New Perspectives on Trade and Development

The first meeting of the United Nations Conference on Trade and Development (UNCTAD) in 1964 marked a turning point in relations between poor and rich countries. As we approach the second conference, now scheduled to convene in New Delhi early in 1968, it is fitting to assess the impact of UNCTAD on thought and policy with respect to the trade problems of the low-income countries.

The first UNCTAD dramatized a salient fact about the development process- namely, that the sluggish increase in the poorer countries' capacity to import had become a principal constraint on their economic growth. But the conference went far beyond a diagnosis of the problem and gave expression to some basic policy implications and prescriptions, mainly in the form of measures to be adopted by the advanced countries to increase the foreign- exchange receipts of the less developed countries. Furthermore, the conference set up institutional machinery designed to exert continuous pressure on the rich countries to find ways of meeting the needs of the poorer countries.

Today, not quite three years after the conclusion of the 1964 conference, the policies of the rich countries are being subjected to a steady pounding in a formidable array of international organizations operating under the aegis of UNCTAD: the conference itself which is a plenary body of more than 120 countries; a 55-nation Trade and Development Board which acts as an executive organ between meetings of the conference; and numerous more specialized committees, subcommittees, working parties and expert groups, all serviced by a permanent secretariat of several hundred people. In 1966 scarcely a week went by when one of these UNCTAD bodies was not in session.

Talk is cheap. And one can well understand the frustration reflected in a recent statement by U Thant, Secretary-General of the United Nations, when he lamented "the slow rate of progress on virtually every recommendation of the first UNCTAD Conference, even those adopted unanimously."[i]

At the same time it would be a mistake to underestimate the cumulative force of the process of confrontation launched at UNCTAD. When a responsible Western government is faced with a series of international meetings on an issue such as tariff preferences for less developed countries, it cannot simply send someone to sit on his hands. As part of its preparation, the government will reexamine its policies; it will react to proposals put forward by an international secretariat; it will often suggest alternatives; it may draw upon the resources of the academic community for analysis and ideas; it may sound out various domestic interest groups; and, increasingly, it will consult with other advanced countries in seeking a concerted position. In the three years since the first UNCTAD, there has in fact developed a certain institutionalization of this process of consultation among the industrial countries as the problems of the low-income countries have gradually become one of the principal preoccupations of the Organization for Economic Coöperation and Development (O.E.C.D.).

All this ferment is bound to shake things up. Within the U. S. Government, for example, there has been a searching examination of a variety of policies, some of which would scarcely have been considered a few years ago. Other countries too are giving high priority to the trade problems of developing countries. Related ideas and initiatives are being studied and formulated by international organizations such as the World Bank, the International Monetary Fund (LM.F.) and the General Agreement on Tariffs and Trade (GATT). While this activity has not yet produced any basic changes in policy, it must be recognized that the gestation period for such changes is necessarily a long one. But gradually, as rigid ideological positions on the side of both developed and developing countries give way to a more receptive pragmatism, certain approaches representing a broad consensus are coming to the fore.

Before assessing the state of current thinking on trade and development, however, I might indicate how the trade of the developing countries has in fact evolved during the first half of the 1960s. A review of the major trends is particularly appropriate because some significant changes have emerged since the decade of the 1950s-the period that served as the main backdrop for the original UNCTAD conference.

II

What sparked the concern in the early 1960s about the growth prospects of developing countries was the unequivocally adverse trends in their exports during the latter half of the fifties. In terms of physical volume, exports increased only sluggishly; because of falling prices for many basic commodities, earnings from exports grew at an even slower rate, averaging 3 percent annually. Looking to the future, the United Nations projected a widening gap between the imports needed to support accepted growth targets of 5 percent annually and the capacity of developing countries to pay for such imports from the proceeds of their exports. This gap between required imports and anticipated exports was the point of departure for the entire UNCTAD approach.

In examining the 1960-65 record, however, one finds another type of "gap"-a marked divergence between U.N. projections prepared for the first UNCTAD conference and the actual trends in the foreign trade of developing countries. Exports of developing countries increased at an annual rate of 6 percent during the first half of the sixties, a rate 50 percent higher than the rate projected by the U.N., and twice as great as the corresponding figure for the latter half of the fifties. Pointing out this difference does not imply that the U.N. was "wrong." In no sense did it purport to forecast what would actually happen; it intended merely to project trends based on certain past relationships and assumptions about the future.

As it turned out, demand for certain products was more responsive to increases in income than had been assumed in the U.N. projections. But the main factor that threw the projections off was the unexpectedly high growth rates of the industrial countries comprising the principal export markets of the developing countries. The U.N. assumed that total output in the advanced countries would increase annually by 3.7 percent, the same rate as in the decade 1950-60. Since, in the latter half of that decade, output increased even more slowly, the U.N. projections did not seem unduly pessimistic. In fact, however, the increase in output of the industrial countries in 1960-65 accelerated to 4.7 percent, largely due to the doubling of the growth rate of the United States compared to the preceding five years.

