2003 U 842 The Political Economy of Trade Liberalization in Developing Countries: The Sri Lankan Case een wetenschappelijke proeve op het gebied van de Managementwetenschappen Proefschrift ter verkrijging van de graad van doctor aan de Katholieke Universiteit Nijmegen op gezag van de Rector Magnificus prof. dr. C. W. P. M. Blom volgens besluit van het College van Decanen in het openbaar te verdedigen op maandag 10 februari 2003 des namiddags om 3.30 uur precies door Murugesu Ganeshamoorthy geboren op 8 juli 1964 te Maho, Sri Lanka
CONTENTS vii Page Acknowledgement Contents List of Tables List of Figures List of Boxes Acronyms and Abbreviations v vii xii xiii xiii xiv PART ONE: INTRODUCTION 1 Chapter 1: The Political Economy of Trade Liberalization: An Introduction 3 1.1 Introduction 3 1.2 Trade Liberalization: Meaning and Definitions 3 1.3 The Objectives of Trade Liberalization 8 1.4 The Context of Trade Policies of Developing Countries 9 1.5 Objective of the Study 12 1.6 Contribution of the Thesis to Literature 14 1.7 Methodology 15 1.8 The Structure of the Thesis 17 PART TWO: THEORY AND POLICY 21 Chapter 2: Trade Liberalization: Theory and Policy 23 2.1 Introduction 23 2.2 A Theoretical Perspective on the Reasons for Trade 24 2.2.1 Comparative Advantage Trade Theories [CATTs] 25 2.2.2 Non-Comparative Advantage Trade Theories [NCATTs] 29 2.2.3 CATTs and NCATTs: A Comparison 31 I. Inter-industry and Intra-industry Trade 31 II. Imperfect Competition and Scale Economies 32 [a] Scale Economies 32 [b] Oligopoly 33 2.2.4 Reflections on CATTs versus NCATTs 34 2.3 The Gains from International Trade 35 2.3.1 Static and Dynamic Gains from Trade 35 I. Dynamic Gains from Inter-industry Exchange 36 II. Dynamic Gains Resulting from Intra-industry Trade 36 2.3.2 The Relationship between [Free] Trade and Growth 38
viii 2.4 Should International Trade be Free? Reasons for Policy Intervention 41 2.4.1 The Terms of Trade/ Optimal Tariff Argument 42 2.4.2 The Infant Industry Argument 43 2.4.3 The Increasing Returns Argument 45 2.4.4 Other Arguments against Free Trade 46 I. Wage Differential Argument 46 II. Macroeconomic Disequilibrium Argument 46 2.5 Restoring the Case for Free Trade? The Perspective of CATTs 47 2.6 No Free Trade After All? The Perspective of NCATTs 50 2.6.1 The Arguments 51 2.6.2 Criticisms 52 2.7 Is There a Case for Free Trade in Developing Countries? 54 I. Market Structure 56 II. Size of the Economy 57 III. Technological Character of Exports 58 IV. Gains from Trade Liberalization 59 2.8 Summary and Conclusions 60 Chapter 3: History, Practice and Methods of Trade Liberalization in Developing Countries 61 3.1 Introduction 61 3.2 The Evolution of Trade Policies of Developing Countries 62 3.2.1 The Historical Context of Economic Policy Evolution in Developing 63 Countries I. Ex-colonial Legacy 63 II. The Impact of the Great Depression 64 HI. Demonstration Effect of the Success of the Former Soviet 65 Union 3.2.2 Inward-Oriented Trade Policies 65 3.2.3 Weaknesses of Inward-Oriented Trade Policies 68 3.2.4 A Shift in Thinking: Switching to Outward-Oriented Policies 71 3.3 The Political Economy Reasons for Economic Policy Reforms 74 3.4 The Determinants of Trade Liberalization: 78 3.4.1 Internal Factors that Determine Economic Reforms: 82 I. Crisis Situations in the Economy 82 II. The Type of the Government: Authoritarian Regime or a Right Wing/Left Wing Government 84 HI. Regime Changes 85 IV. Timing and Sequencing 86 V. A Solid Political Base 87 VI. The Type of the Leadership: A Visionary Leader 87
