17 January 2001 - Globalisation and growth - Larry Willmore Pingfan, We are most definitely on the same wave length. However, I would like to elaborate a bit by discussing a case that amounts to the closest thing we have in economics to a controlled experiment, an experiment that illustrates very well our message. The experiment I am talking about is Mexico. Mexico until recently was a very closed economy, with high tariffs and quotas (including prohibitions) on imports as well as restrictions on direct foreign investment. The border regions were characterized by severe problems of unemployment and poverty, so the government decided to lift the trade and investment restrictions for the territory bordering the US in the north and Guatemala and Belize in the south. The customs house was moved 18 km down the road, so the border regions became essentially a free trade zone. I myself observed Mexican workers in Nuevo Laredo (Mexico) crossing the bridge on foot into Laredo (Texas), purchasing groceries, and returning without facing any customs official. Trucks (lorries) from the US could similarly drive into this region unchallenged by Mexican customs officers. What happened? Well, the border region with the US prospered. Foreign ?maquiladores? were attracted by the cheap, abundant labour and the proximity to the US market. US policy helped by collecting import duties on only the value-added of Mexican assembly of US components. Prostitution virtually disappeared in the formerly seedy border towns, household help became scarce, and workers began to migrate from the rest of Mexico to the northern border. The southern border, in contrast, continued to stagnate. It was located far from markets. Guatemalan firms had no interest in setting up plants in Mexico. In any case, they had lots of low- skilled, cheap labour at home, and would have faced high tariffs on anything shipped back to Guatemala. Chetumal (the capital of Quintana Roo) got a bit of business as a duty-free port for vacationing Mexicans, and the odd Belizian. Much later, Cancun was developed as a major resort with duty-free privileges, but this was a conscious development of the government, not a result of free trade per se. What is the lesson of all this? I think it shows that opening an economy to trade can have powerful effects on development, provided the conditions are right. Mexico?s northern border is located next to a wealthy market. This turned out to be a blessing, despite the Mexican lament that they reside ?so far from God and so close to the United States!? The southern border continued to stagnate because transportation costs were so high to move goods from there to any feasible markets. Free trade is no panacea. But, with the right conditions, it can produce a miracle. Mexico, as a result of its lowering of trade barriers and subsequent entry into NAFTA, is now extending this miracle of the northern border to other regions of the country. The southern portion of the country (including Chiapas) is not benefiting from this ?globalisation?, however, because the roads and infrastructure are so poor in that region ************ 25 January 2001 - Export pessimism Larry Willmore I would like to invite comments on the following message that I sent to a colleague this morning: Dear colleague, In conversation yesterday, following our return from the globalisation retreat, you expressed regret that we had focused on internal policies rather than the external environment that developing countries face when they attempt to promote exports. In particular, you emphasised an 'aggregation' problem: if all developing countries try to export labour-intensive manufactured goods, they may spoil the market for their output. I, too, regret that this issue did not come up at the retreat, for such pessimism, in my view, leads to very poor policy advice. While it is theoretically possible for export-led growth to make a country worse off (Bhagwati demonstrated this long ago), this requires monopoly power in export markets, such that increased exports cause prices (more rigorously, the terms of trade) to fall. This may well be true for the entire group of low-income countries, should they simultaneously decide to expand their exports of shoes, clothing, and other low-skilled labour-intensive manufactures. This was the reasoning of ECLAC in the 1970s, which advised Latin American countries to turn inward rather than seek export markets. But ECLAC staff forgot that they were advising countries, not the entire group of low-income countries. As a consequence, while Latin America languished with import substitution behind high trade barriers, East Asia was growing at 'miracle' rates, exporting simple, l! abour-intensive manufactures to the industrial countries. ECLAC gave poor policy advice to Latin America, even if such advice might have been appropriate for all low-income countries combined (though that surely would call for reduced exports, via an optimum tariff, not a blanket prohibition of all exports of labour-intensive manufactures). Let us assume, however, that your fears are correct: increased exports of shoes, clothing