Economics
Liberalization in a single southern economy. Here, only southern nation 1 engages in unilateral import tariff liberalization, with all other barriers held constant. The solid line marked S1 in the right-hand panel of figure 3.14 shows the outcome, with the unilateral opening leading to industrialization. This is not always what happens, but it is certainly one possibility, and the one that actually occurs under the specific Puga-Venables setup. The point is that although extra import competition from the North has a negative effect on industrial location in the South (the product-market local competition effect), the cheaper supply of imported intermediate goods becomes the dominant force at some point, and industry becomes established in southern nation 1. This result is not general; for example, if southern nation 1 were very small and faced high export barriers, unilateral liberalization would not induce industrialization. But where this is not the case, the combination of low wages and low-cost intermediates (resulting from import liberalization) eventually leads to industrialization, as is shown in the right-hand panel. Unilateral liberalization by northern economies: The generalized system of preferences (GSP). Next, consider the case in which the North makes a gesture to the South by unilaterally removing tariffs on imports from the South. The outcome will be similar to that shown in the right-hand panel. The northern tariff cutting improves the prospects of locating industry in the South because it erodes the demand-linked causality that favors the North to begin with. However, since the South is not lowering its tariffs and much industry will remain in the North, the input-cost linkage continues to strongly favor a northern location. Moreover, as mentioned above, if the southern market is small enough, or the input-cost linkages are strong enough (or both), the North’s unilateral tariff cutting may have no effect on industrialization. In terms of figure 3.13, we could have a situation like A1 and D1 where, despite the shift in attractiveness toward the small region, the balance of forces still favors full agglomeration in the North. Given how little most GSP programs have done to promote southern industry, this is not a case worth keeping in mind. Liberalization by both southern economies. We now look at MFN liberalization by southern economies in tandem. All southern import tariffs are reduced in the same way, so only northern tariffs against southern exports remain. Initially, the outcome is like that of unilateral liberalization by a single southern nation. The lower southern tariffs heighten the anti-industrialization product-market competition from the North, but it encourages southern production by lowering the cost of inputs. If the southern markets are not too small and the importance of inputs is
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sufficiently high, industrialization will start in one southern nation. As before, the logic of cluster economics tells us that the process begins in only one southern nation but then shifts to the other. Preferential Liberalization If the two southern nations sign a PTA and lower tariffs between themselves, something like multilateral liberalization occurs. As long as the two markets are not too small, the liberalization will cause industry to become established in the South, but the mechanism is completely different: the driving force here is the effective market enlargement caused by reducing intra-South barriers. This is, of course, the classic argument made in the 1960s and 1970s for South-South PTAs. As in the multilateral case, the spread of industry to developing countries is uneven, initially taking place in one country and only spreading to the second when trade barriers are lower. Indeed, this sort of uneven development did occur in some early South-South PTAs. For example, in the East African Community, industry started to grow in Kenya at the expense of Uganda and Tanzania. The key difference is that the countries do not benefit from better access to northern markets or to North-produced intermediate inputs. The impact of a North-South PTA is particularly interesting. Here, the southern nation obtains better access to the big northern market and benefits from lower-cost inputs, but in each case only with respect to the partner. The liberalizing southern economy suffers from more competition from northern firms, but because its wages are lower, the balance of better reciprocal market access is in favor of the South. This spread of industry is associated with a large decline in the North’s share of industry. The loser is the other southern economy, which does not attract any industry and now has to contend with industrial clusters in both North and South. It is not difficult to see how a single North-South PTA such as the U.S.–Mexico agreement proposed in 1991 or the one between Japan and Malaysia could trigger a spate of requests from other southern nations. Liberalization of Parts and Components But not Final Goods A very common liberalization strategy among developing countries is to reduce tariffs unilaterally on inputs but not, or to a lesser degree, on final goods. This evokes the old measures of the effective rate of protection, whereby the actual protection provided by a nominal tariff of, say,