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ABCDE 2002: Trade, investment, and productivity have key roles in development

Author(s):
International Monetary Fund. External Relations Dept.
Published Date:
January 2002
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In his opening remarks, Wolfensohn laid out the key questions associated with implementation: How can development be managed in a coherent, well-coordinated way? How can the effectiveness of development efforts be improved? And how can what’s proved effective be scaled up and rolled out in a sustainable way? Nicholas Stern, Chief Economist and a Senior Vice President at the Bank, echoed the call for action in his keynote address by urging the development community to change the way things are done and be willing to finance the cost of that change rather than underwrite the cost of not changing, as it had done sometimes in the past. The Bank, the IMF, and other international financial institutions have the critical ability, through their convening and advocacy roles, to bring about change at the international level, Stern pointed out. An important example of the convening role, Stern said, is the way in which the IMF and the World Bank support developing countries in carrying out the poverty reduction strategy process. This process requires that poor countries seeking low-cost loans from the IMF and the World Bank prepare comprehensive poverty reduction strategies with wide popular participation. The biggest challenge now in the area of advocacy, according to Stern, is to “change hearts and minds in rich countries on trade issues the same way we changed hearts and minds on debt issues.” But explaining to people in rich countries that subsidies are deeply damaging to both themselves and developing countries is very difficult, he said.

The links between trade, growth, and poverty were taken up in more detail by Anne Krueger, IMF First Deputy Managing Director, and Andrew Berg, of the IMF’s Research Department. Krueger and Berg concluded from their survey of the literature that trade liberalization in developing countries indeed tends to increase growth and that this growth is essential for poverty reduction. But they cautioned that “openness is not a ‘magic bullet.’” Trade policy is central, but just one of many determinants of growth, which is also promoted by strong institutions, macroeconomic stability, a supportive international environment, and avoidance of conflict.

Alan Winters, Professor of Economics at the University of Sussex, concurred with Krueger and Berg’s point about the importance of trade liberalization for poverty reduction. But Winters argued that the links between trade policy and poverty reduction are “less direct and strong than the volume and stridency of the current debate about the new round of trade talks would suggest.” In fact, Winters warned that parts of the agenda for the Doha Round of trade talks could actually threaten growth because they could distract resources from some of the higher-priority agenda items—such as cutting trade barriers in agriculture, which has great potential to reduce poverty. For this reason, Winters urged keeping the Doha agenda simple and focused on issues relevant to development. He recommended, for example, deferring the “Singapore issues,” arguing that investment, competition policy, government procurement, and trade facilitation should be taken up later. Discussant Julio Nogués of Di Tella University in Argentina echoed this sentiment, pointing out the large gap between developing and developed countries in terms of capacity for negotiating trade policy.

Why hasn’t Africa diversified?

Focusing on Africa, the region with the highest proportion of poor people, Paul Collier, Director of the World Bank’s Development Economics Research Group, observed that “30 years ago, the whole developing world was dependent on primary commodities; now Africa is uniquely dependent.” Other developing regions have undertaken massive diversification of their economies to avoid the problems inherent in an overreliance on commodities: exposure to large price shocks (and their negative consequences for output), poor governance, and a substantially higher risk of civil war. Given the push for diversification elsewhere, does this mean Africa has an immutable comparative advantage in primary commodities? Based on the main findings of his paper, “Primary Commodity Dependence and Africa’s Future,” Collier argued that Africa’s resource endowments and locations are not intrinsically different from those of other regions. Rather, he said, Africa has bucked the overall trend toward diversification because its investment climate is poor and the costs of doing business are high. Under these conditions, its options are limited.

Collier proposed export-processing zones for African countries as one way oflowering these high costs and becoming more competitive in manufacturing. While he predicted that Africa will have no choice but to live with dependence on primary commodities for the next decade, he stressed that this does not lessen the urgency ofaddressing the associated problems. A range ofpoli-cies would help, according to Collier, including making aid contingent on commodity prices and increasing transparency in corporate payments of primary commodity rents to governments.

In a thought-provoking presentation, “Could Africa Be More Like America?” Adrian Wood, Chief Economist of the United Kingdom’s Department for International Development, argued that the two regions share important similarities that have been almost completely neglected and upon which useful policy lessons for Africa can be drawn. For example, because Africa, like America, has abundant land, it will always have a larger primary sector and a smaller manufacturing sector than the land-scarce regions of Asia and Europe. And because much of Africa’s land is far from the sea—as much of North and South America’s land is—Africa is apt to have demographic and economic patterns comparable to that in America. That is, it will likely have relatively low concentrations of people living in its interior, and these people will be engaged primarily in agriculture and mining. Inhabitants in the more heavily populated urban coasts will likely be employed in industrial activities. But Africa’s tropical climate and its division into smaller economies will probably never quite allow it to catch up economically with North America, Wood suggested. He distinguished three policy priorities for a land-abundant region such as Africa: applying knowledge to nature by promoting scientific research, education, and training in agriculture and mining; spending more on transport and communications to facilitate the movement of people; and ensuring widely distributed access to land and education to minimize inequalities.

