DISCUSSION PAPER Report No c DRD217 FOREIGN TRADE REGINES AND ECONONIC GROWTH IN DEVELOPING COUNTRIES by Deepak Lal and Sarath Rajapatirana I I ~~~======-===----=~~ Development Research Department Economics and Research Staff 'i-Jorld Bank The World Bank does not accept responsibility for the views expressed herein which are those of the author(s) and should not be attributed to the World Bank or to its affiliated organizationso The findings, interpretations~ and conclusions are the results of research supported ~y the Bank; they do not necessarily represent official policy of the Banko The designations employed~ the presentation of material~ and any maps used in this document are solely for the convenience of the reader and do not imply the expression of any opinion whatsoever on the part of the World Bank or its affiliates concerning the legal status of any country~ territory» city~ area~ or of its authorities~ or concerning the delimitations of its boundaries~ or national affiliationo REVISED September 1986 Paper prepared for the Conference on "Free Trade in the World Economy: Towards an Opening of Markets .. organized by the Institute for World Economics, Kiel, June 24-26, 1986 FOREIGN TRADE REGIMES AND ECONOMIC GROWTH IN DEVELOPING COUNTRIES by Deepak Lal University College London and World Bank, Washington, D.C. and Sarath Rajapatirana Wo~ld Bank, Washington D.C. Address for correspondence: Room S-9137 World Bank Washington, D.C. 20433 u.s.A The World Bank does not accept responsibility for the views expressed herein which are those of the authors and should not be attributed to the World Bank or to its affiliated organizations. The findings, interpretations, and conclusions are the results of research supported by the Bank; they do not necessarily represent official policy of the Bank. The designations employed, the presentation of material, and any maps used in this document are solely for the convenience of the reader and do not imply the expression of any opinion whatsoever on the part of the World Bank or its affiliates concerning the legal status of any country, territory, city, area, or of its authorities, or concerning the delimitation of its boundaries, or national affiliation. DLR-026/9.10/86 Table of Gontents Introduction ••••••••••••••••••••••••••••••••••••••••••••• 1 I. The Static Gains from Trade ••••••••••••••••••••• - •••••••• 4 II. Exports and Gro~th ••••••••••••••••••••••••••••••••••••••• 8 III. Trade Regimes: The Evidence from Five Comparative Studies ......... ~~ ................................. , •••••••• 10 IV. Exogenous Shocks in the 1970~ and 1980s ••••••••••••••••• l3 V. Trade and Growth: Income Effects •••••••••••••••••••••••• 23 VI. L2vel and Growth Effects: Unravelling the Technological Black Box ••••••••••• ~···••••••••••••••••••27 DLR-026/9.10/86 Abstract This paper surveys empirical studies which seek to demonstrate the limited static gains from a movement towards free trade in Section I. Section II surveys statistical studies which have established the dynamic effects of growth in exports on that of per capita income. Section III summarises the results from a series of comparative studies of developing countries trade regimes undertaken in the 1960s to 1970s, which show fairly conclusively that so-called 'outward-orientation' does in practice seem to be positively associated with better economic performance in terms of growth rates of per capita income (as well as in terms of equity). Section IV examines whether the conclusions of these studies were also valid for the more volatile global environment of the 1970s and 1980s. Section V considers various arguments which seek to provide a link between growth performance and trade regimes through the 'dynamic' income effects of the growth in world income and trade on a free trading country's economic growth rate - the so-called 'trade as an engine of growth' view. Section VI introduces certain insights of the classical writers - in particular Adam Smith which ha.ve reemerged in the nee- Austrian as well as the more recent neoclassical "new political economy" schools which might explain the stylised facts about the links between trade and growth performance. These emphasize the importance of the non- quantifiable aspects of a free trade (as compared with a protectionist) regime in creating (in an irreducibly uncertain world) a general economic framework conducive to the emergence of domestic market processes which are favourable for promoting individual entrepreneurship, productivity and thrift. In this context we argue that free trade is the 'handmaiden of growth' as it indirectly constrains the actions of the State from going beyond the bounds of necessary public action for the provision of those domestic public goods which are essential for development. DLR-026/9.10/86 Foreign Trade Regimes and Economic Growth in Developing Countries* By Deepak Lal and Sarath Rajapati.rana Introduction The 'static' case for free trade is as simple as it is powerful. The removal of barriers to foreign trade expands the feasible set of consumption possibilities of an economy by providing in effect an indirect 'technology' for transforming domestic resources into the goods and services which ultimately yield consumer's current and future utility. As is well known this so called 'static' case for free trade does not involve any commitment to laissez-faire !1, or to particular domestic distributional or organisational preferences. The law of comparative advantage, and the gains from trade it underpins, applies to both socialist and capitalist economies. The dynamic version of the law incorporates investment in line with the country's changing comparative advantage which minimises the present value of the resource costs of its future demands.. In addition, by "widening the market", foreign trade allows the enploitation of economies of scale beyond those permitted by the size of the domestic market. Furthermore, the competitive pressures exerted by imports prevent the emergence of welfare reducing domestic monopolies, * The authors wish to chank Jagdish Bhagwati and Soogol Young for valuable comments on the draft of this paper and Sopie Kim and John Wayem for research assistance. 1/ Thus it is recognised that endogenous domestic distortions may require appropriate domestic public interventions for their correction, and where the country has monopoly (monopsony) power in trade, and can feasibly influence its terms of trade, taxes/subsidies on trade may be justified. DLR-026/9.10/86 - 2 - whilst inducing welfare improving quality and cost reducing adjustments by producers. To the extent the static gains are saved and invested efficiently, they will grow dynamically pari passu over time, whilst the introduction of new 'goods' and more importantly the transmission of new technology through foreign trade can affect the rate of technical progress of the economy. Most of the9e conventional effects of a movement towards free trade, will lead to a higher level of per capita income. However, in the conventional steady state neoclassical growth theory, except for those effects which raise the rate of technical progress (and hence the economy's natural rate of growth), the initial acceleration in the rate of growth arising from trade liberalisation will not be sustainedo This is one sophisticated argument currently being applied to denigrate the case for the removal of barriers to trade as a means of enhancing growth (see Lucas (1985)). We return to it in the last section of this paper. Many other economists whilst conceding the static welfare gains of free trade, have nevertheless sought to undermine this case by arguing first, that the size of these estimated static gains is fairly small for even large reductions in tariffs; secondly that dirigiste foreign trade regimes (which in the first two decades of the post World War II period sought to promote an import substitution (IS) strategy and lately an export promotion (EP) strategy) are likely to yield larger gains in terms of unspecified dynamic benefits which effect a country's