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Free trade or fair trade? An enquiry into the causes of failure in recent trade negotiations

Discussion paper by Mehdi Shafaeddin, UNCTAD, 2000

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What: Trade policy is at a crossroads. So is trade diplomacy. The failure of the traditional import substitution policies of the 1950s-1970s has been followed by the failure of trade liberalization in the 1980s and 1990s by developing countries. In particular, the deadlock in the negotiations during the recent meetings of WTO has demonstrated the severe differences among various groups of member countries. Focusing on frictions between developing countries and industrial economies in the particular area of trade in manufactured goods, this paper argues that the failure of the negotiations is related to a number of fallacies and contradictions surrounding the concepts and practices of universal trade liberalization and infant industry protection. Who: Can be used for course and/or research work on trade negotiations, policy and diplomacy, liberalization and WTO issues. How: As a background reading material on trade negotiations and WTO issues.

UNITED NATIONS CONFERENCE ON TRADE AND DEVELOPMENT


DISCUSSION PAPERS


FREE TRADE OR FAIR TRADE?
An enquiry into the causes of failure


in recent trade negotiations


Mehdi Shafaeddin


No. 153
December 2000




FREE TRADE OR FAIR TRADE?


An enquiry into the causes of failure in recent trade negotiations


Fallacies surrounding the theories of trade liberalization and
protection and contradictions in international trade rules


Mehdi Shafaeddin


No. 153


December 2000


The author would like to thank a referee for his very useful and constructive comments.


UNCTAD/OSG/DP/153




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The opinions expressed in this paper are those of the author and do not necessarily reflect the views
of UNCTAD. The designations and terminology employed are also those of the author.


UNCTAD Discussion Papers are read anonymously by at least one referee, whose comments are taken
into account before publication.


Comments on this paper are invited and may be addressed to the author, c/o Editorial Assistant,*
Macroeconomic and Development Policies, GDS, United Nations Conference on Trade and Development
(UNCTAD), Palais des Nations, CH-1211 Geneva 10, Switzerland. Copies of Discussion Papers and Reprint
Series may also be obtained from this address. New Discussion Papers are available on the website at:
http://www.unctad.org/en/pub/pubframe.htm




* Tel. 022–907.5733; Fax 907.0274; E.mail: nicole.winch@unctad.org


JEL classification: F130, O140 and O200.




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CONTENTS


Chapter Page


I. INTRODUCTION 2


II. SUMMARY OF EVENTS 2


III. FALLACIES IN THE PHILOSOPHY BEHIND
UNIVERSAL TRADE LIBERALIZATION 5


A. The foundation of theory of trade liberalization 5
B. Unrealistic assumptions 6
C. Perfect competition and constant return to scale 8
D. Full employment and similarities between countries 11
E. Explanatory power of the theory 12
F. Alternative views on comparative advantage 15


IV. FALLACIES SURROUNDING THE THEORY
OF INFANT INDUSTRY PROTECTION 16


A. Infant industry protection versus import substitution (Frederick List) 16
B. Import substitution versus export expansion? (Raul Prebisch) 18
C. Implementation problems 20


V. CONTRADICTIONS IN THE GATT/WTO RULES 20


A. Contradictions in design 20
1. Agriculture 21
2. Textiles, clothing and footwear 22
3. Infant industry protection 23


B. Contradictions in implementation of commitments 24
1. Agreement on Textiles and Clothing 25
2. Applying anti-dumping rules 26
3. Differential treatment of developing countries 28


VI. INTEREST OF DEVELOPED COUNTRIES 28


VII. CONCLUDING REMARKS: TRADE NEGOTIATION
AND DEVELOPING COUNTRIES 32


REFERENCES 35




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FREE TRADE OR FAIR TRADE?


An enquiry into the causes of failure in recent trade negotiations


Fallacies surrounding the theories of trade liberalization and protection
and contradictions in international trade rules


Mehdi Shafaeddin


United Nations Conference on Trade and Development


Abstract


Trade policy is at a crossroads. So is trade diplomacy. The failure of the “traditional import
substitution” policies of the 1950s–1970s has been followed by the failure of trade liberalization in
the 1980s and 1990s by developing countries. In particular, the deadlock in the negotiations during
the recent meetings of WTO has demonstrated the severe differences among various groups of member
countries. Focusing on frictions between developing countries and industrial economies in the
particular area of trade in manufactured goods, the purpose of this paper is to argue that the failure
of the negotiations is related to a number of fallacies and contradictions surrounding the concepts
and practices of universal trade liberalization and infant industry protection. These main fallacies
include: the philosophy behind universal and across-the-board trade liberalization; the
contradictions in the design and implementation of GATT/WTO rules to the detrimental interest of
developing countries; the theory and practice of infant industry protection; and, in particular,
perceptions about the interests of developed countries in universal and across-the-board trade
liberalization by developing countries.


