Expanding Trade and Unleashing Growth: The Prospects for Lasting Poverty Reduction, Remarks by Anne O. Krueger, First Deputy Managing Director, IMF
December 6, 2004
Expanding Trade and Unleashing Growth: The Prospects for Lasting Poverty Reduction
Remarks by Anne O. Krueger
First Deputy Managing Director
International Monetary Fund
At the IMF Seminar on Trade and Regional Integration
December 6, 2004
Good morning Governor, Ministers and distinguished guests. Thank you for that kind introduction. Let me say first of all how pleased I am to be here and to be able to participate at this seminar. The topic we are addressing today, trade and regional integration, is a particularly important in the African context—indeed, I would argue it is vital.
All of us here are concerned to ensure that there is more rapid progress in reducing poverty and raising living standards in Africa. I have no doubt that it is perfectly possible for African countries to achieve the rapid rates of growth and of poverty reduction that countries elsewhere in the world have attained. The evidence is clear that economic agents in Africa respond in exactly the same way to incentives as do agents in other economies. As one African central bank governor put it recently, the supply curve does not slope downwards in Africa.
There is now almost universal agreement on what the principal economic objectives should be—and, I would argue, on how to achieve them. All developing economies need more rapid and sustained rates of growth that will in turn permit large scale and lasting poverty reduction and rising living standards for all.
Trade has a central role in helping achieve more rapid growth. So I want in my remarks this morning to say something about the link between trade, growth and poverty reduction; and to explain what I see as the contribution that regional trade integration can make.
Trade and global prosperity
Let me start by putting our discussions into a broad context. A healthy rapidly growing world economy is desirable for everyone—and it is vital if we are to see more rapid growth in Africa. It is vital, too, for African countries to be full participants in the global economy. No country has achieved the sustained rapid growth needed to reduce poverty without opening up its trade with the rest of the world. Of course, the more rapid growth of intra-African trade is, of itself, desirable. But it will never be a substitute for the growth of trade between Africa and all other countries.
Trade liberalization is closely linked with economic growth. We can go right back to the days of trade around the Mediterranean to see that the countries that traded most actively were also the most prosperous. The industrial revolution of the eighteenth and nineteenth centuries led to a surge in trade as manufacturers sought new export markets and scoured the world for inputs that enabled them fully to exploit new technological processes.
Yet the experience of the past sixty years is, even by historical standards, remarkable. The rapid growth of the world economy that followed the Second World War was unprecedented. And the surge in global growth led directly to improvements in material welfare and in the quality of life. Most people in most countries shared in the benefits of this. Some countries grew much more rapidly than others, of course. And the evidence shows that the best performers were those where policy reforms aimed at creating macroeconomic stability, liberalizing trade and encouraging enterprise.
Postwar global growth was accompanied, indeed driven by, an unprecedented expansion in world trade. In 1950, world merchandise exports amounted to about 8% of world GDP. Today that figure is close to 26%. In the IMF's latest World Economic Outlook, world growth this year is expected to be 5%—an impressive number. But we estimate that world trade will have grown by 8.5% this year—an even more impressive number.
Trade is an engine of global growth because it brings competition. It enables producers to have access to inputs at the lowest possible prices. No modern industry can compete without access to the world market for inputs. Trade ensures that scarce resources are used in the most effective possible way.
One important feature of the structure of trade today is the extent to which the "value-added chain" has been chopped up as transport and other costs have fallen, enabling firms in different countries to specialize, importing parts and intermediate goods, and often exporting products that will be further processed or assembled in yet other countries. Trade also enables firms and individuals to move up the value-added chain as they accumulate experience.
The benefits from trade are large and diverse. The challenge is therefore to provide the framework in which trade can thrive.
The role of trade liberalization
Trade liberalization is the key. The progressive dismantling of trade barriers has been at the heart of the multilateral economic framework established in the aftermath of the Second World War. It is the process of multilateral trade liberalization—by which I mean all countries acting together to lower their trade barriers against each other—that has created the environment in which trade has grown rapidly, and driven global growth.
And I am talking here about the reduction and removal of both tariff and non-tariff barriers. All barriers act as an impediment to trade—indeed, that is their primary purpose. All lead to inefficient allocation of resources, because they introduce distortions into price signals. Trade barriers raise costs, both to final consumers and to the users of intermediate inputs. They enable vested interests—the firms in protected industries, and the workers in those firms—to benefit at the expense of the majority.
Firms can make what sounds like a plausible case for protection—without some kind of barrier, either a higher tariff or a quantitative restriction, they can argue that they would lose business to a foreign competitor and have to lay off workers. But the evidence has repeatedly shown that such protection only delays necessary adjustments, because it enables firms to avoid the need to cut costs and become competitive. Eventually no amount of protection will keep an inefficient firm in business. And while some workers in protected firms may keep their jobs for longer than they might have otherwise, others will be deprived of jobs in new or growing firms that would be able to perform better in the absence of the distortions that protection brings. And, interestingly, many firms and industries seeking, but failing to achieve, protection often survive and even prosper despite their pessimistic view of their prospects.
