The Trade Policies of Developing Countries: Recent Reforms and New Challenges

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The Trade Policies of Developing Countries

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The Trade Policies of Developing Countries Recent Reforms and New Challenges Sarath Rajapatirana

The AEI Press Publisher for the American Enterprise Institute W A S H I N G T O N , D.C. 2000

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Available in the United States from the AEI Press, c/o Publisher Resources Inc., 1224 Heil Quaker Blvd., P.O. Box 7001, La Vergne, TN 37086-7001. Distributed outside the United States by arrangement with Eurospan, 3 Henrietta Street, London WC2E 8LU England. ISBN 0-8447-7152-X © 2000 by the American Enterprise Institute for Public Policy Research, Washington, D.C. All rights reserved. No part of this publication may be used or reproduced in any manner whatsoever without permission in writing from the American Enterprise Institute except in cases of brief quotations embodied in news articles, critical articles, or reviews. The views expressed in the publications of the American Enterprise Institute are those of the authors and do not necessarily reflect the views of the staff, advisory panels, officers, or trustees of AEI. The AEI Press Publisher for the American Enterprise Institute 1150 17th Street, N.W., Washington, D.C. 20036 Printed in the United States of America

Contents

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Contents Acknowledgment

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Trade Trends in Developing Countries

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What Led to Trade Policy Reforms?

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The Political Economy of Trade Reforms

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Reform Trends in the 1990s in a Twenty-Country Sample 14 Issues Arising from the International Trading Environment

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Extending the Trade Reforms of the 1990s

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Conclusions

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Notes

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References

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About the Author

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Acknowledgement

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Acknowledgment

The author is grateful to Claude Barfield, American Enterprise Institute, for his incisive comments on an earlier version of the paper; to Gokce Ozbilgin, Smith College, for her excellent research assistance; and to James Morris and David Stetson for their superb editorial advice.

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T

he failure of the Seattle ministerial meeting of the World Trade Organization (WTO) to launch a new round of multilateral trade negotiations brings into sharp focus the increasing divide between developed and developing countries in their respective agendas for reforming the international trading environment. The developing countries need a genuine and well-defined agenda for moving the reform process forward. While there is no unanimity among developing countries with regard to the particular items that belong on the agenda, there are common areas of interest that are different from the agenda of the developed countries. This essay attempts to set the background for a new round of multilateral negotiations, though it may take place later than was thought possible on the eve of the Seattle meeting. The 1980s saw nearly all the developing countries reform their trade regimes, improve their economic performance, and provide increased access to exports from developed countries. Many developing countries joined the WTO, and many others are now waiting in the wings to join. The 1990s saw a continuation of the reform trend of the 1980s, despite a few pauses such as the 1994 payments crisis in Mexico and the East Asian crisis that began in 1997. The implementation of the Uruguay Round of multilateral trade negotiations since the mid-1990s gave a definite fillip to trade liberalization in developing countries, as the decade saw the intellectual case for free trade receive new support. But there were also deflections from the mainstream position. New challenges to trade liberalization in developing countries have arisen both from the need to complete the agenda of their domestic reforms and from developments in the international trading environment. Research in the 1970s and 1980s strengthened the case, both theoretical and empirical, for the more-open trade policies that eventually led to widespread trade liberalizations. The research gives us a basis to judge the trade regimes that have come into being in the 1990s. Despite reforms, those regimes are still far from the ideal regime of low levels of protection and low variance in protection, based on tariffs and characterized by transparency. A new round of multilateral trade negotiations is needed to address the unfinished 1

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agenda of domestic trade reforms and to meet the new challenges to liberal trade policies emanating from the international trading environment. This essay deals only with the main items on that unfinished agenda. We first discuss the trade trends of developing countries in the 1990s in a global context. We then consider the factors that led to reforms, the political economy aspects of trade reforms, and, using a twenty-country sample, the main trends in reform at the country level. Next, we examine issues in the international trading environment that impinge on developing countries, the main issues that emerge from the reforms, and the new challenges to liberal trade that arise from the international trading environment. Before presenting our conclusions, we identify a future agenda for reforms for the next round of multilateral trade negotiations. Trade Trends in Developing Countries During 1990–1997, the volume of world trade (export and import volumes) grew by 6.5 percent per year, and the exports of developing countries grew by 8.7 percent per year. Although the East Asian crisis in 1997 led to a reduction in export growth in that region, the growth rate of exports from developing countries in the first seven years of the 1990s was substantial. World output grew at 2.3 percent per year over the 1990–1997 period, and developing country output grew at 3.1 percent per year (World Bank 1999). Developing economies also became more integrated into the world economy. The estimates of trade openness in developing countries (as indicated by their trade ratios) show an equally good performance (Drabek and Laird 1998). World exports of commercial services grew by 8 percent per year during 1990–1997. Starting from a low base, the share from developing countries grew faster than the world rate of growth of commercial services (World Trade Organization 1998). In 1997, developing countries accounted for 30 percent of the world’s exports of commercial services. The “other commercial services” category, which includes financial services, construction, and computer services, was the fastest-growing category of services exports. World services exports slowed in 1997, in part because of the economic crisis that began in East Asian countries, which were the main importers of commercial services in the developing world. Given the further liberalization of

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services trade following the Uruguay Round (1995) and the two ministerial meetings that took place prior to 1998, the opportunities for faster growth in world trade in services will be even greater. Once East Asia recovers from its crisis, developing countries will be able to make use of the opening-up of services trade. The average volume in commodity and services trade during the 1990s masks many differences in the individual performances of countries and regions. The East Asian countries led the way in the growth of exports and permanently changed the patterns of trade between developed and developing countries. First, manufacturedgoods exports from the developing world, and from East Asian countries in particular, were the fastest-growing component of trade. They averaged increases of some 12–15 percent per year during the 1990s, thereby continuing a trend that started in the late 1960s when East Asian countries liberalized their trade regimes. Second, there was a decline of trade in mining products from developing countries after the decline in oil prices. The previous decade had begun with the oil shock of 1979–1980, when oil prices rose to unprecedented levels. Third, there was an increase in intraregional trade among developing countries, attributable to unilateral liberalizations and to the reduction in trade barriers against one another on a preferential basis—that is, the institution of lower tariffs and the granting of greater market access for fellow members of regional trading agreements (RTAs). Latin America led the developing world in rejuvenating and creating RTAs. Africa had the slowest growth in trade in the 1990s, because of its slower liberalization and because its commodities were concentrated in primary products. World trade slowed in the three years preceding 1998, primarily because of trade contraction in East Asia but also because of the decline in commodity prices, which fell sharply in 1997–1998 and began to recover in early 1999. The price declines were so sharp that primary product prices fell to 50 percent of their peaks for the first time since World War II. The declines were somewhat moderated in 1999 with the recovery of oil prices. In terms of regional groups, the most severely affected were the African and Middle Eastern economies, because of their concentrations in primary products. The prices of services exports fell to their lowest level in dollar value since 1983, and the prices of all the major commercial services, including transport and travel, declined. It is worth noting, however, that the price declines are a transitory phenomenon and that prices are sure

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to recover with the revival of the East Asian economies. Indeed, evidence of a recovery in the region began to emerge in 1999. The trade policies of developing countries in the 1990s differed from those of the 1980s in terms of their dominant themes and the policy experiences of different groups of countries. Writing on the main features of the trade policies of the 1980s, Anne Krueger (1990) concluded that “it is by no means clear that the trade policies of developing countries are any more restrictive in 1987 than they were at the end of the 1970s!” For most developing countries, trade regimes are more open in the late 1990s than at any time in the post–World War II period. There is no better way to demonstrate the trade trends in developing countries than to contrast the themes of the 1980s (Krueger 1990) with the emerging themes of the 1990s. First, a comparison of the trade regimes of the 1980s with those of the period 1950–1980 shows increased differentiation in trade policies among the developing countries. Many East Asian countries took the lead in liberalizing their trade regimes, while nearly all other developing countries maintained restrictive regimes. In the 1990s, there is less differentiation, because nearly all of the developing countries have begun to liberalize their regimes. Second, a long-term trend toward less-restrictive trade regimes was observed in the 1980s. In the 1990s, trade reform has become a unifying goal, varying only according to the speed of liberalization. The response to reform has differed among countries depending on the strength and credibility of their initial reforms and the different circumstances within individual countries. A third aspect of the reforms of the 1980s saw developing countries become more integrated with the world economy, in both trade and capital flows, than in the previous three decades. This process of integration into the world economy continued in the 1990s. Measured by trade-intensity indexes (the ratio of the sum of exports and imports to GDP), developing countries are more closely integrated into world trade than ever before. They are also closely integrated into the world capital market. In fact, the amounts of both short- and longterm capital flowing into developing countries in the 1990s are four times the levels of the 1980s, which was a period characterized by debt problems. It is beyond the scope of this essay to explore the consequences of integration into the world capital market, but we can observe that manufactured exports from developing countries have

