Journal Issue
Share
Article

Countertrade Reconsidered: Countertrade may hinder, not help, growth

Author(s):
International Monetary Fund. External Relations Dept.
Published Date:
June 1987
Share
  • ShareShare
Show Summary Details

Whileitmayappearattractive, mandatorycountertradehasmanydrawbacks

Bruce Fitzgerald

Countertrade refers to a variety of unconventional international trade practices which link exchanges of goods—directly or indirectly—in an attempt to dispense with currency transactions. The most common countertrade arrangements are: barter, a simultaneous exchange of goods of equal value; counterpurchase, in which a supplier agrees to purchase other, unrelated goods from the initial purchaser; buy-back, under which a supplier of machinery, equipment, or factories agrees to purchase goods manufactured with that equipment and technology; and offsets, where foreign suppliers are required to assemble, purchase, or manufacture components locally. The common feature of all forms of countertrade is the contractual linkage of discrete, separable transactions. A firm, as a condition of supplying its usual line of goods and services, becomes a trader in new, unrelated products or services in which it may have no market expertise, or begins to manufacture at a location which would not otherwise be economic. (For an introductory article on this subject, see “Countertrade: trade without cash?” by Kyung Mo Huh, December 1983 issue.)

Where countertrade has emerged voluntarily to circumvent governmental restrictions, obstacles or currency controls, it can expand trade and benefit development. However, because countertrade is a costly business practice, it is generally preferable for a government to remove the obstacles that give rise to it rather than to discourage it. Where countertrade is required by government policy, it can restrict trade and stifle growth.

Extent of countertrade

The array of countertrade transactions reported in the trade press is intriguing. Coca Cola has traded its syrup for cheese from a factory it built in the Soviet Union, for oranges from an orchard it planted in Egypt, for tomato paste from a plant it installed in Turkey, for Polish beer, and for soft drink bottles from Hungary. A Swedish band was paid in coal for its concerts in Poland. Boeing exchanged ten 747s for 34 million barrels of Saudi Arabian oil. Argentina awarded a fertilizer factory contract to Czechoslovakian firms with the stipulation that suppliers buy vegetables and other agricultural goods produced with the fertilizer.

This article draws upon the author’s longer paper “An Analysis of Indonesian Trade Policies: Countertrade, Downstream Processing, Import Restrictions, and the Deletion Program” and upon “Countertrade: A Developing Country Policy Perspective” by Neil Roger of the Bank’s Economics and Research staff. Both are available from the authors.

Systematic data on the extent and significance of countertrade obligations are unavailable, but speculative published estimates have placed the share of world trade involved in countertrade obligations between 5 and 30 percent. Generally, official estimates tend toward the low end, while higher estimates come from traders. Researchers at GATT estimated countertrade at 8 percent of world trade in 1984. US and Canadian governments’ surveys of their exporters’ experiences with countertrade support the lower estimates. The US survey covered 520 corporations with 1984 export sales of $127 billion (more than half the total US merchandise exports). The firms reported that about $7.1 billion in sales were affected by some form of countertrade restrictions. The value of the countertrade obligations—80 percent of which were offsets on sales of military and aerospace products—was $2.8 billion. The Canadian study found at least 2-3 percent of export sales entailed countertrade obligations. Countertrade transactions are widely thought to be growing, and the Canadian study confirms this impression. The value of transactions reported by Canadian sources increased about eightfold between 1980 and 1984.

Countertrade is routine among controlled Eastern European economies such as Czechoslovakia, Hungary, and Romania. A recent survey (Creative Countertrade by Kenton Eldurkin and Warren Norquist) cites countertrade laws or government policies in 30 other nations. Of the countries which mandate countertrade, all but China limit their requirements to government purchases. The least restrictive policy is New Zealand’s, which considers countertrade proposals only as a “tie-breaker” in government procurement when bidders submit proposals that are otherwise comparable.

Countertrade practices vary extensively among commodities. Offsets are frequently negotiated in military equipment and aircraft purchases. Other forms of countertrade have commonly involved petroleum, steel, and fertilizers. At some terms, any commodity can be involved in countertrade, but standardized commodities that can be easily traded—such as metals, minerals, rubber, cocoa, palm oil, and cement—are preferred. Canadian exports involved in countertrade were primarily capital goods and factories, but also included sulfur, potash, potatoes, and dairy products. In return, Canadian firms were offered such diverse commodities as: ham, jam, mangoes, fish and fishing rights, sesame seeds, rice, sugar, coconuts, spices, sorghum, wine, beer, cotton, shipping services, salt, pulp, wood, furniture, keys, machine tools, electric motors, medical equipment, truck axles, and fire fighting and lighthouse equipment.

