TWN Info Service on WTO and Trade Issues (July09/20)
24 July 2009
Third World Network

LDCs need new development path in wake of crisis
Published in SUNS #6744 dated 20 July 2009

Geneva, 17 Jul (Kanaga Raja) -- The least developed countries (LDCs), hit the hardest by the current global economic crisis, need a new development path, with the State playing a greater role, and adopting an incremental approach for building "new developmental States", according to the UN Conference on Trade and Development (UNCTAD).

In its "Least Developed Countries Report 2009" released Thursday, UNCTAD said that the crisis has laid bare the structural deficiencies of the world's 49 poorest countries and has demonstrated their inability to achieve long-term growth and poverty reduction.

To enable the LDCs to overcome their structural constraints and reduce dependence on external support, there is a need for a re-consideration of the role of the State, UNCTAD said.

For the LDCs, the market has not been able to generate sustained and inclusive growth, in part, because the market only works through incremental changes and small steps. These countries therefore need to "build developmental States" -- "a state whose ideological underpinnings are developmental and that seriously attempts to deploy its administrative and political resources to the task of economic development," UNCTAD added.

According to the report, the current economic crisis is the result of weaknesses in the neo-liberal thinking that has shaped global economic policies over the last three decades; weaknesses that have been magnified by policy failures and lax regulation in the advanced countries. Most advanced economies are in recession and emerging markets have slowed.

But the major victims of this contagion are likely to be the LDCs, many of which are still suffering the adverse impact of recent energy and food crises and have the least capacity to cope with yet another major external shock.

The LDCs are unlikely to weather the crisis without considerable additional international assistance in the short run and support for alternative development strategies in the longer run. Changes on both fronts will be needed to induce a steadier and more resilient development trajectory.

The report points to the fact that reliance on commodities as the main source of export and fiscal revenues, along with the strong pro-cyclicality of commodity prices, contributes to the considerable volatility of output growth in many developing countries, but especially in the LDCs.

Another factor is the high levels of indebtedness which represent a chronic structural weakness in LDCs. Despite an overall improvement during the recent boom, the debt burden remains unsustainably high in most LDCs, much higher than in other developing countries - an average of 42% of gross national income (GNI), compared to 26% in other developing countries.

The LDCs are also sensitive to changes in capital flows and exchange rate fluctuations. While an overvalued exchange rate can be an obstacle to industrialization in the long run, exchange rate volatility against major trading partners can add to investment uncertainty and amplify financing problems, particularly through its effects on the values of external debt, debt servicing, and the domestic value of remittances.

The current economic crisis creates both the necessity and the opportunity for a change of direction by LDCs and their development partners. The LDCs, although in a vulnerable position, must start to address their chronic structural weaknesses, says the report, recommending in this context: refocusing attention on developing productive capacities; building a new developmental State based on a better balance between States and markets; and ensuring effective multilateral support.

Neither the good governance institutional reforms which many LDCs are currently implementing, nor the old developmental State, including successful East Asian cases, are entirely appropriate models now for the LDCs. What is required now is a developmental State that is adapted to the challenges facing an interdependent world in the twenty-first century.

Such a State should seek to harness local, bottom-up problem-solving energies through stakeholder involvement and citizen participation that creates and renews the micro-foundations of democratic practice.

It should also embrace a wide range of development governance modalities and mechanisms within a mixed economy model to harness private enterprise, through public action, to achieve a national development vision. There is also a need for policy space to allow experimentation.

The report argues that the developed market economies, which are most responsible for the global financial collapse, not only have a moral obligation to help the poorest countries through the present crisis, but also share a mutual interest in setting the LDC economies on a sustainable growth path. Failure to do so will risk increasing the number of unstable States and thus wider threats to peace and security.

According to the report, LDCs should aspire to a kind of good governance in which the practices of governing are imbued with the principles of participation, fairness, decency, accountability, transparency and efficiency in a non-culturally-specific way.

They should also aspire to a kind of good governance that delivers developmental outcomes, such as growing income per capita, structural transformation, expanding employment opportunities in line with the increasing labour force and reduced poverty.

In building developmental State capabilities in LDCs, what is necessary is to look at successful models and then identify which principles and practices provide a "good fit" with the circumstances of each LDC. What constitutes a "good fit" to particular country circumstances will change over time.