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become closely linked to private foreign direct investment in the export sectors. That became possible with the reduction of bias against exports through trade liberalization and the creation of a more hospitable environment for private foreign direct investment in most of the developing countries, thanks to the reform of their regulatory regimes in the 1990s. Finally, in the 1980s, real oil prices reached a peak, and mining products were a large share of the total exports of developing countries. In the 1990s, many developing countries moved from being exporters of primary products (agricultural and mining products) to becoming exporters of manufactures on a wider scale than before. That was a consequence of the changed economic environment of the 1990s and the decline in the real price of oil, which fell to its lowest levels since the early 1970s and reduced oil exports as a component of total exports. In the mid-to-late 1990s, the prices of agricultural exports also fell, thereby increasing the relative value of manufactures. The manufactured exports of developing countries significantly increased their share of the total exports of developing countries—from 17 percent in 1980 to 24 percent in the 1990s. Despite the East Asian crisis of 1997, the past decade has been less turbulent than the 1980s. Many of the countries that were in desperate straits in the 1980s have staged recoveries thanks to reforms and to the return of private foreign direct investment. The irony is that some of the East Asian countries that were setting a strong pace for export growth, such as Malaysia, South Korea, and Thailand, fell victim to their own success in the late 1990s. The crisis was attributable to weaknesses in their financial systems, to inadequate vigilance in the conduct of macroeconomic policies (which led to the appreciation of real exchange rates), and to the recession in Japan, which reduced the demand for their exports. What Led to Trade Policy Reforms? The 1980s were the decade of initiating reforms; the 1990s, of continuing them. Although there was less of an urgent need to undertake reform in the 1990s than in the 1980s, many developing countries did so and fashioned more-liberal trade regimes. We shall now consider the reasons for their actions. The 1980s were a decade of crises, starting with the second oil shock of 1979–1981, a debt shock that began when Mexico was

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unable to service its debt, the rise in interest rates as U.S. monetary policy was targeted to reduce double-digit inflation, and the ensuing worldwide recession. Those negative shocks led to crises in the majority of developing countries (save the oil exporters). The crises were not wholly external in origin. In many cases they were homegrown after consumption and investment booms in the mid- to late 1970s. Whatever the origin of the crises, they led to reforms, which are now termed “new liberalizations” (Little et al. 1993; Lal and Snape, forthcoming). One of the principal reasons for the reforms was the breakdown of coalitions that supported the existing protectionist regimes. Policymakers found it easy to push through reforms when the alternative became increasingly more costly. In my sample of twenty countries, there is only one—Colombia in 1991—in which reforms were undertaken without crisis. The impetus for change in Colombia came when Cesar Gaviria assumed the office of president. Deeply committed to change, he compressed a planned four-year program of trade reform into eighteen months (Rajapatirana, de la Mora, and Yatawara 1997). New research has strengthened the intellectual case for continuing and consolidating trade reforms in the 1990s. For example, the creation of endogenous growth models by Romer (1986), Lucas (1988), and others permitted an analysis of policy reforms that had not been possible within the neoclassical growth model. Again, the empirical research associated with Dollar (1992), Sachs and Warner (1995), and Edwards (1997), among others, built on the work done by Little, Scitovsky, and Scott (1970), Balassa and Associates (1971), Bhagwati (1978), and Krueger (1978). In the 1990s, some rejected the line of argument that liberalized trade regimes based on neutral incentives were at least partially responsible for the very rapid growth in exports and high GDP growth in the East Asian countries. Amsden (1989), Wade (1990), Lall (1996), and Rodrik (1992), in particular, have argued that the selective promotion of specific sectors and well-targeted public investment led to economic success. The principal agreements and disagreements between the mainstream researchers and the revisionists may be stated as follows. Both sides generally agree that macroeconomic fundamentals such as low inflation, fiscal stability, and competitive exchange rates are essential for the proper conduct of trade policy. The revisionists also agree with the mainstream economists that education and the development of human capital, as well

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as basic infrastructure, are needed for development. The revisionist view focuses on the interpretation of the success of East Asian economies and claims that the success can be attributed not so much to neutral incentives as to selective government intervention. This view emphasizes the importance both of acquiring technological mastery as the key to successful industrialization and of building the institutional structure needed to conduct sound industrial policy. Revisionists consider selective intervention the means to address distortions and believe that cooperation between the government and the private sector is essential for industrial success. They also consider the mainstream economists’ belief in the success of neutral policies to be an ideological commitment to laissez faire rather than a representation of the real world. In addition to the individuals mentioned above, proponents of the revisionist view include some, such as Singer (1950), who were ardent advocates of the import substitution strategy in the past. The revisionists gained ground in the debate about the factors responsible for the success of East Asian economies. The main point of contention was that, in addition to getting the fundamentals right, the East Asian countries selectively intervened in their economies to depart from neutral incentives. Those who espouse the revisionist view insist that the success of the East Asian economies (prior to the 1997 crisis) was due to dynamic factors. These factors include learning by doing (associated with the adoption of new technology) and externalities (benefits that one firm creates for others but that do not result in compensation to the firm that creates the benefits), neither of which can be realized by relying on market forces alone. In addition, the revisionists claim that the success of East Asian economies is attributable not to neutral incentives but to factors that are not yet fully understood. In the opinion of some scholars, the East Asian Miracle study (World Bank 1993) departed from the well-established view within the World Bank that neutral incentives were more likely to lead to better economic performance than were selective interventions and supported the view that the correct balance of laissez faire and intervention led to the East Asian miracle. However, there is nothing in the study that indicates how this correct balance is to be achieved. In addition, the study—written before the East Asian crisis— could not account for the fact that at least part of the crisis originated in the attempt to promote specific industries by using the financial system to subsidize those industries. In the event, the financial sectors

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became weak and vulnerable to macroeconomic shocks. Dani Rodrik (1994) contends that the East Asian Miracle study helped accommodate the view that the state and the market could cooperate to produce a superior outcome. But the debate does not rigorously define neutral incentives and selective promotion approaches. The main issue is to determine which type of regime provides the best opportunity for rapid development: a regime of neutral incentives that allows comparative advantage to assert itself, or a regime that needs selective promotion to achieve outcomes superior to those that neutral incentives could provide. Alice Amsden (1989) and Robert Wade (1990) have been among the most ardent recent advocates of using the East Asia arena as the basis for asserting the superiority of the selective intervention approach. The main argument used by Amsden is that the newly industrializing countries do not fit the old paradigm of innovative industrialization in developed countries—that the latter, in fact, are special cases. Wade contends that “governing the market,” in which government deliberately distorts prices to promote certain activities, is the dominant explanation for the success of East Asian economies. He agrees that the free-market and “simulating free-market” explanations can also be used to explain that success, but that such explanations are not as valid as those based on governing the market. Like Amsden, Wade claims that the newcomers operate in a different paradigm from the earlier industrializing countries, and he caricatures neoclassical explanations, as do many of those who argue for selective intervention. The caricatures portray the alleged neoclassical position as being “get prices right, and everything will follow.” Amsden and Wade say that the neoclassical position is not relevant to developing countries because the concern should be not with static but with dynamic comparative advantage. Sanjaya Lall (1996), another advocate of selective intervention, bases his position on the need to promote technology in developing countries. Although he says that incentives are important for industrialization, he advocates government intervention to induce firms in developing countries to acquire technology, and he alleges that neoclassical economists ignore micro-level dynamic efficiency based on the acquisition of technology and skills. Many of the arguments that have been leveled against the alleged neoclassical position of the 1970s and 1980s are based on a highly