growth rate in addition to (or to be offset against) the static gains (losses) from more efficient (inefficient) resource allocation which follow from the adoption of a (less) neutral trade regime. Empirical studies which seek to demonstrate the limited static gains from a movement towards free trade are surveyed in Section I. Section II DLR-026/9.10/86 - 3 - surveys statistical studies which have established the dynamic effects of growth in exports on that of per capita income. Section III summarises the results from a series of comparative studie~ of developing countries trade regimes undertaken in the 1960s to 1970s, which show fairly conclusively that so-called 'outward-orientation' does in practice seem to be positively associated with better economic performance in terms of growth rates of per capita income (as well as in terms of equity). Section IV examines whether the conclusions of these studies were also valid for the more volatile global environment of the 1970s and 1980s. Section V considers various arguments which seek to provide a link between growth performance and trade regimes through the 'dynamic' income effects of the growth in world income and trade on a free trading country's economic growth rate- the so-called 'trade as an engine of growth' view. Section VI introduces certain insights of the classical writers - in particular Adam Smith which have reemerged in the nee- Austrian as well as the more recent neoclassical "new political economy" schools which might explain the stylised facts about the links between trade and growth performance. These emphasize the importance of the non- quantifiable aspects of a free trade (as compared with a protectionist) regime in creating (in an irreducibly uncertain world) a general economic framework conducive to the emergence of domestic market processes which are favourable for promoting individual entrepreneurship, productivity and thrift. In this context we argue that free trade is the 'handmaiden of growth' as it indirectly constrains the actions of the State from going beyond the bounds of necessary public action for the provision of those domestic public goods which are essential for development. DLR-026/9.10/86 - 4 - I. The Static Gains from Trade The early studies of the costs of protection measured the static gains in terms of the familiar welfare triangles associated with complete or partial trade liberalisation (as in the case of customs unions). Harberger ' (1959) estimated that the cost of protection in Chile amounted to 'no more than 2-1/2 percent of the national incomet (p. 135)Q Scitovsky (1958) estimated the gains to the EEC from increased specialisation at "less than one-twentieth of one percent of the gross social product of the countries involved" (p. 67). Johnson (1958) estimated the gain to Britain from the formation of a Free Trade Area as at most 1 percent of national income. Recently, a number of computable general equilibrium (CGE) models have been built to examine the general equilibrium effects qf trade liberalisation. l/ In Figure 1 which is the standard trade-theoretic diagram these measures report the costs AB. These estimates are based on the standard Heckscher-Ohlin model, with constant returns to scale. The gains are estimated as Hicksian equivalent variations as percentages of base period GDP. The gains from trade liberalisation either at the global level or at the national level appear to be small, ranging from Whalley's (1984) estimate of a global~ gain of about 0.3 percent of world GDP in 1977, and do not exceed 0.5 percent of GDP for any region or country (see Srinivasan (1986), (1986a)). Moreover, in Whalley's model, with a move to world free trade, the NIC-LDC group lose 4 percent of their GDP! However, as Srinivasan (1986) has argued the results of these models are not credible, partly because of their 1/ See Srinivasan and Whalley (1986) for a comprehensive discussion and evaluation of the major models in this genre. Also see Srinivasan (1986), {1986a)~ (forthcoming). DLR-026/9.10/86 - 5 - Figure 1 I I PI Importable pII \ \ \ \ Exportable Note: PP - is the production possibility frontier. F is the free trade output when world prices are given by tt. With a tariff, and no lobbying or rent seeking, the production point is P, with the domestic price ratio being given by dd, and the welfare cost is given by AB. With lobbying for the tariff, the 2roduction possibility curve shifts to P'P', the production point to Pn and the welfare loss is CB. To avoid various 'immiserising paradoxes (which depend upon the relative slopes of the Rybczynski line between P and P*, and the world price ratio tt) which could imply a 'welfare gain' from the lobbying equilibrium at P* as compared with P, it is better to decompose the welfare loss CB, into the loss due the tariff as CE (this is the usual triangle estimate) and of lobbying as EB. (See Bhagwati (1980a)~ With rent seeking, the production possi2ility curve shifts further inwards to P"P", the production point to P~:-.~, and the welfare loss at world prices is DB. DLR-026/9.10/86 - 6 - manipulation of data to make them an internally consistent equilibrium set, when we know the data themselves come fran non-equilibrium situations, and partly because of their particular specifications of crucial elasticity parameters. In particular they all make use of estimated trade elasticities (see Stern, et al (1976)) which have a well-known specification bias leading to underestimation (see Orcutt (1950), Kemp (1962), Kakwani (1972))~ !/ Also, most of these models do not take account of scale economies and imperfect competition. An exception is a model for Canada by Harris (1982) which does show that a multilateral reduction of all tariffs yields welfare gains of more than 5 percent of GDP. Furthermore, most of these models do not take account of the 'rent seeking', and 'directly unproductive' activities triggered· by quota and tariff regimes (see Tullock (1967), Krueger (1974), Bhagwati (1980). In the case of rent seeking, the deadweight loss associated for instance with a tariff is not merely the conventional net change in the consumer and producer surplus triangles, but also the whole of the associated transfer payments for whose capture economic agents will, in the limit, be willing to expend an equivalent amount of real resources. In addition, if there is lobbying for the tariff, the opportunity cost of the real resources absorbed would have to be added to the cost of the tariff. Thus in Figure I, the lobbying costs shift the production possibility (PP) curve inwards, with an associated welfare cost of ll Also see Krueger (1984), Taylor and Black (1974), and de Melo (1978), for other model based estimates of these static gains. DLR-026/9.10/86 ..~· - 7 - protection CB, ll whilst if there are further resource costs associated with a struggle over the disposition of the 'rents' associated with the tariff, the welfare costs rise to DB, as the PP curve shifts further inwards. (See Srinivasan (1986a)). A CGE model by Grais, et al (1984) has atte~pted to estimate the costs of rent seeking (but not lobbying) associated with the Turkish import quota regime. They found that if tariffs were removed but the QRs were maintained, there was little effect on real GOP, which however rose between 5 to 10 percent if quotas were also eliminated. So far we have neglected the deadweight losses of domestic monopoly and X-inefficiency associated with protection (see Leibenstein (1966), Carden (1974), Krueger (1984)). Thus "a reduction in tariff levels might be expected to result in a downward shift in industry supply curves. The welfare costs of protection would then consist of the conventional production cost, plus an inefficiency cost and possibly a monopoly cost", (Krueger (1984) p. 544). The only attempt to measure these total deadweight costs, is by Bergsman (1974). He found that the costs of protection as a proportion of GNP, consisting of the conventional allocative inefficiency costs (A), the X-inefficiency cum monopoly costs (X), and the total costs (T = X+A) were as follows