Trade Liberalisation and the Trade‐Off Between Growth and the Balance of Payments in Latin America

Abstract

The broad purpose of trade liberalisation is to raise the rate of growth of countries on a sustainable basis, consistent with the achievement of other macroeconomic objectives. In this article we consider whether trade liberalisation in 17 countries of Latin America has improved the trade‐off between gross domestic product (GDP) growth and the trade balance, allowing the countries to grow faster without sacrificing foreign exchange. We find that in the aftermath of liberalisation, the majority of countries did grow faster, but at the expense of a deteriorating trade balance. Testing formally for the impact of trade liberalisation in a full model of trade balance determination, we find that only in Chile and Venezuela has the trade‐off unequivocally improved. In other countries there has been a significant deterioration or no change. Nine out of the 17 countries have grown faster post‐liberalisation than pre‐liberalisation but, except for Chile and Venezuela, at the expense of a wider trade or current account deficit.

Key Words:

• Latin America
• trade liberalisation
• growth
• balance of payments

Jel Classifications:

• C21
• C22
• F13
• F32
• F43

Acknowledgements

The authors are grateful to Dr Bill Collier for statistical advice, and Professor Thirlwall is grateful to the Leverhulme Trust for the award of an Emeritus Fellowship, which provided financial support for the research project. Helpful comments were also provided by two referees.

Notes

1. See Table 1 for the dates of liberalisation. The dates are taken largely from Sachs and Warner (1995) and corroborated by information from the IMF, World Bank and WTO. See Appendix 1, which describes the liberalisation process in each of the years.

2. A growth acceleration is defined as a difference of 2 percentage points or more between eight years before the event and eight years after, with a minimum post‐acceleration growth rate of 3.5%.

3. This is because virtually all trade barriers between Mexico and the United States had already been removed. The major impact of NAFTA was on foreign direct investment into Mexico.

4. We focus on the trade balance rather than on the current account, firstly because trade liberalisation (as opposed to financial liberalisation) does not impact directly on invisible items such as remittances, net tourist earnings and net factor payments abroad, and secondly because it is clear from the accounts that many invisible items are highly erratic (see IMF, International Financial Statistics, various issues).

5. In Section (4), the same procedures are applied to individual countries.

6. Most of the ‘deviant’ observations in the bottom right quadrant of the scatter diagram come from Nicaragua, but estimating the equation without Nicaragua in the sample makes very little difference to the coefficients.

7. The real exchange rate (or real terms of trade), rer, is measured as the domestic price of foreign currency multiplied by the ratio of foreign to domestic prices. The sign on the rer variable will be positive if currency depreciation is successful in improving the trade balance.

8. The model is a standard one in the literature derived from multiplicative export and import demand functions. An exact specification of the dependent variable would be the rate of change of the trade balance, but it is the ratio of the trade balance to GDP that countries and financial markets focus on, which is also of interest in its own right.

9. For Costa Rica, the liberalisation coefficient is positive but only significant at the 90% level.

10. The full results are available on request.