The impact of direct trade controls and an overvalued exchange rate on factor proportions in manufacturing

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Abstract
This paper is an analysis of certain aspects of manufacturing development under a regime of import and foreign exchange controls, where such controls are accompanied by an overvalued exchange rate. The analytical framework is a modification of the ‘effective rate of protection’ analysis. The argument proceeds from the fact that the overvalued rate represents a subsidy on imported capital equipment and intermediate goods. Two implications are drawn from the analysis. First and most important, the subsidy on imported intermediate goods will exacerbate the oft‐noted tendency of import‐substitute industry to take the form of ‘processing and packaging’ operations with minimal domestic value added. Second, the subsidy on imported capital equipment will give entrepreneurs an incentive to substitute imported capital equipment for domestic labour.

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