Trade, Development and Political Economy

Anne Krueger has been an influential thinker, researcher and policy adviser on economic development and its relationship with openness to international trade, investment and technology flows. Recently, in her presidential address (Krueger, 1997) to the American Economic Association, aptly titled ‘Trade Policy and Development: How We Learn’, she recalled that:

Ideas with regard to trade policy and economic development are among those that have changed radically. Then and now, it was recognized that trade policy was central to the overall design of policies for economic development. But in the early days, there was a broad consensus that trade policy should be based on import substitution … It was thought import substitution in manufactures would be synonymous with industrialization, which in turn was seen as the key to development.

The Mexican, Asian and Brazilian crises from 1994 to 1998 have led to a great debate about the choice of exchange-rate regimes for developing countries. In particular, ‘fixed-but-adjustable’ regimes have been shown to be incompatible with high capital mobility. This is not a new conclusion — and indeed is the principal explanation for the breakdown of the Bretton Woods system — but it is one that has been dramatically brought home by these more recent emerging market crises. At the same time, when the exchange rates have been reluctantly allowed to float as a result of crises, there has been excessive instability, as reflected in short-term overshooting of depreciations in the market. Again, the recognition of exchange-rate instability under floating rates is an old theme, stimulated especially by the extreme behaviour of the dollar and the yen during the 1980s and 1990s.

It is likely that very few contemporary economists would recognize the real exchange rate as a very recent arrival on the list of important economic concepts, or would realize that real exchange-rate analysis, as we know it today, was not part of the standard preparation of international trade economists, even as late as forty or fifty years ago. It has been my good fortune to witness the arrival of this new offspring of our intellectual heritage and to observe at close hand its development over recent decades.

The current consensus in the academic literature, endorsed by the IMF and other international organizations, is that one of the main lessons of recent financial crises in East Asia and Latin America is the need for more flexible exchange-rate arrangements. Stanley Fischer, the Deputy Managing Director of the International Monetary Fund, stated the matter thus:

There is a tradeoff between the greater short-run volatility of the real exchange rate in a flexible rate regime versus the greater probability of a clearly defined external crisis financial crisis when the exchange rate is pegged. The virulence of the recent crises is likely to shift the balance towards the choice of more flexible exchange rate systems, including crawling pegs with wide bands. (Fischer, 1999)

Developing-countries’ trade policies in the 1990s owe much to the events of the 1980s. Many events had helped to shape trade policies of developing countries in the 1980s. Of these, the economic crises of that decade, which led some to condemn it as the ‘lost decade’, spawned unprecedented policy reforms.² The reforms that began in the 1980s continued in the 1990s. Despite the East Asian crisis that began at the end of 1997, the 1990s were less turbulent than the 1980s. However, the participation of developing countries as full members in the Uruguay Round (UR) negotiations was a decisive factor in their 1990s liberalizations.

The failure of the World Trade Organization (WTO) 3rd Ministerial Meeting in Seattle to launch a new round of multilateral trade negotiations was a setback for the development of a liberal international trade system governed by multilaterally agreed rules. This failure should be a cause of concern to developing countries since they benefit greatly from a rules-based trading system. The lack of agreement in Seattle to review existing rules that are not helpful to development will not cause the problems faced by developing countries to disappear; nor will their reasonable concerns be addressed about the implementation of the Uruguay Round (UR) agreements or their needs for additional assistance. At the same time, WTO negotiations on Agriculture and Services, already mandated under the UR, will go forward, as will a review of the Trade Related Intellectual Property Rights (TRIPs) Agreement, scheduled for 200O. Thus, in the months and years ahead, developing countries will need to develop strategies regarding the ongoing negotiations, identify topics that they themselves want to bring to the WTO as well as positions on issues that others propose for multilateral trade negotiations. No single strategy will suit them all. Their varying trading interests require that they develop different strategies and pursue them in the context of coalitions with other WTO members.

International trade agreements have been around for centuries, if not millennia. They take innumerable forms, but all involve reciprocity in one form or another, explicit or implicit. Whether a country should enter into trade agreements can be and is debated; if it does enter into such agreements, the form and terms of reciprocity are at the heart of the issue.

