Working Paper: NBER ID: w2358
Authors: Kenneth A. Froot
Abstract: This paper investigates the effects of imperfectly credible trade liberalization programs on welfare and the allocation of real resources. We present a rational expectations model in which a government, with limited access to international financial markets may be forced to abort a liberalization program if hard-currency reserves are depleted too quickly. The liberalization's lack of perfect credibility arts as a distortion which becomes (rationally) intensified under the typical first-best policy of a direct move to free trade. A gradual lowering of trade barriers turns out to he welfare-superior to an immediate liberalization, and to improve the chance that. the program will ultimately succeed. We then derive the optimal speed of liberalization, the intertemporal allocation of resources, and the liberalization program's credibility.
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Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| lack of credibility in trade liberalization policies (F13) | higher likelihood of program failure (C88) |
| gradual liberalization (P39) | increases probability of success for the reform program (E69) |
| gradual liberalization (P39) | welfare-superior compared to immediate liberalization (D69) |
| gradual liberalization (P39) | reduce real interest rates (E43) |
| gradual liberalization (P39) | shift production towards the export sector (F16) |
| immediate tariff elimination (F15) | exacerbate risk of policy reversal (E65) |
| gradual lowering of trade barriers (F15) | increases chance of successful liberalization (F69) |