Chapter

6 Liberalizing the Trade System

Editor(s):
Laura Wallace
Published Date:
January 1999
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Author(s)
Robert Sharer

Increasing links between international markets is not a new phenomenon. Indeed, growth in the value of international trade in goods and services has significantly exceeded GDP growth almost every year for the past 30 years. In the last decade, however, the growing integration and knowledge of world markets, fostered by major changes in information technology, has led to an explosion of investment flows to developing countries. As the pace of technological change and information flows quickens, and associated costs fall sharply, this globalization of the world economy will only accelerate.

How can Africa reap the benefits of globalization and foster an environment conducive to private investment? This paper looks at the prominent role that liberalization of the trade regime can play, focusing on the challenges facing Africa.

Challenges of Globalization in Africa

The opportunities and potential gains that globalization presents for Africa are apparent from a comparison of past trends (see Figure 1).

Figure 1Africa Underperforms in Trade …

Source: IMF, World Economic Outlook.

1 China, Hong Kong SAR, Indonesia, Korea, Malaysia, Singapore, Taiwan, and Thailand.

  • From 1975 to 1996, the average annual export growth for Africa was 4.8 percent, or about one-half the rate for industrial countries and for non-African developing countries, and only about a third of the rate for the export-oriented economies in Asia. As a result, Africa’s share of world trade fell from 4.6 percent to below 2.0 percent during this time period.
  • Foreign investment shows an even more dramatic picture. Net private capital flows to all developing countries increased to $23 billion in 1988 from $12 billion in 1980, and then rose sharply to $207 billion in 1996. But while net private capital flows to Africa grew to $12 billion in 1988 from $9 billion in 1980, they stagnated thereafter. In other words, net private capital flows to Africa, as a percent of inflows into all developing countries, fell to below 10 percent by 1996 from about 50 percent in the mid-1980s.

This relative decline is the counterpart of dynamic performance elsewhere, notably, of Asian economies—although the recent financial crisis in Asia has meant a setback for all emerging market countries—with foreign investment in Africa falling sharply. This setback may well prove to be temporary. Nevertheless, the timing is now propitious for Africa to capitalize on the trend toward globalization. This means dramatically speeding up the pace of trade liberalization, if Africa hopes to benefit from the increasing global pattern of production and trade, by improving both incentives and the investment climate.

Why is trade liberalization so important? It improves the efficiency of resource allocation, enhances economic growth, and improves transparency and governance. As for the benefits for economic efficiency and comparative advantage, these are well known and need not be elaborated on further. Overall, there is a large, and growing body of empirical research that provides ample evidence that liberalization of the trade system provides an important stimulus to exports and economic growth.1 Indeed, there is no case of a highly restrictive trade regime being associated with sustained strong economic performance. Trade policy does not work in a vacuum, but as a complement to appropriate macroeconomic and other structural policies. Lowering trade barriers reduces the cost of imported inputs and improves access to them, reduces anti-export bias, and facilitates the transfer of knowledge and foreign technology. Trade reform is thus a critical component of moving to a virtuous cycle of export-led growth.

What is a reasonable level of openness? In principle, the objective of trade reform should be free trade, and the faster it is implemented the faster the benefits are attained. In practice, however, very rapid movement from a restrictive to a completely open regime is difficult to achieve. Thus, the goal should be early movement to a trade regime that minimizes distortions and enhances transparency. This means moving to relatively low and broadly uniform tariffs, and the progressive elimination of nontariff barriers to the flow of goods, services, and investments.

Establishing a broadly uniform tariff structure should be complemented by consolidating all other duties and charges into the basic tariff structure and eliminating exemptions, particularly discretionary exemptions, for particular individuals or groups. Dismantling non-tariff barriers should include removal of measures that restrict trade, either through quantitative restrictions or by allowing administrative discretion so as to restrain trade. These reforms improve transparency, predictability, and simplicity of the trade regime, thereby promoting good governance.