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exaggerated and distorted version of the neoclassical approach to the use of neutral incentives. The neoclassical position does not claim that outward-oriented strategy is the necessary and sufficient factor for efficient industrialization, and many of its proponents discuss the importance of property rights, infrastructure, sound macroeconomic policies, and an institutional environment that is supportive of industrialization. Where outward orientation has failed, many of those supportive factors were absent. In addition, there has been much confusion about the use of neutral trade policies and laissez faire. Many of the revisionists, including Amsden and Wade, claim that the neoclassical position is untenable because it is based on a very limited role for the government. All of them assume a benevolent and omniscient government. They argue that the role of the government should not be limited, due to volatility in the markets and to the need to support infant industries; they also argue that coordination of the different activities of the private sector is not just desirable, but is in fact essential for raising GDP growth rates. The East Asian experience (save that of Hong Kong), they claim, demonstrates that large and interventionist governments using selective promotion were the cause of industrial success. That position is in sharp contrast to the literature on public choice theory, which argues that government is an economic entity like any other, trying to maximize its gains (Krueger 1974), and is not the benevolent entity that revisionists or the neoclassical economists of the past make it out to be. Government is not a guardian angel but, at times, a predator. The literature on rent seeking and revenue seeking finds that governments can be captured by different elements of the private sector to serve their own ends, and that the opportunity to receive selective support for different activities encourages capture by different interest groups. But neither mainstream economists nor policymakers have accepted the position of the revisionists, and some revisionists have begun to mute their advocacy of selective intervention in the wake of the East Asian crisis. One reason for the weakened financial systems in East Asia was the use of financial markets to target different activities selectively. This was a major cause of the weaknesses in the commercial banks’ portfolios that precipitated the crisis: selective intervention took the form of targeted credit subsidies to some enterprises, and these subsidies compromised the financial viability of the banks,

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which were not encouraged to evaluate the financial risks when making loans but were instead pressured by governments to make loans to certain enterprises. In addition to the revisionists’ failure to influence policymakers— which led to strong import liberalization (a departure from the revisionists’ alleged East Asia model)—there was a strong negative lesson from the collapse of the Soviet model that had been emulated by countries like India. The demise of that planned, state-led, and highly inefficient closed-economy model may have had a salutary effect on countries that were not previously prepared to commit to liberalized trade in one form or another. The negotiations that preceded the signing of the Uruguay Round were another important factor in facilitating trade reforms in the 1990s. Preparation for the round moved trade issues to center stage, brought an external force to bear on the domestic policies of developing countries, and committed the countries to reducing trade barriers and binding their tariffs. Though domestic crises created the impetus for trade reform, the Uruguay Round provided a mechanism to reduce barriers and to link reform to an external guard against slippage. To be sure, many aspects of the round could have served a liberal trade environment better, but it did create the atmosphere for trade reform in the 1990s. Prior to the 1990s, developing countries were reluctant to participate in previous rounds and preferred to “free ride” when developed countries reduced barriers on a most-favored-nation basis. They invoked “special and differential” treatment as the reason not to enter into reciprocal negotiations with developed countries. That stance changed in the 1990s, for several reasons. First, given the increasingly strong intellectual argument that liberalized trade was good for developing countries, multilateral trade negotiations based on reciprocity became attractive. Second, developing countries realized that they would lose out by not participating and by forgoing an opportunity to influence the agenda for negotiations. Third, they realized that special and differential treatment (in which developing countries did not have to reciprocate when they received access to markets in developed countries) was not beneficial. In fact, such treatment had prevented them from using external pressures as a rationale for trade policy changes; consequently, many developing countries had continued their highly restricted trade regimes, much to their own detriment. In the same vein, developing countries had received

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concessions through the Generalized System of Preferences, under which these countries could have zero or low tariffs for their products in industrial country markets. This access was not bound, which meant that the developed countries could withdraw the concessions at will. Fourth, because many developing countries had become important players in world trade, particularly in manufactures, developed countries would no longer allow them to “free ride.” Consequently, developing countries joined GATT, and later the WTO, in larger numbers than ever before. By 1998, the WTO had some 132 members, and some 32 countries were in the process of negotiating entry. All of the potential new members are developing countries and transition countries. In short, the 1990s saw an unprecedented increase in the participation of developing countries in the multilateral trading system; they accepted its laws and processes, and they attempted to secure greater access to the world market on a bound basis. Another notable stimulus to trade liberalization in the 1990s was the large-scale adoption of flexible exchange rates by developing countries. This move allowed countries to remain competitive internationally. Changes in domestic prices came to be reflected in exchange rates and thus removed a constraint on trade liberalization that had existed in the 1960s and 1970s. The period since 1984 can be described as a time of flexible exchange rates. In fact, very few trade liberalizations were associated with fixed exchange rates. Finally, the international financial institutions (the World Bank and the International Monetary Fund), along with GATT and the WTO, continued their support for trade reform. The World Bank had led the way in the 1980s, but its support declined in the 1990s with the decline in structural adjustment lending. In contrast, the IMF has increasingly included trade policy conditions in its standby programs (IMF 1998). These programs allow countries with balance of payments difficulties to undertake a smoother adjustment by financing a part of their deficits using IMF resources. Access to these resources is conditioned on a program of actions designed to address the balance of payments disequilibrium. The creation of the WTO, the inclusion of agriculture and services within multilateral trade discipline, the establishment of the trade review mechanism, and the newly reformed dispute-settlement mechanism have all contributed to a more favorable environment for liberalizing trade further on a most-favored-nation basis.

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The Political Economy of Trade Reforms To understand the timing of trade reforms in the late 1980s and the early 1990s one must consider the reforms in the context of political economy. A new literature emerged in the 1980s that formalized the view that trade policymaking was subject to political influences. This literature recognized that the existence of trade protection in the 1960s and 1970s reflected the political equilibrium of that time: powerful and influential groups within developing countries favored protectionist trade policies. Those groups differed from country to country and over time in different country settings. They appropriated the power to make trade policy and passed on the costs of protection to the society, largely to the agricultural and rural sectors. The prevailing ideologies of the time gave intellectual support to protection as the way that developing countries could industrialize. The political economy framework must be set within the context of the demand for, and the supply of, protection. The supply side of trade policymaking involves the trade policymakers’ preferences (infused by ideology) and the institutional structure of government (democratic or authoritarian, multiparty versus biparty). The demand side involves individual preferences and organizations that lobby for protection. From the research of Mancur Olson, it is well known that the costs of protection are dispersed across a large part of the population, while the benefits of protection accrue to a much smaller group of individuals and firms; those who benefit from protection have the ability to organize and lobby against the removal of protection (Olson 1982). In the 1960s and 1970s the protectionist lobbies held sway; they demanded and received protection. The equilibrium that existed was somewhat stable and was dominated by different groups in different countries, such as the military and labor in Argentina, the industrialists and bureaucrats in India, and the oligarchs and industrial interests in Mexico. In the late 1980s and the 1990s, the political economy equilibrium changed in the developing countries, for several reasons. First, there were large macroeconomic shocks, including oil and debt shocks, that upset the balance of power among the different groups. Second, in some parts of the world, particularly in Latin America, there was a return to democracy, which led to the exercise of majority choices and the emergence of dynamic leaders—both within the existing milieus, as in Colombia and India, and, more dramatically, within

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changed political milieus, as in Argentina, Brazil, and Peru. Third, as noted earlier, market-favoring ideologies took hold because of the failure of command economies and the visible success of marketbased economies. The large economic shocks that turned into crises and unsettled the existing political equilibrium were the common factor in all of the trade liberalizations (with the possible exception of the reform in Colombia, which liberalized under stable macroeconomic conditions in 1991 after the election of President Gaviria). An examination of the trade liberalization experiences of these countries reveals that many populist (that is, democratically elected) governments were prepared to undertake nonpopulist reforms— such as trade reforms—because the cost of populist policies had begun to exceed the cost of not adjusting to the macroeconomic shocks. The crisis factor seems to be ubiquitous, and the research of Bates and Krueger (1993), Haggard and Webb (1994), and Little, Cooper, Corden, and Rajapatirana (1993) confirms that crisis was indeed a prerequisite for reform. The theoretical literature on political economy supports the crisis hypothesis. Alesina and Drazen (1991) have developed a model in which fiscal adjustment, the primary element in overcoming a crisis, is delayed because of the uncertain distribution of the burden of adjustment. A crisis allows one group to dominate and to carry through the reform. More often than not, trade reforms are tacked on to fiscal reforms, because the costs of not adjusting to macroeconomic reforms are higher. By contrast, the absence of a macroeconomic crisis delays trade reforms. There might exist a seeping or a quiet crisis, as in India, but the macroeconomic crisis in the country has to grow before the introduction of trade reforms. Other models, such as that of Fernandez and Rodrik (1991), explore a system that reinforces inaction to maintain the status quo. Given the narrow time horizons of politicians and the uncertain distribution of the benefits of reform, the equilibrium of the status quo can be broken only when a crisis becomes so severe that reform is the only recourse. Small crises generally preserve the status quo. Severe crises can be cathartic. All theoretical models postulate the presence of a distributive constraint—the cumulative pressures and costs of nonadjustment leading to the emergence of a group that can undertake the reforms. In Latin America, for example, severe crisis and strong leadership have been the principal factors behind trade

