Aid Or Trade Essay

Today’s post from EU Trade Commissioner Karel De Gucht is the second in a series published to coincide with the 2013 Dialogue on Aid for Trade taking place at the OECD on January 16-17, in collaboration with the Government of Sweden and the Overseas Development Institute, with the support of the European Commission.

One thing is for sure: No country has ever lifted itself out of poverty without international trade. Trade is key to help countries develop. So we need to make sure that people in the world’s poorest countries have access to markets, to create jobs and encourage growth as a result. But trade needs the right conditions to flourish. Bottlenecks and inefficiencies – whether at border crossings, or in the way the economy is regulated, or even within the private sector – get in the way of progress and prosperity.

That’s where  Aid for Trade comes in: as financial assistance to build new infrastructure, improve ports or customs facilities in developing countries – in short: we want to help developing countries “trade” their way out of poverty.

Today, the EU and its Member States provide more trade-related development assistance than the rest of the world put together. We contributed a third of world-wide Aid for Trade assistance, or €10.7 bn, in 2010 – that’s a quarter of our own total official development assistance (ODA) budget. And the results speak for themselves:  a 10% increase in Aid for Trade spending on infrastructure has been shown to lead to a 6.5% increase in goods exports.

However, what really counts in the current crisis, with ODA shrinking, is that we continue to support developing countries’ integration into the global economy – and make the most of our aid budgets for this purpose.

How do we do this?

The starting point is of course that we use the resources available effectively. This means we need to target Aid for Trade right and prioritise especially Least Developed Countries (LDCs).

Also, the most effective Aid for Trade projects involve multiple countries – like those focused on key regional trade corridors, for example. So we need to count on cross-border and regional programmes.

That is why I believe Economic Partnership Agreements (EPAs) can make an important contribution to the development of ACP countries. World tariffs have never been this low and the EU already offers very favourable market access to poor countries. So where EPAs can make a real difference are non-tariff issues or so-called ‘behind the border issues’ – standards, services, intellectual property rights, public procurement, technical, social and environmental rules, infrastructure and packaging facilities. We have already gone this far with developing countries in Latin America and aim to do the same with partners in South-East Asia.

Today’s modern trading environment is dominated by the way manufacturers build up, assemble or even improve a product at different stages in the production chain. With two-thirds of world trade now involving intermediary inputs, it is vital to address these ‘behind the border issues’ so that developing countries can really be part of this process and integrate into global value chains.

Eventually, we need to involve the private sector better. If companies are not integrated in the design of Aid for Trade projects – by identifying the constraints that most need to be tackled for example – then they are unlikely to make use of the results. Aid for Trade can empower companies in developing countries to boost their trade to the EU, making the best of the EU’s generous tariff preferences.

At the same time, the success of Aid for Trade of course depends on requests from our partner countries, as we always encourage them to take the lead. Aid for Trade works best when governments are aware of the role that openness to trade plays in development. They need to include trade policy in their national development strategies to create a business-friendly environment to attract foreign direct investment.

There are some who say that these arguments are all very well for developed countries but that infant industries in developing countries need protection. I disagree entirely with this: if there is one thing that is not lacking in developing countries, it is entrepreneurship and the will to compete. What entrepreneurs need are opportunities – opportunities that trade can provide. Just look at the practice – in China, India, Brazil, South Africa and all across the emerging world. The economies that have opened up have reaped the rewards.

Finally, a WTO deal on trade facilitation will be an important factor to make trade work for developing countries. Improving custom procedures by computerisation, cutting red tape, and simplifying rules and documents makes doing business more predictable and helps goods move faster across borders.  Studies suggest that the cost of doing so would not be more than €10 million per country.  But in Sub-Saharan Africa alone, an average 5% reduction in time spent at the border could achieve a 10% increase in intra-regional exports.  In some African countries, revenue losses from inefficient border procedures even exceed 5% of GDP. If an exporter cannot say for certain when his products are going to get to customers then he is going to lose business. Lack of transparency – especially with respect to fees – creates high transaction costs.

With this in mind, the EU is actively working with other partners to secure a WTO Trade Facilitation Agreement for the WTO Ministerial meeting in Bali in December this year. We need everyone to get behind such a deal. Because Aid for Trade will work so much better if all WTO Members commit to making the necessary policy reforms. At the same time, any deal on trade facilitation will be impossible to implement on the ground without the right financial support – so this is also an opportunity to make the case for continuing support to Aid for Trade.

But we know that the story doesn’t end there. If we want to see further results we need to be there as partners for development over the long haul. It is only through a collective effort to deliver a well-funded, effective policy that we will achieve our objective: to see developing countries, particularly the poorest amongst them, make the most of globalisation. As far as the European Union is concerned, that means at both Member State and European level we must therefore do our very best to maintain these levels of commitment. I certainly am ready to do so.

Useful links

Aid for Trade Policy Dialogue 2013

OECD / WTO: Papers and publications on Aid for Trade

Government of Sweden

Overseas Development Institute

European Commission, DG Trade

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Definition of ‘Trade not aid’

This is the economic idea that the best way to promote economic development is through promoting free trade and not providing direct foreign aid.

