OPEN ECONOMY



An open economy is the opposite of a managed economy. It is one that is characteristically market-oriented, with free market policies rather than government-imposed price controls. In an open economy industries tend to be privately owned rather than owned by the government. In the area of international trade an open economy is one whose policies promote free trade over protectionism.

On the other hand, a managed or closed economy is characterized by protective tariffs, state-run or nationalized industries, extensive government regulations and price controls, and similar policies indicative of a government-controlled economy. In a managed economy the government typically intervenes to influence the production of goods and services. In an open economy, market forces are allowed to determine production levels.

A completely open economy exists only in theory. For example, no country in the world allows unlimited free access to its markets. Most nations have fiscal and monetary policies that attempt to improve their economies. Many economies that are open in some respects may still have government owned, monopolistic industries. A country is considered to have an open economy, however, if its policies allow market forces to determine such matters as production and pricing.

Chile and Argentina are examples of two countries that have moved or are moving from a managed economy to an open economy. Chile has led the way for South America and Central American countries in adopting open economy and free market policies that have led to greater prosperity. As a result of its open economy, Chile became the fastest-growing economy in Latin America from 1983 to 1993.

Among the steps Chile took to make its economy more open was a reduction of its protective tariffs to a uniform 11 percent, which was one of the lowest rates in the world. Such a reduction in tariffs forced its domestic producers to become more competitive in the international market. As a result Chile improved its balance of payments to the point of enjoying a surplus of $90 million in 1991, compared to a deficit of $820 million in 1990. The country became less dependent on its copper exports as the economy diversified under new policies. Chile also improved its international trade by negotiating a series of bilateral trade agreements.

In Argentina similar measures were taken to promote an open economy, including more favorable treatment of foreign investors. An open economy provides the same treatment to foreign investors as it gives to its own investors. Price controls were eliminated for most products, and several governmentowned industries were privatized. As a result, Argentina's gross domestic product increased by 18 percent between 1991 and 1995. By 1997, however, a widening gap between the country's richest and poorest inhabitants caused widespread social unrest.

The transition from a managed economy to an open economy can be a difficult one. Following the collapse of the Soviet Union, efforts to establish free trade and an open economy in Russia resulted in widespread hardship among the nation's middle class and a failed bank system. In Southeast Asia a fullscale financial, economic, and social crisis erupted in 1998, revealing how difficult it was to maintain a small open economy in countries such as Thailand, Indonesia, Malaysia, the Philippines, and Singapore. In South Korea, the nation's president asked its citizens to accept widespread unemployment and bankruptcies in order to move the country toward an open economy by selling off government-owned industries. Germany's transition to an open economy resulted in high levels of unemployment throughout the nation.

Social, political, and economic instability can be avoided in countries moving toward open economies, but domestic conditions must be favorable. For example, states with powerful bureaucracies can establish favorable domestic economic conditions if they have the proper ideology, accept diversity, and achieve legitimacy in the eyes of their citizens. For open economies to succeed in small countries that formerly had managed economies, favorable domestic conditions include a working education system, legal system, judicial system, and low inflation. Such conditions provide the stability necessary for an open economy to flourish.

While the United States supports free trade and an open economic policy, it has never been a completely open economy. The imposition of tariffs and duties has always been a source of revenue for the U.S. government, as it has been for other governments of the world. The conflict between an open economic policy and the need to protect domestic industries from unfair international competition, was illustrated during 1998 as low-priced steel imports into the United States from Japan tripled. President Clinton was forced to warn other nations that they must#x0022; play by the rules#x0022;—rules that covered dumping and other trade practices—or the United States would press other nations to restrict their exports to the United States.

Economists recognize an open economy as being more efficient than a managed economy. In the 18th century, economist Adam Smith (1723 1790) wrote Inquiry into the Nature and Causes of the Wealth of Nations to explain the benefits of an open economy and free trade. He wrote that interventions in international trade, such as tariffs and duties, serve only to reduce the overall wealth of all nations. Similarly, interventions in the domestic economy are also regarded as inefficient. Smith developed the concept of "the invisible hand," which in effect stated that when individual enterprises work to maximize their own profits and well-being, then the economy as a whole also operates more efficiently. He argued that the economy does not require government intervention, because the operations of domestic producers are guided, as if by an invisible hand, to benefit the economy as a whole.

SEE ALSO : Argentina, Doing Business in ; Closed Economy

[ David P. Bianco ]

FURTHER READING:

Koenig, Robert. "German Jobless Struggle On." Journal of Commerce, 20 January 1998, 5A.

Landers, Jim. "U.S. Official Urges Japan to Open Economy to Imports." Knight-Ridder/Tribune News Service, 3 November 1998.

Orr, Deborah. "Can South Korea Save Itself?" Institutional Investor, July 1998, 125.

Parker, Stephen. "Out of the Ashes?" Brookings Review, summer 1998, 10-13.

Sanger, David E. "Clinton Warns U.S. Will Fight Cheap Imports." New York Times, 11 November 1998, 1.

Yergin, Daniel. "Don't Write Off Russia—Yet." Fortune, 28 September 1998, 99-102.

Zonis, Marvin. "What's the World Coming To?" Chief Executive, September 1997, 60-61.



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