The perils of excessive trade and financial liberalisation

UNCTAD's latest Trade and Development Report has sounded a warning against the current policies of financial and trade liberalisation being pursued by developing countries as a result of pressure and advice by Northern governments and multilateral agencies and institutions under their control. In calling for a reappraisal of such policies of closer integration into the global trading and financial system, the Report urges developing countries to retain their policy options and economic instruments, including the regulatory tools to control financial inflows and outflows.

by Chakravarthi Raghavan

THE closer integration of developing countries into the global trading and financial systems, by following the edicts of the Washington Consensus, has not worked, and the present pattern of developing countries maintaining open markets, sucking in imports and financing it through hot money or selling domestic assets, is not sustainable.

And there will be an inevitable backlash against the trading system and developing countries may be forced to opt out, unless industrial countries change course, open up their own markets to exports from the South, and provide developing countries with real market access and special and preferential treatment on a temporary basis to enable them to establish competitive industries and export.

This is the central message of the United Nations Conference on Trade and Development (UNCTAD) 179-page Trade and Development Report 1999 (TDR-99) made public on 20 September.

In a reference to the upcoming Seattle meeting of the World Trade Organisation (WTO) and the negotiations that may be kicked off there, UNCTAD says that market access for the South in the industrialised world must be the centrepiece of a 'positive trade agenda.'

There must be an assault on tariff peaks and their frequency and escalation with every stage of processing in areas of export interest to the developing world, and a dismantling of the annual $350 billion agricultural subsidies of the industrialised world (or twice the value of exports of developing countries). Anti-dumping procedures, possible abuse of health and safety standards to control imports, and signs of backsliding by industrial countries on their commitments under existing agreements, such as 'voluntary' export restraints, have to be confronted.

Special and differential treatment

The upcoming reviews of the TRIPS (Trade-Related Aspects of Intellectual Property Rights) and TRIMs (Trade-Related Investment Measures) agreements of the WTO should be used to remove elements in them that are detrimental to developing countries, and the special and differential (S&D) treatment principle should be made into a WTO contractual obligation.

Warning against excessive trade and financial liberalisation, TDR-99 advocates developing countries retaining their policy options and instruments like controls on capital inflows and outflows.

'Control capital flows'

DEVELOPING countries need to improve their management of exchange rates to benefit from greater integration into the international trading system, and must not only sustain competitive rates over the longer term but also retain policy autonomy to make orderly adjustments when faced with exogenous shocks.

This, says UNCTAD in its Trade and Development Report 1999, is best achieved by managing nominal exchange rates flexibly to minimise fluctuations in real exchange rates, and combining this with controls on destabilising capital inflows.

Discussing the three options of fixed exchange rates, floating exchange rates, and a currency pegged to an external one and a currency board regime, UNCTAD says none of the three can provide financial stability.

'The question is not so much one of designing an appropriate exchange rate regime as of managing and regulating capital flows; no exchange rate regime can ensure the stability and autonomy needed for successful trade performance unless destabilising capital flows are brought under control.'

Referring to the experiences of Chile and Colombia, TDR-99 adds: 'It is important to recognise that the main objective of controls in a world of integrated capital markets is to prevent the cumulative build-up of foreign liabilities that can be easily reversed. Consequently, controls on capital inflows should be a permanent feature of policy, to be used flexibly and in the light of circumstances.'

Exchange rates can also be used to deter arbitrage flows - a crawling exchange rate band, clearly targeted to avoid persistent real appreciation, a band width that creates a modicum of uncertainty and selective intervention by the central bank to smooth fluctuations, but with the width of the band and announced adjustment margins never being less than the forward discount on the currency. The goal should be to substitute changes in controls for use of reserves and to free interest rates for domestic policy objectives.

Discouraging dollarisation of the economy should also be part of the overall regime for capital controls.

And the need for controlling outflows would be reduced to the extent speculative inflows can be prevented and dollarisation avoided.

But no developing country is immune to a currency crisis, particularly if it limits its control over capital movements to market-based measures and prudential regulations, TDR-99 says.

