Trade Policy at the Crossroads: The Recent Experience of Developing Countries Author : Mehdi Shafaeddin

Publisher : Palgrave Macmillan

ISBN : 978-0-333-59559-6

About the Book

Analyzing the experience of developing countries in recent years and the deadlock in trade negotiation in WTO, the author argues that the theories and practices of trade and industrial policies are surrounded by a number of fallacies: that universal and across-the-board trade liberalization is to the benefit of all developing countries, irrespective of their level of development; that the Invisible Hand of free market alone is conducive to industrialization, that the infant industry argument is against export expansion; that developed countries industrialized without government intervention; that WTO rules are conducive to development.

About Author

Mehdi Shafaeddin is a development economist with D.Phil from Oxford University, UK. He is in charge of the Macroeconomics and Development Policies Branch, Globalization and Development Strategies Division of UNCTAD. He has extensive experience at national and international levels as a researcher, university lecturer and trainer. He has published a large number of articles on trade and industrial policies, economic reform, development of oil exporting countries and other development policy issues.

Book Review

by Amitayu Sengupta

This recent book by Mehdi Shafaeddin is a detailed study on the contemporary issues regarding international trade. The neo-liberal policies endorsed by the IMF-World Bank through the Structural Adjustment Programmes and other policy prescriptions propose an open trade policy as the panacea for all problems of the developing countries. The counter arguments from the alternative schools of thought point out the pitfalls of such policies, based on the fallacies of the economic arguments in favour of such policies. The book, written in this context provides a detailed analytical study of all the points of debate with meticulous empirical evidence for the arguments put forward.

The book has nine chapters (including an introduction and a conclusion), each delving into the various issues of the broader debate.

The first chapter, the introduction, gives a detailed historical study of the debate. It provides a brief summary of international events that led to the present context, and traces the evolution of the various schools of arguments that give shape to the issue today. In this regard, the author traces the arguments from Adam Smith’s An Enquiry In The Nature And Causes Of The Wealth Of Nations to the more recent arguments of Prebisch, Singer, Kruger and John Williamson, whose proposals were labelled subsequently as the ‘Washington Consensus’. All the arguments are beautifully traced in different phases, contextualising them with respect to the international scenario to better explain their evolution. The chapter elucidates the conceptual differences between the various economic terms like ‘trade liberalisation’ and ‘export promotion’, ‘trade liberalisation’ and ‘liberal trade policy’, ‘outward looking’, ‘inward looking’ and ‘export promotion’ and ‘import substitution’, thereby highlighting the fallacy often committed in interchangeably using the terms. The first chapter thus sets the background for the subsequent analytical study that follows.

The second chapter, titled ‘Growth and Diversification’ looks into different aspects of the two concepts. The relationship between these two economic concepts and the causality has been interpreted differently by the neo-classical and the alternative school of thought, thereby giving rise to differing conclusions regarding policy prescriptions. The author briefly highlights this matter before going into an empirical study of the same. The data consists of a sample study of selected developing countries for the period of 1990s as this is the period when “reform was intensified in most countries”. 1989-91 is taken as the base period for the study. The sample countries have been selected on the basis of three criteria in order to cover countries which have a certain degree of industrial base and manufacturing export capacities. The first criterion is that exports of manufactured goods exceed, on average, $90 million, taking into consideration that these exports include re-exportation (for example, repairing machineries). The second criterion is that, in the base period, the share of manufactures products in exports and GDP is greater than 10% and 5% respectively.. However, some low income countries that did not fulfil these criteria were also included for better comparisons. The samples cover countries from Latin America, Africa and Asia. The study looks into the structural changes that have resulted in these countries due to the new economic policies implemented and whether this has led to any increase in the vulnerability of the economy. Special focus is given on the process of upgradation of the respective export structures in these countries and its’ fallouts in this regard. The case of Latin America is given special focus given the fact that Maquila trade of this region is often cited as a success story of developing manufacturing base through trade liberalisation by neo-classical economists. Special focus is also given on the effects of Structural Adjustments in African regions (with special attention on Ghana) since their experiences were quite in contrast to the Latin American phenomenon. The issue of de-industrialisation as a fallout of liberalisation too is dealt with in this chapter. The chapter concludes that slow growth of exports and increased de-industrialisation has resulted along with increased vulnerability given higher import dependence in the majority of the 46 countries studied. For the NIEs of East Asia, trade liberalisation was followed gradually and selectively, as an integral part of a long term industrial policy. Expansion of supply capacity was stressed on by these countries before opening up the industries. Consequently these countries reaped the maximum benefits of trade liberalisation. In contrast, majority of the countries (especially African countries) embarked on a rapid across-the-board trade liberalisation, which resulted in “development and re-orientation of the industrial sector in accordance with static comparative advantage with the exception of industries that were near maturity”. In fact, across the board it is seen that those industries that were ‘near maturity’ before liberalisation benefited from the process. In case of the African countries like Ghana, liberalisation failed to increase production and export capacity instead leading to massive de-industrialisation, as a result of which these countries have been reduced to depending on exporting primary commodities and simple processed products.