How Africa Compares

How do African trade regimes compare with other regions? One way to judge this is by looking at an index of overall trade restrictiveness that the IMF developed as part of a recent study of trade liberalization in IMF-supported programs during the 1990s2 (see Figure 2). The index provides a 10–point scale that summarizes the aggregate restrictiveness of key elements of the trade regime, namely tariffs and non-tariff barriers, ranging from 10 (most restrictive) to 1 (completely open). For analytical simplicity, trade regimes can be classified as open (1–4 rating), moderate (5–7 rating), or restrictive (8–10 rating).

Figure 2Africa Remains Restrictive …

Source: IMF staff estimates.

1 Based on most recent available data, 1996–98.

2 Includes other discriminatory duties and charges.

The study showed that during the 1990s, many African countries have liberalized their trade regimes, often significantly, in the context of structural adjustment programs. At the outset of the programs in the early 1990s, trade restrictiveness in Africa, however, was generally high. About 70 percent of these countries had trade regimes classified as restrictive—and most of these were highly restrictive, classified as 10 on the index. None of the regimes were classified as open. The reform programs usually targeted a quantifiable reduction in overall trade restrictiveness. In fact, the average degree of liberalization targeted was about the same in the African programs as in all the IMF-supported programs and in the great majority of cases the targets were achieved. Thus, significant trade liberalization did occur but because African countries started from a more restrictive position, most trade regimes remained restrictive or moderate even after the reform programs.

The analysis shows a similar pattern when it is extended to the whole of Africa, rather than to just those countries with medium-term IMF-supported programs, and updated with the most recently available data. We see that non-tariff barriers continue to be widespread, tariffs remain relatively high, and that, compared with the rest of the world, a significantly higher proportion of Africa’s trade regimes remain restrictive (see Figure 2). Moreover, Africa’s average tariffs are above 20 percent, which is higher than an average 13 percent for non-African developing countries, and substantially higher than the average 6 percent for industrial countries. It is the last group that dominates world trade. These findings underscore the need for most African countries to target significant further trade liberalization to enhance competitiveness.

Moving Toward an Open Regime

Of course, some difficult issues arise when it comes to implementing trade liberalization. First, trade reform, like any important economic adjustment, necessarily involves the reallocation of resources. As trade barriers are lowered, some formerly protected sectors are exposed to competition. Workers lose their jobs and must search for new employment. But there are policies to mitigate these inevitable social costs—generally referred to under the rubric of social safety nets. These include severance payments, training and relocation programs, and measures to develop alternative employment opportunities.

Such programs are not only right, they also help to create the needed public support to make the reform package sustainable. The design, implementation, and funding of social safety nets presents difficulties, but this should not be used to substantially delay trade reforms, as it also delays the benefits, in essence “throwing out the baby with the bath water.” Trade reform programs need to be credibly ambitious in their scope and timing.

A second difficulty arises because trade taxes may be an important source of revenue, particularly in low-income countries. But here, too, the difficulty should not significantly delay reform. The answer lies in focusing first on the tariffication of non-tariff barriers and the removal of exemptions, as both of these reforms act to increase tax revenue. Moreover, any loss of revenue from tariff reduction should be offset through introducing broader-based taxes such as a value-added tax. An important element of program design, however is that, where necessary, trade reform should be preceded by technical assistance to improve the efficiency of tax administration and increase enforcement. Indeed, an IMF study on trade reform showed that when programs were successfully implemented, revenue performance was not weakened.3

In an ideal world, trade reform should be complete and immediate, but in the real world, choices among competing objectives have to be made. How fast can countries reform? The experiences of some “good practice” countries sheds light on what is feasible (see Figure 3). These countries—Chile, Colombia, and New Zealand—progressively accelerated their growth rate and trade performance in a sustained manner, in the context of implementing broad-based economic reforms. This included moving from restrictive (index categories 8–10) to open (index categories 1–4) trade regimes over periods of about seven years. Although these countries are star performers, this time frame is consistent with the experience of many other countries. Of course, beginning with a less than highly restrictive regime, a country should be able to move to an open regime more rapidly.

Figure 3How Fast Can Countries Reform?

Source: IMF staff estimates.

