Economic Liberalization

ECONOMIC LIBERALIZATION refers to the removal of both price and nonprice barriers to the functioning of markets in the economy. In a liberalized economy, decisions are made in and by the markets, as dictated by free market forces, that is, supply and demand conditions. The idea behind support of economic liberalization is that in an economy where all the markets (output, input, financial, and external) are liberalized, prices set by supply and demand reflect the true resource and opportunity costs of factors of production and allocate resources in the most efficient way, providing the most effective and efficient solution to the problem of scarcity.

The emphasis on free-market reforms in industrial and developing countries over the last few decades is a response to the protected and regulated markets of the 1960s and 1970s that resulted from Keynesian macroeconomic policies in industrial and import-substitu-tion-industrialization (ISI) policies in some developing countries. The two oil shocks in the 1970s and the world debt crisis in the mid-1980s aggravated the ills of the world economy, raising questions about the wisdom of regulation and protection. Economic liberalization and deregulation, it was argued, would reallocate resources more efficiently, contributing to increases in competition, productivity, and growth.

Economic liberalization became part of the official development strategy of international economic organizations: the International Monetary Fund (IMF), World Bank (WB), World Trade Organization (WTO), and Organization of Economic Cooperation and Development (OECD). Especially in developing countries—plagued with market rigidities and financial bottlenecks in markets—economic liberalization, coupled with the appropriate macroeconomic stabilization policies, is [Page 292]typically seen as the only way to access the world financial markets and secure development loans. Economic liberalization, it is argued, reduces overall market risk and uncertainty by allowing market forces to interact freely, and secures allocative efficiency.

Distributive issues, that is, which groups benefit from the process of resource reallocation and growth, are not a concern since in theory everybody becomes better off in the long run. The IMF has an extensive list of documents supporting economic liberalization. In the short run, however, the economy goes through an adjustment period. Within this period, some industries shrink, some expand. The shrinking industries lay off labor and the expanding industries hire new labor. If the expanding industries fail to absorb the unemployed labor, overall unemployment rises.

In developing countries, the lack of social safety nets and economic institutions that would otherwise support the unemployed deepens poverty. In addition, economic liberalization has historically targeted labor market institutions and dismantled them (as reflected by the all-time-low unionization rates), weakened job safety, and reduced wages and benefits as increased global competition threatened corporate profitability. The advocates of economic liberalization, however, see these adverse developments as temporary phenomena and refer to them as short-run adjustment costs. Once the adjustment to free markets is completed, the argument is that the rising economic tide will lift all boats and eventually eradicate unemployment and poverty.

Trade and capital-market liberalization have been the two most controversial aspects of overall economic liberalization in terms of their effects on poverty. Trade liberalization is assumed to reallocate resources into areas where the economy has a comparative advantage, and therefore to stimulate specialization in the production of exportable goods and services.

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