'If all else fails, debt standstill accompanied by temporary exchange controls over all capital transactions, by residents and non-residents alike, including transfers involving deposits and investments in securities and stocks, provide an effective and equitable response to speculative attacks and self-fulfilling debt runs.' -CR/SUNS 4513

The report calls for rethinking policies for development and, in an understated way, challenges some of the voodoo economic policy prescriptions (of the Washington Consensus) pushed on the South by the Organisation for Economic Cooperation and Development (OECD), the International Monetary Fund (IMF), the World Bank and the WTO (and UNCTAD's TNC division which promotes foreign direct investment (FDI)) - get prices right, deregulate the economy, liberalise trade and open markets to imports of goods, services and capital, allow foreign investors and transnational corporations (TNCs) a free hand, and development will be automatic.

Analysing empirical evidence of their experience in pursuing such liberalisation policies for more than a decade, TDR-99 points out that developing countries are ending the 1990s with a slower rate of growth than in the 1970s, with poverty and unemployment again on the rise everywhere in the developing world, and the income and welfare gaps within and among countries widening further.

'Since UNCTAD's first assessment of globalisation in TDR 1997, conditions in the developing world have deteriorated drastically,' says UNCTAD Secretary-General Rubens Ricupero in the overview.

The few bright spots, mainly in East Asia and Latin America, he points out, have been dimmed, and the much-hoped-for turning point in Africa has not been reached. The predicted gains to developing countries from the Uruguay Round have proved to be exaggerated and, as feared, international capital movements have been particularly disruptive.

'As the 20th century comes to an end, the world economy is deeply divided and unsteady,' says Ricupero. 'The failure to achieve faster growth that could narrow the gap between the rich and the poor must be regarded as a defeat for the entire international community. It also raises important questions about the present approach to development issues.'

Development thinking and policies need a radical review if developing countries are to be assured better growth prospects, narrow the income gap with the advanced industrial countries and remove the scourge of widespread and persistent poverty, says TDR-99 in a final chapter 'Rethinking Policies for Development.'

Not sustainable

Developing countries need to manage better their integration into the global economy if they are to overcome the imbalances and instabilities associated with international flows of goods and capital - 'by a reorientation of their policies to regulate capital flows, and establish competitive industries that would not only increase exports but also reduce the import content of growth.'

But actions by developing countries alone would not be a complete answer and serious attention should be given to the systemic biases and asymmetries in the workings of the international trading system which impact on their growth prospects.

In underscoring the conclusions, the leader of the team that produced the TDR, UNCTADÕs chief macro-economist Yilmaz Akyuz, said: 'It is not possible for the South to maintain open markets without open markets in the North to exports from the South. Basically, the South has been maintaining open markets, sucking in imports from the North and paying for it through inflows of 'hot money' and foreign investments from abroad (through mergers and acquisitions) by selling domestic assets.

'This is just not sustainable. If developing countries don't earn money, and cannot and do not export, eventually they would be forced back into protectionism and forced to opt out of the trading system.'

At present trends, the countries of the South would eventually be faced with the alternatives of large external payments deficits and slowing growth, or getting out of the system.

'This is not something that UNCTAD is advocating,' Akyuz emphasised. But if other measures are not taken by the industrialised countries, there would be a backlash in the developing world, and countries would be forced to adopt ad hoc restrictions.

The solution lies in the industrialised countries allowing access to their markets for exports from the South. Identifying the manufacturing industries where the developing countries can export and earn, and opening up Northern markets for them, would result in developing countries being able to earn four or five times more money than what they get from private financial markets.

TDR-99 says that developing countries have been striving hard, often at considerable cost, to integrate more closely into the world economy, but protectionism in the developed world has prevented them from fully exploiting their existing or potential competitive advantage.

In low-technology industries alone (footwear, textiles, metal products, wood products, rubber products, plastic products, manufctured beverage products (excluding coffee and cocoa) and tobacco, says the TDR, because of the trade barriers in the North, developing countries are missing out on an average $700 billion in annual export earnings or four times private foreign capital inflows, including FDI.

But sustained improvement in the external balance of developing countries can only come about through productivity growth and technological upgrading, achieved by augmenting the existing stock of physical and human capital and shifting existing resources away from traditional low-productivity activities.