for four developing countries: Mexico: A= 0.3; X = 2.2; T = 2.5. Brazil: A= 0.3; X= 6.8; T = 7.1. Philippines: A = 1.0; X = 2.6; T = 3.6. Pakistan: A= 0.5; X = 5.4; T = 5.9. !1 But see the note to the figure for the decomposition of this loss into that due to the tariff and lobbying. DLR-026/9.10/86 - 8 - Thus it would seem that once scale economies, imperfect competition, X-inefficiency, rent and revenue seeking are accounted for and the statistical biases in the CGE model est·mates are removed, the static welfare gains from trade liberalization could be quite substantial. But as noted in the introduction, in terms of growth economics these would still be 'level' effects, and though providing a partial explanation of a rise in transitional growth rates in economies which liberalise their trade regimes, they do not explain why the growth rates of such countries should be higher on a sustainable basis, as seems to ha,,e been the case. II. Exports and Growth The relationship of trade (more precisely exports to GDP) and of the relative growth rates of exports and real income has also been investigated in a number of statistical studies. See Table 1.1 for a summary of the estimated relationships. Michalopoulos and Jay (1973) estimated an aggregate neoclassical production function with domestic capital, and foreign capital as its arguments for 39 countries. The power of the function increased when exports were included as an additional argument. Exports were found to be highly significant in the relationship and the growth rate of GNP was significantly correlated to the growth rate of exports. Estimating the relationship between the change in the proportion of exports to GNP to the rate of GNP in 41 countries for the 1950-73 period, Michaely (1977) found a significant relationship at tne 1 percent level for DLR-026/9.10/86 - 9 - the Spearman rank correlation between the two variables. The Michaely study attempted to avoid autocorrelation between exports and the national product by using the.proportion of exports in the product to represent the rate of expansion of exports which was then regressed against the rate of change of per capita income. ll In her study for the NBER on Foreign Trade Regimes and Economic Development, Krueger (1978), regressed the GNP growth rate for each of the 10 countries under study against the rate of growth of its exports. It was found that a positive and significant relationship existed between export earnings and the rate of growth in GNP. Similarly, estimating the link between export growth and GNP (by re-estimating Michaely's equations and incorporating the Michalopoulos-Jay factors); Balassa (1978) noted a robust relationship and recognized that the relations that he estimated for some .tl countries understate~ the effects nf export growth on that of GNP. In another inquiry of the relationship of exports to growth, Feder (1983) not only found a positive correlation between exports and GNP growth, but also provided evidence to support the hypothesis that export-oriented polici~s both led the economy to an optimal allocation of resources and through an inter-sectoral externality had a general economy-wide productivity enhancing effect. All these studies confirm a statistical relationship between export and income growth. They thus provide us with a stylised fact rather than a theory. 1/ Ibid., p~ 50. DLR-026/9.10/86 - 10 - III. Trade Regimes: The Evidence from Five Comparative Studies More substantial are the results from a series of 5 comparative studies undertaken in the 1960s and 1970s !/ which provide fairly firm evidence that countries which adopted or switched towards a so-called 'outward oriented' or export-promotion (EP) strategy did much better in terms of growth rates of per capita income as well as equity than those t~ich followed an 'inward looking• or import-substituting (IS) strategy. In interpreting the results of these studies there has been some confusion about the terms 'IS and EP' strategy. As it has now come to be used, a movement from the neutral free-trade position is described as import- substituting (IS), and a movement back toward that point (that is from P to F in Figure 1) is· labelled export promoting (EP). Thus the EP (or outward oriented) strategy does not entail a policy of export subsidization beyond the level which restores equality between the effective exchange rates on imports and exports. ~/ In this context it may also be useful to distinguish a liberal from a neutral trade regime, ~/ as a failure to do so has caused some confusion about the nature of the trade liberalisation undertaken by different developing countries. A neutral trade regime as noted above is one where incentives for import substitution do not outweigh those to export promotion. But it does 1/ Little, et al (1970), Balassa (1971), Donges (1976), Bhagwati (1978) and Krueger (1978). 2/ See Lal (1981), and for an emphatic reassertion of this point see Bhagwati (1986). This point is also emphasized in the last chapter of Bhagwati (1978). 3/ We owe this point to Soogil Young's comment on our paper at the conference. DLR-026/9.10/86 - 11 - not rule out (essentially offsetting) trade interventions. A liberal trade regime is one where this neutrality of trade incentives is assured by the absence of trade intervention. For our purpose we need only note that these studies have firmly established the misallocation of resources resulting from import-substituting (particularly QR) regimes. Whilst there are some analytical doubts about the use of domestic resource cost (DRC) measures as indicators of static efficiency in some of these studies, the general conclusion is reinforced by the more appropriate indicators of allocative efficiency provided by estimates of divergences between Little-Mirrlees (LM) shadow prices and market prices for a number of developing countries. l/ More significantly, these studies, in particular the NBER study, showed that countries which succeeded in reducing or removing the bias against exports had accelerated growth rates of per capita incomes whilst those which continued with or lapsed back into an IS strategy, did not. In this context it is important to make the distinction between the degree and pattern of protection. It has been argued ~/ that the existence of some highly protected industries in an economy whose trade regime on average shows little import-substituting bias (e.g. Korea) invalidates drawing any inferences from its experience in favour of a neutral trade reg1me. Jagdish Bhagwati (1986) has given the correct firm response to this line of argument: 1/ For these LM shadow price estimates see the references in Little and Scott (1976), in addition sei Little and Squire (1979) for Pakistan and Lal (1978) for the Philippines, Lal (1978a) for Korea, Lal (1979) for Jamaica, Lal (1980) for India, and Lal (1979b) for Sri Lanka. 2/ See Wade (1985). DLR-026/9.10/86 - 12 - '* Thus, within the broad aggregates of an EP country case, there may well be activities that are being import-substituted (i.e. their EERm exceeds the average EERx):. 1:/ Indeed there often are. But one should not jump to the erroneous conclusion that there is therefore no way to think of EP versus lS and that the distinction is an artificial one - any more than one would refuse to acknowledge that the Sahara is a desert, whereas Sri Lanka is not, simply because there are oases". (p.93). From Table 2, which summarises the divergence between market and 1M shadow prices for traded goods in India and Korea, it should be apparent from even casual inspection that though there may be highly protected activities in both India and Korea~ the latter has on balance a much more neutral trade regime than the former and also the dispersion of its protection 1s lower. 