Juergen B. Donges and Ulrich Hiemenz
There is a voluminous theoretical and empirical literature about the
implications of alternative trade regimes for economic development. On balance it points
out that export-oriented strategies, along with an efficient use of available resources,
including indigenous labor, provide the most appropriate framework of economic incentives
conducive to sustained and rapid growth (see, for instance, the surveys by Balassa 1980a;
Donges 1983; and Krueger 1984a). Accordingly, an increasing number of developing countries
have, in varying degrees, linked their economies to world production on the basis of
comparative advantage and by doing so have been transformed into the now "newly
industrializing countries" (NICs). South Korea is one of the outstanding cases in
point. It committed itself to the notion of international specialization, adhering to it
even when the world economic environment sharply deteriorated during the 1970s.
Yet, many governments of developing countries (and some influential
academic economists as well) have remained skeptical about the implementation of
outward-oriented trade regimes. The standard argument is that, after a long-lasting period
of economic development based on policies of import substitution for industrialization,
trade liberalization would cause excessively high adjustment costs, while the potential
benefits from such a liberalization would only be small (if not negligible) in an
unfavorable international economic environment such as the
The authors would like to thank Heinz W.
Arndt, Lawrence B. Krause, and Rolf J. Langhammer for critical comments and suggestions on
a previous draft of this chapter.
present one. The fact that some South American countries that embarked
upon liberalization experiments during the 1970s fell into deep economic recessions, often
accompanied by social and political upheavals, provides convenient support to such
anxieties, despite pervasive evidence to the contrary in Asian countries. There are also
instances, again mainly in Latin America, in which governments, faced with pressing
foreign-exchange needs to service foreign debt, undid prior shifts to relatively
outward-oriented trade regimes and readopted import-substitution strategies.
The purpose of this chapter is to reassess the case for outward-oriented
trade regimes in the process of economic development. The nature of outward-orientation is
briefly explained in the next section. As developing countries usually start their
industrialization through import-substitution strategies, the shift from an inward- to an
outward-oriented trade regime raises questions concerning the set of economic policies to
be reshaped, the timing of the policy reform, and the feasibility of such changes, all of
which are discussed in the third section. The fourth section provides evidence on both
successful and unsuccessful liberalization attempts in the seventies and inquires into the
causes for success or failure by relating the countries' experiences to the policy
framework for export liberalization outlined in the previous section. In the fifth
section, the revival of export pessimism is evaluated.
Essence of an Outward-Looking Strategy
Discussions of appropriate development strategies should start by
recognizing that there are two dimensions of government policy that are analytically
distinct, though sometimes mixed together. One is whether the government is intrusive in
the process of economic development or is more "laissez-faire," and the other is
whether government policies distort relative prices and markets or not. A government can
be relatively "laissez-faire" and rely on market signals for the allocation of
resources and economic growth (as in Hong Kong) or it can take a strong hand in steering
the process of development without distorting markets (as in Singapore, South Korea, and
Taiwan). It can distort prices but not try to plan the economy very much (as in Israel) or
it can be both intrusive and distorting (as was the case in India and Mexico). Governments
that do not want to rely heavily on market forces for development may resort to import
substitution, but they could also apply an outward-looking strategy; in either case, the
outcome of the chosen strategy will crucially
depend on whether or not relative prices are in line with relative
scarcities (of goods, services, and production factors). Though it is conceivable that an
inward-looking government would pursue market-oriented economic policies, in reality such
policies are more "normal" in countries integrated into the system of
international division of labor, as shown below.
Export promotion and outward-oriented trade regimes have frequently been
misinterpreted as policies that deliberately promote exports over other economic
activities and beyond the level attainable under free-trade conditions (see, for instance,
Streeten 1982). The crucial point to remember, however, is that government incentives for
industrialization should be compatible with an optimal allocation of resources, to the
largest extent possible (as elaborated in the rejoinders to Streeten by Henderson 
and Balassa ). Disregarding externalities, an optimal allocation of resources
requires that the domestic rate of transformation equal the international rate of
transformation. Taking international prices as given (small country assumption), the ratio
of relative domestic prices of importables and exportables over the respective world
market prices must be unity (Krueger 1978). Then the system of incentives is neutral with
respect to sales in domestic or in world markets. It is in this sense, and only this, that
the export-promotion strategy is differentiated from the import-substitution strategy.
Export-promotion strategies provide incentives to exports sufficient to compensate for the
discrimination against export production inherent in import protection; they provide a
uniform incentive to both import substitution and exports, and thus to saving and earning
foreign exchange per unit of domestic resources used they do not aim at boosting exports
beyond free-trade levels. The emphasis is on specialization based on comparative
advantage, not on export expansion, per se.
An outward-oriented trade regime does not provide sectoral preferences
either; agriculture, industry, and services can expand in accordance to the
natural-resource endowments of the countries concerned. Hence the pattern of production
and the composition of exports will vary substantially among developing countries. Small
resource-poor countries with an abundant supply of semiskilled labor are likely to
specialize in the production and export of labor-intensive manufactures, while
resource-rich countries by definition have a comparative advantage as producers and
exporters of primary commodities. Even in the case of the latter group of countries, it is
important, for at least two reasons, that industrialization not be impeded by
First, nonrenewable resources, by definition, are bound to run into
depletion, and economic development sooner or later will have to be based on other
activities; industrial production that promises high productivity gains and the creation
of remunerative new jobs should be the prime candidate. Second, the sooner resource-rich
countries diversify their export structures by including manufactures, the better the
chances are that export earnings will be stabilized and the vulnerability to international
commodity price fluctuations be reduced. A stable foreseeable framework is important if
investors are to allocate their funds efficiently.
Judged in terms of the ideal of completely neutral policies, development
strategies as actually applied can obviously err on both sides: too restrictive of imports
or too promotive of exports. Both would probably raise marginal capital-output ratios and
hinder economic growth. When the trade regime is biased toward import substitution based
on a variety of trade barriers, ranging from high tariffs and restrictive quotas to
outright import bans, too many resources are attracted by the protected industries.
Moreover, as the process of import substitution goes on, encompassing the production of
intermediate and investment goods, the incremental capital-output ratio will rise. This is
likely to adversely affect the rate of economic growth, thereby leading to a vicious
circle of generally lower saving and investment paths and weakening productivity and
development trends. In the absence of corrective measures, exports will be discriminated
against. On the one hand. exporters will have to pay higher prices than they otherwise
would for protected locally produced or imported inputs (which they cannot pass on to
potential customers on the world market unless they have a monopoly power, which is
unlikely for most developing countries). On the other, the exchange rate tends to be
overvalued owing to protection, a self-inflicted export obstacle par excellence.
