The Pandemic Depression
The Global Economy Will Never Be the Same
WHAT'S IN A NAME?
The attacks of September 11, 2001, refocused international attention on the problem of global poverty. In the United States, the Bush administration pledged a 50 percent increase in development assistance and launched the Millennium Challenge Account. Internationally, debt relief for heavily indebted poor countries was extended to include money owed to multilateral agencies such as the International Monetary Fund (IMF), and at the 2005 summit of the G-8 group of industrialized nations in Gleneagles, Scotland, members pledged to increase official development assistance by $50 billion per year by 2010.
The Doha Round of trade talks, launched shortly after September 11, was christened the "development round" in part because of the perception that the need for development was more urgent than ever. This urgency has persisted: multilateral trade negotiations should no longer be viewed as business as usual, but as a high-stakes process with important implications for global development.
One reason for the new emphasis on development is the recognition that the initial results of the Uruguay Round of talks were modest for developing countries. Their most important gain -- elimination of textile and apparel quotas under the Multi-Fiber Arrangement -- was back-loaded and has come into full effect only this year. Agricultural liberalization ended quotas but replaced most of them with tariffs and tariff-rate quotas, resulting in little actual change. Intellectual-property agreements went too far in restricting developing-country access to medicines, a problem finally addressed in a special agreement shortly before the Cancún meeting in September 2003. It is of the utmost importance, then, that Doha provide improved trade opportunities for developing countries.
TRADE, GROWTH, AND POVERTY
There is ample evidence that trade opportunities spur growth and a clear correlation across countries between export growth and GDP growth over the past two decades: each additional percentage point in export growth has been associated with an extra 0.15 percent growth in GDP. One reason for this correlation is that a bigger export base helps countries avoid external-debt problems by providing them with a good source of foreign exchange. Another is that there are productivity gains from integration with the world economy: open trade helps spur domestic technology to world-class levels and dislodge domestic monopolies that curb growth. Meanwhile, cooperation with foreign investors helps raise product quality to international standards. Studies have also confirmed a relationship between trade and productivity gains: a rise of 1 percent in the ratio of trade to GDP has been associated with a 0.5 percent increase in long-term output per worker.
Trade also helps reduce poverty by spurring economic growth, the main engine of poverty reduction. Statistical studies show that for developing countries, there tends to be a relatively close relationship between poverty reduction and growth. For example, in Asian countries, where income is relatively equally distributed, an increase of 1 percent in per capita income tends to reduce the number of people living in poverty by 2-3 percent; this "impact parameter" is 1-2 percent in Latin America and Africa.
The Doha Round offers an important opportunity for developing countries because there is still substantial protection against their products in the markets of industrial countries, and also because their economies benefit from liberalization of their own trade barriers. Protection is especially high in agriculture. The combined influence of subsidy and tariff protection in agriculture amounts to a total tariff equivalent of about 20 percent in the United States, 50 percent in the EU, and 80 percent in Japan. Tariffs are also high in textiles and apparel (10-12 percent).
In my 2004 book Trade Policy and Global Poverty, I used a leading model of world trade and protection to quantify the impact a move to global free trade would have on global poverty. The model results provided estimates of the effects on production, trade, and unskilled wages, and of the traditional income gains from more efficient allocation of resources according to each country's comparative advantage. In addition, the estimates took account of two dynamic effects: greater investment in response to new export opportunities, and productivity gains from more open economies.
My overall estimate was that some 500 million people could be lifted out of poverty (defined at living on $2 per day or less in purchasing power) over 15 years by global free trade. That would amount to a 20 percent reduction in poverty. The impact would be especially large in India, China, Pakistan, and sub-Saharan Africa.
Income gains for developing countries would amount to $200 billion annually (in 1997 dollars). Of this total, at least half would come from the removal of trade protection in industrial countries. This means that industrial countries could convey benefits about twice as large to developing countries through removing their protection as they currently provide in development assistance. Moreover, these benefits to developing countries would help consumers in industrial countries by lowering import prices, rather than imposing a burden on taxpayers as aid does.
These findings do not suggest that industrial countries should replace aid with trade. But they do underscore how inefficient it is for policymakers in the developed world to be taking away from developing countries twice as much in trade protection as they provide in aid.