It is necessary to have an evolutionary approach in which policies and institutions are adapted to the level of development of both productive capacities and governance capabilities. A pragmatic approach to building developmental State capabilities in LDCs would involve the adoption of a small number of institutional reforms that fit well within the existing context.

Developmental State capabilities should be built up over time through a strategic incrementalist approach, building on islands of excellence in public administration or executive agencies, promoting policy learning and nurturing growth coalitions. Particular effort should be focussed on building the governance requirements to address factors that are slowing down capital accumulation, technological upgrading, sectoral diversification and structural change.

It will be very difficult to realize a domestically-owned developmental vision and programme without the support of donors, says the report, noting that half the LDCs had less than 18.4 cents a day (compared to $3.20 per capita per day in lower-middle income countries in 2006, and $38.40 per capita per day in high-income countries) available per capita to spend on private capital formation, public investment in infrastructure, the running of vital public services such as health, education and public administration, as well as the provision of law and order.

The report also discusses how macroeconomic policies of the LDCs can be modified in light of the global deterioration in real and financial conditions.

It will be important for LDC Governments to continue to devote a significant share of their budgets to public investment, which will enable them to maintain some degree of momentum in their previously achieved growth trajectories, which were brought about by the global boom in the export of primary commodities.

It would be a mistake for LDCs to reduce taxes in order to provide a fiscal stimulus to their economies, and the governments should continue to invest in building up their capacities to raise domestic revenues. While tax revenues will surely decline in the coming period, as incomes drop, there is no reason why the capacities to raise more revenue in the future cannot be strengthened in the near term, the report says.

The central challenge for LDCs will be to balance the need for short-term counter-cyclical measures - to provide a needed stimulus to their economies - with the longer-term priority of financing public investment as the basis for expanding their productive capacities.

It is imperative that donor countries stick to their previous commitments to ODA (official development assistance) and also increase donor financing to offset the negative impact of the global recession on LDCs.

Continuing to provide debt relief, where it is necessary, would also make a great deal of sense, particularly because this is unlikely to have a large short-term impact on donor-country budgets. In some cases, a debt moratorium should be considered.

The report advances an alternative view on more growth-oriented and inclusive macroeconomic policies. Fiscal policy plays the central role in this approach, driving the development process primarily through public investment, while monetary and financial policies are designed to stimulate private investment, and exchange rate policies are tailored to support export growth.

The report finds that much of the recent discussion has focussed on the need to increase ODA in order to promote growth and development in low-income countries, and in LDCs in particular. However, far less attention has been paid to mobilizing domestic revenue, even though this is widely recognized as the primary long-term financing solution.

To strengthen their fiscal bases, UNCTAD says, the LDCs should refrain from further trade liberalization, increase VAT (Value Added Tax) on luxury goods, improve the effectiveness of taxation of high incomes and corporations and strengthen property taxes.

The report lays out some general outlines for the kinds of tax policies that LDCs both in sub-Saharan Africa and elsewhere could usefully adopt. Countries should refrain from further reducing tariffs until domestic indirect and direct taxes are able to substantially boost revenue.

Noting that tariffs can be expected to fall further in the coming years as countries join free trade areas and customs unions, the report says that since trade taxes still account for a significant share of tax revenue, the revenue losses from further liberalization, especially under conditions of declining trade, could be significant.

Domestic indirect taxes need to be increased at a faster rate than has been the case hitherto. Reducing VAT exemptions could contribute to this goal and raising VAT rates on luxury consumption items would help to augment revenues and to enhance the equity of the tax structure. High-income taxpayers, who often provide the majority of direct tax revenue, could be covered more effectively. Reducing tax holidays and exemptions for corporations would contribute to increased revenue.

The recent upheaval in the financial markets underscores the possibility of taxing the financial sector, especially in order to rein in excessive speculation. Imposing a nominal securities transaction tax - for example at 0.1% - could help to raise revenue, and could also stem speculative activities and market volatility. Various controls on foreign exchange outflows could also help check the volatility of "hot money", which often contributes to destabilizing a country's exchange rate.

The report also highlights the importance of trying to direct ODA more towards building the domestic capacities of LDCs to mobilize domestic sources of development finance, saying that this implies much greater emphasis on mobilizing domestic savings.