It has been argued that in cases in which the private costs of export
production are higher than the social costs, and this positive externality is higher than
the corresponding externalities associated with import substitution, a bias of the
incentive system in favor of exports could be justified on economic grounds (Mayer 1984).
The general problem with this version of the "infant industry" argument is,
however, that it may turn out to be very difficult in practice to accurately demonstrate
the existence of significant externalities and, if this were possible, to discontinue the
extra subsidies to exporting (or the protection of import substitutes) later on when the
assisted activities have become mature. For these reasons, policy-induced export expansion
runs the risk of fa-
voring a composition of exports that is not in line with the
comparative advantage of the exporting country and may ultimately slow down economic
development in very much the same way an import-substitution strategy does.
However, economic reasoning suggests a greater danger of policymakers
slipping into excessive import substitution than into excessive export promotion. A
successful export-promotion strategy requires a framework of incentives to free producers
of exportables from cost disadvantages vis-Ã -vis foreign producers. As long as
import protection is granted on the grounds of nonpecuniary dynamic externalities,
exporters have to be compensated by some form of subsidies and/or duty-free import
allowances, as discussed below. Since subsidies constitute drains on government budgets,
they provide a stimulus to policymakers to refrain from excessive export promotion, to
maintain realistic exchange rates as an alternative to public subsidies, and to keep
import protection at moderate levels.
By contrast, import-substitution strategies have revealed built-in
tendencies toward reinforcing the inward bias of the incentive system (Bhagwati 1978;
Donges 1983, 280 82; Krueger 1983, 32 33). Tariffs, if not prohibitive, create government
revenues and thus lead to their implementation being abused, often for purposes totally
unrelated to the chosen industrialization strategy. Furthermore, import-substituting
industries replace fewer imports than are actually required as intermediate inputs or for
investment purposes, thus aggravating existing, or giving rise to new, balance-of-payments
problems. Growing current account deficits, as well as the exhaustion of narrow domestic
markets by the newly established industries, put pressure on governments to implement
additional trade restrictions and to intervene in foreign-exchange, capital, and labor
markets thereby further penalizing export activities.
The Framework of Export Liberalization
The outward-oriented trade regime aims at promoting sustained economic
development and a rapid process of industrialization by exposing the domestic economy to
international competition. The objectives are to improve the allocative efficiency of the
economy as a whole by bringing the structure of production into line with the country's
comparative advantage at each instant and to reap irreversible external benefits from the
exploitation of economies of scale through exports, the stabilization
of export earnings through export diversification into manufactured
goods, the increase of savings for investment through raising real incomes, and the
acceleration of technological innovation and human-capital formation through competition
from, and contacts with, other countries. Such gains are forgone in an inward-oriented
trade regime since import protection and the whole system of market regulations not only
discriminate against exports and distort the structure of production and make it rigid,
but also cause losses in efficiency through cartelization, rent-seeking behavior, the
formation of a labor aristocracy, and the expansion of bureaucracy.
Export liberalization entails substituting price signals for
administrative controls and adjusting domestic relative prices to international relative
prices, either by gradual measures or shock treatment. Liberalization does not necessarily
mean the implementation of free trade and nonintervention in all other markets; it rather
means a reform of economic policies so that the price mechanism can work more effectively
and competition is less distorted. Government measures to remove market failures are
perfectly justified, provided that such market imperfections are real (nonpecuniary
externalities, public interest in goods or services produced or consumed by the society,
natural monopolies, and the like) and not the result of excessive encroachment of public
authorities on the market process (as so often happens; see Krueger 1983; chap. 7).
A liberalization reform requires that ad hoc measures be replaced by a
stable and foreseeable policy framework, uniform rather than selective interventions, and
a return to price flexibility that allows for a proper response to market changes. What
does this mean in detail? The answer will differ between countries, depending much on the
nature of the inward-oriented trade regime previously in force. The common characteristics
of an inward-oriented trade regime may therefore provide an appropriate starting point for
a discussion of essential elements of a reform package.
The Inadequacies of Inward-oriented Policy Regimes
Once a country embarks on an import-substitution strategy, there seems
to be a logic to the evolution of direct government controls on prices and quantities over
time (Bhagwati 1978). Initial tariff protection for "infant industries" soon
proves to be insufficient. Unprotected domestic sectors and discriminated-against export
industries vehemently complain about unfair treatment, and protection creates an incentive
to evade controls
via smuggling, over- and underinvoicing, or black market transactions.
The public authorities, yielding to political pressures of (often disparate) sectional
interest groups, tend to react by moving from tariff protection to quantitative controls
and import-licensing procedures, effected with ever-increasing product coverage and
ever-finer selectivity. When easy import substitution possibilities have been exhausted,
but the inward-looking policy approach is maintained, a complex control network is likely
to evolve, encompassing direct import allocation by category of commodity, by type of
domestic use, and by source of foreign exchange.
Despite proliferating import controls, import-substitution regimes will
generally not come to grips with the balance-of-payments difficulties that typically
afflict developing countries. As industrialization proceeds, the demand for imported
intermediate and capital goods, which are complementary to domestic production, continues
to grow at high rates, while the policy-induced overvaluation of the national currency
retards or impedes export expansion. Rising trade deficits and subsequent shortages of
foreign exchange make intervention in foreign-exchange markets inevitable and resort to
external credits a pressing need. Hence, import controls are supplemented by a direct
allocation of foreign exchange to domestic uses and also complemented by administrative
Capital-market interventions usually arise from two sources. First,
unchecked import-substitution policies favor production of relatively capital-intensive
products (as typically the industrial structure gets diversified in the vertical
direction), the application of capital-intensive technologies (because of relatively low
barriers to imports of capital goods), and an inefficient use of capital (owing to the
lack of competition in domestic markets). High incremental capital-output ratios will soon
slow down industrialization and economic growth unless access to financial capital at
reasonable rates of interest can be maintained. To sustain the momentum of import
substitution, intrusive governments will, therefore, impose interest-rate ceilings on both
deposits and loans and & 217 or provide preferential treatment for selected economic
activities as has actually occurred time and again. As these interventions usually are
administered in a discretionary way, they create uncertainty among investors; as they tend
to be guided by public preferences rather than by comparative advantages, investment
patterns are likely to be distorted. In addition, interest rate and other subsidies to
capital formation become an increasing burden to the public budget.