The objective of the Doha Round should be to go as far as possible toward global free trade. Industrial countries should cut existing protection by no less than 50 percent, especially in agriculture and in those manufacturing sectors with high tariffs. Developing countries should also cut their own protection, for two reasons. First, it would benefit most developing countries to liberalize their own trade, because their current protection levels are frequently excessive and thus curb economic growth. Second, reciprocity will be needed to help overcome the resistance of interest groups currently benefiting from import protection in the industrialized world.
An important quid pro quo in the Doha Round is the liberalization of developing-country protection in manufacturing and services in exchange for liberalization of industrial-country protection in agriculture. Outside of textiles and apparel, industrial-country manufacturing tariffs are already low, at an average of about 3 percent. In comparison, applied tariff levels in non-textile manufacturing average about 12 percent for developing countries. Tariffs in textiles and apparel are higher on both sides, at an average of about 12 percent for industrial countries and 18 percent for developing countries. There are also "peak" tariffs (usually defined as over 15 percent) in some industrial-country manufacturing sectors, although these too are concentrated in textiles and apparel.
The tariff-cutting formulas proposed in manufacturing have tended to be harmonization approaches that cut high tariffs by larger proportions than low tariffs. The July 2004 agreement allowed less than full reciprocity from developing countries. So far, the 20 group of developing countries (which includes key players such as Brazil, China, and India) has waited to see what the EU and the United States will offer in the agricultural negotiations before arriving at a proposal in manufacturing. Meanwhile, the EU has usefully proposed cutting peak tariffs by setting a ceiling of 10 percent on all industrial-country manufacturing tariffs. Special and differential treatment for developing countries might correspondingly imply that they would be expected to set a ceiling of 15-20 percent on all of their manufacturing tariffs. Even the least-developed countries (LDCs) would do well to adopt some ceiling tariff to avoid severe distortions and inefficiencies in their economies, although it might be set higher than in the middle-income countries (in the range of 20-25 percent).
Negotiations have gone further in agriculture and manufacturing than in services. Many economic analyses, however, show that the gains from liberalization would be even greater in services than in goods. Industrial countries want to expand access for their multinational firms in such areas as financial services, construction, and infrastructure. Developing countries have tended to be cautious about opening these areas. Instead, they have tended to seek openings for temporary labor services, which would create new opportunities for their guest workers in industrial countries. Negotiations consist of country-by-country "offers" and "requests," rather than a uniform mechanism such as a formula for cutting tariffs, in part because services protection is mainly by regulation rather than by a price mechanism.
As part of an overall bargain, both industrial and developing countries should start with the easier aspects of services liberalization. For example, most developing countries that have opened their banking sectors to foreign firms have found that doing so helps stabilize the domestic banking system, and expanding market access in financial services would both benefit their own economies and help sweeten the deal for industrial countries. For their part, the industrial countries could usefully offer to lock in the current open-market treatment of cross-border offshoring services such as call centers and software development. This is an area that has ignited great concern about loss of jobs, and clearer industrial-country commitments to keep these markets open would be insurance that developing countries might be well advised to purchase.
The largest potential offer that industrial countries could make in services would be in liberalization of cross-border movement of temporary labor. However, this area is so politically and culturally sensitive that it seems unlikely that a major new agreement can be achieved within the timetable of the Doha Round, and it would be a serious mistake to derail Doha because of the absence of such an agreement. It is not even clear whether this issue belongs in the WTO, or would be better left to bilateral arrangements between geographically and historically linked countries.
DISMANTLING FARM BARRIERS
The G-20 rejected the minimal concessions toward agricultural liberalization offered by the United States and the EU at Cancún in September 2003. The framework agreement reached in July 2004 in Geneva got the negotiations back on track. It pledged elimination of agricultural-export subsidies and a cut of at least 20 percent in other agricultural subsidies. That is a start, but export subsidies are a small part of total agricultural subsidies and used mostly in the European Union. For other, more important, subsidies, the "bound" (WTO-committed) levels greatly exceed the applied levels, and a 20 percent cut in bound subsidies would not reduce actual amounts. So the Doha Round will need to go far beyond the framework agreement to achieve major results in agriculture.
