Watch out NAMA : You are on a Slippery Sip Road of De-industrialization and Backwardness Mehdi Shafaeddin

Following the failure of the talks on NAMA and a number of other issues in WTO to conclude before the end of April, Mr. Lamy has warned that the price of the “failure” is high. I entirely agree with him that the “price of the failure will be high”, but my concept of “failure” is different from that of Mr. Lamy. He is referring to the “failure” to conclude an agreement. What I have in my mind is the risk of the “failure” by developing countries to fully appreciate that accepting the proposals made by developed countries on NAMA will put the majority of developing countries on the slippery slip road of de-industrialization. In fact, they will be locked in the production of primary commodities and simple resource-based and labour intensive products. Then the price of the failure will be extremely high for generations to come.

Having an agreement is not for the sake of an agreement; hence let it fail if it does not serve the objective of industrialization and development. The failure to reach an agreement will be success. Let me back-up my claim by some argument: the proposed formula …will tie hands of developing countries for ever in terms of flexibility in their trade and industrial policy; treats all developing countries, with little exceptions, the same way and puts all industries of any particular country in the same basket. These are recipes for “backwardness”, not progress. All it does is to facilitate the operation of translational companies-globalization not development. Let me explain further.

Although the text of the Hong Kong Declaration of December 2005 on NAMA is vague, since the beginning of the Doha Round, developed countries have been pushing for the trade liberalization in manufactured goods which has three main characteristics:

• Reduction of tariff rates across-the board, leading eventually to zero tariff rates;
• Reduction in tariff dispersion; uniformity of tariff rates; and
• Universal application: applying the same principal and tariff reduction formula to all countries irrespective of their level of industrialization and development- with some special treatment of LDCs for a temporary period.

Accordingly, it is proposed that all countries, with the exception of the LDCs, for a temporary period, cut average tariffs rates and reduce their dispersion and bind 95 per cent of their individual tariff lines at the same low rate. For example, the USA proposed cutting the tariffs to 8 per cent by 2010 and reducing them to zero by 2015. Certain sectors were proposed to be subject to zero tariffs immediately upon the conclusion of the Doha Round. The EU has suggested non-linear cuts in tariffs according to the Swiss formula, and a low and uniform coefficient of 10 chosen for both developed and developing countries. Further, EU has proposed a tariff cap of 15 per cent for developing and 10 per cent for developed countries for binding all industrial tariff lines.

The Swiss formula proposed by EU, and approved in Hong Kong, despite the opposition of the majority of developing countries, is:

T= (a. t)/ (a+t), and R=t/ (a+t) 

Where T and t are the new and initial tariff rates respectively and a is the constant coefficient, and R is the rate of tariff reduction.

This formula has the following main characteristics. First of all, the coefficient “a” determines the maximum tariff rate possible under the formula. Therefore, a coefficient of 10 implies that the highest new tariff rate a country can have will be 10 per cent irrespective of its present tariff rate. Secondly, the higher the initial tariff rate, the higher the rate of reduction in tariff. Thirdly, the lower the coefficient, the higher will be the rate of reduction in tariff. Fourthly, for high tariff rates, the rate of reduction in tariffs is higher than the rate of reduction in tariff when simple linear formula is applied according to which the same percentage reduction is applied to all tariff lines. Finally, the formula will lead to lower rates of percentage reduction than those generated by a tariff independent linear reduction, in a certain range of low tariff rates.

The choice of the value of the coefficients of the formula for developing and developed countries is still subject to negotiation. Nevertheless, the proposals so far 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 per cent for developed countries will be reduced to 3.33 – a reduction of 33 per cent or 1.67 percentage points. By contrast, a tariff rate of 60 percent for developing countries will be reduced to 8.8 – or a deduction of 85 per cent, or 51.2 percentage points. (See SUNS, November 1, 2005) This maximum rate will also apply to all unbound tariffs after tariff cuts and binding.

The application of the proposed Swiss formula has a significant detrimental long-term effect on the industrialization of developing countries, apart from their loss in government revenues. But it has no negative effects on developed countries. Developed countries are already industrialized; they have the supply capacity to produce capital, skilled and technology intensive goods. By giving up trade barriers on imports in exchange for market access in developing countries, they do not sacrifice their long-run industrial development. Of course their upgradation of the industrial sector depends on development of new technology. But they have firmly secured protection of their new technologies through TRIPs, with patents protected for 25 years.

By contrast, tariffs remain almost the only remaining means of trade policy for developing countries as NTBs have been removed almost entirely, and they are effectively denied subsidies geared to export performance. Yet the industrial sector of most developing countries is, unlike that of developed countries, underdeveloped, thus they need to apply higher tariffs to some of their industries, particularly new ones, than developed countries. Thus the low and bound tariffs rates will disarm them of an important policy tool for establishing new industries and upgrading the existing ones.

Of course, by obtaining further market access in developed countries, they will improve the prospects for the expansion of exports for their existing efficient industries i.e. industries in which they have static comparative advantages. But binding tariffs at low levels deprives them of the tool of expansion of supply capacity in new industries in which they may wish to develop dynamic comparative advantage. Therefore, even when market access is provided for such potential products, the prospects for their supply expansion will be absent due to the lack of policy space. In other words, for better access to markets for their current export products, they sacrifice their ability to establish new industries or upgrade into new products.