Proponents of countertrade claim it can conserve foreign exchange, increase liquidity, provide credit, improve marketing, promote exports, transfer technology, and develop industry. Careful examination of the practices (as demonstrated below) shows otherwise. Countertrade requirements, like any trade restrictions, increase the cost of doing business. These costs cannot be passed into the international market but must be borne within the country imposing the requirements. Other policies or, more likely, corrections of existing policies are preferable to mandatory countertrade in pursuit of national objectives such as increasing foreign exchange reserves or promoting exports.

The Indonesian experience

Indonesia’s counterpurchase program illustrates some of the difficulties of mandatory countertrade. In December 1981, in an effort to increase exports, the government announced that foreign suppliers awarded government contracts for construction or procurement in excess of 500 million rupiah (about $450,000) would be responsible for the export of an equal value of one or more of 33 eligible products including rubber, tin, fish, plywood, spices, and coffee. Such exports were were to be in addition to “normal” trade transactions. It was originally expected that $8 billion in government projects would be subject to counterpurchase requirements through the development plan which ended in 1984. As a result of changes in public investment schedules in 1983, only about $1.7 billion was subject to counterpurchase through 1984.

In the early months there was uncertainty within the government and confusion among suppliers about how the program would be administered. The government announced it would be flexible in interpreting the guidelines, but the penalties for noncompliance were high—50 percent of the value of exports not purchased. Suppliers were unable to indemnify themselves against loss should Indonesian exporters not deliver merchandise. The early transactions were characterized by protracted negotiations which delayed contracts and subsequent deliveries of goods. In the face of the penalties and uncertainty, some companies refused to bid on contracts to supply the government.

Few corporations are organized to fulfill countertrade obligations economically, and the cost to a typical firm of meeting the requirement could have been prohibitive. There is no reason why a firm which is the lowest cost manufacturer of a given item (fertilizer, a cement plant, a coal mine, satellite equipment, passenger ships, or railroad cars) would also be the lowest cost exporter of an equal value of fish, rubber, plywood, or tin. The government permitted assignment of responsibility for counterpurchase to third parties. A group of brokers emerged to fulfill suppliers’ obligations. Their work typically consisted of identifying transactions which were being negotiated in the normal course of business between exporters and foreign buyers, and submitting these to the government as evidence of counterpurchase.

Initially, few brokers were available, procedures were unspecified, and there was difficulty in obtaining sufficient quantities of export commodities. Brokers reported commissions as high as 13 percent, but rates of 5-7 percent are widely cited elsewhere as “normal.” To obtain cooperation from local exporters, the brokers in turn paid exporters commissions of as much as 4-5 percent. As procedures were clarified and standardized, as competition increased among brokers, and as the government’s countertrade-linked purchases dropped, brokers report that commissions fell to 1 percent, with Indonesian exporters receiving only to ¼ percent. While it is impossible to know the total commissions, at the normal rates of 4-5 percent, local and foreign brokers received between $85 million and $120 million for counterpurchase services up to the end of 1984. Only an eighth to a third of these commissions were passed back to Indonesian exporters.

Brokerage commissions are only one element of the costs paid by foreign suppliers in connection with countertrade. Other costs are associated with protracted negotiations with the government and allowances for risk and uncertainty. Of course, foreign suppliers can anticipate these costs and build them into their bids so that the costs are borne ultimately by the government. In addition, the government must hire staff to implement and monitor the program, must endure delays in delivery of critical materials, and must choose from a reduced set of foreign competitors willing to supply. A full accounting of the effects would likely show that, as in the Indonesian case, the gains through exports resulting from countertrade amount to a very small portion of the costs arising from such arrangements.

