Preferential treatment by developed countries of their imports from developing countries clearly is an important element of the overall web of economic (and political) relations between North and South. Trade preferences aim at fostering economic growth in the South, by making it possible for developing countries to engage in economically rewarding activities. The fundamental purpose of trade preferences, therefore, is to provide developing countries with better opportunities to achieve, by themselves, a self-sustained improvement of their economic, and hence hopefully social and political, fate. For some time in the past, trade preferences have clearly been seen as a possible alternative to financial and technical assistance, as reflected in the slogan “trade rather than aid”. This slogan, and the underlying economic concept, has much intuitive appeal, and has probably helped to convince politicians in developed countries that they should agree to opening markets in their countries more widely to imports from developing countries.
It is certainly a persuasive argument that the South should be given better opportunities for improving its economic situation through its own activities, with a hopefully lasting positive effect, rather than being dependent on aid provided by the North, often with no prospect of achieving self-sustained economic growth. If combined with critical comments on developed countries’ trade policies, which arguably do no more than provide protection for outdated industries, the argument in favour of “trade rather than aid” is even stronger. It becomes virtually irresistible if the point is added that the world is anyhow moving in the direction of trade liberalization, through both multilateral negotiations in GATT/WTO and unilateral policy reforms in many countries. Trade preferences for developing countries, then, appear merely to anticipate the more general liberalization of global trade that will (hopefully) be achieved in the near future, and they are granted in one sector of international trade where the exporting countries concerned are in particular need of that early harvest.
Even though occasionally exaggerated in the political domain, the “trade rather than aid” perspective indeed makes some economic sense. However, it also has some drawbacks. Let us briefly consider some of the direct economic implications of trade preferences in order to better understand the role they can play in the overall framework of economic relations between developing and developed countries. Based on these economic implications we can also identify some important factors in the political economy of trade preferences.
At a fundamental level, and in a way taking the “trade rather than aid” perspective literally, trade preferences can be seen as a mechanism for making an economic transfer from the North to the South. Developed countries forgo part of their tariff revenue, providing for larger export revenues in the developing countries concerned. In other words, through trade preferences money is transferred from the budgets of developed countries to the economies of developing countries, in addition to the expansion of quantities exported from the developing countries and the resulting domestic effects in these countries. From this perspective, trade preferences can be viewed as a direct substitute for financial assistance that is channelled into development projects, be it in the area of infrastructure, in sectoral programmes or anywhere else as part of bilateral or multilateral programmes of development assistance. Donor and recipient countries must then ask themselves whether trade preferences are a better form of support for development than financial assistance. The answer depends on a number of considerations, including the size of the transfers that can be generated in either way, and which form of support promises to do better in terms of fostering self-sustained economic growth in the developing countries. This is not the place to dig deep into such considerations, but at least some of the more important factors can be discussed.
In this context, it is useful to take a brief look at the economic mechanics involved in trade preferences, in order to see, inter alia, what the implications are for market development in developing countries, and to understand precisely who gains and who loses from trade preferences. As we shall see, some results depend on the market situation and a number of other factors, and hence the economic implications of “trade rather than aid” are not unequivocal.
Let us start with a simple situation in which a given developed country (country A) begins to extend a trade preference to (all or some) developing countries (country group B) for a given product (say maize).[7] Country A has in the past imported maize also from other developed countries, and continues to charge the (higher) MFN tariff on those imports. World market supply of maize from the other developed countries is available at a given price, irrespective of the quantity imported by country A.[8] The quantity of maize shipped from developing country group B, though, is the larger the higher the price received for exports. Maize exported from country group B is of the same quality as maize exported from other developed countries, and receives the same price in the domestic market of country A.
Once country A grants a trade preference to country group B, some part of the maize originally imported from other developed countries is now sourced in country group B, without any effect on the domestic market price in country A.[9] In this case, as suggested above, the most obvious effect of the trade preference, in addition to the expansion of exports from country group B, is that country A forgoes some of its tariff revenue (that it used to earn on maize imports now coming from country group B), while country group B now obtains a higher price for its exports of maize to country A. In other words, there is now a transfer from the budget of country A to the economies of country group B. The “trade rather than aid” element of preferential tariffs can, in this case, to some extent be described as a mechanism whereby country A provides financial assistance to country group B, where the amount of money transferred does not flow to some development project but to country group B producers of the product concerned (and possibly to some market intermediaries).
In terms of development strategy, both country A and country group B will have to consider the question of whether this form of support provided to country group B maize producers, and to the overall economies of the group, is more useful for longer-term self-sustained economic growth in the latter than an equivalent amount of money that might have been transferred, as financial assistance, directly from the exchequer of country A to development projects aimed at improving, say, infrastructure in country group B. The answer to this question will tend to be the more positive the more likely it is that country group B would export the larger post-preference quantity of maize to country A anyhow under free trade conditions. After all, if the trade preference allows country group B to gear up its production structure early to what one day, when world trade has (hopefully) been liberalized completely, will anyhow be optimal, then it should really be in its interest to get the chance of receiving this trade preference, and thus to be able to provide its maize producers with market incentives which point in the right direction. The alternative, i.e. receiving financial assistance e.g. for infrastructure projects, may also have significant benefits, but may contribute less to self-sustained growth than allowing producers to develop their production capacities on a private basis, through ‘proper’ price incentives.