Sophisticated infant-industry programme

And while there is a need to secure rapid growth of exports in order to expand investment and output, this alone may not remove the balance-of-payments constraint on growth, says TDR-99.

'A sophisticated infant-industry programme designed to reduce the import content of growth also needs to be part of the policy arsenal available to developing countries.

'The current aversion to such programmes reflects a misreading of the reasons for the failure of an earlier generation of import-substitution policies. A careful review of past experience shows that design and implementation problems, and not misguided logic, were the main sources of failure.'

The experience of East Asian and other fast-growing developing economies showed that an export push often followed the buildup of domestic productive capacity for replacement of imports.

'In view of the evidence that the import content of growth in developing countries is now an even greater constraint on sustained economic growth than in the past, a rethinking of this issue is an urgent necessity in many developing countries.'

The lessons of the East Asia experience - the mix and sequencing of trade, industrial and technology policies that successfully combined export promotion with import substitution - have lost little of their relevance.

And while the post-Uruguay Round trading regime has circumscribed the scope for replicating such policies in most developing countries, 'there remains a need for policy advice and technical assistance to developing countries in designing strategies to promote competitive industries, rather than an emphasis on what is not possible under existing rules.'

More importantly, says TDR-99, in view of the growing pressure on countries to push domestic producers into world markets, the concept of infant-industry protection needs to be extended beyond the earliest stages of manufacturing and include 'nourishing more advanced competitive industries through appropriate policies and support.'

Need for re-examination

Developed countries cannot justify protecting and helping mature producers in their agricultural and high-technology sectors and, while denying such possibilities to developing countries facing their own particular problems.

'If existing multilateral rules are indeed impeding the learning and upgrading process in the industrial sectors of developing countries, then a re-examination is called for,' says the TDR.

'Such an examination is particularly desirable in respect of Art. XVIII, Sections A and C of GATT 1994, where the compensation requirements are so onerous that they are likely to nullify the very intent of the article, which is to allow developing countries to promote new industries. Part IV of GATT 1994, together with the Tokyo Round Enabling Clause, which lay down broad principles and objectives of differential and more favourable treatment, could provide a starting point, although their best-endeavour status is not adequate in the light of the remaining biases and asymmetries in the international trading system.'

Stagnant and falling growth rates

ALL projections and estimations suggest that developing countries need to grow at an annual 6% to tackle their unemployment problem and catch up with the industrial world. This would require enormous inputs of capital, but more than 40 to 50% of the needs cannot be met by current private capital markets.

It is necessary to find these resources by enabling the developing world to export and earn - that is, to rely on trade and not hot money - and for the surplus countries like the EU and Japan to directly inject liquidity into these countries, where the propensity for consumption is much higher. This would have a beneficial effect on growth in the world economy, says TDR-99.

TDR-99 notes that the world economy grew by 2% in 1998, and about the same rate is expected in 1999. Unacceptable in itself, the 2% growth hides a growing rift between the developed and the developing world. Output growth in the latter in 1998, at an average 1.8%, was lower than population growth and, for the first time in 10 years, the developing world grew more slowly than the industrial world (2.2%).

Asia's growth continues to depend on how the crisis and its aftermath are managed. The speed and sustainability of recoveries are varied and uncertain, and for the region as a whole, much will depend on developments in China and Japan.

China's exports have slowed down, but the momentum of the economy has been mainained through heavy public expenditure. But if prospects worsen significantly, devaluation may become a more attractive option, and 'the consequential risk of broader currency realignment across the region remains a worry.'

Despite continued pursuit of structural reforms, Latin America has suffered a serious setback, with growth peaking at 5.4% in 1997. All the major economies have been affected. And despite poor growth, all the major economies in the region are running external deficits above the critical level of 4% of GDP. External indebtedness and dependence on foreign capital flows are again on the rise, and the region is vulnerable to a loss of investor confidence and/or a hike in US interest rates.

