Trade reform: impacts for the North and the South

by Ian GOLDIN and Dominique VAN DER MENSBRUGGHE

There is little doubt about the role trade plays in growth and development. Both over time, and across countries, the growth in trade volume exceeds GDP growth. Trade policies play a pivotal role in determining trade volumes and patterns, and the elimination and/or reduction of trade barriers has been the basis for successive rounds of trade liberalisation negotiations, the Uruguay Round being the most recent. The contrast between trade liberalisation theory and practice in the industrialised countries is increasingly stark. Whereas OECD member countries unanimously endorse liberalisation as an economic ideology, their trade practices point in the opposite direction. Formerly centrally planned economies and developing countries, who in the past have been seen as more protectionist, have been making major reform efforts. Their remarkable courage in undertaking economic adjustments is now threatened by the failure of the industrialised countries to undertake reciprocal measures. Since the Uruguay Round was launched in 1986, over 60 developing and former centrally planned countries have unilaterally liberalised their trade, but only 12 industrialised nations have responded similarly.

This article presents some of the key issues of discussion of the Uruguay Round and, with the help of a trade model, will quantify the anticipated benefits and impacts from trade reform. In summary, the trade reform simulations indicate that the industrialised countries are expected to gain most from a liberalisation agreement, because their economies are currently most distorted by protectionism. However, from a development and poverty alleviation perspective, the former centrally planned and developing countries stand to suffer most from a failure of the Round. Global income from a successful accord would increase by over $195 billion (1992 prices), with $90 billion accruing to the developing countries and formerly centrally planned economies, and the rest to the OECD countries.

 

The GATT

The General Agreement on Tariffs and Trade (GATT) is the basis for a global rule-based trading system. Members agree to treat others equally and to reduce barriers to trade. The tariff concessions are linked to non-discrimination through the principle of most-favoured nation (MFN) treatment. Through tariff concessions, contracting countries reduce the tariffs imposed on imports from other GATT signatories, while the MFN rule obliges contracting states to extend to other GATT signatories the most favourable trade treatment accorded to an individual country. These non-discriminatory rules are critical to the developing and formerly centrally planned countries whose future growth depends on access to industrialised markets. The non-discrimination policies which are at the heart of the GATT provide a basis for equal treatment with well-established traders. Meanwhile, the multilateral nature of the GATT, including its disputes procedures, prevents large countries exerting undue pressure on smaller ones; the latter can and do use the rules to win equal status with larger ones.

Tariff concessions have been periodically negotiated for among contracting parties through a series of Rounds conducted under the auspices of the GATT. The Uruguay Round is the eighth since the General Agreement came into being. The latest negotiations include sectors so far largely or completely excluded, such as services, intellectual property and agriculture.

The Uruguay Round is taking place in a difficult economic and political environment. Many participants, both developed and developing, face a slowdown in growth, rising unemployment, and large domestic and/or international debts. Moreover, in many countries, excess capacity in traditional industries and intense competitive pressures in these and more modern sectors, such as electronics, from emerging industrial competitors, have provided an impetus for strengthening protectionism. Politically, governments in the industrialised countries appear insecure, with the governing parties or coalitions vulnerable to small swings in support. Meanwhile, the democratic tide sweeping developing and formerly centrally planned economies has meant that competing political claims have imposed added constraints on their ability to negotiate.

Against the background of growing protectionism and politicisation, it is not surprising that, while the previous seven Rounds concentrated on tariff structures for industrial products, the Uruguay Round has also devoted attention to domestic subsidies for agriculture, non-tariff barriers, services, textiles, trade-related investment measures (TRIMs) and trade-related intellectual property rights (TRIPs). Whereas developing countries have much, and perhaps even most, to gain from the discussions on services, TRIPs, TRIMs, and textiles, the discussions concerning agriculture have occupied the centre stage. They have also proved to be the major sticking point and source of friction among the industrialised countries.

