Aid for Trade: Connecting to Value Chains

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Click to see the report

Today’s post is from OECD Secretary-General Angel Gurría

Since the Aid-for-Trade Initiative was launched in 2005, much has changed in the trade and development landscape. The Initiative continues to mobilise a range of actors, adapt to new realities, and succeed in building trade capacities for shared prosperity.

Increasingly, the global economy is characterised by geographically fragmented production. This creates networks of interlocking value chains where different stages of production take place in different regions, countries or even continents.  The emergence of these value chains creates an enormous growth opportunity for developed and developing countries alike. They allow countries to maximise competitive advantages and optimise resources. They also allow firms and economies to use intermediate goods and services to focus on, and be competitive in, one “link” of the value chain without having to develop a whole industry.

Motivated by the success of a number of emerging-market economies, developing countries are aiming to become more integrated into international production networks, or what we call Global Value Chains (GVCs). But despite their advantages in terms of competitive labour costs and abundance in natural resources, developing countries are disadvantaged in other aspects. High trade and transport costs, excessive red tape, poor infrastructure, credit constraints, skills shortages and challeneging business environments all serve to undermine competitiveness. Firms in developing countries require support and governments need assistance to overcome these supply-side constraints.

Judging by their national development strategies, many developing countries recognise the potential promised by emerging value chains. But they require assistance to train trade negotiators, build trade-related infrastructure, and improve the business environment to take full advantage. Increasingly, this is being recognised, leading partner countries to mainstream trade in their development strategies and give a higher priority to trade-capacity building in their dialogues with donors.

In Aid for Trade at a Glance 2013, the OECD and WTO demonstrate how aid for trade can play an important role in connecting developing countries to value chains. Three quarters of the 700 firms which contributed to the 2013 OECD-WTO monitoring survey were from developing countries. Their responses give us a good picture of the constraints facing companies and are presented in sector studies for agrifood, textiles, transport and logistics, information and communication technology and tourism.. These studies found that development assistance plays a crucial role in facilitating new trading opportunities by helping firms and producers raise the quality of their products to international standards and access market information. Development assistance can also improve firms’ competitiveness by reducing tariff and non-tariff barriers and bringing down the cost of essential services required to export, such as credit, insurance and transport.

Data from the OECD-DAC Creditor Reporting System tells us that $174 billion in aid for trade has been disbursed since 2006, while annual commitments reached $41.5 billion in 2011, 57% above the 2002-05 average baseline. Complementing these efforts, providers of South-South co-operation such as India and China have scaled up their own contributions.  Furthermore, aid for private sector development programmes has continued to grow and amounted to $18 billion in 2011.

Through successive rounds of monitoring aid for trade, the OECD and WTO have collected abundant evidence that these sums are well spent and result in lower trade costs and improved trade performance. For instance, our analysis found that $1 in aid-for-trade increases exports from the poorest countries by $20 and $8 for richer developing countries. These findings are even higher for exports of parts and components, underscoring the benefits that value chains offer to developing countries.

These results are substantiated by the 269 aid-for-trade case stories published in Aid for Trade in Action that were submitted in the context of the last Global Review. The stories probe more deeply into the objectives, challenges and processes of trade-related assistance to better understand what works in the provision of aid for trade, what the key ingredients of success were, and what governments and practitioners could learn from experience.

Success was reported for programmes in trade expansion, improved infrastructure, new linkages to value chains, employment creation, mobilisation of foreign and domestic investment, gender empowerment, and poverty reduction. The analysis concludes that aid for trade works best when it is focused on improving infrastructure, facilitating trade, and supporting the private sector. Such programmes are especially effective when developing countries have a supportive business environment, including stable macroeconomic policies and an investment climate that encourages private investments.

While these findings are encouraging, there remains a need to strengthen the management of limited aid resources to ensure that trade objectives are being met. The OECD has produced Aid for Trade and Development Results – A Management Framework based on national monitoring frameworks in Bangladesh, Colombia, Ghana, Rwanda, the Solomon Islands and Vietnam. The Framework provides a tool to help design frameworks for results-based management of aid for trade and is based on a menu of trade-related targets, as well as indicators to measure their performance. This provides a powerful system to ensure that aid for trade contributes to meeting ambitious development objectives, where links between inputs, outputs, outcomes and impacts depend on many factors beyond programme reach.

