The indirect approach to trade liberalization: dynamic consideration on liberalization-cum-stabilization policies in Latin America

World Development, Vol. 16, No. Printed in Great Britain.

8, pp. 883-897,

0305-750X/88 $3.OU + 0.00 0 1988 Pergamon Press plc

1988.

The Indirect Approach to Trade Liberalization: Dynamic Consideration on Liberalization-cumStabilization Policies in Latin America

Ibero-America

HEINZ GERT PREUSSE* Institute for Economic Research, Goettingen,

West Germany

Summary. - Recent experience of some Latin American countries has shown that a switch to an outward oriented development strategy involves difficult adjustment prohlems. These problems may overburden the economy’s adjustment capacity when the heritage of an extended period of import substitution has to be overcome together with severe macroeconomic imbalances. When these conditions apply, priority should be given to the elimination of the anti-export bias (even at the expense of new temporary export subsidies) and of the macroeconomic disturbances, before trade liberalization in the proper meaning of the word would have to bc realized.

1. INTRODUCTION It is widely accepted today that less developed countries (LDCs) should integrate into world markets after an initial period of import substitution in order to benefit from trade and to promote economic growth and development.’ While there is little doubt concerning the positive effects of international trade on income and wealth in the long run, transition from an inward to an outward-looking strategy appears to be complicated and painful. Some Latin American countries which tried to replace traditional import-substituting policies by an open trade regime in the 1970s did not manage to overcome these difficulties and even had to reverse their liberalization programs in the early 1980s. In this paper some of the critical points of trade liberalization policy will be analyzed with reference to the experiences in the Southern Cone countries (Argentina, Chile, Uruguay) and Peru. In these countries severe macroeconomic imbalances had to be corrected together with the reformation of the system of incentives.’ Two different but interrelated questions will be raised. First, is there a case for a gradual approach to trade liberalization in LDCs’? Second, is it advisable to foster anti-inflation and trade liberalization policies simultaneously? In Section 2 the optimal sequence of trade liberalization will be discussed. In Section .7 the empirical evidence from Peru and the Southern Cone countries will be analyzed.

It is suggested that an indirect approach to trade liberalization and a well defined sequence of macroeconomic and liberalization policies should allow the critical period of transition to take place with relative stability and growth. This would be the appropriate answer to the adjustment problems which frequently arise in countries switching from import substitution to export promotion.

2. DEVELOPMENT POLICY LIBERALIZATION

AND TRADE

Due to the beneficial effects of free trade, opening-up to the world market as soon and as fast as possible has become an important element of many development strategies. However, switching to an outward-looking strategy after an extended period of import substitution calls for major changes in the structure of production and in the distribution of income. Carrying out these changes has proved to be a difficult task. One of the most important problems which have to be managed during the transition period derives from the fact that costs of the reallocation process do arise immediately when existing capacities are scrapped and workers released who will *The author Paus and the for Economic for the very 883

would like to thank members

Helmut Hesse. Eva of the Ihero-America Institute

Research of the University of Goettingen helpful discussions.

Exports

not always gain proper access to new employment opportunities. Yet. the gains which can be expected from opening up to the world market will be fully available only in the medium and long run’ when the adjustments of the productive capacities according to the country’s competitive position on the world market have been carried out. Those who will remain in the (relatively) declining sectors and those out of the total of dismissed workers who will not find a job in the exporting industries will have to hear the costs of the liberalization process without being able to participate directly in the gains from trade.4 TB

(a) Critical points of trade lihrralixtior~ The process of change during the course of economic growth will only take place smoothly when the industries with a growth potential rise fast enough to absorb the factors of production which arc released from shrinking industries. Such a synchronized development cannot always be expected when a general liberalization of imports challenges a large part of national production immediately while new competitive export industries are emerging only s10wly.~ During the lag period between the almost immediate rise of imports and the slowly emerging new exports. the costs of trade liberalization become effective in the form of temporary unemployment. These costs will become higher, the larger and the longer-lasting is the unemployment effect of trade liberalization. Apparently there is a close link between the level and the durability of uncmploymcnt on the one side and the development of imports and exports under the new trade regime on the other side: the greater the pressure on national industry imposed by new imports and the less rapidly export expansion will provide for new jobs, the greater and the longer-lasting will be the trade deficit and unemployment caused by trade. Disregarding any other impact on employment and supposing that wages foregone constitute the most important determinant of the total costs of adjustment, the dcvclopment of the trade balance after the implementation of the liberalization program can, by and large, be used as an indicator for the costs of trade liberalization. In Figure 1 a simple stylized geometrical exposition of these considerations is given. Balanced trade is assumed vvhen trade is liberalized in period t,.. The development of exports as given by F_X”A is seen to be exclusively determined by > the lag period of adjustment of the national structure of production to world markets. Exports based on comparative advantage are rising

= Trade

Ex”=

I

balance

Elports

IA-4

= Imports

t,

= Period

hosed

Of trade

on tOmparOtlYe

advantage

~,beral,zatlon.

