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Finance & Development, March 1978
Article

Differential trade treatment for LDCs: An examination of the claims by developing countries for preferential treatment in international trade

Author(s):
International Monetary Fund. External Relations Dept.
Published Date:
March 1978
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Bahram Nowzad

In pursuit of development, international efforts have traditionally emphasized the need for the transfer of additional resources, especially in the form of financial aid from developed to developing nations. These efforts have focused on the quantum of financial transfers rather than the use to which they are put. In the past few years, however, a shift in emphasis of some significance has occurred. The less developed countries (LDCs) and their “lobbies” continue to press for more economic assistance but they have redirected much of their attention to a new goal: radical change in the framework of international economic relations, which would change the rules of the game and thereby correct the allegedly inequitable economic structures imposed on the LDCs. In this way, they seek to alter the imbalance in international economic relations and to end discriminatory practices and obstacles harmful to the trade of the LDCs.

The reasons for this shift in negotiating stance are complex. They probably result from several factors, including the achievement of political sovereignty by a very large number of countries whose small size makes them highly dependent on foreign trade and vulnerable to external economic conditions, and from disenchantment in some countries with policies of import substitution recommended and pursued in the early postwar era. The developing countries have realized that financial assistance alone is insufficient for their needs; political factors have become increasingly important in economic relations, but the LDCs, which had enjoyed numerical superiority in international institutions for a long time, did not find it easy to arrive at unified positions and common action. Recently, however, they have begun to show a much greater degree of cohesion. The oil producing countries, once considered an impotent adjunct to the economies of the advanced industrial countries, have, through the Organization of the Petroleum Exporting Countries (OPEC), demonstrated the economic-power that can be wielded by a group of primary producers. The reform of the international monetary system and the Multilateral Trade Negotiations (MTN), as well as the meetings of the United Nations Conference an Trade and Development (UNCTAD) and the North-South dialogue, have given the developing countries convenient and timely forums for airing their demands.

Preferential treatment

An important ingredient of this “new awareness” is the demand for “differential” or “preferential” treatment in favor of the LDCs across the entire spectrum of international economic relations. The case for preferential treatment seems to rest on the premise that equal treatment among unequals is not just and that the economically weaker countries should not be expected to abide by the same rules that apply to other countries. The implication is that the rules and expected norms underlying international economic relations should be adjustable in their severity and application, according to the level of economic development. The basis for this reasoning is regarded as self-evident among spokesmen for the developing countries; it has also found a large measure of acceptance elsewhere.

The demands of developing countries for preferential treatment have been presented in many forums, most completely in the Manila Declaration and Programme of Action of the Group of 77. Broadly speaking, the Manila Declaration seeks to enhance the benefits to developing countries from international trade by modifying the terms, conditions, and structure of their trade relations with developed countries. The spectrum of issues covered by the Declaration is wide, as are the demands of the LDCs. Trade, however, is a major part of economic relations between the developed and the developing countries and this article focuses upon LDC demands for preferential treatment in this area.

No attempt is made here to determine whether the perception of the existing rules that underlies the demands of the developing countries is justified by the facts. Whether justified or not, the LDCs’ perception of how the world economic order operates has a direct bearing on the nature and extent of their demands for reform.

It must be understood that there is no universally accepted definition of what group of countries are LDCs. While for the sake of discussion it is assumed that there exists a definable group of LDCs, the definitional problem must be clearly resolved if preferential treatment of a binding nature is to be instituted with ease.

It is no easy task to weigh and to evaluate the longer-term implications of the many proposals by LDC spokesmen to introduce new preferential arrangements into the rules that govern international trade and payments. In addition, it cannot be taken for granted that the implementation of these proposals would always result in concrete benefits for the developing countries and would bring about a more favorable distribution of the fruits of international trade and exchange.

The existing framework within which world trade takes place is the result of international negotiation among nations. If includes negotiations which at times merely served to codify and legitimize practices that had evolved earlier. The negotiations that eventually led to the General Agreement on Tariffs and Trade (GATT) (and the seven rounds of subsequent negotiations) created the ground rules that govern world trade.

The question of reciprocity

The principles of reciprocity and “most-favored-nation” treatment constitute two of the principal pillars of the GATT. The former provides the basic ground rule for trade negotiations, while the latter extends the benefits of trade concessions to all GATT members without discrimination.

