The Adjustment Process and the Timing of Trade Liberalization

This paper examines the appropriate time path of the tariff rate for a small open economy that has decided to move from protection of import competing industries to free trade. Adjustment costs for moving resources to alternative uses do not provide a rationale for gradual adjustment of the tariff rate because in the absence of distortions, rational optimizing agents will make socially appropriate investment decisions with respect to adjustment when they are qiven correct price signals. Some distortions of the adjustment process imply the desirability of gradual adjustment of the tariff rate to slow adjustment, but other distortions imply the desirability of subsidizing imports in the short run in order to speed movement of resources out of previously protected industries. Concern with the income redistribution effects of reductions in the tariff rate(which usually injure owners of factors in previously protected industries) does provide a general rationale for a gradual move to free trade. The influence of the unemployment consequences of tariff reduction on the appropriate path of commercial policy depends on the nature and shape of the respone of the rate of resource reallocation to the level of unemployment in previously protected industries.