The effects of protection on the growth rate and on the need for external assistance

Abstract

Host studies of protection in developing countries are concerned with questions of static losses of real output or inefficient resource allocation at some point of time. These studies are often criticised as not relevant to problems of development. This paper incorporates the effects of protection into the most widely used macro—economic projection model, the 'two—gap' model of Chenory and Strout, and examines some dynamic implications of protection. The adaptation of the two-gap model explicitly allows for two facts related to protection: 1) The apparent amount of import substitution or foreign exchange saving, overstates the actual, import saving if the new industry is protected. 2) The apparent amount of export growth or new foreign exchango earned, is understated whenever protection applies only to import substitutes. Thus, the presence of protection will cause the usual macroeconomic projection models to understate import demand whenever conventional definitions of value added are used, if there is emphasis on import substitution behind protection in the plan period. The adaptation to the model makes it qui+e clear why oountries pursuing industrialization by means of protection often run into balance of payments difficulties; The factor payments generated in import—substituting industries cxceed the value of foreign exchange saved in the industry - sometimes by substantial amounts. For countries like Kenya, Uganda and Tanzania with a high marginal propensity to import, and for industries &s highly protected as come of the largo establishments in East Africa, it is quite possible for an investment in import substitution to produce a deterioration, rather than an improvement, in the balance of payments. The paper also explores the implications of protection for the "requirements" of foreign assistance to sustain a given development programs The results show that, because protection to industries in fact results in less balance of payments improvement than it appears to, the need for foreign assistance will be greater (i.e. the balance of payments constraint is more severe) the greater is the reliance on protection to "encourage" growth.