Second, interest-rate ceilings on bank deposits discourage domestic
private savings and encourage capital flight, as well as an overvalued exchange rate both
of which augment demand for external funds. Reflecting donor rules or preferences for
securing external financing by government guaranties, loans from abroad may largely be
channeled through public institutions, reinforcing the heavy hand of the government in the
allocation of credit. Foreign borrowing is not, however, an unlimited source for financing
public budget deficits. Governments that are not able (or not willing) to reduce the
deficits may be tempted to turn the screw of the inflation tax by accelerating the rate of
growth of the money supply. To collect the inflation tax, the banking sector has to be
exposed to tighter supervision of the central bank. High non-interest-bearing reserve
requirements on bank deposits, forced lending to public-sector enterprises and,
ultimately, nationalization of private banks, are tools to make sure that the inflation
tax accrues to the government, but these tools further weaken the functioning of the
capital market. The experience of Argentina until the implementation of the "Austral
Plan" in mid 1985 is a case in point (Fischer, Hiemenz, and Trapp 1985, chap. 3).
Import protection and the availability of credit at subsidized interest
rates promote expansion of capital-intensive lines of production and thereby boost labor
productivity at the expense of creating sufficient employment opportunities to absorb a
rapidly growing labor force. The distorted structure of production paves the way to
nominal wage levels in excess of equilibrium wages in the formal sector of the economy,
with the well-known consequences of labor migration and informal labor markets.
The situation worsens if governments pursuing inward-oriented
development strategies do keep wages above their equilibrium levels by minimum-wage
legislation and if they artificially increase labor costs to employers further by
excessively rigid labor codes and generous social policies. Such interventions have, in
fact, occurred in many developing countries (Squire 1981; Berry and Sabot 1984). They were
meant to secure the political support of the (in most cases well-organized) urban labor
force for the development strategy applied by the government. For this reason, governments
also sought to shelter the urban labor force from the costs derived from high inflation
through price controls for essential consumer goods, publicly decreed wage increases,
and/or formal indexation of wages. Thus, labor markets become subject to a significant
degree of government regulation and control as inward-oriented eco-
nomic development proceeds over time, and the benefits of comparative
advantage based on a relatively elastic supply of labor are not exploited.
It is against such a background (an economic environment characterized
by manifold interrelated and distorting government interventions in the economy) that
export liberalization has to be contemplated. Attempts to liberalize the economy have to
take into account the nature of controls and regulations as well as the interactions
between them. Welfare theory suggests that in a case of multiple distortions, removal of
one distortion may make things even worse. Export liberalization will, therefore, require
a reform package that includes some degree of policy change vis-Ã -vis all major
What Policy Reform Package?
From a theoretical point of view, export liberalization is best
achieved by an instantaneous removal of all controls and regulations that distort the
allocation of resources and contribute to an underutilization of available capacity. This
best solution is, however, not likely to be feasible in the context of a highly regulated
economy, since adjustment costs may become excessively high and even disrupt the political
system as such. A more cautious approach to liberalization, which may therefore be chosen,
raises a number of questions. Which are the key markets to be liberalized? What degree of
deregulation is both necessary and feasible? What timing and sequencing of policy changes
should be envisaged?
Under a fixed exchange-rate system, import liberalization can reduce the
import-substitution bias of trade policies and may have a beneficial effect on inflation
rates. It may, though, fail to achieve the desired export expansion if capital and labor
markets remain under tight control. Export prices do not change because of the fixed
exchange rate. Although intermediate input costs decline as a result of import
liberalization, labor costs remain high, and artificially low capital costs, owing to
interest-rate ceilings, provide little incentive to redirect investment flows toward
export activities which usually yield a higher capital productivity than does import
A devaluation of the currency might appear to be more promising than
import liberalization with respect to export expansion, since, even with quantitative
import controls persisting, the relative domestic price of exportables would increase.
This result depends very much, however, on how the necessary exchange-rate adjustment is
effected. In the presence of high rates of inflation, the authorities may underestimate
difference between domestic and international inflation and thus cause
a real appreciation of the exchange rate rather than a depreciation.
Even a freely floating exchange rate and a liberalization of the
foreign-exchange market can have its drawbacks unless domestic financial markets are
simultaneously liberalized. For, in the presence of controlled (and usually negative)
interest rates, full liberalization of the exchange regime for both current and capital
accounts, when coupled with a floating exchange rate, would surely result in capital
outflows and rapid depreciation of the currency in excess of the rate of inflation. In
countries with high and persistent inflation, a complete deregulation of financial markets
will, however, hardly be feasible (at least not in the short run) since the tightly
controlled banking sector will have lost the ability to collect and allocate financial
Obviously, there are no recipes for initiating the transition from an
inward- to an outward-oriented trade regime. Level of development, size of country,
resource endowment, and relative importance of controls in individual markets will all
have to be taken into account when designing an effective and feasible reform package.
However, empirical evidence strongly suggests that trade interventions have been a major,
if not the biggest, single source of distortion (Krueger 1984b, 417).
For this reason, it is a safe proposition that any policy reform will
have to focus on the removal of obstacles to an expansion of exports in the first place.
Depending on the nature and degree of protection, a combination of the following three
elements of an import-liberalization strategy will have to be applied to accomplish this
task: a transformation of quantitative trade interventions into tariffs, harmonization of
tariff protection across sectors, and a reduction of the average level of protection.
As to the first aspect, tariffs are preferable to quantitative
restrictions not only because the latter tend to veil the actual degree of protection, but
also because the competition for import licenses diverts productive resources from more
efficient uses elsewhere in the economy, apart from encouraging corruption in the
Second, reshaping the (new) tariff structure toward a uniform tariff
system serves the purpose of eliminating, or at least reducing, the escalation and
deescalation effects of selective nominal tariff protection on effective rates of
protection. A more uniform effective rate of protection across sectors lowers artificial
advantages for import-substituting activities through, for instance, duty-free imports of
capital goods, and leaves
the choice of efficient import-substitution possibilities to market
forces rather than to bureaucrats. An intrusive government may be tempted to liberalize in
a selective manner rather than across the board on the grounds that the benefits of
comparative advantage will then be captured faster; this is dangerous, in that new sources
of distortions emerge, to say nothing of the difficulty of accurately assessing
comparative advantages in a dynamic setting.
