10 by which the two-tier exchange rate system raises the domestic price of the importable and lowers the domestic price of the exportable, respectively. The estimated division of the total foreign exchange distortion between an implicit export tax,<sup>_e_</sup> _x_ , and an implicit import tax, _em_ , will depend on the estimated elasticities of supply of exports and of demand for imports.6 If the demand and supply curves in Figure 1 had the same slope, then _em_ =<sup>_e_</sup> _x_ and ( _em_ + _ex_ ) is the secondary market premium or proportional rent extracted by the government or its agents.7 If the government chooses to allocate the limited foreign currency to different groups of importers at different rates, that is called a multiple exchange rate system. Some lucky importers may even be able to purchase it at the low official rate. The more that is allocated and sold to demanders whose marginal valuation is below _Em_ , the greater the unsatisfied excess demand at _Em_ and hence the stronger the incentive for an illegal or ‘black’ market to form, and for less-unscrupulous exporters to lobby the government to legalize the secondary market for foreign exchange and to allow exporters to retain some fraction of their exchange rate earnings for sale in the secondary market. Providing such a right to exporters to retain and sell a portion of foreign exchange receipts increases their incentives to export, and thereby reduces the shortage of foreign exchange and hence the secondary market exchange rate (Tarr 1990). In terms of Figure ' 1, the available supply increases from _QS_ to _QS_ , bringing down the secondary rate from _Em_ to _Em_ ' such that the weighted average of the official rate and _Em_ ' received by

> 6 From the viewpoint of wanting to use the _NRA_ and _CTE_ estimates later as parameters in a CGE model, it does not matter what assumptions are made here about these elasticities, as the CGE model’s results for real variables will not be affected. What matters for real impacts is the magnitude of the total distortion, not its allocation between an export tax and an import tax: the traditional incidence result from tax theory that also applies to trade taxes (Lerner 1936). For an excellent general equilibrium treatment, using an early version of the World Bank’s 1-2-3 Model, see de Melo and Robinson (1989).

7 Note that this same type of adjustment could be made where the government forces exporters to surrender all foreign currency earnings to the domestic commercial banking system and importers to buy all foreign currency needs from that banking system where that system is allowed by regulation to charge excessive fees. This apparently occurs in, for example, Brazil, where the spread is reputedly 12 percent. If actual costs in a non-distorted competitive system are only 2 percent (as they are in the less-distorted Chilean economy), the difference of 10 points could be treated as the equivalent of a 5 percent export tax and a 5 percent import tax applying to all tradables (but, as with non tariff barriers, there would be no government tariff revenue but rather rent, in this case accruing to commercial banks rather than to the central bank). This is an illustration of the point made by Rajan and Zingales (2004) of the power of financial market reform in expanding opportunities.