One might well have expected that, in doubling their export growth rate, the low-income countries would also have increased imports substantially. To the surprise of many observers, however, the growth rate of imports did not accelerate but remained at the 4 percent per year figure that obtained in 1955-60. At that rate, the import requirements of sound development plans remained unsatisfied.

Another way of looking at the changing export-import relationship may cast some light on what has been happening. In 1957-59, the developing countries imported an average of $3.2 billion of goods per year in excess of their exports. By 1963-65, however, this net transfer of goods from the outside world had contracted to an annual average of less than $0.6 billion. According to both GATT and the United Nations, if imports as well as exports are measured on an f.o.b. basis, there was actually in 1965 a small net transfer of real resources away from the developing countries, in the sense that their exports of goods exceeded their imports.

How does one explain this anomalous situation? After all, the essential purpose of aid is to permit low-income countries to invest in excess of their own current savings by allowing them to make net drawings on the real resources of the rest of the world. But now we find that, because of a much slower growth of imports than of exports, these net drawings have, for the developing world as a whole, shrunk to zero.

As is true of so many aspects of economic development, it is difficult to evaluate this trend while speaking of "the developing world as a whole." To some extent, the explanation lies in the more rapid expansion of exports of petroleum than of other products from developing countries, and in the channeling by oil countries of a significant part of their proceeds into reserve accumulations. For non-petroleum exporters, however, the most important factor appears to have been the rapidly increasing sums required to service their foreign debts. In Latin America, where the burden is most acute, debt service absorbed 15 percent of export earnings in 1964 as compared to only 6 percent in 1956, For some countries-Chile, Brazil, Turkey-public debt service has grown to 20 percent or more of export receipts. At the same time, payments by developing countries for other "invisible" items in their balance of payments-transport and other services dividends and other investment income-have increased sharply correspondingly reducing the sums available to pay for commodity imports.

The disappearance of the import surplus previously enjoyed by the low- income countries may be viewed from another perspective. At the beginning of the sixties aid and other capital flows to developing countries were of sufficient volume to offset net payments for invisible items in the balance of payments, with enough left over to finance a sizeable excess of imports of goods over exports. With the failure of the volume of aid to increase significantly during the first half of the sixties, while financial claims mounted, the low-income countries as a whole have simply had to limit their imports to what they could pay for with the proceeds of their own exports. As put by the World Bank in its most recent annual report, "A shortage of such resources [aid] is reflected most directly by insufficient growth in imports. Barring an unforeseen change in world markets, imports of developing countries cannot be expected to grow sufficiently unless the flow of external funds is increased considerably."

The situation has been further aggravated by the tendency for food production in the low-income countries to lag significantly behind food requirements. The Indian food crises of 1965 and 1966 are dramatic instances, but the problem is widespread. Consequently, food imports have been rising as a proportion of total imports into low-income countries, thereby impairing their capacity to import goods contributing more directly to development.

In sum, despite impressive statistics on the rapid growth of exports from developing countries in the first half of this decade, those countries as a group still face the problem which set the stage for the first UNCTAD conference-namely, a squeeze on their capacity to finance the imports necessary for satisfactory growth.

One line of action to meet this problem is to step up substantially the flow of capital, and particularly the flow of aid on liberal repayment terms. If the United States were willing, despite Viet Nam, to take the lead on this score, one could be quite hopeful. A crucial test will be the scale on which the United States supports the pending replenishment of the resources of the International Development Association. Even if we accept the most optimistic expectations, however, increases in aid are not likely to obviate the need for increasing the earnings of low-income countries from their own exports.

III

In the foreseeable future, export prospects of low-income countries will depend overwhelmingly on markets for primary products-food, raw materials and fuels. Not that exports of manufactures have been lagging. On the contrary, one of the most impressive achievements of the 1960-64 period was the rapid growth in manufactured exports from developing countries. But they still represent only about 10 percent of total exports.

Given the continuing dominance of primary commodities as a source of export earnings, it is understandable that the main concentration at the first UNCTAD conference was on issues of commodity policy. Since then, much attention has been devoted to this subject; and I believe that real progress has been made, both in understanding what has been happening and in evolving mechanisms for coping with some of the problems.

An important advance is the wider recognition that there is no panacea in this field, and that the beginning of wisdom is to take as hard a look at the differences among commodities and countries as to generalize about the similarities. The dictum that aggregates conceal as much as they reveal is particularly pertinent to international commodity policy.