Third, a more uniform tariff system in itself usually entails a lower
overall degree of import protection for domestic industries, since sectors granted low
protection in the past will now exert pressure on the government to treat other sectors
equally. Obstacles to the expansion of exports are thus mitigated. However, additional
efforts will be required if the general level of protection is to be lowered further.
As long as some degree of import protection prevails, export activities
remain discriminated against both directly through higher prices for imported intermediate
and capital goods, and indirectly through the effects of protection on the general level
of product and factor prices. Direct cost disadvantages of export activities can be
remedied by one or all of the following measures, which have been applied in a wide range
of developing countries: duty-free importation of inputs for export production, drawback
schemes for import tariffs, and the establishment of free export-processing zones. From
the point of view of administrative ease, duty-free importation and export-processing
zones are clearly superior to drawback schemes, and free zones, if appropriately
established, may offer additional net benefits in terms of employment creation and
strengthened linkages to the domestic economy.
A closer vertical integration of the economy is also promoted by
measures compensating export activities for indirect cost disadvantages. Such measures
include income and sales tax rebates, special depreciation allowances, preferential
credits, and straightforward subsidies (for details, see Wulf 1978). These various kinds
of subsidies of either output
or factor use can be compared to a partial, export-related devaluation
of the currency, which may be necessary to balance the incentive system with respect to
sales in domestic and foreign markets. However, this approach bears some risks. To begin
with, it is almost impossible to determine the subsidy rate required to compensate for
disadvantages accruing from import protection, which may lead to an undesirable
overshooting. Moreover, the subsidies, typically related to the amount of investment, lend
to encourage the use of capital over labor, and may thus be detrimental to a satisfactory
rate of employment growth. And last, but not least, export subsidies can provoke
retaliation from industrialized countries, which tend to ignore the compensatory nature of
these subsidies, regarding them as price dumping. For these reasons, the emphasis of trade
policy reform should be on import liberalization rather than on the implementation of
With import liberalization, the compensation of indirect cost
disadvantages can be achieved by a more rational exchange-rate policy that increases the
prices of exportables without inflating import prices. In the medium and long term,
exchange-rate policy has to neutralize differences between domestic and foreign rates of
inflation to shelter domestic suppliers from inflation-induced cost disadvantages
vis-Ã -vis foreign competitors. This goal cannot be achieved if the exchange rate is
used as a policy instrument to influence other macroeconomic variables as well, such as
the rate of inflation itself. If the exchange rate is used to break the inflation
mentality, as was done for instance in Chile in 1979 81, this is at best a short-term
policy, the success of which depends on the credibility of the government's effort to
contain inflation and the ability of the export sector to cope with the temporary
discrimination implied by the real appreciation of the currency.
The choices for an appropriate medium-term exchange-rate policy are ad
hoc devaluations in an otherwise fixed exchange-rate system; a sliding peg, or
preannounced, devaluation schedule: or a freely floating exchange rate. The first can be
dismissed as impracticable both on theoretical and empirical grounds. In a fixed
exchange-rate system, the external value of the currency is adjusted retrospectively to
inflation differences. This in itself contributes to permanently fluctuating real exchange
rates, which discourage export orientation on the part of domestic firms, is detrimental
to long-range investment planning, and induces destabilizing speculation. These negative
effects are aggravated if necessary devaluations are delayed on account of national
prestige considerations, as frequently occurs, so that further uncertainly is caused.
The choice between administered stepwise devaluations and freely
floating exchange rates is a much more difficult one because the potential effect on
resource allocation of either policy depends on monetary and credit policies pursued
simultaneously. A controlled sliding peg has the advantage of leveling exchange-rate
fluctuations and, hence, reducing exchange-rate risks for exporters and both local and
foreign investors. Countries such as Brazil, Colombia, and South Korea successfully
applied such a policy in the late 1960s and early 1970s (Donges and MÃ¼ller-Ohlsen 1978,
112). Problems have been encountered with preannounced stepwise devaluations (tablitas
) in some Latin American countries, such as Argentina and Uruguay, however, with high
increasing rates of inflation (for details, see Barletta, Blejer and Landau, eds., 1984).
In these countries, throughout the second half of the 1970s and early 1980s, the tablita
has repeatedly failed to bring about the desired devaluation of the currency in real
terms, since governments have usually underestimated future rates of inflation. The result
was a real appreciation of the currency, since nominal devaluation rates fell short of
international inflation differences. The lesson is that a tablita policy will only
help to restore foreign-exchange equilibrium if governments simultaneously pursue a strict
anti-inflationary monetary policy, which usually implies incisive cuts of public deficits
(Sjaastad 1983; Fischer, Hiemenz and Trapp 1985). In order to alleviate short-term
adjustment costs as much as possible, anti-inflationary policies will have to be
accompanied by financial policies designed to enhance the restructuring of the economy
according to comparative advantage, a topic to which we shall return shortly.
The other alternative, transition from a fixed, overvalued exchange rate
to a freely floating one, usually implies a large initial devaluation, with an equivalent
rise in the price level, which is difficult to cushion by import-liberalization measures
at least in the short run. Moreover, with low or negative real rates of interest in local
capital markets, devaluation expectations are likely to give rise to an uncontrollable
capital outflow, which will further reduce the ability of the economy to adjust to new
relative prices. Yet a freely floating exchange rate may be the only feasible policy
alternative as long as high inflation has not abated, since governments lack the foresight
to predict future price increases correctly in an inflationary environment.
It thus seems clear that appropriate trade policies have to be combined
with fiscal and monetary policies designed to curb inflation, and with a deregulation of
capital markets as well, if the shift to an
outward-oriented trade regime is to succeed. The deregulation of
capital markets gains particular significance once the adjustment process is considered.
With greater reliance on market forces and increased competition from abroad, parts of the
installed capacity will be rendered obsolete, while expansion into new profitable
activities creates demand for credit to finance the necessary investment. The ease and the
speed of the adjustment process will depend heavily on whether this demand for fresh funds
can be met. Efforts have therefore to be made to mobilize domestic savings and attract
capital from abroad.