2 / Of the five, only the NBER comparative study explicitly sought to quantif~ the possible effects of alternative trade regimes on savings rates, technical progress and entrepreneurship - the dynamic factors which could be expected to affect the country's growth rate. However, the evidence (surveyed in Bhagwati (1978)) on entreprenuership, innovation and technical change is inconclusive, though it does support the negative conclusion that there is little basis for the view that there are beneficial dynamic effects in these 1/ EERm - effect~.ve exchange rate for imports. EERx - effective exchange rate for exports. 2/ Wade in a private communication has stated that we have misrepresented his position, which he says is from Wade (1985): "In the comparison between Taiwan and Korea on the one hand, and India and Latin America on the other, the first important fact about trade regimes is that the East Asia type is more 'liberal' in the sense that the average level of protection is much lower. But the second important fact, which the neoclassical argument has tended to ignore, is that dispersion around the average is much higher in East Asia, because selective promotion of some industries requires high protection to a small number". (P. 27) However, as can be seen from Table 2, the dispersion around the average protection is also lower in Korea as compared with India, as measured by the respective standard deviations of the accounting ratios in the two countries. DLR-026/9.10/86 - 13 - dimensions which outweigh the static efficiency costs of import-substituting QR regimes. On savings, Bhagwati {1978) concludes that the evidence does not support the view that restrictionist exchange control regimes "will or are likely to contribute to increased domestic savings, and/or to augmented capital formation. If anything, much of our evidence - at least on the domestic savings issue - suggests an opposite relationship" (p. 174). The NBER study furthermore emphasized the importance of appropriate macroeconomic and exchange rate policies in maintaining a realistic real exchange rate when liberalising a repressed foreign trade regime. As Krueger (1978) put it: ''It seems a fair conclusion that one of the policy mistakes of the two decades covered by the country studies was usinr devaluation to a new fixed exchange rate as an instrument designed to attain both domestic price stabilisation and a liberalised trade regime" (p .. 297). IV. Exogenous Shocks in the 1970s and 1980s Nor have the favourable effects of an open trade regime on growth performance established by the above studies been controverted during the more turbulent world economic enviornment of the 1970s and 1980s. The 1970s and 1980s saw the global economy buffetted by two oil shocks, the worst recession since the Great Depression, and a roller coaster movement in real interest rates 9 which after being very low and even negative for most of the 1970s, rose to historically unprecedented levels as most OECD countries sought to control an inflation which was becoming endemic. During this period, when the global shocks were commonly experienced by all developing countries, the relative performance of the relatively 'outward' as DLR-026/9 .. 10/86 - 14 - compared with 'inward' looking countries was far superior. l/ More inward looking countries are not less buffetted by external shocks than outward looking ones, for all countries need some foreign trade. In dealing with external shocks the more inward looking countries w~ich by and large have their imports dominated by intermediate and capital goods, face greater costs of output foregone through compressing imports, and more difficulty in expanding exports b~cause of the smaller porportion of output that is tradeable. For these reasons inward looking countries have not only had lower growth but also more serious adjustment and debt problems than more outward looking countries. The contrast between the South East Asian Newly Industrializing Countries (NICs) and the Latin American Southern Cone countries is instructive in this context, and in this section we review the economic performance of a select group of countries during this periode Three groups of countries have been selected. Group A includes the newly industrializing countries - Hong Kong, Singapore, South Korea and Taiwan. Th~se are referred to as countries following export promotion strategies as defined in the Bhagwati-Krueger studies. ~/ Group B includes the Southern Cone countries - Argentina, Chile, Uruguay and a South Asian country - Sri Lanka. They, as a group, are referred to as moderately import substituting countries recognizing the efforts to liberalize their trade 1/ See Lal and Wolf (eds.) (1986). ~/ This is in relation to the effective exchange rates for exports and imports. DLR-026/9~10/86 - 15 - regimes in the late 1970s. !/ In Group C we contrast the experiente of Indi- as an import ~ubstituting country which has made little or no attempt to· liberalize its trade regime and conforms to the traditional definition of ati IS trade regime, that is, one in which the effective exchange rate for imports markedly exceeds that for exports. Group A: Export Promotion Countries The newly industrializing countries of Hong Kong, Singaporey South Korea and Taiwan have had an outstanding growth performance since the 1960s compared to other developing countries. These countries have been the most dynamic exporters in the world. During the 1970-79 period exports from these NICs grew d~ an annual average rate of 25 pe~cent with manufactured exports growing at 30 percent. During 1978-81 exports grew at 19 percent per annum but with the world recession of the early 1980s, the rate of export growth turned negative. But they soon recovered, and the recovery from the recession was faster than for any other group of countries. This was despite experiencing greater external shocks than the average of 6 percent of GNP for all developing countries (viz. 18 percent for Singapore, 10 percent for Taiwan and 9 percent for Korea). ~/ The GDP growth rates of all four countries fell in 1982 compared to the 1970-82 average but recovered by 1983. So did their trade balances and export growth. The NICs used two modes of adjustment. First, they expanded exports by raising their market shares even in depressed world demand conditions. ll These countries attempted to move from Phase II to Phase III of the restrictive trade regimes in the Bhagwati-Krueger sense. See Krueger (1978). 2/ Bela Belassa (1984). DLR-026/9.10/86 - 16 - Second, except for South Korea, they were able to raise domestic ~savings and ~o restore macroeconomic balance following the external shoc~s. South Korea was an exception because its financial market has remained repressed since the early 1970s. Instead, it financed part of the temporary loss in income by increasing its external borrowings. However, South Korea was able to meet its debt service obligations without cuts in domestic output unlike a number of heavily-indebted countries. The latter also borrowed externally to finance consumption in the face of external shocks but because of repressed trade regimes were not able to generate export surpluses through export expansion, and had to compress imports instead, with concomitant adverse effects on domestic output. !