Policy, Plnning, and Resarch WORKING PAPERS Trade Policy Country Economics Department The World Bank November 1988 WPS 122 Import Demandin Developing Countries RiccardoFaini, Lant Pritchett, and Fernando Clavijo As a less restrictive trade regime is associated with greater re- sponsivenessto economicincentives,econometric evidence that does not allow for the impact of import controls cannot be used reliably to assess the effect of a devaluation on the trade balance. The PohLcy PlanImn&ad Reseach Canplex distributes PPR Wo* ug Papes to disseminatethe findings of wrk tn progess and to encomage the exchange of ideu among Bank stff and al others inteested in development issue Thesc papers cairy the nam of the authos, reflec only their views, and should be used and cited sccordingly. he findings. intrpetutiats, and ecclusions ae the authoos own. T'hey should not be attrnbuted to the World Bank, its Board ofDirectos, manageonent,orany of its meanbercntruies.
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Policy, Plnning, and Resarch
WORKING PAPERS
Trade Policy
Country Economics DepartmentThe World BankNovember 1988
WPS 122
Import Demand inDeveloping Countries
Riccardo Faini,Lant Pritchett,
andFernando Clavijo
As a less restrictive trade regime is associated with greater re-sponsiveness to economic incentives, econometric evidence thatdoes not allow for the impact of import controls cannot be usedreliably to assess the effect of a devaluation on the trade balance.
The PohLcy PlanImn& ad Reseach Canplex distributes PPR Wo* ug Papes to disseminate the findings of wrk tn progess and toencomage the exchange of ideu among Bank stff and al others inteested in development issue Thesc papers cairy the nam ofthe authos, reflec only their views, and should be used and cited sccordingly. he findings. intrpetutiats, and ecclusions ae theauthoos own. T'hey should not be attrnbuted to the World Bank, its Board ofDirectos, manageonent, orany of its meanbercntruies.
Polac,Pnning, and Romrwh
Trade Policy
"Measured income elasticities in developing Option 1: Trade import equations work wellcountries are generaUy higher than I -- and rela- when import controls are relatively stable overtive prices, although mostly inelastic, signifi- time, but it is difficult to determine if this is thecantly affect demand for imports. When a lack case. Without a priori information, and short ofof foreign exchange or, more generally, a restric- using aU misspecification tests, ont: couldtive trade regime effectively constrains import perhaps rely on a comparison between estimatedflows, the measured impact of price and activity elasticity and the "norm" computed in this study.variables becomes less pronounced. To recover If the difference between the two values isstructural elasticities in such a case, one can deemed too high, consider.develop a direct modeling of quantitative Option 2: This takes into account the impactrestrictions (which is arduous) or use the experi- of foreign exchange availability. If it seemsence of a structurally similar country (which is clear that the country has foreign exchangequicker). In gencrai, a less restrictive trade constraints, the traditional specifications shouldregime is associated with greater responsiveness be bypassed, but incorporating this constraintto economic incentives. into the import demand equation is difficult for
several reasons. At a minimum, the authors rec-Econometric evidence that does not allow ommend using the broadest possible instrument
for the impact of import controls cannot be used list, including indicators of world demand,reliably to assess the effect of a devaluation on competitors' prices in export markets, ex-the trade balance. Indeed, devaluation combined ogenous capital flows, and international re-with trade liberalizadon (a common feature of serves.many adjustment programs) will have a more Option 3: The direct incorporation of quan-pronounced effect on import demand than titative restrictions is the main method of recov-available evidence would suggest. ering structural (notdonal) demand parameters
and assessing, for example, the impact ofThe authors compare three approaches to removing import restrictions. Unfortunately, a
modeling and estimating import demand--which good indicator of quantitative restrictions is notis arduous when trade controls are pervasive: usually available and, even if it exists, interpret-
ing its behavior may be difficult.
This paper is a product of theTrade Policy Division, Country Economics Department.Copies are available free from the World Bank, 1818 H Street NW, Washington DC20433. Please contact Karla Cabana, room N8-065, extension 61539.
The PPR Working Paper Series disseminates the findings of work under way in the Bank's Policy, Planning, and ResearchComplex. An objective of the series is to get these fmdings out quickly, even if presentations are less than fully polished.The findings, interpretations, and conclusions in these papers do not necessarily represent official policy of the Bank.
