dangerous in local politics, that the policy program is externally imposed rather than internally generated.

(iii) Adaptability to external shocks Another key issue in recent debate over trade

strategy concerns the adaptive capacity of developing countries with different trade regimes and

strategies in the face of exogenous macroeconomic shocks. Balassa’s energetic proselytizing seems more or less to have carried the day in the mainstream literature - in favor of outward-oriented strategies (Balassa, 1984, 1985b). But this “vic- tory” has been by default. Alternative analyses have been few; and Balassa’s evidence is far from conclusive. For instance, Fishlow has noted the far greater importance of external shocks, particularly financial market shocks, relative to exports in the relatively less successful Latin American countries, and the bias implicit in Balassa and others’ use of shocks measured relative to GNP (Fishlow, 1987). On the face of it, one would expect many other dimensions of economic structure and the overall level of development to dominate trade orientation in influencing the capacity to adjust to shocks. The structure of the export bill (Bond and Milne, 1987) the structure of the import bill and other determinants of the capacity to import (like capital flow and debt service) are deserving of at least as much policy attention in this respect as the degree of outward orientation per se.

Obviously, other factors, not least the quality of macroeconomic management and access to external credit, are of critical importance. The instability of import volume is statistically significantly related to longer-term growth rates in low- and middle-income countries of Africa and Latin America in the 196&80 period (in some recent analysis at the University of Toronto, see also Helleiner, 1986), and to savings rates in Latin America more generally (Leff and Sato, 1987, p. 565).

(iv) Direction of trade Trade strategy may consciously incorporate

directional objectives as well as the commodity- compositional ones to which reference has already been made. To the degree that developmental objectives are met via the pursuit of directional objectives, two birds may be killed with one stone. Thus if learning is achieved better in the skill- intensive manufacturing destined for markets in other developing countries than in production for export to the North, as Amsden (1986) suggests, the cultivation of South-South trade will also have positive growth effects. Production and consumption technologies developed in the developing countries are also more likely to be suitable for use in other parts of the developing world than in the North; and may be seen as more “appropriate” in other developing countries than competing processes and products from the North (Stewart, 1976). Where import substitution efforts are planned, there may also be joint gains from “industry-swapping” to take advantage of potential scale economies. Moreover, both growth prospects


and income elasticities of demand for the relevant export products may be higher in parts of the developing world - though demand may also be more unstable - than in the North. The record of economic integration or preferential trade agree- ments among developing countries has not been a very promising one, but there remain solid economic, as well as noneconomic, arguments for continuing to try to develop them. Recent Argentine- Brazilian cooperation in the capital-goods sector and ASEAN experience in others suggest that experimentation with such schemes will continue. (For a more skeptical account, see Havrylyshyn, 1985.)

4. CONCLUSION

Many gaps in our knowledge of the role of trade strategy in growth-oriented adjustment and longer-term development have been identified in the above account. At the most general level, what seems to emerge from this survey is the need for a fresh review, of fairly major propor- tions - analogous to those of the OECD Develop- ment Centre (Little, Scitovsky, and Scott, 1970) and the National Bureau of Economic Research (Bhagwati, 1978; Krueger, 1978) some years ago - of experience and knowledge of the interactions between trade and other policies, and their joint effects upon industrialization, growth, and development.

Such a review would be particularly valuable if it:

NOTES

1. Note that export and import shares are influenced by the structure of relative prices, particularly the exchange rate. Not only may this cause difficulties in the interpretation of both cross-sectional and time series analysis, but it also implies that constant and current price series generate different share data.

2. This is usually measured as:

where X, and M, are exports and imports of industry i, respectively.

3. This has also been formulated, by Krueger, as

(4

(b)

(cl

(4

traced the evolution (and, where appropriate, cycles) in national policies and experience in particular industries and countries over time; avoided prejudgments about the relative efficacy of specific trade and other policies in general; and instead explored the specific circumstances in which particular policies, instruments, and policy mixes were less or more effective; devoted particular attention to phenomena that have received relatively less research attention in the past but are now prominent in both theoretical and policy debate on trade, adjustment, and industrialization policies. e.g.: / u

6)

(ii)

(iii)

(iv)

(v)

market structure, firm size, ownership (foreign/local, state/private, etc.) and policy relating to them, technical change, learning, and technology policy, spillover effects, both positive (learning) and negative (environmental), interaction with macroeconomic experience and policy, including exogenous shocks, impacts upon poverty and income dis-

tribution; and

avoided oversimplified and overgeneralized

analytical frameworks such as the dichotomous categorizations currently in vogue in the World Bank and much of the academic literature.

or

where the Ps refer to commodity prices, VAs to activities’ value added, the superscripts refer to domestic (d) and world (w) values, and the subscripts to import-competing (M) and exporting (X’) commodities or activities. The “normal” anti-export bias yields a value of these ratios that exceeds unity.

4. It also proves difficult to find any systematic correlation between the political complexion of countries and their degree of outward orientation. “Liberalization” has been the cry of radical reformers as well as con- servative Chicago-bred advisors (Diaz-Alejandro, 1981).

TRADE STRATEGY 895

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