Uniform Commercial Policy, Illegal Trade, And The Real Exchange Rate: A Theoretical Analysis

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World Bank Economic Review


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.