Productivity and prosperity

Reflecting on the guiding premise of the Bush administration’s approach to development policy, U.S. Treasury Undersecretary for International Affairs John Taylor cited increased productivity as essential for growth and poverty reduction. Greater numbers of higher-productivity jobs are “the explanation,” he said, for why some countries are rich. Taylor also reminded the gathering that the founders of the International Development Association (IDA), the World Bank’s concessional lending window, considered raising productivity to be a main purpose of the IDA and stated this explicitly in its very first principle.

Focusing on “a rather narrow slice” of the many important factors that affect the investment climate, productivity, and growth—specifically in African countries—Kenneth Rogoff and Carmen Reinhart, Director and Deputy Director, respectively, in the IMF’s Research Department, examined the role of price and exchange rate stability. Taking a historical perspective, they looked at why Africa has lagged other regions in attracting investment and concluded that four main weaknesses have hobbled the investment climate: bouts of high inflation, frequent currency crashes, the high incidence of war, and the likelihood of high free market premiums in countries that have dual exchange markets and multiple exchange rates. With regard to high inflation and frequent currency clashes, Reinhart and Rogoff found Africa’s experience little different from those of developing Europe and Asia; indeed, in some cases, Africa’s experience had been better. But in terms of conflicts and high free market premiums, historically, Africa has been different from all other regions.

Wars are an extreme form of instability, and Africa has had more than its share, Reinhart and Rogoff noted. Forty percent of the countries in Africa had at least one war during 1960-2001; 28 percent had two wars or more. Not only are wars likely to deter foreign direct investment, Reinhart and Rogoff pointed out, they also are often a source of another deterrent to foreign direct investment— inflation.

How prevalent have dual exchange markets and multiple exchange regimes been in Africa, and how have they harmed the investment environment? For one-third of the 1970-98 period, parallel market exchange premiums exceeded 50 percent in the sub-Saharan African countries that do not peg their currencies to the euro. Reinhart and Rogoff argued that these high premiums are “breeding grounds” for significant governance and corruption problems. While it takes persistence and consistency for a country to build an attractive investment climate, Rogoff emphasized that unifying multiple exchange rate regimes would reduce the distortions to which they give rise and be a key element in a transparent macroeconomic framework.

In a presentation on “The New Comparative Economics: A New Look,” Andrei Shleifer, Professor of Economics at Harvard University, explained the varying performance of capitalist economies by looking at differences in how they regulated market activities and legal procedures. There are, Shleifer stressed, “no perfect institutions” for market economies that are “suitable for every country and every time.” Legal history, level of development, and law and order all matter in determining the institutions that are most appropriate for a particular country, he said.

Effects of financial liberalization

Is financial liberalization worth it? Several papers presented during a parallel afternoon session of an economists’ forum explored the question and generally agreed that the results were mixed. Carmen Reinhart of the IMF and Ioannis Tokatlidis of the University of Maryland found that “as regards savings, anything goes.” After financial sector reforms, savings increased in some regions but fell in most cases. Overall, they argued, financial liberalization delivers greater access to international markets, although the effects appear uneven across regions and income groups.

Graciela Kaminsky, Professor of Economics at the George Washington University, presenting the results of her research with Sergio Schmukler of the World Bank, concluded that financial liberalization can trigger changes in institutions that, in turn, support better-functioning financial markets. This is certainly true, they said, in the long run, as the excessive boom-bust patterns that may occur as an early response to liberalization tend to disappear. Looking specifically at equity flows to developing countries, Hali Edison of the IMF’s Research Department and Francis Warnock of the U.S. Federal Reserve Board’s International Finance Division said that the effect of freeing capital controls on future equity inflows varied by country and likely depended on whether or not controls were altered when they were binding.

The ABCDE, historically, features an assortment of topics. This year was no exception. Other papers covered intellectual property rights, restructuring and agricultural development in transition countries, network industry privatization, service delivery and quality of life in urban areas, health, financing constraints to the growth of small and medium-sized enterprises, making public services work for the poor, political economy of fiscal outcomes in federal countries, and the economic geography of poverty. Copies of the papers presented at the conference are available on the World Bank’s website at www.worldbank.org/abcde.

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