Trade Liberalization in Developing Economies: Modest Benefits but Problems with Productivity Growth, Macro Prices, and Income Distribution

Arguments regarding trade and other forms of liberalization in developing countries are reviewed. Microeconomically, the standard case for liberalization is dubious under increasing returns to scale and when firms can invest directly in productivity enhancement. Distributional effects of commercial policy changes can be regressive and large, but the "rents" they generate can serve as a basis for effective policy intervention contingent on firms' performance. Macroeconomically, the case of liberalization rests on Say's Law, which is not always enforced. It is complicated by the facts that recent combined current and capital market liberalizations have been associated with strong exchange rates and high interest rates, and that output and productivity growth have positive mutual feedbacks which liberalization may well suppress. All these effects can only be sorted out by institutional and historical analysis at the country level, as opposed to cross-country regressions or computable general equilibrium models with causal structures favoring trade liberalization already built in.