Why Trade Liberalisation is Good for Growth

Abstract

There are three titles that might have been assigned for this paper: 1) Why Is Growth so Rapid with Outer-Oriented Trade Strategies?; 2) Do Countries with Outer-Oriented Trade Strategies Grow Faster? and 3) the one actually assigned. They are not the same. Of the three, the first is probably the most difficult to answer. The second is a factual question, and the empirical demonstration is straightforward (Sachs and Warner, 1995). The third, by focussing on trade liberalisation, implies that developing countries have highly restrictive trade regimes and thus asks if a move away from those regimes is good for growth. It is far easier to show why, especially over time, liberalising a restrictive trade regime is conducive to more rapid growth than it is to show why outer oriented trade strategies have been so highly successful. Trade strategies and development strategies are closely related, and it is useful to start by defining a few terms. An import-substitution (IS) industrialisation strategy was adopted by most developing countries in the years following the Second World War. In most cases those countries were then predominantly agricultural and exporters of primary commodities. The belief then was that rapid industrialisation was the essential (if not the sole) feature of economic growth and that only by domestically producing goods then imported could developing countries industrialise.1 Under IS, it was intended to provide protection to new industries during their developmental period until they could compete with their counterparts in industrialised countries. In practice, the IS strategy pulled most new resources into import-competing activites (with a number of negative consequences discussed later) and one result was that export earnings grew less rapidly than the demand for foreign exchange and usually less rapidly even than real GDP. An almost universal policy response was then to impose restrictive import licensing in response to 'foreign exchange shortage'. The stated reasons for this were the need to 'conserve scarce foreign exchange' for 'essential' developmental needs. The outcome was, of course, a restrictive trade regime. For reasons to be discussed below, as IS strategies continued, trade regimes increased in restrictiveness and growth slowed. Hence, to discuss trade liberalisation is to address the removal (or at least reduction) of incentives for IS industrialisation. And, because again to be discussed below growth spurred under an IS industrialisation strategy slows