Multilateral liberalization provides the greatest gains. The benefits from trade liberalization in one country are larger when others liberalize at the same time. But that is not an argument for waiting until others are ready. The benefits from trade liberalization are significant even when it is done unilaterally, on a most favored nation (MFN) basis. The countries that have experienced phases of really rapid growth have all been ones where policymakers recognized the gains to be had from unilateral liberalization of their trade with all countries and have acted accordingly. Korea and Chile are both obvious examples of the rewards of unilateral trade liberalization. Both economies grew rapidly as their trade barriers were lowered.
In this context, let me say something about the trade barriers of the rich industrial countries. I know that policymakers in many developing countries argue that it is up to the world's more prosperous economies to take the lead in trade liberalization.
It is true that the trade restrictions of industrial countries, especially in agriculture where average tariffs remain high, impose costs on developing countries. It is clear that the industrial countries should lower tariffs and other trade barriers, and improve access to their markets. They themselves would benefit greatly by removing these barriers.
But action by the industrial countries would not, by itself, bring many of the gains that many in the developing world expect. Barriers imposed by developing countries on each other are far higher than those imposed on them by industrial countries. The gains from lowering developing country trade barriers are accordingly greater. And developing countries have much to gain from unilateral liberalization. Yes those benefits will be greater if there is subsequently further multilateral liberalization. But developing countries will not be in a position to gain the maximum possible benefits from multilateral liberalization if they do not liberalize themselves, and open their trade to all countries.
The evidence is incontrovertible. Multilateral trade liberalization is the most desirable policy option. That is why a successful Doha round is so important. That is why the IMF has worked hard to support the WTO during the Doha process.
But this is not a justification to wait. The evidence of the gains from unilateral liberalization is, as I said, unequivocal.
There will always be some who lose as a result of trade liberalization. The fact that not everyone will gain in the short-term is not an excuse for postponing liberalization, far from it.
We need to bear several important factors in mind when assessing the short-term impact of trade liberalization. First, of course, is that trade liberalization of itself results in more rapid economic growth. This brings new business opportunities for firms, and new employment opportunities for individuals. As I have already noted, economic growth is the principal route to lasting poverty reduction.
Second, those who are disadvantaged as a result of lowering trade barriers are far fewer than people anticipate ex ante. Those who think they are going to lose out often do not. Fear of change is the source of much opposition to trade liberalization.
And third, remember that those who may lose have a far better idea of who they are than those who are likely to gain. Those in heavily protected but highly inefficient industries or firms might well be right to fear competition, although more firms and industries find ways of adjusting than is generally realized. But it is almost impossible to predict where the new business and employment opportunities will come ahead of time, because we cannot know in advance which sectors and firms will best respond to the new opportunities that trade liberalization brings. What we can be certain of is that those new opportunities will materialize—and that somebody will seize on them.
Let me illustrate this with a true story. During the negotiations for the North American Free Trade Area, one of the principal opponents of Mexican participation was the main manufacturer of Mexican refrigerators. In those days, Mexican refrigerators were of such poor quality that they barely counted as durable goods, at least in the eyes of most Mexican consumers. Our manufacturer was convinced that his business would be wiped out when, under NAFTA, American manufacturers, offering a much better quality product, gained free access to his home market. He did not see how he would be able to compete.
He could hardly have been more wrong, and his misguided reasoning is a textbook illustration of the benefits that trade can bring. It turned out that the fatal flaw in Mexican refrigerators was the compressor. Mexican-made compressors were just not up to the job, with the result that the refrigerators had a short lifespan. Once NAFTA came into effect, our manufacturer was able to obtain much better-made American compressors at competitive prices.
The result was that far from losing business, he gained a great deal of new business, much of it in the form of exports. His company became the largest supplier of smaller, apartment-sized refrigerators to the US market.
So as trade barriers were lowered, Mexican consumers gained access to much higher quality refrigerators at a competitive price; the Mexican manufacturer was able greatly to improve his product by gaining access to competitively-priced and high-quality inputs; additional workers were employed; and he was as a result able to exploit a large new export market.
I tell this story not because it is unusual but because it is typical. The benefits of trade liberalization aren't confined to some theoretic textbook—they are there for all to see, and for firms and individuals to experience for themselves.
I am not suggesting that we should be unconcerned for the plight of those who lose their jobs in firms that go out of business as a result of competition and who for one reason or another are unable to find another job. But denying opportunities to a larger number in order to protect a small minority—often at considerable expense both to consumers and taxpayers—is not the way to respond to concern. Properly targeted and effective social safety nets are a better, fairer and far cheaper way to help those who lose out as economies adjust to the beneficial changes that trade liberalization brings.