1 Shaded area indicates IMF staff projections as of May 1998.

A number of African countries have also made impressive efforts to liberalize. In 1985, for example, Ghana and Uganda had high tariffs, pervasive non-tariff barriers, distorted exchange rate regimes, and other restrictions. Overall, their trade regimes were highly restrictive (see Figure 3). But starting in the mid-1980s, both countries undertook ambitious policy reforms, including trade reforms, initially focusing appropriately on dismantling non-tariff barriers and subsequently lowering tariffs. This opened them up to much needed external competition. As a result, the overall restrictiveness of their trade regimes has moved into the moderate range, and further planned reforms will move them into the open category. The beneficial impact of the reforms are clearly evident in the greatly enhanced economic performance of these countries.

The Investment Climate

So far, we have focused on average import tariffs and the coverage of non-tariff barriers. Other elements of the trade regime are also important, however, including trade-related exemptions, tariff dispersion and variability, and the complexity of the system and its administration. These other elements can detract from the efficiency of resource allocation and thus affect the investment climate directly through the impact on economic efficiency. They may also have a substantial effect on the investment climate by reducing transparency and impairing governance.

Owing to their highly disaggregated nature, trade policies are particularly suited to the redirection of resources to narrow interest groups. Transparency is an issue because those adversely affected by trade policy are often affected indirectly and may not be aware of the effect. Complex and discretionary trade policy regimes not only create opportunities for corruption—particularly in the case of discretionary licensing and tariff exemptions—but also lead to legal but inefficient and nontransparent rent-seeking.

The first session of this seminar discussed a variety of features of the overall regulatory regime that are critical to improving the investment climate including foreign investment restrictions, the legal system, the financial system, and infrastructure development. A simple, transparent, and predictable trade regime plays a similar role in fostering a healthy climate for foreign and domestic investment, because it eliminates discretionary actions, is fair to all, and reduces opportunities for rent-seeking behavior that discourages many investors. Furthermore, an open and predictable trade regime not only creates a level playing field, but also signals to potential investors that the government is serious about creating an economic climate that is market-oriented and favors productive activity. Indeed, broad-based and comprehensive trade reforms, preferably preannounced, can contribute importantly to improved governance.

Lessons from Asia

Can Africa draw any specific lessons from the trade reform experiences of East Asia? Certainly, trade reform has moved these economies, often starting from restrictive trade regimes, in a clear direction of openness approaching or matching those attained by the good practice countries cited above (see Figure 4 on page 91). Hong Kong and Singapore have maintained, for many years, completely open trade regimes. Other countries in the region have levels of openness broadly approaching full openness, although maintaining moderate non-tariff barriers for some sectors. Underpinned by a strongly supportive macroeconomic climate, these trade and other structural reforms have contributed to impressive economic growth and export performances (see Figure 5).

Figure 4East Asia Has Become Quite Open

Trade Policies in Selected East Asian Countries

Source: IMF staff estimates.

Figure 5Higher Exports Help Overall Growth

Source: IMF, World Economic Outlook.

But one lesson that should not be overlooked is that although these countries had liberalized trade substantially in terms of lower tariffs and moderately in terms of non-tariff barriers, this appears to have masked a high degree of administrative discretion in some areas. While these transparency and governance issues were indeed known prior to the crisis, the actual extent of problems, particularly in the financial and corporate sectors, emerged only following the onset of the crisis.

Even so, these weaknesses should not detract attention from the policy framework underlying East Asia’s tremendous success over the last few decades. Africa now needs to emulate East Asia’s record on trade liberalization, if it hopes to adjust and reap the benefits from globalization.

1For evidence on the links between open trade regimes and economic growth, see International Monetary Fund, World Economic Outlook, May 1993: A Survey by the Staff of the International Monetary Fund, World Economic and Financial Surveys (Washington); International Monetary Fund, World Economic Outlook, May 1997: A Survey by the Staff of the International Monetary Fund, World Economic and Financial Surveys (Washington); Robert Sharer and others, Trade Liberalization in IMF-Supported Programs, World Economic and Financial Surveys (Washington: International Monetary Fund, 1998); World Bank, The East Asian Miracle: Economic Growth and Public Policy (New York: Oxford University Press, 1993).
2See Sharer and others (1998).
3The sharply improved economic performance of these countries is detailed in Sharer and others (1998).

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