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reform (Rajapatirana, de la Mora, and Yatawara 1997). Thus, both the empirical evidence and the theory argue that the political economy of trade reform supports crisis-driven reforms. Reform Trends in the 1990s in a Twenty-Country Sample In this section we identify the main trends in trade policy reforms in the 1990s within twenty individual countries (table 1). The countries in the sample are from four continents, and the sample is sufficiently diverse to represent developing countries in general. It includes the relatively rich developing countries (“middle-income,” as defined by the World Bank), such as Argentina, Chile, South Korea, and Venezuela, and poor countries, such as India, Kenya, Nigeria, Sri Lanka, and Pakistan. It also includes countries with large populations, such as India, Indonesia, and Brazil, and less populous countries, such as Bolivia and Costa Rica. There are countries that are relatively more industrialized, such as Brazil, Mexico, and South Korea, and countries that are mostly agricultural, such as Côte d’Ivoire, Kenya, and Thailand. Three countries of the twenty are oil exporters: Cameroon, Indonesia, and Mexico. The time period chosen to identify the trends in developing country trade policies is 1985–1996, because only by extending the period back to the mid-1980s can we clarify the trends of the 1990s. As we have seen, many countries began trade reform in the 1980s in response to crises. Many others had begun even earlier, in the 1970s, and some, such as South Korea, in the 1960s. Thus, to have limited the time period for the sample to the 1990s would have made it impossible to judge accurately the main trends of the decade. Many countries in the sample undertook reforms in the 1990s that continued reforms begun in the 1980s (the reform years are indicated in parentheses): Argentina (1991–1993), Brazil (1990–1992), Cameroon (1990–1994), Colombia (1990–1991), Costa Rica (1992), Côte d’Ivoire (1994), India (1991–1992), Kenya (1989–1995), Nigeria (1995), Pakistan (1994), Thailand (1990), and Venezuela (1996). Korea was the earliest of the strong reformers. Five other countries undertook reforms in the 1970s and 1980s that qualify those countries not only as early reformers but also as strong reformers, in comparison with the mild and weak reformers identified in the table. Early reformers in the strong reformer group are Bolivia (1985), Chile (1974), Korea

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Table 1 Trade Reform in Twenty Countries, 1985–1996 Reform Years

Overall Outcome Average GDP growth 1985–96

Avg GDP growth postreforma

Before 1985

1985–1996

Type of reforms

Bolivia Chile Colombia Korea Mexico Sri Lanka Turkey Mean SD (Mean/SD)b

--1974–79 1984–87 1966–71 --1977–80 1980

1985–87 1992–93 1991–92 --1985–90 1989–90 1985–86

S S S S S S S

3.26 7.03 4.23 8.44 2.03 4.40 4.73 4.87 2.19 2.23

3.70 6.70 4.70 8.60 2.50 5.10 4.40 5.10 2.01 2.54

Argentina Brazil Indonesia Thailand Mean SD (Mean/SD)

1976 1968 -----

1991–93 1990–92 1986–89 1988–91

M M M M

2.17 2.94 7.19 8.72 5.26 3.20 1.64

3.30 3.20 8.00 8.50 5.75 2.89 1.99

Cameroon Costa Rica Côte d’Ivoire India Kenya Morocco Nigeria Pakistan Venezuela Mean SD (Mean/SD)

------1980–85 --1984–85 1973–74 1972–73 ---

1989–93 1986–89 1986–89 1991–92 1991–92 --1986–90 1987–88 1989–90

W W W W W W W W W

-0.61 3.85 2.15 5.91 3.72 3.96 4.59 5.41 2.58 3.51 1.96 1.79

-0.70 3.90 2.00 7.00 2.90 3.70 4.80 4.70 2.80 3.46 2.13 1.62

Countries

Note: S = strong, M = mild, W = weak a. Estimated with one-year lag after initiation of reforms. b. Mean/variance = coefficient of variation. Source: World Bank 1997 database.

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16 ✜ TRADE POLICIES OF DEVELOPING COUNTRIES

(1966), Mexico (1985–1990), Sri Lanka (1977), and Turkey (1980). Bolivia and Chile enjoy the distinction of having introduced reforms that amounted to complete regime changes and that led to low protection and very low variance in protection. Bolivia has a two-tier tariff system of 5 percent and 10 percent, and Chile has a 10 percent uniform tariff. In both countries quantitative restrictions (QRs) apply to less than 1 percent of their imports. The six countries in this group of strong and early reformers have low protection—in the 11 percent to 13.5 percent range—and low variance in tariffs (measured by tariff dispersion); QRs apply to less than 10 percent of their tariff lines. All six countries entered the 1990s with liberalized trade regimes. Colombia undertook reforms in 1991–1992 and joined the group of strong reformers. (It should be noted that the coefficient of variation for GDP growth is higher for strong reformers than for the other two groups.) The mild reformers defined in the sample are Argentina, Brazil, Indonesia, and Thailand. With the exception of Indonesia, all of the countries in the group undertook their trade reforms in the early 1990s. Indonesia attempted to cope with the sharp decline in oil prices by means of a package of reforms that began in 1986. Thailand began the reform process in 1988, but the more substantial reforms came in the early 1990s. For the group as a whole, tariffs are between 13.5 percent and 33 percent. Tariff dispersion ranges from zero to 80 percent. QR coverage is between 11 percent and 30 percent of their imports. The third group, made up of what we characterize as weak reformers, comprises the largest number in the sample: Cameroon, Costa Rica, Côte d’Ivoire, India, Kenya, Morocco, Nigeria, Pakistan, and Venezuela. Like the other two groups, this one includes countries that began the reform process in the mid-1980s. The reforms were limited in scope and were implemented slowly by comparison with the action of the strong reformers. The levels of protection in these countries, as measured by nominal tariffs, range from 19 percent to 70 percent, and tariff dispersion from 19 percent to 134 percent. QRs still cover a large part of the tariff lines. QR coverage is as high as 30 percent for India and 50 percent for Pakistan. Table 2 shows the main features of the reforms during the period 1985–1996. The reforms are noteworthy in several respects. First, the most common reform was to reduce barriers against exports as a first step. This type of reform included the reduction and elimination of export duties and the provision of duty-free status to imported inputs used in the production of exports, either through duty exemptions

AT 42 (p) 12 (m) 51 -35 61

53 (p) 26

128

35 53

Country

Argentina (1986)

Bolivia (1985)

Brazil (1987)

Cameroon (1988)

Chile (1985)

Colombia (1984)

Costa Rica (1984)

Côte d'Ivoire (1985)

India (1989)

Indonesia (1986)

Kenya (1985)

0–100

0–225

0–300

40

20

70

--

--

Import licenses reduced. Export compensation system replaced by duty drawback.

Removed restrictions on exports; reduced QRs.

Reformed export incentives; removed import restrictions on imported inputs.

Reduced export taxes and QRs on imports and abolished reference prices.

Replaced QRs with tariffs and reduced protection.

Provided imported inputs for exports and automatic access to foreign exchange.

Promoted nontraditional exports and improved export procedures.

Reduced export taxes.

Reforms mostly on exports.

Streamlined import and export procedures and reformed customs.

Reduced barriers on exports and streamlined QR coverage.