In October 2005, the United States issued a new proposal for deep cuts in agricultural tariffs. Building on the G-20 proposal for graduated cuts by tiers, the proposal called for tariffs under 20 percent to be cut by about 50 percent, with the cuts rising to 85-90 percent for tariffs above 60 percent. There would also be a post-reform ceiling of 75 percent on all agricultural tariffs. This proposal involves extremely large cuts -- reducing, for example, a 60 percent tariff to 9 percent. The U.S. emphasis on tariff cuts reflects its own relatively low agricultural tariffs, which average about 9 percent; the post-cut U.S. average would be only about 4 percent.
The EU, which relies much more heavily on tariff protection, responded with a proposal to cut tariffs by up to 60 percent for the highest tariffs, and by an overall average of 46 percent. Considering that the average EU agricultural tariff is about 33 percent, this implies a post-reform average of about 18 percent. The difference between the U.S. and EU proposals is even greater for above-quota tariffs in tariff-rate quota categories, which average 35 percent for the United States and 79 percent for the EU. (Tariff-rate quotas apply a lower tariff until total imports reach the quota threshold and a higher tariff thereafter.) The latter would be cut to 36 percent under the EU formula but to 13 percent under the U.S. formula. Importantly, the U.S. proposal would allow only 1 percent of tariff items to be classified as "sensitive" products, whereas the EU proposal would allow 8 percent. By some accounts, the latter could encompass the great bulk of EU agricultural imports.
The Uruguay Round established a grading system for agricultural subsidies: amber for output-distorting subsidies, such as commodity payments; blue for those accompanied by output limits, such as acreage set-asides, and thus less distorting; and green for subsidies that do not distort output at all, such as income payments based solely on historical acreage rather than output. It also identified an Aggregate Measure of Support (AMS) for subsidies in the amber "box," but exempted payments of up to 10 percent of output value as de minimis, or too small to warrant control. The July 2004 framework agreement usefully defined overall trade-distorting domestic subsidies as the sum of amber-box, blue-box, and de minimis subsidies.
The October 2005 U.S. proposal called for a 60 percent cut in the bound AMS ceiling for amber-box subsidies for the United States and an 83 percent cut for the EU (from its much higher level). The proposal would also cut the de minimis limit in half and set a limit of 2.5 percent of output value for blue-box subsidies. After phase-in over five years and a subsequent five-year waiting period, remaining subsidies would be fully eliminated. (The EU once again responded with a less aggressive set of liberalization proposals, offering to cut its allowed AMS by 70 percent.)
The sheer number of boxes, definitions, and exemptions contributes to a severe lack of transparency in agricultural subsidies. Nonetheless, the core principles of how to liberalize agricultural protection are simple. The high tariffs in the sector should be cut sharply, and subsidies should be forcefully decoupled from output, so they do not induce production above levels representing normal market forces, with the consequence of depressing world prices. A worthy goal for the Doha Round is to cut permitted levels for subsidies still coupled to output by at least half from actual recent-year levels.
First, however, an important flaw in the current way that the base of output-distorting subsidies is measured needs to be corrected. The amber-box AMS includes an artificial concept called price support, equal to output times the difference between a target administered price and the average world price in 1986-88. This measure does not represent taxpayer spending, and it overstates the base of subsidies. There is no payment to farmers; instead, they benefit indirectly as tariffs and tariff-rate quotas boost the price to the target level. When a country eliminates its administered price program but keeps overall protection unchanged by leaving other tariffs in place, as Japan did for rice in 1998, the measured market-price support in the AMS disappears, giving the illusion of subsidy reform with no real change in protection. This part of the trade-distorting subsidy base should be excluded from all calculations and commitments. Against this narrower and more properly measured base, neither the U.S. nor the EU proposal of October would cut trade-distorting subsidies much at all from their actual levels of $16 billion and $28 billion respectively (for 2001, the most recent year for which WTO data is available). The goal should be to cut subsidies under this narrower definition by at least half.
Developing countries should also insist on stiff WTO surveillance of subsidies to ensure that any uncontrolled green-box subsidies in fact do not give an incentive to production. This will be particularly important given the large shift of EU subsidies from the blue to the green box scheduled under the 2003 reform of the Common Agricultural Policy. In addition, a crucial reform for effective WTO surveillance should be a requirement for timely reporting on subsidies, perhaps within six months of the completed subsidy year. At present the typical lag of four years for reporting makes a mockery of effective monitoring.
