Trade Policy and Efficiency:

Aggregate  cross  sectironal analysis does not reveal the channels through which trade policy might affect economic performance.  Detailed analysis of  the impact of trade and  industrial policy was undertaken in two major projects. The results of the two studies are surnmarised in Little, Scitovsky and Skott (1970), Bhagwati (1978), and Krueger (1978). Their conclusions  were some-
what similar  in  that  the countries  following  more open export oriented  policies and  using  the  market  mechanism  rather than  quantitative  controls  had performed  better.

We follow  the  discussion  in Bhagwati, as  this  is  a  detailed  analysis of  the working of trade and industrial policies. Bhagwati argued that the operation of a QR regime resulted in iriefficiencies, as the lack of sufficient relevant economic information resulted in the allocation of licenses among the many alternative users on the basis of some  notion of equity  rather  than on the basis of economic costs and benefits. For instance,  licenses  for  the import of raw materials were often allocated proportionately to installed capacity.  Since the  output  of efficient  firms was limited, there would be a  demand  for  the output  of inefficient firms, who would also receive their share of licenses.  Bhagwati also argued  that an  efficient  firm might get additional  imported  inputs  for larger production only  by expanding  capacity, even though it may have under-utilised capacity. Bhagwati identified the major static  inefficiencies  as excess holding of  inventories, capacity  undemtilisation,  the choice of inappropriate techniques of production of due to distorted factor prices, and  inefficient allocation of investment.  

But  the evidence is mixed  as the quantitative controls  system  may  itself frustrate the achievement of the allocations desired by economic agents  in response  to the incentives  created by the system. For instance, the granting of licenses may take time, so producers may desire  to hold excess  inventories of imported intermediates. But licenses for sufficient  imports to hold the excess inventories may not be granted, so  the actual  level of inventories  may not reach the desired level above the normal level of inventories.  Also, other factors might explain  the excess  inventories. Though Turkey, which had a restrictive regime had  a high mtio of  inventories, Chile, which also had  a restrictive regime, had a lower  ratio than Japan and Spain and a ratio only slightly higher than in Franqe and the USA.

The experience of most countries which have liberalised would bear out the conclusion that the existing industries were not very inefficient. The lack of bankruptcies  on a  large scale  in most  liberalisation  episodes except Chile would suggest that industries established during the protectionist  period were not very inefficient and, given a few years to  adjust, were able to meet  international competition.  The relationship  between efficient  industries  and  export performance may be even more tenuous,  as was argued above.  Even  if a consumer  industry in an LDC is eficient, if it is owned by a transnational  the parent company might prefer  to export  from its home plants.  For instance,  the General Motors subsidiary in Korea, Daewoo, did  not  export,  unlike  the domestically owned firm Hyundai, despite the same policy environment. Exports of capital goods industries might also be constrained  by the inability of LDCs to grant credit.