Pol licies in support of trade integration
1. A comprehensive strategy to make trade work for structural transformation 1 Coherence between trade and industrial policy
The importance of making external trade and trade policy central elements of least developed countries’ (LDCs) strategies for structural transformation has already been underlined in this Compendium (m ch.I.B). The crucial role of trade policy in the context of industrialization strategies has also been emphasized (m ch.IV.C). It should be stressed that trade development in support of structural transformation does not only depend on trade policy in the sense of setting rules, incentives and disincentives for the cross-border flow of goods and services. Trade development also depends on all other policies referred to in this Compendium which aim at expanding, upgrading and diversifying productive capacities. It is therefore essential that governments pay due attention to achieving coherence among these different areas of trade policy (UNCTAD 2016a: 50).
Most importantly, to maximize the benefits of trade for structural transformation, trade policy should be linked to industrial policy (m ch.IV.C.4). Since the building of productive capacities and export capacity takes time and cannot progress simultaneously in all manufacturing sub-sectors, trade integration must be gradual and selective. On the one hand, export growth and import substitution can be important drivers for the expansion of manufacturing activities. On the other hand, trade performance often depends on industrial performance and the expansion of productive capacities (UNCTAD 2016a:
53) (m ch.IV.C.4).
Consideration should be given to the creation of a National Trade Council as a coordinating entity to oversee the design and implementation of a medium-term trade strategy. Based on consultations with stakeholders in government, public administration and the private sector, this trade council should identify priorities, and ensure coherence and consistency across different policy areas over time (UNCTAD 2016a: 76). This can help the private sector to develop their own business plans and strategies. A national LDC trade strategy should focus on enhancing the competitiveness of domestic enterprises and access to markets. It should also contribute to building export capacity and reducing trade transaction costs (UNCTAD 2016a: 60 and 76).
Trade in manufactures is very sensitive to exchange rate movements. Therefore, avoiding instability and the overvaluation of the domestic currency is a prerequisite for the success of industrial policies. Appropriate exchange rate management is essential to prevent the “Dutch disease” as a result of sharp increases in commodity export earnings or capital inflows. Exchange rate management can even become an instrument of trade management itself when the central bank is able to keep the exchange rate at a slightly
undervalued level. This strengthens the international competitiveness and profitability of domestic manufacturing activities, while discouraging imports (UNCTAD 2016a: 64) (m ch.II.C.2; mch.IV.C.4).
1.2 Use and preservation of policy space
LDCs should exploit their policy space for strategic integration into the international economy to the largest extent possible. It is true that national economic policy space is increasingly constrained by international rules and commitments. However, with respect to trade-related policy instruments, there are many flexibilities in the provisions of World Trade Organization (WTO) Agreements in favour of LDCs (The Least Developed Countries Report (LDCR) 2016: ch.3). Many of them grant LDCs that are signatories to these agreements or in the process of accession to WTO longer transition periods for phasing in certain reforms. Other flexibilities, for example those under the WTO Agreements on Trade-related Investment Measures (TRIMs) and Subsidies and Countervailing Measures (SCM), give LDC governments the possibility to use policy instruments, which are no longer available to governments of other countries, to support structural transformation in LDCs. These are some of the export promotion and import protection instruments that, in the past, have played a central role in the development process of most of todays industrialized countries. Countries that have leveraged these policy instruments include many late industrializing countries, such as those in East and Southeast Asia.
LDC governments should also consider the scope for using tariffs as an instrument of trade policy. In many cases, tariffs applied by LDCs are far below their bound rates under WTO commitments. However, conditionalities attached to official development assistance (ODA) or provisions of bilateral free trade agreements sometimes exclude the use of this instrument (LDCR 2010: ch.5; LDCR 2014: ch.6). Moreover, membership in customs unions may also reduce the trade policy autonomy of individual LDCs because such membership implies common external tariffs.
In any case, LDCs should use the available policy space to the largest possible extent for strategic integration into the international economy. It is, however, important that trade policy instruments are used in a manner that evolves flexibly over time. New, promising activities may merit timebound infant industry support, while maturing sectors could be gradually opened up in consideration of the ability of domestic firms to compete with foreign producers (LDCR 2010: ch.5).
