Chair:

Sheila Page, ODI
Speakers:

Peter Tulloch, WTO

John Thrilwell, British Bankers Association

Does trade have a role in financing development?
Peter Tulloch

1. The WTO is actively involved in the preparatory process for the forthcoming High-Level Event on Financing For Development.

We are involved at two levels. Firstly, during 2000 and early 2001, WTO secretariat staff have participated in regional consultative meetings and in the Preparatory Committee for the FFD event. We have also given evidence to the High-level Panel established by the UN Secretary General. Secondly, the WTO as an organization is one of the three key agencies involved in the process, along with the IMF and the World Bank. But we are a member-driven organization, and our Members are preparing their own political input to the High-Level Event via our Committee on Trade and Development. Discussions on this are ongoing.

2. The multilateral trading system has an important and distinctive contribution to make to financing for development.

The UN Secretary-General's report states - and we in the Secretariat would agree - that open trade policy is one of the most important policies that play key roles in promoting the development prospects of developing countries. We also support the report's emphasis that the potential impact of expanding market access can be many times greater than direct financial assistance, provided that it is combined with successful efforts to increase and diversify developing countries' productive capacity.

There are strong and significant links between trade and financing for development: these include the role of trade in generating foreign exchange earnings; the role of trade liberalisation in promoting economic growth through increased efficiency and the removal of distortions; and the role trade regimes and trade rules can play in encouraging inflows of foreign investment in both goods and services.

The WTO is not a development finance organisation. But as a forum for negotiated multilateral trade liberalisation, and as the guarantor of multilateral rules for international trade, it plays an important role in enhancing financing for development.

3. Trade liberalisation and trade policy reform are fundamental to promoting growth in national income and the reduction of poverty.

By trade liberalisation and policy reform, we mean both the lowering of trade barriers in developing countries, and increased market access opportunities for developing countries through the lowering of barriers in their industrialised trading partners. In the past decade, developing countries have made great strides in reducing their levels of external protection. Although there remain questions about the appropriate pace of liberalization, the evidence suggests strongly that those regions that have liberalized have experienced the fastest growth in trade and output, and in reducing absolute poverty; while those that have not taken on board the lessons of liberalization have fallen further behind, both relatively and absolutely.

4. Trade liberalization in developing countries remains unfinished business.

Trade liberalisation in developing countries remains unfinished business, with average nominal tariffs in excess of 15 percent still prevailing in some developing regions, and often a significant gap between bound and applied rates, which can reduce the predictability of policy reform. These barriers also affect exports from other developing countries, including the least developed countries. There is therefore still considerable scope for cutting tariffs, reducing other barriers to trade, and locking-in such reforms through binding commitments in the WTO.

5. Better market access in developed countries for goods and services is vital.

Though average tariff rates in industrial countries are low, tariff peaks and tariff escalation still affect a number of areas of export interest to developing countries, not least in agriculture. Rural poverty is the most endemic and corrosive form of poverty in the world. Continuing high barriers to agricultural trade are part of the problem, and these have to be brought down. Developing countries also stand to gain abundantly from the removal of quantitative restraints and lowering of tariffs in textiles and clothing, and from enhanced liberalisation in sectors and modes of trade in services where they have a comparative advantage.

6. Regional and North-South agreements are attractive politically, but remain a second-best solution.

One of the challenges that the multilateral system has to face is the rapid spread of regional and other preferential trade agreements. We have recently identified over 170 regional or cross-regional trade agreements in the world, rising to over 250 by 2005 when it is expected that agreements like the Free Trade Area of the Americas will have been concluded. Major countries that never before accepted the idea of RTAs are now doing so - for example Japan. In addition, the conditions for North-South trade are changing; for example, the new Cotonou Convention will eventually set up new reciprocal arrangements between the ACP and the EU, and the AGOA offers new opportunities for African countries in the US market.

We have to accept these new facts of life and recognize them for what they are. Where they offer genuine market opening and the prospect of improved and more stable trading relations among developing countries, between developed and developing countries, or across regions, they are to be welcomed. But they also contain the risks of diversion, not only of trade, but also of trade policy interests. In addition, they create a new challenge to trade-related capacity, including that of negotiating capacity. The increased focus of trade negotiators' attention on regional trade agreements in Africa, for example, means that a limited number of officials are involved in multiple negotiations at once - sometimes four or five different sets of negotiations. Is this an optimal use of scarce skills?

7. It is particularly important that market access for the least-developed countries be improved significantly, speedily, and that it be combined with assistance for capacity-building and trade-related infrastructure.

This is part of the necessary process of "mainstreaming" trade into development for these countries. Assistance - including aid for human and infrastructural capacity-building to finance the vital development needs of LDCs and to build up their capacity for production, and free access for their products, have to work in combination. Otherwise we are blocking one of the most important channels through which these countries can earn their way to greater levels of welfare and prosperity. Initiatives like the European Union's "Everything But Arms" initiative, and other improvements to GSP schemes that have been made or are being announced by a number of developed markets, are very welcome. Nevertheless, the majority of poor people in the world do not live in the LDCs, and efforts to promote trade liberalization and capacity building in LDCs must not be at the expense of, or ignore, the interests of the poor in other developing countries.

8. One area where the linkages between trade policy, trade rules and financing for development are particularly strong is that of trade in services.