Reconsidering benefits

In light of this experience, it is instructive to reconsider some of the benefits attributed to mandatory countertrade:

Marketingandpromotionofexports. Counterpurchase is said to be a way to force foreign firms—which may have greater expertise—to develop export markets for the country imposing the requirement. While there may be some marketing services performed in countertrade, they are minimal. They are not provided free, and the costs are borne by the government. It is impossible to ascertain that a transaction is “additional to normal trade” and for the most part, traders simply identify transactions which would have taken place anyway but which meet the countertrade guidelines. In Indonesia, for example, any “marketing” was done by the same traders who routinely export Indonesian products, so no new services appear to have been provided. To the extent that additional marketing expertise is desirable, it could be contracted directly by the government at lower costs than the complex counterpurchase arrangements.

It is often claimed that goods exported in barter arrangements (especially with Eastern European nations) are of low quality and not easily exportable. The notion that counter-traded exports would otherwise have been “difficult to sell” or that they were “additional” sales ignores the fact that the goods were saleable—otherwise the transaction would not have occurred. Perhaps extra selling effort was required, or a spot price was met rather than a longer-term contract price, or an appropriate discount was given for lower quality, or the goods taken in exchange may have been of low quality or implicitly overpriced, but somebody, somewhere was willing to buy. Countertrade simply obscures the low price received, or high commission paid, or the poor quality of the merchandise received in exchange. The Canadian study found that most goods taken in countertrade were sold for cash in third markets, rather than in Canada, and the buyer was not even aware the goods were involved in a countertrade transaction.

Ultimately, the quantity of exports depends on their price in world markets, and mandatory countertrade does nothing directly to lower price. Where brokers share a fraction of their commission with exporters, there is a small, indirect subsidy, but unless it is stable and predictable, it will be a windfall for already-negotiated export agreements and a payment for exporters’ paperwork costs rather than an efficient incentive to expand exports. To the extent that a government seeks to increase exports through subsidies, other forms could accomplish the same effect at lower cost.

Conservationofforeignexchange. Many developing countries have “shortages” of foreign exchange and view barter and counter-purchase, because they relate each import to a corresponding export, as a way of saving foreign exchange. Since two conventional cash transactions would have the same effect on foreign exchange reserves as a barter or countertrade, this view is mistaken. In fact, mandatory countertrade probably drains foreign exchange by increasing transaction costs and reducing competition, so that a nation pays more for its imports and receives less for its exports.

Countertrade services

Countertrade has become a sophisticated specialty within international trade and finance practiced by a network of bankers, traders, and brokers. There are at least 12 national and international professional associations, regular conferences, and magazines(Countertrade Outlook, and Countertrade and Barter Quarterly) dealing with specific countertrade techniques and opportunities, regional and national policies, and developments in particular commodities and industries. A recent issue of Countertrade and Barter Quarterly, for example, contained advertisements of 26 firms specializing in various aspects of countertrade.

The College of Petroleum Studies in Oxford (UK) offers several short courses for countertraders. The Singapore Trade Development Board has established a Countertrade Services Unit to promote Singapore as a countertrade services center. A feasibility study has been completed for an international currency and barter exchange to facilitate trade currently stymied by lack of third world credit, to assist in the creation of new trade finance mechanisms, to create an international market for soft currencies, and to enhance the marketing of Third World products.

Increasedcreditandliquidity. Many see countertrade as a means for developing countries to obtain trade credit, particularly where conventional sources have dried up because of economic difficulties. But because countertrade does not address the basic causes of the nation’s credit standing, it is unlikely to add to the supply of credit. If a factory is financed by pledging its output to the supplier, then that output is unavailable to expand the country’s hard-currency exports. It was exactly that expansion in exports which would have increased the country’s debt-servicing capacity and its credit standing. To the extent credit is extended in countertrade, its cost will be reflected in the terms of the agreements covering imports and exports. Because the countertrade involves complicated multiparty transactions in unfamiliar markets, it is riskier than conventional transactions, and the terms of financing will be harsher than equivalent conventional financing.

A related view often is that countertrade reduces the amount of foreign exchange required to carry out international trade. However, most countertrade involves payment in hard currency for both sides of the transaction. Only barter (which is rare outside Eastern Europe) or buy-back is actually “trade without cash.” Thus any reduction in a country’s required liquidity is likely to be small, and any advantage gained here must be weighed against the probable loss in the terms at which barter or buy-back transactions are offered.