/ Finally, the NICs maintained a healthy macroeconomic environment reducing domestic absorption rather than financing consumption or introducing trade controls in response to the shockso Thus, the orientation of the trade regime influenced not only the GNP growth rates during the shocks but also the rates of their recovery. Group B. Moderately Import Substituting Economies The countries included in this category attempted to liberalize their trade regimes from the mid-1970s up to the early-1980so These are the Southern Cone countries of Argentina, Chile and Uruguay and one South Asian country - Sri Lanka. All the countries met with initial success in liberalizing their trade regimes, experiencing higher growth of GOP and of exports and improvements in their external accounts compared to the previous 1/ Ibid Balassa's studies of the external shocks of 43 countries subject to shocks in 1974-76 and 1979-81 confirm the superior response of the NICs to external shocks. DLR-026/9.10/86 ... - . - 17 - decades. However, in the 1980s, their attempts to libera~ize their economies failed, largely because of macroeconomic stabilisation crises. The Southern Cone countries have shared a common path up to the mid- 1970s. Their initial conditions di~fer somewhat from the Sri Lankan case which is discussed separately be~ow. In the mid-1970s, Argentina was characterized by low growth, and a highly protected trade regime. Effective rates of protection ranged from 111 percent for manufacturing to -13 percent for agriculture. It had followed an import substitution strategy going back to the 1930s. After an initial spurt, it experienced slow industrial growth, high rates of inflation - around 180% in 1975 - and high unemployment~ GNP growth averaged 0.5% per year during the 1965-1973 period. Similarly, the initial conditions for Chile were very difficult. GDP growth was a negative 5.6% in 1973 on the eve of the reforms. Inflation had reached 1000%. The trade regime was characterized by high rates o£ protection which averaged 217 percent and their variance was considerable ranging from 1140 percent for petroleum and coal products to -7 percent for agriculture. Uruguay had experienced prolonged stagnation during the 1950-70 period. GDP growth averaged 2.0% per year during 1965-1973 period. Inflation had reached 97%, there was substantial capital flight and the currency was overvalued. By 1970 its import substitution strategy had hit the limits of the small domestic market. All the three Southern Cone countries undertook substantial economic reforms during the 1975-80 period of which a principal feature was trade liberalization. DLR-026/9.10/86 - 18 - In Argentina, taxes on exports were reduced, ll as were import tariffs which lowered both the average level· and the variance in protection. Following these reforms GOP growth averaged nearly 4% per year between 1978-80. Manufactured exports increased by 216% in the 1975-80 period. In 1978 the government adopted a scheme of pre-announcing exchange rates (the tablita). With its failure to curb the fiscal deficit, the ensuing domestic inflation coupled with a slowly adjusting nominal exchange rate led to a real exchange rate appreciation, a balance of payments crisis, capital flight, and the collapse of the banking system. ~/ By 1982 because of this stabilisation crisis the trade reforms were reversed. The Chilean reform of the trade regime was the most far reaching. All quantitative restrictions were eliminated except those on motor vehicles. All tariffs were reduced to a uniform 10% by 1979. By 1977-78, fiscal deficits were fully eliminated. A crawling peg was introduced and later fixed against the U.S. dollar in 1979. Also by 1979 the capital account was liberalized. The results of these reforms were dramatic. During the 1976-81 period GOP grew by 8% per year and manufactured exports by 30% per year. However, the opening of the capital account and the fixing of the nominal exchange rate, led to a large unsustainable real exchange rate appreciation, followed by a balance of payments crisis, capital flight and the collapse of the domestic banking system. In 1982 GDP declined by 14%, a large 1/ The export tax on wheat was reduced from 56% to 5%, on corn from 46% to 16% and for wool from 33% to 16% during the July 1976 to July 1977 period. Reported by Nogues (1981). 2/ Guillermo A. Calvo (1986). DLR-026/9.10/86 .- 19 - external debt had been accumulate~, ·and unemployment had reached 22% of the labor force. Uruguay launched a wide ranging economic reform program in the mid- 1970s. Export taxes on traditional exports were lowered. Non-traditional exports were given additional incentives. Domestic price controls were reduced sharply and restrictions on private capital inflows were eliminated. The impact of the reforms was very favorable. The trend in GDP growth of Uruguay was 1.0 percent per year during 1955-73. It rose to an average of 4.5 percent during the 1974-80 period. In 1982 however, the worldwide rise in interest rates combined with an appreciation in the real exchange rate (due to its tabilita) and a rise in the fiscal deficit, led to a balance of payments crisis. GDP declined by nearly 10% in 1982. The Southern Cone experience with economic reforms, in which trade reforms played a principal note, yields a number of lessons. The trade reforms were successful in raising export and GDP growth. The results being particularly dramatic for Uruguay and Chile. The overall attempt at economic liberalisation failed eventually because of unsustainable macroeconomic and/or real exchange rate policies. l/ The more difficult initial conditions, the large adjustment needs at the time trade liberalisation was initiated, and errors 1n macro-policy in dealing with external shocks represent major differences between the experience of the South East Asian NICs and the Southern Cone countries in the late 1970s and 1980s. 1/. Corbo and de Melo (1985); de Melo and Tybout (1986). DLR-026/9.10/86 - 20 - We now turn to Sr1·· Lanka's 1977 trade liberalisation experience, which reversed its.long standing import substitution strategy. The limitations of a small domestic market within which the easy import substitution phase was rapidly exhausted had led to a highly distorted economy. It was, however, not subject to the inflationary instability typical of the Southern Cone. During the 1960-77 period, the economy's performance was lackluster. For instance, in the 1965-77 period GDP growth averaged 2.9% per annum. The share of exports in world trade declined, as did total exports (in constant prices), by 1.5% over the 1970-77 period. The wide ranging reforms of 1977, mainly of the trade regime, led to a dramatic recovery of the Sri Lanka economy. GDP grew by 6% per annum in the 1978-85 period and unemployment fell from 24% in 1973 to 12% of the labor force in 1981. !/ However,·by 1983 because of macroeconomic imbalances the government had to put the brakes on its reform program. A large public sector expenditure program and the reluctance to close loss-making public enterprises, proved to be incompatible with the trade reforms. 2 1 As in the Southern Cone, macroeconomic imbalances - in this case brought about by a large public expenditure program - led to a real appreciation of the rupee, and a balance of payments and fiscal crisis. This set back the liberalization effort. The experience of these moderately import substituting countries points to three important aspects of the trade liberalisation process. First, appropriate macroeconomic policies are vital in assuring the sustainability of 1/ Bhalla and Glewwe (1986). 2/ Lal and Rajapatirana (1985). DLR-026/9.10/86 - 21 - trade liberalisation, as balance of payments crises induced by macroeconomic imbalances have usually been mainly responsible for the reversals in trade liberalisation. Second, the maintenance of an appropriate real exchange rate plays an important role in trade liberalizations much more so than was realized in the five comparative studies. Third, the sequencing of reforms of different repressed markets seems to be of importance$ In the case of both Chile and Uruguay the liberalisation of financial markets played a destabilizing role. It is still an open question whether this is due to the domestic structure of the financial market or is an inherent property of financial liberalization itse.lf, or is due to poor macroeconomic and exchange rate management. Group c: Import Substituting Countries India's relative immHnity to the external shocks which have buffetted other developing countries in ~he 1980s is being used to suggest that, over the long haul, and despite the acknowledged productive inefficiencies associated with the Indian trade regime, its defacto 'delinking' from the world economy has allowed it to maintain a much stendier growth path in the last two turbulent decades. !