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Berkeley A,RESEC C253 - Price policies and industrialization strategies

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1 10/26/04PP 253-14/ARE 253, Fall 2004 Alain de JanvryPrice policies and industrialization strategiesHandout #8I. Industrialization strategies: ISI (import substitution industrialization) vs. EOI (export orientedindustrialization) vs. OEI (open economy industrialization)ISI: Protect sectors of industry until competitive and then open (ISTE: import substitute then export)EOI: Open and subsidize selected firms until competitive.OEI: Open, create “investment climate”, and call on FDI.Economies of scale in production and learning-by-doing: what can an efficient challenger do? AC Infant industry ProtectionISI OEIWorld market price =AC in MDC Subsidy EOIMDC incumbent (inefficient)AC AC – Subsidy LDC efficient challengerOutputProduce for domestic market (ISI) Produce for international market (all strategies)Produce for international market (EOI)II. Import Substitution Industrialization (ISI)1st phase of ISI: protect finished products (consumer goods)2d phase of ISI: protect intermediate and capital goods1. Why protect? Arguments for protection1850s-1930s: Liberal period, open economy models. LDC primary export-led growth strategy (ag., mines) againstimports of manufactures from MDC.1930s-1970s: Depression and WWII, collapse of open-economy model, ISI strategy in East Asia and Latin America.Arguments: Infant industry: economies of scale, learning-by-doing, entry costs.New entrants, infant industries can be more efficient than MDC incumbent, but cannot enter: need temporaryprotection to achieve competitiveness.2. ISI is a strategy that can fail- Recall definition of tradable (T) vs. non-tradable (NT) goods:T have their price set by the international market:PT = eP$ (1 +/- t)Non-tradables have their price set by supply equal demand on the domestic market.(Note: A commodity traded with an import or an export quota is a non-tradable since the price is set byequilibrium between supply and demand.)2 10/26/04- Recall definition of overvalued nominal exchange rate and appreciated real exchange rate:e RER e import tariffsRationing $ $Overvalued exchange rate Appreciated exchange rate- Instruments for ISI: import tariffs, import quotas, overvalued exchange rate (fixed exchange rate  e belowequilibrium) and foreign exchange rationing (appreciated real exchange rate).• Short run impact: raises prices of tradables, creates inefficiencies through protection, redistributes incomefrom consumers to producers, produce for domestic market to substitute for imports.Bias against agriculture: industry protected but not agriculture: high industrial input costs; overvalued exchangerate: low prices for tradables (ag goods).Bias against employment: imported capital goods cheap through overvalued exchange rate.Protected industries:  pT= e p$1+ tM( ) increases if tariff large enough to compensate for low  e .Unprotected industries:  pT= e p$ falls due to low  e (anti-agriculture, anti-employment).• Long run impact: AC falls, can decrease protection, ISTE.• ISI can fail: • (i) If AC does not fall : no competitive pressures (as no foreign competition, domestic monopolies), domesticmarket too small (insufficient opportunities for economies of scale).(ii) If pr otection is not removed : successful lobbying and rent seeking by entrepreneurs and workers in protectedindustries not to remove protection. Political pressures for protection are high if: industry is concentrated; smallentrepreneurial class; limited democratic checks by farmers and consumers; strong organized labor in formal sector.Conditions for success: needs good/strong/credible governance.(iii) Needs large domestic market : large countries, income redistribution (e.g., land reform)III. Price policy1. Definitionsp$ = international market price in foreign currency ($)pb = border price in local currency units (LCU)pd = domestic pricee = nominal exchange rate in LCU/$.Let pd= pb(1 + t), pb= ep$t = tM = import tariff ratet = -tE = export tax ratet = s = domestic subsidy (+) or tax (-) rate Domestic price Trade policy Border price Exchange rate policy World market price Border pd= pb1 + tM( )  tM pb= ep$Nominal ep$Example India: 400*1.3 = 520 tM= 0.34*100 = 400 e = 4 RS/$ 100$/MT3 10/26/04How important are tariffs? (1999)NPCAgricultureIndustryUnited States5.53.8European Union10.54.1Japan11.73.6Australia3.310.6Korea62.211.4Argentina32.830.6China35Indonesia47.238.6Bangladesh83.883.52. Indicators of protection(1) Nominal protection coefficient = NPC NPC =pdpb=pb1 + t( )pb= 1+ t.If NPC > 1, producers are protected, consumers (users) are disprotected.If NPC < 1, producers are disprotected, consumers (users) are protected.(2) Nominal rate of protection = NRP NRP =pdpb− 1 = t, tariff rate.If NRP > 0, producers are protected, consumers (users) are disprotected.If NRP < 0, producers are disprotected, consumers (users) are protected.(3) Effective protection coefficient = EPCDefine:p = price = unit value of output.c = cost of intermediate goods used in production per unit of output.VA = value added = cost of primary factors such as labor, land, and financial capital per unit of outputp = c + VA. Hence: VA = p – c. EPC =VAdVAb=pd− cdpb− cb.If EPC > 1, producers are protected, consumers (users) are disprotected.If EPC < 1, producers are disprotected, consumers (users) are protected.(4) Effective rate of protection = ERP ERP =VAdVAb−1If ERP > 0, producers are protected, consumers (users) are disprotected.If ERP < 0, producers are disprotected, consumers (users) are protected.Note: Effective protection a better measure than nominal protection since product may be protected but inputs alsoprotected, in which case effective protection is less than nominal protection. But calculation of value added needscharacterization of technology, and is hence more difficult to do.4 10/26/04Example:Free tradeProduct protectionProduct andfactorprotectionTrade policytM product010%10%tM intermediate inputs0020%Costs and pricesIntermediate costs300300360 (+20%)Value added200250190Product price pd500550 (+10%)550 (+10%)ProtectionNPC11.1 (10%)1.1 (10%)EPC11.25 (25%)0.95 (-5%) (5) Real protection: combine trade and


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