Figure

1.

slowly6 at the beginning and become a dynamic force only after the initial restructuring procedures have been carried out successfully. Imports (IM) are supposed to be rising rapidly after a short time period’ and then they return to a moderate rate of growth at a relatively high level? Under these conditions the trade balance will improve slightly during the lag period of imports, but it will deteriorate strongly when the abrupt increase of imports takes place. Recovery will start only slowly but will accelerate in later periods when exports are rising more dynamically. The trade deficit will become larger the bigger is the import-competing sector relative to the exporting sector and the higher was the discrimination of imports when the liberalization program started; and it will recover the more hesitantly the slower the new export-oriented structure of production is established. There are a number of reasons why the shortrun elasticity of supply of exports tends to be low in most import-substituting LDCs. First of all, before new competitive export industries based on comparative advantage can actually emerge on ii broad level some timc-consuming reallocation and upgrading procedures have to be carried out and, to make things worse, as the infant industrv argument inasmuch applies, even the skills and physical jnputs which are necessary for export production may not be available within due time. Second, the so called Linder hypothesis” lends support to the expectation of a relatively low rate of export expansion at the beginning of the liberalization period. Linder claims that new industries have to pass through a period of production for local markets before they can venture to turn to the world mar-

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kets. This initial learning period is followed by still another one during which the new exporters have to gain experience and establish contacts throughout the world. Argentina, Chile, Uruguay and Peru were facing some other problems during the transition period compared with those countries which opened up to the world market after a relatively short period of import substitution. On the one hand, the authorities in these countries mainly disregarded the dynamic link between initial infant industry protection and subsequent liberalization and stimulated national industries without due consideration of future comparative advantages. It even has been argued that the development strategies of most Latin American countries were in fact intended to separate the national manufacturing sector from the world market.‘” Under these conditions, in response to heavy governmental assistance, a number of industries emerged, which could not be expected either to compete successfully on the world market or to produce efficiently for the local market. Instead of catching up, the national manufacturing sectors could not keep pace with international economic developments and after a short period of prosperity - lost competitiveness again. As a result many characteristics of economic backwardness still apply to the Southern Cone countries and Peru despite the existence of industrial manufacturing sectors of relative quantitative importance.” On the other hand, these four countries are already endowed with a relatively qualified labor force and a well educated population, and manufacturing production, albeit relatively inefficient under the prevailing conditions, has a long tradition. The speed of the restructuring process will therefore not so much be limited because of the complete non-availability of skilled labor, but because of the time needed to change the sectoral composition of output. Under these circumstances it seems to be a promising strategy at a first glance to foster traditional low skill labor-intensive industries such as textiles, clothing and shoes. However, wages in these countries are already relatively hi h as compared to Southeast Asian competitors ,B and real wage resistance has been frequently observed. Under these conditions comprehensive efforts to upgrade a number of second stage export industries” rather than downgrade to the basic non-traditional ones appears to be a more promising policy target. This strategy would certainly help to minimize sectoral adjustments, as a number of industries would be enabled to survive, which otherwise would have to fade out, but it would also critically depend on the success

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88.5

of a rapid upgrading process of the respective industries. In any case, adjustment would not take place instantaneously. Due to the diverse obstacles to change and the severe factor distortions, low rates of economic growth prevailed in each of the four Latin American countries before the reformist programs of the mid-1970s were actually started (Table 1). Low or even negative rates of growth of income per capita, however, form still another impediment for a successful liberalization policy for a number of interrelated reasons. First, inasmuch as structural adjustments go hand in hand with growing income, production and employment. the burden imposed on those to be dismissed in shrinking industries can be minimized, because even relatively shrinking industries may be able to sustain output growth and employment.‘” Second. private investors will accept temporarily idle capacities due to indivisibilities of the capital goods more easily (and they will be ready to invest more aggressively) the more steadily and rapidly final demand is growing. This argument becomes more important the more closely technical progress is linked to larger capacities.” Third, output growth plays an important role in the investment functions which build on the accelerator hypothesis. It is claimed that steadily growing markets are the most reliable guide for investors in an otherwise even less reliable future. Altogether, these arguments underline the hypothesis that private investors’ propensity to invest and workers’ attitude towards changing conditions of life tend to be positively related to the stability of total demand and its rate of growth. The positive correlation between growing markets and the adjustment flexibility of capital and labor signifies that liberalization policies have to face relatively unfavorable conditions in stagnant economies. This point becomes particularly important for LDCs which are trying to integrate into the world market. Since newly exporting firms depend heavily on the local market during the initial learning period, this maturing process will proceed more slowly the worse is the national economic performance. As a matter of fact, the resource pull towards the exportables sector will also proceed slowly and the expected gains from free trade will be delayed. This negative effect of stagnant national markets on export expansion will become more important the less integrated into the world market the country has initially been. When a poor creditability of government policies adds to this critical situation entrepreneurs may even refuse to adjust to the new policy framework and wait (or even work) for its abol-

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ishment. In this case, even the economically and technically possible movements of the factors of production will not be brought under way. In the Southern Cone countries and Peru the economic framework has frequently been subject to radical but short-lived reforms so that any new approach will find a more skeptical audience than its predecessor. Structural changes in the real sphere are likely to take place only slowly and hesitantly under these conditions and the development of new competitive export industries will only proceed at a relatively low rate.