Reform Content

45 (1989)

25

71

15

11.2

43

11 (1991)

18.8

14.3

7.5

--

AT

--

0–70

--

5–30

5–20

0–100

0

--

0–35

0–10

0–40

TD

60 (1989)

13

32

<10

<10

63

<2

43

20

<2

43

CQR

SARATH RAJAPATIRANA ✜ 17

Table continues on next page.

Reforms 1989–95.

Main reforms 1990–93.

Reforms in 1991–92. Consumption goods mports remain restricted.

Stronger liberalization following devaluation of CFA franc in 1994.

Exchange controls rescinded in 1994.

Undertook a strong reform in 1990–91 and reduced AT to 12.5%.

Undertook a strong liberalization in 1974–79.

Reforms during 1990–94.

Liberalized its trade regime during 1990–92.

Liberalized its trade regime in 1985.

Liberalized its trade regime in 1991.

Comments

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25–350

0–1400

83

<2

--

39

<2

60

CQR

Trade Regime after Reformsb

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0–220

0

--

0–100

5–10

0–115

TD

Trade Regime before Reformsa

Table 2 Content of Trade Reform in Twenty Countries, 1985–1996

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18.1

24 (p) 60

50

69 20 23 31.4 37

Korea (1988)

Mexico (1985)

Morocco (1985)

Nigeria (1986)

Pakistan (1986)

Sri Lanka (1990)

Thailand (1986)

Turkey (1985)

18 ✜ TRADE POLICIES OF DEVELOPING COUNTRIES

Venezuela (1988)

0–135

-40

--

30

--

80 (est)

--

90

92

15.5

CQR

Reduced import tariffs and CQR.

Liberalized agriculture imports and improved procedures.

Main reforms 1988–91.

Reduced import duties and tariff dispersion.

Increased export subsidies, bonded warehouses, and studies.

Abolished import surcharge. Export procedures simplified. Improved duty drawback system.

Removed restrictions on exports and on imports used for exports. Reformed temporary admission regime.

Reduced tariffs and QRs; eliminated reference prices.

Korea's second reform package 1977–83.

Reform Content

19 (1991)

9 (1993)

11.4 (1990)

12 (1985)

65

34.3

45

12.5

8.3

AT

0–50

--

--

0–50 (est)

--

0–60 (est)

0–100

--

--

TD

10

2.7

5.5

<5

14.5 (est)

--

--

17.3

<2

CQR

Adopted the Andean Group common external tariff 5, 10, 15, 20 in 1995.

Liberalized in 1980.

AT=27% (1993), 17% (1994).

Main liberalization in 1977.

AT=35% in 1994. Remains protected country.

1993 AT=32.8%. By 1995 CQR=88%.

By 1995 AT=23%. Liberalization possible after abandoning fixed exchange rate in 1994.

Greater liberalization after joining NAFTA (1991).

First liberalized in 1965–67; second episode in 1977–83. By 1994. AT=7.9% and CQR<2%.

Sources: World Bank and GATT-WTO trade policy reviews.

a. AT, TD, and CQR are shown for the year before trade reforms. b. AT, TD, and CQR are shown for the year following trade reforms.

Comments

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0–100 (est)

10–114

0–140

0–100

0–150

0–100

--

TD

Trade Regime after Reformsb

8/16/02

Note: AT = average nominal tariff (average unweighted ad valorem rate unless otherwise noted), p = production weighted, m = import weighted, TD = tariff dispersion, CQR = coverage of quantitative restrictions (percentage of import items), -- = not available.

AT

Country

Trade Regime before Reformsa

Table 2 Content of Trade Reform in Twenty Countries, 1985–1996 (cont’d)

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SARATH RAJAPATIRANA ✜ 19

or duty drawbacks. A second feature of the reforms that came early on was the replacement of QRs with tariffs. Of course, some countries—India and Pakistan in the 1990s, and Argentina, Brazil, and Colombia until 1992—retained QRs for a large part of their imports. A third feature, which emerged in the 1990s, was the reduction of import tariffs. Cameroon and Côte d’Ivoire, the two CFA countries1 in the sample, were able to undertake reforms following their devaluation of the CFA franc in 1994; Morocco, although not a CFA country, followed suit. Finally, there were institutional reforms in trade policy making and in the administration of customs and of export and import procedures. We can make several generalizations, based on the sample, about the trade reforms and trade regimes of the 1990s—and, in so doing, we can begin to shape an agenda for future reforms. First, although the 1990s saw most countries make further progress with reforms begun in the 1980s, the trade regimes that have evolved still have different rates of protection for different goods, leading to a wide variance in protection. It is true that many countries have liberalized their trade regimes and that protection is lower than at any time in the last five decades. But all of the countries in the mild and weak reform groups need to undertake a substantial agenda of additional reforms if they are to move toward the ideal liberalized trade regime. If Chile is the yardstick, because it has low protection, low variance, and hardly any QRs (and thus is close to the ideal trade regime identified in research), the other nineteen countries have a long way to go. To be competitive, countries must reduce their levels of protection as compared with those of other countries— they must not be satisfied with reductions that diminish protection relative to their own previous levels of protection. Those in the strong reformers group have less far to go to equal Chile than those in the mild and weak categories. Chile resolved to reduce its uniform tariffs to 7.5 percent in 1996 and then postponed action on the decision; it has now resolved to adopt a 6 percent uniform tariff by 2003. Similarly, Sri Lanka had decided to move toward a uniform 15 percent tariff in 1998, but it has now postponed the change indefinitely. The reason these countries have deferred further liberalization is unclear. But the delay indicates a slowing down of the reform effort, even among the leaders. Second, variance in protection may have increased in some countries in the 1990s, for several reasons. Many countries have continued

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20 ✜ TRADE POLICIES OF DEVELOPING COUNTRIES

to protect agriculture, even after they, like the developed countries, have reduced overall protection. A high level of protection for agriculture is a key feature of current trade regimes in the developing countries; Nigeria, for example, has tariffs of over 100 percent. Others have bound tariffs on agriculture at much higher rates than those for manufactures. Brazil has bound agricultural tariffs in the 80–230 percent range, while India has bound its agriculture tariffs at a 0–300 percent range. Many of the rates cited have been reduced over time, and the applied tariff rates for agriculture are currently much lower than those bound rates. Yet the potential to raise rates in the future still exists. In addition, various nontariff barriers are more prevalent in agriculture than in industry. For some agricultural products, Colombia uses a domestic procurement scheme that treats imports as a residual, after domestic production is bought up. The Andean Group as a whole uses a price band system for some agricultural products that imposes a variable levy. That levy can rise to inordinately high levels, above the bound rates, when the international prices of agricultural goods decline—as in fact happened in the late 1990s. Another reason for the increasing variance in tariffs is the RTAs. Their tariff preferences have led to zero or low tariffs among the member countries, thereby widening the variance between both high and low tariffs and between member- and nonmember-country import tariffs. Third, as described above, most of the reforms in the 1990s were confined to export rather than import liberalization. A typical sequence has been to reduce barriers on exports, such as export duties; to provide duty drawbacks and credit subsidies; and to compensate for tariffs on imported inputs that are used to produce exports. These measures compensate for the bias against exports found in many developing countries. Some countries have gone beyond the point of eliminating the bias against exports by providing direct subsidies based on performance criteria. Thus in many instances they do more than provide “free trade status” for exports. These countries place less emphasis on reducing import protection and instead attempt to promote exports through subsidies. Brazil, India, Indonesia, Nigeria, Thailand, Turkey, and Venezuela have followed this sequence. Venezuela has gone so far as to identify “sector leaders” and target them for special concessions, such as energy subsidies. A number of the countries extend credit at concessional interest rates to small and medium-sized exporters. Under the Uruguay Round

