G24 meeting warned of de-industrialization effects of NAMA talks

16 March, 2006
The proposals for cutting tariffs of industrial products in the World Trade Organisation's current negotiations will have significant adverse effects on developing countries' industrialization, according to a paper presented at the Group of 24 Technical Group meeting held in Geneva on Friday 17 March.

The Group of 24 is the largest developing-country grouping that operates in the IMF and World Bank.

'The application of the proposed Swiss formula (in the WTO's non-agricultural market access negotiations) has a significant detrimental long-term effect on industrialization of developing countries, besides their loss in government revenues,' according to Mehdi Shafaeddin, a development economist who was formerly head of UNCTAD's Macroeconomics and Development Policies Branch.

In a paper, 'Does trade openness favour or hinder industrialization and development?', Shafaeddin said the industrial sector of most developing countries is underdeveloped, thus they need to apply higher tariffs to some of their industries than developed countries.

'The low tariffs rates, as proposed by developed countries, will make them lose an important policy tool for upgrading their industrial structure. Further, binding of tariffs at low levels would not allow a developing country to raise them beyond a certain low level when it faces balance of payments problems.'

He said that the developed countries are pushing the 'trade liberalizationhypothesis' through the IMF and World Bank as well as GATT/WTO. In the Doha Round, they are pushing for universal and across-the-board trade liberalization of manufactured goods. It is proposed that all countries, with the exception of LDCs, apply the same formula to cut tariff rates on manufactured goods drastically and reduce their dispersion by binding 95% of their individual tariff lines at the same low rate.

The Swiss formula, approved in the WTO's Hong Kong Ministerial, implies that the higher the initial tariff rate, the higher the rate of reduction in tariff; the coefficient determines the maximum tariff rate possible under the formula; and the lower the coefficient, the higher the rate of reduction in tariff.

Although the choice of the coefficients of the formula is still subject to negotiation, Shafaeddin said, the proposals made by developed countries are not in the interest of developing countries. Initial tariffs for developing countries are well higher than that of developed countries. Therefore, they would be subject to significantly greater reduction in their tariff rates not only in absolute terms but also in percentage terms.

For example, if the EU proposal is approved, a tariff rate of 5% for developed countries will be reduced to 3.33% - a reduction of 33% or 1.67 percentage points. By contrast, a tariff rate of 60% for developing countries will be reduced to 8.8% - or a reduction of 85%, or 51.2 percentage points. For higher initial tariff rates, the new rate would not exceed the cap of 10%. This maximum rate will also apply to all unbound tariffs after tariff cuts and binding.

Shafaeddin said that trade liberalization is essential when an industry reaches a certain level of maturity, provided it is undertaken selectively and gradually.

'Nevertheless, the way trade liberalization is recommended under the 'Washington Consensus', it is a recipe for destruction of the industries which are at their early stages of infancy, or development, withoutnecessarily leading to the emergence of new ones.

'If through NAMA negotiations of the Doha Round, developing countries submit to developed countries to accept their proposed Swiss formula, with a low coefficient (10), and binding of their tariff lines at low levels, it would be at the cost of halting their industrialization process. The low-income countries and others at early stages of industrialization, in particular, will be trapped in production and exports of primary commodities, simple processing and at best assembly operation and/or other simple labourintensive industries.'

He added that a framework for 'development oriented' trade and industrial policies can be established, but its implementation would not be easily done without a fundamental change in the international trade rules.

'The current WTO rules are not conducive to industrialization and development. Developing countries should not submit to the 'blame game' of developed countries during trade negotiation; it is better to be 'blamed' for defending their policy autonomy to enhance their development than getting trapped in underdevelopment. Unfortunately, since the beginning of the Uruguay Round they have been in a slippery slope road. Any seriousattempt in changing the international trade rules begins with a change in perception.'

Shafaeddin said two categories of trade policy reform and liberalization has taken place in developing countries since early 1980s: first, a number of countries in East Asia undertook some trade liberalization as a part of their long-term dynamic trade and industrial policies; second, are countries (including many African and Latin American) whose trade liberalization was based on the 'trade liberalization hypothesis' designed by international financial institutions in the early 1980s.

The trade liberalization hypothesis (TLH) implies that trade policy reform is synonymous with trade liberalization. Further, as it is taken for granted that trade liberalization always leads to export promotion and rapid GDP growth, the hypothesis gives the impression that trade liberalization is an end per se rather than being a tool of development.

Shafaeddin argued that there is neither a theoretical justification nor historical and empirical evidence to support the TLH. The theory behind TLH is the doctrine of comparative cost advantage which cannot be used as a guide to caching up and achieving dynamic comparative advantage which is a policy-based effort.

Almost all successful industrializers went through a long period of selective infant industry protection before subjecting their industries to trade liberalization gradually. The forced trade liberalization imposed on the Third World during the colonial era led to their de-industrialization, specialization in primary commodities and underdevelopment.

