Can Trade Policy Help Mobilize Financial Resources

Can Trade Policy Help Mobilize Financial Resources

for Economic Development?

1. Background.

With the background of the violent protests of "anti-globalizers" in Seattle, Washington, Prague, Gцteborg and, most recently, in Genoa, trade policy makers are no strangers to controversy. Liberal trade policies have been traditionally targeted as the primary reason for loss of domestic jobs due to foreign competition. Most recently, the critics have expanded their "arsenal" of attacks by blaming trade liberalization for poverty, income inequality, marginalization of countries in the globalized world, poor labour standards, environmental degradation and even for social instability and political turmoil, to name just a few. Proponents of liberal trade policies have been having their plate full of so many different attacks that they must wonder whether they have started a new book of "genesis".

There have been wide ranging attacks in relation to the debt burden, foreign aid and the role of multinational firms, but there has so far been relatively little informed discussion of the crucial question for developing countries concerning the linkages between trade and resource mobilization. Certainly the inter-linkages are complex, but the low-level of the debate is surprising because resource mobilization and the improved allocation of scarce resources are the keys to sustainable long-term financing of economic development which, in turn, is at the heart of poverty, lack of education, poor medical standards, spread of diseases, malnutrition, open or disguised unemployment, low incomes and even environmental degradation. More resources would help developing countries tackle social programs, poor infrastructure, and weak private sector investment. It is, therefore, fortuitous that the issue has recently been raised by top international policy makers.

The linkage between trade policy and resource mobilization is also interesting from a theoretical and conceptual angle. The relevant branch of economic theory - growth theory - has surprisingly little to say about the nature of the linkages. Starting from Solow's growth model, modern theory is focused

on the role of capital accumulation, labour, technical progress and the degree of substitutability between production factors. Trade enters the theory only as an instrument of capital accumulation or a factor stimulating domestic competition and thus the elasticity of substitution. The World Bank "two-gap" model of economic growth, used as the analytical tool for economic advise of the World Bank to client countries, is not a formal model derived from a theory but a framework based on accounting identities. While these identities include an external balance as an element of the model, the mechanism influencing the balance is unclear. Perhaps the "growth model" closest to the examination of the trade policy-resource mobilization linkage is the well known Prebisch's model of economic development. However, even this model does not provide clear answers to the problem at hand. The main reason is that the model only addresses the question of terms of trade as a specific issue of international trade. It does not, therefore, address the much broader questions of the linkages between trade and finance.

The present paper seeks to fill this gap. The purpose is not to formulate a new theory or a model of growth in which trade policy would figure prominently as a separate argument. Rather we attempt to outline the main linkages between domestic resource mobilization and trade policy. We outline in conceptual terms various areas in which trade policy operates and the channels through which trade policy affect domestic resource mobilization. The discussion is not merely of hypothetical situations but also looks at practical evidence. We ask the following simple questions. How can trade policy affect domestic resource mobilization? What are the main channels through which trade policy operates? What is the evidence that trade policy has been instrumental in stimulating domestic resource mobilization?

A discussion of the linkage between trade policy and resource mobilization could theoretically cover the following areas - mobilization of domestic resources, mobilization of foreign resources, international financial cooperation such as ODA, external debt and coherence and consistency of international monetary, financial and trading systems. While undoubtedly interesting, these areas cannot be covered in a short paper. We have, therefore, decided to limit ourselves only to three of these areas - mobilization of domestic resources, foreign direct investment and aid and the role of international trade negotiations. The latter is, of course, only a sub-set of the latest systemic issue related to coherence and consistency of activities of international financial and trade institutions.

The paper is divided into the following sections. In Section 2 we identify and discuss the transmission channels of the effects of trade policy on domestic and foreign resource mobilization, including foreign direct investment and aid. In Section 3 we consider the question of autonomous liberalization and look at the empirical evidence on the effects of trade liberalization on economic growth and income distribution, on tariff revenues and on inefficiencies caused by trade protection. Whatever the merits of autonomous trade, it is a fact of life that most countries find it politically easier to liberalize when other countries are doing the same. We, therefore, include in Section 4 a discussion of the merits of trade liberalization through trade negotiations. The paper concludes with a discussion of the policy implications.

2. The Role of Trade Policy in Development Financing

Trade rйgimes both in a home country and in the country's trading partners can have significant implications for development financing. Such rйgimes reflect a variety of national sectoral strategies and fiscal choices. In the area of goods, trade instruments include price-based or non-price based measures, which may be applied at the frontier (e.g., tariffs, import restrictions or export subsidies) or domestically (e.g., discriminatory internal taxation, domestic licensing, regulations, investment incentives or other subsidies). In the area of services, intervention more often takes the form of domestic regulation, which may be applied equally to domestic and foreign service providers or more restrictively against foreign suppliers.

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