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SARATH RAJAPATIRANA ✜ 21

agreement, many of these subsidies granted by countries to their domestic producers must be phased out. Developing countries have an eight-year time horizon for phasing out subsidies; developed countries have a five-year time horizon to do the same. Irrespective of the country in which they occur, such subsidies distort trade regimes and hence prevent the best allocation of resources worldwide. A bias against exports arises from the prevailing import protection, and it cannot be corrected through export subsidies without incurring additional costs. Many countries do not appreciate the presence of the bias (Clements and Sjaastad 1984). Part of the problem can be traced to the attempt by countries to follow the “Japanese-Korean model” espoused by the revisionists, which delayed import liberalization for a few years until export success was achieved. This view presupposes that import tariffs do not harm exports, that a period of import protection is not only harmless but necessary, and that there are clever bureaucrats who can implement a system of targeted export subsidies efficiently and can be immune to corruption in the bargain.2 Recent research and observable experience in East Asia confirm that a sequence that neglects import liberalization has led to lower total productivity growth in Japan and Korea (Beason and Weinstein 1996; Lawrence and Weinstein 1999). Fourth, although many developing countries have reduced tariff barriers and QRs, they have begun to use antidumping on a wide scale. Of the countries in the twenty-country sample, Argentina, Brazil, and Colombia have increased their antidumping initiations. Interestingly, antidumping duties have been imposed within RTAs as other barriers to trade have been reduced. In their increased use of antidumping, developing countries are beginning to imitate developed countries. Australia, the European Union, and the United States have led the way in the use of antidumping, which has become the weapon of choice for protection. The Uruguay Round left antidumping open to abuse, even though the round did tighten the circumstances in which it could be used. One irony is that some countries that did not have antidumping, countervailing-duty, or safeguards laws have introduced them in the 1990s following the Uruguay Round and have begun to use them as protectionist devices. Colombia, which had strict antidumping and safeguard laws, made them less stringent after the Marrakech Agreement of June 1, 1994. In general, it has become easier for countries to initiate antidumping and safeguards actions (Rajapatirana 1998).

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22 ✜ TRADE POLICIES OF DEVELOPING COUNTRIES

Finally, the increasing number of RTAs is an important feature of trade regimes in the 1990s. Their number has quadrupled since the 1970s. Just over one hundred regional trading agreements have been notified to the WTO as required by GATT and now WTO rules. Some agreements are not formally notified to the WTO; they are established outside the standard rules for regional integration, under the enabling clause of 1979 (part 4 of GATT), which confers a special concession to regional agreements formed among developing countries. The character of RTAs has changed since the 1960s and 1970s when they were conceived as protectionist devices. In the 1990s, they have become devices that can restrict trade—not deliberately, but because of the sheer difficulty of implementing them. The main problem arises from the rules of origin usually found in free-trade agreements. To give one example, Bolivia has signed twenty-eight regional agreements with a variety of rules of origin; they give customs officials wide discretion in classifying imports, and they provide wide opportunities for corruption and rent seeking.3 All RTAs have the potential for trade diversion—trade that is generated due to cost differences arising from the concessions exchanged, rather than from genuine differences in the costs of production and transport. Such trade diversion is welfare-reducing.4 Issues Arising from the International Trading Environment The international trading environment has become more important to developing countries than it was in the past. Reductions in transport costs, the increased participation of developing countries in global trade, the opening of developed-country markets (as well as those of developing countries), and increased private foreign direct investments in the countries have led to the phenomenon now universally acknowledged as globalization. It has coincided with, and contributed to, the liberalization of trade policies in developing countries. Moreover, the increase in private foreign direct investment has created many investment and production activities that can, and do, move across borders with much greater ease than before. The comparative advantage that determines the investments has a thin edge. Since technology diffuses rapidly, and capital markets are closely integrated, the variance in costs across countries tends to decline. This decline increases the sensitivity of domestic trade and investment regimes to the international trade and investment environment.

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SARATH RAJAPATIRANA ✜ 23

While developing countries were engaged in reform in the period 1985–1996, several changes occurred in the international arena that are of great importance to the countries’ future role in the international trading environment and to their trading relationship with the developed countries. The first is a growing concern in developed countries that the greater penetration of exports from developing countries would reduce real wages in the industrial countries; this has led to a clamor that labor standards be imposed on developing countries. Second is the movement in developed countries to impose environmental standards on developing countries—to harmonize the standards and to prevent an alleged “race to the bottom” in setting and observing them. Third is the concern in developing countries about the fulfillment of undertakings that developed countries gave in the Uruguay Round, in particular with respect to textiles, clothing, and agriculture. And fourth is the developing countries’ concern about the increased use of antidumping and countervailing duties against their exports. The United States and the European Union have espoused labor standards, some of which are already recognized—such as the International Labor Organization (ILO) rule against the use of prison labor for economic activities. In 1998, the board of the World Bank resolved to include labor standards as a condition in approving loans, and labor unions have strongly encouraged developed countries to take an interest in the standards. In the United States there is a fear that rising imports from developing countries will drive down the wages of unskilled labor. In Europe the fear is that exports from developing countries will increase unemployment levels, which are already high. Some groups in developed countries call for labor standards on moral grounds: they argue that the absence of standards leads to child labor and paltry wages for unskilled labor. Thus, the interests of those who favor labor standards on moral grounds to support high wages in developing countries converge with the interests of those who want to protect their real wages by keeping out laborintensive products. Studies in the United States show that imports from developing countries have had very little impact on the wages of unskilled labor. The reason the wages of unskilled labor fell in the 1980s and have been stagnant in the 1990s is technological change (Krugman and Lawrence 1993). In fact, Bhagwati (1998) believes that free trade has had a moderating influence on the decline in real wages of unskilled

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labor, because trade leads to the more efficient use of unskilled labor in the United States. The introduction of labor standards in developing countries will create a bias against the exports of developing countries and will prevent both developed and developing countries from realizing the full gains from trade. Moreover, if labor standards were formally introduced into international trade rules, they could easily deteriorate into a protectionist device, with trade unions lobbying to raise the standards over time. And yet, ignoring the issue of labor standards may lead to a worse outcome. It is true that free trade might be harmful to the real wages of unskilled labor, but protection is no solution: it will make everyone, including unskilled labor, worse off. In addition, it will undermine United States leadership, which has been an important factor in the liberalization of trade worldwide. Thus all could lose as a result of protections for unskilled labor in the United States. This is not to argue that the welfare of unskilled labor is not important, but merely to point out that trade measures are not the appropriate means to assist unskilled labor. The proper forum to address labor issues is the ILO, rather than the WTO. But the better solution would be for each country to determine its own labor standard through its political process. In this context, the failure of the Seattle ministerial to launch a new round of trade negotiations was particularly disappointing, for it was at least partly due to the present United States administration, which wanted at the last minute to appease trade unions in an election year by insisting that labor standards become an important issue for a new round. In the previous two ministerials and in the meeting of trade ministers of Latin America, developing countries have argued against the inclusion of labor standards as an agenda item for a new round of multilateral trade negotiations. Like labor standards, environmental standards have become a salient issue on the agenda of developed countries. In the United States, for example, lobbies led by the Sierra Club, among others, have begun to influence policymaking. Environmental standards become an international trade issue when economic activities have cross-border environmental effects; if they are confined within the borders of a country, they can be addressed through domestic regulation rather than through international trading rules. Domestically, the issue is one of identifying both positive and negative effects of the actions of firms on the environment—the positive and negative externalities as commonly defined by economists—and devising a system

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SARATH RAJAPATIRANA ✜ 25

of subsidies and taxes to address the positive and negative externalities respectively. With such a subsidy and tax scheme in place, along with a free-trade regime, countries have two instruments that they can deploy to achieve two targets. The deployment of these two different instruments to achieve the two goals sought—free trade and a clean environment—leads to much better progress toward both goals than use of the trade instrument alone. Trade policy will not serve either goal well, but it will prevent developing countries from specializing in labor-intensive products and thus will harm developing countries, which are much less responsible for global environmental problems than are the developed countries. Additionally, global trade issues are unsuited to deal with domestic environmental problems; in most instances, proper domestic policies (such as tax and subsidy policies) will also minimize global environmental problems. The environmental lobbies join those demanding the harmonization of environmental standards across countries. Such harmonization is conceptually flawed to begin with—and, in addition, environmental standards, like labor standards, could be captured by protectionist interests. Harmonization attempts to equate costs across countries. But resource endowments differ among countries. For example, the costs of reducing carcinogens through a capital-intensive technology will be high in a developing country, while a labor-intensive technology for the same purpose would cost less there. Additionally, tastes can differ among countries. One country may rank reducing water pollution as of greater importance than reducing air pollution. Developed countries are greater polluters than developing countries, given their larger use of natural resources, so they may end up having to pay more than developing countries to reduce pollution. Given the different supply (endowments) and demand (tastes) conditions, the costs of reducing pollution differ across countries. Harmonization that attempts to equate the costs does not work. And if it should work (by accident), the basis for trade is removed. Hence, policies that try to harmonize environmental standards deny countries their gains from trade, irrespective of their level of development. Empirical research on Latin America shows that liberalized economies have less pollution than those with restricted trade regimes (Birdsall and Wheeler 1993). One reason is that the machinery used for production in liberalized economies is more up-to-date and pollution-reducing than older machines that do not incorporate the new pollution-minimizing technology. In addition, a liberalized