3.4.2 External Factors that Determine Economic Reform: 89 I. Ideological Changes/ Demonstration Effects and Policy Advice 90 II. Influence of Multinational Financial Institutions [MFI] 91 3.4.3 Summing Up the Discussion 95 3.5 Summary and Conclusion 97 Chapter 4: Trade Liberalization and the Government Sector: A Survey 99 4.1 Introduction 99 4.2 Trade Liberalization and the Government Budget 101 4.2.1 The Link between International Trade and the Government Sector 102 4.2.2 The Effects of Trade Liberalization on the Government Budget 106 4.3 Direct Implications of Trade Liberalization on the Government Budget 108 4.3.1 Reform of Quantitative Restrictions 108 4.3.2 Tariff Reforms 111 I. Reduction in Tariff Levels 112 II. Reduction in Tariff Dispersion 115 HI. Reduction in Tariff Exemptions and Tax Evasion 116 IV. Reduction in Export Taxes 117 4.4 Indirect and Interactive Effects of Trade Liberalization on the Government Budget 118 4.4.1 Changes in Import Composition and Economic Growth 118 4.4.2 The Role of Domes tic Indirect Taxes in Trade Liberalization 119 4.5 Should Revenue Concerns Really Matter? Some Empirical Evidence 122 4.6 Summary and Conclusion 125 PART THREE: EMPIRICAL ANALYSIS 127 Chapter 5: Trade Policies in Sri Lanka since Independence: An Investigation 129 5.1 Introduction 129 5.2 The Sri Lankan Setting 130 5.2.1 The Structure of the Economy at Independence 131 5.2.2 Welfare State 136 5.2.3 Trade Dependency 139 5.3 Sri Lanka's Trade Policy: Political Regime Changes and Policy Reforms 141 Continuation of the Pre-independence Open Economy under the UNP Regime [1948-1956] 143 5.4 Introduction of Inward-Oriented Development Policies: Closing up the Economy under the SLFP Regime [1956-1965] 146 5.6 A Partial Opening of the Economy under the UNP Regime [1965-1970] 151
5.6.1 Import Liberalization and Export Promotion 151 5.6.2 Impediments to Liberalization in the 1965-1970 period 154 5.7 The Era of Closed Economy: Import Substitution Strategy under the ULF [SLFP-led coalition] Regime [1970-1977] 156 5.7.1 Major Policy Changes 157 5.7.2 The Role of the State 157 5.8 The Main Drive of Trade Liberalization under the UNP Regime [1977-1994]: A Turning Point of Sri Lanka's Trade Policy 160 5.8.1 Trade Policy Reforms since 1977 164 5.8.2 Export Promotion 166 5.9 Open Economy with a Human Face under the [SLFP-led] Peoples Alliance [PA] Regime [1994-2001] 167 5.9.1 Trade Liberalization since 1994 168 5.10 Summary and Conclusion 171 Chapter 6: Trade Liberalization and the Government Sector: The Sri Lankan Case 173 6.1 Introduction 173 6.2 Sri Lanka's Fiscal Policy: An Overview 174 6.2.1 Salient Features of die Fiscal Sector [1948-1977] 175 6.2.2 Fiscal Policy Orientation in the Post 1977 Period 180 6.3 Custom Tariff Structure of Sri Lanka: Major Developments [1950-2000] 182 6.3.1 Tariff Changes During 1950-1977 182 6.3.2 Tariff Reforms Since 1977 184 6.4 Sri Lanka's Government Revenue: Structure and Changes 192 6.5 The Revenue Impact of Trade Liberalization: What does Sri Lanka's 195 Post-1977 Experience Reveal? 6.6 Summary and Conclusion 201 Chapter 7: The Political Economy of Trade Liberalization: The Sri Lankan Case 205 7.1 Introduction 205 7.2 Background to Economic Policy Making in Sri Lanka 206 7.3 Internal Influences on Economic Policy Making 208 7.3.1 A Crisis Situation 209 7.3.2 Ideological Change/Regime Change 214 7.3.3 A Solid Political Base 218 7.3.4 The Type of the Leadership 221 I. The Presidency of Junius Richard Jayawardane 222 n. The Presidency of Ranasinghe Premadasa 227 HI. The Presidency of Chandrika Kumaratunga 233
7.3.5 The Type of Government 237 I. Introduction of a New Constitution with a Presidential System 237 H. The General Strike in July 1980 240 III. Stripping the Civic Rights of the Opposition Leader 241 IV. Referendum of 1982 for the Extension of the Term of Parliament 242 7.3.6 Timing of Liberalization and Pressure-Group Activities 247 7.4 External Influences on Economic Policy-making 253 7.4.1 The Demonstration Effect/ Policy Advice From Abroad 253 7.4.2 The Role of the Multinational Financial Institutions [MFIs] in Policy Reforms: The IMF and The World Bank 255 7.5 Summary and Conclusion 267 PART FOUR: CONCLUSION 269 Chapter 8: Summary and Conclusion 271 8.1 Introduction 271 8.2 Reflections on Research Objectives and a Summary of the Thesis 271 8.3 General Findings of the Research 275 8.3.1 Internal Factors 276 8.3.2 External Factors 281 8.3.3 The Relative Importance of the Factors in Economic Liberalization 283 8.4 Some Methodological Reflections, Dirctions for Further Research 285 Bibliography 287 Appendix 311 Nederlandse samenvatting [Summary in Dutch] 333 Curriculum Vitae 337