Such a trade off will result only in the deepening of their static comparative advantage; but long-run industrialization and development are sacrificed even if there is an efficiency gain through reallocation of resources in the short run. The experience of successful industrializers and premature liberalization in colonies and developing countries provide us with lessons from history.

The experience of successful early and late industrializers indicates first of all that: with the exception of Honk Kong, no country has managed to industrialize without going through infant industry protection phase, although across-the-board import substitution and prolonged protection have also led to inefficiency and failure. Secondly, government intervention, both functional and selective, in the flow of trade and in the economy in general has played a crucial role in the process of industrialization. In all cases, including Great Britain, industrialization began on a selective basis, although to a different degree, and continued in the same manner until the industrial sector was consolidated. Thirdly, when their industries matured, they began to liberalize selectively and gradually. Therefore, trade liberalization is essential after an industry reaches certain level of maturity, provided it is done gradually and selectively. Otherwise, premature trade liberalization, whether during the colonial era or in more recent decades, has been disappointing. In the case of the USA, when the country tried to liberalize prematurely in 1847-61, the industrial sector suffered and the country had to revert to protectionism against imports from Great Britain.

Fourthly, government intervention was not confined to trade, the state intervened through other means; directly and indirectly, in particular to promote investment and to develop the necessary institutions and infrastructure. In particular, industrialization was supported by attention to and growth in the agricultural production.

Fifthly, while different countries did not follow exactly the same path, all learned from the experience of others; the USA learned from the UK, Germany from the USA, Japan from Germany and the Republic of Korea from Japan, etc.

Sixth, all main early industrializers tried to open markets in other countries when their industrial sector matured. In the 19th century, free trade policy was forced on colonies and 5 per cent rules (according to which 5 per cent was the maximum tariff rate allowed on any import item) were imposed on semi-colonies and independent countries through “unequal” bilateral treaties and, or, through force (e.g. the imposition of the opium war of 1839-42 on China). During recent decades, developing countries have been pushed through multilateral organizations and bilateral trade agreements to open their markets. The policy space of the colonies, in the 19th century, was further limited by England by outlawing high value-added manufacturing activities in the colonies and banning export of competing items from the colonies to England. Instead, production of primary products was encouraged. During recent decades, tariff peaks and escalations and arbitrary anti-dumping measures have been among means of restricting imports of high-value added products from developing countries. The outcome of imposition of premature trade liberalization on the colonies was devastation and de-industrialization.

The results of a study by the author of about 50 developing countries, which have undertaken trade liberalization for the 1990s indicate that with the exception of East Asia, their trade liberalization has had three main characteristics- common with the proposals of developed countries in NAMA negotiations: Uniformity: i.e. a tendency toward uniform tariff rates for various industries in each country; Universality, i.e. application of the same recipe to all countries irrespective of their level of industrialization and development; and premature and rapid liberalization. And the results have been disappointing for most countries other than East Asian ones. First of all, Only (20 countries) in over 40 percent of the sample with manufactured exports showed high growth rates (more than 10 per cent a year), out of which only in about 10 countries- mostly in East Asia, high growth rate of exports was accompanied by accelerating, or high growth rate of MVA. In fact, in half of the sample countries, de-industrialization took place over 1980-2000; MVA/GDP ratio declined without recovering to the initial level; in many countries industrial employment also suffered severely.

Secondly, when exports expanded, it was mainly in resource-based industries and some assembly operations without much upgrading, except for industries which were dynamic during import-substitution era and were near the stage of maturity, or continued to benefit from some sort of support from the government.

Thirdly, even though the relative incentives changed in favour of exports, the manufacturing industry suffered from low investment despite a significant increase in FDI in some cases e.g. Brazil. Investment in manufacturing suffered because the balance of risk and return turned against the manufacturing sector.

In short, low and uniform bound rates, particularly if it tends to zero in the next round, would imply the end of industrialization of many developing countries. What is needed is a dynamic flexible tariff structure where only average tariffs (which may be even higher than the current average rate) are bound with significant dispersion. In developing countries different industries require different rate of protection and different length of time for their development. This is because they involve different risks, scales of production and the time and experience needed to learn the industry and the technology involved. Further, uniform tariff rates provide different effective rate of protection for various industries, depending on their import intensity. For given uniform rates for output and inputs, the higher the import intensity the lower the effective rate of protection. As a result, uniform rates involve biases against new industries as new industries usually have high import intensity. This explains why assembly operation does not easily lead to increase in value added.

Since the conclusion of the Uruguay Round, developing countries have stepped in a slippery slop situation. The solution, I am afraid, is to change the road as the change of slop only postpones their slipping into the depth of backwardness. The change of the road is achieved only by the change in the philosophy behind GATT/WTO rules which is the static version of the international trade theory. What is needed is a dynamic trade policy with dimension of space and time which would allow:

• for different level of industrialization and development at each point in time, as a rule not as an exception;
• change of trade policy in each country as the country develops
• applying export performance requirement and national treatment clauses in relation between host countries and TNCs;
• transfer of technology to developing countries more easily by changing TRIPs rule.

Most important of all, however is that developing countries should be clear in their mind what their industrial policy is before entering negotiation; not to follow a tit-for-tat diplomacy and be bullied by developed countries. Developing countries do not need to bemoan the failure of the talks, if the results of negotiations are a recipe for de-industrialization.