and the like will 'spoil the market' and cause prices to plummet. Even so, why would you want to block export promotion in Angola or Mozambique? Should these small economies be successful beyond their wildest dreams, they will nonetheless never account for more than a tiny share of the world market for labour-intensive manufactures. You should instead direct your attention to India and China, huge countries that are expanding exports at a rapid pace. Are you willing to advise India and China to turn to inward development (import substitution), or at least reduce the rate of growth of their exports? If you are not willing to give this advice to two giants, I suggest, then, that you have no moral right to advise countries like Angola or Mozambique to stay out of markets dominated by India and China. PS: I apologise if I sound combative on this issue, but it touches me deeply, not least because I was unsuccessful in Santiago even in getting colleagues to discuss the effects of high tariff barriers when I was an ECLAC staff member there from 1978 through 1982. I spoke out repeatedly, but no one listened. Worse, my views were dismissed as irrelevant 'northern economics'. ECLAC has since changed for the better, thanks to compulsory retirement of staff at age 60 and thanks to Chile's very successful trade liberalisation. I have no illusion that I had anything to do with the intellectual opening of ECLAC. I intend to post this message on the globalisation board, without the PS and without mentioning your name. Please feel free to reply with your own post, for this is an important issue that deserves attention. DESA should never become like the ECLAC of old, closed to views of outsiders. *********** 31 January 2001 -Larry Willmore- Protection and comparative advantage As Paul Krugman pointed out, Ricardo's theory of comparative advantage is a difficult idea. Another concept that people find equally difficult to comprehend is the idea that protection, via a tax on imports, is equivalent to a tax on exports. This is known as the Lerner Symmetry Theorem, after A.P. Lerner, who formalised the theorem in a 1936 Economica article. In the classroom, we typically rely on a geometric proof using a simple two-good model. Some years ago I was asked to give a series of talks on trade liberalisation to businessmen and government officials in Central America, and I found the customary blackboard demonstration to be much too abstract for an audience of practitioners. So, I introduced an exchange rate to illustrate the anti-export bias of import tariffs. A written version ended up in an article that I co-authored with an ECLAC colleague: _____________________________________________ If the State wants to eliminate anti-export bias for favoured goods (which may be termed "non-traditional")without granting explicit subsidies, it will have to effect a _compensated devaluation_ of its currency and impose export taxes on unfavoured products (which may be termed "traditional"). The implications of this option can be better understood with a hypothetical example. If the uniform, free exchange rate is 10 pesos per dollar and there exists a uniform tariff of 20% on imports, then there is an anti-export bias because a good that is worth 12 pesos in the local market is worth only 10 pesos when it is exported. If the currency is devalued to 12 pesos per dollar and the tariff is simultaneously lowered to zero, this compensated devaluation is not inflationary because the good that sold for 12 pesos in the local market will continue to sell for 12 pesos. But the same good will now be worth 12 pesos in export markets: the anti-export bias will have disappeared. If the State does not want exporters of traditional products (coffee, bananas, beef, etc.) to benefit from the devaluation, it need only collect a tax of 16.7% so that they continue to receive only 10 pesos for each dollar of exports. The export tax will also help to compensate for the loss of tax revenue that results from the elimination of the import tariff. L. Willmore and J. Mattar, "Industrial restructuring, trade liberalization and the role of the State in Central America," Cepal Review 44 (August 1991), p. 11. _____________________________________________ Fortunately, I did not give any lectures in Panama, for that country has no Central Bank! The didactic technique will soon fail as well in El Salvador, which recently began official dollarisation of its economy. ************** 31 January 2001--Henk-Jan Brinkman-Protection and comparative advantage Protection and comparative advantage Henk-Jan Brinkman Brinkman brinkman@un.org Larry's argument about the Lerner symmetry only holds if the same good that is imported is exported as well. But who would do that? In general, the problem with the Lerner symmetry is its uni- dimensionality. The uni-dimensionality implies that it is impossible to have outward oriented policies combined with import protection. In other words, any bias in favour of import substitution means a bias against exports. This view, however, can be challenged. Liang (1992) showed that the bipolar interpretation is based