© 1992 International Bank for Reconstruction and Development / The World Bank
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Uniform Commercial Policy, Illegal Trade, and the Real Exchange Rate: A Theoretical Analysis
Stephen A. O'Connell is with the Department of Economics at Swarthmore College, Swarthmore, Pa. This article is a revision of World Bank PPR Working Paper 185 (see O'Connell 1989). The author wishes to acknowledge his indebtedness to the Macroeconomic Adjustment and Growth Division of the Country Economics Department at the World Bank for its hospitality; to the Council on Foreign Relations for its financial support; and to Bill English, Ravi Kanbur, Saul Lizondo, Dani Rodrik, Oren Sussman, and an anonymous referee for their helpful comments.
Countries on fixed exchange rates sometimes use uniform tariff cum subsidy (UTCS) schemes as a way of achieving a real depreciation without disturbing the nominal exchange rate. A potential drawback of this policy in relation to an across-the-board devaluation is that a UTCS scheme provides incentives for illegal trade. Using an optimizing model with currency convertibility and illegal trade. I find that welfare is lower under a UTCS scheme than under a corresponding across-the-board devaluation and that in some cases the real exchange rate actually appreciates in response to an increase in the UTCS rate.