Produced at the PPR Dissemination Center
Import Demand in Developing Countries
byRiccardo Faini, Land Pritchett, and
Fernando Clavijo
Table of Contents
Introduction ...................................... 11. The Traditional Approach ....................... 32. Cross-Country Patterns ......................... 83. The Impact of Foreign Exchange Availability .... 104. Modeling Non-Tariff Barriers Directly .......... 175. Conclusions .................................... 20Appendix .......................................... 22References ........................................ 27Footnotes ......................................... 29
* Thls paper sumLres oUgong work at the Trade Policy Dilvision onimport behavior In developing countries. hlUe providing new evidence,the paper draw on two main sourcesg Prltchett (1987) and Bertola andFaini (1987). We are very grateful to Bela Saiassa, Mario Blejer, EngoGrilli, Jaime de Kelo, Viod Thomas, and JiS Tybout for their veryvaluable camonts. Abdel Senhadii-Semlall provided skilled researchaslstance at various stages and Karla Cabana skillfully typed themanuscript.
Introduction
Understanding how import flows react to changing economic
conditions is essential to the design of a successful structural adjustment
program. There is widespread agreement that imports generally react more
swiftly than exports to substantive trade liberalization, resulting in
short-run current account imbalances and a need for temporary financing.
This is, incidentally, one of the main justifications used by international
organizations for supplementing structural adjustment packages with
external loans. Being able to predict import flows more accurately can
help policymakers assess more confidently the overall sustainability of an
adjustment program, determine the appropriate speed of the trade
liberalization process, and avoid the possibility of unexpected foreign
exchange constraints jeopardizing the adjustment effort.
Unfortunately, several factors make predicting import flows in
developing countries difficult. In particular, quantitative restrictions
can be singled out because they drive a wedge between actual and desired
imports, makin- the estimation of notional, i.e. unconstrained,l demand
parameters problematic. Other complications include the pervasive presence
of high and variable tariffs, which make observed border prices an
unreliable indicator of import costs. Similarly, developing countries
marked dependence on foreign capital goods makes aggregate estimation
sometimes misleading (Khan 1975; de Helo and Vogt 1986 because the marginal
propensity to import is highly dependent on the composition of income.
These issues have been addressed to some extent in the empirical literature
on trade focusing on developing countries. Also, the modeling of the
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impact of quantitative restrictions has been given considerable attention.
Khan (1974), by positing that import restrictions vary over time in a
serially correlated way, models their effect by assuming an autoregresFive
process in the error term. Others CDutta 1964, Turnovsky 1968 and more
recently, Chu et al. 1983, Pritchett 1988 and Moran 1988] have used
indicators of foreign exchange availability as a proxy for the government's
inclination to impose import controls. An important shortcoming of this
approach is that, with some noticeable exceptions (e.g. Chu et al. 1983),
it does not allow for the recovery of the structural demand parameters.
This paper presents new and relatively comprehensive evidence
about import behavior in developing countries, updatin; and generalizing
the evidence presented in Khan (1974). We focus on the impact of import
controls and, because of data limitations, overlook the effect of tariffs
and the aggregation problem (although in section 4 the issue is touched
upon). Even in this more restricted framework, two tasks appear
particularly worth pursuing: (1) the identification of *stable, parameters
in the description of import behavior and (2) an analysis of the structural
and policy determinants of the parameters themselves.
In pursuing these objectives, we have relied on three different
but complementary approaches. First, traditional import demand functions
relating import flows to relative price and domestic output were estimated
for a set of 50 countries. The resulting parameters were then retained for
a subsequent cross-country comparison of the pattern of income and price
elasticities. This approach allows us to move closer to establishing a
"standard' elasticity for countries with similar characteristics. The
second approach relied on incorporating the foreign exchange constraint
directly in the import demand equation. This approach was applied to
- 3 -
countries for which a statistically satisfactory import demand equation
could not be identified using the first approach. Finally, the third line
of attack relied on d'rect measures of import controls. The value of the
structural impor't parameters was recovered from a behavioral equation
relating the share of imports not subject to controls to price, output, and
rationing measures (the latter to allow for any spillover effect). Given
the large amount of data required to construct an adequate indicator of
quar.itative restrictions, the equation was estimated for only one country.
The first four sections of this paper discuss the three approaches
outlined above in more detail. A finding that recurs throughout these
sections is that import restrictions in general significantly diminish the
responsiveness of import demand to price and income incentives. The last
section offers some conclusions.
1. The Traditional ALproach
A traditional import demand function relating real imports (M) to
real income (Y) and the ratio of import prices (Pm) to domestic prices (PD)
Note: Y : income (GDP)Pm: import pricePD: domestic goods price (GDP deflator)Px: export priceR : foreign exchange reservesM : imports* t constrained coefficient (based on the homogeneity test)
+ : null hypothesis rejected at 3 percent significance level
++: null hypothesis rejected at 1 percent significance level
- 27 -
RNhPuCBS
Bahmani-Oskooee, M., 1986. "Determinants of International Trade Flows:The Case of Developing Countries." Journal of DevelopmentEconomics.
