A review of trade liberalization and its aftermath
Keywords: economic development
International trade
export complexity
economic growth
export diversification
JEL Classification Numbers: F1, O1, O4

Large barriers to international trade were gradually but systematically and substantially reduced across the world in recent decades. Virtually all countries moved away from trade policies designed to promote import substitution to development strategies that embraced international trade as the main avenue for prosperity. Trade policy restrictions are still significant in most developing countries, but their trade regimes are substantially more open than they were decades ago.
Even though a return to the Imports Substitution Industrialization (ISI) Strategy is not part of mainstream economics today, such seismic reorientation in trade policies across the world has not been without criticism. This thesis addresses three important areas of questioning about these trade liberalizations and their aftermath. Have there been enduring negative effects on some economic segments of the population because of lifting import restrictions? Is state interventionism a needed requirement to thrive under the new export-oriented environment that followed ISI? Are we accurately measuring the magnitude of trade liberalizations? While all these questions have already been addressed through different angles, this thesis proposes new answers based on new perspectives.
The first chapter, co-authored with Yothin Jinjarak (Senior Economist at the Asian Development Bank), contributes to the literature that seeks to identify, at the district level, the impact of increased import competition linked to import tariff reductions in developing countries by accounting for spillovers from neighboring districts. As opposed to other district level assessments that are based on liberalization events in the 1990s, we focus on a later trade liberalization event (in Peru in 2008-10) for which there are very comprehensive datasets and during which there were no simultaneous structural reforms that could blur the relation between trade liberalization and its outcomes. With these improvements on board, commonly used OLS regressions find an unexpected positive impact of tariff reductions on import-competing districts, which contradicts the findings in related studies for other countries. We find some evidence that significant migration in response to tariff reductions could be affecting OLS estimation and note that spatial panel techniques may partly control for the migration reaction to enhanced trade exposure and for trade-related spillovers. And, in fact, we do identify the expected negative effect of increased import-competition under a spatial panel estimation framework. We thus conclude that accounting for spillovers is an important methodological improvement over existing estimation techniques, as there can be significant spillovers among localities not only through trade but also through migration. This may be very important in studying numerous developing countries with high labor informality and no legal restrictions to migration.
This first chapter was started in 2013 under guidance of Professor Beata Javorcik. Initially, the intended main contribution was simply to provide an analysis of trade liberalization in a developing country with no legal restrictions to migration, as opposed to India, the country studied in the seminal analysis of Topalova (2005, 2010). However, Kovak (2013) and Dix-Carneiro and Kovak (2017) analyses on the 1990s trade liberalization in Brazil, a developing country without legal restrictions to migration, took away the novelty initially expected for this chapter. Yet, I noted that these studies on Brazil mainly relied on formal sector surveys and that labor market legislation in Brazil is relatively rigid. In addition, the trade liberalization event in Brazil was simultaneous to other major structural reforms including on the labor market and I also noted the possibility of significant spillovers among localities (especially within Brazil’s large cities) that were not accounted for in any related study. Considering time constraints, I reached out to a former co-author, Yothin Jinjarak, to work on this chapter, splitting between us the data gathering and econometric work (we both worked on both aspects). In contrast to the study on Brazil, our study on Peru relies on household surveys that include both formal and informal sectors. Another important difference is that the share of informal labor in Peru’s labor force is about twice as high as in Brazil, thus suggesting higher de facto labor mobility. The main contribution of our study is the use of spatial panel regression techniques that allow for a better understanding of potential spillovers through inter-localities trade or migration.
Lack of a clear link between general economic fundamentals and export diversification indicators has backed the believe that diversification necessarily requires heterodox/industrial policies, which were also key components of ISI strategies. The second chapter of this thesis, however, does find a strong connection between horizontal policies and export diversification by making two substantial changes to traditional estimation methodologies. Noting that indices commonly used as dependent variables are exogenously determined by natural resource abundance, it focuses instead on export categories that lead to diversification (for example, manufacturing exports). And besides including productivity-related independent variables, it adds gravity equation and labor costs related variables, in line with international trade theory. Income per capita is introduced to control for endogeneity. Regression fits are higher than in other studies and coefficients more robust. Proximity to other economies explains close to a third of cross-country heterogeneity of dependent variables, and four fifths when adding horizontal policies (mainly governance, education, infrastructure, and trade policy openness). New role models of diversification policies arise including Australia, Chile, and New Zealand.
This chapter was started recently, in 2018, responding to intense discussion in the international trade policy literature on the need to diversify export baskets in a vast number of countries that are over dependent on hydrocarbon or mineral commodities. The chapter has just been published as an IMF Working Paper (cited in chapter two) and, per request of the head of the IMF Western Hemisphere Department, will be summarized and published as an IMF blog and used to develop a toolkit for IMF country teams to assess policies that promote export diversification. Although I include this research as a second chapter of my thesis, I believe its contribution to the economic literature is by no means less important than the first one.
Given significant criticism to studies on the economic impact of trade liberalization because of measurement error of the strength of the liberalization, chapter three proposes a methodological improvement by focusing on the import reaction to liberalization. Measuring the degree of trade liberalization has traditionally involved measuring the restrictiveness of trade policies before and after reforms, but existing measures of restrictiveness are either imprecise or not available for years in which the most significant liberalization episodes occurred. This chapter takes a different approach in measuring the degree of import liberalizations and their economic impact. It estimates an index that reflects the strength of liberalizations based on the evolution of imports right after liberalization, after controlling for other determinants of imports through a demand equation. To illustrate its potential use, the resulting index is incorporated into a traditional growth regression setting that aims to estimate the impact of liberalization on economic growth.
This third chapter is a combination of analysis presented in two chapters for my D.Phil. confirmation in 2006, and which I worked under the guidance of Professor Gavin Cameron. I used part of this analysis for a World Bank Working Paper (cited in chapter three) coauthored with World Bank Senior Consultant, Mr. Ataman Aksoy, but chapter three is fully based on work developed by myself before working with Mr. Aksoy. The working paper with Mr. Aksoy was recently cited and commented in a review of the trade and growth literature by Dartmouth College Professor Irwin Douglas (cited in chapter three). I decided to combine these two thesis chapters into one because they are complementary to each other and because I have two other pieces of research (chapter one and two) that I would like to include in my thesis to strengthen it.