Inappropriate rules, IMF/WB conditionality risk development

Geneva, 9 Sep (Chakravarthi Raghavan) - Inappropriately restrictive WTO rules and IMF-World Bank policy conditionalities on developing countries will result in a process of ‘Risky Development’, an NGO, World Vision, has underlined in a study.

The study, ‘Risky Development: Export concentration, Foreign Investment and Policy Conditionality,’ by Brett Parris, looks at a range of academic studies of mainstream economists to bring out the inapplicability and bad advice to developing countries on trade and investment liberalisation, and/or export oriented trade policies. The report cautions developing countries not to agree to these policies.

The report is by the World Vision International, (and produced by its Australian unit, World Vision Australia), and is in the process of being made available on their websites.

“WTO agreements and conditionalities tied to loans or grants that require countries to liberalise their trade regimes or open particular sectors to foreign investment regardless of the consequences for particular sectors and industries, are unlikely to be in the best interests of the country concerned,” the World Vision report says.

“Policy advice and aid conditionalities for individual countries should be based on detailed studies of the local economy and society, its institutions and its history, and should also be grounded in a deep understanding of the interactions between poverty reduction, human capital development, technological innovation and economic growth,” says the study in its conclusions.

The study has undertaken a survey of existing literature and economic modelling exercises used and their inappropriateness in relation to developing countries and their markets to reach its conclusions.

The former Australian ambassador during the Uruguay Round negotiations, Mr. Alan Oxley, in a Wall Street Journal op-ed article, has said that the world’s trade ministers bungled badly at Doha by focussing on ‘development’, and that “....trade liberalisation delivers primary benefit to the liberaliser itself.”

However, when Oxley was Australia’s representative at the GATT, this wisdom was not practised, and in fact Australia engaged in hard ‘reciprocal mercantalist bargaining’.

That apart, the economic theory underpinning benefits of trade and investment liberalization, is full of problems, when cited by economists who ignore the underlying assumptions, or use computable general equilibrium (CGE) models ignoring their many assumptions or when they apply it in particular developing countries.

About the benefits of free trade, writing in the Guardian newspaper on Monday, Larry Elliot points out that the modern text on free trade is by Paul Samuelson, who won a Nobel Prize, that free trade benefits all nations. His thesis, Elliot points out, is however based on questionable assumptions - “no government, no trade deficit, wages are equal in all industries and capital stays at home rather than working out low wages abroad.”

The World Vision study has made a singular contribution to this debate, even in listing the 31 assumptions behind such models, apart from its analysis of literature and the conclusions from them.

But even those assumptions do not mention, a primary assumption of post-war economics and welfare theories, namely the ‘full employment.’

Now for the 31 assumptions that economists or CGE modellers don’t mention are:

“Perfect competition; Constant returns to scale (i.e. doubling a firm’s inputs leads always and only to a doubling of outputs); Perfect information for economic actors (i.e. there is no uncertainty and therefore no risk); No information, search, assimilation or computation costs; Unlimited computational capacity of agents; Purely rational optimising agents - no bounded rationality or irrationality; No transaction costs; No learning costs; No barriers to entry to new firms; Perfect, complete, capital markets; Irrelevance of capital ownership - whether by domestic or foreign investors; Perfect, complete, risk and insurance markets; Perfect, complete, labour markets with no involuntary unemployment; Unlimited availability of different types of labour - especially skilled labour and entrepreneurs; Costless redeployment and retraining of labour across sectors (labour from a declining sector such as subsistence agriculture is costlessly redeployed to a booming sector such as software engineering); Prices reflect true economic, ecological and social resource costs and benefits (and therefore there are no externalities and so market prices equal shadow prices - for labour, capital, foreign exchange, government revenue);

“Prices freely adjust according to supply and demand - they are not sticky; Irrelevance of distributional issues (a dollar is a dollar) - therefore Pareto optimality is the policy yardstick; Changes are only made if someone can be made better off without making anyone else worse off; Perfect and costless enforcement of contracts and property rights; No hysteresis or path dependency (eg. bankrupted firms are costlessly resurrected after a recession; the unemployed do not lose their skills while out of work etc.); No difference between the private and social rates of return or discount rates; Knowledge and technology for firms are freely available as blueprints. which can be easily and costlessly absorbed, so that all firms lie on the production possibility frontier and there is no tacit knowledge; A smooth continuum of substitution possibilities between capital and labour on a production possibility frontier; Production inputs are not lumpy;

“No fallacy of composition - the whole is no different from the sum of the parts (eg. If a country exports more coffee it will be better off, and the possibility that 30 other countries are doing the same thing, pushing down prices, is ignored); Irrelevance of money - eg. trade models are usually barter models with money ignored; Government spending (consumption.) is a cost no matter what its purpose - therefore spending on education, health, infrastructure and research is considered consumption expenditure to be minimised, not investments in physical, human and knowledge capital to be maximised; Irrelevance of regional geographic considerations - no distinction is made between an evenly spread welfare gain and a net welfare gain by one region within a country at the expense of another; Irrelevance of ethnic divisions - no distinction is made between an evenly spread welfare gain and a net welfare gain by one ethnic group at the expense of another; All transactions are voluntary and by definition make each party better off; Co-ordination failures do not exist; Revenue losses from distortionary tariffs are not compensated for in welfare comparisons of pre- and post- trade liberalisation scenarios - or revenues are replaced by an artificial.lump sum. non-distortionary tax which is not feasible in the real world.

The World Vision study also notes that while the simplified assumptions behind CGE models used to convince developing country decision-makers are not necessarily fatal, a policy model’s relevance depends on two crucial factors: which of the model’s core explicit and implicit assumptions are violated in the local circumstances and by how much? Are the results of the model’s simulation and the policy recommendations that may flow from it sufficiently sensitive to these assumptions that the model loses its policy relevance in this instance?