Bertola G. and R. Faini, 1987. *Import Demand and Non-Tariff Barriers AnApplication to Morocco." EPDCO Working Paper No. 1987-2.
Chenery H. and H. Syrquin, 1975. Patterns of Development, United Kingdom:Oxford University Press.
Chu K., E.C. Hwa, and K. Krishnamurty, 1983. "Export Instability andAdjustments of Imports, Capital Flows, and External Reserves: AShort-run Dynamic Model," in Exchange Rate and Trade Instability:Causes, Consequences, and Remedies, edited by D. Bigman and T.Taya.
Clavijo F. and R. Faini R, 1988. "A Note on Cyclical and Secular IncomeElasticities of import demand for LDC's," in process.
Clavijo F., R. Faini, L. Pritchett and A. Senhadji-Senlali, 1988. "CriticalParameters in the Trade Adjustment Process." The World Bank,Trade Policy Division, Washington, D.C., February.
Dutta, M., 1964. "A Prototype Model of India's Foreign Sector,"International Economic Review, 5:82-103.
Geraci, V. J. and W. Prewo, 1980. "An Empirical Demand and Supply Model ofMultilateral Trade." (University of Texas).
Goldstein, M. and M. Khan, 1985. "Income and Price Effects in ForeignTrade,' ch. 20 in Handbook of International Economics, edited byElsevier Science Pub.
Goldstein, H., M. Khan and L. Officer, 1980. "Price of Tradable and Non-Tradable Goods in the Demand for Total Imports." Review ofEconomics and Statistics, 62:190-199.
Grossman, G., 1982. "Import Competition From Developed and DevelopingCountries." Review of Economics and Statistics, 64.
Hemphill, W.L., 1974. "The Effect of Foreign Exchange Receipts on Importsof Less Developed Countries." IMF Staff Papers, No. 21.
Khan, H., 1974. "Import and Export Demand in Developing Countries." IMFStaff Papers, No. 21: 678-92.
Khan, M., 1975. "The Structure and Behavior of Imports of Venezuela."Review of Economics and Statistics, 57:221-224.
- 28 -
Khan, M. and K. Ross, 1975. *Cyclical and Secular Income Elasticities ofthe Demand for Imports.' Review of Economics and Statistics, 57:357-361.
Kiviet, Jan F., 1985. *Model Selection Test Procedures in a SingleEquation of a Dynamic Simultaneous System and The'Ir Defects inSmall Samples.' Journal of Econometrics, 28: 327-62.
Kiviet, Jan F., 1986. 'On the Rigour of Some Misspecification Tests forModelling Dynamic Relationships.' Review of Economic Studies.
McCarthy, D., L. Taylor and C. Talati, 1985. *Trade Patterns in DevelopingCountries, 1964-1982.' World Bank Staff Working Paper No. 642,revised version.
Melo, 0. and G. Vogt, 1986. 'Determinants of the Demand for Imports ofVenezuela.' Journal of Development Economics, 14:351-358.
Moran, C., 1986. 'Manufactured Exports for Developing Countries: AnEmpirical Analysis." EPDGL Division Working Paper No. 1986-8.World Bank, Washington, D.C.
Moran, C., 1988. *Imports Under a Foreign Exchange Constraint.' The WorldBank, PPR Working Paper No. 1, Washington, D.C.
Neary, P. and Roberts, 1980. 'The Theory of Household Behavior UnderRationing.' European Economic Review, 25-42.
Orcutt, G., 1950. 'Measurement of Price Elasticities in InternationalTrade.' Review of Economics and Statistics, pp. 117-121.
Pritchett, L., 1987. 'Import Demand Elasticities: Estimates andDeterminants.' The World Bank, EPDCO, Working Paper 1987-4,Washington, D.C.
Pritchett, L. (1988) Empirical Essays on International Trade, Ph.Ddissertation, ch. 2, MIT, Cambridge.
Sargan, J., 1964. 'Wages and Prices in the U.K." in Econometric Analysisfor National Economic Planning, edited by P. Harts et al., London:Butterworth.
Turnovsky, S., 1968. 'International Trading Relationships for a SmallCountry: The Case of New Zealand.' Canadian Journal ofEconomics, 1:772-790.
Winters, A., 1985. 'Imports of Developing Countries, An Empirical Model ofInternational Allocation and Financial Constraints.' World BankStaff Working Paper No. 740, Washington, DC.
- 29 -
FOOTNOTES
1/ It is well known (Neary and Roberts, 1980) that the priceresponsiveness of consumer demand will vary if some commodities happento be rationed. Accordingly, it is useful to distinguish betweennotional price responsiveness, i.e., the consumer response to pricechange when no commodity if subject to ration and constrained priceresponsiveness.