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trade regime is apt to use more price-oriented approaches to dealing with a problem like pollution and to employ the “polluter-pays” principle. Developing countries worry that obligations entered into by developed countries, related to the Uruguay Round, may not be fully met. Laws relating to these obligations may be passed in developed countries, but the actual implementation may not take place. The developing countries’ concern in this regard centers on implementation of the Textiles and Clothing Agreement, on protection for agriculture, and on the increased use of antidumping and countervailing-duty actions by developed countries. The Textiles and Clothing Agreement brought the Multifiber Arrangement under GATT-WTO discipline and was intended to end a system of bilaterally “agreed” quotas with developing countries. Bringing textiles and clothing under WTO scrutiny is a major achievement, but the benefits that developing countries will reap from this change will be delayed. The liberalization of trade is to take place in four stages, and only in the last stage, in the year 2005, will trade be completely liberalized. Meanwhile, the items that are being liberalized by developed countries are those that are least competitive (i.e., very low value added textile and clothing items), and the gains they may bring to developing countries are therefore limited. In addition, developed countries are using the transitional safeguard measures provided under the agreement to keep developing countries from the competitive export of textiles and clothing. The Textile Monitoring Body created to supervise the implementation of the agreement suffers from the old GATT problem of acting only in consensus, which means that the implementation of the agreement is slow and countries are not subject to any sanctions if obligations are not met.5 The Uruguay Round also caused agriculture to be brought under international trade discipline. To begin with, domestic subsidies and quantitative restrictions were “tariffied” at high rates, which led to an increase in the protection of agriculture after the Uruguay Round. It is true that agriculture was liberalized to the extent that prices were substituted for nonprice restrictions such as QRs. However, the trade gains from that liberalization are far from being realized. Agricultural liberalization will lead to gains for exporters from developing countries and losses (through terms-of-trade effects) for the importers of agricultural goods in developing countries. But all will gain in the long run, as the world’s resources are better allocated.

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Meanwhile, developed countries have been using the special provision of tariff quotas to continue protecting agriculture in areas where there could be further liberalization. The Uruguay Round allowed the gradual reduction of protection in agriculture through the use of tariff quotas. Countries are allowed to apply temporary quotas to a part of their imports within a given commodity group, and the quotas are reduced over time to allow tariffs to determine the level and composition of imports. Since many developed countries carry over unfulfilled quotas across commodity groups within agriculture and from one year to another, the liberalization of imports of agriculture is delayed further. While this is not WTO-illegal, it is against the spirit of liberalizing agriculture trade. Moreover, agriculture subsidies persist within the “green box” category (those allowed under environmental grounds) and lead to the persistence of agriculture protection. Developing countries are concerned that these measures amount to trade protection rather than environmental protection. Developing countries also protect agriculture, as we have seen above. There is no reason for them to have a special concession, apart from the longer period of time they have been accorded to end all export subsidies, including those for agriculture. Though they seem not to use the “green box” category, developing countries retain high levels of protection for agriculture. A final issue of concern to developing countries is the increased use of antidumping and countervailing duties against their exports in developed countries. Goods produced in developing countries tend to be labor-intensive; marginal costs are therefore a large proportion of their average costs. Productivity enhancements and shifts away from labor-intensive production processes can yield reductions in marginal costs for developing countries, but antidumping measures are often invoked to challenge such reductions. Developing countries are therefore particularly vulnerable to accusations of dumping; this is especially true because of current WTO law and procedures for calculating “constructed costs,” under which it is relatively easy to allege that there has been dumping even when dumping has not occurred. In addition, incentives exist for a country that is bent on imposing antidumping duties to construct costs that will support its case and that will lead to a finding that dumping has indeed occurred. The initiation of antidumping actions of itself has a protective effect, because dumping duties can be imposed while a case is pending. Moreover, developing countries lack the human and financial

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resources that are required to challenge antidumping actions. They may agree to reduce exports in lieu of a continuation of antidumping actions. A similar situation holds for countervailing duties, even though it may be difficult to show that a public subsidy has been involved in the production and export of a good. Developing countries themselves have begun to imitate developed countries in the use of antidumping, and the practice has now become more widespread than ever (Guasch and Rajapatirana 1998). Extending the Trade Reforms of the 1990s The foregoing concerns help to shape agendas, both domestic and international, that will affect how developing countries carry forward the trade liberalization of the 1990s. The Domestic Agenda. Let us begin by citing the actions to which developing countries should assign priority on their domestic agendas. 1. They must reduce protection toward the level of Chile. A 10 percent uniform tariff would be ideal and would be within reach of the majority of the developing countries. Reducing variance in protection is as important as reducing the level of protection, for wide variances interfere with resource allocation. There is now evidence that the reduction of tariffs, when combined with a devaluation and the replacement of QRs with tariffs, does not lead to a reduction in tariff revenues in most cases (the loss of revenue is a common reason given by developing countries for not reducing tariffs). As a first step in reducing tariffs, countries need to consider reducing the bound rates to applied tariff levels and replacing QRs with tariffs. There is also little justification on balance-of-payments grounds to impose QRs (GATT article 19), for the simple reason that they do not work. Instead, they lead to inefficiencies and rent seeking. Only a regime based on tariffs can ensure that variance in protection is kept within known limits. In both these moves, namely replacing QRs with tariffs and reducing the variance in protection, the average level of protection could remain the same; such moves are easy to accomplish and send a signal to economic agents that a country is on the path of reform and that its protection levels have become predictable. It is noteworthy that, despite the East Asian crisis of 1997, Korea and Indonesia have not introduced new trade restrictions. Instead, they have resolved to reduce protection in the near future. Some countries (Argentina, Brazil,

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India, and Thailand) did increase protection when they confronted negative shocks in 1994 and 1997. The increases have been relatively small and have not changed the character of their trade regimes. 2. New evidence confirms that reducing barriers on the export side while maintaining import protection does not realize the full benefits of a trade liberalization (Lawrence and Weinstein 1999). Imports provide an efficient and significant channel for learning and for acquiring technological knowledge. Before the Uruguay Round, there were no strong strictures against export subsidies. That allowed countries to liberalize on the export side while maintaining import restrictions. This alternative may not be available in the future, given the challenges to export subsidies through countervailing duties and the dispute-settlement mechanism. While developing countries have been given eight years (as compared to five years for developed countries) to eliminate export subsidies, the longer the subsidies remain in place, the longer the misallocation resulting from such subsidies will persist. 3. As noted earlier, antidumping has increased in the 1990s, and developing countries have begun to use it more than ever before (although the main users of the measure are still developed countries, led by Australia, the European Union, and the United States). Argentina initiated fifteen antidumping cases in 1997, Brazil eleven, India thirteen, Korea fifteen, and Malaysia eight, as reported to the WTO (WTO 1998). Except in the case of predation—and there is little or no opportunity for predation today—there is hardly a sound economic argument to be made in favor of antidumping. As a temporary measure, safeguards are certainly preferable, given that they are imposed on a most-favored-nation basis. Safeguards are timebound and subject to a stricter procedure for initiation. Developing countries could adopt safeguards in place of antidumping. 4. The best way to minimize trade diversion within RTAs is to lower tariffs on nonmember countries, to keep those arrangements open to new members, and to move toward common markets rather than free-trade areas. In theory, common markets do not require rules of origin, because they rely on a common external tariff. However, many common markets have used differential rules of origin as temporary measures until they reached agreement on common external tariffs. To that extent, the adverse effects of rules of origin are found in common markets too. There is also the danger that the need to agree on a common external tariff could lead to higher tariff rates than

