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Economic Liberalisation Notes

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Pip Reeve DEMT10W8T8 'Should economic liberalisation be part of a policy package aiming at reducing poverty and stimulating economic growth?' Following the debt crises of the 1980s, 'many countries began to shed their import substitution policies and endorsed market oriented ones.'1 For the East Asian economies, this was a very successful strategy, however, there is some reason to cast doubt over whether similar policies would be as successful elsewhere. There is an increasingly agreed upon view that economic strategy should emphasise 'fiscal rectitude, competitive exchange rates, free trade, privatization, undistorted market prices, and limited intervention (save for encouraging exports, education and infrastructure.' 2 In this essay, I will discuss some of the advantages and disadvantages of both trade and capital liberalisation. I will discuss a number of case studies of Latin American and East Asian economies. Finally, I will suggest a number of methods and situations in which economic liberalisation is likely to lead to enhanced economic growth and poverty reduction. I will argue that there are some situations where some amount of protection is required in the short run, however, the long run aim should be economic liberalisation with state intervention only to supply public goods which would be undersupplied if left to market forces. In the First Transiton period, 'any duty to succor the poor created a deep problem for the frst atempt to construct a rigorous economics of means and ends: mercantlism.' 3 Mercantlism suggests that the prosperity of a naton is dependent upon its supply of capital, and that the global volume of internatonal trade is 'unchangeable.' As a theory, mercantlism suggests that the government should play a protectonist role in the economy by encouraging exports and discouraging imports, notably through the use of subsidies and tarifs. So, the end was to maximise a naton's export surplus, but this would occur at the expense of the rest of the world. The means to maximise the export surplus was cheap, and therefore poor, labour. Hume Smith then suggested a view of a progressive economy where 'the gains from specialisaton, rising demand for labour and technical progress would increase both the money wage and the availability of corn for it to buy.' 4 This was followed by the Second Transiton period in the 1980s where there were strong reactons against state involvement in development policies and processes. It was suggested that state involvement led to a situaton which was 'rent creatng, price distortng, protectonist, inherently corrupt, and destructurising of enterprise - and as preventng the state, with its limited resources, from providing the privately undersupplied goods, that compromised its potentally useful contributon to development.'5 However, 'early claims, that relaxing trade and other distortons alone could greatly stmulate poverty reducing growth, have given way to more sober assessments.' 6 Lipton and Ravallion suggest that 'growth is to be based on private producton, released in part by the removal of state imposed market distortons that discriminate against agriculture and exports, and fostered by state facilitated physical infrastructure.'7

1 'Understanding economic policy reform' Rodrik 1996 2 'Understanding economic policy reform' Rodrik 1996 3 'Poverty and Policy' Lipton & Ravallion 4 'Poverty and Policy' Lipton & Ravallion 5 'Poverty and Policy' Lipton & Ravallion 6 'Poverty and Policy' Lipton & Ravallion 7 'Poverty and Policy' Lipton & Ravallion

Capital fows can have many advantages for developing countries. Foreign capital can fnance investment, which can 'stmulate economic growth, thus helping increase the standard of living in LDC's.' 8 They can also lead to consumpton smoothing where the 'capital fows can increase welfare by enabling households to smooth out their consumpton over tme and achieve higher levels of consumpton.' 9 Financial liberalisaton is 'associated with declines in the rato of consumpton growth volatlity to GDP growth volatlity, suggestng improved risk sharing.'10 In additon, 'net foreign resource infows can supplement domestc saving, increasing levels of physical capital per worker, and help the recipient country increase its rate of economic growth and improve living standards.'11 Furthermore, foreign direct investment can bring with it experienced management, new technology and useful business skills. Capital infows can lead to enhanced macroeconomic discipline and a more efcient banking system leading to improved fnancial stability. A free fow of capital has the efect of 'increasing the rewards of good policies and the penaltes for bad policies.'12 However, capital fows also have some signifcant disadvantages for developing countries. They can lead to a number of undesirable macroeconomic efects, at least in the short run. These include; rapid monetary expansion, infatonary pressures, a real exchange rate appreciaton, widening current account defcits and, more generally, fnancial instability. For example, 'fnancial contagion may occur when a country sufers massive capital outlows triggered by a perceived increase in the vulnerability of a country's currency.' 13 Furthermore, 'favourable shocks may atract large capital infows and encourage consumpton and spending at levels that are unsustainable in the longer term, forcing countries to over adjust when an adverse shock hits,' 14 leading to procyclical capital fows. It is true that 'the economies of the botom billion are short of capital,' 15 and theory would suggest that the lack of capital in these countries should lead to a high rate of return to capital in these countries, meaning that there would be a large capital infow should capital market liberalisaton occur. Furthermore, 'Africa has twice as much public capital as private capital,' 16 due to the high amounts of aid. This suggests that there is a lack of private investment which 'condemns workers to being unproductve and so to having low incomes.'17 As Collier claims, 'the labour force of the botom billion needs private capital, and in principle globalisaton can provide it.' 18 However, capital does not appear to fow to these countries, most likely because of the perceived investment risk. It seems that 'the government needs to create a convincing signal of

8 Calvo, Leiderman & Reinhart 1996 9 Calvo, Leiderman & Reinhart 1996 10 Agenor & Montiel 11 Agenor & Montiel 12 Agenor & Montiel 13 Agenor & Montiel 14 Agenor & Montiel 15 'The Bottom Billion' Collier 2007 16 'The Bottom Billion' Collier 2007 17 'The Bottom Billion' Collier 2007 18 'The Bottom Billion' Collier 2007

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