For the last three decades, macro-economic policies in the LDCs have been strongly influenced by the recommendations of international financial institutions such as the IMF and the World Bank, and bilateral aid donors.

Typically, they have focused monetary policy on containing inflation, while the role of fiscal policy has been to ensure that budget deficits remained moderate. Public investment has generally not been seen as having an important role in promoting economic development.

Under this approach, says the report, government spending has been cut independently of cyclical conditions and long-term needs. But this strategy has failed to deliver the invigorating investment climate promised by its neo-liberal proponents.

The LDCs should now refocus their macro-economic policies on developing productive capacities. For most LDCs, the required change means adopting expansionary fiscal policies and accommodating monetary policies, as well as managing exchange rates and capital flows.

The current macroeconomic management in LDCs places too much emphasis on monetary policy to the detriment of fiscal and exchange-rate policies. The main objective of monetary policy has been to combat inflation rather than promote growth, employment and exports.

The report calls on LDCs to manage their capital accounts in a way that will allow them to deal more effectively with two major problems -- capital flight and short-term capital volatility. LDCs should also manage their exchange rates to maintain the competitiveness of their exports, for example, by means of a managed float (a market determined rate, but with occasional interventions by the central bank) or by using a loose peg to foreign currencies, with the peg readjusted periodically.

On agricultural policies in the LDCs, the report underlines the need for these countries to raise their investments in agriculture to reduce hunger and prevent future food crises.

Noting that 21 of the 31 countries worldwide currently facing food crises are LDCs, the report says that breaking the cycle of deficient food production, subsistence agriculture, low productivity, declining investment and increasing scarcity of land and water amongst others will require a more active government role than has been the case over the past 30 years.

The report recommends increasing investment in agriculture, promoting technological change to boost farm productivity, enhancing local agricultural capacities and institutions and supporting regional integration of the LDCs.

"Long-standing agricultural export subsidies and domestic support policies in the developed countries remain a critical obstacle to agricultural development in LDCs," says the report, noting that these subsidies are associated with rapidly increasing food imports in LDCs, alongside declines in agricultural production.

Pointing out that the tariff regime is an important tool for raising government revenue and fostering agricultural development and industrialization, the report finds that tariffs in LDCs however have been declining as a result of multilateral, regional and bilateral agreements, structural adjustment programmes and through autonomous reform efforts.

"In view of the negative effects of the food and financial crises, trade policies and associated export taxes could be rationalized and reviewed to ensure availability of imported food staples at affordable prices and to promote agricultural production."

Another key message is that the LDCs must take effective steps to expand domestic industry to weather the current global recession and to grow over the long term. A more diversified economy remains the best insurance policy for LDCs to reduce their vulnerability to future shocks.

Simultaneous efforts in the LDCs to raise investment levels, build new economic links, and upgrade technological capacity - which is at the heart of industrial growth - are the surest way of promoting a more effective involvement in the world economy and the best way to avoid the economic dangers of the lopsided reliance on commodities exports and private capital flows that have been exposed by the current crisis.

However, to carry out such economic transformations, the LDCs need sufficient "policy space" to make decisions that fit their domestic situations and can best lead to economic growth.

"The crucial point is that industrial policy cannot be equated with a particular set of policy instruments, but may evolve over time. Governments should seek to promote structural change towards more dynamic and diversified activities and should have sufficient policy space to intervene in any way necessary with a view to achieving that goal."

The report acknowledges major constraints imposed on the LDCs' policy space at the international level, particularly in bilateral and regional trade agreements, and calls for a rethinking of these arrangements.

It argues that some WTO agreements - including the Agreement on Trade-related Aspects of Intellectual Property Rights (TRIPS) and Agreement on Trade-related Investment Measures (TRIMs) - and regional and bilateral trade and investment agreements circumscribe the use of industrial policy tools used in traditional industrial policy, such as credit and export subsidies, government procurement, credit allocation, price management and local content clauses. These tools were justified on the basis of infant industry protection.

Looking at past success stories and recent experiences in industrial policy in some countries, as lessons for the LDCs, the report concludes "it is strongly argued that LDCs require greater policy space than is currently the case, in order to increase the range of their policy options, to provide time and space for policy experimentation, and to adapt various development 'models' to suit their own needs. Without such freedom to choose, alternative 'models' of trade or industrial policies are no more likely to succeed than their predecessors." +