2/ Libya, Nigeria, Algeria, Egypt, Ecuador, Venezuela, and Mexico allfailed both tests (sub-sample and post-sample) of stability. Amongoil exporters only Indonesia and Gabon were included.
3/ This study capriciously excludes a negative estimate for Israel.
4/ In the summary table of Goldstein and Rhan wrong signed results areexcluded, pushing the 'average' elasticity bias upward. They are notexcluded in the present paper. Excluding the four positive pointestimates would raise the average estimated price elasticity to .771.
5/ One of nine estimates was positive.
6/ Table 4.1 in Goldstein and Khan (1985) summarizes the long-run priceelasticities reported in thea studies.
Žlo. of No. ofAuthor Date Countries Positive (Average of Negative)
7/ The lower price elasticity estimates could be explained by thesectoral composition of developing country imports. Fuels (SITC 3)and food (SITC 0 and 1), which are a larger component of developingcountry than of developed country imports, have on average much lowerprice elasticities than manufactures (SITC 5-9).
8/ Khan does test for auto-correlation and finds significant first-orderauto-correlation in 6 of 15 (40 percent) regressions. This finding issimilar to this paper's rejection of 43 percent (22 of 50), the importfunctions estimated.
9/ Including Turkey's estimate of 2.29 raises the average to 1.07.
10/ The double-log functional form used to estimate the elasticitiesimposes constant elasticity. Therefore, assuming after estimationthat the elasticities vary across countries because of factorsrelated to income violates the original maintained hypothesis.However, the cross-country variation in real per capita income far
Continued on next page
- 30 -
Continued from previous pageexceeds the within country variation. A step-function relation couldbe postulated that would allow constant elasticities within countriesbut a pattern across countries. A functional form that did notimpose constant elasticities was also estimated but precisely thesame pattern was detected using these estimates.
11/ The double-log functional form used to estimate the elasticitiesimposes constant elasticity. Therefore, assuming after estimationthat the elasticities vary across countries in a way related toincome violates the original maintained hypothesis. However, thecross-country variation in real per capita income far exceeds thewithin-country variation. A step function relation could bepostulated that would allow constant elasticities within countriesbut a pattern across countries. Secondly, a functional form that didnot impose constant elasticities was estimated and precisely the samepattern was detected using these estimates.
12/ These GLS results weighing each price elasticity observation by itsestimated standard error to account for the differences in precisionof estimation across countries. The OLS are, reassuringly similar.
13/ McCarthy, et al. (1985) provide some evidence on the relationshipbetween sectoral composition of imports and per capita income, butthey estimate only a linear term.
14/ There are, of course, other justification to the inclusion of foreignexchange availability indicators in an import demand equation. Itcould be argued, for instance, that reserve levels and foreignexchange receipts act as a proxy for present and future wealth, whichin turn is likely to affect import demand. Alternatively, the factthat we observe the border and not the domestic price of imports may,under some conditions, lead to the inclusion of foreign exchangeindicators in the import demand equation.
15/ This can be easily seen if we consider that when we only observe PWm
and not Pm. the error term in the equation will include an expression
in Pm - pw which is obviously correlated with all the exogenous
variables. This effect, first noticed in Clavijo et al. (1988), is
also mentioned in Moran (1980).
161 Lack of sufficiently long series for the full set of foreign exchangeindicators forced us to consider only a subset of 12 out of theinitial 20 countries.
17/ The latter, under the null hypothesis of no correlation betweenerrors and instruments, is distributed as X2(n) with n equal to thedifference between the number of instruments and of right-hand sidevariables.
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18/ We use the term lexogenous' a bit loosely here. By exogenous we onlymean to imply that the right-hand-side variables are not correlatedwith the error term. Notice that we assume throughout that this isindeed the case for R(t-1).
19/ There is no way to rigorously justify this assumption. We can onlyargue that if import regimes are made more stringent by shiftingcommodities into the restricted list, there will be a strong andpositive correlation between the import coverage ratio of NTB and thenon-tariff barriers ratio of the marginal propensity to importrationed goods to the overall marginal propensity to import. Indeedboth indicators will increase when commodities are shifted into therestricted list.
20/ It would also be essential to inquire from national sources howimport prices are computed. In general, import prices are based onborder prices and therefore are an inadequate measure of true importcosts to domestic agents.
21/ An increase in the coverage ratio of non-tariff barriers may indeedindicate that controls are more stringent (more goods are subject toquantitative restrictions) or that they have become more lenient(more restricted goods are allowed into the country). Although forMorocco the quantitative restriction indicator was clear, it iscertainly not so in every developing country.
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