In both respects it is imperative that interest rates reflect the true
scarcity of financial capital so as to allow for a positive real rate of interest and to
strengthen the ability of the banking sector to attract and allocate funds efficiently by
removing excessive banking regulation. In some countries it may
also be necessary to revamp investment legislation so that existing "red tape"
is reduced and foreign investors are guaranteed their property rights, which is much more
important than the provision of generous financial incentives by the host government, as
all available evidence indicates (see, for example, the overview in OECD 1983).
Efficient capital-market policies are crucial, since the social
acceptability of liberalization hinges on swift achievements in terms of output growth and
employment creation. It need not be stressed that such achievements depend not only on
consistency between trade, monetary, and credit policies, as pointed out earlier, but
equally on the presumption that governments do not erode the potentially beneficial
effects of the new incentive system by some countervailing policy action, such as controls
on prices, profits, and dividends or interventions in labor markets.
The positive welfare effects of liberalization arise from a reallocation
of resources following a shift in relative prices, including the wage rate. Any attempt to
maintain the privileged income position of workers in a hitherto protected sector of the
economy endangers the establishment and growth of internationally competitive activities
and prevents the creation of additional productive jobs. Governments may find it difficult
to resist the claim of organized labor to secure, if not increase, real wages, but this
political pressure will relax only when the employment and income effects of
liberalization materialize. This will happen sooner
if real wages are allowed temporarily to decline until productivity
gains accruing from better resource allocation again permit wage increases.
The Timing and Sequencing of Liberalization
Abrupt liberalization is the least painful way of proceeding provided
(1) that with the new system of incentive firmly in place, adjustment proceeds rapidly
without being hampered by resource misallocation during the transition; (2) that
instantaneous adjustment prevents political opposition to the policy change from diluting
it; and (3) that immediate transformation of the economic environment reduces uncertainty
about the credibility of the policy initiative that could delay the response of economic
agents to new incentives. If these considerations are overriding, the issues of timing and
sequencing do not arise.
There is a widespread belief, however, that instantaneous liberalization
of an economy hitherto subjected to exchange controls, import licensing, negative real
interest rates, indexed real wages, and so on will completely disrupt economic activity
and cause high adjustment costs in terms of declining output and increasing unemployment.
Removing controls gradually so as to give economic agents time to prepare for adjustment
(timing) and deregulating individual markets in a stepwise fashion, depending on the ease
with which adjustment can be accomplished in these markets (sequencing), are therefore
Some of these problems have already been discussed above with respect to
import liberalization and exchange-rate policy. Analytically, an optimal liberalization
program depends on the degree of prevailing intervention, on the intensity of linkages
between individual markets (the level of economic development), and on expectations that
have been built up on the basis of past experience with economic policymaking (LÃ¤chler
1985). Although all of these factors do matter, very little is known about their precise
relationships to the time schedule of a reform program. The basis for any proposal
therefore remains largely judgmental. The advantages of graduation in import
liberalization have been emphasized on the grounds that losses of capital and jobs,
inevitable as they are in the process of moving toward a new production structure, will be
minimized. Whether this can be achieved depends on the
success of exchange-rate policy in shifting relative prices in favor
of exportables without propelling domestic inflation.
Concerning the proper sequence of liberalization steps, Jakob Frenkel
(1984) has argued that domestic distortions in the goods and asset markets should be
removed before links with the rest of the world are liberalized. In addition, restrictions
on capital flows should only be lifted after free trade has been introduced, because asset
markets adjust more quickly to new policy regimes than do goods markets. The latter
proposal also emerges from several studies of unsuccessful liberalization attempts in
Chile, Uruguay, and Argentina (McKinnon 1982; Dornbusch 1984; Edwards 1984; Sjaastad
1984), which all conclude that liberalization of the capital account should be postponed
because capital flows will either (under a freely floating exchange rate) push the value
of the domestic currency to a level that impedes the structural transition of the real
sector or (under a tablita or fixed exchange-rate regime) require extremely high
real rates of interest in domestic capital markets to prevent large capital outflows and
thus maintain the chosen parity.
Both effects are clearly undesirable, and there is little doubt that
internal liberalization of capital markets alone could help improve the allocation of
capital without risk of too much or too little (net) capital inflow or outflow. Yet, one
could argue that the negative effects have actually resulted from an inconsistent mix of
exchange rate and domestic economic policies rather than from the liberalization of the
capital account as such. In particular, the attempt to use the exchange rate as an
anti-inflationary device while distortions of domestic capital and goods markets remained
in place has caused the severe economic recessions that each time marked the end of
so-called economic liberalization in Latin America. Even if controls on capital flows had
been maintained, the exchange-rate regime managed by the government would still have
induced an appreciation of the real exchange rate. The resulting decline in the
international competitiveness of the tradables sector, which was enforced by incompatible
domestic policies such as wage indexation (Chile) or persistent monetary expansion
(Argentina), would have been sufficient to prevent the necessary adjustment of the real
sector of the economy and, thus, to provoke a new balance-of-payments crisis. Most
likely, the risks associated with the choice of a "wrong"
exchange rate are by no means smaller than those stemming from destabilizing capital
Furthermore, there is evidence (Corbo, de Melo, and Tybout 1985, 17 27)
that policy inconsistency rather than liberalization of the capital account has caused the
substantial capital movements into, and out of, the countries in the Southern Cone. The
persistent policy-induced distortions of factor and goods markets undermined the
credibility of the tablita policy. Expectations were that the government could not
sustain this policy; hence the perception of the exchange-rate risks hardly changed. For
this reason, interest rates remained high when inflation rates began to decelerate, and
attracted much capital from abroad. The resulting real appreciation of the exchange rate
then increased expectations of the collapse of the exchange-rate regime, and capital flows
were reversed until a new balance-of-payments crisis made a maxidevaluation inevitable.
This assessment suggests that appropriate liberalization policies for
concrete cases can only be delineated after a careful economic analysis of the country
concerned has been undertaken. With this qualification in mind, the history of successful
liberalization in Asian countries and less successful liberalization attempts in Latin
America's Southern Cone (to which we shall return in detail later) would at least suggest
the following policy guidelines. Gradualism tends to be self-defeating with respect to
stabilization and exchange-rate policies, while import and capital markets may be better
candidates for a more cautious removal of controls. It has to be stressed, however, that
at least a partial deregulation of the capital market is an urgent task, since capital
markets have to play a key role in providing the funds needed for rapid and successful
economic adjustment to a more outward-oriented trade regime. To facilitate financial
flows, it may also be advisable in many countries not to postpone the liberalization of
the capital account until the real sector of the economy has adjusted, even if there are
some risks concerning an unwarranted appreciation of the currency. If the government
abstains from interventions in the foreign-exchange market (and does not buy up the
foreign-exchange inflow), a revaluation of the currency is unlikely. A steady course of
the Central Bank with respect to monetary policy can prevent an inflationary increase of
domestic money supply, while import liberalization will help to mitigate the
revaluationary effect of capital inflows. The government should be prepared to accept a
temporary deficit in the current account (J-curve effect) to accelerate productive
investment based on imported capital goods and to limit the inflow of
speculative capital. Once new investments go into operation and export growth is
accelerating, the current account deficit will automatically be eliminated.
