Trade Liberalization and the Budget Deficit.

Abstract

The reluctance of many developing country governments to liberalize their trade regimes is partly due to fears that this will exacerbate their fiscal difficulties. This paper examines the relationship between trade liberalization and the budget deficit, relating some popular but incomplete approaches (such as analysis of the foreign exchange budget) to a more comprehensive approach using an applied general equilibrium model. The argument is illustrated using data from Kenya, as well as a number of stylized cases. The conclusions are that liberalization may be budget enhancing, in certain circumstances strongly so: however, the dynamic adjustment may be problematic. with the budget deteriorating in the short run, even when the reform program is fiscally benign in the longer run.