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THE LIBERALIZATION OF THE WORLD ECONOMY
INTRODUCTION: Liberalization is a global phenomenon. The world economy is in a state of transition.
DEVELOPMENT OF THOUGHT: With the collapse of the Soviet Union and its economic ideology of Communism, the economic implications of this transformation have extended worldwide leading to major policy reforms in many developing countries. The reforms have been occasioned mainly by a balance of payments cum foreign exchange crisis as in India. The essay begins with a discussion on interventions aimed at the merchandise trade account (austerity, devaluation, and liberalization) and then proceeds to current account imbalances, finally closing with observations about factors influencing trade in services.
CONCLUSION: It is uncertainty, not speed, that endangers the success of structural reforms programmes. Speed is essential in keeping uncertainty down to the lowest level.
The world economy is in the midst of a profound transformation. As the countries in Eastern Europe and the Commonwealth of Independent States (CIS) begin to establish near political structures and to liberalize their economies, the economic implication of their transformation has extended worldwide. Policy makers in developing countries have been increasingly preoccupied with the difficulties of implementing conventional policy prescription. Probably the majority of policy reform programmes have been inaugurated because of discomfort with the balance of payments cum foreign exchange situation. Very often, foreign exchange reserves and lines of credit have been exhausted when the programme is undertaken. In some instances, the debt-servicing obligation is becoming due and simply cannot be met. Capital flight may also be a significant contributing factor.
Under orthodox stabilization, the main tool affecting commodity and service transactions are austerity and devaluation. Austerity programmes often work in the sense of making the trade balance improve. But they succeed by reducing output and capital formation (both with high import contents) rather than by promoting import substitution or export promotion. Devaluation suffers the same drawbacks–it helps the trade balance mostly by a contraction in the short run. However, exchange rate movements also have long term effects, some involving improvements in the tradability of domestic products. Besides devaluation, trade liberalisation often shows up in orthodox packages. The moves seem at cross-purposes: one is supposed to narrow the trade gap but the other makes it wider. What improvements can liberalisation bring? Advocates point to three advantages
The first—conjectural—is that removing trade barriers is anti-inflationary. The second is secular according to numerous theorems of neoclassical economics, production arid efficiency rise when distortions are removed. Third, the quantitative restrictions go hand-in-hand with intrusive bureaucracies, wasteful rent-seeking, and so on. So far, the experience of the industrial restructuring process shows liberalisation has led to a new, and as yet evolving, patterns of industrial production in which small-and medium-scale enterprises (SMEs) from many countries have come to play a significant role in export markets and technology transfer. In particular, SMEs in Japan and Asian NIEs (Newly industrialising economies) which began by supplying low-cost, labour-intensive products have reached an advanced state of development through exposure to international trade and institutional support. These enterprises continue to play a critical role in the export of manufactured products from Japan and the NIEs and their presence in technology—skill-intensive industries such as computer and software is increasing with many of them becoming important suppliers of specialised parts and components for the machinery, transport and aircraft industries.
The efforts of developing countries to repeat the success of the NIEs by relying on their SMEs to gain access to export markets may, however, encounter difficulties. First, as external demand in the markets undergoes fundamental changes, the product structures of SMEs would also have to alter correspondingly and SMEs of the NIEs might be better placed than SMEs from other developing countries to respond to this change. This would imply that SMEs from developing countries may have to rely more on intra-regional trade, at least in the short to medium run, to carve out niches in export markets and upgrade their technological base. In addition, information gaps, difficulties in. access to capital and trade barriers also pose special problems. However, regional experience suggests that many of these difficulties can be overcome. For example, trading companies in Japan help SMEs to identify products, markets and joint venture partners. Similarly, the establishment of a Private and Investment Trade Opportunities (PITO) programme between the United States and ASEAN is aimed at overcoming international regulatory constraints faced by SMEs. A similar approach could be adopted in developing a regional mechanism to share information on the export market and explore possibilities to create joint ventures among SMEs of developing, newly industrializing and developed economies of the region
In the future, the modern SME sector is likely to become increasingly specialised and concentrate on the production of intermediates. Along with sub-contracting and ancillarisation, SMEs and larger firms may also develop other forms of long-term arrangements including licensing and undertaking production as affiliates or subsidiaries. This will enable the SMEs to establish specialized segments in many sectors, including garments, leather goods and electronics. In more advanced sectors such as electronics, SMUs will tend to concentrate in single, standardized products which can be used as intermediates across a whole the spectrum of industry. In this process, the SMEs are likely to acquire the requisite quality and efficiency to become competitive in export markets.
The robust growth of world production and trade, accelerated for the first time since 1988 would provide a golden opportunity to developing countries going through liberalisation process by the economic recovery in North America and the sustained strength of import demand in Latin America, the Middle East and non-DECD Asia.
World trade’s role in moderating the slowdown in global economic activity since 1989 is readily apparent from the large gap between the trade and output growth rates. Although trade growth declined, the slowdown is proportionately much less pronounced than for output, and—especially in 1991 and 1992—trade growth has been by historical standards exceptionally strong relative to output growth. At 44 per cent, the expansion in the volume of merchandise trade was considerably faster than the three per cent gain recorded the previous year and close to the average for the past decade. World output growth also picked up but remained well below the average since the 1982 recession. The reversal of the economic slowdown that began in 1989—and in particular the brisk expansion of world trade were bright spots in a year otherwise characterized by concerns about economic trends in key parts of the global economy.