The much-hoped-for takeoff has not happened in Africa, and the growth rate in 1998 was well below that in 1996 and has hardly kept pace with population growth. 'And 1999 is unlikely to see any significant improvement'. The continued burden of Africa's external debt and reliance on commodity exports are a heavy constraint on faster growth in Africa. - CR/SUNS 4512

[Article XVIII of GATT 1994 relates to Governmental Assistance to Economic Development by countries whose economies can only support low standards of living. Part A envisages such countries being able to temporarily deviate from their obligations, and provides for recourse to Art. XXII consultations if commodity export earnings fall sharply because of actions by another contracting party, but this may be of little avail when the financial and macroeconomic policies of the centres reduce growth, consumption and demand. Part B deals with restrictions for balance-of-payments (BOP) purposes, but has been virtually whittled down by the panel and Appellate Body decisions in the India BOP case. Part C enables developing countries to resort to consultations for taking measures inconsistent with GATT obligations in order to promote the establishment of an industry, but envisages compensation by the developing country concerned to its trading partners. When Malaysia tried to establish petrochemical industries and sought to raise tariffs, Singapore, which had benefited, lodged a complaint at the WTO, and Malaysia rescinded its orders: the compensation to be paid to Singapore would have been too high.]

[In the runup to the Seattle WTO Ministerial Conference, some developing countries have now flagged the issue of Art. XVIII:C, particularly in the context of the US, EC and Japan drive to negotiate industrial tariffs and ensure drastic reductions in the current bound tariffs of developing countries. The EC, in some informal discussions, has said that the end objective to be agreed should be to cut industrial tariffs of developing countries to fall into three slabs (with a maximum of 15%), and make bindings of their 'applied' tariffs. There have also been calls that, as part of the launch of a new round, there should be a 'standstill'.]

The emphasis in the Uruguay Round agreements away from differential treatment to allow developing countries to protect their own industries and get preferential access to Northern markets, towards an ad hoc array of special terms on implementing agreements and technical assistance to developing countries to integrate into the world economy, in the light of the findings of this report, does 'not represent a positive step forward,' says TDR-99.

The TDR cites a recent review of the treatment of the S&D issue in the Uruguay Round, to the effect that the old approach based on the existence of endemic BOP problems in developing countries and support for infant industries, was simply ignored (in the Uruguay Round) by the proponents of conventional neo-classicism (whether because of a one-sided interpretation of the East Asian experience or because of a general distrust of policy-makers in developing countries) who came to dominate the intellectual scene in trade negotiations in the mid-1980s.

'Nevertheless,' adds TDR-99, 'the economics behind the old approach remains valid. Serious attention should now be given to how S&D treatment could be integrated into the contractual obligations of the rule-based trading system.'

On the advice to developing countries to attract FDI for the foreign technologies and other advantages associated with TNCs, TDR-99 points out: 'The benefits of hosting TNCs are not automatic and the policy objectives of the host country in such matters as local content, technological upgrading and BOP stability may clash with commercial interests of the corporations.

'Replacing the high import content of TNC activities in manufacturing with domestic production remains an important objective in many countries. Equally, the potential technological and other spill-overs, particularly for middle-income economies and in sectors where specific knowledge and capital equipment are closely knit together, still require that host governments preserve their ability to bargain effectively with TNCs.

'Again the objective of policy-makers should not be to attract FDI under any conditions but to create a domestic economic base which can benefit from the presence of foreign firms. Thus, while TNCs can remain important agents to help build or improve a country's competitive advantages, the terms on which this is done should remain variable.'

TDR-99 adds: 'As was the case with successful experiences in the past, all trade and industrial policies must be designed and implemented so as to reflect differences in levels of economic development, resource endowments and macroeconomic circumstances. In both export orientation and import substitution there are easy and difficult stages, and Governments must be ready to make timely shifts in the incentive structure as their economies graduate through different stages of industrial and economic development.'

Taken together, these conclusions of TDR-99 on FDI and its pluses and minuses suggest that not only is it inadvisable for developing countries to agree to multilateral rules for pre- establishment most-favoured-nation (MFN) and national treatment rights for foreign investors through a WTO investment treaty, but even the latest proposals of the EC, Japan and OECD countries for WTO rules on post-establishment national treatment and MFN rights are against their interests - of development and industrialisation - and should be rejected.

The above article first appeared in the South-North Development Monitor (SUNS- issue no. 4512) of which Chakravarthi Raghavan is the Chief Editor.