The Relative Impact of Trade Liberalization on Developing Countries

Executive Summary

In recent years, new trade agreements have often been promoted on the basis of their potential benefit to developing countries. Political leaders, international financial institutions, and even advocacy groups have argued that rich countries such as the United States have an obligation to expand trade in order to help poorer countries grow and develop.

These claims are often grossly exaggerated, as can be seen from an examination of the economic literature on trade. Furthermore, there are costs associated with trade liberalization in the developing countries, and with the changes required by such agreements as the WTO's TRIPS (Trade-Related Aspects of Intellectual Property Rights). When the benefits and costs of continued liberalization along the lines set out in these agreements are evaluated according to standard economic research, it is not clear that the developing countries as a group are facing a net gain.

Regarding the gains from increased access to the markets of rich countries:

* The removal of all of the rich countries' barriers to the merchandise exports of developing countries--including agriculture, textiles, and other manufactured goods--would result in very little additional income for the exporting countries. According to the World Bank's estimates, when such changes were fully implemented by 2015, they would add 0.6 percent to the GDP of low and middle-income countries. This means that a country in Sub-Saharan Africa that would, under present trade arrangements have a per capita income of $500 per year in 2015, would instead have a per capita income of $503.
* Some of the most widely used economic models show that many developing countries will actually lose from trade liberalization in important sectors, such as agriculture and textiles. There are three reasons for this outcome. First, some countries will be hurt by the elimination of quotas that now allow them to sell a fixed amount of exports at a price that exceeds the competitive market price. Second, trade liberalization changes the relative prices of various goods, and some countries will find that their export prices fall relative to the price of imports (the "terms-of-trade" effect). Third, some developing countries currently benefit from access to cheap, subsidized agricultural exports from the rich countries.

In standard trade models, the gains to developing countries from removing their own barriers are much greater than the gains from increased access to the markets of rich countries. However, developing countries also incur substantial costs from opening their markets, which are often overlooked:

* Developing countries incur substantial problems from reducing their trade barriers. In many developing countries, tariff revenue accounts for 10-20 percent of government revenue, and in some cases considerably more. If tariffs are reduced or eliminated, these countries will have to impose large increases in other taxes in order to keep their budgets in line. The distortionary effect of these tax increases, as well as the costs and problems associated with collecting taxes from other sources, are generally ignored in economic models that project gains from eliminating trade barriers.
* The removal of trade barriers is also likely to lead to large disruptions in agriculture. In most developing countries, a large portion of the population is still tied to the agricultural sector. If barriers to agricultural imports are removed too quickly, it can lead to large-scale displacement of the rural population. Standard economic models implicitly assume that these people are re-employed in other sectors of the economy, but rapid import liberalization can lead to substantial unemployment and underemployment, as well as dangerous levels of social and economic instability.

There are two other sets of costs that have been attached to trade liberalization that must also be taken into account:

*

Recent trade agreements, such as the TRIPS provisions in the WTO, have sought to impose U.S.-style patent and copyright protections in developing countries. This will lead to the transfer of billions of dollars from developing to high-income countries in the form of royalties and licensing fees. In addition, the efficiency loss resulting from higher prices of patented and copyrighted items is likely to be even larger. The World Bank's estimates indicate that the cost of TRIPS to developing countries is likely to be comparable to any gains they might receive from trade liberalization.
* As a result of increasing instability in world financial markets, developing countries have felt the need to vastly increase their holdings of foreign exchange reserves. These reserves are held in the form of short-term deposits that pay little or no real interest. By contrast, this money could otherwise be invested in building up the infrastructure or the physical and human capital in a developing country. The opportunity costs of these increased reserve holdings are also of the same magnitude as the World Bank's projections for the benefits of trade liberalization.

The implication of this analysis is that developing countries may benefit at least as much from measures such as the repeal of TRIPS, or a restructuring of the international financial system that restored its stability, as from any progress on trade liberalization. At the least, the costs associated with these changes deserve much more attention in policy discussions than they have thus far received.

Furthermore, if the costs and benefits of increased liberalization along the lines of recent agreements are evaluated according to standard economic research and evidence, there is no basis for assertions that these policies will qualitatively improve the plight of the poor in developing countries. In fact, the research provides substantial evidence that these policies may actually cause a net loss for low and middle-income countries as a group.

Full report: http://www.cepr.net/relative_impact_of_trade_liberal.htm