The excess of trade growth over output growth is both the result of recent developments and of ongoing longer-term changes in the world economy. A rising share of manufacturers in world trade (manufacturers are traded more intensively than most other products), the stimulus to trade in components from closer investment ties, and technological advances in communications and transportation that reduce the “economic distance” between countries are well-known examples of the long-term developments. More recent developments include the unification of Germany (in 1991 German import demand grew more than ten times faster than output); imports into the Middle East sustained a rise in consumption while the region’s overall output stagnated during the Gulf War in 1991; the relatively sharper impact on world output than on world trade of the pronounced decline in economic activity in Central and Eastern Europe and the former USSR (the weight of this region in world GDP calculations is much larger than its weight in world trade); the booming re-export trade between Hong Kong and China, whose impact on trade far exceeds the impact on output growth; and the strong growth of imports in North America as the economic recovery took hold (in 1992 import volume increased five times faster than output) and into Latin America in 1991 and 1992 a result of, among other developments, economic restructuring and a greater openness to trade.
Turning to the current account, it may be noted that the current account imbalances of four of the five leading traders widened in 1992. The onset of the recession in Japan was largely responsible for the increase in Japan’s current account surplus to a record $ 118 billion. In the United States, the economic recovery raised the merchandise trade deficit and the resulting increase in the current account deficit, from $4 billion to $62 billion, reversed four years of declining deficits. The recovery of import demand in the United Kingdom contributed to an increase in the current account deficit from $ 11 to $ 21 billion. Although the onset of the recession in Germany in the second half of 1992 reduced import growth sharply, the current account deficit rose from $20 to $25 billion due to an increasing deficit on trade in commercial services and a decline in the surplus on investment income. France, alone among the leading traders, reported moving from deficit to virtual balance in the current account, as strong export growth caused the merchandise trade balance to shift from deficit to a small surplus. However, while considering recent current account developments, it is important to keep in mind that the widening of last year’s current account imbalances it, to a large extent, the result of the divergent trends in economic activity in 1992. Relating the imbalance to GDP for the five leading traders provides an even better perspective. Since, it eliminates most of the effects of inflation and changes in exchange rates and adjusts for the fact that a current account imbalance of a given size declines in significance, as GDP expands.
Generally, it is evident that on this basis the current account imbalances of four of the five leading traders in 1992 were considerably smaller than in most other years since the early 1980s. Although Japan’s surplus as a share of GDP increased for the second consecutive year, it remained below the levels recorded during the three years 1985-87.
During the liberalization process, if the shifts in trade orientations are to succeed in developing countries, it is vital that these are full of estimates into exporting at the same time as there are pressures on import-competing industries to contract. That, in turn, means that the required adjustment in the real exchange rate must be sufficient not only to offset past real appreciation (given the structure of protection) and any sustainable component of the current account deficit but also to increase the competitiveness of exports.
Analysis of the various factors influencing trade in services show that most poor countries run deficits on non-factor service trade, some components of which (such as tourism) are sensitive to the exchange rate. But such payments are not a central concern for stabilisation. Factor services flow interests and remittances of profits and labour income–often are, however, boosted by faster volume growth, The value of world merchandise trade expanded by 54 per cent last year, to $ 3.7 trillion. On the basis of the limited data currently available, preliminary estimates point to an increase of eight per cent in world trade in commercial services in 1992, to $ 960 billion. It was the fourth consecutive year in which the value of trade services which include transportation, tourism, telecommunications, insurance, banking and other professional services expanded merely rapidly than trade in merchandise. Factors behind the growth of services trade include the stimulus to trade in travel and transportation services from the economic recovery in North America and the rebound from the effects of the Gulf War.
Vested interests seeking to preserve their privileges will always argue strongly for a slower pace of change. It gives them more time to mobilise public opinion against the reforms. On the other hand, vested interests cannot obtain the pay-off from change until the Government has moved far enough to reduce the costs imposed on them by the privileges of other interests. Even at maximum speed, the total reform programme will take some years to implement, and the short-, term trade-off costs start from day one. But there are serious dangers in seeking to hold down the pace of change. The policy cannot be fine-tuned with enough precision to ensure that, for example, inflation will be reduced successfully by a modest error or a miscalculation to move backwards instead of forward, thus destroying credibility.
It is uncertainty, not speed that endangers the success of structural reform programmes. Speed is an essential ingredient in keeping uncertainty down to the lowest achievable level.
Two lessons for trade policy are evident from this brief review of recent developments. One is the need to keep markets open. As is clear from the large excess of trade growth over output growth in recent years, trade has been a source of relative strength in an otherwise mostly weak economic environment, especially for slow-growth countries. The risks which trade friction pose for the current economic recovery are therefore even greater than usual. Second, the opportunity to implement major trade liberalization and an extension of the rules safeguarding market access has added advantages when the world is searching for ways to give a non-inflationary stimulus to output and employment. In this context, the failure of governments to seize the opportunity provided by the Uruguay Round especially when the results are so close, adds to uncertainty in the private sector and makes recovery harder to achieve.