 

The Uruguay Round and agriculture

Successive GATT Rounds have treated agriculture as an exception and it has not been subject to the same disciplines as industrial products. The broadening of the GATT Contracting Parties' ambitions in the Uruguay Round may be understood in the context of the growing international concerns regarding the adverse effects of existing trade practices. In agriculture, rising protectionism in the EC, United States and Japan has seen a growing juxtaposition between falling world prices and high and rising domestic prices, implying both an increase in costs to consumers and a rise in public expenditures on agricultural subsidies. These and other problems convinced the GATT's contracting countries of the need to 'bring more discipline and predictability to world agricultural trade by correcting and preventing restrictions and distortions, including those related to structural surpluses, so as to reduce the uncertainty, imbalances and instability in world agricultural markets'.

The instability is partly due to increasing domestic subsidies and unfair trade practices. During the 1980s, industrial countries have strongly increased subsidies to agriculture while agricultural trade has been increasingly regulated by bilateral agreements and market-sharing provisions. Moreover, the growing use of non-tariff barriers (NTBs) has reduced the effectiveness of negotiated tariff reductions. Since the end of the Tokyo Round in 1979, the average level of industrial tariffs in developed countries has fallen by nearly half to 6.4 per cent. The value of total world merchandise trade has grown by a remarkable 4.8 per cent per year. This growth is mainly confined to the industrialised countries; in the 1980s, developing countries' exports grew by only 1.6 per cent, and their share of world trade fell from 28 to 21 per cent.

In part, the explanation for these trends is to be found in the protectionist policies of developed countries, but developing countries have also discriminated against their own agriculture. In the latter, the situation tends to be the mirror image of that in the richer countries, with distortionary policies used to discriminate against rather than in favour of agriculture. Many developing countries followed 'infant industry' policies in order to promote industrialisation by protecting manufacturing from competitive imports, and taxed agricultural producers. In part, this penalisation has occurred through 'direct' taxation of agriculture, through tariffs and other means, but, 'indirect' taxation, from overvaluation of exchange rates and other macroeconomic distortions, has also served to penalise agriculture.

 

The implications of an agreement: a quantitative analysis

In order to assess the implications of trade reform for production, consumption and trade, it has proven useful to develop a formal framework which can trace through the implications of policy reform in a consistent manner. Accordingly, the OECD Development Centre, in association with the World Bank, has developed a model of global production and trade. The model is known as the Rural Urban-North South Model, or RUNS. Briefly, RUNS is in a class of models known as global applied general equilibrium models. The world economy is aggregated into 22 regions: six regions comprise the OECD, 14 the developing countries, and two Eastern Europe and the former Soviet Union. The model specifies supply and demand relations for 20 commodities, 15 of which are agricultural, while the other five are nonagricultural and relatively aggregated. Based on consensus estimates of the trends for the world economy, the model projects supply, demand, and trade to the year 2002 with the additional assumption that trade policies remain at their current levels during the period in question. The analysis of trade reform below is with respect to this base projection.

In this article we will concentrate on the effects of partial trade reform as that envisaged by the December 1991 draft Final Act of the Uruguay Round of Multilateral Trade Negotiations, which is indicative of a possible compromise. The reform scenario which is implemented and analysed below includes a 30% across-the-board reduction in border protection and a 30% cut in agricultural input subsidies. The full 30% reduction is applied in 1993 and is maintained at that level for the remainder of the period analysed, i.e. up to 2002.

 

The results

In very brief terms, the partial trade reform leads to a rise in the world price of most agricultural commodities. This is a consequence of the decline in production in the OECD countries as farmers react to a fall in domestic agricultural prices. While this leads to a relative drop in farm incomes and output in many OECD regions, the overall impact for the OECD is very positive. Consumers benefit from a reduction in food prices and taxes, and the non-agricultural sectors benefit from lower factor prices and an increase in trade. The impact on developing countries is positive on aggregate. In particular, rural incomes increase significantly as a result of a rise in world agricultural prices and a decline in taxation. Poverty in many developing countries tends to be concentrated in the rural areas, therefore trade reform leads to a reduction in income inequality. The negative impact occurs in food-importing regions which suffer from a decline in their terms of trade as the world price of food increases.

However, the overall level of the losses can easily be compensated for by the gains to other regions which would leave all regions better off.