Consider, for example, the growth of the world market for traditional exports in the first half of the sixties. The record varies from an increase in the value of world exports of over 80 percent in the case of maize, tin and zinc to actual declines for other commodities including cocoa, manganese ore and rubber. Among commodities registering increases of between 30 and 50 percent are not only petroleum but also iron ore, wood, rice, lead, meat and livestock, citrus fruit and copper. Even within broad commodity categories there was a significant degree of dispersion. For example, although agricultural raw materials as a group showed the slowest export growth rate, exports of wood were among the fastest growing of all commodity exports.

One might expect, then, that the foreign trade performance of individual countries would be determined largely by the composition of their traditional exports. For a particular country a rapid growth of exports would thus be associated with specialization in commodities for which world exports increase rapidly. One of the most revealing findings of a recent GATT study, however, is that the trade fortunes of a particular country are likely to be dependent less on how its traditional commodities fared worldwide than on changes in its share of world trade in these commodities and on its success in developing new lines of production for export. These results-which are broadly substantiated in preliminary studies by the World Bank-underline the importance of a country's own internal and external policies.

A major objective of international commodity policy is the achievement of a higher level of export earnings for developing countries as a whole. Since the first UNCTAD conference, thinking has tended to shift increasingly away from the notion, espoused by the French, that this objective can be universally pursued through commodity agreements or, as the French put it, the "organization of markets." Today it is widely recognized that policy must depend largely upon the market characteristics of the particular commodity in question.

From this viewpoint, UNCTAD, in recent studies, distinguishes three broad categories of commodities by their market characteristics: commodities produced wholly or mainly in developing countries and not subject to serious competition from substitutes (e.g. coffee); commodities produced wholly or mainly in developing countries but subject to competition from substitutes, especially synthetics (e.g. natural rubber); and commodities produced in substantial quantities by both developed and developing countries (e.g. sugar). While some commodities may not fall squarely in any one group, the distinction is nevertheless useful for policy purposes.

Broadly speaking, agreements aimed at raising prices can be effective in increasing producers' incomes mainly with respect to commodities in the first group, for which somewhat higher prices will not significantly reduce demand. For commodities in the second group, higher prices for the natural product would be self-defeating, since the result would be to encourage further substitution. What is required for this group are cost reductions to improve the competitive position of the natural product, and diversification over the longer term into production with more favorable market prospects. Regarding the third group of commodities-those produced in substantial amounts in both developing and developed countries-the main problems arise from import barriers in the advanced countries. Here the principal aim of policy should be to increase the access of low-income countries to the high-income markets.

The scope for commodity price-fixing agreements as a means of raising the export earnings of developing countries is quite limited. Only five major commodities-coffee, tea, cocoa, bananas and tin-clearly meet the two most important conditions: that production take place primarily in developing countries, and that demand for the product be relatively inelastic with respect to price changes. In 1964, exports of these commodities amounted to approximately 12 percent of the total exports of developing countries. If coffee and tin are excluded-since agreements already exist for them-the remaining products account for only about 4 percent of exports.

For a number of years the United States has insisted that the subject of commodity agreements could usefully be considered only on a case-by-case basis. This ad hoc approach has not always been taken at its face value by representatives of developing countries, some of whom have paraphrased the U.S. position as "opposition to commodity agreements on a case-by-case basis." Actually, the United States took the lead in 1962 in negotiating the International Coffee Agreement and in bringing opposing producer interests together. Although the implementing legislation required for complete American participation had rough going before it was passed by the Congress, we have coöperated fully in efforts to make the agreement work.

Despite a series of crises during the five-year life of the Coffee Agreement, there is reason for optimism. The agreement has certainly contributed to the stability of the coffee market. And, with prices well above the 1962 level, it has more than fulfilled the original objective of preventing declines below that level. Moreover, the long-run prospects for a smoother and more effective functioning of the Coffee Agreement are favorable because of improvements that have recently been introduced. Adjustment of quotas has now been made less subject to political pressures, and more responsive to the automatic test of price changes in the submarkets for the principal types of coffee. And steps have been taken to prevent the previous widespread evasion of quota limitations and to encourage diversification out of coffee.

In the last several years the United States has participated actively in two major attempts to negotiate a cocoa agreement. While neither was crowned with success, there are grounds for hoping that the air has now been cleared sufficiently to make possible the conclusion of a workable agreement on the next try.

If there is wider acceptance today of the limited applicability of commodity agreements, there is also franker acknowledgment that their prime purpose is not the traditional one of moderating price fluctuations around a long-term trend. Rather, it is to alter the trend itself in order to increase the export earnings of developing countries, or, as a minimum, to prevent them from falling. This is what is meant in UNCTAD parlance by the objective of "equitable" and "remunerative" prices, and it has been broadly accepted today by all the advanced countries.

