I **Policy, Research, and External Affairs** I

# **Public Economics**

# WPS 737

T; ,i' 1'. Ipe r a product ol' thc Public Economics Division, Country Economiiics Dcpartment -- is part of a aice .. lcort in PRE to cxaminc open-cconomy tax reforin and adjusiment policies in dcveloping **,'W tlir s.** Copies are available free from thc World Bank, 1818 II Sircc NW, Washington DC 20433. 1 1 contact Ann l3halla, room N 10-059, exteinSioin 37699 (48 pages).

k **t,dcx** cl)pcd a m;odel that integrates 1 I tem iuporal an:1d forward-looking behavior in i;, -, imcni ii anid conisumption decisions in a , lliEcc ioat general equilibrium framework **.** iabkh **al** t) developing counitries. It formulates .;IJ IP""" u ll inminite horizon growth mo(lel to .Ofi,,}t. **tilt** adjustment, growth, and debt . ! hmi. of' a i-iddle-incomic couiltry, which Go ,:l,<' (I .1mg data lol iltc Plhilippincs.

. _i_ indalions t illustrate the importance of' .: xx aid looking behavior in conisump1! " n nx cstInent. Tlhc) shiow **how** an import -ht k could lea(i to an investimnct boom i I i I C xpalsion of forcigin debt, as happened , _i_ i. i _d_ s.c cnmtic, to many develophing couIn-

**1!** apid cxpansion is hard to explain 'i!; umtoatino the dynamic competitive btween domestic an1d : ioreign goods .i!n in itkeponisC to this shock. TlC increasc j: **!:.** Ill account dcficits and ioreigni debt aitcr I I't price shock, for examiiple, is certainly : thinm s 'o(ild be implied by just thc inI inl lircltin prices. Go concludes, among

from the perspective of the interest rate shock of' 1979. The expectation that debts could be stacked indcfini:cly was clearly wrong and the initcrest rate shock after 1979 came as a surpristo many.

The results demonstrate both the prrmise and danger ol liberalizationi, an adjustment policy ofrten recomiimenided in the 1980s. Tariff' reform shows ihc cxpected benefits in the primary sector and to some degree in exports. But it may easily lead to a contractioni in the protccted sector like manufacturing, a decline in tax revenues, more current account deficits, and more debt. Other mcasures ar needed.

* In general, Go 1iiids that a combiniationi of policies is effective in maintaininlg growth and exports wvithout a rapid accumulation of'debtscven duiing a permanent import price shock. In fact, an import price slhock is an attractive occasion lor tariff reform, as it cases prcssures on domestic piices, prevents exports f'roimi declining too much, and docs not lead to an expansion of import demand thal normally accompanies a tariff reduction.

vi ildion is a kcy factor. Contrary to Ole **t i: ,.U** I sugge:stionl that anl economy should . ail' and colntrac in response to a pemianent 1111m,i I pl)iic shock, tile behavior- suggested in a aJ. i, t x ith raitional cxpeciationis in investment !'i),;l,, 1i' that thC opix)site can be rtrc. 1 -,].wcladtions prevailing in the imnid-sevenlties J) 'hit ilic energy crisis was pennanent, 1- the i C kjlvap ea1' oil were over, and petrodollars v. o ntilt iitit tuc to he available. But condiitions ;. IanTd. 'I'Thc actioins of thc high-debt j 'i, ng countlies apiear "inmpudent" viewed Cotabined with other policies, tariff refonn could rechannel investment and resources toward the morc tradable sectors an(i exports cain be emphalsized and increased. If domestic resources are also mobilized tirough increased tax collectioin, thc combir'.cd effect wvill be to reduce or slow the accumulation of foreign debt.

In other words, middle-inicomc coLintries likc the Plhilippines IImissed a goldcie opportunity for policy reform in the 1 970s anid found it harder to implemnIt adjustimicni policies unide less favor-able circumistances in the 1980s.

i\ 1 LI iu per S.ries. dissemrnates the findings of work undeles \ay in tlie Bank's l'olicy, Researth, and Extemal l u ie .i Atl obJ c tie eol the scrie. cis to get these findinlgs out qulickly, evesn if presentaltionls arc less thlan fullly pxlished. ' ]. **F,, s1]** intctletitions. ,aid conclusionn in ilesc papers do not neces-arily represent official BRnk policy.

Produced **by thc l'RE** D)issemination Ceniter