The Political Economy of Export Liberalization
Despite some open questions, the switch from an inward- to an
outward-oriented trade regime has hardly been hampered by a lack of knowledge concerning
the economic management of transition; it was rather impeded by a lack of political will
to change the direction of economic development. The major problem with liberalization is
that government officials, politicians, and the informed public can readily foresee those
interests that are likely to be damaged in the short run by any liberalization effort. The
damage accrues primarily to those benefiting most from controls and regulations, and it is
in the logic of the system that the main beneficiaries of the regime, such as
import-substituting industries, the labor aristocracy, and bureaucrats exerting power
through controls, also tend to be well organized into political pressure groups. For them,
it pays to invest in the continuity of an inward-oriented trade regime. Conversely, those
who have to foot the bill for excessive regulations in terms of income and employment
forgone, such as consumers, informal labor, export industries, and agriculture, often do
not realize the price they are paying and, hence, have little incentive to organize
themselves into special interest groups. They also usually find it difficult to perceive
the medium- and long-term benefits that export liberalization holds out to them. For these
reasons, there has always been a lot of opposition to, and little support for, a change of
the trade regime.
Yet not just the so-called "Four Tigers" in Asia (Hong Kong,
Singapore, South Korea, and Taiwan) but also quite a number of developing countries
adopted export-promotion strategies in the 1960s and 1970s. This raises the question of
which political conditions are conducive to liberalization. Bhagwati (1985, chap. 1) has
hypothesized that authoritarian regimes can more easily choose appropriate policies than
can democratic governments. His main argument is that the import-substitution strategy
confers more political power than the export-promotion strategy, since it provides
politicians with greater patronage. Hence, where politicians take power directly by
authoritarian means, they have no need to use the economic system to generate and exercise
power, freeing them to embrace economic liberalization. Though analytically appealing,
Bhagwati's hypothesis does not carry very far in the
light of empirical evidence. There are military dictatorships in some
Latin American countries clinging to populist policies, while politicians in fairly
democratic countries such as Malaysia and Thailand took the initiative to liberalize their
economies in the 1970s.
So far we in fact know very little about the politicoeconomic background
of economic decision making in developing countries and the constellation of power groups
that provide governments with enough independence to implement appropriate policies for
sustained economic development. Much more research is needed in this area. All that can be
said at this stage is that the standard arguments against the political feasibility of
export liberalization did not stand the test. The attempt to preserve national
independence through a diversified domestic industrial sector, largely de-linked from the
world economy, has increased dependence on imported intermediate and capital goods and has
contributed to the currently intractable foreign indebtedness. Trade unions were not
pacified by maintaining the course of import-substitution strategies the political
pressure exerted by organized labor against the government was as strong under
inward-oriented trade regimes as when liberalization was attempted. And, finally,
persistent reliance on import-substitution strategies for fear of political and social
upheavals in case of a policy change has not protected many countries in Africa and Latin
America from plunging into economic crises and civil disorder, with subsequent changes of
government. The new governments, often military, then had little choice but to implement
some liberalization measures to remedy the economic crisis.
Evaluation of the Evidence
The proposition that an open trading environment promotes an efficient
use of available resources has received impressive support from the experiences of an
increasing number of old and new NICs, which gradually opened their markets during the
1960s and 1970s. Export liberalization has caused manufactured exports from the Third
World to expand spectacularly, outpacing both world trade expansion and domestic
industrial output growth. As table 6.1 shows, manufactured exports of developing countries
grew on average at an annual rate of roughly 14 percent in real terms in the period 1965
82 about twice as fast as world trade. Export expansion was predominantly achieved by the
nineteen countries listed in table 6. 1, which accounted for 79 percent of
|TABLE 6.1 Manufactured Exports of Newly
Industrializing Countries (NICs), 1965 82
(SITC 5 + 6 + 7 + 8 - 67 - 68)
||Value in millions of U.S. $
||Share in total exports (%)
||Annual real rates of growth (%)a
| Hong Kongb
| South Korea
|TABLE 6.1 Manufactured Exports of Newly
Industrializing Countries (NICs), 1965 82
(SITC 5 + 6 + 7 + 8 - 67 - 68)
||Value in millions of U.S. $
||Share in total exports (%)
||Annual real rates of growth (%)a
|Total (all NICs)
|in % of developing
|in % of world exports
|Manufactured exports of:
| Developing countries
|SOURCES: United Nations, Commodity Trade
Statistics, Yearbook of International Trade Statistics , and Monthly Bulletin of
Statistics, various issues; UN Council on Trade and Development 1983 (with 1984
supplement); India 1984; Peru 1971; Singapore 1980 and 1984; Taiwan 1983; Uruguay 1973.
a Export values deflated by unit value indices for manufactured exports of
b Excluding re-exports.
d 1973 81.
total Third World manufactured exports in 1982. With rapid domestic
industrialization, the export portfolio of these countries significantly shifted toward
manufactured goods, as shown by the shares of these goods in total exports, which
increased from 7.2 percent in 1965 to 44.8 percent in 1982.
The nineteen countries in table 6.1 are quite diverse. Some (the
firstgeneration NICs) had already established a substantial industrial base in 1965,
whereas others (the second-generation NICs) were latecomers who began to promote
industrialization and exports of manufactures only in the 1970s. Furthermore, a few
first-generation NICs have pursued predominantly inward-oriented development policies, and
for the reasons given in section 3 the consequences for their export performances were
negative: either real growth of manufactured exports remained low throughout the whole
period under observation (as in the case of India) or it slowed down considerably when the
international economic environment deteriorated in the 1970s (as in the cases of Argentina
This is in clear contrast to the experience of the more outward-oriented
first- as well as second-generation NICs. As to the latter, the interesting point to make
is that they were able to launch export drives in spite of successive oil shocks, economic
recession in industrialized countries, high interest rates, and new protectionism during
the past decade. The unfavorable external environment did not prevent these countries from
penetrating the markets of industrialized countries further and from intensifying trade
within the Third World. The real rate of manufactured export growth of 10.1 percent for
all countries taken together, which has to be compared to a rate of 4.5 percent for world
trade in manufactures, indicates the continuity of export success in the period 1973 82.
