Does Liberalization Reduce Instability? A Look at the Interests of Developing Countries

By using a three countries-one-commodity trade model, this paper measures the export earnings instability of LDCs in free trade and in an import tariff distorted equilibrium. Free trade is superior to the policy regime when the instability of LDCs’ exports is less than that observed under the import tariff scenario. However, the results do not allow us to draw the general conclusion that free trade is a source of benefits for LDCs. Ceteris paribus, the size and the nature of the shock matter in determining exports instability of LDCs when disturbances are located in the exporting areas, whereas the slope of LDCs’ excess supply schedule becomes crucial when the shock is in the importing country.