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IMF Trade Research Conference: Do trade agreements and trade openness help developing countries?

Author(s):
International Monetary Fund. External Relations Dept.
Published Date:
January 2004
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The landscape of the world trading system is being altered by a proliferation of regional trade agreements (currently, over 200 are in place) and unilateral preference schemes granted to some developing country exports for select products. Are these changes, which are taking place against a general backdrop of on-off global trade liberalization and unilateral liberalization in some countries, good for developing countries? Does the IMF have a role to play in this process? A half-day conference on October 19 sponsored by the IMF’s Research Department took a closer look at these issues.

An overarching theme of the conference was that preferential trade policies—whether in the form of trade agreements or tariff reductions for exports from developing countries—are not equivalent to trade liberalization. It is useful to remember, the IMF’s John Romalis (Resident Scholar, Research Department) suggested, that these arrangements do not extend to every country’s trading partner. It would be more accurate to call these “preferential” rather than free trade agreements, as they reduce trade barriers on trade flows among the member countries only.

While preferential access for developing country exports might seem like a good idea at first glance, the World Bank’s Cağlar Özden (Economist, International Trade Division) emphasized that such schemes are riddled with problems. Somewhat surprisingly, lowincome countries do not fully utilize these preference schemes—on average, the preference utilization rate is 35 percent. Furthermore, sectors of export interest to the recipient country are often “sensitive” sectors for the donor country and, thus, frequently exempted from preference schemes. In addition, these schemes often carry a fair amount of”strings,” requiring other steps to meet concerns about rules of origin, labor and environmental standards, and intellectual property rights. And, frequently, once the preferences are utilized, they are removed. A key test of the effectiveness of such schemes is whether they help create viable industries in the recipient countries; there is no clear evidence that they do. In effect, Özden saw preference schemes as having minimal impact and providing little incentive for recipient countries to liberalize their own trade policies.

From preferential to multilateral?

On the thorny issue of preferential agreements, the IMF’s Hans-Peter Lankes (Division Chief, Policy Development and Review Department) observed that such agreements are here to stay. He urged the World Trade Organization (WTO) to strengthen its oversight of these agreements and asked the IMF to devote greater attention to them, in the context of both surveillance and program negotiations, in an effort to ameliorate their undesirable effects.

But are these agreements beneficial? Romalis acknowledged that the evidence is ambiguous, but he did see some benefit where trade between the member countries is already large, which would lessen the possibility of trade diversion; when external tariffs are quite high; and when these agreements are made between developed and developing countries. On the larger question of whether agreements will hinder multilateral liberalization, he found the evidence mixed.

Other speakers were fairly unanimous in finding these agreements undesirable, given their potential for diverting trade. IMF First Deputy Managing Director Anne Krueger saw the proliferation of regional or preferential trade agreements as an obstacle to trade liberalization because once a country signed such an agreement, it cannot alter its trade policy without the consent of its partners. This, she said, provides a way for countries to “hide behind each other” and avoid liberalization.

T.N. Srinivasan of Yale University went as far as to say that such agreements “do not belong in a globally liberalized, multilaterally liberalized world, and the sooner we get away from them, the better off we all would be.” Srinivasan would support the formation of a regional trade agreement if it extended tariff reductions to nonmembers. But the World Bank’s Alan Winters (Director, Development Research Group) did not think this feasible. Instead, he recommended that greater attention be paid to the fact that with so many regional agreements, every country is outside some of them, and outsiders typically lose.

David Richardson of Syracuse University took a somewhat more nuanced view, suggesting that these agreements could, in fact, be stepping stones to wider multilateral liberalization. Regional trade arrangements could become more palatable, he suggested, if they included a provision that bound participating members to harmonizing and reducing external tariffs over perhaps 10 to 20 years. Harmonization would solve the rules-of-origin problem, and a reduction in the external tariff would reduce the likelihood of trade diversion. Progress in implementing this reform, he added, could become a regular part of the trade policy reviews conducted by the WTO.