The third chapter titled ‘The Impact of Reform on Investment’ takes on from where chapter 2 ends; and that is to answer the question ‘why did the liberalisation process not bring in the kind of changes that it was supposedly meant to?’ The answer lies in the difference in investment patterns that liberalisation essentially entails. The first section of the chapter attempts to provide an understanding of the interrelations between investment and exports. The second section carries on with the empirical analysis on this issue. For countries in a very nascent stage of industrialisation, the role of investment is essentially to establish and develop the industrial base. However, for a more mature economy, structural changes in the industrial base are important “for responding to, or creating, new opportunities in international markets”. The author also points out that growth of exports can have positive effects on investment through ‘income effects’ ‘supply effects’ and ‘vent for surplus effects’. However, under certain circumstances there maybe a supplementarity between exports and investment, for example, if material inputs and resources are diverted from the investment sector to exports or “if ‘supply effects’ of export are not present due to ‘import compression’ needed for payment of debts”. The author concludes that “the impact of investment on growth of supply capacity depends not only on the rate of investment (I/GDP ratio), but also on the structure of investments, its allocative efficiency and X-efficiency, i.e. efficient utilisation of the installed capacity. …hence a reform programme and trade liberalisation succeeds in accelerating growth of total output/or output of a sector, if it achieves, inter alia, greater I/GDP ratio, a ratio beyond what would have been otherwise attainable, or makes the structure of investment more conducive to growth and development”.

In the context of this background, the author then goes on to the empirical analysis. The overall levels of investment in all the sample countries are first looked into. Detailed break-ups in terms of functional and sectoral allocations of such investment, distinctions between private and public investment, distribution of all investments amongst the different manufacturing industries are eventually studied to get a deeper understanding. Changes in investment (in terms of patterns) due to structural reforms and changes in market structure are critically examined; the latter distinguishing between the impact of TNCs in the domestic economy and the manner in which domestic firms responded to the reform policies. A special study of Brazil is done in the latter part of the chapter. The chapter concludes that “investment, rather than exports, has been the main contributing factor to the expansion of industrial activities. In the countries where reform was guided by the ‘Washington Consensus’ and/or SAPs, the structural reforms had negative impact on domestic investment, at the early stages of reform”. It is noted that TNCs (particularly in Latin America) are mainly interested in purchasing existing plants and services that fit into their international production network, namely resourced based industries and assembly operations, instead of Greenfield investments. Their contributions to technological upgradation have so far been negligible. The author further reiterates that countries where some industrial base was developed under import substitution policies need some competitive pressure to make them viable in the international market, but open market policies render them helpless in the face of sudden and unequal competition, increase investment risks and adversely affect profit motives.

The author then goes on to study some basic concepts in international trade, discussing the different points of those arguments.

The fourth chapter titled ‘Market and Government’ looks into the apparent contradictions between the two. While neo-classical economists argue that free market is the key to efficient allocation of resources, their detractors point out the different forms of market failure for a conclusive case for government intervention. The author here deals with the issue in detail. First, the key problems of the developing countries are discussed, and then the various limitations of the market and its different inadequacies are addressed. The issue of ‘market failure’ is studied extensively identifying its main causes. The product market and labour markets are studied separately and the emerging trends occuring as a result of reforms are traced through historical evidence. The theoretical aspects of the debate too are discussed in detail. The issue of external economies is also referred to in this regard. The issues of government failure and the various counterarguments are posted next. In the conclusion the author argues that most of the economists pit the market vis-à-vis the government as different alternatives. Instead, the author suggests they should be treated as complementary to each other as proposed by the likes of Arnd, Shapiro and Taylor, etc. This third alternative is explained in expanse, where the government plays the key role in shaping the economic institutions of the country and providing the launching pad for the domestic industries, while the market plays the role of providing the incentive structure for such development in accordance.

