Openness, deficits and lack of development

Jayati Ghosh argues that, in view of the findings of UNCTAD's
latest Trade and Development Report, greater trade and
financial integration of the developing countries has resulted
in the worsening of their balance-of-payments position and
domestic economic growth; it is time to revise the
now-hackneyed policy prescriptions which see liberalisation as
the universal economic panacea.

AT last, it's official. Although many economists and analysts
in developing countries have been emphasising it for some time
now, most multilateral economic agencies have tended to steer
clear of noting the uncomfortable consequences that greater
international economic integration has already implied for
most developing countries. The latest Trade and Development
Report (TDR) just released in Geneva by UNCTAD (the United
Nations Conference on Trade and Development), however, finally
does look closely at this issue.

In doing so, it has come to accept that both financial and
trade liberalisation can have undesirable consequences not
just for the balance of payments but also for domestic
economic growth. The current received wisdom in the
mainstream literature, especially from the World Bank, is
rather different, and can be briefly summed up in the mantra
'trade liberalisation good, financial liberalisation bad'.
But this is a simplistic view. More perceptive observers have
noted that trade liberalisation can play a role in building up
to crises like those in East Asia, or in causing recessions or
declines in domestic manufacturing industry in several other
developing countries, or even in limiting the possibilities of
major shifts in the international division of labour.

Thus, the TDR '99 admits that 'developing countries have
striven hard, and often at considerable cost, to integrate
more closely into the world economy. But in the face of
deep-seated imbalances in economic power and systemic biases
in the international trading and financial systems, their
expectations of the gains from such integration in terms of
faster growth, greater employment opportunities and reduced
levels of poverty have been disappointed...the downside risks
have proved far greater than was generally expected... the
20th century is closing on a note of crisis and a growing
sense of unease about the policy advice that was proffered in
the past decade' (page V).

On the basis of a slightly longer look at the experience of
growth and external imbalance in developing countries, the TDR
points out that growth in developing countries as a group in
the 1990s has been at an annual average of around 4.3%. This
does represent a recovery from the levels of the 1980s, but it
is still well below the average of 5.7% per annum of the
1970s. Moreover, this partial recovery in economic growth has
been accompanied by a significant worsening of external
deficits. Indeed, if China (whose performance was exceptional
for a variety of specific reasons) is excluded, then it turns
out that the average developing country trade deficit for the
1990s is higher than that for the 1970s by almost 3
percentage points of GDP, while the average growth rate is
lower by 2 percentage points per annum.

Of course, low oil prices in the 1990s (compared to high oil
prices in the 1970s) have played some role in this average
since a number of developing countries rely on oil exports.
But the same pattern is evident, to almost the same degree,
even for non-oil-exporting developing countries, indicating
that the basic problem lies elsewhere.

The pattern is also the same across regions. In Latin America,
growth has been lower while trade deficits as a share of GDP
have been the same. In sub-Saharan Africa, growth has fallen
but trade deficits have risen. Countries in Asia have on
average run greater external deficits in the 1990s without
achieving faster growth.

Widening external deficits

The general tendency among the majority of developing
countries over the 1990s, therefore, is of widening external
deficits combined with stagnant or falling growth rates. This
is precisely the opposite of what had been promised by the
proponents of liberalisation at the start of the decade.

Two forces were supposed to create a virtuous cycle of growth
and (eventually) lower deficits for developing countries: the
Uruguay Round of the General Agreement on Tariffs and Trade
(GATT), which was supposed to bring about a dramatic increase
in market access for developing country exports; and the
greater freedom accorded to international capital flows in the
wake of financial liberalisation, which would allow developing
countries to finance deficits easily and increase their
domestic growth rates.

Obviously, neither of these forces has acted quite in the
manner predicted by their votaries. What explains the more
depressing reality? To its credit, the TDR eschews the
simplistic explanations which have been all too readily
advanced in the recent past, which tend to blame everything on
'over-hasty financial liberalisation' or domestic problems
like 'crony capitalism'.

Instead, it seeks to find some common features which apply to
all or most developing countries, and which also reflect the
general conditions of the world economy. It thus isolates two
important factors behind the adverse combination of payments
deficits and lower growth: terms-of-trade losses and rapid
trade liberalisation.