(b) Inflation and trade liberalizution polic_y In many LDCs inflation is one of the core problems of macroeconomic policy. High and fluctuating rates of inflation effectively hinder the process of capital accumulation; they seriously affect the allocation of resources and the distribution of income and wealth, and they undermine the predictability of economic, social and political developments. Thus, policies to fight inflationI represent another important area of concern for development policy. Without going into a detailed discussion of particular strategies to attack inflation, suffice it to suggest that stabilization policy is required “to keep real demand within the limits of potential wage and price supply and to moderate increases.“” Such a policy may be successfully applied without an absolute reduction of aggregate demand (and real wages) if the imbalances are small. However, with a high rate of inflation. a large government deficit and international creditworthiness being eroded, a moderate policy will usually not suffice to bring about the necessary results. It rather appears to be indispensable to correct the macroeconomic imbalances by reducing aggregate demand absolutely. In LDCs such an orthodox program will be primarily focused on the reduction of government expenditures coupled with tax increases and price adjustments for publicly supplied goods and services, a reduction of real wages and the depreciation of the real exchange rate. Unfortunately, the success of an austerity program of this kind also depends on the ability to overcome some particular constraints. Among them, insufficient adjustment flexibility of the macroeconomic aggregates is known as a most unfavorable condition for a stabilization program to work.lx Apparently. this problem is greatest in countries where relatively weak governments are opposed to well organized and politically powerful interest groups.‘” In this case, which appears to characterize the situation in the

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Southern Cone countries and Peru during most of the 1960s and 1970s an initial success in correcting the macroeconomic imbalances may be eroded step by step in that the burden imposed on (some) social groups is shifted back by inflationary adjustments -- just to provoke another stabilization program of the same type. Under these circumstances stabilization policy faces the danger of an accumulated downswing with productivity and real wages decreasing altogether. The program may succeed, if at all, only after a long and painful adjustment period during which economic growth is sluggish and income per capita eventually declining. The negative impact of a restrictive macroeconomic policy on production and employment will be cushioned when local producers are able to penetrate foreign markets in order to employ underutilized capacities. Unlike exports based on comparative advantage this kind of “vent-forsurplus” exports may be pushed forward without a time-lag even if producers do not have a competitive edge on the world market. For them, exports will contribute to total revenue as long as the world market price (including export subsidies) is slightly higher than short-run variable costs. Following this strategy will become even more promising if “economies of scale” apply. However, vent-for-surplus exports will contribute to total revenue (or to a reduction of total loss) only for a limited time period because industries which are not competitive under normal conditions will stop exporting as soon as new investments have to be undertaken. Furthermore, export markets, which are penetrated by means of heavy subsidies and aggressive price policies react sensitively. Countervailing duties and other “defense mechanisms” may quickly be introduced by the trading partners. The critical points of a policy which simultaneously aims at inflation and trade liberalization can now be analyzed. In Figure 2 the potential impact of a restrictive macroeconomic policy on the development of the trade balance during the liberalization process is stylized. This is done by superimposing the effects of a restrictive stabilization policy on the effects of trade liberalization as outlined in Figure 1. It is supposed that both policies are introduced together in

It_.

To begin with, vent-for-surplus exports (.5X”‘) are to be considered. They add to Es’” as defined above. EXvs are supposed to be rising instantaneously as a result of the combined effects of trade liberalization and macroeconomic stabilization. However, they will decline gradually again, as soon as existing capacities become obsolete. Apparently, the trade surplus at the

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Imports TB,

= Trade

TB8, =

Trade and

TB2, = Trade

balance

WIthout

balance

lncludlng

vent-‘or-surplus

“e”t-‘or-s”rp(“s

exports

exports

mcludmg

vent-for-surphs

exports

EX? balance

andEXk-" EX”’

Exports bored on co,“parat,“e odvontage kvoht~on m 0 growing economy)

Exy=

Exports based on comparotwe advantage kvolutlon in a depressed eConOmV)

Figure 2.

beginning of the liberalization process will be larger with vent-for-surplus exports and it will be maintained during a longer time period. The subsequent trade deficit, in turn. will be smaller and more short-lived (TB,). Ultimately, the rate of growth of GDP and of real effective demand have to be taken into consideration. Both are negatively influenced by the austerity measures. Given a positive correlation between the rate of economic growth and adjustment flexibility, the speed of transformation of the resources from import-substituting to exporting industries slows down and so does the evolution of exports (I?,@%). The deficit in the trade balance will have to be borne over a longer period of time and the costs of the liberalization process will rise (T&J. The negative impact of a restrictive macroeconomic policy at the speed of structural change will be even more pronounced when the real cxchange rate appreciates because it is used as an instrument to curb inflation.“’ In this case. the competitiveness of the tradables sector as a whole is eroded and imports are expected to rise even more rapidly while exports will be negatively affected.

With regard to the financial restrictions under which many LDCs frequently operate and the employment implications of a sustained period of additional trade deficits, the adjustment costs

which are to be expected from a comprehensive liberalization-cum-stabilization program may overburden a country’s capacity to adjust. In this case, it is appropriate to slow down the liberalization process and distribute the adjustment costs over a longer time period. Such a strategy can be outlined according to the following principles. As a first step an almost immediate elimination of tariff redundancy is necessary. However, unlike a conventional trade liberalization policy which would reduce tariffs on imports and establish a free trade regime directly (although not necessarily immediately) the approach which is proposed here would avoid reducing average tariff protection immediately beyond that level. It would rather concede new subsidies on exports first in order to end their discrimination within the tradables sector itself. Once balanced incentives on both exports and imports are established, this will help to draw resources gradually away from import-competing industries. Furthermore. as the import-competing industries are not exposed to increased foreign competition immediately while the discrimination of exports is ended at once, the tradables sector as a whole is better prepared to stand the negative impact of a restrictive macroeconomic policy on the local market. At the beginning such a policy extends the protection of national producers to the exporting industries and may, in fact, be seen as a (preliminary) move away from free trade. Yet, eliminating the discrimination of exports relative to sales on the local market without moving to free trade instantaneously is still compatible with what is usually proclaimed as an “outwardlooking” development strategy” and, in fact, there is no difference between both concerning their ultimate goals. What makes the difference is that priority is given to a non-discriminatory treatment of exporting industries in order to improve growth performance before subsidies are attacked. When in a second step the liberalization process is actually started, a relatively uniform rate of protectionism and its gradual reduction in both exporting and import competing industries should be aimed at. This policy would have to be guided by a definite time table to be published in advance. A liberalization policy designed in this way should be called an “indirect” approach to trade liberalization as opposed to the direct approach that is most often meant when trade policy is discussed. It may be argued that such a strategy is selfdefeating because the new subsidies which have to be conceded to the exporting industries first are likely to provoke new claims on national in-