The principle of reciprocity has traditionally been the cornerstone of trade negotiations, and not solely on purely economic grounds. The political and psychological aspects of the principle of reciprocity must also be considered. With reciprocity, trade negotiators have been able to present the results of their efforts and defend them publicly as a bargain based on an equitable distribution of the gains and burdens of trade liberalization.

Yet the concept of reciprocity has often been criticized: it tends to work to the disadvantage of countries with low tariffs; it ignores the special needs of countries at different levels of development; and it lacks clear and objective criteria, thus limiting the scope of successful negotiations. Its economic rationale has also been severely questioned. More recently, the concept of reciprocity has been challenged by the LDCs which feel that the rules of the game are biased in favor of developed countries.

During the past twenty years, various attempts have been made to secure preferential treatment for developing countries in trade negotiations. The concept of differential treatment was formally introduced into the General Agreement in 1957. Under it, negotiations would take into account “(a) the needs of individual contracting parties and individual industries; (b) the needs of less developed countries for a more flexible use of tariff protection to assist their economic development and the special needs of these countries to maintain tariffs for revenue purposes; and (c) all other relevant circumstances, including the fiscal, developmental, strategic, and other needs of the contracting parties concerned.”

In 1961, and again in 1963, the Contracting Parties agreed that there should be a more flexible attitude on the degree of reciprocity expected from less developed countries and that developed countries should not expect to receive reciprocity from the less developed countries.

These points were more explicitly incorporated into the GATT when Part IV of the General Agreement, dealing specifically with the problems of the LDCs, entered into force in 1965. The principles and objectives of that chapter state that “The developed contracting parties do not expect reciprocity or commitments made by them in trade negotiations to reduce or remove tariffs and other barriers to the trade of less developed contracting parties.” An interpretative note adds that “the less developed contracting parties should not be expected, in the course of trade negotiations, to make contributions which are inconsistent with their individual development, financial and trade needs, taking into consideration past trade developments.”

The principle of nonreciprocity was clearly recognized during the Kennedy Round of Trade Negotiations (1963-67) and an attempt was made to apply it. But what role it played in actual negotiations and, more particularly, whether any LDCs were obliged to make concessions contrary to the principle of nonreciprocity is difficult to determine.

Preferential treatment in monetary affairs

This article is based on a much longer study which included a survey of the provisions for differential treatment in the existing framework of world trade and payments, as codified in the General Agreement on Tariffs and Trade and in the Fund’s Articles of Agreement. It also included a summary of the proposals for preferential treatment advanced in the context of the Multilateral Trade Negotiations and the reform of the international monetary system.

The developing countries’ proposals for preferential treatment in the monetary system were considered as regards (a) the negotiating process; (b) the provision of financial resources; and (c) the code of conduct. The author found that these proposals essentially sought to expand the net flow of resources channeled by the Fund to the developing countries rather than to change the uniform set of rules which governs international monetary relations. In trade negotiations, by contrast, the developing countries have sought to achieve preferential—that is, nonuniform—treatment in all spheres, as the article shows.

The proposals for reform of the negotiating process focused on the discussions surrounding the second amendment of the Articles of Agreement of the Fund, now being ratified by members. There were several forums where these proposals were voiced, the most significant being the Committee of Twenty and its successor, the Interim Committee. Although there were, and there remain, no special rules in their favor, the author finds that the developing countries succeeded to a remarkable degree in leaving their imprint on the reports of these Committees, particularly on the Outline of Reform of the Committee of Twenty.

In spite of the principle of uniform treatment contained in the Articles of Agreement of the Fund, that its resources, under its regular tranche policies, are available to all members to meet payments problems, some of the facilities are in practice mostly used by developing countries. These include the compensatory financing facility, the buffer stock facility, and the extended Fund facility. There have been many proposals for the Fund to expand the availability of its resources to developing countries and there have also been proposals to establish a link between the creation of special drawing rights and assistance to developing countries.

As regards the code of conduct of the Fund, the principle of formal equality has wide acceptance and there have been relatively few proposals for special provisions for developing countries in this code. The problems of economic development are not neglected in the Fund’s code of conduct, even if there is little by way of explicit preferential treatment for developing countries. Thus, written into the Articles of the Fund are the principles of promoting economic development (Article I) and of sustaining sound economic growth (Article IV). Under Article IV, Section 3(b), it is also stated that the Fund is to exercise “firm surveillance” over the exchange rate policies of members, and in doing so, “the Fund shall pay due regard to the circumstances of members.” These principles provide the possibility for, if not preferential, at least more flexible, treatment for developing countries, while retaining the principle of uniform treatment as the core of the Fund’s code of conduct.