In income terms, the global gains from partial trade reform would be over $195 billion (in 1992 prices). The developing countries would reap $91 billion (or 46 per cent) of the gains, and the OECD countries the remainder. Losses amount to $7 billion. This represents only 3.5 per cent of the total gains, and is less than 20 per cent of the current level of official development assistance. The developing countries which lose are concentrated in Africa and around the Mediterranean. The largest gainers are in Far East Asia and China, and in Latin America. The regions/countries with the largest gains tend to be those with the highest levels of distortions.

 

Conclusions: protectionism and poverty

Many of the arguments justifying past and present agricultural policies have ceased to be valid in developed countries In particular, the objectives of food security and protection of consumers' living standards can be demonstrated not to be served by protectionist policies. On the contrary, existing agricultural policies have led to severe distortions in resource use. The resulting misallocation of resources has affected the growth potential of all sectors of the economy. Indeed, the spill-over economy-wide effects of agricultural protectionism are more serious than the soaring direct budgetary and other costs. It has been estimated that the total cost to consumers and taxpayers of agricultural protection in 1986 was $36 billion The net benefit to producers was $15 billion In other words, of the total transfer from consumers and taxpayers of $36 billion, 60 per cent was lost to inefficiency Over time, these negative effects are amplified, so that existing policies need to be examined not simply in terms of their existing costs, but in terms of their dynamic impact on income generation, investment, growth and the environment

Direct income supports and other more targeted measures are more effective in overcoming rural poverty and achieving distributive and other social objectives, and more efficient in terms of the budgetary cost of achieving these objectives. Equally important, decoupled direct income support is neutral in its impact on international markets and developing countries, and therefore is compatible with the objective of a level international playing field and global, as opposed to simply national, redistribution.

Failure to reform developed countries' agricultural policies will significantly reduce the growth potential of developing and formerly centrally planned countries. A reduction of subsidies to producers in developed countries would raise world prices of key commodities and place developing and other countries on an equal footing with the industrialised countries. Trade liberalisation would benefit food production and those developing countries with export potential, but also have a negative impact on food importers' balance of payments A reduction in developed countries' agricultural production may result in lower quantities of food aid Mechanisms should be developed to ensure that developing countries do not suffer from higher cereal prices resulting from trade liberalisation, and that food aid is not conditional on protectionism in the industrialised countries A number of the poorest countries - and notably those in Africa - stand to gain last from liberalisation. Development assistance packages should be enhanced to compensate for the potential losses in these low-income regions

The quantitative analysis has shown the high cost of protectionism. Partial trade reform would lead to an increase in world income of over $195 billion, and it is estimated that complete elimination of trade barriers would lead to an increase in world income approaching $500 billion

In fact, many developing and formerly centrally planned countries already have adopted trade liberalisation policies; their levels of distortion have fallen dramatically since 1985. Policies which favour equity need to be placed alongside those favouring growth. This will ensure that the critical problem of nutrition and personal food security is addressed. For the 800 million or more people in the world facing malnutrition, what matters is their entitlement to food - the economic power to grow or buy food - rather than the national level of agricultural production. Most poor and malnourished people live in the countryside, and hence policies which are favourable to agriculture tend to improve their prospects. Liberalisation on a global and a national level encourages developing country agriculture and improves rural income in these countries.

Developing countries have learned from bitter experience that they cannot afford the subsidies and distortions which have become endemic in industrialised countries. Their future depends on the establishment of a standardised rule system of international trading, such as that offered by the Uruguay Round of the GATT. The results of our analysis show that the most powerful contribution which industrialised countries can make to their own and to global development is to honour their Punta del Este commitments to 'halt and reverse protectionism and to remove distortions to trade'. The challenge for the industrialised countries is to do as they preach, breaking away from the straitjacket they currently find themselves in. The alternative is to leave in place an economic system that violates the principles of the market system on which the OECD economies are based. This deprives the citizens of OECD and non-OECD countries of potential employment and income, undermining their food security, economic prospects and social harmony. The continuation of the current system feeds the forces of political nationalism and economic protectionism. It would be unfortunate if the industrialised world missed this opportunity to incorporate the economies in transition - the formerly centrally planned economies - on an equal basis, providing these countries, as well as the developing countries, with a greater chance to participate in a growing world economy. The failure to reach an agreement poses a threat not only to economic recovery and global equity but also, by fuelling trade conflicts, to peace in the world.

I.G. and D. vd. M.