Logic of ‘Trade not Aid’

  • A culture of dependency. Foreign aid to developing economies is invariably wasteful and can create a culture of dependency. Also, recipients of aid may feel lower self-esteem, which is damaging in the long-run. Milton Friedman argues that, whilst aid can increase capital in a developing economy, it is also likely “that they lead to a noticeable increase in the amount of capital devoted to economically wasteful projects.” (“Foreign Economic Aid: Means and Objectives” (1995), p.6 Stanford University.
  • Aid given for bad motives. Aid is often subject to vested interests and fails to make real improvements in living standards. For example, government aid is often tied to bilateral agreements – aid to India with an expectation of demand for buying British exports. WIth private aid foundations, there is a concern that it gives power to unelected individuals in deciding priorities of societies.
  • Trade increases welfare. Increasing trade is the best way for developing economies to improve their real economic welfare, and enable a sustainable increase in economic welfare. Most economists are united on the benefits of free trade to improve economic welfare. For example, US and EU tariffs on food, lead to higher prices of food for consumers in developing economies. Removing these tariff barriers would enable cheaper prices of global foodstuffs. This would make a real difference to economic welfare in developing economies. Also, farmers in developing countries would have more chance to export to the developed world. Further reading on benefits of trade.
  • Success of trade in S.E.Asia. Supporters of ‘trade not aid’ point to countries in south east Asia who have been able to dramatically increase economic welfare through increasing trade. China has lifted record numbers of people out of absolute poverty through two decades of economic growth – largely driven by growth in free trade. Aid to China has played a very small role.
  • Democratic costs. Foreign aid can disrupt political democracy in developing economies. Milton Friedman writing in “Foreign Economic Aid: Means and Objectives” (1995), notes that “many proponents of foreign aid recognize that its long-run political effects are adverse to freedom and democracy.” Aid may be given to prop up a government – and avoid a democratic change. It is arbitrary which groups receive aid.
  • Foreign aid can displace domestic government incentives to invest in public infrastructure. If aid finances public health care, governments in developing economies may feel they don’t need to set up efficient tax collection and spend money – as they can rely on foreign aid. This is damaging for the long-term. For example, the Gates Foundation has been criticised for its decisions to target single diseases (such as Polio eradication) – whilst this is a laudable aim, it has also led to the neglect of basic healthcare provisions, but encouraged a more fragmented private system. Global Justice has been critical of the Gates Foundation for using aid to promote a particular economic ideology.

“There is extensive evidence that the promotion of markets in healthcare leads to an increase in health inequities and inefficiencies.” Global Justice report on Gates Foundation, 2016.

How to Implement ‘Trade not Aid’

  • Supporters of ‘trade not aid’, would seek to remove any tariff barriers or obstacles to free trade and opening up markets to competition
  • Supporters of free trade usually support free market reforms to reduce the role of government interference and allow market forces to encourage innovation, efficiency and increased economic output. Policies to support free trade may involve.
  • Reducing power of trades unions
  • Privatisation of inefficient state owned industries.
  • Cracking down on corruption
  • Lower corporation and income taxes to increase the incentive to invest in export industries.

Criticisms of ‘Trade not Aid’

  • Aid for trade. Joseph Stiglitz has argued that aid is necessary to deal with global inequality and enable the poorer developing economies to fully benefit from the potential of trade. For example, aid can help improve infrastructure and transport links. Stiglitz argues the case for aid for trade is that it “should be motivated by the imperative to create ‘effective market access’ by removing internal barriers to trade.”

“The aid for trade agenda reflects the realisation that, for developing countries, the necessary investments are particularly large, and the capacity to meet them is particularly small. There is an emerging consensus that the current WTO Doha Round will require adequate trade related assistance to mitigate the detrimental effects of trade reforms, and to enhance the trading capacity of developing countries.”  Joseph E. Stiglitz, Andrew Charlton, (2006) “Aid for trade”, International Journal of Development Issues, Vol. 5 Issue: 2, pp.1-41

  • Infant industry argument. Developing countries may not be in a position to benefit from free trade. For example, their comparative advantage may lie in primary products which are subject to fluctuating commodity prices. The infant industry argument suggests that developing countries may benefit from temporary tariff barriers as the new industry develops.
  • Not all countries are the same. Several south-east Asian economies have benefitted from growth of trade (though it was not without protectionist measures) but this doesn’t mean the same model can be transferred to land-locked economies in Sub-Saharan Africa
  • Aid can help overcome capital shortages and crippling debt payments. The Harrod Domar model of growth suggests that increasing capital is an effective way of increasing the rate of economic growth. For developing economies stuck in a cycle of low growth and low savings, aid can help break the negative cycle.
  • Benefits of free trade are not always equitably distributed. Aid can enable assistance to areas of the economy that have missed out. For example, retraining for those who are geographically or occupationally immobile.
  • Market failure can lead to an underprovision of important infrastructure such as education and infrastructure. Aid can help overcome these areas of market failure and help the economy to grow at a faster rate.
  • Aid needed in emergencies. At various times, international aid has helped to rebuild countries and regions recovering from shock. For example, the Marshall Plan for Western Europe – post-Second World War. Foreign aid to help with humanitarian crisis.

Trade vs Aid conclusion

Both aid and free trade have the capacity to improve economic welfare. It is not so much trade vs aid – but what quality and type of aid is given. Does it complement government efforts to extend public support? Does it help overcome market failure and improve access to global trade markets. Free trade can also play a role, that aid cannot match. Trade and economic development are ultimately the goal as they enable countries to be self-sufficient. But, thoughtful aid can accelerate this process.

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