Aid for trade works. It is making a difference, has mobilised regional and national efforts and has proved to be a good investment. We must maintain momentum, continue to show results, and demonstrate that aid for trade helps to connect developing countries to value chains.

OECD’s Frans Lammersen discusses Aid for Trade with journalist Larry Speer

Useful Links

Interconnected Economies: Benefiting from Global Value Chains

Getting Globalization Right: China Marches to its Own Beat

Foreigners are welcome if they foster domestic capabilities

Today in collaboration with Americas Quarterly, we’re publishing the last of a series of three articles on globalisation and the fight against poverty by Dani Rodrik, Professor of International Political Economy at the John F. Kennedy School of Government, Harvard University.  You can read a print version in AQ’s Spring 2012 edition on social inclusion (online version here) and the first article in the series here

China’s experience offers compelling evidence that globalization can be a great boon for poor nations. Yet it also presents the strongest argument against the reigning orthodoxy in globalization, which emphasizes financial globalization and deep integration through the World Trade Organization (WTO). China’s ability to shield itself from the global economy proved critical to its efforts to build a modern industrial base, which would in turn be leveraged through world markets.

Since 1978, income per capita in China has grown at an average rate of 8.3 percent per annum—a rate that implies a doubling of incomes every nine years. Thanks to this rapid economic growth, between 1981 and 2008 the poverty rate in China (the percent of the population below the $1.25-a-day poverty line) fell from 84 percent to 13 percent, much of it from reducing rural poverty. This meant a whopping 662 million fewer Chinese in extreme poverty, a number that accounts for virtually the entire drop in global poverty over the same period.

During the same period, China transformed itself from near autarky to the most feared competitor on world markets. That this happened in a country with a complete lack of private property rights (until recently) and run by the Communist Party only deepens the mystery.

China’s big break came when Deng Xiaoping and other post-Mao leaders decided to trust markets instead of central planning. But their real genius lay in their recognition that the market-supporting institutions they built, most of which were sorely lacking at the time, would have to possess distinctly Chinese characteristics.

China’s economy was predominantly rural in 1978. A Western-trained economist would have recommended abolishing central planning and removing all price controls. Yet without a central plan urban workers would have been deprived of their cheap rations and the government of an important source of revenue, resulting in masses of disgruntled workers in the cities and the risk of hyperinflation.

The Chinese solution to this conundrum was to graft a market system on top of the plan.

Communes were abolished and family farming restored, but land remained state property. Obligatory grain deliveries at controlled prices were kept in place, but once farmers had fulfilled their state quota they were now free to sell their surplus at market-determined prices. This dual-track regime gave farmers market-based incentives and yet did not deprive the state of revenue nor deprive urban workers of cheap food.  Agricultural productivity rose sharply, setting off the first phase of China’s post-1978 growth.

Another challenge was how to provide a semblance of property rights when the state remained the ultimate owner of all property. Privatization would have been the conventional route, but it was ruled out by the Chinese Communist Party’s ideology.

Once again, an innovation came to the rescue. Township and village enterprises (TVEs) proved remarkably adept at stimulating domestic private investment. They were owned not by private entities or the central government, but by local governments (townships or villages). TVEs produced virtually the full gamut of products, everything from consumer goods to capital goods, and spearheaded Chinese economic growth from the mid-1980s until the mid-1990s. The key to the success of TVEs was the self-interest of local governments, which would reap substantial income from their equity stake in the enterprises.

China’s strategy to open its economy to the world also diverged from received theory. The Chinese leadership resisted the conventional advice to remove trade barriers. Such an action would have forced many state enterprises to close without doing much to stimulate new investments in industrial activities. Employment and economic growth would have suffered, threatening social stability.

The Chinese decided to experiment with alternative mechanisms that would not create too much pressure on existing industrial structures. While state trading monopolies were dismantled relatively early (starting in the late 1970s), what took their place was a complex and highly restrictive set of tariffs, nontariff barriers and licenses restricting imports. These were not substantially relaxed until the early 1990s.

In particular, China relied on Special Economic Zones (SEZs) to generate exports and attract foreign investment. Enterprises in these zones operated under different rules than those that applied in the rest of the country; they had access to better infrastructure and could import inputs duty free. The SEZs generated incentives for export-oriented investments without pulling the rug out from under state enterprises.