In 1970 the generalized system of preferences (GSP) was introduced, which permitted developed countries to grant unilateral tariff preferences to LDCs. In June 1971, the GATT waived the “General Most-Favored-Nation Treatment” obligation for developed countries for a period of ten years to the extent needed to grant preferential treatment under the GSP.

The current series of trade negotiations, begun in 1973 and known as the Tokyo Round of Multilateral Trade Negotiations, set the general tone for the MTN in its Tokyo Declaration. The Declaration reaffirms the concept of nonreciprocity embodied in the GATT:

“The developed countries do not expect reciprocity for commitments made by them in the negotiations to reduce or remove tariffs and other barriers to trade of developing countries, that is, the developed countries do not expect the developing countries, in the course of the trade negotiations, to make contributions which are inconsistent with their individual development, financial and trade needs.”

The Tokyo Declaration also states that the negotiations should aim to “treat tropical products as a special and priority sector.” Indeed, the provision of this specific form of preferential treatment has led to the first concrete results of the MTN. By mid-1977 trade concessions and contributions to LDCs for tropical products were put into effect by most industrial countries, with others expected to follow soon after.

Another development was the creation in December 1976 of a Framework Group within the MTN. The Group proposes “to seek to negotiate improvements in the international framework for the conduct of world trade, particularly on trade between developed and developing countries and on differential and more favorable treatment to be adopted in such trade.”

Codes of conduct

World trade is conducted in the context of certain rules or guidelines, enumerated in the provisions of the GATT, which seek to ensure, to the extent possible, that countries will conduct themselves in a manner consistent with international welfare.

Apart from the question of nonreciprocity in tariff negotiations, GATT rules make two types of provisions, reflecting two strands of economic philosophy, that may be construed as preferential treatment in favor of developing countries. The “original” GATT articles—especially Article XVIII concerning governmental assistance to economic development—imply that the trade problems of developing countries are related to the development of domestic industries and, accordingly, these countries should be allowed greater leeway than other GATT members to erect import barriers to shield these industries. The provisions of Part IV emphasize market access and market stability for the export products of developing countries. This involves commitments by developed countries to facilitate LDC exports. In short, import substitution and import protection are the main concerns of the earlier provisions, while export promotion and access to markets are the focus of the provisions of Part IV.

There are other preferential trade arrangements which favor developing countries. These provide preferential tariff treatment to exports of LDCs in line with the spirit and provisions of Part IV. The most universal of these arrangements is the GSP, under which developed countries grant preferential tariff treatment to products from LDCs while continuing to apply the normal tariff rates to imports from developed countries. Each developed country participating in the GSP has its own national scheme which specifies the details of its preferential treatment, such as eligible developing countries, type and depth of preferential treatment, and goods covered by the scheme. The GSP was agreed upon in the United Nations, and the resulting deviation from the most-favored-nation principle has been sanctioned by the GATT.

In theory the GSP is applicable to all LDCs. Other preferential schemes apply only to a specified group of countries. The best known of these schemes is that under the Lome Convention of 1975 between the European Economic Community and 46 African, Caribbean, and Pacific States (ACP). The Lome Convention encompasses favorable tariff treatment, stabilization of export earnings, industrial cooperation, and financial assistance.

Why preferential treatment?

Despite these international sanctions already given for preferential treatment, the LDCs have come to view the existing rules of the game as written by, and primarily in the interests of, developed countries. These GATT rules were originally formulated when many LDCs lacked political independence and, in economic matters, were closely bound to a particular developed country. Thus, LDCs perceive the rules as inadequate for their current requirements and aspirations and therefore in need of change. Such change, they assert, should be achieved on a number of fronts: by the application of the existing rules in a manner preferential to LDCs, by the modification of existing rules, and by the adoption of new codes that have explicitly preferential provisions in favor of LDCs.

The call for differential treatment is separate from other demands, such as increased aid, special arrangements for commodities, and special treatment of LDCs’ debt problems. It focuses on restructuring the framework for world trade and payments in ways that would explicitly favor the LDCs. Typically, the new rules would allow the LDCs much greater freedom of action in adopting measures and generally in behaving in ways that would be denied to the developed countries. At the same time, they would exempt LDCs from measures taken by developed countries that would be construed as detrimental to the economies of the LDCs.