In this difficult period, the second-generation NICs were even more successful than their
forerunners, as shown by rates of export expansion of 14.6 and 9.6 percent respectively.
Equally noteworthy is the fact that the early export drive of the old
NICs has not clogged the markets of industrialized countries leaving no room for
latecomers, as is often asserted. Most of the new NICs started industrialization based on
relatively open trade regimes in the 1970s, and were able to compete successfully with old
NICs and with suppliers from industrialized countries. All second-generation NICs except
Colombia (which had abandoned outward orientation by then) have achieved rates of
manufactured export expansion in excess of the group of old NICs (for further details, see
Havrylyshyn and Alikhani 1982). An
analysis of ASEAN countries (Indonesia, Malaysia, the Philippines,
Thailand, and Singapore) (Hiemenz 1985) even suggest that the take-off to export-oriented
industrialization may have been easier for the latecorners, since the experience of the
old NICs served as an indication for choosing an appropriate product mix, tapping the
right markets, and exploiting established trade links. Most important, however, the
demonstrated superiority of choosing an outward-oriented development path in the old NICs
created an expectation of success that all segments of society in the new NICs could focus
A great number of country studies show that exports, which expanded so
rapidly under outward-oriented trade regimes, have been the major driving force of
economic growth and employment creation, exceeding any performance observed in countries
pursuing import-substitution strategies (Donges 1983, and the references given there; Ram
1985). The domestic saving rate increased rapidly and so did the proportion of investment
in GDP, both behind remarkable rises in the export-to-GDP ratios (table 6.2). Again,
predominantly inward-oriented old NICs did not fare as well as the other NICs. Increments
to savings and investment remained modest; hence real rates of GDP growth trailed far
behind those achieved by most outward-oriented NICs.
What appears as an "export-led type" of economic development
in most NICs in fact meant a continuous strengthening of the supply potential of the
economy and a steady increase in productivity. Relatively low real wages provided the
inducement to build up manufacturing-production capacities using labor-intensive
technologies to a large extent, which allowed the absorption of surplus labor. When later
on labor became scarcer during the industrialization process, and consequently real wages
increased more rapidly (particularly in the leading NICs), the economies had gained
sufficient flexibility on the supply side to be able to shift the production structure
toward more physical-capital and skill-intensive activities and to be internationally
competitive in these new undertakings. Direct foreign investment has contributed to the
success of export orientation and diversification, mainly by providing technical knowledge
and marketing expertise and by upgrading skills of domestic workers. With the exception of
Singapore, the significance of (totally or partly) foreign-owned firms, in terms of
investment, production, export, or employment shares, was much more modest than commonly
The empirical evidence also confirms that these encouraging results have
been brought about by improvements in trade and trade-related
|TABLE 6.2 Indicators of Export-Oriented
||Percentage Share in Gross Domestic Product
||Annual Percentage Rates of
||Real Manufacturing Output
73 1973 83
73 1973 83
| Hong Kong
| South Korea
|TABLE 6.2 Indicators of Export-Oriented
||Percentage Share in Gross Domestic Product
||Annual Percentage Rates of
| Middle-income countries
| Upper-middle-income countries
| Lower-middle-income countries
|SOURCES: World Bank 1985; Asian Development Bank
policies along the lines discussed in section 3. A corrected and more
sensible import-tariff and export-subsidy policy, combined with more realistically valued
real exchange rates, more rational factor pricing, and less intervention in goods markets,
have constituted the pillars of outward-oriented trade regimes. State intervention
remained important in all NICs (with the exception of Hong Kong, which has always come
very close to a laissez-faire economy), but the readiness of governments to consider
comparative-cost criteria, to modify plans when circumstances changed, and to learn from
past mistakes was much greater than elsewhere in the Third World. When export
liberalization involved some kind of resource misallocation for instance, because the
government promoted exports bearing high marginal domestic resource costs per unit of
foreign-exchange earnings the country's industrialization process did not come up against
a balance-of-payments constraint, as it almost inevitably would have under an
inward-oriented regime; those exports at least provided foreign-exchange revenues.
It should also be noted that the transition from an inward-oriented to
an outward-oriented trade regime nowhere caused traumatic dislocations in production and
employment. On the contrary, the more or less gradual approach adopted by the governments
in reforming policies greatly facilitated the needed adaptation. Even many of the
inefficient producers, which lived so comfortably with the previous protectionist
environment, demonstrated that they were actually quite able to reduce costs through
process innovations and to develop new markets through product innovations once the
increased competitive pressures made such efforts imperative for survival.
External Shocks and Foreign Indebtedness
One frequently raised objection to export liberalization concerns the
dependence of outward-oriented economies on conditions in world markets. It is argued that
open economies are vulnerable to external shocks, while less trade orientation provides a
protective shield against disruptive external demand or price changes. The experience of
the 1970s and 1980s, when all developing countries were suddenly confronted with the need
to overcome increasing balance-of-payments pressures in order to preserve the momentum of
their development process, reveals the opposite. Outward-oriented economies commanded
enough flexibility at both the macro- and micro-levels to meet the challenge of
deteriorating world market conditions without falling into the debt trap, while
inward-oriented economies suffered from severe economic depression
and, in many cases, mounting foreign indebtedness. India is the major
exception to this rule, perhaps because this country had previously not borrowed much
abroad and has benefited from an improved performance of its agricultural sector more
recently. Balassa (1984) has shown that outward-oriented economies relied largely on
output-increasing policies of export promotion and import substitution to offset the
balance-of-payments effects of external shocks in the 1974 76 and 1979 81 periods and
accepted a temporary decline in the rate of economic growth in order to limit their
external indebtedness. Inward-oriented economies, however, failed to apply
output-increasing policies of adjustment; they financed the balance-of-payments effects of
external shocks by foreign borrowing in 1974 76 and had to take deflationary measures in
1979 81 as their increased indebtedness limited the possibility of further borrowing. The
policies applied led to economic growth rates substantially higher in outward-oriented
than in inward-oriented economies, with the differences in growth rates offsetting the
differences in the size of external shocks several times.