The World Vision report and study comes as 146 member nations of the WTO gather and kick off their Ministerial Conference at Cancun on Wednesday - where the WTO and the majors are pushing for wide-ranging trade liberalisation by developing countries, sharp redactions in their tariffs and harmonisation of industrial tariffs, and even harmonisation of agricultural tariffs of developing countries to match their own, but leaving a large escape route for the US and EU through budget support for domestic subsidies, via the ‘Green Box’, and investment and other rules under ‘Singapore issues’.

Analysing the various models and the advices about trade liberalisation and export orientation, and looking at some of the outcomes by using regression exercises, the World Vision report brings out that “higher levels of export concentration are associated with higher terms of trade volatility of the purchasing power of exports, lower growth and worse poverty. Higher terms of trade volatility is associated with lower growth, and both terms of trade volatility and volatility of purchasing power of exports are associated with worse poverty.

The report also cites some UNCTAD studies and data, and comes to the same conclusion as UNCTAD that the types of products a country exports matters.

“A country that simply liberalizes and specialises according to its current comparative advantage no matter what that may be in, may not be taking the wisest course of action. Diversification into manufactures would still appear to offer the surest path to a stronger export profile, stronger long-term growth and better social development.”

On the Singapore issues, where FDI has produced, “and rightly so” an acrimonious debate at the WTO, the World Vision study has also done some amount of the study of the literature (on both sides of the argument) about benefits of FDI, and says:

“FDI has costs as well as benefits. It is not always a net benefit to the host country and whether it is a net benefit, depends not just on the quality and integrity of the company concerned, but on local economic structure. Some studies have shown that up to a third of projects can be a net cost to the host country. Major FDI proposals should therefore be evaluated carefully in a comprehensive cost-benefit framework.”

The study adds, “cost-benefit analysis is a much-neglected, but essential skill and most developing countries need increased technical assistance and resources to build their capacities to undertake it. Neglecting sound cost-benefit analysis of FDI is a dangerous false economy.”

The report says: “Moves to begin negotiations on investment in the WTO are premature, and any proposals that would limit developing country policy options in regulating FDI are inappropriate.”

On the various questions about FDI and role of TNCs, and the suggestions that these could be dealt with through codes of conduct, the study says: “FDI can contribute to economic growth; but whether it does so is highly dependent on the domestic economic environment. FDI will be important for some countries, but there is not simply enough FDI to assist most developing countries, particularly in Africa. Most such countries still require substantial amount of ODA to lift their population out of poverty and all require a well-crafted domestic development and investment strategy.”

Also, in the discussions about TNCs, FDI and codes of conduct, “it is often assumed that FDI is beneficial and that the real question is the conduct of the company concerned... (however) while company conduct, and therefore codes of conduct are obviously important, we must not neglect the prior question of whether a given investment is in fact likely to be of net benefit to the host country. Should developing countries simply solicit and accept any FDI?”

Some FDI may even be harmful - from ‘big tobacco’ companies or FDI in junk food production and distribution among the poor, especially in urban areas.

On the problem of transfer pricing, the study cites a Wall Street Journal report that the US internal revenue service has estimated that transfer pricing abuses costs the US government $2.8 billion a year. However, finance professors, John Zdanowicz and Simon Pak, from Florida International University in Miami, have put the figure as closer to $38 billion in 1998.

“This kinds of results make it difficult to assess the true benefits of trade consequences of FDI and undoubtedly result in large losses of fiscal revenues for government.”

The study also underlines the balance-of-payments consequences and potential volatility of FDI and warns that this should not be ignored or under-estimated.

On the international policy front and negotiations at the WTO on investment rules, the World Vision study says: “Developing countries must retain the freedom to devise FDI policies appropriate to their own circumstances, including measures such as export performance requirements and restrictions on entry to particular sectors. Any moves to curtail these freedoms under future WTO investment agreements should be strenuously resisted by developing countries.”

The report also cites other important questions to be addressed in this regard, and adds:

“In the light of these issues,” says the study, “World Vision does not support the launching of negotiations on investment in the WTO. An international investment agreement negotiated under the WTO would most likely reduce the flexibility of developing country governments to restrict certain types of investment, and make it more difficult for governments to impose on companies the kind of performance requirements that may be necessary to make the investment a net benefit for the country.”

The report adds: “An ideology advocating ‘trade not aid’ underlies both the push for blanker liberalisation in the WTO and the cuts to many OECD countries’ aid budgets over the last 25 years. But this ideological slogan rests on a vacuous, misleading dichotomy that has more to do with fiscal and political expediency and economic vested interests in the OECD countries than sound development principles.

“Trade is essential for developing countries and developed countries must take seriously their need to provide greater market access for developing country goods and services. But trade is only one side of the coin. More aid is also essential in order to help poorer countries to build the infrastructure, strengthen the institutions and nurture the human capital bases they need to be able to reduce poverty and participate equitably in the international trading system.

Without much greater assistance and without developed countries eliminating their own export subsidies and granting substantially greater market access for developing country goods and services, any description of the WTO negotiations as a ‘development round’ will remain pure rhetoric - and the world will be poorer for it.” – SUNS5415

[c] 2003, SUNS - All rights reserved. May not be reproduced, reprinted or posted to any system or service without specific permission from SUNS. This limitation includes incorporation into a database, distribution via Usenet News, bulletin board systems, mailing lists, print media or broadcast. For information about reproduction or multi-user subscriptions please contact: sunstwn@bluewin.ch