The bases for the demands of the LDCs for preferential treatment are easy to appreciate even if some aspects of the arguments put forth are not compelling. The arguments are frequently formulated in the ideological terms common to contemporary intellectual debate. Freedom in trade and payments as an objective of the international economic order has never been fully attained. Such freedom is now increasingly questioned by the LDCs, which question its validity as the philosophical pillar of what would constitute the most efficient system of world trade and payments. In this view, a new order must evolve, which would be less dependent on market forces. It would be characterized by greater organization, intervention, regulation, and preferential rules in favor of the LDCs. This line of reasoning is only partially based on economic considerations and scant attention is paid to the possible costs—particularly in terms of managerial burdens and misallocation of resources—of placing additional reliance on governmental action.

Proposals for differential treatment of LDCs

Tariffs

With the principle of nonreciprocity in tariff negotiations generally accepted, the LDCs have focused on institutionalizing preferential tariff rates and, in particular, on preserving and improving their tariff benefits under the GSP. The proposals aim to modify the legal basis of tariff schedules that would affect the most-favored-nation principle; to establish a “built-in differentiator”; and to bind the preferential GSP tariff rates. The LDCs also seek compensation for any erosion of the GSP from general tariff reductions under the MTN. Other proposals include accelerating the implementation of generally agreed tariff reductions on goods of special interest to LDCs; exempting products of interest to LDCs from exception lists of developed countries (where no tariff concessions are made); attacking the problem of effective protection in developed countries; and adjusting any agreed tariff-cutting formula to whether larger or smaller tariff cuts would be beneficial to LDCs. The LDCs also favor greater flexibility to use tariffs and to change their schedule of tariff concessions according to their needs.

Nontariff restrictions

The LDCs seek to eliminate quantitative import restrictions, or at least significantly increase their quotas; to remove the so-called “voluntary” export restraints imposed on LDCs; and, where import quotas cannot be liberalized, to reallocate them in favor of LDCs. Other proposals include preferential treatment in the proposed Code of Conduct for Preventing Technical Barriers to Trade. The LDCs have adopted a two-pronged approach to restrictions imposed for balance of payments reasons. First, they propose that they should have far greater leeway in using trade restrictions for balance of payments purposes. Second, they feel that the balance of payments consultations in the GATT should not be limited to an examination of the balance of payments situation and restrictions of the consulting LDC under review, but should also extend to ways of helping LDCs overcome their balance of payments difficulties.

“Safeguard” action

“Safeguard” action (or the authority to impose import restrictions to protect domestic producers from injury) has a direct impact both on the exports of many LDCs and on those of certain developed countries; the lack of “safeguard” action can bring strong pressures for unilateral or excessive protective actions from the affected groups in the developed countries. LDC proposals here range from more effective implementation of the existing provisions of the GATT to the formulation of an entirely new code. It has been suggested that imports from LDCs be totally exempt from “safeguard” action or, at the least, that much more stringent criteria be applied before “safeguard” measures could be taken against such imports. Other proposals include mandatory prior consultation with the GATT before “safeguard” action is taken; a time limit of one year; a commitment to specific import levels from LDCs; collective retaliation by LDCs to “safeguard” action; mandatory compensation to LDCs; and the obligatory implementation of adjustment assistance measures by developed countries to deal with problems of import injury.

In “safeguard” action taken by LDCs, the proposals allow these countries maximum freedom to take necessary measures, including “safeguard” action to protect their exports.

Subsidies

The LDCs want greater flexibility in utilizing export subsidies to offset some of the disadvantages their exporters face. In the MTN, LDC representatives have proposed that preferential treatment be woven into each article of any new code on subsidies, that LDCs be given maximum flexibility to use subsidies for economic development and industrialization purposes, and that LDCs be exempt from countervailing duties when these are imposed by developed countries.

Agriculture

The MTN have made little progress to date on agriculture. Nevertheless, LDC representatives have asserted that urgent attention should be given to the trade barriers affecting agriculture about which the MTN has been notified by the LDCs, while special and preferential procedures should be adopted with regard to liberalizing agricultural trade in favor of LDCs.

Tropical products

The MTN singled out tropical products for priority consideration. Agreements in this area constitute the first concrete results of the MTN and are taking effect before the negotiations as a whole have been completed. By July 1, 1977, Australia, Austria, Canada, the European Economic Community, Finland, Japan, New Zealand, Norway, Sweden, and Switzerland had put into effect trade concessions and contributions on tropical products from developing countries. The concessions implemented by the European Economic Community, Finland, and Japan covered both tariff and non-tariff trade barriers, while those of other countries involved reductions in tariffs only.