Aborted Liberalization Attempts in Latin America
The liberalization attempts initiated in Uruguay, Chile, and Argentina
in the mid 1970s (for details see the country papers in Barletta, Blejer, and Landau 1984)
seem to run counter to the arguments presented in previous sections. True, all three
economies experienced initial success in reducing inflation and accelerating the rate of
economic growth, but the positive developments ended abruptly, as each country encountered
a sudden economic downturn, large increases in external indebtedness, and internal
Closer examination of the experiences of these countries underlines the
extreme importance of internal consistency in the policy package implemented to liberalize
an economy. In particular, a fixed exchangerate system pegged against an appreciative
currency (then the U.S. dollar) turned out to be incompatible with fiscal, monetary, and
wage policies. In the Chilean economy, the momentum of economic development achieved by
trade liberalization and anti-inflationary budget policies broke down when the exchange
rate was fixed against the U.S. dollar in 1979. A sharply appreciating real exchange rate
in 1980 81 combined with a considerable rise in real wages (owing to wage indexation to
and higher, inflation rates) and persistently high interest rates
(owing to bank regulations causing substantial arbitrage costs) could not but erode the
international competitiveness of the tradables sector and provide strong incentives for
speculative investment (mostly in construction activities).
A lack of consistency between exchange-rate policy and trade policies,
as well as fiscal policies, also caused the failure of economic liberalization in
Argentina, where a tablita was implemented, with a concomitant opening of the
capital account, while protectionist trade interventions remained untouched and large
fiscal deficits continued to fuel domestic inflation. This combination of contradictory
policies put the trade sector under untenable pressure (as in the case of Chile) and gave
rise to an unprecedented outflow of domestic capital. Both countries accumulated
staggering levels of foreign debt within a relatively short period as a result of
unresolved balance-of-payments problems.
These partial deregulation attempts can clearly not be used as examples
against export liberalization based on a package of stabilization-cum-restructuring
policies as suggested in section 2 and applied in most of the second-generation NICs.
However, they do provide lessons with respect to the crucial link between exchange rate,
interest rate, and wages, and with respect to the disastrous consequences of step-by-step
approaches to liberalization. Sjaastad (1983, 19) makes the point unequivocally: "The
fatal flaw is not to be found in the liberalisation programme per se, but rather in policy
inconsistencies. Policy inconsistencies are of minor importance when markets are heavily
regulated. Free markets, however, require a high degree of policy coherence."
World Market Conditions-Obstacle to Export Liberalization?
The above analysis has stressed that the main factors determining the
success of outward-oriented economic development are to be found on the supply side of the
economy. To be sure, world market conditions also matter, and when they are as favorable
as they were in the 1950s and 1960s the chances for accomplishing a successful transition
to an open trade regime are particularly good. But even a buoyant external demand can only
be transformed into an impetus to economic development if there is adequate export
potential. Nevertheless, persistent skepticism fuels new variants of export pessimism,
resting on the as-
sumption that the revival of protectionism will further restrict
access to the markets of industrialized countries, that these markets cannot absorb
expanding exports from a large number of developing countries, and that world demand will
remain sluggish owing to the weak economic performance of the industrialized countries.
Though "new protectionism" in industrial countries has not
completely eroded the gains from earlier rounds of trade liberalization (Hughes and
Waelbroeck 1981, 131) and has not prevented exportoriented economies (in particular the
East Asian NICs) from penetrating foreign markets, the danger is that it generates
additional uncertainty among investors in developing countries concerning engagement in
export-oriented activities. Investors may then turn to presumably "safe"
investment opportunities geared toward production for local markets, and political forces
favoring an import-substitution type of economic development may succeed in forestalling,
or at least slowing down, any attempt to liberalize the system of economic incentives. In
this sense, protectionists in the industrial countries play into the hands of
protectionists in developing countries.
As to the proposition that it will be impossible for all developing
countries to emulate success stories because the resulting surge of manufactured exports
to Western markets would cause a glut on those markets and provoke further protectionist
tendencies (Cline 1982; Spraos 1983, 140), it reflects a fallacy of composition. When
moving in the direction of market liberalization, it takes a longer time for large,
resourcerich countries, like those in Latin America, starting from a higher level of
distortion, to arrive at the same manufactured export share in GDP than it does for small,
labor-abundant countries like Korea. Taiwan, Singapore, and Hong Kong. In fact, it is
likely that manufactured export shares in the former group will always fall behind those
in the latter group, even at the same population and income levels. Nor, given differences
in resource endowments and skills, will all developing countries export the same products.
Even in the labor-intensive segment of the product range, there is a wide variety of
manufactures that developing countries can specialize in, and market penetration is rather
marginal in industrialized countries for most of these products.
Moreover, the implementation of an outward-oriented trade regime will
provide for some degree of import liberalization. This offers the chance to expand
South-South trade along with South-North trade, in particular with labor-intensive and
products. And, finally, should too many developing countries
specialize in the same exports, their terms of trade will deteriorate (other things being
equal), but this can be only a temporary effect, because it is unreasonable to assume that
investors and exporters do not learn. Most likely, they will react to declining prices by
changing the product mix.
As to export pessimism derived from slow economic growth in developed
countries, it should be emphasized that for industrializing developing countries there is
not a stringent and invariable link between the rate of expansion of world demand and that
of exports (Riedel 1984). The composition of output changes and so does the structure of
exports. In fact, the changing composition of exports has been the major reason behind
rapid export expansion of developing countries over the past twenty-five years. Third
World manufactured exports grew twice as fast as real GDP in industrialized countries in
the 1960s, and more than four times faster after 1973, when industrialized countries
experienced successive economic recessions.
This chapter has reviewed the arguments and the empirical evidence for
the superiority of outward-oriented trade regimes in promoting industrialization and
accelerating economic development. Trade policies that do not discriminate between local
and foreign sales improve allocative efficiency and provide dynamic gains from economies
of scale, enhanced transfers of technology, and better access to international financial
markets. Beyond outward-oriented trade policies, internal liberalization of markets
increases the flexibility of the economy, which is one necessary condition for successful
economic development. These advantages accrue even in an international economic
environment less buoyant than that of the 1960s and early 1970s. It is, however, of
crucial importance that a high degree of coherence between trade liberalization and
related economic policies be achieved, that the policies be credible, and that they be
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