To what extent can commodity agreements add to the external resources available to developing countries? According to a recent estimate,[ii] if monopoly pricing were pushed to the point of maximum returns for producers, it would add perhaps a billion dollars per year to their revenues. As an increment to export receipts, this theoretically maximum figure would represent only a modest increase of 3 percent or the equivalent of only half of the average annual increase in export earnings by the developing countries in the period 1960-65. Viewed, however, as a form of aid or net resource transfer from rich to poor countries, the figure is substantial, amounting to 10 percent of the public and private flow of capital to developing countries in 1965.

It is proper to regard international price-fixing agreements as a form of aid, since they are a disguised means of taxing consumers in the developed countries in order to provide resources to the low-income countries- resources which the governments of those countries can, at least potentially, mobilize for purposes of development. However, as Harry Johnson points out, once one begins to think of international taxing mechanisms for financing development, one is struck by the relative inefficiency of commodity agreements.[iii] The distribution of neither the burden nor the benefits conforms to optimum tax principles; and such agreements are notoriously difficult to negotiate and administer.

In a rational world, there would be no particular reason for disguising taxation through a price-raising mechanism. Nor would it be necessary to link international taxation exclusively to primary commodities. Any number of other, more general and equally automatic schemes could be devised. For instance, if the advanced countries were to earmark for development assistance a 2 percent tax on imports of all commodities from all sources, it would yield over $2 billion, a sum equal to an increase of one-third in the current volume of bilateral aid to less developed countries. Moreover, because the trade of advanced countries has been increasing rapidly, the yield of the tax would rise by about 9 percent annually. I am not advocating any particular tax, but merely illustrating the theoretical possibilities for simpler and more efficient devices to mobilize resources for development.

In connection with domestic farm-support programs, economists have long urged the superiority of direct subsidies financed through general taxation over indirect transfers through market-support schemes. The widespread resort to the less efficient technique reflects the farmers' preference for disguising the subsidy and the government's preference for reducing its budgetary cost. Similarly, in the case of foreign aid, practical considerations argue in favor of the commodity agreement where it is feasible. With the volume of bilateral aid remaining virtually stationary at $6 billion for several years in the face of rising prices and an increasing need for assistance, methods such as commodity agreements, whatever their limitations, can provide a much-needed additional transfer of resources to developing countries.

More important over the long run is improved access to the markets of industrialized countries. With the notable exception of petroleum, industrial raw materials move relatively freely in international trade. But primary agricultural products face a wide range of restrictions-tariffs, quotas, excise taxes, as well as preferential trading arrangements benefiting particular low-income countries at the expense of others. Pledges to moderate or eliminate such restrictions were made by the advanced countries both at the UNCTAD conference and, more recently, in the new GATT article on trade and development. Despite high-sounding expressions of principle, little progress can be reported. The basic pattern of restrictions remains-either because of a fiscal interest in maintaining revenues, or, more commonly, because of the overriding desire of governments to protect competing domestic producers. Moreover, given the internal political pressures in advanced countries, it is probably unrealistic to expect any major dismantling of agricultural restrictions in the near future.

IV

Although little has been accomplished in easing access to markets for primary products, the first UNCTAD conference did induce a substantial advance in coping with the short-run instability of export earnings. Traditionally, international efforts to moderate export instability concentrated on the commodity-agreement approach. Partly as a result of the complexity and limitations of arrangements tied to individual commodities, a new and more generally applicable technique was adopted in 1963 by the International Monetary Fund. It provides for special drawing rights on the Fund to "compensate" countries for shortfalls in their export proceeds below the level of the medium-term trend. At the first UNCTAD conference in 1964, the developing countries pressed for a substantial liberalization of this facility, and in 1966 some of their major recommendations were adopted by the Fund.

As now liberalized, a Fund member may draw up to 50 percent (although ordinarily not more than 25 percent in one year) of its quota to offset export shortfalls as compared to only 25 percent previously. These drawings are additional to a country's normal borrowing rights in the Fund and, as a practical matter, are available on virtually automatic terms. Moreover, compensatory drawings no longer affect the conditions under which members have access to successive "tranches" of ordinary drawings. Like ordinary drawings, however, funds borrowed under the compensatory arrangement are repayable in three to five years.

In assessing the importance of compensatory finance, it would be a mistake to be unduly influenced by the fact that the original fund facility was used only a few times-by Brazil and the United Arab Republic in 1963 and by Sudan in 1965. This infrequency of use reflects partly the improvement in commodity markets after the new facility had been established, and partly the initial reluctance of countries to prejudice the terms of their access to ordinary fund drawings. With the latter consideration no longer applicable under the liberalized rules, and with a softening in a number of commodity markets already in view, there is good reason to expect more active recourse to this facility in the future.

