By raising the cost of pursuing bad economic policy, openness to world markets helps ensure that good policies will be recognized and will be pursued. Openness to world markets gives wealth, firms, and workers an exit option. If both policy makers and economic actors know that adverse policy shifts can lead to a flow out of the country of economic resources and activity, policy makers will have a stronger incentive to avoid such policies. Moreover, economic actors have an additional reason to believe that such adverse shifts will not occur. Thus openness to world markets enhances the credibility of sound economic policies.
Openness to world markets can also enhance the credibility of economic policy by providing an external standard for evaluation. For example, industrial policy designed to foster the development of a particular industry can be measured by the export performance of the industry in world markets. Without such a clear external standard, it is much more difficult to recognize when an economic policy has failed. Similarly, openness to world capital markets can make more apparent implicit government subsidies flowing through the capital market. The international standards that come with openness make policy more credible by making it harder for the government to misrepresent the effects of policies.
Policy Credibility Learning Module