THE

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come and ultimately strengthen the resistance against trade reforms. However, eliminating the bias against exports helps to improve resource allocation and to foster economic growth at once, thus improving the preconditions for a successful restructuring policy afterwards. Furthermore, exporters who tend to be much more inclined to free trade than producers competing with imports are becoming actively involved in the bargaining for a liberal trade regime and they also gain importance quantitatively. Both effects work in favor of the forces proclaiming a liberal trade policy and may more than outweigh the potential new claims for protection. Without considering the tariff structure the approach is equivalent to the “concept of exchange rate protection.“** Both strategies are aimed at subsidizing tradables temporarily and are interchangeable to some degree. Thus, a depreciation coupled with a reduction of tariffs on imports and, alternatively, an increase of subsidies on exports coupled with a fixed exchange rate can both be designed in a way which does not affect the real effective competitive position of national producers vis-ri-vis the world market.” On the other hand, when the real exchange rate appreciates while the protection of tradables is reduced the speed of change of relative prices is increased and an even greater pressure is put on local producers.

3. EXPERIENCES WITH THE LIBERALIZATION-CUM-STABILIZATION APPROACH TO PERU AND THE SOUTHERN CONE Before the empirical evidence is discussed, it must be emphasized that it is neither possible nor intended to present a complete picture of the liberalization and stabilization policies of the four countries during the last 10 to 15 years. The purpose of this paper is rather to shed light on some common aspects of the liberalization-cumstabilization strategies. However, the important differences in the countries’ policy experiences*” will not be denied, and, in fact, one of these differences even has to be mentioned in this context: while Peruvian authorities emphasized macroeconomic policy first and superimposed trade liberalization policies later, the reverse is true for the Southern Cone countries and especially for Chile.*” This implies that the simultaneous application of anti-inflationary measures and liberalization policies was not exercised in any of the four countries before 1979. Nevertheless, it is most important to look at the pre-1979 reform period and to recall the major problems

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which had been inherited from previous development strategies in order to understand the economic dynamics more clearly which led to the failure of the liberalization-cum-stabilization approaches in the early 1980s.

(a) The situation ut the end of the pre-reform era In the mid-1970s Peru and the Southern Cone countries faced the common problems of the aging import-substituting countries. At that time the rates of growth of GDP had remained below the average value for Latin America for almost 25 years (Table 2). “As an unparallelled phenomenon in the world economy”” the average rates of growth of exports remained even below the GDP growth rates during most of this period and despite the strong efforts to substitute imports for local production each country had to face high deficits in the balance on current account in 1975. Government deficits also reached extraordinarily high shares in GDP, and inflation threatened to get out of control in Chile and Argentina and was unacceptably high in Peru and Uruguay. Another heritage from the import substitution era w-ere the highly distorted incentive structures within the economies and towards the world market. Vast empirical evidence illustrates this situation. In Argentina, Chile and Uruguay “average nominal tariff rates of 100% or higher”27 could be observed, which practically separated the national economies from the world market. These average figures even hide the fact that extraordinarily high deviations between the individual tariff positions were intended to give strong allocational devices. In Chile, for exnominal tariffs between 22&750% ample, applied to 8”/0 of all tariff positions contrasted with low tariffs of less than 25% for another 4% of the products.** While in Chile tariffs on imports were the major regulatory mechanism applied to the foreign sector, the system of regulations in Argentina and Uruguay was far more complicated. In Argentina about 14% of the tariffs on imports were calculated on the basis of so-called uforo prices which reflected the most arbitrary evaluations of the customs authorities rather than “cif” market prices.2y Furthermore, advance deposits on imports on 3,800 positions of the Brussels Tariff Nomenclature (BTN), preferential rates on a number of imports from LAFTA (Latin American Free Trade Association) and some “special” import regimes contributed to the “simultaneous existence of tariff redundancy and domestic production that did not compete with imports.“3” In Uruguay a complex

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Average annual growth rate of
3.7 2.9 5.1 1.8 5.6

DEVELOPMENT

Average annual growth rate of Exports Imports 195k-75 E,Y IM 1.7 3.1 4.s 1.0 4.2

1.6 4.0 7.7 0.7 4.9

Balance of current account * 1975 -3h.2 -33.1 -93.1 -43.h -31.0

Average annual rate of intlation (different years) 443.2 504.6 33.5 97.0

(1976) (1974) (1976) (1973)

Source: ECLA. Stnfistical Yearhook.r o/Latin Anwrim. 1978 and 1983. own calculations. ‘As a percentage of the “fob” value of total exports of goods and services.