Winners and losers

Can developing countries afford trade reform, given that trade liberalization sometimes leads to a loss of tax revenue and, thus, a weaker fiscal position? The concern is a substantial one for some countries, especially in Africa, which derives one-quarter to onethird of its tax revenue from taxes on international trade. The IMF’s Michael Keen (Division Chief, Fiscal Affairs Department) noted that in theory substituting indirect taxes for trade taxes should generate a welfare gain, as well as raise revenue.

In preliminary research, however, he found that, with some exceptions, low- and middle-income countries were able to recover only 30–50 percent of lost trade-tax revenue. There is also some evidence, he added, that replacement of revenue has decreased over time and is greater in Latin America and Africa than in the Middle East and Asia.

Keen’s findings raised a number of questions about whether the observed revenue reductions were due to policy changes or shocks, and whether the results establish a causal relationship between changes in tariffs and revenue. Clearly, more work needs to be done on this important topic.

There has been a great deal of discussion, too, about the potential impact of agricultural trade liberalization on developing countries. The popular belief is that developing countries would reap large gains from the removal of agricultural support in the rich countries. But this may not be true, according to the IMF’s Stephen Tokarick (Senior Economist, Research Department). He reported that estimates from a global model of world trade show that the gains from liberalization accrue mainly to rich, not developing, countries. And while estimates show that developing countries gain in the aggregate, some could lose, notably developing countries that import agricultural products.

However, the matter is complicated by the possibility that net-importing countries could become net exporters—and thus “winners”—if international prices for agricultural products rose following liberalization, which would increase production and reduce consumption in these countries. Furthermore, developing countries tend to tax, not subsidize, their agricultural sectors. An increase in international prices would cause output to expand and offset the tax on agricultural production. Nonetheless, even if developing countries face higher import costs, the size of the increases is likely to be relatively small: about 2 percent of affected imports (although about nine countries would experience an increase in costs up to 3 percent of imports). For these countries, some sort of financing mechanism, such as the IMF’s Trade Integration Mechanism, might be needed.

The IMF’s role

Does the IMF have a role in fostering trade liberalization? According to Raghuram Rajan (the IMF’s Economic Counselor and Director of the Research Department), it will be important for the IMF to continue to emphasize the benefits of freer, more open trade—not just in goods but also in factors of production such as labor and capital. Indeed, the IMF’s Articles of Agreement specifically call on the IMF to “facilitate the expansion and balanced growth of international trade,” observed the IMF’s Shang-Jin Wei (Head of the Trade Unit in the Research Department), and IMF research has already helped dispel some misconceptions about trade-related issues, such as outsourcing.

Srinivasan saw the organization primarily as an advocate of trade liberalization, while others suggested a somewhat deeper, more engaged role. Krueger indicated that the IMF stands ready to work with countries in addressing the potential adverse effects of trade liberalization, particularly the loss of tax revenue, since this argument is sometimes used to forestall liberalization. Winters thought the IMF could also provide objective research and advice on the likely impact of trade liberalization, particularly the fiscal implications, and help persuade countries that “trade policy needs to be made consistent and coherent with countries’ objectives on development.”

Richardson offered the intriguing suggestion that the experience of the World Bank and the IMF with weighted voting could help the WTO deal with governance problems that have plagued that institution.

Final thoughts

A main conclusion emanating from the conference is that preferential trade policies are not unambiguously beneficial; they may hurt the countries that enter into them. Recent research has brought us closer to understanding the nuances of the changing landscape in the world trade system. As that global landscape continues to change, however, the need for solid research goes on.

Photo credits: Nabil Ismael, pages 313-14; Henrik Gschwindt De Gyor, Eugene Salazar, and Michael Spilotro for the IMF, pages 315-19, and 328; and Michaela Schrader, page 320.

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