What fueled China’s growth, along with these institutional innovations, was a dramatic productive transformation.

The Chinese economy latched on to advanced, high-productivity products that no one would expect a poor, labor-abundant country to produce, let alone export. By the end of the 1990s, China’s export portfolio resembled that of a country with an income-per-capita level at least three times higher than China’s.

Foreign investors played a key role in the evolution of China’s industries. They created the most productive firms, introduced new technology to the economy, and became the drivers of the export boom. The SEZs, where foreign producers could operate with good infrastructure and with a minimum of hassles, deserve considerable credit.

But if China welcomed foreign companies, it always did so with the objective of fostering domestic capabilities. It used a number of policies to ensure that technology transfer would take place and that strong domestic players would emerge. Early on, they relied predominantly on state-owned national champions. Later, the government used a variety of incentives and disincentives to foster joint ventures with domestic firms (as in mobile phones and computers) and expand local content (as in autos). Cities and provinces were given substantial freedoms to fashion their own policies of stimulation and support, which led to the creation of industrial clusters in Shanghai, Shenzhen, Hangzhou, and elsewhere.

Many of these early policies would have run afoul of WTO rules that ban export subsidies and prohibit discrimination in favor of domestic firms—if China had been a member of the organization. Chinese policy makers were not constrained by any external rules in their conduct of trade and industrial policies and could act freely to promote industrialization.

By the time China did join the WTO, in 2001, it had created a strong industrial base, much of which did not need protection or nurturing. China substantially reduced its tariffs in preparation for WTO membership, bringing them down from the high levels of the early 1990s (averaging around 40 percent) to single digits in 2001. Many other industrial policies were also phased out.

However, China was not yet ready to let the push and pull of global markets determine the fate of its industries. It began to rely increasingly on a competitive exchange rate to effectively subsidize these industries. By intervening in currency markets and keeping short-term capital flows out, the government prevented its currency (renminbi) from appreciating, which would have been the natural consequence of China’s rapid economic growth.

Explicit industrial policies gave way to an implicit industrial policy conducted by way of currency policy.

Asia’s economic experience violates stereotypes and yet offers something for everyone. In effect, it acts as a reflecting pool for the biases of the observer. If you think unleashing markets is the best way to foster economic development, you will find plenty of evidence for that. If you think markets need the firm, commanding hand of the government, well, there is much evidence for that too.

Globalization as an engine for growth? East Asian countries are a case in point. Globalization needs to be tamed? Ditto. However, if you leave aside these stale arguments and listen to the real message that emanates from the success of the region, you find that what works is a combination of states and markets. Globalization is a tremendously positive force, but only if you are able to domesticate it to work for you rather than against you.

You become what you produce. That is the inevitable fate of nations. Specialize in commodities and raw materials, and you will get stuck in the periphery of the world economy. You will remain hostage to fluctuations in world prices and suffer under the rule of a small group of domestic elites.

If you can push your way into manufactured and other modern tradable products, you may pave a path toward convergence with the world’s rich countries. You will have greater ability to withstand swings in world markets, and you will acquire the broad based, representative institutions that a growing middle class demands, instead of the repressive ones that elites need to hide behind.

Globalization accentuates the dilemma because it makes it easier for countries to fall into the commodities trap.

The international division of labor makes it possible for you to produce little else besides commodities, if that is what you choose to do. At the same time, globalization greatly increases the rewards of the alternative strategy, as the experiences of Japan, South Korea, Taiwan, and China amply show.

Sustained poverty reduction requires economic growth. A government committed to economic diversification and capable of energizing its private sector can spur growth rates that would have been unthinkable in a world untouched by globalization. The trick is to leverage globalization through a domestic process of productive transformation and capacity-building.

Useful links

This series is adapted from Dani Rodrik’s The Globalization Paradox: Democracy and the Future of the World Economy published by Norton

Americas Society – Council of the Americas

OECD work on China

Perspectives on global development (publications from the OECD Development Centre)

Natural Resources and Pro-Poor Growth: The Economics and Politics

OECD work on poverty reduction and social development

OECD work on the benefits of trade liberalisation