On the basis of empirical study of a sample of developing countries which have undertaken trade liberalization during the last quarter of a century and the case study of Mexico, which has been the champion of liberalization, the author also makes the following conclusions:

level of maturity, provided it is undertaken selectively and gradually;

'Washington Consensus', however, it is a recipe for destruction of the industries at their early stages of infancy, or development;

submit to developed countries to accept their proposed Swiss formula, with a low coefficient, and binding of their tariff lines at low levels, it would be at the cost of halting their industrialization process;

industrialization, in particular, will be trapped in production and exports of primary commodities, simple processing and at best assembly operation and/or other simple labour intensive industries.

Shafaeddin added that the experience of successful early and late industrializers indicates that with the exception of the territory of Hong Kong, no country has managed to industrialize without going through the infant industry protection phase. While across-the-board import substitution and prolonged protection have led to inefficiency and failure, theexperience of developing countries which have undertaken across-the-board and universal trade liberalization has also been disappointing.

In all successful early and late industrializers, government intervention,both functional and selective, in the flow of trade and in the economy in general has played a crucial role. When their industries matured, they began to liberalize selectively and gradually. Premature trade liberalization,whether during the colonial era or in more recent decades, has been disappointing.

The evidence on the results of across-the-board trade liberalization by developing countries during recent decades is also disappointing. Cross-sectional and time-series studies have revealed no, or little, evidence that there was any statistically significant correlation between trade barriers or openness and economic growth in recent decades. Forlow-income countries, there is evidence that trade liberalization has led to de-industrialization, particularly in Sub-Saharan Africa.

A study by Shafaeddin on 50 developing countries found that all low-income countries experienced de-industrialization during 1980-2000. De-industrialization is not, however, confined to low-income countries. In fact, half of the sample countries for which the necessary data are available have faced de-industrialization during 1980-2000, including countries such as Brazil which had a considerable industrial base before liberalization of its trade regime.

Only a few countries (mainly East Asian) experienced export growth that was accompanied with fast expansion of industrial supply capacity (manufacturing value added) and growth of GDP and absorption capacity. The performance of the other countries was unsatisfactory in terms of growth of manufacturing value-added and GDP even when their manufactured exports expanded fast.

Contrary to the claim made by the international financial institutions, trade liberalization and structural reform programmes failed to encourage private investment, particularly in the manufacturing sector. The average Investment/GDP ratios for 2000/4 were lower in 30 out of 44 countries than their levels in 1979/81.

In the minority of successful countries (East Asian newly industrialized economies), trade reform took place gradually and selectively as part of industrial policy. They embarked on infant industry protection for import substitution in certain consumer goods, but quickly shifted their strategy by pushing some of these industries for export promotion. They eventually subjected them to gradual import liberalization.

At the same time, they established some other industries through protectionand eventually export promotion and followed the same procedures. In such a process, by following a mixture of import substitution and export promotion, protection and liberalization, they moved from traditional light consumergoods to intermediate and ultimately capital and technology intensive industries until they consolidated their industries.

Throughout the period, they used not only trade control measures, but also taxes, subsidies and stable, and when necessary under-valued, exchange rates as their policy tools. For them neither liberalization, nor protection was an end per se; they used them as means to industrialization and development. As far as liberalization is concerned, they embarked on gradual trade liberalization after an industry had reached a certain level of maturity and development.

By contrast, the 'majority group' embarked, in the main, on a process of rapid and across-the-board liberalization a la 'Washington Consensus'.

In another paper presented Friday, Rolph van der Hoeven and Malte Lubker of the International Labour Organisation argued that financial liberalization had effects on employment and incomes which often carry great disturbances for economic and social development.

The paper, 'External openness and employment: the need for coherent international and national policies' said that therefore financial liberalization warrants at least as much attention as trade liberalization.

The paper compares and weighs the potential benefits in terms of growth against the adverse effects of volatility and crisis that are frequently associated with financial liberalization, and in particular with debt and portfolio flows.

The authors stress the concern of the World Commission on the Social Dimension of Globalization that gains in trade and FDI run the risk of being set back by financial instability and crisis. They draw the conclusion that volatility in international financial markets is currently one of the most harmful factors for enterprises and labour in developing countries.

The paper also stresses the need for greater policy coherence between international and national financial, economic and employment policies, aimed at giving greater attention to employment and incomes.

Another paper by Kym Anderson of the World Bank addressed how government trade and subsidy policies affect exports and welfare in developing countries. Among the data provided was the effects that full liberalisationwould affect the cotton trade and production of developing countries.

If cotton tariffs and subsidies were eliminated, then in 2015 there would be a fall in the US of $4.7 billion in output, a fall in value added of $2.8billion and a fall of $3.5 billion in cotton export value. EU countries would have declines of $1.4 billion in output, $0.5 billion in value added and $1 billion in exports.

For Sub Saharan African countries, there would be increases of $2.2 billion in cotton output, $1.1 billion in cotton value added and $1.9 billion in cotton export value. Latin American countries would gain $1.2 billion in output, $0.6 billion in value added and $0.7 billion in export value. Other developing countries would also have gains of $1.8 billion in output, $0.4 billion in value added and $1.6 billion in export value.