system of quantitative controls and various surcharges obscured the “real” incentives provided by the foreign trade regime. Benison and Caumont find “exchange surcharges ranging up to 225% and a tariff with five components ,“- ’ In both countries. the structure of effective protection was further complicated by various subsidies and taxes imposed on non-traditional and traditional exports, respectively. In Peru in 1Y73 the average nominal tariff was only 6Y’%, with a standard deviation of 25 points?’ However. the rqistro national de mmnuficc.turasrestricted the import

of

all

products

for

which

national

pro-

ducers claimed protection. Thus. for about 28% of all goods covered under the Tariff Nomsnclature of the Andean Pact (Nahandina) imports were LIc ,facto prohibited.j3 On the export side, raw materials were effectively taxed (17% in the case of copper) while non-traditional exports rcceived an average of 26% tax credit certificate (CERTEX) in 1976 and export financing facilities were provided by a no?-traditional export fund (FENT). The CERTEX system which originally applied to only a small number of items ultimately conceded a relatively uniform rate of nominal subsidization and covered a major share of non-traditional exports. Nevertheless, a highly distorted structure of effective protection resulted, because the CERTEX credits were calculated on the basis of “fob” export prices. The highest rates of effective protection were therefore provided to those industries which had only a minor value added content and the implementation of advanced processing was effectively hindered. For a serious evaluation of the countries’ adjustment flexibility it is most important to note that the internal markets also suffered from a

number of disincentives and restrictive regulatory mechanisms which proved to be adverse to the efficient use of capital and labor.jJ In each country the industrial sectors were dominated by inefficient public enterprises. Administered prices and an almost complete governmental control over money and credit’5 rendered an inefficient resource allocation and paved the way for increasing rates of inflation. On the labor market, the Peruvian labor stability law formed a notable obstacle to growth - and it still does today.3h In its original version it prohibited dismissing workers after three months in occupation and even in-plant reorganization became a complicated tnatter. As a result, the structure of the labor force became practically fixed and structural change could only take place inasmuch as new jobs were created. Summing up, the evidence from the Southern Cone countries and Peru indicates that in the mid-1Y70s the incentive systems were highly distorted. Discontinuous but frequent policy interventions with repeatedly changing priorltles had led to inconsistencies and to self-liquidating or unintentionally accumulatmg incentives and disincentives. Consequently, the real effects of the economic policy on resource allocation remained unclear and unreliable. and for many private investors it became more promising to bargain for political support rather than to look for profitable investments in competitive markets.

(b) The refornlist policies in Peru In Peru restrictive policies to fight inflation, to lower the governmental deficit and to reduce the external imbalance were started in 1976. The

THE INDIRE,CT

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TO TRADE

almost conventional approach to fighting the macroeconomic disequilibrium (a number of supplementary measures were added during the course of time) provoked a steady decline of total absorption during three consecutive years.“’ Even in 1981 private consumption remained at a level slightly below the one of 1976.“’ Nontraditional exports formed a notable exception (Table 3) due to a more realistic real exchange rate policy and the provision of strong export subsidies, which reduced the traditional antiexport bias. This effect is underlined by the

(1) Non-traditional exports* Argentina 1973 1974 1975 1976 1977 1978 1979 1980

LIBERALIZATION

results of a detailed constant market share analysis which explains 46% of export growth between 1975 and 1980 by the competitiveness effect.‘” As could be expected especially high rates of export growth to the world market were found in textiles and clothing. But regional trade also increased considerably and a relatively complex set of product groups with a successful export performance emerged. Nevertheless, despite the fact that the share of non-traditional exports in GDP more than doubled between 1974 (10%) and 1980 (21%), even within the parti-

(2) Growth rate (%)

(3) Total exports

(4) Non-traditional ‘Total

735,408 936.246 722,475 975,480 17346,335 1,671,723 1,883,767 1,856,472

30.98 -25.00 35.02 3X.02 24.17 12.68 -1.45

3.266.003 3,930,702 2,961,?64 3,911,926 5,641.666 6.394.179 7,807,751 8,021,402

22.52 24.51 24.40 24.94 23.86 24.17 24.13 23.14

Chile 1973 1974 1975 1976 1977 1978 1979 1980

44,502 107,908 165,388 230,297 228,615 248,916 636.400 675,100

142.48 53.21 39.25 -0.73 8.88 16.91 6.08

I,2493427 2.480.567 1,648,707 2,208,459 2,138,421 2,462,112 3,763,400 4.818,lOO

3.56 4.35 10.03 10.43 10.69 10.11 16.91 14.01

Peru 1973 1974 1975 1976 1977 1978 1979 1980

28,584 51,818 37.185 58.369 129,580 176,992 495,959 552,779

81.28 -28.24 56.97 122.00 36.59 180.22 11.46

1.049,519 1,517,371 1,307,263 1,304,437 1,665,789 1.819,768 3,389,905 3,308,9X9

2.72 3.4 2.84 4.47 7.78 9.73 14.63 16.71

Uruguay 1973 1974 1975 1976 1977 1978 1979 1980

114,227 181,841 234,579 290,467 373,786 401.751

59.19 29.00 23.82 28.68 7.48

381,198 536,022 598,545 681,863 787,233 1,058,991

29.97 33.92 39.19 42.60 47.48 37.94

*SITC 5-X excl. 68.