To supplement the I.M.F. scheme, the United Kingdom and Sweden put forward at the UNCTAD conference a proposal for dealing with adverse movements in exports which could not be dealt with adequately by short-term balance-of- payments support. At UNCTAD's invitation, the proposal was examined by the World Bank. Concluding that it was addressed to a major problem confronting the developing world, the Bank staff submitted a specific scheme to the United Nations for carrying it out. The Bank's proposal aims to insure against the disruption of development programs resulting from unpredictable adverse movements in export receipts in cases where those movements are either too sustained or too severe to be dealt with by short-term balance- of-payments assistance.

To be eligible to receive support under the Bank proposal, a country would have to enter into a prior understanding with the administering agency both as to reasonable expectations of export earnings over the period of its development plan and as to the policies to be pursued in carrying out the plan. Provided the country lived up to its policy commitments and had no other readily available source of finance, support from the scheme in the form of long-term loans would be triggered by a deficiency of exports as compared to the agreed reasonable expectations. According to World Bank estimates, between $300 and $400 million per year would be needed to operate the scheme over an experimental period of five years, even after taking account of other possible sources of finance including the I.M.F.

The Bank's proposal would provide a valuable addition to the existing array of international instruments for long-term development finance. Countries ready to meet the disciplines implicit in the scheme would be assured that their development efforts would not be disrupted by export shortfalls due to causes beyond their control. And, as a natural concomitant of the scheme, a new and constructive relationship should emerge between individual developing countries and the international community, a relationship in which "the incentives and prospects for effective internal development performance would be greatly strengthened."[iv]

V

Developing countries are convinced that over the long run they must increasingly become exporters of manufactured products. In their view, no matter what measures are taken to improve the conditions of trade in primary materials, the long-term prospects are not encouraging for most of the basic commodities in which they specialize. Diversification into manufacturing would lead to a more rapid expansion of exports while moderating the sharp short-term swings to which primary commodity trade is peculiarly vulnerable. Even aside from foreign exchange considerations, developing countries regard the growth of manufacturing as essential in the modernization process because of its "linkage" effects in inducing investment in related sectors-that is, in industries supplying the inputs and using the outputs of the manufacturing sector.

Recent trends support the view that manufacturing is the most "dynamic" export sector of the low-income countries. Excluding processed metals, exports of manufactures to the developed countries increased 14 percent annually in 1960-64, outstripping even the growth rate of petroleum exports. But the absolute volume of exports of manufactures is still low and heavily concentrated in a small number of developing countries-Hong Kong, India, Mexico, Taiwan and Pakistan.

Obstructing efforts to broaden and accelerate the expansion of developing countries' exports of manufactures are two main roadblocks: restrictions imposed by the advanced countries, and questionable policies in the developing countries themselves. On the first set of barriers, UNCTAD has had a notable impact. In contrast, the obstacles erected by the developing countries themselves have until recently been regarded in UNCTAD as virtually forbidden territory, the subject being introduced only in connection with the World Bank's proposal for supplementary finance.

In dealing with the first roadblock, one of UNCTAD's accomplishments has been to help dispel a widespread misconception in advanced countries. Until recently, the prevailing view was that, with average rates of duty in the United States and the European Economic Community at only about 12 percent, tariffs did not significantly limit exports from low-income countries. In a report prepared for the first UNCTAD conference, however, the U.N. gave prominence to data assembled from GATT and other sources which showed that figures on average tariff levels substantially understate the degree of protection of manufactured products of the kind originating in less developed countries.[v]

Two reasons explain this underestimation of protection. First, the duties on products which the less developed countries are capable of manufacturing are generally higher than the average of 12 percent. Clothing, for example, is dutiable at 25 percent in the United States, 15 percent in the Common Market, and 25 percent in Japan. Comparable figures for shoes are 17, 20 and 30 percent; for bicycles, 14, 21 and 25 percent; for toys and sporting goods, 25, 18 and 22 percent.

Second, and equally important, is the fact that tariff rates typically increase with the degree of processing. While the Common Market's tariff is zero on hides and skins, it is 9 percent on leather and 16 percent on leather manufactures. A similar escalation of duties in relation to the degree of processing is found in the tariff schedules of other industrial countries as they pertain to such products as cocoa, cotton, jute, paper, rubber, wood and others. That this structure of tariffs discourages trade in the more highly fabricated products is obvious. In fact, the deterrent is considerably greater than first appears.

