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The Poor's Best Hope - Trading for Development

Author: Jagdish N. Bhagwati
June 22, 2002
The Economist

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The launch of a new round of multilateral trade negotiations (MTN) at Doha dealt a needed blow to the anti-globalisers who triumphed at Seattle just two years ago. But it was also important for a different reason. The word "development" now graces the name of the new round. This is unconventional, but it underlines the fact that development of the poor countries will be the round's central objective.

Pleasing rhetoric aside, however, we must ask: What does this mean? The question is not idle. For if the current thinking among policymakers and NGOs is any guide, the answer they would give is not the right one. And that is cause for alarm.

Of course, proponents of trade have always considered that trade is the policy and development the objective. The experience of the post-war years only proves them right. The objections advanced by a handful of dissenting economists, claiming that free-traders exaggerate the gains from trade or forget that good trade policy is best embedded within a package of reforms, are mostly setting up and knocking down straw men. But if trade is indeed good for the poor countries, what can be done to enhance its value for them? A great deal. But not until we confront and discard several misconceptions. Among them:

  • the world trading system is "unfair": the poor countries face protectionism that is more acute than their own;

  • the rich countries have wickedly held on to their trade barriers against poor countries, while using the Bretton Woods institutions to force down the poor countries' own trade barriers; and

  • it is hypocritical to ask poor countries to reduce their trade barriers when the rich countries have their own.

In fact, asymmetry of trade barriers goes the other way. Take industrial tariffs. As of today, rich-country tariffs average 3%; poor countries' tariffs average 13%. Nor do peaks in tariffs— concentrated in textiles and clothing, fisheries and footwear, and clearly directed at the poor countries— change the picture much: the United Nations Council for Trade, Aid and Development (UNCTAD) has estimated that they apply to only a third of poor-country exports. Moreover, the trade barriers of the poor countries against one another are more significant restraints on their own development than those imposed by the rich countries.

The situation is little different when it comes to the use of anti-dumping actions, the classic "fair trade" instrument that has ironically been used "unfairly" to undermine free trade. The "new" users, among them Argentina, Brazil, India, South Korea, South Africa and Mexico, are now filing more anti-dumping complaints than the rich countries (see chart 1 on next page). Between July and December 2001 alone, India carried out more anti-dumping investigations than anywhere else. The wicked rich?

These facts fly in the face of the populist myth that the rich countries, often acting through the conditionality imposed by the World Bank and the International Monetary Fund (IMF), have demolished the trade barriers of the poor countries while holding on to their own. Indeed, both the omnipotence of the Bretton Woods institutions, and the wickedness of the rich countries, have been grossly exaggerated.

The World Bank's conditionality is so extensive and diffused, and its need to lend so compelling, that it can in fact be bypassed. Many client states typically satisfy some conditions while ignoring others. Besides, countries go to the IMF when there is a stabilisation crisis. Since stabilisation requires that the excess of expenditures over income be brought into line, the IMF has often been reluctant to suggest tariff reductions. These could reduce revenues, exacerbating the crisis.

Then again, since countries are free to return to their bad ways once the crisis is past and the loans repaid, tariff reforms can be reversed. Countries do not "bind" their tariff reductions under the IMF programmes, as they do at the World Trade Organisation (WTO). Equally, tariff reductions may be reversed when a stabilisation crisis recurs and the tariffs are reimposed to increase revenues. My student Ravi Yatawara, who has studied what he calls "commercial policy switches", documents several instances of such tariff-reduction reversals by countries borrowing from the IMF. For instance, Uruguay in 1971 increased trade protection during an IMF programme that began the year before, and even managed to get another credit tranche the year after. Kenya's 1977 liberalisation was reversed in 1979, the year in which another arrangement was negotiated with the IMF.

Moreover, the comparatively higher trade barriers against labour-intensive products are not usually the result of wickedness, but of simple political economy. Unilateral reductions of trade barriers are in fact not uncommon, and I document them for many countries and several sectors in the post-war period in my new book, "Going Alone: The Case for Relaxed Reciprocity in Freeing Trade" (MIT Press, July). But the fact remains that the developing countries were exempted by the economic ideology of the time, which embraced "Special and Differential" treatment for them, from having to make trade concessions of their own at the successive multilateral trade negotiations that reduced trade barriers after the war. The rich countries, denied reciprocal concessions from the poor countries, wound up concentrating on liberalising trade in products of interest largely to themselves, such as machinery, chemicals and manufactures, rather than textiles and clothing.

