and that open trade regimes are more conducive to growth.<sup>8</sup> Mor-eover, virtually all recent development success stories have been based on strong indlustrial export growth and relatively low barriers to imports - Chile, Hong Kong, Malaysia, Mauritius, and Singapore - or continually falling barriers - the Republic of Korea and Taiwan (China). Industrial sectors in these economies not only have higher export: growth but generate more employment as well; and trade reforms have usually been accompanied by increased flows of foreign investment.

An effective trade policy is central to the integration of developing countries into the international economic system and the growth that will generate. It provides links with international markets, and, together with the exchange rate, forms the transmission mechanism through which international trade affects domestic resource allocation, the efficient and competitive restructuring of industry and agriculture, access to new and diverse technologies, improved incentives to exporters, and reduction of smuggling, rentseeking<sup>9</sup> and corruption in customs.

Tariff policy is the centerpiece of trade policy in a markei: system. Tariffs are, with very few exceptions, the only acceptable policy tool for pro tection under the GATT/WTO. They are superior to alternative instruments of protection, such as nontariff barriers (NTBs) like quotas, licenses and technical barriers to trade (TBTs), because they are less likely to lead to rent seeking and corrupt practices, and because tariffs limit the exercise of domestic monopoly power where it exists whereas NTBs do not.

# **III. The Problems of an Overvalued Exchange Rate**

Experience has shown that countries that attempt to maintain overvalued exchange rates significantly impede their growth in the medium t;o long term. Theory, cross-country statistical studies, and case histories all reinforce the basic findings that exchange rate overvaluation can reduce economic efficiency, misallocate resources, increase capital flight, and most perniciously, lead to exchange aad trade controls.

# **Problems Caused by an Overvalued Exchange Rate - Theory**

Theory suggests that there are many channels through which an overvalued exchange rate hurts the economy and growth: (1) it discriminates against exports. Since a significant portion of the costs of production is paid in domestic currency, the overvalued exchange rate results in a reduction of incentives and ability of exporters to compete in 8Sachs and Warner in a recent article (1995) have estimated that open economies have grown about one percent per year faster than closed economies, and that the difference is greater among developing countries. For a review of the extensive literature on the link between open trade regimes and economic growth see Edwards (1993). See also Dollar (1992).

9 Rent-seeking refers to the expenditure of resources to achieve a favorable re,gulatory intervention by government. In this context, it refers to lobbying of government officials (including bribes) to achieve protection from international competition. It is generally rather inefficient since resources that could be used on productive activities are diverted to influence government decisions regarding protection.

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