Suppose that unprocessed logs are admitted duty-free; that plywood manufactured from these logs is subject to a duty of 20 percent; and that the logs constitute 50 percent of the value of the finished plywood. In this case, a domestic manufacturer of plywood benefits from a 20 percent duty calculated on the full value of output, not just on the 50 percent of the value which he contributes in the manufacturing process. As a result, the height of the tariff as a percentage of the value added by him is not 20 percent but 40 percent. Thus, tariffs really protect processes rather than products; and the process of manufacturing plywood is protected to the extent of 40 percent.

"Effective" tariffs are generally higher than the "nominal" rates due to the admission of raw materials and semi-finished goods at lower rates than finished goods. Although much of the empirical work in measuring effective tariffs has been carried out in the past few years by university economists independently of UNCTAD, the U.N. conference provided a strong impetus. In a recent study, Professor Bela Balassa of Johns Hopkins has demonstrated that the average effective tariff for consumer goods is 25.9 percent in the United States, 30.9 percent in the European Common Market, 40.4 percent in the United Kingdom and 50.5 percent in Japan. These figures underscore the significance of including in the Kennedy Round, and in subsequent tariff negotiations, reductions in duties on manufactured products important to the present or potential export trade of less developed countries.

Regrettably, UNCTAD's success in highlighting tariff obstacles has not been matched by a comparable impact on what is undoubtedly the most restrictive set of barriers to processed exports confronting the low-income countries. I refer to the Long-Term Cotton Textile Arrangement negotiated in 1962 under GATT auspices. As expressed in the preamble, its purpose is to permit increased access for low-income countries' exports of cotton textiles, while insuring that the growth in this trade takes place in an "orderly manner" so as to avoid market "disruption." However, what started out as an understandable accommodation to certain social and political realities in the advanced countries has in practice become the vehicle through which highly restrictive quotas have been imposed-in Europe as well as in the United States-with little regard to the criteria for determining the existence of market disruption.

Recently, the Director-General of GATT deplored the current trend in restrictions imposed under the sanction of the Cotton Textile Arrangement. Last fall it was denounced in much blunter language, by Congressman Thomas Curtis of Missouri, who is the ranking Republican on the House-Senate Joint Economic Committee and one of four Congressional delegates to the Kennedy Round: "The operation of the cotton textile agreement is shocking to me. It allows a kind of administrative discretion and lack of objectivity that to my knowledge is equalled nowhere else in the U.S. Government." Despite these criticisms, however, the arrangement has been the subject of surprisingly little public debate, and the prospects are good that it will be renewed when it expires this year. Surely here is an area where UNCTAD should be helping to expose the gap between avowed purposes and actual performance. Although a formal review of the arrangement is conducted annually in GATT, no study has been made by UNCTAD nor has it established any committee to review the workings of the textile agreement.

In contrast, the continuing interest of developing countries in preferential, rather than simply equal, access for their processed and manufactured goods to the markets of advanced countries has by no means been neglected. At the first conference, the lines seemed tightly drawn, with all developing countries firmly supporting the idea of tariff preferences, and the United States opposing it in principle. In the intervening period, however, one detects a certain convergence of the two positions, with the developing countries displaying a livelier sense of the complexity of the technical and policy issues involved, and the United States, on its side, showing a greater willingness to examine specific proposals on their merits and expressing a more sympathetic attitude toward the objectives of preferences. In a speech last November, Anthony Solomon, the American Assistant Secretary of State for Economic Affairs, posed the issue as follows: "Does equal treatment for all make sense when the competitive strength of infant industries in the poor countries is obviously no match for long-established mature industries in the developed countries?"

The argument for preferences is in some respects an extension into the export sector of the infant-industry argument for protection of the home market. It rests on the need to overcome the initial disadvantages faced by a newcomer in manufacturing, including the high cost of gaining a market foothold. But unlike infant-industry tariffs which can totally insulate inefficient domestic industries from outside competition, preferences extended to all developing countries provide built-in limitations on inefficiency. The exporter in the developing country would have to compete on equal terms with suppliers from other less developed countries, and with domestic producers in the advanced countries to which he seeks to export. He would also continue to compete, although not on equal terms, with exporters of the same product from other advanced countries, who might still be in a position to overcome their tariff disadvantage.[vi]

On the other hand, there are also strong arguments against a system of preferences. Once granted, they would tend to create a vested interest in existing levels of protection as among the advanced countries, and would militate against further efforts to liberalize world trade, since lower most-favored-nation tariffs would result in lower margins of preference. Secondly, preferences applying to all developing countries would favor the more advanced among the developing countries, since they would be the ones in a position to take prompt advantage of the new opportunities. If efforts were made to distinguish among developing countries, a preference system would become exceedingly complicated to administer and would tend to fragment the world trading system even further. Lastly, any general preference system adopted by the advanced countries would inevitably be accompanied by quantitative safeguards against "market disruption," and in the end these might leave the developing countries with less effective access than they had before.