Anne Krueger’s career, which we celebrate in this volume, has straddled two of the ‘fields’ of our discipline — International Trade and Economic Development. The intersection of these two fields, which in the language of set theory is a subset of their union, has been particularly rich and fertile for both of them. Concerns about ‘development’ and the closely related issue of ‘growth’ have inspired a large and growing volume of work on the dynamization of the traditionally static corpus of pure trade theory and also on the role of skills, externalities, infrastructures and numerous other factors. Our concern in this chapter, however, will be to look at this intersection from the opposite direction. What difference does a ‘global’ or ‘open economy’ perspective make to how the problems of the development and growth of a national economy are perceived?

An important part of Anne Krueger’s research has dealt with the relationship between economic policy and growth in developing countries. Her numerous articles on commercial policy and growth, including her detailed studies on Turkey and Korea, have been an inspiration for a generation of scholars (Krueger, 1978, 1988). In much of this work Anne Krueger has tried to identify the factors behind a rapidly growing economy, at the same time as trying to explain why some nations grow slowly over long periods of time.

Competition among economists is presently generating an abundant supply of books and articles which display a high level of professional quality. We are free to choose but must select from too large a heap of reading material. A rational choice is quite time-consuming. One way out is to concentrate on authors who have given us rich food for thought in the past. High up on my own reading list is Anne Krueger. I owe her a great intellectual debt and hence a contribution to the Festschrift in her honour. Moreover, I learned a great deal from her in private discussions when she visited Kiel before and after her successful service in the World Bank. Even a phone call from her is a memorable event.

One of the landmarks of Anne Krueger’s tenure at the World Bank was the initiation of five large-scale comparative studies of various issues in development. Deepak Lal co-directed the study of the political economy of poverty, equity and growth. This unsurprisingly found that the proximate causes of growth and of differences in growth performance were differences in the rate and efficiency of investment. The synthesis volume (Lal-Myint, 1996) was largely concerned with explaining the latter. The purpose of the present contribution in honour of Anne is to try and provide some explanations for the differences in investment and hence savings rates. We do this by developing a very simple framework for charting the virtuous circle between growth and savings in India — in particular, the effects of growth on the shifts of households from low to higher savings income brackets, thereby raising aggregate savings, which in turn feeds back into higher growth.

Because the United States is the world’s traditional leader in promoting globalization, US international economic policies have important implications for other countries as well as for US citizens. Consequently, an understanding of the political, economic and social forces shaping congressional voting behaviour on trade and foreign assistance bills is important for both public- and private-sector leaders in the United States and other countries. The change in the voting behaviour of the US Congress (specifically, the House of Representatives) between the early and late 1990s from supporting trade-liberalizing measures such as NAFTA and the GATT Uruguay Round, to rejecting efforts to renew fast-track authority for the president and approving import quotas for the steel industry, makes an analysis of congressional voting patterns especially relevant as we approach the next century.

Anne Krueger is best known around the world for her contributions to international economics — including economic development. But much of her work transcends these fields. Nowhere is this more evident than in her highly influential article published more than a quarter of a century ago: ‘The Political Economy of the Rent-Seeking Society’ (Krueger, 1974). This insightful contribution integrated elements of the economic theory of bureaucracy with the systematic study of economic policy making. This theory, in the hands of Professor Krueger and later writers, reveals how efforts of entrepreneurs, traders and managers to gain favourable treatment from government diverts energies and resources from productive activities, thereby curbing economic growth and also skewing the rewards from economic activity.

Since the mid-1990s, the US foreign economic assistance program has enjoyed a period of benign neglect. This is in sharp contrast to the late 1980s and early 1990s when the US Agency for International Development was the subject of vigorous criticism from both the right and the left. Reform proposals included the extensive reorganization or even the elimination of the agency. Changes in both the domestic and international political environment suggest that the US economic assistance program as it has been conceived and managed since the early 1950s is no longer viable. Some critics view this as a cause for celebration. But I come to this conclusion reluctantly.