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an individual country would be willing to adopt on its own. In addition, further liberalization becomes more difficult if the stronger members of the common market resist it. A short-term palliative for regional arrangements is to adhere to article 24 and to avoid use of the “escape clause” under which developing countries are exempt from article 24 provisions. The International Agenda. If the full benefits of unilateral trade liberalization are to be realized, four issues in the international trading environment, as it affects the trade policies of developing countries, need attention. The issues are difficult because they are at the heart of the political economy processes at work in developed countries. 1. It would indeed be a step backward for the liberalization process to introduce labor standards into international trade rules. Labor standards could be handled through the ILO, which has the responsibility to ensure that the more egregious practices, such as forced and prison labor, are not used. Prohibiting child labor may mean greater deprivation, and even starvation, for children. The better way to help poor children is to supply poor countries with the resources they need to ensure at least minimum levels of education and health for the children. That approach serves both free trade and the children’s welfare. 2. The optimal policy for dealing with the environment is to employ two instruments to achieve two goals. Free trade can be compatible with a clean environment through the use of domestic regulations that make polluters pay. Where there are cross-border pollution issues, the best solution is market-based and requires polluters to buy permits or pollution “rights.” Those rights can be bought and sold to create a market—an international analogue of the domestic “polluter-pays” principle. The real problem is how best to allocate pollution permits. The permits must be given to those countries that have had low pollution and have not consequently “used up” their “quotas” of pollution, as developed countries have. Developing countries could become sellers of the permits, and developed countries the buyers. Developing countries argue for allocation on the basis of population; developed countries, on the basis of income level. Such differences should be resolved through negotiation. Witness the allocation of special drawing rights (SDRs) in the 1970s, when the principle of combining population, income level, and trade openness was used to

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distribute SDRs among the countries. A similar approach may be used to construct “pollution balance sheets” on a consistent set of principles: countries that have already used up a part of their quota will get less than those whose use has been limited. This approach would require a round of negotiations and compromise. The main point here is that the exercise must not be related to trade rules. The United Nations Environmental Program, not the WTO, is the appropriate forum to negotiate and to implement allocation principles for pollution permits. 3. Three ministerial meetings on the implementation of the Uruguay Round have already taken place. The third ministerial meeting, which took place in Seattle in late November 1999, turned out to be a debacle. This was largely due to the Clinton administration’s last-minute sop to labor unions and environmental lobbies. That action helped protectionist forces to gather strength and to resist the call for a new round of multilateral trade negotiations to carry forward the agenda identified at the end of the Uruguay Round and in the earlier two ministerial meetings. These two ministerials had created a process to analyze and exchange information on implementing the Uruguay Round and to identify items for a new round. That process would be the proper forum in which to discuss the Textiles and Clothing Agreement and to handle some of the problems that have arisen with the implementation of the agreement (such as the transitional safeguard provisions and the inappropriate use of the tariff quota system that was intended to ease implementation). The differences between the developed and the developing countries can be reduced by undertakings to be made by both sides. After all, both sides protect their textile and clothing industries. A similar approach will benefit agriculture. The Uruguay Round left agriculture protection even higher than it had been. The analysis and information-exchange process has already led to some discussion of how best to proceed. The goal is clear: to reduce agriculture protection to a level similar to that of manufactures, sooner rather than later, so as to reap sooner the benefits of reduced protection. To be sure, views will differ, even among the developing countries, because of the different interests of the exporters and the importers of agricultural goods. Nevertheless, a negotiation would identify those differences and would build coalitions across countries and interest groups to reduce protection. The Cairns Group (a group that met in Cairns, Australia, comprised of both developed and developing countries,

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including Australia, the United States, and Argentina) was singularly successful in getting agriculture onto the Uruguay Round agenda. The same group could repeat its success with an expanded membership. 4. The increased use of antidumping and countervailing duties demands attention. The WTO rules have to be tightened with respect to calculating the costs of production and closing the current loopholes. But the main improvement would lie in replacing antidumping with safeguards and in tightening the rules for the measurement of public subsidies to limit countervailing actions. Here again, the ministerial meetings could be used to highlight the problems, and the analysis and information-exchange process could bring the issue before the next round of multilateral trade negotiations. To resolve many, if not all, of the foregoing agenda issues (both domestic and international) would require a new round of multilateral trade negotiations, notwithstanding the failure of the Seattle ministerial meeting to launch a new round. Such a negotiation would bring trade issues to the fore again and would provide opportunities to address, for example, lowering of the levels and variance in protection; eliminating export subsidies earlier than promulgated by the Uruguay Round; reforming antidumping and countervailing-duty rules; changing the law with respect to the “escape clause” in RTAs; evaluating labor and environmental standards; and completing the Uruguay Round issues that affect the continued protection of textiles, clothing, and agriculture. In addition, a new round of negotiations should discuss topics that go beyond the “built-in agenda” of the Uruguay Round and are of particular interest to developing countries because they are matters in which the developing countries enjoy a comparative advantage. Some leading developing countries, such as India, have argued that a new round is not warranted until the Uruguay Round agreements are fully implemented (Hedge 1998). They are the very countries that were initially less than enthusiastic about the Uruguay Round. But to delay multilateral trade negotiations is to delay the achievement of higher growth and living standards through further trade liberalization. Conclusions Trade regimes in developing countries were more liberal in the late 1990s than at any time since World War II. Yet theoretical and empirical work on trade in the 1990s reveals that the benefits would be

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greater still if developing countries maintained more-liberalized trade regimes than they now do. Developing countries would do well to reduce protection and its variance, to rely on tariffs, to avoid imitating the protectionist stance of developed countries in their use of antidumping and the continued protection of agriculture, and to embrace most-favorednation–based trade over regional arrangements. Beginning a new round of multilateral trade negotiations sooner rather than later would best serve the agenda for reform. The negotiations would facilitate further liberalization and would allow developing countries to realize their objectives in many of the areas of interest to them. In the 1980s and 1990s, the macroeconomic crises that many countries experienced were the principal stimulus to reform, and both theoretical and empirical aspects of the political economy of reforms support a crisis-driven hypothesis. But crises are not an efficient way to generate reforms; hence the need for an external impetus, such as multilateral trade negotiations. Country-tocountry or multilateral negotiations do not generate optimal outcomes, for they may be confined to limited sectors. Even multilateral trade negotiations limited to a few sectors would not be optimal, because they would advance the trade interests of only the more-powerful countries, which would take the opportunity to “cherry pick” from an agenda the items that might not be as beneficial to developing countries. As soon as developed countries accomplished their goals through this process, they would be unwilling to negotiate measures to reduce barriers in areas of interest to developing countries. Of course, developing countries could liberalize their trade regimes unilaterally—and some have already done so. (Chile is the prime example.) That strategy remains the best option for developing countries. But multilateral trade negotiations, such as the proposed Development Round or Millennium Round (whatever the politicians choose to call it), would allow developing countries to make gains over and above those of unilateral trade liberalization, and would allow them greater latitude as well in addressing items of interest to them. Further, such negotiations would help to check domestic protectionist interests, which may resist further liberalization. Multilateral trade negotiations are a more efficient mechanism than crises to induce reforms, because the give-and-take of the nego-

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tiations, if properly conducted, allows all parties to benefit, and to a greater measure than any one of them could achieve unilaterally. The failure at Seattle should be seen as only a temporary setback, and it should not be allowed to spoil the case for a new round.

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Notes

1. Exchange rates in CFA (francophone) countries are fixed to the French franc. The countries have access to foreign exchange resources from the Bank of France to meet balance-of-payments deficits and are subject to rigid rules of monetary and fiscal conduct in exchange for this access. 2. This view is attributed to Amsden, Wade, Lall, and others, as well as to the World Bank’s East Asian Miracle study (1993). 3. The extent of the choices can be gauged by the fact that, with some 7,200 tariff lines, twenty-eight different agreements with different rules of origin, and three phases of implementation, the theoretical choice set exceeds 600,000! While a yard of cloth cannot be classified as a live animal, the set remains large enough to give great discretion to customs officials. 4. Yeats (1997) demonstrated that trade diversion was likely in the automotive sectors in the Mercosur agreement. 5. Of course, developing countries cannot be fully absolved of their conduct. Textiles and clothing are the among the most protected goods in developing countries, however much they have liberalized their trade regimes.

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About the Author

SARATH RAJAPATIRANA is a visiting scholar at the American Enterprise Institute. He joined AEI after a long and distinguished career at the World Bank. His latest book (his sixth) is Liberalization and Industrial Transformation in Sri Lanka (written with Premachandra Athukorala), published by Oxford University Press in 2000.

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