The fifth chapter of the book, titled ‘Universal Trade Liberalisation’, looks into some of the theoretical fallacies of the argument. The introduction and theoretical background sections give the basic premises of the argument. The next section elucidates the unrealistic assumptions on which the argument is based. Issues like perfect competition, increasing returns to scale, risks and its different implications, the case of full employment and similarities of countries are analysed theoretically in detail. A brief overview of alternative views on ‘comparative advantage’ as proposed by Cline, Amstden, Gomery, Baumol etc is given. The author finally concludes that “free trade should be the ultimate aim of all countries. Nevertheless, as long as countries are at different levels of development, one cannot expect that universal trade liberalisation as currently recommended would be beneficial to industrialisation and development of all developing countries. …Although some trade is better than no trade, free trade is beneficial to all participating countries in international trades only under certain restrictive assumptions”.

The sixth chapter titled ‘Infant Industry Argument and Import Substitution’ traces the theory in depth. It gives the background and its’ origin as expatiated by List elucidating the justifications for the same. The different modalities of protection and the basic features of an infant industry are laid out next. The issue of the market size is dealt with separately as a different section. The concept of ‘Import Substitution’ as proposed by Raul Prebisch is discussed in detail where the various misinterpretations of the theory are succinctly pointed out. In the conclusion the author raises the question whether the infant industry argument is still valid in today’s context. His opinion is that the “argument as developed by List, within the context of its general theory of ‘productive power’ is still valid if properly applied”. However the author reiterates that the original theory stated clearly that trade should be liberalised selectively aiming at the ultimate goal of free trade given all countries reach the same level of development.

Chapter seven titled ‘History of Trade and Industrial Policy’ looks into the history of the development of manufacturing industries in the major industrialised countries. The chapter aims to establish two points: “no developed country-city states are excluded-has developed its industrial base without prior infant industry protection…..” and second, “in the process of industrialisation and export expansion, functional and selective government intervention has been an important factor”. This chapter studies the development of Great Britain, laying stress on its industrial and trade policies throughout history in order to explain how it has reached the current state that it is in. However, in this regard, the role that the colonies played in Britain’s development is underplayed in this study. The development history of USA is also studied next with a detailed account of government interventions at different points of time in this process. The cases of Germany and France too are mentioned in the study in a separate section. The author also makes a comparison of recent trade liberalisation with that of the nineteenth century. The chapter concludes by suitably substantiating the two moot points that it laid out at the onset.

Chapter eight titled ‘The World Trading System and Industrialisation’ is a detailed study of the GATTS and WTO. It lays special emphasis on the contradictions of these two bodies, dealing separately with the different sectors under WTO negotiations such as agriculture, textile clothing and footwear, highlighting the discrepancies that have led to numerous controversies surrounding the WTO as a whole. The chapter highlights how these trade agreements limit the policy space for developing countries thereby encroaching on their autonomy in developing their industries. It also points out how developed countries have openly flouted certain rules and regulations that are binding under the agreement. In this regard the issue of dumping, especially in the case of the cotton controversy is stated in detail. Through these issues, the differential treatment meted out to developing and developed countries is highlighted.

The final chapter titled ‘Concluding Remarks: An Alternative Approach’ sums up the arguments of the previous chapters. It draws the conclusion that trade liberalisation as practised today under the IFI aegis has been discriminatory and in fact detrimental for the developing countries, especially the LDCs. The reason for the same is stated to be the faulty design of the reforms programme. “Influenced by the orthodox approach, trade policy reform has been envisaged as synonymous with ‘uniform’ import liberalisation, applicable ‘universally’ to all developing countries; the levels of development, industrial base and special structural characteristics of individual countries were disregarded”. The author concludes that the general theoretical abstraction of all these arguments based on the theory of static comparative cost advantage is the major flaw of these theories. As an alternative, the author states that trade policy should be development oriented, with special attention on capacity building and industrialisation. In this process, the government has a big role to play. Even though the author accepts the risk of government failure, he, all the same, reiterates that given the fact that international market is not perfectly competitive, the market forces cannot guarantee proper resource allocations and incentives and hence the government has to play the role of the regulator in the process. He talks in length about developing the agricultural sector, identifying industries best suited for exports and gradual nurturing of the same, laying stress on factors like technological upgradation and learning capacity. He also suggests control over the activities of TNCs and finance capital in the developing countries in this phase of early development.

The book is an extensive study on the topic of choice, giving a detailed picture of the issue. The meticulous studies in all the chapters helps one get a comprehensive picture of the broader debate. The different theoretical debates and their backgrounds are well elucidated throughout the book. However the author downplays the political economy that has historically played a big role in shaping international trade. Moreover, the history of colonial rule that has shaped the divide between developed and developing countries is overlooked. This issue is of paramount importance in tracing the history of development of the different countries. Even in the present context, the viability of the alternatives suggested by the author is hinged on the political economy of the day.