The situation changed when the poor countries became full participants. In 1995 in Marrakesh, where the Uruguay round was concluded, action was taken at last to dismantle the infamous Multi-fibre Arrangement (MFA), which— from its birth in 1961 as the Short-term Cotton Textile Arrangement— had grown by 1974 into a Frankenstein monster incorporating several separate agreements restricting world trade in all textiles. At Marrakesh the MFA was put on the block, and was scheduled to end in ten years.

But even if rich-country protectionism were asymmetrically higher, it would be dangerous to argue that it is therefore hypocritical to suggest that poor countries should reduce their own trade barriers. Except in the few cases of oligopolistic competition, such as that between Fuji and Eastman Kodak (hardly applicable to poor countries) where strategic tit-for-tat is credible, the net effect of matching other people's protection with one's own is to hurt oneself twice over. But there is ample evidence that many leaders of the poor countries have predictably made the wrong inference: that rich-country protectionism excuses, and justifies, going easy on relaxing their own barriers to trade.

In fact, the protectionism of the poor and the rich countries must be viewed together symbiotically to ensure effective exports by the poor countries. Thus, even if the doors to the markets of the rich countries were fully open to imports, exports from the poor countries would have to get past their own doors.

We know from numerous case studies dating back to the 1970s (which only corroborated elementary economic logic) that protection is often the cause of dismal export, and hence economic, performance. It creates a "bias against exports" by sheltering domestic markets that then become more lucrative. Just ask yourself why, though India and the far-eastern countries faced virtually the same external trade barriers in the quarter-century after the 1960s, inward-looking India registered a miserable export performance while outward-looking South Korea, Taiwan, Singapore and Hong Kong chalked up spectacular exports. Just as charity begins at home, so exports begin with a good domestic policy. In the near-exclusive focus on rich-country protectionism, this dramatic lesson has been lost from view. A strategy for change

Rich-country protectionism matters too, of course. And it must be assaulted effectively. But here, too, we witness folly. The current fashion is to shame the rich countries by arguing that their protection hurts the poor countries, whose poverty is the focus of renewed international efforts. And where action is actually undertaken, the preference is for granting preferences to the poorer countries, with yet deeper preferences for the poorest among them (the least-developed countries, or LDCs, as they are now called). But the former solution is woefully inadequate, and the latter is downright wrong.

If shame were sufficient, there would be no rich-country protectionism left. Trade economists and international institutions such as UNCTAD and the General Agreement on Tariffs and Trade (the GATT) have denounced the rich countries on this count over three decades. Added support, from charities such as Oxfam, could help in principle. But these charities need both expertise and a talent for strategy, not simply a conscience and a voice. They fall short. By subscribing to the counterproductive language of "hypocrisy" and the rhetoric of "unfair trade" to attack protection by the rich, a charity such as Oxfam, splendid at fighting plagues and famines, does more harm than good.

The argument to rich countries should be made in quite a different way: If you hold on to your own protection, no matter how much smaller, and in fact even raise it as the United States did recently with steel tariffs and the farm bill, you are going to undermine seriously the efforts of those poor-country leaders who have turned to freer trade in recent decades. It is difficult for such countries to reduce protection if others, more prosperous and fiercer supporters of free trade, are breaking ranks.

Beyond this, an effective tariff-reduction strategy requires that we handle labour-intensive goods such as textiles separately from agriculture. The differences between them dwarf the commonalities. Labour-intensive manufactures in the rich countries typically employ their own poor, the unskilled. To argue that we should eliminate protection, harming them simply because it helps yet poorer folk abroad, runs into evident ethical (and hence political) difficulties. The answer must be a gradual, but certain, phase-out of protection coupled with a simultaneous and substantial adjustment and retraining programme. That way, we address the problems of the poor both at home and abroad.

