Trade and development

July 9, 2010, 5:55 am IST in Occasional Paper | Economy | ET

Over the last three months, I have looked, in these columns, at some dramatic changes that have taken place in world trade between 1995 and 2005. The period chosen is important. First, it coincides with the first phase of trade negotiations under the World Trade Organization (WTO) when industrial tariffs had fallen in most developing countries. Second, it does not include the recession years after 2007 and represents some normality in world trade. Third, since it includes the East Asian crisis years after 1997, it would, if at all, show a bias against trade of developing countries of Asia. Ithen looked at some implications of these trends for the world in general and India in particular. Of these trends, three are worth repeating. One, the dominance, in terms of both magnitude and growth, of developing country trade (south-south , or SS, trade) over trade between developed and developing countries (north-south , or NS, trade). Second, the emergence of regional trade hubs in the developing countries. Third, the dominance of intra-regional trade over interregional trade. In this column, I will look at some implications of these patterns for development issues. First, consider the issue that Prof Jagdish Bhagwati and others have red-flagged : that regional trade arrangements (RTAs) may be a ‘stumbling block’ to multilateralism. Since most of the RTA developments took place since about 1991 or so, it may well be argued that the dominance of regional trade is testimony to such fears. RTAs would be harmful if they replace competitive global trade with inefficient trade. However, given declining tariffs since 1995 and the bigger stumbling block of uncoordinated ‘rules of origin’ included in all RTAs, two points may be worth noting. One, what is the advantage of RTAs that require considerable bureaucratic capital to tie up? Second, do traders actually use the RTA trading route given that the complicated spaghetti bowl of rules of origin agreements may be a bigger stumbling block than MFN tariffs? It is possible that RTA trade is driven by multinational corporations (MNCs) and reflects traditional market segmentation or sharing arrangements. But then, these are not issues to which answers exist in traditional neoclassical trade theories. In addition, it is possible that the international politics of the new plurilateral world order is driving trade. Here, RTAs simply ratify existing trade patterns for political gains and, thus, cannot be said to replace multilateral trade. Consider the other developmental issue that is now hotly debated. The issue of trade and inequality. If trade is driven by countries’ resource endowments (land, labour or capital ), then it is impossible that trade can drive income inequalities between countries (or within a country). This proposition is fairly well known. However, much of the empirical evidence indicates that trade is driven more by technology than resources. To the extent that developed countries are technological leaders, it could well be argued that trade could lead to income inequality between countries. The argument is that technology, being a scarce resource, is able to command a greater premium that other inputs to production . Yet, what we are seeing today is growing SS rather than NS trade. Since technologydriven trade is generally a feature of NS trade, the responsibility for growing income inequality in developing countries in the last decade or so can hardly be place at the door of NS trade. It is necessary to look within. Finally, the data on growing regional rather than multilateral trade deserves attention. Much of the trade between developing countries is trade in inputs as world transport costs have declined dramatically. This is also part of the process of internationalisation of production where MNCs now dominate trade. These MNCs (many quite small firms) source inputs globally according to comparative advantage and sell products in final markets that are largely regional. This, thus, implies that a study of trade policy must concentrate more on issues of why firms trade rather than why countries’ trade. The dominance of MNCs breaks down the simplification of perfectly competitive trade and, hence, the elegance of traditional trade theories. This has another important implication : countries will now be linked more closely not merely by trade but by tax policies as MNCs move production around to minimise their world tax liabilities. This is one area where developing countries are far behind developed countries. The bottomline is that the changing nature of world trade also necessitates changes in trade policy. In this short essay, I have noted that as MNCs dominate trade, FDI policies might need to take precedence over standard export-import polices. Second, study of taxation of foreign companies must be given greater importance in developing countries, particularly in matters like transfer pricing. Finally, it is unlikely that the world will ever return to the kind of multilateral trade that traditional trade theory posits as the first best policy: the underlying framework of perfect competition no longer exists. With global trade increasingly dominated by multinationals, focus may shift to FDI policies from export-import policies. As MNCs redeploy production across the world to save tax, developing countries need to redraw their taxation rules. In absence of perfect competition, multilateral trade as we have known it all along may now exist only in textbooks.

DISCLAIMER : Views expressed above are the author's own.
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