/ However, this view is mistaken. For attaining stability of domestic incomes by delinking from a vola~ile world economy can lead to a lower average income than if the world economy roller coaster is ri~den efficiently. Thus though, by insulating itself from international competition? India has maintained a trend growth rate of GDP of about 3-4 percent per annum ll The external shock to India was 2.1 percent of GNP in the 1974-78 period. See Balassa (1981). DLR-026/9.10/86 - 22 - ove~ three decades, this stability was bought at the cost of eschewing the gains from even higher growth which were available from integration into a world economy which boomed for two decades. To illustrate this loss, in 1960 the absolute size of Korea's manufacturing sector was a quarter of India's; in 1980 it was more than 60 percent of India's. Korean manufactured exports rose from virtually nothing to more than $15 billion in 1980. In the same period India's manufactured exports rose from $0.6 billion to only $4.1 billion. ''Even tiny Singapore has managed to export more manufactures in value terms ($11.7 billion in 1981) than India! India's share in world exports has declined steadil~ from 2.4% in 1968 to a miniscule 0.41% in 1981'' (Srinivasan (1986)). If it is noted that labor intensive manufacturing is a major means of providing employment and alleviating poverty in countries with a rapidly growing labor force, and suffering from pressure on land, the long run damage done by India's 'inward looking' policies to both growth and equity is evident. Though it is now fashionable to castigate the Latin American 1 countries for having followed debt-le!d 1 growth in the late 1960s and 1970s, it should be noted that the subsequent income losses they may have suffered to service their debts have to be set off against the enormous previous gains in living standards that debt financed growth entailed (see Bhagwati (1986)). DLR-026/9.10/86 - 23 - V. Trade and Growth: Income Effects !/ Finally, two of the most influential development economists, Nurkse (1961) and Lewis (1980) have adduced a link between trade and growth in terms of the transmission of the demand effects of a rapidly growing world economy to an open developing ccuntty. ~his is the famous view of "trade as the engine of growth''. Nurkse (1961) argued that in the 19th century, trade had provided such an engine for the growth of white settler communities, but predicted that it would no longer do so for the Third World in the latter half of the 20th century. Nurkse's reading of history and his predictions about the future both proved false. The view that international trade was an engine of growth in the 19th century for the countries of new settlement has been questioned by · Kravis (1970). Essentially, he argues that economic growth is determined by internal factors. International trade provides an extension of the domestic opportunitiPs available for converting domestic resources int~ goods and services required for either investment or consumption. Furthermore, by widening the market for a country's products, it enables it to produce goods which have decreasing costs of production on an efficient scale. Finally, and probably most important of all, exposure to international competition is the best anti-monopoly ~olicy in practice, and prevents the development of high- cost industries. Most of these benefits concern the efficient use of available resources and hence the supply side of the economy. The demand factors with which Nurkse and others were so preoccupied cannot be as important because the ll Much of this 1s based on Lal (1983)~ DLR-026/9.10/86 - 24 - development experience of countries which shared in the, 19th century expansion of trade was so different. For instance, Australia seemed to devel~p whereas Argentina did not, despite similar resource bases, 'white' populations (Argentina had none of the problems of assimilation posed for other countries in Latin America.by a 'backward' indigenous population), and a similar stimulus from the rise in export demand for their major primary products. Thus, as Kravis emphasises, though a strong external demand for a country's exports may be helpful. 'it is neither a necessary nor sufficient condition for growth or even trade to play a helpful role in growth ••• The term "engine of growth" is not generally descriptive and involves expectations which cannot be fulfilled by trade alone; the term "handmaiden of growth" better conveys the role that trade can play.' !I More recently, L~wis (1980) has presented auother model where trade serves as an engine of growth. He bases this theory on the following empirical regularity: 1 The growth rate of wor!d trade in primary products over the period 1873 to 1913 was 0.87 times the growth rate of industrial production in the developed countries; and just about the same relationship, about 0.87, also ruled in the two decades to 1973. World trade in primary products is a wider concept than exports from developing countries, but the two are sufficiently closely related for it to serve as a proxy. We need no elaborate statistical proof that ~rade depends on prosperity in the industrial countries. ~/ Riedel 11 has recently tested Lewis's thesis that developing countries' exports are driven by external demand, as well as the postulated 1/ Ibid, po 869. 2/ Ibid, p. 556. 3/ Riedel (1984)o DLR-026/9.10/86 - 25 - empirical relationship between the two. The words underlined from Lewis's Nobel lecture contain by no means an innocuous assumption, for one of the profound changes in the structure of developing countries' exports has been that, whereas manufactures accounted for only 10 percent of their non-fuel exports in 1955 9 that share had risen to over 40 percent by 1978. Primary product exports can no longer serve a.s a proxy for developing country exports, as Lewis asserts. Nor, except for sub-Saharan Africa, is the picture much altered by descending from these aggregate heights. For, though there are major differences in the export structure of different developing countries, with manufactures now accounting for 75 pe~cent of the exports of the four East Asian super-performers, most of the countries in South Asia~ plus Egypt, Brazil, Mexico, Tunisia and some smaller Latin American countries accounting for about two-thirds of the population of the developin~ Qorld have also raised the share of manufactures in their exports (on a rade- weighted basis) from an avei~age of 15 percent in 1950 to above 50 percent in 1978 .. Nor does Lewisus link coefficient of 0.87 between the rate of growth of Northern 'indus;rial prcduction' and Southern exports fare any better once both the time period (1953-73) and Southern exports are disagg~egated. Broadly speakingp the hypothesised link is unstable over time, and the only primary commodities for which it seems to obtain are tea and s~·gar~ For manufactures, the dominant and growing element in Southern exports, Riedel concludes that 'the evidence o•o suggests that supply rather than demand factors have principally determined LDC export performance in manufactures. 0 !/ This is also the conclusion of the numerous historical 1/ Ibid .. DLR-026/9.10/86 - 26 - studies of the tr.ade and industrialisation policies of Third World countries cited earlier !1. It should have been obvious to the faint-hearted had they noted that, despite creeping protectionism and the slowing down of Northern growth, 'whereas in the 1960s LDC exports of manufactures grew almost twice as fast as DC real GDP, ••• in the 1970s, despite a general slowdown of growth after 1973, LDC exports maintained their r(Jpid pace," growing four times as fast as DC real GDP.' '!:.,! Thus the 'trade as the engine of growth' view cannot adequately explain the link between neutral or liberal trade regimes and growth. In this context an argument has been advanced (see Streeten (1982), Cline (1982)) that there is a fallacy of composition involved in generalising the example of the South East Asian NICs to the rest of the world. It is argued that, a general move to EP regimes by LDCs would lead to a spectacular increase in their exports to developed countries, which the latter would seek to resist through protectionist measures. Ranis (1985) provides a thorough critique of these views. The most important counter argument is that with the adoption of an EP strategy "the much more substantial growth of per capita income resulting in the exporting countries would enable them to increase their imports from the North as well as each other" (p. 544). Unless it is envisaged that the Third World runs continual and massive trade surpluses, the concomitant increase in developed countries' exports to the South should put 1/ Little, Scitovsky, Scott (1970), Balassa (1971, and 1982), Bhagwati (1978), and Kr~eger (1978). 