Both of these stem directly from the attempts of developing
countries - pushed by public international institutions like
the International Monetary Fund (IMF) as well as private ones
like the World Economic Forum - to integrate more closely with
the world economy in terms of both trade and finance, to make
their economies more 'open' and to rely more heavily on
exporting activity as an engine of growth.

Crowding into saturated markets

Thus, the terms of trade losses reflect the growing numbers of
developing country exporters crowding into already saturated
markets, pushing down prices further and reducing the income
gains from additional exports. Interestingly, the process of
relative price decline occurred for both primary and
non-primary goods exported by developing countries.

The decline in commodity prices (both oil and others) is
well-known by now, reflecting both slow growth of aggregate
demand in industrial countries as well as substitution away
from the use of such commodities because of technological
change. But standard adjustment policies continue to promote
reliance on these traditional exports for most developing
countries, further worsening the problem.

But even for manufactured exports by developing countries,
relative prices fell. In fact, since the beginning of the
1980s, the terms of trade of developing countries relying
mainly on manufactured exports have fallen by as much as 1%
per annum on average. This reflects the increased
concentration of developing country interest on certain
labour-intensive or natural-resource-based manufactured
products, including low-technology inputs to the electronics

The TDR points to the concern that such manufactures may be
acquiring the characteristics of primary commodities in world
markets. The fear that several analysts had expressed
earlier, that all countries cannot play the same game of
aggressive export promotion in labour-intensive manufactures
without affecting international prices, now appears to have
been justified.

The problem has been aggravated by inadequate market access
for developing country exports in developed markets. This has
turned out to be one of the major false hopes raised by the
Uruguay Round and the formation of the World Trade
Organisation (WTO). The TDR is emphatic that increased market
access for developing country exports should form the basis of
negotiation in GATT, since it may turn out to be more
important than capital inflows for development prospects.

While developed country markets have not become more open for
developing exporters, the markets of developing countries have
been significantly liberalised. Many developing countries
opted for 'big bang' forms of trade liberalisation which
drastically changed the structure of domestic demand in favour
of imports, but even the more gradual liberalisers have seen
imports make big inroads into their markets and erode the
viability of domestic manufacturers.

In the past, it used to be felt that trade liberalisation
combined with currency devaluation would ensure that trade
deficits would not get too large. Indeed, the inability to
finance such deficits typically ensured that trade would
eventually be brought into balance, even at the cost of
domestic contraction. But the possibility of using private
capital markets to finance such deficits, even if only for
short periods, has meant that deficits now continue for
slightly longer periods. More significantly, because trade
liberalisation has often been accompanied by financial
liberalisation, it has broken the link between the current
account and exchange rate movements, which now get determined
by the behaviour of capital flows at the margin. So the new
scenario is one of exchange rate instability and currency
'misalignment' driven by capital flows that further cause
trade balances to deteriorate.

Rapid reversal

Often the imbalances can be sustained for some time because of
continued capital inflow. But the story of the 1990s has been
one of increasingly rapid reversal of such capital movements,
leading to boom-and-bust cycles. The Asian crisis and the
ongoing difficulties in Russia, Brazil and elsewhere, are
evidence of this. In the process, there is also significant
damage to domestic industry, in many cases leading to
effective de-industrialisation because nascent manufacturers
simply disappear in the face of severe and cheap external

This is portrayed by some determined advocates of
indiscriminate liberalisation as being bad for workers but
good for consumers in the country. But it can only be good
for consumers if domestic economic expansion is somehow
sustained sufficiently to ensure that there is more
purchasing power in the hands of consumers. The pattern of
terms-of-trade movements along with effects on domestic
economic activity and employment suggests that this has not
been the case for most developing countries.

So the greater openness of developing countries in the 1990s
has been associated not only with higher volatility and larger
payments deficits, but even with inferior economic growth

Clearly, it is time for those in developing countries to
revise the now-hackneyed policy prescriptions which see
liberalisation as the universal panacea, and take a more
sophisticated and realistic view of the economic challenges
ahead. To push for any real change in economic reality, ideas
must change first. - (Oct/Nov 99)

The above article first appeared in Frontline (22 October
1999) and is reproduced here with the kind permission of its

Jayati Ghosh is a Professor of Economics at the Jawaharlal
Nehru University in Delhi, India.