When we come to focus on issues concerning regional integration, then, we must not lose sight of the bigger picture. Economies need to open up to the rest of the world as fast as possible. Full participation in a healthy growing world economy is essential if countries are to experience the rapid growth needed to alleviate poverty on a significant scale. Multilateral trade liberalization—all countries reducing their trade barriers with each other—is undoubtedly the best way to achieve this opening, but unilateral liberalization still offers very considerable benefits—far more than waiting for others to lower their trade barriers.
We should not look on the debate as one between unilateral and multilateral. It is rather a question of the large benefits that unilateral opening, on an MFN basis, will bring, or the even larger ones that will flow from multilateral trade liberalization. Those countries that open unilaterally will still reap the benefits of multilateral liberalization when it happens.
So it is essential that regional integration does not act as a distraction from this wider picture. Regional trade agreements (RTAs) must not be used as a cover for protectionist behavior. It is not enough to lower tariff barriers among the members of an RTA. This will severely limit the benefits that trade liberalization can bring: these will pale in comparison to the gains to be had from full-scale trade liberalization.
The experience of what is now the European Union is important in this context. Recall the context in which the European Economic Community was founded in the 1957. The original six members of the EEC as it then was experienced rapid growth over a long period and experienced a considerable degree of economic integration. They did so in large part because the EEC was established at a time of rapid multilateral liberalization. Intra-European tariff barriers fell rapidly to zero from in excess of 40%; but the EEC's external tariff was also reduced from the same 40% plus level to a weighted average of just over 3% now (excluding estimated ad valorem equivalents of specific tariffs);6.5% if AVEs are included. Quantitative restrictions were also eliminated. RTAs are most effective when they are a complement to, and not a substitute for, multilateral liberalization.
The economic success of the EU over a long period of time was the result both of the removal of internal trade barriers and the growth of intra-European trade; and of trade liberalization with the rest of the world. And the EU's trade framework, by locking in the principle of tariff reduction, acted as a disincentive to protectionist lobbying.
There is a great danger that external trade restrictions associated with regional trade agreements will harm the economic prospects of member countries. For efficiency reasons any would-be importer should have incentives to choose the lowest-cost source. Systems that ignore this fundamental precept simply store up trouble for the future—even if the arrangements are meant to be temporary and only a route to further liberalization. Regional trade agreements give higher cost producers an advantage that distorts the market.
And to the extent that RTAs are inward-looking, and give lower priority to trade and economic engagement with the rest of the world, global trade will be lower than it otherwise might be and the global economy will grow less rapidly than it otherwise could.
Regional trade agreements have long proliferated in Africa. Yet as both the IMF paper tabled for this seminar and a recent study by the World Bank conclude the economic benefits have been at best questionable. Intra-African trade actually fell in the 1970s and only recovered to its 1970 levels in the mid-1990s. It remains at around 10% of total African trade.
Tariff and non-tariff barriers to trade are a serious obstacle to trade within Africa and, more importantly, to trade between African countries and the rest of the world. There are also huge practical impediments to trade on the continent. These include high costs, partly a result of poor infrastructure. As the IMF paper notes, it costs around $5,000 to ship a car from Addis Ababa to Abidjan—more than three times the cost of shipping the same car from Japan.
But these practical obstacles also include inefficient customs procedures and other bureaucratic hurdles than often hamper business activity in general. These problems need to be tackled, whether policymakers choose to focus on trade opening at the regional or global level. Without action, such practical obstacles to the distribution and transfer of goods will continue to place limits on the benefits to be had from trade liberalization.
I know that one of the recurring concerns about lowering trade barriers in Africa is the potential revenue losses that governments face. We in the Fund understand those fears: we recognize the importance of infrastructure investment in the appropriate macroeconomic framework. But we also remain convinced that revenue concerns should not be an excuse for postponing trade liberalization. Removing quantitative restrictions, which arbitrarily distort market signals, and switching to tariffs will, in the short term boost customs revenues. It is also important to remember that as lower barriers stimulate trade, the revenues from lower tariffs may be greater than those from higher tariffs.
Most important, though, is the need to broaden the tax base and improve tax collection rates. This is the best way of ensuring that government revenues and macroeconomic stability are not undermined. The Fund is ready to provide technical assistance to help in this process.
Let me conclude. Africa has great economic potential. The fruits of macroeconomic reforms are already beginning to show in several countries, with growth picking up and inflation falling.
Trade liberalization has to be a central ingredient in any economic program if lasting high rates of growth are to be achieved. Without progress on lowering trade barriers, economic growth will, at best, be lower than it otherwise would.
It is all too easy to identify the problems associated with opening up an economy to trade and, as a consequence, all too easy to lose sight of the enormous gains that will flow from trade liberalization—not just at the regional level but, more importantly, with the rest of the world economy.
Today's seminar is going to explore these issues in far more detail than I can here. I am sure it is going to be a productive day, and I wish you well.