How and How Far to Liberalize A Small Open Economy with Informal Sectors and A Non-Traded Intermediary

Abstract

Whether a liberalizing developing economy should implement the entire WTO-prescribed package and to what extent this is expedient, are the two burning questions, especially because available empirical evidence suggests that the developing countries have been facing substantial adjustment costs in their endeavor in implementing trade and investment reform. The present paper makes a humble effort to provide answers to the above questions in terms of a three-sector general equilibrium model with informal sectors and a non-traded intermediary. Welfare implications of three liberalization policies: inflow of foreign capital, tariff reduction and labour market reform, have been analyzed. The paper shows that there is no need for a liberalizing country to follow all the recommendations of the WTO, without taking into consideration the net welfare outcome of these policies. Unless, a proper choice among different prescribed policies compatible to the internal institutional, technological and trade related characteristics is made, drastic implementation of reform measures may produce counterproductive result on welfare of the relevant country.