Alternatively, if it should turn out that the trade preference ‘sucks’ the production structure in country group B into a pattern, which is not sustainable in the long run, then the situation is more problematic. This is the case if the trade preference leads producers in country group B to invest human and physical capital in a sector which promises attractive immediate returns as a result of the preferential market opening in country A, but which has no long-run prospects as a sector for profitable exports. This more problematic situation prevails if the volume of exports from country group B triggered by preferential treatment exceeds the quantity that it will be able to ship to country A once trade has been completely liberalized. In that case, the trade preference distorts the production structure in the developing countries as new adjustment costs will have to be borne once exports go down again as liberalization of MFN tariffs is achieved. In such a situation, country group B might have been better off had country A transferred the same amount of money to it not through a trade preference, but in the form of direct financial assistance for the development of infrastructure or for other development projects with lasting positive effects for economic growth.[10] Alternatively, the Government of the exporting country could skim off (part of) the preference margin and use the revenue for development purposes not directly related to the preferential export activity. In that way, the danger of the production structure being ‘sucked’ in a non-sustainable direction can be averted by the developing country concerned.
In the case discussed so far, there is not the slightest doubt that country group B exports of maize to country A after the introduction of the trade preference are larger than they would be under free trade. The reason is that even after introduction of the preferential tariff the domestic market price in country A is still the prevailing world market price plus the MFN tariff (as some imports still come in from other developed countries). In other words, on its maize exports to country A, country group B earns the going world market price plus the MFN tariff, minus any remaining preferential tariff. As that remaining preferential tariff is less than the MFN tariff, the net price earned by country group B is higher than the world market price. However, once country A eliminates its MFN maize tariff altogether, country group B earns no more than the going world market price. As that price is less than the price earned under the preferential tariff (and with the MFN tariff still in place), complete elimination of country A’s maize tariff will result in a reduction of country group B maize exports, and hence a new downward adjustment of the latter’s maize production, from the higher level reached after the introduction of the preferential tariff.[11]
In this case, it is clear that country group B would have been better off had it received the equivalent sum as a purely monetary transfer in the form of financial assistance. However, this may not be a realistic alternative. Trade policies, including trade preferences on the one hand and development assistance on the other, are decided by different policy makers, influenced by different lobbies and on the basis of different criteria. Hence the rate of substitution among transfers through trade preferences and financial assistance may be far less than one. Giving up on one dollar’s worth of a trade preference that developing countries could have received does not at all mean that one dollar more will be made available in the form of financial assistance. The ‘development lobby’ in developed countries will argue for both trade preferences and financial assistance. However, its influence on trade policies is not directly comparable with its influence on development aid, the more so since there is typically an asymmetry in the political assessment of revenue forgone and expenditure made. Revenue forgone is invisible, as it is not accounted for in the public budget. Expenditure, on the other hand, is highly transparent in the relevant budget line. Hence, tariff revenue forgone because of a trade preference is likely to count far less in the political debate than actual budget outlays on development assistance. In consequence, developing countries probably do not have to fear that they might lose (significant amounts of) financial assistance if they manage to obtain trade preferences.
On the other hand, developing countries have only a given amount of ‘negotiating capital’ that they can bring to bear on developed country governments, and they must consider where the last ‘dollar of negotiating capital’ achieves most. From this perspective it is, of course, relevant that attempts at achieving trade preferences can run counter to the interests of those producer groups in the developed countries that benefit from trade protection. In the case discussed so far, maize producers in country A (if they understand the situation correctly) have no reason to be concerned, as the only effect of the trade preference is to replace imports from other developed countries by imports from developing countries. It does not affect the domestic price in country A, and hence does not result in a loss to domestic maize producers. Opposition to the trade preference could, then, come only from maize producers in other developed countries, who lose market shares in country A. It can also come from developing countries not benefiting from the same tariff preference. Opposition might, though, also come from economists, who can well argue that in this case there is an overall welfare loss as low-cost imports from other developed countries are replaced by higher-cost imports from country group B.[12]
Starting from this simple case other, more complex, cases can easily be derived, though not all constellations of possible assumptions need to be discussed here. If export supply from other developed countries is less than infinitely elastic, the trade preference will depress the domestic market price in country A. As a result, imports into the country will rise, making a loss in world welfare somewhat less likely. However, in addition to opposition from producers in other developed countries, there will also be opposition from maize producers in country A itself. This strengthens the relative advantage of using developing countries’ ‘negotiating capital’ for arguing in favour of financial assistance. On the other hand, it is less certain that the production structure in the developing countries is ‘sucked’ in a sub-optimal direction that may not be sustainable after complete trade liberalization.[13] A somewhat similar situation is when the trade preference for country group B has the effect of squeezing all imports from other developed countries out of the market of country A. In this case, too, the domestic market price in country A will fall as the trade preference is introduced, and opposition will come from producers in both country A and in other developed countries.
In sum, the “trade rather than aid” perspective has some economic appeal. Trade preferences can help developing countries to foster self-sustained economic development. They can substitute for, but probably also add to, economic transfers from developed to developing countries in the form of financial assistance. However, there are also drawbacks, the most obvious of which is resistance from producers in developed countries. Less obvious, but still relevant, is that they lead to a production structure in developing countries which is not sustainable when overall trade liberalization makes progress. Finally, there is the possibility of a loss in world welfare resulting from trade diversion.