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cular export industries, trade in non-traditional exports could not compensate for the losses in the local markets4” Consequently, national capacities were heavily under-utilized during the whole period and in almost all industries. Gross capital formation decreased to the 1973 level in 1978 and recovered thereafter without surpassing the 1975 level before 1981.“’ The fact that competitiveness on the international markets could not be achieved even in most parts of the textile industry up to 19814’ demonstrates that the new investments carried out between 1978 and 1981 hardly sufficed to replace the most seriously outdated parts of the existing capital stock. Most definitely, they contributed only marginally to a transformation of the structure of industrial capacities towards the international market. When in 19794” the comprehensive program of trade liberalization was started, which suddenly exposed the national industry to the international markets, many producers were unable to face the new situation within due time. Non-traditional exports began to decline steadily after 1980 (except for 1982) while imports rose at a high rate. The trade deficit in manufactures (SITC S-8 less 68) rose from US $557.705 million in 1979 to US $1,902.618 million in 1082.‘” It suddenly became obvious that the bad performance of the national economy between 1975 and 1979 had effectively hindered any perceptible process of structural change towards the exporting industries. Even the upgrading process within the existing industries had - by and large -. been unsatisfactorily slow. An explanation for the discrepancy between the especially high rates of growth of non-traditional exports and the slowly changing structure of production may be found in the depressed national economic environment which stimulated vent-for-surplus exports but slowed down adjustment flexibility. Apparently the (partial) success of non-traditional exports during that period had led the authorities to misjudge the real competitive position of the country and provoked a liberalization program which was too hasty in view of the country’s potential for growth and change. In addition to the liberalization program the real exchange rate appreciated considerably because of the boom in the copper sector and added to the burden that had already been imposed on the industrial manufacturing sector. In 1982 the liberalization process came to a standstill when a 15% surcharge on import tariffs was implemented; in the same year increasing pressure from national producers led to a reintroduction of a number of administrative restrictions. In 1983 a 10% tariff on “cif” import prices substituted for the surcharge. This new measure

was limited to the end of 1983. Instead of being reversed, however, it just formed a higher basis for the implementation of additional restrictions on foreign trade in the following years. In 1986 a complicated system of tariff and non-tariff barriers again separated the Peruvian economy from the international market.

(c) The reformist policies irl the Southern

Cone

In the Southern Cone, policies and economic performance followed a quite different path than in Peru, but the dynamic interaction of trade and anti-inflation policy led to quite similar economic problems. Real wages had been cut between 1974 and 1975 in Chile and the government deficit was reduced from the 1973 peak of 24.5% of GDP to zero only a few years later. Contrary to Peru, the economic situation began to improve steadily when the initial shock treatment had been overcome. Private consumption recovered at an average rate of nearly 10% between 1976 and 1981” so that the growth of foreign markets was accompanied by increasing local demand. and the gradual reduction of tariffs on imports to a uniform rate of 10% in June 1979 found a relatively favorable environment. In c’ruguuy, too, economic growth resumed shortly after the implementation of the 1073 reformist program. GDP grew at an average annual rate of 3.Y% between 1974 and 1978, and non-traditional exports even became the most important source of foreign exchange earnings.‘” Contrary to Chile, however, the government budget was balanced at a relatively high level with public investment substituting for public consumption. The restrictions on imports were also maintained (except for a number of non-tariff barriers) and subsidies on non-traditional exports were imposed to defend the anti-export bias of the previous periods. On the other hand, the financial sector was far more quickly liberalized than in Chile. Argerltirzu also opened the capital account and started a set of liberalization efforts, but it did not manage to reduce the fiscal deficit.i7 Furthermore it is doubtful if there was any significant liberalization effect at all until 1979, since the efforts undertaken in this field were just enough to eliminate tariff redundancy.“x The fact that neither liberalization nor stabilization policy really worked in this country before 197Y helps to explain the relatively poor growth performance and the persistence of high inflation rates during the lY7Os. Despite the fact that the reformist policies in the Southern Cone yielded a number of positive results, some important shortcomings remained. Most importantly, the inflationary pressure could

THE

INDIRECT

APPROACII

not be lowered substantially in Chile and Argentina and it even increased in Uruguay. Furthermore, excessively high rates of unemployment applied to Chile and Uruguay and the public deficit could not be brought under control in Argentina. As a matter of fact, the ultimate task of stabilization policy as outlined above had not been realized in the three countries. The responses in the Southern Cone to the persisting problems of macroeconomic disequilibrium and, in particular, the extraordinarily high inflation rates were the widely discussed tablita policies which were introduced in 1978-79 in order to force the national inflation rate down to the average world level. These policies will not be discussed here in detail again. However, there are some aspects which are relevant to the conflict between stabilization and liberalization policy, so that a short characterization of the main idea underlying this policy will be useful. The “tablita” policy essentially consisted in a pre-announced crawling peg of the nominal exchange rate at a rate that did not fully reflect the difference between the national rate of inflation and the world average. It was expected to put pressure on the price of tradables and this, in turn, should spill over to the non-tradables sector without too much delay. If this would have happened satisfactorily, the initial appreciation of the real exchange rate would soon have been corrected by the following price and cost reductions. As the rate of inflation would soon have decreased to the world average rate (it should, indeed, have fallen even below for some time to make good for the previous appreciation of the real exchange rate) the pressure on the tradables sector imposed by the crawling peg would have disappeared again. However, putting pressure on the tradables sector directly to force down the overall inflation rate would only have worked without major disruptions. if the expected changes in relative prices and the reduction of total claims to GDP had taken place almost instantaneously. In fact, the cost effect of the appreciation of the real exchange rate (Table 4) worked almost immediately only in the export sectors. The import-competing industry, on the one hand, enjoyed a time lag of up to almost one year4” before the increased foreign competition could be felt. At that time, the maintenance of the government deficit in Argentina and the indexation of wages in Chile effectively helped to resist the stabilizing effect of the exchange rate policy. Thus, as decreasing world market prices (in national currency) did not translate into a corresponding reduction of production costs, the real exchange rate appreciated continuously and the tradables sector steadily lost competitiveness.