Once this is done, church groups and charities can be asked to endorse a programme that is balanced and just. Such a strategy is morally more compelling than either marching against free trade to protect workers in the labour-intensive industries of the rich nations— while forgetting the needs of poor workers in poor countries— or asking for trade restrictions to be abolished without providing for workers in such industries in the rich countries.

The removal of agricultural protection does not raise the same ethical problems; production and export subsidies in the United States and the European Union go mainly to large farmers. That should make it easier to dismantle farm protection on the grounds of helping the poor. At the same time, however, agricultural protectionism is energetically defended as necessary for preserving greenery and the environment. With the greens in play, protectionism becomes more difficult to remove. But, just as income support can be de-linked from increasing production and exports, so measures to support greenery can be de-linked too. Such new measures, and other environmental protections added as sweeteners, must be part of the strategic assault on agricultural protection.

The target date of Jubilee 2000 helped greatly to focus efforts on the objective of debt relief. Following that example, I and Arvind Panagariya of the University of Maryland suggested well over a year ago— with a nod from Kofi Annan, the UN's secretary general— a Jubilee 2010 movement to eliminate protection on labour-intensive products by 2010. Since agricultural protection is politically a harder nut to crack, 2020, rather than 2010, is probably a more realistic date for its demise. Leaders of rich and poor countries could endorse both targets at the mammoth UN Conference on Sustainable Development in Johannesburg in August. The perils of preferences

A final word is necessary on the efforts to open rich-country doors. This is often done not by dismantling barriers on a most-favoured-nation (MFN) basis, which reduces them in a non-discriminatory manner, but through grants of preferences to the poor countries. This approach goes back to the Generalised System of Preferences (GSP), introduced in 1971 through a waiver and then granted legal status in 1979 with an enabling clause at the GATT. Under this, the eligible poor countries were granted entry at preferentially lower tariff rates.

GSP did little for the poor countries. The eligible products often excluded those on which poor countries had pinned their hopes of increasing exports. Thus the United States' GSP scheme excluded textiles, clothing and footwear. Upper caps were also introduced. The United States imposed a $100m limit on exports per tariff line, per year, per country; beyond this limit, the preferential rate vanished. Even the benefits granted were not "bound", and could be varied at a rich country's displeasure. Thus, when India was put on the Special 301 list in 1991 and the United States trade representative determined unilaterally that India's intellectual-property protection was "unreasonable", President George Bush senior suspended duty-free privileges under GSP for $60m in trade from India in April 1992.

Preferences were also often dropped for commodities when they began to be successfully exported, a fact documented in a forthcoming study by Caglar Ozden and Eric Reinhardt of Emory University. Rules of origin served to curb exports, too. Exported items had to satisfy stringent local-content specifications (for example, shoes had to have uppers, soles and laces made locally) to qualify for GSP benefits.

The rich countries are still going down this preferential route today. The United States has introduced the Africa Growth and Opportunity Act (AGOA), while the EU has brought in the "everything but arms" initiative, properly known as the EBE, to eliminate trade barriers for the 49 LDCs. Yet virtually every drawback of GSP applies to these schemes as well. If anything, they are worse. Under the AGOA, for example, preferences for African garments are tightly linked to reverse preferences for American fabrics.

Since preferences typically divert trade away from non-preferred countries, they tend to pitch poor nations against each other. They are also a wasting asset, since they are relative to an MFN tariff that will probably decline with further multilateral liberalisation. And since they are non-binding and can be readily withdrawn for political reasons, investors are not likely to be impressed by them.

Preferences sound attractive and generous, and the poor countries have accepted them as such. But this has been a mistake. There is no good substitute for the MFN reduction of trade barriers in the rich countries. It should go hand in hand with enhanced technical and financial assistance. By focusing this help preferentially on the poor nations, the poor should be able to exploit the trade opportunities that are opened up for them by non-preferential treatment. This is the only way ahead.


Jagdish Bhagwati is University Professor at Columbia University and Andre Meyer Senior Fellow in International Economics at the Council on Foreign Relations. His most recently published book is "Free Trade Today" (Princeton).

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