Fiscal faux pas? An empirical analysis of the revenue and expenditure implications of trade liberalization

Trade liberalization tends to be an intrinsic part of structural adjustment programs due to its presumed beneficial effects on growth. Paradoxically however, trade reform policies can have fiscal effects that hinder growth and development. This dissertation takes a critical look at the effect of trade liberalization on public finances across countries. It demonstrates how trade liberalization leads to declining tax revenues in developing countries. This occurs because the structural characteristics of developing economies limit their ability to make the transition from trade to domestic taxes. Moreover, devaluation of the currency, an integral part of the reform process, increases the burden of debt-servicing. The fiscal squeeze, consequent upon declining tax revenues and rising interest payments, adversely affects productive expenditures on physical and social infrastructure. Using panel data for eighty developing and industrialized countries over 1970–98, a fixed-effects regression framework is employed to examine the evidence. The results indicate that trade liberalization has led to a fiscal squeeze in low-income countries with unfavorable consequences for infrastructure expenditures. The cross-country analysis is supplemented by case-studies of three low-income economies; India, Ghana, and Malawi. The aim is to analyze why India and Malawi have suffered deleterious fiscal effects, while Ghana has not, even though the three economies have similar structural characteristics. In particular, does Ghana provide a set of “best-practices” to be adhered to and pitfalls to be avoided to ensure fiscal sustainability