In brief compass it is difficult to probe more deeply into the complex issues in the debate on preferences. There may, however, be a fairly simple way of providing some preferences, limited in time, without departing too radically from the existing framework of domestic legislation and international negotiations. Whatever concessions are negotiated in the Kennedy Round will be put into effect only gradually; in the case of the United States the staging of tariff reductions will be spread over a period of not less than five years. Consideration should be given to making the new rates effective for developing countries immediately upon conclusion of the negotiations and perhaps extending the staging of the reduction for the advanced countries over a period of at least ten years. Tariff cuts negotiated multilaterally after the Kennedy Round could similarly be applied in advance to developing countries. Such limited preferences might provide a basis for assessing the costs and benefits of some of the more far-reaching schemes recently proposed.

VI

Improved access to the markets of advanced countries, whether on a preferential or on a nondiscriminatory basis, is unlikely by itself to be a major stimulus to exports of manufactures from low-income countries. Crucial to the success of such measures are the trade and financial policies of the low-income countries themselves. Because of their sensitivity, however, UNCTAD has thus far scarcely attempted to come to grips with the range of problems in this field.

Policies of import substitution-that is, of manufacturing those products which otherwise have to be imported-frequently operate at cross-purposes with the avowed objective of promoting exports of manufactured products. Reliance on a highly protected domestic market tends to relieve an industry of the disciplines required for achieving international competitiveness. This is not to say that import substitution is undesirable. Newly established industries often do require some initial protection before they can stand on their own feet and compete on equal terms with foreign manufactures. And balance-of-payments considerations often impel developing countries to seek to save foreign exchange by producing at home manufactured goods that were formerly imported.

The issue today is not whether developing countries should pursue policies of protection or of free trade. After all, neither the United States nor Continental Europe industrialized under conditions of free trade. For the developing countries, the issues are rather which industries to protect, by how much, and in what way to effect the transition from import substitution to export promotion. These are questions to which UNCTAD should address itself.

A protective tariff is among the most powerful instruments of economic planning. It is a means whereby a levy is imposed on the community at large in order to permit the establishment or continuation of an industry. Unless a tariff is selective so that it lends support to those sectors where the present or potential comparative advantage is greatest, there will be a misallocation of resources that few poor countries can afford. Yet in many countries the system of protection is often arbitrary and completely independent of the priorities in their development plans. Planning and foreign trade are administered in separate compartments as if they bore no relation to each other.

Research recently undertaken by Hal Lary of the National Bureau of Economic Research provides one promising empirical approach to the identification of manufacturing industries in which developing countries should have a competitive advantage. By using data on "value added" by manufacture in different industries, Lary was able to array various industries in relation to the intensity of their use of the two factors which are typically scarce in less developed countries: labor skills and physical capital. His technique involves separating value added per employee in each industry into its wage and non-wage components, and using the wage part as a measure of skills and the non-wage part as a measure of physical capital. Lary's studies are still preliminary, but they illustrate one possibility of working out a basis for a reasonable policy of protection for low-income countries by concentrating on those industries in which skill and capital requirements are toward the lower end of the scale.

One would hope that UNCTAD, with the help of the newly established U.N. Industrial Development Organization, would turn some of its resources toward developing a basis for a rational foreign trade policy for low- income countries. And as part of such a policy, consideration should be given to techniques for maintaining some pressure of external competition on protected industries, possibly through the gradual lowering of tariffs. In this way, a policy of import substitution can evolve into a growing capacity to export manufactured products.

Foreign trade policies of low-income countries frustrate development in other ways. For example, the importation of luxury goods is typically subject to a high degree of import restriction in order to conserve foreign exchange and encourage saving. Commonly, however, both objectives are defeated by stimulating the production of the same goods at home, using imported raw materials and intermediate products as well as imported capital goods. Luxury consumption continues, and the imports required to sustain domestic production may leave little net saving of foreign exchange. A more effective way of meeting the country's objective would be through a nondiscriminatory internal consumption tax applying equally to domestic production and to imports. Yet very little attention has been given in UNCTAD to the relation between internal tax structure and trade policy.

Internal fiscal and monetary policies are touchy subjects for developing countries. Too often these countries have been at the receiving end of preachments about financial rectitude by governments of advanced countries, including some which themselves have not achieved notable success in maintaining price stability under conditions of strain on real resources. Considering the lesser capacity to save and to tax in low-income countries, and the tremendous pressures on precisely those resources that are essential to a vigorous development effort, one cannot but be impressed with the enormity of the job of managing a development program with a reasonable degree of price stability. Despite the widespread international attention already devoted to this problem, it cannot sensibly be avoided by UNCTAD. For inflationary fiscal and monetary policies operate with special force to frustrate a country's objectives in foreign trade.