Nominalpricing. Countertrade has been used to disguise or falsify prices or quantities in international trade. A state company swapping oil for aircraft has great latitude in the claims it can make regarding the price it received for the oil. The preponderance of commodities subject to international price or quantity agreements (oil, bauxite, steel) in countertrade reflects this use. Similarly, countertrade could be a means for firms to “dump” exports (i.e., sell at prices below the cost of production) or to over-invoice exports to increase export subsidies or under-invoice imports to reduce duties. These practices occur in conventional trade as well, and countertrade is just another means of obscuring transactions and recording nominal rather than actual prices.

Industrialpolicy. Offsets have been cited as means to foster industrial development through investment or joint ventures in particular sectors or industries. In return for importing aircraft or munitions, a country may require that the supplier establish local manufacture or assembly operations, in the hope that this will eventually grow into a thriving domestic industry. Of course, the government must bear fully—in the price of its purchases—the added cost of such arrangements. If it is not correct in picking a “winner,” then there may be an endless stream of subsidies to maintain employment in an uneconomic investment after the foreign manufacturer’s obligation is fulfilled. Even if a government were able to identify growth industries and there were attributes which made governmental assistance of this particular industry socially profitable, then production subsidies would be more efficient than offsets.

Buy-back arrangements may be a mechanism for sharing or shifting the risks inherent in new ventures. In a developing country building a fertilizer plant, a buy-back arrangement under which the supplier purchases fertilizer may, under some conditions, be an efficient incentive for technology transfer and timely completion of a plant producing high-quality, competitively-priced fertilizer. Whether it is actually efficient depends on a careful analysis of the prices negotiated for the plant and the fertilizer relative to the costs of alternative ways of enforcing contract terms.

A manufacturer seeking a stable supply of raw materials from a country where direct investment is risky or prohibited may consider a buy-back where equipment is supplied and a mine developed in return for a share of the output. A buy-back may also reduce risks of nonrepayment or delays due to periodic foreign exchange shortages and controls. But, countertrade entails its own risks of lax quality control, slipped delivery dates, changes in rules, and so on. In this context, buy-backs are only one of a range of options such as tighter contracts, joint ventures, or long-term supply arrangements for sharing production and sharing risks.

Conclusion

Mandatory countertrade programs can be restrictive, costly, and disadvantageous for the countries which require them. The International Monetary Fund discourages countertrade and advises members that the objectives of countertrade can more efficiently be achieved through appropriate fiscal, monetary, and exchange rate policy. Countertrade directly increases the cost of international transactions and, to the extent that it restricts trade to bilateral or triangular exchanges, it reduces the efficiency of the multilateral trading system. Governments would maximize their own countries’ gains from trade—and the benefits to the international system—by opening their economies to competition among all willing participants.

Most elementary textbooks on the principles of economics explain that barter is an inferior method of exchange, because it relies on an improbable “double coincidence of wants.” On the other hand, monetary transactions give choice and flexibility, and facilitate specialization and economic development. It is ironic that this lesson is so easily forgotten and trade restrictions in the form of countertrade obligations can be viewed as a method of promoting trade and development. Where countertrade is compulsory, it increases costs, and these costs cannot be shifted abroad. Where voluntary (and otherwise legal) countertrade is permitted, it can overcome restrictions and policy-induced distortions to reduce costs and facilitate trade and investment. Increased trade, even under unconventional procedures, will generally be an improvement. However, countertrade in all its forms signals the opportunity for governmental policy changes to reduce transactions costs further and thereby expand trade.

Do you wish to receiveFINANCE& DEVELOPMENT regularly?

New readers must either type or print in capital letters their names and addresses and Identify their professional category from the list given at right when applying for inclusion in our mailing list.

Regular readers are requested to send us their latest mailing label or previous address when requesting a change of address.

Professional category

(Mark one only)

  • 23□College student

  • 11□Centraf bank

  • 13□Finance ministry

  • 31□Commercial bank

  • 32□Other financial institution

  • 14□Planning agency

  • 49□International or regional organization

  • 26□Public library

  • 22□Facuity—college or university

  • 19□other government agency

  • 47□Nongovernmentai organization

  • 59□News media

  • 39□Private enterprise

  • 99□Other

PUBLICATION SERVICES, FINANCE & DEVELOPMENT, Washington, DC 20431 USA

Other Resources Citing This Publication