TO TRADE

893

LIBERALIZATION

Table 4. Real exchange rates* in Argentina, Chile, Peru and Uruguay,

Argentina 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984

1972-84

Chile

100 118 116 76 116 93 109 146 161 129 76 86 93

100 72 49 36 40 44 39 39 46 49 40 33 29

Source: Schinke (forthcoming). International Financial Stabtics,

monthly publications. * PIN w,, _:[ P(:,”

Uruguay

Peru

100 126 136 113 110 114 120 149 160 153 131 91 104

100 94 95 102 93 82 65 67 73 80 78 69 64

Calculated from IMF, Yearbook, 1984. and

PluSA PoUs*

r=

1

WI = real exchange rate = nominal exchange rate

r W

p”

= National Consumer Price lndex

pusa = USA Export Price Index

With the squeeze of profits in the tradables sectors” the incentive to transfer resources to export production diminished and ultimately disappeared. The discrimination of tradables which was implicit in the policies to fight inflation under the given degree of adjustment flexibility counteracted the initial goal of establishing a competitive trade-oriented economy. The depressive effects arising from the difficulties in the tradables sector spread over and contributed to the severe downswings of economic activity in the three economies. As a consequence, these governments, too, were ultimately forced to reverse their stabilization policies together with the trade liberalization process. In Argentina and IJruguay the ongoing liberalization programs which had been announced in 1978-79 were postponed in the following years and are still pending today. In Chile the 10% uniform rate of tariffs, one of the core elements of the whole reformist policy package, was reversed in March 1983 (20%) and again in September 1984 (35%).”

4. CONCLUSION From

the experiences

in the Southern

Cone

WORLD

894

DEVELOPMENT

countries and Peru it can be concluded that some basic propositions of a gradual and socially balanced liberalization-cum-stabilization policy have been disregarded during the 1979-82 period. In Chile and Url~guay non-traditional exports and national income had grown rapidly after the initial stabilization crisis, and even trade liberalization had proceeded fairly well. But inflation had not been brought under control in all three Southern Cone countries. When the authorities decided to attack this particular problem directly, a high and cumulating rate of apprrciation of the real exchange rate was accepted without due consideration of its impact on the real sphere. The erosion of international competitiveness seriously hurt the tradablcs sectors and contributed to the breakdown of the liberalization-cum-stabilization programs. In Peru the macroeconomic imbalances had been reduced to some extent during a long and painful period of depression starting 1975-76. When, at the end of the decade, a comprehensive liberalization program was superimposed, the economy still suffered from highly underutilized capacities. It could not stand the rapidly growing competition from the world market mainly because structural change towards, and upgrading procedures within, the exportahles sector had hardly taken place during the years of economic depression. The trade reforms were reversed step by step from 1982 onward also in this country. It must be emphasized that some other important factors which have not been considered here also contributed to the economic performance of the four countries. First of all, the international

economic situation worsened during the early 1980s and put a severe burden on exporters of minerals like Peru and Chile. Furthermore climatic events like the reappearance of El nitio in Peru and other external shocks contributed to the bad performance during the period of transition. In the case of Uruguay geographical proximity to a dominant economy (Argentina) had a negative impact. Nevertheless, two conclusions can be drawn from a comparison between the reference model outlined in Section 3 and the particular policies which have been carried out in these four countries. First, a bias against exports is frequently observed under import-substituting regimes. In order to improve the probability for a trade liberalization program to succeed, priority should be given to the immediate elimination of this bias even at the expense of new temporary export subsidies. Liberalization in the proper meaning of the word would have to follow in later periods. Sc~~nrf, there is an intrinsic tension between trade liberalization and a restrictive macroeconomic pohcy because the success of the former depends heavily on the economy’s adjustment capacity and this, in turn, tends to be lowered by austerity measures. An indirect approach to trade liberalization and a careful evaluation of the interactions between macroeconomic and liberalization policies are the appropriate answers to the adjustment problems which frequently arise during the period of transition from an inward- to an outward-looking strategy.

NOTES 1. Agarvalrr (19x3); Balasaa (1985); Riedel Tuong (1985); Havrylyshyn/Alikani (1982).

(198-l);

7 _. WogartiMarques p. 7.

(19X3).

(19X4),

p. 19; Sjaastad

3. There is one notable exception because consumers and producers who rely on imported inputs benefit immediately from lower import prices. 4. In the long run they will also he better off inasmuch as the open trade regime contributes to the rate of economic growth. In the short run a Pareto optimal situation can be achieved when adequate compensations are paid. However, other than in the traditional model. political and financial restrictions may inhibit such payments when costs and benefits from opening up arise at different time periods. 5. Edwards and van Wijnbergen are analyzing the welfare effects of trade liberalization formally under the condition that “capital account controls are still in

cffcct.” They assume that “as is empirically the case in many developing countries, when borrowing from abroad is restricted the borrowing constraint falls disproportionately on investment. In this case new investments are hindered in the cast of an instantaneous opening up of the trade account and a gradual approach becomes the optimal strategy.” Edwards and van Wijnbergcn ( IYXh), p. 144.

6. There will most certainly he a small instantaneous rise in exports because the discrimination of sales on the national market relative to those on the world market is eliminated. There may also be some producers who are able to compete on the world market without a time lag.

7. The lag period due to transportation. administration etc. may be remarkably long. For Argentina a lag period of up to one year was found. This time-lag is also assumed in Figure I and Figure 2. Wogart (1983), p, 452.

THE

INDIRECT

APPROACH

8. Nothing can be said here about the development of exports and imports after the structural adjustments have been carried out. Most probably, however, trade flows will proceed at a higher rate under an open trade regime. 9.

Linder

10.

