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Locking together aid, trade and investment for a prosperous future

Written by Dirk Willem te Velde

What future for Aid for Trade? The fourth global Aid for Trade (AfT) review at the WTO from 8-10 July 2013 is an ideal moment to reflect. The concept of Aid for Trade has come a long a way since its inception at the Hong Kong ministerial in 2005 when it established AfT as a commitment. Aid for Trade now represents a third of ODA and more and more donors and recipients have increased their attention to trade. Aid for Trade can be effective in stimulating exports, but researchers from ODI, DIE and ECDPM have also suggested it can be more effective by targeting it at reducing the cost of trading, ensuring effective coordination between donors and recipients, addressing trade-related constraints at the trans-national and regional levels and by working more with the private sector in integrating production into global value chains.

But with aid, trade and investment conditions rapidly changing, Aid for Trade needs to keep up the pace (I discuss the evolution of a connected, embedded, and decoupled ‘third-generation AfT’ in this blog). One way to think about this is to extend the commitment to provide AfT at the WTO to include AfT as one of the central pillars in the new Global Partnership for coherent policy-making that is required to ‘transform economies for jobs and inclusive growth’ – one of the transformational shifts identified in the recent UN High-Level Panel Report on the post-2015 development framework.

Structural transformation and job creation is best promoted by the policies and institutions of developing countries themselves, but the international community can provide the enabling environment. AfT is a crucial element in this. It is uniquely well placed to help lock together aid, trade and investment for promoting growth and transformation towards more sustainable economies in the future. Appropriate instruments range from using grants for project preparation, to concessional loans and guarantees to leverage private investment for infrastructure finance. These should be put in place in a transparent, open (and hence, untied) manner.

The aid and investment context is changing rapidly: whilst AfT resources to developing countries declined in 2011 (after growing strongly since 2005), remittances are growing steadily and private capital flows are seeing renewed dynamism in the bond and equity markets, including in low-income and African countries. As we have recognised in our recent research on AfT, the trade context is also changing. The importance of value chains means that trade performance increasingly relies on the ease of collaboration amongst firms and efficient trade logistics. These, in turn, are dependent on trade rules that affect trade at the border as well as behind it.

Thus, the impact of AfT should also be assessed on how it can leverage more financial resources that can build trade capacity; specifically, effective AfT is focused on addressing market and coordination failures amongst investors (inevitably implying a tighter focus of the AfT concept). It should also complement and incentivise progress on concluding trade rules, allowing AfT to contribute to the provision of governance global public goods (the original aim behind AfT). For example, it could be an important factor for a deal on trade facilitation at the Bali WTO ministerial conference in December 2013.

As countries grow and structurally transform themselves, they rely less on external aid and more on other capital flows (in addition to domestic sources). Cambodia (and Viet Nam)’s aid-to-GDP ratio decreased from 11.2 (5.5)% in 2000 to 6.9 (2.9)% in 2010, whilst the FDI-to-GDP ratio increased from 4.1 (4.2)% in 2000 to 7 (7.5)% in 2010. Cambodia’s current efforts in doing a trade diagnostic are leading the shift away from seeing aid alone as the solution, and towards a package of investment in which aid might play a catalysing role. As in Viet Nam, its institutions are increasingly taking on the new role of attracting and using international capital.

Rwanda potentially presents a similar case in Africa. It received around US$200 million in Aid for Trade in the past five years: FDI was US$75 million per year over past five years; remittances were US$100 million a year; but, on top of this, a recent bond issue yielded US$400 million in 2013 (which attracted mainly US and UK investors), which is also aimed at financing infrastructure that be used to boost exports. Other financial flows are growing in relation to Aid for Trade. In this context, it clearly makes sense to move from Aid for Trade to Investment for Trade, where a country tries to make use of a combination of investment flows to build up trade capacity.

Moves towards Investment for Trade may also have implications on the donor side. What donors of AfT do at home is important. For example, whilst attempts to consolidate trade and development under one roof are often viewed with some scepticism by the development community, there is the possibility that, by using knowledge and assets at home to address market failures and binding constraints and leverage other financial flows (on an untied basis), such consolidation can actually catalyse the provision of much-needed resources, including from the private sector. Attempts at increased coordination between aid and trade include BIS/DFID’s Trade Policy Unit in the UK, the establishment of a trade and development minister in Ireland and the Netherlands, and placing aid and trade in ministries of foreign affairs in Australia and Canada. We need to examine whether and how such coordinating mechanisms can indeed deliver better development outcomes.

A shift from Aid for Trade to Investment for Trade potentially has many implications. As researchers, we used to look at the consequences of aid, but with AfT appearing as part of a new agenda that includes its role in leveraging other flows, we also need to examine how the leveraged investments help to build trade capacity and how effective AfT is in leveraging other flows (rather than the other way around). Here and here are some first attempts of how this could be done in the context of DFIs. It also has implications for fora such as the G20, which deal with development in a development working group, and finance for investment in a separate stream. It makes more sense to link the two, and to think about mechanisms that can make linkages between core G20 areas (e.g. finance, investment) and development (see also our suggestion on investment-related aid in this 2004 paper for the Commission for Africa).

Meanwhile, AfT is here to stay, and can and should take on its pivotal roles in complementing trade policy-making and in filling a niche in the international development finance architecture to enable developing countries to achieve their development goals in the future.