on the traditional 2-goods model (exportables and importables) which yields one relative price and one dimension. When three sectors are introduced, by adding a non-tradable home good, two relative prices and two dimensions result. Hence, we have four combinations of (dis)incentives for export and/or import activities. This can of course be expanded to the real world with many more goods and services. There is also a logical error. The Lerner symmetry would lead to a conclusion that import protection and export promotion cancel each other out and would yield a neutral trade regime. Yet many countries in East Asia import substitution policies were often combined with export promotion strategies. ------ 1 February 2001 -Larry Willlmore- Protection and comparative advantage In response to Henk-Jan's comment, I would like to point out that the Lerner Symmetry Theorem is based on two goods or sectors, not a single good. In other words, the good that is exported is not the same as the good that competes with imports. Max Corden, in his book _The Theory of Protection_ (Oxford University Press, 1971, pp. 119-122) generalised the Lerner Theorem to 'n' goods. ****************** 7 February 2001-Larry Willmore-Free trade versus protection Dear colleague, We had an interesting, though brief, exchange of views yesterday whilewe were both waiting for the lift (elevator) in the DC2 building. I would like to share this exchange with those who visit this bulletin board, and expand somewhat on my own views. You said that you are much too busy to write e- mails or post messages. That is a pity, for unless people with differing views take the time to post messages, this site will be one-sided and rather boring. Your concern, if I can summarize it with fairness, is "If globalisation is such a good thing, why don't we tell low- income countries to dismantle their barriers to trade and investment and leave it at that?" My response to you was that you misconstrue the free trade position. Development is a difficult process, and one that we don't understand all that well. Free trade is not a magic solution to the problems of underdevelopment and poverty. Free trade does not guarantee development, but it does facilitate development. Karl Marx understood this very well, which is why he supported free trade. Marx was an admirer of Adam Smith, and took his trade economics from _Wealth of Nations_. Today, 225 years after the publication of _Wealth of Nations_, the insights of Smith are widely ignored by the public and intellectuals alike, including those who claim to be followers of Karl Marx. The question is not whether free trade will guarantee development, but rather whether protection will do the job. My position is that cutting off a region or country from the benefits of specialisation through trade and investment harms development. I appreciate, though, that some people conclude the opposite, that 'delinking' is beneficial. It may help to think of an underdeveloped region of a national economy, such as Appalachia in the United States. Now, there is a completely free flow of goods, capital, and even labour between Appalachia and the rest of the country. There are no customs houses, no immigration officers at the borders of Appalachia. Yet, the region remains depressed. Obviously, free trade and free movement of factors did not induce development. But, ask yourself, would protection help? Would the inhabitants of this poor region be better off if they erected a tariff wall and restricted the inward flow of direct investment? I think not, but you have to answer this question honestly for yourself. I repeat: development is a difficult process. There is no simple solution to the problems of poverty and underdevelopment. Opening up a region or country to trade and investment will not help very much if investors choose not to come and residents have low productivities and little to trade. Even large flows of foreign aid may not help, for they can result in dependency rather than development. Witness, for example, the continued underdevelopment of the south of Italy or of Atlantic Canada despite massive flows of assistance from each respective central government. No, by embracing free trade there is no danger that development economists will put themselves out of a job. But they can do a service to their clients by recommending policies that help rather than hinder development efforts. And remember, free trade does not equal laissez-faire. Competent governance is essential for development. In conclusion, I would like to emphasise that none of this is new. It is all in Adam Smith. Modern readers sometimes find Smith too wordy. (I love his writing, but I am very old fashioned, according to my children.) For a short, readable account of these issues, I recommend _Against the Tide: An Intellectual History of Free Trade_, by Douglas A. Irwin (Princeton University Press, 1996). It is available in paperback for less than 15 dollars. I look forward to seeing your views posted here in the near future. Please take the time to participate. That way, we can all learn from each other. ***************** 