Guest blogger Bernard Hoekman sets out the challenges and priorities for G-20 leaders in global trade governance in the context of the food, fuel and financial crises.
The recent food, fuel and financial crises have imposed large external shocks on households and firms in all developing countries. They have prompted questioning of the risks and rewards of globalization and identified areas where the global governance of trade urgently needs improvement. (Here, I broadly define good global trade governance as international cooperation in the form of a set of agreed rules that reduce the negative spillovers of national policies affecting international flows of products and production factors.) At the same time, the financial crisis has revealed the robustness and importance of the trading system. A major feature of the current crisis is the dog that did not bark: that is, to date, we have not seen the widespread imposition of the types of trade protection that characterized the 1970s and early 1980s, not to mention the 1930s.
Over the last three decades, technological changes and policy reforms to reduce restrictions on cross-border flows of goods, services, workers, finance, and knowledge made the world much more integrated. Trade to GDP ratios increased significantly, as did the value of financial flows, remittances, and royalty payments. Businesses specialized in parts of global supply chains, engaged in foreign direct investment (FDI), and associated embodied transfers of knowledge. This made traditional trade policy less relevant as a tool of public policy: why protect an industry if so doing puts barriers in place that prevent participation in a global supply chain? Even for industries where fragmentation of production is less feasible, (e.g., many services) widespread inward FDI gives governments less incentive to resort to traditional protectionism to support industries as much of the benefit will accrue to non-nationals.
The globalization of production and investment since the early 1990s helps explain both the limited interest of firms in the Doha Round and the absence, to date, of major protectionist backsliding in response to the recent decline in global demand and world trade. Thus, the global governance of trade in manufactures appears to be in decent shape, reflecting both the multilateral trading system’s set of rules and the structure of global specialization that has emerged over time. That said, the financial crisis is generating new challenges to the status quo.
The situation is less positive, for instance, in regard to trade in commodities. The recent food and fuel crises revealed that producing countries/governments will not hesitate to impose export restrictions in an effort to keep supplies at home and to lower domestic prices. Ideally, policy reactions to global shortages and resulting high prices need to be global – national reactions can (and did) have major negative cross-border spillovers. This applies as much to net importers as to net exporters: the incentives put in place to stimulate local production of biofuels in a number of net oil importers drove up prices of key agricultural food crops further. The message that was sent and received was that global markets are unreliable in times of shortage and that national policy should promote domestic supply capacity. The scope for nationalistic responses to global shortages to result in welfare reducing inefficiencies and distortions is great.
As with the food and fuel crises, the financial crisis is also generating “nationalistic” responses by governments: bailouts, forced mergers, or and/or nationalization of key financial institutions have been accompanied by a rapid exit from international activities as financial services providers rebuild balance sheets and deleverage. Short-term trade finance has particularly suffered because it could be scaled back rapidly and has a relatively low return. While the source of this shock was inadequate domestic regulation, the result was that another vital global market was shown to be unreliable in times of stress: liquidity dried up for firms in developing countries that had come to rely on international banks and capital markets.
The negative spillovers of the financial crisis may have impacts on the willingness of governments to liberalize trade in financial services, leading to a reconsideration of the regulatory framework that is needed to accompany liberalization. The crisis may also have implications for the viability of manufacturing supply chains and outsourcing that have driven globalization in recent decades. Insofar as global production fragmentation was conditional on cheap finance and ample liquidity, a reversion to a period in which trade finance is more expensive may result in a geographic restructuring of production chains and greater vertical integration within large firms. Similar forces may arise as a result of bailout programs directed towards industries such as automobiles. In the medium term, pressure on the global supply chain model may increase further if policies to reduce carbon emissions create incentives to shorten supply chains. The end result may be a shift of production towards regional instead of global platforms and networks.
The forgoing suggests that the major challenge is to safeguard and bolster an open trading regime. Rapidly concluding the Doha Round is important both as a signal of commitment to multilateral cooperation on trade and as insurance. If global production platforms unravel (at this stage just a possibility), further locking-in (binding) current trade policies will help prevent a rise in traditional protectionism at the national or regional level. But Doha is also important as it is the only mechanism through which governments can commit to reducing trade-distorting agricultural support policies that generate negative spillovers for many developing countries and the world as a whole.
Openness is as important for food, fuel, and finance where key policy instruments are not adequately covered by Doha. The policy responses to high food and fuel prices over the past several years illustrated the importance of disciplining export restrictions and ensuring that all countries have equal access to these commodities – whatever the global market clearing price at any point in time might be. Implicit (or explicit) subsidies for domestic consumption in net exporters reduces global welfare both directly and indirectly because they create incentives for net importing countries to increase production by emulating the highly distortive and costly support programs that high-income countries use for agriculture and biofuel production. WTO members can make an important contribution by agreeing to discipline the use of export-restricting policies.
The international community should complement this by encouraging the adoption of more efficient instruments to improve agricultural productivity and foster adaptation to/mitigation of climate change. A unique feature of the Doha Round is the recognition that trade negotiations should be complemented by support in order to enhance the competitiveness of developing country exporters: that is, aid for trade. A key element of the cooperation needed to safeguard openness and to address exogenous shocks through non-trade instruments is to ensure that the financial crisis does not crowd out the aid for trade commitments made by major donor countries. For countries that confront high trade costs, improving competitiveness is as important, if not more, than before the crisis struck.
Greater attention is also needed to documenting and monitoring the extent to which national policies generate negative spillovers on developing countries. An immediate priority is to monitor and analyze the financial bailouts and fiscal stimulus packages that are being implemented by governments, which may have trade- and investment-distorting (and reducing) effects by biasing expenditures away from least-cost suppliers, wherever they may be located. Transparency and objective analysis of the cross-border effects of support policies is a pre-condition for identifying alternative, superior, instruments that are nondiscriminatory in effect.
Bernard Hoekman is the Sector Director of the Trade Department in the Poverty Reduction and Economic Management (PREM) Vice-Presidency (PRMVP) at the World Bank. He is also a Research Fellow, International Trade Program, at the Centre for Economic Policy Research (CEPR), London, UK.
This article is part of a forthcoming compilation on a trade agenda for G20 leaders edited jointly by Dr. Carolyn Deere Birkbeck (Global Economic Governance Programme) and Ricardo Meléndez-Ortiz (International Centre on Trade and Sustainable Development (ICTSD)). The compilation will be published in mid-March 2009.
