Liberalizing Foreign Trade in a Socialist Economy: The Problem of Negative Value Added

Quite often, transition economies are characterized by centrally owned and planned industries, many of which would not be economically viable if they were privately operated. In a traditional Stalinist economy, the implicit structure of tariff equivalents "cascades" downward from very high levels for the domestic production of finished consumer goods through manufactured intermediate products through industrial raw materials and energy, whose production is negatively protected because of implicit export • taxes (or import subsidies). This highly cascaded structure of implicit tariffs raises effective protection in finished goods to the point where most manufacturing will exhibit negative value added at world markets prices. In such circumstances, a move to free trade would provoke the collapse of most domestic manufacturing industries -- no matter how the exchange rate is set, and no matter that some of these industries might eventually be viable at world market prices. A proposed reform is the simultaneous "tarification" of quantitative restrictions on competing imports and the elimination of implicit export taxes • on energy and material inputs as the economy moves quickly to a market-based system. Once made explicit, the highest tariffs in the cascade can then be phased down step-by-step to zero over a preannounced five to ten year time horizon. The newly marketized economy would then converge to free foreign trade at a more deliberate pace -- one that better adjusts to the problem of overcoming distortions from the preexisting system of protection.