2/ Riedel (1984). DLR-026/9.10/86 - 27 - countervailing pressure~ on protectionist lobbies in OECD countries. In fact, despite the dangers and fears expressed about the 'new protectionism' in the West, the important fact is that protectionism has by and large been kept at bay during the deepest recession since the Great Depression. VI. Level and Growth Effects: Unravelling the Technological Black Box How then does one explain what seems to be as firm a stylised fact as any in the economics of developing countries, namely that a sustained movement to an outward oriented trade regime leads to an acceleration of the growth rate of both exports and national income? Krueger (1978) in fact argues that mere neutrality of the trade regi~e is not enough: "There are numerous countries where incentives for export and import substitution have been about equal, and the results have not been spectacular •••• Although economic theory suggests that incentives for exports and for import-substitution should be equated at the margin, in fac~ neither Brazil nor South Korea did so; during the rapid growth years [Korea after 1964 and Brazil after 1968) the bias in their regimes was toward exports" (pp. 282-83). Krueger then compares two consciously activist policies to encourage growth, "the alternative of a strictly laissez-faire regime is not explored" (p. 284) and argues that "a growth strategy oriented towards exports entails the development of policies that make markets and incentives function better, while an import-substitution strategy usually involves policies designed to frustrate individuals' maximizing behaviour under market incentives" (p. 284). These statements have misled some economists (see Streeten (1982) and the riposte by Henderson (1982)) to suggest that an "outward oriented" strategy necesssarily involves an export biaso They quite rightly note that export promotion can be as inefficient and chaotic as protection, as is DLR-026/9.10/86 ... 28 - witnessed by the case of India (see Lal (1979b)). The liberal position on trade and growth (which we support) would as a first step entail a neutral trade regime, and needs to be contrasted with advocacy of an EP trade regime interpreted as having an export bias. The fact that such a neutral or liberal regime does not necessarily lead to growth merely emphasises Kravis 'trade as the handmaiden of growth' view which finds internal factors as the most important determinants of growth,'with trade a helpful though not dominating influence. The maintenance of a liberal and even a neutral trade regime (and mutatis mutandis an export biased one) as compared with a protectionist regime can help more directly, however, than Kravis has allowed, in the creation of a domestic economic framework which is conducive to growth. This was one o£ Jan Tumlir's major insights developed in a series of papers in the late 1970s and early 1980s but unfortunaLely not consolidated into the book he was planning to write when his life was so tragically cut short~ Analytically he accepted that as shown by the mode!"r~ theory of t?"ade and we~ fat"e the case for government inteevention in foreign trad~ can be sep8rated from that in the domestic economy, so that despite what view one takes about the latter, the former is unjustifiable (except for the optimal tariff case). Ho~ever, he argued that the analytical separation in this "management economics for governments", was misguidedm (Tumlir (198l))o Though it mitigated some of the irrational dirigisme of governments, it nevertheless emphasized a view of the world in which 'market failure' was ubiquitouso Benevolent, omniscient and omnipotent governments were then charged to intervene in the social interest in line with the canons of second best welfare economicso By contrast on the more clear headed view of government motives and DLR·"'026/9 o 10/86 - 29 - foresight, (associated with Adam Smith and the classicists - whose modern day votaries are the so-called neo-Austrians) which recognises the ubiquitousness of 'government failure', the case for a liberal or at least neutral trade regime becomes part of the general case for markets against mandarins. The ideal balance between the two is not discussed in this paper. (but see Lal (1986)). But, if the need for restraints on the naturgl and often irrational dirigisme of mandarins in most Third World countries is accepted, then the adoption of a liberal trade regime (irrespective of the ensuing gains from trade-static and dynamic) becomes an important means to this end. This line of thought can be further developed by making use of some ideas on 'investment and growth' due to Maurice Scott. l/ This also provides an antidote to the Lucas criticism, namely that static gains from free trade merely effect the level but not the rate of growth of income. Scott argues that "investment is •oe~by definition ••• the cost of chan~e,. and so will cover all activities associated with growth" 2 1 and that "growth due to capital and technical progress are both the result of investment" ~_/ in the sense of "the cost, in terms of consumption foregone, of propelling the economy forward instead of leaving it in a stationary state .. " !!._/ "Incurring capital expenditure leads to a rearrangement of the things of this world. It does not lead to there being any more of some substance 'capital' coo There is then simply change which is due to investment, and to population growth. We cannot 1/ Scott (1976). 2/ Ibid p. 317. 3/ Ibid P• 330. 4/ Ibid P• 318. DLR-026/9.10/86 - 30 - separate change which is 'more capital' from change which is 'technical progress'. We must abandon the attempt to distinguish between movements along a production function whose arguments are labor, land and all capital, and a shift in that function due to technical progress." ll Within his proposed framework, "the rate of increase of static income is a function of only two variables: total savings and labor force growth. There is no independent technical progress" f:./ The most important aspect of Scott's proposed framework is its emphasis on "the importance of allocation" for the growth rate. In contrast to the conventional framework which views allocative improvements as providing "a once-and-for-all increase in output and a temporary boost to the growth rate while it is occurring", Scott argues that "if, however, investment is essentially a matter of incurring costs to reallocate resources, then the efficiency with which this is done must affect the yield of investment, and so the proportionate rate of growth in the long run. So long as investment is occurring, reallocation is occurring. It is not once-and-for-all, but a continuing process, and, indeed, the principal source of growth in many countries'} (p. 332-33). Moreover, argues Scott "investment at any given time is undertaken in a state of ignorance about the future. We make changes whose consequences we cannot wholly forsee, and, simultaneously, others are making changes of which we can only become aware after they are made. In the light of these changes we are then in a better position to make the next round of changes." This 1/ Ibid p. 331. 