9 February 2001 - Larry Willmore - Globalisationa and poverty Henk-Jan's post prompts me to respond with the following quote: "I am first going to risk annoying nearly everyone by making a case that the very term "globalization" has become so slippery, so ambiguous, so subject to misunderstanding and political manipulation, that it should be banned from further use ... at least until everyone is agreed as to its precise meaning and proper usage." Gerald Helleiner, "Markets, Politics and Globalization: Can the Global Economy be Civilized?" Raul Prebisch Lecture, UNCTAD, 11 December 2000. Martin Wolf and Clare Short in their praise of globalisation are referring to trade and direct investment only, not to short term capital flows. Short term capital flows is one area where nearly everyone would now agree that incomplete globalisation is probably a good thing. Nonetheless, I would like to point out that sudden reversals of short term capital flows is a problem only for successful economies. Desperately poor and marginalised economies do not face this problem, for there are no inward capital flows to reverse. Trade liberalisation is painful, of course. Enterprises that produce exportables benefit, while those that produce importables are hurt. The creative destruction of technological change is also painful: new jobs are created and others disappear. Blocking trade and technological change spares societies this pain, but it also prevents them from reaping the rewards. Without these rewards, it is difficult if not impossible to lift people out of poverty. When we see that a formerly protected industry cannot survive without subsidies, our response should not be to restore the protection. We should look, instead, at ways of sharing the cost of transforming the economy, possibly by slowing the pace of trade liberalisation, or by retraining displaced workers. One of the difficulties in moving to an open trading regime (or adopting new technologies, for that matter) is that benefits are spread over many consumers whereas the costs are borne by relatively few producers. Bhagwati's 'immiserizing growth' refers to the adverse terms- of-trade effects of increased exports of a product in which the country has monopoly power. This is now recognized (even by Bhagwati) as an interesting theoretical possibility with no empirical relevance. Another type of immiserizing growth is, however, very relevant empirically. This is the case of direct foreign investment attracted by high tariff barriers. Suppose a country has a 100% tariff on a particular good, say television sets. Without local production, the government will collect a 100% tax on each television set purchased by residents of the country. But producers can 'jump the tariff' by setting up production (or, more often, only assembly) inside the country. They can charge double the international price, and the consumer will pay the same domestic price as before , but the government will no longer collect any revenue. This is equivalent to collecting a tax on TV sets and giving all the proceeds as a subsidy to the producers. It is easy to show that the country might well be immiserized by this type of inward investment. The policy implication is that allowing free inflow of investment in the presence of high import tariffs is not a good idea. Domestic investment in these circumstances might also be immiserizing, but this is less likely because the excess price paid by consumers goes to residents rather than non-residents. But what if a country wants to tax consumption of luxuries like TV sets, for distributional reasons? In that case, the country should levy not a tariff, but rather a specific sales tax, to be collected in the customs house on imports and in the factory or warehouse in case of local production. I used TV sets as an example, because this, in effect, is what Chile has done. Chile has a uniform tariff of only 10%, and no quantitative restrictions on imports. It also has a value added tax (VAT) of about 15%, which it collects on imports and on domestic production that is not exported. Now, Chile prefers to tax some products, such as TV sets, at a much higher rate than 10% or 25%, so it collects a special sales tax of an additional 75% on imported TVs. No televison sets are currently assembled in Chile, but the government has made it very clear that any local production would become subject to the tax of 75% in addition to normal VAT. If the 75% tax were an import duty rather than a sales tax, rest assured that there would be a number of firms assembling TVs in Chile to avoid paying the duty. This has gone on much too long, but I do have one final quibble. Could we agree to cite all references in full? Otherwise, we have to go to EconLit or Google to search for the publication. The paper "Globalization and the happy few" sounds intriguing, but I have no idea where or when it was published. I just noticed that I am also guilty of not giving a full citation, so shall atone for my sins: J. Bhagwati's paper "Immiserizing growth: a geometrical note" appeared in the Review of Economic Studies, vol. 25 (1958), pp. 201-205.