International negotiations at the multilateral, plurilateral or bilateral level towards agreed trade rules and trade agreements are an important element of trade policy (UNCTAD 2016a: 73). LDCs have duty-free, quota-free (DFQF) access to most high-income developed countries’ markets. However, they do not have DFQF access to many
fast-growing developing countries, some of which including China and India, are also increasingly important sources of foreign direct investment (FDI). LDC governments should therefore continue efforts to obtain preferential access to these countries’
markets. Another important part of the trade policy agenda is to deal with non-tariff measures, primarily through quality upgrading and the strengthening of regulatory mechanisms and institutions (o ch.VI.A; och.VII.F).
In shaping their external economic relations, LDC governments may be well advised to maintain their policy autonomy to the largest possible extent, in order to strategically support their productive sectors. Even though improved, legal market access obtained through preferential trade agreements with industrialized countries may initially seem like a quick gain, the potential of future, more sustainable, gains from trade will be reduced when options for policies to support upgrading and diversification are significantly curtailed. LDC governments should be prudent in trade negotiations and not fall into the trap of “buying” market access by giving up a degree of development policy autonomy, in other words, by shrinking their own policy space.
1.3 Promoting exports
As exports of manufactures can be an important driver for the expansion of industrial capacities, LDCs should, to the largest extent possible, use their trade policy space, including all the flexibilities provided under multilateral trading rules, to pro-actively promote exports (LDCR 2014: ch.6; LDCR 2016: ch.3). Related instruments include:
WTO-compatible export subsidies for infant industries, the public provision or subsidization of trade finance, and the provision by public trade promotion agencies of information on international market opportunities and related marketing support (LDCR 2014: ch.6) (m ch.IV.C). A national Export Promotion Agency, operating in close cooperation with private sectoral associations at home and partners abroad can enhance the export capacity of local firms (Diagnostic Trade Integration Study (DTIS) Ethiopia).
Programmes that enable domestic producers to make better use of preferential market access, and to meet international quality standards are also important for LDCs (DTIS Ethiopia) (o ch.VI.A.3).
1.4 Managing imports
Structural transformation can also be supported on the import side by a differentiated tariff policy. A trade regime in support of achieving structural transformation and the Sustainable Development Goals (SDGs) should provide selective, temporary protection to sectors that are at an early stage of development and have the potential to create employment and advance structural change by increasing exports or substituting imports,
or both. Where possible, selective use of import tariffs should assume an important role because fiscal space in LDCs to use subsidies or other types of public expenditure as incentives to promote new activities in support of structural transformation is very limited. In contrast, most LDCs have considerable scope to use tariff instruments more actively, given the large gap between their bound and applied tariff rates (LDCR 2010:
ch.5; LDCR 2014: ch.6).
Such a trade regime should allow for the duty-free import of certain goods, while imposing relatively high customs duties or import taxes on others. It should exempt intermediate inputs to domestic production, as well as machinery and equipment from import duties. This should make these goods more affordable for domestic enterprises and agricultural production units. Intermediate import supply enterprises or agencies at the sectoral level could help to further reduce the cost of essential imported inputs for agricultural or manufacturing activities.
In contrast, tariffs should be imposed on certain goods for which productive capacities already exist, or are being developed. This is especially important in sectors that are considered to be of strategic importance for structural transformation (m ch.I.C.4; m ch.IV.A). This way new or infant industries can be shielded, temporarily and during a reasonable period of learning and experimentation, against overwhelming competition from internationally well-established or foreign firms (LDCR 2010: pg.185) (m ch.IV.C).
As initially protected sectors mature, this protection should be phased out and shifted, again temporarily, to new emerging industries.
High tariffs or specific excise taxes may also be used to discourage imports of luxury goods. Here, the reason for the introduction of custom duties would be to avoid excessive trade deficits and manage scarce foreign currency earnings. In other cases, tariff and non-tariff measures may be justified to protect domestic agriculture against heavily subsidized imports from developed countries, and to increase food security (LDCR 2010: ch.5).
For LDCs that are members of the WTO, in order to make more active use of WTO measures to promote their infant industries, the rules have to be interpreted flexibly.
This would give LDCs more policy space to shift from their heavy dependence on commodities to more diversified and higher value-added production. This would also enable producers in LDCs to take full advantage of their preferential access to the markets of developed countries and integrate more favourably into the global economy (LDCR 2010: ch.5).