Fishlow

(1961),

p. 87.

TO TRADE

LIBERALIZATION

895

24. The literature on this subject is abundant. For good compilations of some of the more important contributions see the special issues of World Developmenf. Vol. 13, No. 8 (1985); The Journal of Interamerican Studies and World Affairs, Vol. 25 (1983); Economic Developmcnt and C’ulfural Change, Vol. 34, No. 3 (April) 1986; and Barletta et al. (1984).

11. In Peru, for example, the share of manufacturing production in GDP was 24.7% in 1970. This figure indicates a relative size similar to that of the manufacturing sector of South Korea. IJNIDO (1986), p. 6.

25. A detailed analysis would have to qualify this statement because both Chile and Uruguay cxperienced a short austerity period right after the political changes in 197>74. Most important in this context, however, those policies did not reduce the rate of inflation considerably.

12.

26.

Kadar

27.

Sjaastad

28.

Cauas

29.

Berlinski

30.

Ibid.

31.

Benison

32.

World

Bank

33.

Ibid.,

p. 42.

UNIDO

13. For countries 14.

(lY85),

pp.

123-148.

(1986)

a detailed analysis of all Latin see, Syrquin (1986).

Horn

(1985),

American

(198(J),

p. 75.

(1983). and

p, 6.

de la Cuadra

(1981),

p. 200.

p. 533

15. It is very difficult to estimate the impact of the development of micro-electronics on this relationship. At a first glance it appears to be clear that smaller production units will be possible in the future since many complex manufacturing procedures will be fragmented and the resulting subprocesses organized separately. But there may also be some strong forces working contrary to this effect. If there is, for example, a sophisticated numerically controlled machine tool which may be switched from one operation to another with only minor operational costs, it may be able to efficiently produce a single variety on a very small scale. However, this may not be a sufficient condition for profitability to be secured, if this variety covers only a small part of the total capacity installed. Despite this, it may be necessary to find quite a number of new markets for other product varieties in order to absorb total capacity. In this case the nature of the indivisibility has changed but the phenomenon itself has remained.

and

and

35.

See McKinnon

36.

See UNIDO

37. Banco p. 84.

and

(1981),

UNIDO

(1973) (1985),

Central

38.

ibid.

39.

Preusse

40.

Schydlowsky

17.

Corden

41. Banco p. 60.

18.

Taylor

19.

Olson

p. 175.

Caumont

(1982).

p. 87

p. 498.

(1981),

p. 41.

34. For a more detailed discussion see Sjaastad (1983); Hanson and de Melo (1983) and Zahler (1983).

16. There is no simple answer to the question what a “tolerable” rate of inflation will be. Cautious estimates for LDCs are in the range l&20%. However, there is no doubt about the damaging effect of inflation rates far beyond that range. (1980),

Schydlowsky

and

Congdon

p. 22; World

de la Reserva

(1981).

(1985). Bank

(1981).

de1 Peru

(1982),

del Peru

(1982),

p. 7.

(1985)

Central

de la Reserva

(1979). 42.

UNIDO

(lY86),

p. 53.

(1982).

20. Note that such an exchange rate policy runs counter to the intention of a conventional restrictive macroeconomic policy. Yet, this policy played a major role as an instrument in fighting inflation in the Southern Cone. 21.

Krueger

(1985).

22.

Corden

(1978).

23.

Balassa

(1978),

pp. 2&23.

p. 51.

43. For a detailed discussion of the trade reforms see Banco Central de la Reserva de1 Perti (1983), pp. 8-19. 44.

UNIDO

(1986),

45.

Banco

46.

Notaro

47.

Blejer

(l983),

48.

Wogart

and

Central

p. 22. de Chile

(1984),

(1984),

p. 60

p. 62. p. 440.

Marques

(1984),

p. 23.

WORLD

896

49.

Wogart

(1983),

50. See special No. 8 (1985).

DEVELOPMENT

51.

p. 452.

issue of World Development.

Banco

Central

de Chile

(1984),

p. 81.

Vol. 13,

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THE

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position of developing country exports.” Devclopmenf und Chungr, Vol. 11 (1986). pp. 531-544. UNIDO, “Industrial restructuring in Peru: Policies for growth and development,” IS. 614 (Vienna: UNIDO, Fehruary 1986). UNIDO “Peru,” Industrial L)evelopmmt Series. IS. 552 (Vienna: UNIDO. August 198.5). United Nations, Nukmul Acc&nrs Snnisks: Anulysis of Main Apprepuks. 1Y82 (New York: IJN, 1985). Wogart, .I. Py:: “Combining ~’ ‘price stabilization with trade and financial liberalization policies: The Argentine experience, 19761981,” Journnl of Elmerumericun Studies and World A,ffuirs,. Vol. 2.5, No. 4 (November lY83), pp. 445-476. Wogart, J., and J. S. Marques, “Trade liberalization, tariff redundancy and inflation: A methodological exploration applied to Argentina,” Weltwirrschuffliches Archiv. Vol. 120, No. 1 (lY84), pp. 18-39. World Bank, Peru: Major Development Policy 1ssue.s and Recommendufions (Washington. DC: The World Bank, 1981). World Bank/UNIDO co-operative program, “Peru, development and policy issues of the manufacturing sector,” Report No. 13 (Washington, DC: The World Bank, 1981). Zahler, R., “Recent Southern Cone liberalization reforms and stabilization policies: The Chilean case, 1974-1982,” Journal of Interamerican Studies and World Affairs, Vol. 25, No. 4 (November 1983), pp. SOY-562.