# **Policy Research**

**_V -VIYLO i_ Macroeconomic Adjustment and Growth WPS 838**

- This paper a product of thc Macroeconomic Adjustmcnt and Growth Division, Coountr) Economics Departmcnt- is part of a larger effort in the tIXpartmcnt to estimate policy measures relevant for growth. The research was funded by the liank's Rcsearchi Support Budget, "How Do National Policies Affect LongRun Growth'?" (RPO 676-66) Copies of thc paper arc available free from the World Bank, 1818 H Street NW, Washington **DC** 20 433. Please contact Rebecca Manin, room N 1 1-053, extension 39(65 (48 pages). January 1992.

In the debate about the relationship between trade policy and growth,various mcasures for trade intervention hiave been used, Aitken presents a new mcasure based on a country s relative price structure and the structure of relative world prices. This measure, hc argues, conforms more closely than existing measures to thc conccpt of tradc intervention.

rhe relationship between "opetness" and trade liberalization is more complicated than is often believed. Whether a country intervenes does not tell the whole storv about its trade policy, .nd misscs an essential aspect of intervention: whichi goods arc f'avored by subsidies and wihich are protected by tariffs. Indonesia and Peru, for example, havc comparable moasurcs of intervention, but the relative price of cquipment is very high in Pcru and vcr) low in Indoncsia: consumer nondurables appear to flow freely in Latin America, while prices for these goods in Japan and Korca are inexplicably high. tJnderstanding differences in the growth expericnce of these countries clearly requires a more subtle view of trade policy than "outward" and "inward" orientation, and a more informed understanding of the nature of intervention.

The debate has been confused by the f;ailurc to distinguish between tradc intervenition and outward orientation. Trade intervention implies policics that distort the flow or pattem of trade: outward orientation implies incentives to export that are greater than incentives for import substitution. The two may be related but a hcavily interx cntionist policy could be outiA ardly oriented.

And a country could impose trade policies that raise the (zverage incentive to export, while incredsing the _dispersion_ of incentives wvithin the export and import sectors - so that when such a c*,"itry liberaliies. tradc iiighlt return to its original pattern hut with incentives inwardly oricnted.

The index of rclative price dispersion that Aitken develops has the advantage that it is objective, measures intervention in both exports and imports, is comparable across countries, and is indepcndenit of fluctuations in exchange rates caused by macroeconomic mismanagement. Unlike average tariffs and mcasures of nontariff barriers and price levels, the relative pricc dispersion index measures incentive distortions _within_ categories of goods.

The Leamer index looks directly at the cffects of trade policy in!ervention. hut the theoretical assumptions required to calculate the pattem of trade in the absence of distortion are questionable. Such assumptions are unnecessary when calculating relative pricc dispersion, as world prices are directly observable.

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