Experience has shown that a sustained and rapid rate of inflation under a system of fixed exchange rates results in an almost chronic overvaluation of a country's currency. Whatever correction takes place periodically through devaluation is quickly overtaken by the increase in the domestic price level. The most direct effect of the overvaluation is to encourage imports and discourage exports since, at existing exchange rates, domestic prices will be too high in relation to prices in the world market. As foreign exchange reserves become exhausted, the government has no alternative but to intervene to offset the incentive to import and the disincentive to export. And here is where the difficulties get compounded, because the management of such a "disequilibrium system" tends to get more and more complex and is soon beyond the capacity of most governments.

To encourage exports, special exchange rates may be declared for particular commodities, rebates may be granted on transport charges, special rights may be given to keep or sell on the free market some part of the foreign exchange earned from exports. Yet, while incentives to export are being adopted, other government departments may be leaning in the opposite direction, trying to hold down the volume of exports through taxes or outright prohibitions in order to prevent consumer prices from rising or to insure supplies of materials for domestic processing. On the import side, overvaluation tends to vitiate, in whole or in part, tariff protection intended for domestic industry. To counter the encouragement of imports, tariffs (including surcharges) may be raised to astronomical levels, advance deposits may be required of importers, and, most commonly, a system of quantitative import controls may be instituted.

Controls are, of course, unavoidable in some situations. But as comprehensive controls become the normal way of life because of the persistence of disequilibrium, adverse effects on development are inevitable. The system tends progressively to insulate a country from the competitive pressures of the world market, to introduce wasteful and inequitable distortions, to invite corruption and increasingly to substitute for constructive activity a preoccupation with "beating the system."

According to an UNCTAD report issued in 1966: "The majority of the developing countries, which generally maintain comprehensive control systems, have continued-and in many instances reinforced-their existing import policies, in the form of increased duties, quota or license restrictions . . ." [vii]Considering the pervasive effects on foreign trade and development of internal fiscal and monetary policies which give rise to comprehensive controls, it is essential that these policies now be brought within the orbit of UNCTAD's discussions.

VII

As a new organization born in 1964, UNCTAD has not had easy going. It has set as its goal no less than the reshaping of world trade in the interests of developing countries. But, as any practitioner in foreign economic policy will testify, tough as it is to get funds for foreign aid, it is even tougher to bring about changes in trade policy favorable to "low-wage" countries. The domestic interests immediately affected are more concentrated and the political resistance more difficult to overcome.

In focusing world attention on the growth needs of the developing countries, UNCTAD has made a solid contribution toward greater accommodation to those needs by the advanced countries. It can also claim a considerable measure of credit for stimulating such specific advances as the adoption by GATT of a new set of articles on trade and development; the liberalization by the International Monetary Fund of its facilities for compensatory finance; and the pending World Bank proposal for supplementary finance to offset unexpected adverse movements in exports.

UNCTAD is viewed by the developing countries as their organization. Unlike GATT, the I.M.F. and the World Bank, which came into being through the initiative of the advanced countries, it was a creature of the less developed countries and was brought to life over the initial indifference or opposition of the advanced countries. Perhaps this explains, at least in part, why its pressures have thus far been directed almost exclusively toward changes in the policies of advanced countries. It remains to be seen whether UNCTAD can evolve into an organization capable of dealing with the totality of the trade problems of the developing world, including those policies of the low-income countries themselves which are so crucial to their development.

[i] Statement made to the Economic and Social Council at its 41st session, in the summer of 1966.

[ii] John A. Pincus, "Trade, Aid and Development," New York: McGraw-Hill, 1967. The commodities included in the Pincus estimate are coffee, tea, cocoa and sugar.

[iii] Harry G. Johnson, "Economic Policies Toward Less Developed Countries." Washington: Brookings Institution, 1967.

[iv] International Bank for Reconstruction and Development, Supplementary Financial Measures, December 1965.

[v] The report was reproduced in 1963 in the United Nations, World Economic Survey, 1962, Part II. See especially p. 66-68 and p. 79.

[vi] Two other differences should he noted. First, in infant-industry protection, the costs are borne by consumers in the less developed country imposing the tariff; in the case of preferences, the costs would be borne by the developed countries, chiefly those granting the preference. Second, the degree of advantage to particular industries conferred by a system of preferences would depend on the accident of relative tariff levels in the preference-giving countries rather than, as in the infant-industry case, on the potential international competitiveness of the industries receiving the tariff advantage.

[vii] UNCTAD, Review of International Trade and Development 1966, Part II, p. 23 ( mimeographed report TD/B/82, 20 July 1966).