ARE 253 PP 253 Fall 2008 Alain de Janvry Elisabeth Sadoulet Strategy can fail i If AC does not fall no competitive pressures as no foreign competition domestic monopolies domestic market too small insufficient opportunities for economies of scale ii If protection is not removed successful lobbying and rent seeking by entrepreneurs and workers in protected industries not to remove protection Political pressures for protection are high if industry is concentrated small entrepreneurial class limited democratic checks by farmers and consumers strong organized labor in formal sector Conditions for success Needs good strong credible governance that protection will be removed Needs large domestic market large countries income redistribution e g land reform to expand the domestic market Trade industrialization and exchange rate policies Handout 6 Part I Trade and industrialization strategies I ISI import substitution industrialization vs EOI export oriented industrialization vs OEI open economy industrialization Three contrasted strategies ISI protect sectors of industry until competitive and then open ISTE import substitute then export EOI open the economy and subsidize selected firms until they are competitive OEI open the economy create investment climate and call on FDI III Trade policy 1 Definitions p international market price in foreign currency pb border price in local currency units LCU pd domestic price e nominal exchange rate in LCU QR quantity restriction on imports or exports Tradable goods price determined by border price and by trade and exchange rate policies Non tradable goods price determined by supply demand d b b Tradable good p p 1 t p ep t tM import tariff rate t tE export tax rate t s domestic subsidy or tax rate Economies of scale in production and learning by doing AC Infant industry Protection ISI OEI World market price AC in MDC Subsidy EOI Domestic price AC AC Subsidy Produce for domestic market ISI Produce for international Produce for international market EOI market all Trade policy p p 1 tM Example India 4000 1 3 5200 d b Border price b p ep tM QR tM 0 3 Exchange rate policy Border Nominal e 40 100 4000 e 40 RS World market price p 100 MT Output 2 Indicators of protection 1 Nominal protection coefficient NPC pd NPC b 1 t p If NPC 1 producers are protected consumers users are disprotected If NPC 1 producers are disprotected consumers users are protected II ISI sector protection 1 Why protect Arguments for protection History 1850s 1930s Liberal period open economy models Primary export led growth strategy ag mines LDC against imports of manufactures from MDC 1930s 1970s Depression and WWII ISI strategy in East Asia Latin America Arguments Infant industry economies of scale learning by doing entry costs New entrants infant industries not competitive need temporary protection to achieve competitiveness Phases of ISI 1st phase of ISI protect finished products consumer goods 2d phase of ISI protect intermediate and capital goods 2 Effective protection coefficient EPC Define p price unit value of output c cost of intermediate goods used in production per unit of output purchased inputs from other industries VA value added cost of primary factors such as labor land and financial capital per unit of output p c VA Hence VA p c 2 ISI is a strategy that can fail Instruments import tariffs import quotas overvalued exchange rate fixed exchange rate and foreign exchange rationing appreciated real exchange rate decline in demand for foreign exchange due to import tariffs and import quotas Short run impact raises prices of protected tradables creates inefficiencies through protection redistributes income from consumers to producers of protected goods produce for domestic market to substitute for imports Bias against agriculture industry protected but not agriculture high industrial input costs overvalued exchange rate low prices for tradables ag goods Bias against employment imported capital goods cheap through overvalued exchange rate Long run impact AC falls can decrease protection ISTE EPC VA d VA b d d b b p c p c If EPC 1 producers are protected consumers users are disprotected If EPC 1 producers are disprotected consumers users are protected Note EPC a better measure of protection than NPC since product may be protected but inputs also protected in which case effective protection is less than nominal protection 3 Real protection 1 10 16 08 Imported goods or import substitutes p ep 1 tM d Sector Exported good p ep 1 tE Can protect tradables through exchange rate policy devaluation or depreciation raises e Can protect tradables through trade policy raise import tariffs or lower export taxes Exchange rate and trade policies can be substitutes or complements in protecting For example when there is a devaluation in Argentina typically the country raises export taxes on agriculture to redistribute income from agriculture to the urban sectors d Ceramic tiles Frozen concentrate OJ Women shoes Sugar b p p 1 tM M a p b c d b change in Compared to free trade CS a b c d PS a B Gvt budget c NSG net social gain b d S D a b c p p Consumer cost per capita 0 5 1 02 1 37 6 S Compared to no subsidy DCS 0 DPS a a DB a b cost of subsidy NSG b b b a Subsidy ISI c invested SR loss LR gain D q EOI export subsidy to unit costs Advantages of subsidy NSL b NSL with tariff or quota no impact on domestic price Better targeting than tariff subsidy per firm conditional on performance But need i Budget for subsidies and credit vs ISI that creates government revenues costly but less incentives to excessive subsidies less possibilities to surrender to rent seeking for continued protection ii Good non venal bureaucracy for information and monitoring of firms for credibility of rules but dangers of cronyism and collusion between government officials and managers iii Need be able to enter the world market under subsidies from the beginning especially if small domestic markets quality of products advertising trade missions contracts with distributors If auction of M DB c d S a d q ii Quantity restrictions import quotas licenses vs free trade Note this remains a non tradable in spite of trade licenses Price determined by S D after administered trade S M Compared to free trade DCS a b c d DPS a D importers rent c pd M NSG b d pb Consumer cost per job 401 000 57 000 102 000 137 250 IV EOI firm subsidies Selective incentives to firms subsidies and credit lines to potential exporters pick the winners
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