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Cutting Trade Costs to Kick-Start Growth

John Wilson's picture

The ongoing turmoil in Europe with the euro and sluggish global economic recovery has important implications for growth and trade in developing countries. A World Bank report released recently suggests that as a result of instability in advanced economies, developing country growth will slow to a relatively weak 5.3 percent in 2012. In a speech recently, WTO Secretary General Pascal Lamy described the rise in trade protection as alarming. Restrictive measures put in place since the global economic crisis in 2008 amounts to 3% of world merchandise trade, and almost 4% of G-20 trade. They have remained unabated over the past seven months.

Given economic slowdown in developing countries and an increase in restrictions on trade, what policy steps can the global community take to ensure trade remains a source of jobs and growth? 

The New Landscape of Trade: Value Chains and Trade Costs
The global trade landscape looks vastly different than it did 20 years ago. The vast majority of developing countries have completed a first generation of trade reforms, consisting mainly of slashing tariffs, eliminating quotas, and floating their exchange rates. Imports from developing countries (as a % of total world imports) have increased from 15% in 1990 to 28% in 2008. Traditional tariffs are at an all-time low. Trade as a percentage of GDP has increase from 38% in 1980 to 56% in 2010.

Complementing this reduction of traditional tariff barriers, there has been spectacular growth of global value chains. Trade is now characterized by a complex web of trade in international goods and services, whereby production is separated from assembly. Intermediate goods cross borders many more times than they did when trade was characterized by sending raw materials abroad to complete a finished product. Specialization occurs no longer at the level of the good or industry, but at finer levels such as firms and tasks. 60 percent of global commerce involves intermediate products, and 30 percent of the total is conducted between affiliates of the same multinational corporation. 

The proliferation of global value chains have made the cost of conducting trade more important, mainly because the trip from producer to consumer is now significantly more complicated, lengthy, and repetitive. Successful integration into the world economy – particularly for small and land-locked developing countries – now depends on minimizing trade transaction costs. These costs can be minimized by realizing a series of complex, behind-the-border measures that we call trade facilitation. Trade facilitation reform includes anything from institutional and regulatory reform to port upgrading and simplifying border procedures.

Cutting Red Tape and Investing in Infrastructure – Still a Good Investment in Hard Times?
In a recent journal article Alberto Portugal-Perez and I estimated the impact of trade facilitation reforms on the export performance of developing countries. To do this we used factor analysis to construct four new aggregate indicators related to trade facilitation from a wide range of primary indicators. The indicators are broken down into “hard” and “soft” categories. Hard indicators include the quality of physical infrastructure such as ports, roads, and railroads. Soft indicators pertain to border and transport efficiency, for example the number of days it takes to export and import, as well as the effectiveness of the regulatory and business environment. The indicators are derived for 101 countries over the 2004–07 period.

Estimates show that trade facilitation reforms do improve the export performance of developing countries. This is particularly true with investment in physical infrastructure and regulatory reform to improve the business environment. Higher tariffs, longer distance between partners, and being landlocked discourages trade. By contrast, the trade volume is higher between partners in a regional trade agreement, as well as between richer and more populous countries. Estimates show that improving the quality of physical infrastructure so that Chad’s performance indicator increases half-way to the level of South Africa’s would increase Chadian exports by 80 percent. This is equivalent to a 58 percent cut in tariffs faced by Chadian exporters across importing markets.

The Path Forward: Support Growth by Cutting Trade Costs
The proliferation of global value chains compounded by global economic uncertainty has created new challenges for policymakers trying to determine how to best promote trade in developing countries. Rather than protect domestic industries through imposing trade restrictions, countries should look to investments in trade facilitation including upgrading infrastructure, overhauling customs and borders procedures, and reforming the regulatory environment. Our research demonstrates these investments – policies that decrease the cost and complexity of trade - result in substantial benefits in terms of increased exports. This research complements the recent call from leaders of global development banks to move forward on a WTO Trade Facilitation Agreement. Trade Facilitation has all the hallmarks of a win-win proposition – decreasing costs and boosting business through relatively modest levels of investment in reform. Trade facilitation reform also allows developing countries to upgrade technology and further integrate into global value chains. This integration can lead to sustained growth and poverty reduction over the long-term.