In reaching agreement, it would help greatly if key developing countries such as Brazil and India were prepared to adopt deep cuts of their own sometimes inordinately high agricultural tariffs. Although actual applied tariffs in agriculture for developing countries are an average of about 30 percent, modestly lower than the actual average of 36 percent for industrial countries, in some products the bound rates can be 100 percent. U.S. farm interests, for example, would be far more inclined to commit to the dismantling of production-linked subsidies at home if they saw an opportunity to lock in reform abroad. Additionally, the bound rates are often so high that their actual application would be damaging to the country in question. Instead of keeping bound rates self-injuriously high, developing countries would do better to rely on WTO-authorized temporary safeguard mechanisms in the event of any surge in agricultural imports, and to insist on industrial-country decoupling of subsidies from output so there is less threat of such surges.
Liberalizing agricultural trade would boost world prices of agricultural goods, as industrial countries stop artificially stimulating supply and start importing more from developing countries. Because about three-fourths of the world's poor are in the agricultural sector, and would tend to benefit from improved opportunities for agricultural exports, there is good reason to expect that liberalization of industrial-country agricultural markets would help reduce global poverty.
Some have argued, however, that the LDCs would actually be hurt, because they are food importers and would face higher prices after global liberalization. My 2004 study examined this issue and concluded that this concern is misplaced. The LDCs do have a trade deficit in food, but they have even larger deficits in manufacturing, because of large overall trade deficits financed by aid. It turns out that they have comparative advantages in food and agriculture, just like most other developing countries. So if one carefully thinks through both the direct and indirect effects, the LDCs benefit from global agricultural liberalization rather than lose from it. They experience terms-of-trade gains that should more than offset any direct losses from higher food prices. Recent World Bank modeling work confirms this for sub-Saharan Africa. And although it is true that the largest LDC, Bangladesh, has comparative advantage in manufacturing, not agriculture, it stands to gain from the Doha Round from liberalization of manufacturing markets. As for the inhabitants of other LDCs, only about one-fourth of them live in countries that have comparative disadvantage in the production of food. Three-fourths should gain from global agricultural liberalization.
Another issue of considerable debate is whether global free trade would actually hurt the LDCs more generally because it would reduce or eliminate their special advantages from tariff preferences (known as preference erosion). This discussion tends not to take the full picture into account. If there were global free trade, LDCs would gain more from new markets in the many countries where they do not have free entry, including middle-income developing countries, than they would lose through erosion of preferences in the United States and the EU. Moreover, LDCs should gain from liberalizing their own markets. Free entry for the LDCs could be substantially widened as part of an overall package.
The issues of perceived risk of higher food prices for LDCs and perceived losses from preference erosion must be addressed, because otherwise the Doha Round could be blocked by opposition from the LDCs. So far the international policy response on this issue has been to propose "aid for trade" -- increased development assistance to LDCs that might face preference erosion, in part on grounds of the need to improve infrastructure to ensure capacity to respond to new trade opportunities. IMF and World Bank staff have proposed a program of assistance totaling $200 million to $400 million over five years through the multi-agency Integrated Framework for trade-related technical assistance. However, the usual question arises: Would these funds be drawn at the expense of other programs? Spokespersons for the LDCs have suggested, in any event, that the amount offered is too small to be meaningful (about $2 million per year per country).
Instead of (or in addition to) aid for trade, industrial countries should extend their existing preferential entry to LDCs to complete free entry, as proposed by the EU. Middle-income countries should join in this effort by offering free (or at least preferential entry) to imports from LDCs. This major expansion of the base for free and preferential entry should generate gains that exceed any losses from the reduction in the preference margin on the existing base.
NO MORE BUSINESS AS USUAL
The major trading nations have the opportunity to make the Doha Round truly meaningful as a vehicle for fostering economic development and reducing global poverty. Industrialized countries should commit to making deep cuts in their protection, especially in agriculture and in peak tariffs in other sectors, including textiles and apparel. Middle-income developing countries should cut high tariffs by enough to ensure a significant reduction in actual applied tariffs for both agriculture and industrial goods. Meanwhile, both industrialized countries and middle-income developing countries should pledge to help LDCs benefit from trade -- the former by extending complete product coverage for free entry of imports from LDCs, the latter by offering new free or preferential entry. With strong political leadership, a Doha Round outcome along these lines is achievable -- and success would make an important contribution to the fight for global development and against global poverty.