Many developing countries derive a major part of their earnings from exports of tropical products such as coffee, cocoa, tea, spices, and a variety of other raw, processed, and semiprocessed goods. Many of the negotiated concessions or contributions concern primary products, but in a number of instances also cover semiprocessed and processed products. The negotiating group on tropical products is expected to keep under review the question of further progress in the negotiations on this sector.

As in the case for foreign aid, the case for differential treatment in favor of the LDCs in international economic relations is regarded by many as self-evident. Many of the proposals would indeed be justified in their general form: the provision of greater assistance; the expansion of export opportunities; a greater freedom for LDCs to levy measures to suit their particular needs; and the exemption of LDCs from restrictive measures adopted by more developed countries which are better able to afford needed adjustments. Proposals along these lines are clearly of potential benefit to the LDCs.

Ramifications

It has become increasingly clear that the only viable and lasting arrangements for preferential treatment are bound to be those that take account of the needs and interests of developed countries as well as LDCs. The presentation of intransigent lists of demands to be “imposed” on developed countries by numerical majorities in various international forums are unlikely to succeed.

Further, the absence of or substantial derogation from the present rules or guidelines would not necessarily be in the interest of the LDCs, even though in the short run it may make it easier for the LDCs to pursue their own policies. This would be true, for example, if preferential provisions led to the proliferation of high-cost industries and a misallocation of resources in developing countries. Moreover, in order to obtain preferential treatment, the LDCs may have to make concessions which, though immediately attractive, may turn out to be excessive. For instance, as a quid pro quo for better market access and preferential tariff treatment, LDCs may have to undertake commitments to refrain from certain market actions and to give guarantees in respect to the prices of their exports and access to their export products. However, it is by no means clear that it would be advantageous for developing countries in the long run to make such commitments in return for preferential trade arrangements. A typical situation is their negotiating strategy regarding tariffs. The developing countries have laid greater emphasis on securing and improving the preferential arrangements under the CSP scheme than on general tariff liberalization. A recent study has suggested, however, that the gains from general tariff cuts would outweigh the losses from the simultaneous erosion of the GSP preferences (see R. E. Baldwin and T. Murray, “MFN Tariff Reductions and LDC Benefits Under the GSP” Economic Journal, March 1977).

Another question concerns the mutual compatibility of the preferential treatment demanded in the various spheres; some may cancel others out. If, for instance, developing countries are given far greater leeway to use devices to protect local industries against imports, this could lead to overvalued exchange rates and the introduction or exacerbation of distortions in relative prices. Both create difficulties in pricing exports. These problems would be particularly acute in many developing countries where the development of manufactured exports is a major element of national economic policy. The easier access to import restrictive devices under preferential rules, apart from possibly fostering inefficient domestic industries, would tend to lead to pressures for export subsidies. In a sense the subsidies would be required to offset the import restrictive measures and in the process would subject the economy in question to progressively greater distortions. Such distortions could retard development.

Finally, the concept of having a special code of conduct, or a code with special provisions for a particular group of countries, is open to debate. The question has been raised whether it is possible to have one set of rules that applies equally to countries, large and small, developed and less developed, industrial and primary producing. Historically, the tendency has been to have a single code, albeit with some special provisions for LDCs. Also relevant, however, is the question whether, even with preferential provisions, a single code of conduct could cover the problems facing a heterogeneous group of countries.

The differences among developing countries, however, are almost as large as the difference between them and developed countries. Moreover, there is a radical difference between the transfer of resources in favor of developing countries and a code of conduct slanted in their favor. Resource transfers can more easily be tailored to the particular needs of countries at various stages of development, but it would be virtually impossible to have a code of conduct that would be responsive to the needs of each and every country. A country can be exempt or not from certain measures applied by another country, or it can be free to impose certain measures. It would be difficult for the degree of exemption or the freedom to use measures to be tied to the level of development or to any of the proxies that are customarily employed to measure it. On average, would preferential codes benefit developing countries? It is a question that cannot be answered in the abstract.

Any uniform code of conduct can serve as a protective umbrella for LDCs. In its absence, stronger countries would be freer to use measures which best serve their purpose and objectives. Thus a strict, but nonpreferential code, may be preferable to an insecure preferential code. The incorporation of preferential provisions in a code of conduct, and thus the creation of special rights and privileges for developing countries, may lead to demands for differential treatment by other groups and the promotion of a pattern of bilateral and regional preferential schemes. Preferences too great in number or too far-reaching in nature could threaten the very existence of the code; the advantages would be irrelevant if the code itself were eroded.

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