2/ Ibid p. 331. DLR-026/9.10/86 - 31 - implies "that there is an externality to investment." lf... But "if the externality exists just because we are ignorant of the future effects of in.vestment, it may be impossible to discover very much about the characteristics of investment that produce the externality." True. But this argument. needs to be extended. It suggests the importance of the general economic environment which is conducive to this 'ignorance' based--externality creating form of investment. This is the place for the nee-Austrian insights concerning the role of the entrepreneur in an economic environment characterized by ignorance. (see Lal (1986) for references and a fuller discussion). The entrepreneur is redundant in neo- classical economics which assumes an economic environment of purely actuarial Knightian risk. But he is at the centre of the nee-Austrian stage--creating and searching out investment opportunities and taking gambles on the future. Like the speculator and middleman, the entrepreneur is an economic agent who lives by making money out of irreducible Knightian uncertainty. In a world where we are ignorant about the future, this entrepreneurial function must, for reasons concerning incentives and information, be decentralised. To the extent that faux mieux an EP strategy has to rely on this entrepreneurial function (as export markets cannot be assured by local mandarins), it will induce the creation of that economic frawR~ork in which Scott's externality creating investments will lead to an acceleration of the growth rate. 1/ Ibid p. 334. Lucas (1985) presents a neo-classical model of economic development in which a central element is an externality in human capital investment. Many of his insights would seem to complement those of Scott, except that he draws unwarranted dirigiste implications from them. DLR-026/9.10/86 - 32 - The case for a free (and as a second best-export biased) trade regime, looked upon as 'the handmaiden of growth', is thus close to that argued by the classical (and their modern day descendents - the nee-Austrian) economists. As Keynes emphasised, the classical case against mercantilism was not based on laissez-faire, but rather on limiting state action to areas where such action was indispensable. These broadly speaking are to provide the I essential public goods required for the efficient functioning of market processes--law and order, a stable money--and those infrastructural activities which have important public goods aspects. The modern day variant of the classical case, whilst accepting the need for an activist state would seek to limit its activities from creating those policy-induced distortions supposedly to cure endogenous distortions in the working of the price mechanism, which have led to large, though unquantifiable losses, through diverting energies and resources which could, should and would be deployed towards productive ~eal income growth generating activities, towards the wasteful lobbying and rent seeking activities so common in most publicly repressed economies of today's Third World. It is in this task of confining public action to its proper place that a free trade regime could be an important component of an economic framework which provides the necessary incentives for entrepreneurship, productivity and thrift, which (however little they may be formally understood by economists) remain the ultimate mainsprings of sustained and sustainable economic growth. DLR-026/9.10/86 Table 1.1 Estimated Spearman Rank Correlation Coefficients Between Export Growth and Output Growth fn Developing Countries Average Annual Author Change in Expo1t Incremental Export Increments In ~xport-GNP GNP Ratio vs. Average Export Growth GNP Ratio GNP Ratios Annual Per Capita GNP vs. vs. vs. (No. of obs.; period) Gro~th GNP Growth GNP Growth the GNP Growth Michaely { 4 1 ; 19 50-7 3 ) 0.380 ** (23 middle income llll w lOCs: 1950-73) 0.,523 w I (18 low f ncome lDCs: 1950-73) -0.04 Batassa (11 semi-industrialized lDCs: 1960-73) o.aaa ... 0.813 •• 0.776 •• ~~ indicates one percent level of significance. Source: MichaeJy (1977), pp. 51-52; and Balassa {1978), Table 1. pG184. Table I .2 Estimated Relationship Between Export Growth and Output Growth in Developing Countries Author Dependent Independent Variables (b) Variable (a) (No. of obs.; period) ~) y -AKd AK -y -fl.L -AX -fl. X -AX Di 1T Di2t R2 1 y 1 1 Ll AY x, yt Michalopolous and - 0.25 0.20 0.66 - - - - - v.53 ~ (1.81) (3.35) (2 .44) (39; 1960-66) 0.24 0.12 0.60 0.04 0.71 (9.62) (2.33) (2 .81 ) (4 .82) I w .r;:.. Balassa (1 0; 1960-7 3 ) - 0.18 0.30 1.09 - - - - - ··- 0.58 (3.23) (2.42) (1. 74) 0.15 0.,23 0.97 0.04 - - - - 0.77 (3.33) (2.40) (1.99) (3.57) Feder £./ - 0.284 0.739 - - - - - 0.37 (31; 1964-73) (4.311) (1.990) 0.178 0.747 - - 0.422 (3.542) (2 .862) (5.454) 0.689 0.124 0.696 - 0.131 0.305 - - 0.809 (3.009) (3.399) - (4 .239) (4.571) d/ Krueger - - - - - 0.11 - o.o8 0.16 0.99 (10; 1950-70) (4.29) (0.85) (1.70) (a) The dependent variable #> yl is the GNP growth in Michalopoulos and Jay, Balassa and Krueger. In the Feder study, it refers to GOP growth. (b) The independent variables are; ~} domesticaly financed investment as a proportion of the GNP in the initial y period; (AKt) foreign-financed in~estment as a proportion of GNP in the initial period;~) increase in y population as a proportion of the population in the initial period; ~) incremental export-GNP ratio; AY ~) AX increase in exports as a proportion of the exports in the initial period; ~) increase in exports as a x, 1 proportion of GNP in the initial period; (0 11 > a dummy variable which takes the value of one during Phases l and I I of the trade regimes; a dummy variable which takes the value of one during Phases Ill and IV of trade regimes; and t which is a time variable. (c) The export variables in Feder are ~> AX ,, X y =.M F> y and __If!. X (d) In Krueger's study log refers to a pooled sample of ten countries in which log GNP is regressed on a time trend and w \Ji log (X), a dummy variable for the country's Phases I and II trade regime (i.e. o11 t> and another dummy variable for Phases Ill and IV of trade regime. Numbers in parantheses are t-values. Source! Michalopoulos and Jay (1973); Balassa (1978), Table 2, P. 186; Feder (1983), Table 1, p.65 and Table 3, p. 68, Krueger (1978) Table 11-2, p. 273. - 36 ~ Table 2.1 Summary of estimates of social prices for India ·Pf -Social price P( - Market price (A) ~ccounting ratios for traded commodities (1973) A = Pfl f"r 1 P'tfl) (.'()de number A ''C()UIII ing Commodity ratio, A,1 Tl Electrical equipment T2 Non-electrical equipment 0.36 TJ Transport equipment 0.65 T4 Metal products 1.28 TS Iron and steel 0.29 Pipes and tubes 1.00 Pig iron 1.00 T6 Cement 1.00 1'7 Nuu-lctTou~ metals 0.66 (), ~') TX CHhcr miucrals f'J Rubber 0.61 TlO Leather 0.60 TJ I Other leather products 0.50 T 12 Leather footwear 0.50 Tl3 Animal husba.ndry 0.81 TJ4 Sugar 0.37 TlS Our and khandsari 0.52 T16 Vegetable oils 1.08 T 17 Vanaspati 1.14 Tl8 Starch 0.65 Tl9 Milk products 0.87 '1'20 lllcwcric~ auc.l soft drinks 0.29 T2l <..'unli.:ctioncry 0.6X T22 Cigarettes and cigars 0.60 T23 Other tobacco products 0.39 T24 Fruits and vegetables 0.39 T25 Ca£hew-nut processing 0.32 T26 Cotton 0.27 T27 Cotton yarn 0.51 T28 Cotton textiles 2.04 T29 Jute 0.46 T30 Jute textiles 0.57 T31 Woollen yarn 0.44 T32 Woollt!n textiles 0.60 T33 Raw silk 0.61 T34 Silk textiles 0.71 T35 Man-made fibre (rayon) 0.50 T36 Artificial silk 0.13 T37 Other textiles 0.43 0.44 - 37 - Table 2.1 (Cont.) PAD code Accounting number Commodity ratio, A11 T38 Tobacco 0.43 T39 Fertilizers 1.00 T40 Ceramia and bricks 0.44 T4l Glass and glassware 0.72 T42 Wood products 0.97 T43 Timber 0.80 T44 Chinaware, pottery 0.50 T45 Wood others 0.56 T46 Other forest products 0.27 T47 Petroleum products 0.65 T48 Rubber footwear 0.73 T49 Synthetic rubber 0.73 TSO Other rubber products 0.48 T5l Paper and paper products 0.44 T52 Plastics 0.47 T53 Dyestuff 0.39 T54 Paints and varnishes LJS TSS Insecticides and pcsti\.!ides 0.91 T56 Drugs and pharmaceuticals 0.32 T57 Soaps and glycerine 0.57 T58 Perfumes and cosmetics 0.39 T59 Miscellaneous chemicals 0.53 T60 Coal and coke 0.72 T6l Matches 0.76 T62 Plantations 1.00 T63 Aluminium primary product o.xo T64 Zinc OJ> I T65 Lead 0.5H T66 Tin 0.57 T67 Manganese 1.00 T68 Sulphur 0.65 T69 Sulphuric acid 0.65 T70 Rock phosphate 0.87 T71 Salt 1.00 T72 Wheat O.R7 T73 Soda ash 0.76 T74 Dry cells 0.52 T75 Hall lwarinw> o,.to T7lt l•h-c trw lan., I 00 T77 Radw rccctvcrs 0.)2 T78 Non·ferrous metal alloys 0.69 T79 By-products of foodgrair