Many developing countries have understood the value of opening up their services sectors and of making commitments under the GATS, in order to attract foreign investment in such critical areas as energy, telecommunications, transport and finance. The GATS provides a framework for the sequenced liberalisation of services trade and, as with tariffs on goods, the mechanism of scheduling binding commitments provides a means to lock-in policy reforms.. In services, as in goods, WTO rules improve the transparency, predictability and stability of the environment in which economic agents operate. This in turn may be critical in encouraging both domestic and foreign private sector investment.

9. Lastly, the trade component of financing for development cannot be taken in isolation.

I have already spoken of the need for better consistency between donors' trade and aid policies. Consistency between trade and other development oriented policies is also vital. For effective pro-poor development, policy efforts in trade and other fields must be integrated into a consistent set of mutually reinforcing strategies. This goes beyond merely tinkering with the operation of international institutions, but cuts to the heart of the matter: namely, the need for donor partners, developing countries and all our international institutions to address trade and development objectives through operational strategies aimed both at enabling market access and promoting capacity building, and informed by economic good sense.

Liberalisation of trade in financial services: Is it the right way forward?
John Thirlwell

Mr Reisen initiated the discussion in the background of a theoretical and empirical analysis of the effects of private capital flows on economic growth and inequality.

7. From a theoretical perspective, capital inflows are predicted to finance either an existing foreign exchange gap or a saving-investment gap in developing countries (the "structural" dual-gap theory). While neoclassical theory, and the associated Solow growth model, posit that a poor country benefits from net inflows until the marginal productivity in its economy equals the world interest rate, the new, endogenous, growth theories claim that gross inflows convey positive externalities that offset diminishing returns to capital. A positive, long-term growth effect of capital is so restored. Moreover, international capital flows allow diversification of risk and the smoothening of consumption.

8. Generally, capital flows are associated with both benefits and risks, depending on the types of flows. Among benefits, capital inflows add to domestic savings allowing for higher investment, raise efficiency, and lower consumption risk. Capital flows entail risks, as they magnify distortions in the allocation of investment (credit booms), and are also subject to sudden stops, leading to bankruptcies, credit crunch, and increasing fiscal burden in the recipient economy.

Empirical studies show that FDI has shown distinctive positive effects: it can crowd in local investment, have positive spillover effects and be crisis resistant (however, such qualities are only associated with specific types of FDI).

Portfolio equity, on the other hand, lowers capital cost and facilitates reallocation, but it can add to asset price inflation and is also reversible (leading to high liquidity and transaction costs).

In contrast, debt flows have a consumption-smoothing role, but tend to be pro-cyclical and prone to sudden stops. Moreover, public guarantees might induce distortions in the allocation of debt flows.

A study conducted by M.Soto (OECD Technical Paper 160) on 44 middle-income countries over the period 1986-97, has shown that equity inflows have a positive effect on growth only in the case of countries with a level of bank capitalisation above 14%. If not, risk taking results intensified, leading to credit booms and bankruptcies.

9. Mr Reisen also presented some evidence about the effects of financial boom and bust cycles on poverty. During boom episodes in an undistorted economy, FDI greenfield raises labour demand and equipment of labour, with positive effects on the poor. On the other hand, portfolio flows, bank credit, and FDI M&A, raises demand for short-term inelastic assets, ensuing in a pro-rich wealth effect.

If there is a period of doubt about current account deficits, real exchange rates, or loan quality, the higher interest rates raise currency and default risks and deteriorate balance sheets. This to the benefit of savers. Labour is squeezed. In period of crisis, output losses rise, labour demand falls, as do the margins in the informal sector. Devaluation raises food and medicine prices. Bank failures induce lower social spending, higher public debt. The poor, in particular, bear the social burden of the crisis.

10. Recommendations:

Mr Reisen concluded with the following suggestions for growth promotion and poverty reduction.

(i) Open up to equity inflows.

(ii) Maximise benefits from these:

• Educate people;
• Reduce distortions;
• Deepen stock markets;
• Abolish ownership limits.

(iii) Avoid premature opening up to bank credit flows, strengthen banking system first.

(iv) Beware of credit and spending booms.

• Enforce bank supervision;
• Avoid implicit incentives for short-term flows;
• Avoid exchange rate and any other 'guarantees'.

(v) Bank closures; owners' bail-in.

(vi) Microcredit availability.

Discussion

11. The role of banks in pulling out funds from crisis-affected countries during 1997-8 has been emphasised, in contrast to the interpretation given by Mr Gray in his presentation.

12. In some cases, such as Japanese Banks, the turnaround in bank lending in East Asia was also related to the conditions in the financial sector in the home economy.

13. Access to finance has a different profile when viewed not in absolute numbers but relative to GDP. The difference in net capital flows to developing countries converges significantly among developing countries, if flows are measured as ratio to domestic GDP.

14. The need for a cost-benefit analysis of the composition of capital flows by developing countries.

15. FDI as measured by IIF may not be estimated correctly. Some increase in FDI flows is because of mergers and acquisitions, which is a temporary phenomenon.

For further information about some of the issues addressed by Mr Reisen, please see Helmut Reisen and Marcelo Soto, Why Foreign Capital Is Good for Post-Crisis Asia , International Politics and Society, 4/2000.