Emphasizing that free trade should be the ultimate aim of every nation once all economies have
reached the same level of development, it is argued that there is a need for revision of international
trade rules. In the design of the new rules more attention should be paid to the level of development
and industrial capacity of developing countries. Developing countries should have a clear trade and
industrial policy as well as negotiating strategy before entering the negotiation. To play such a
proactive role, along the lines suggested in the UNCTAD “Positive Agenda”, developing countries
should: link their trade policy to their development objective; and follow a dynamic trade policy
geared to their level of development, industrial capacity, structural characteristics and changes in
the world economy, as suggested by Shafaeddin (1995). Moreover, in their common negotiation
strategy, instead of agreeing on a “least common denominator”, they should attempt to cooperate en
elaborating a strategy aiming at the trading rules that differentiate countries, in accordance with
some agreed criteria. Such criteria may include a number of indicators, such as per capita income,
the degree of dependence on primary commodities, the share of manufacturing in GDP, etc.


Finally, it is a myth to believe that concessions will always be made to developing countries
on “moral grounds”. “Bargaining” is the name of the game. Developing countries should mobilize
and make the best use of whatever bargaining chips they possess, however small they may be; and
developing countries can have some leverage in trade negotiations if they mobilize (Shafaeddin,
1984). Bargaining requires not only bargaining assets, but also knowledge, information about the
issues concerned, and training for undertaking trade negotiations. In such a context, at the country
level there is a need not only for policy formulation and for strengthening the capacity of commercial
diplomacy to enhance bargaining skills, but also for strengthening the capacity for trade and
industrial policy formulation.




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I. INTRODUCTION


Trade policy is currently at a crossroads, as is trade diplomacy. The failure of the “traditional import


substitution” policies of the 1950s–1970s has been followed by the failure of trade liberalization by the


developing countries in the 1980s and 1990s . In particular, the deadlock in negotiations during the recent


meetings of the World Trade Organization (WTO) has demonstrated the severe differences among various


groups of member countries on such issues as universal and across-the-board trade liberalization, movements


of capital, etc. The emergence of the deadlock raises some questions about the reasons for such profound


differences of view. Without a thorough understanding of these differences and conflicts of interests among


the various groups involved, a successful outcome to the negotiations can only be limited.


As far as trade liberalization is concerned, the purpose of this paper is to show that the failure of the


negotiations is related to a number of fallacies and contradictions surrounding the concepts and practices of


universal trade liberalization and protection. The main fallacies are related to: (i) the philosophy behind


universal and across-the-board trade liberalization; (ii) contradictions in the design and implementation of


agreed rules during the various rounds of trade negotiations under GATT and in the positions of some groups


in their implementation; (iii) the theory of protection of infant industry; (iv) and, in particular, perceptions


about the interests of developed countries in universal and across-the-board trade liberalization.


Section II summarizes the recent events since the conclusion of the Uruguay Round Agreement (URA).


Section III refers to the fallacies in the philosophy behind universal trade liberalization and to the limited


explanatory power of the related theory, i.e. the theory of static comparative advantage (CA). Section IV is


devoted to the discussion of fallacies surrounding the theory of protection and the infant industry argument.


Contradictions in the design and implementation of trade liberalization agreements will be examined in


section V. In section VI arguments will be put forward that universal, across-the-board and premature trade


liberalization is not only against the interest of developing countries, but more importantly, is against those


of developed countries too. The final section will present some conclusions outlining policy implications and


present some recommendations.


It should be emphasized from the outset that, as will be explained later in this paper, free trade should


be the ultimate aim of every nation once all economies have reached the same level of development. Hence,


the content of this study should not be interpreted as expressing views against that “ultimate” aim.


II. SUMMARY OF EVENTS


The URA was negotiated and signed in a period during which the Group of 77 was in disarray, stricken


by debt obligations and the impact of changes in the former Soviet Union and the end of the cold war in


world politics. Moreover, developing countries were not, according to the Secretary-General of UNCTAD,


technically prepared for the negotiations while they lacked their own trade objectives and adequate strategies




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(UNCTAD, 1997: 1–8). They were influenced, either ideologically or under pressure, by the dominant views


of the time on the advantages of universal trade liberalization.


A number of factors, however, have caused the governments of many developing countries, as well


as citizens of both developed and developing countries, to have second thoughts on the merits of fast,


universal and across-the-board trade liberalization. One of these factors is the development of the balance-of-


payment crisis in East Asia – which had the most successful economies of the 1980s and early 1990s – and


in Brazil, which led to financial and economic crises not only in these countries but also in the world


economy as a whole. Some severe balance-of-payment crises also emerged in other developing countries.


The second factor was the failure of fast and across-the-board trade liberalization in a large number of least


developing and other low-income countries, particularly in Africa, which are characterized by a low level of


industrial capacity, to diversify into manufacturing exports. The third factor was the change in the industrial


structure in many developing countries, particularly in Latin America, in favour of specialization in resource-


based industries and against labour-intensive industries, thus delaying development of industries in which


these countries could attain dynamic CA (Benavente et al., 1999). Moreover, a concentration emerged of


manufacturing production in favour of large enterprises, both domestic and foreign-owned, and against small-


and medium-sized enterprises, with a consequential impact on the level of employment and income


distribution. Fourth, generally speaking, recent trade liberalization has been accompanied by worsening


income distribution not only within developing countries, but also within developed ones and between


developed and developing countries (UNCTAD, 1998 and UNDP, 1999, chap. 1). Fifth, the emerging


financial and economic crises in developing countries led to a global financial crisis threatening the stability


of the world economy. In other words, the crisis had led to a higher degree of instability (risks) at a lower


level of output and employment in the world economy, with the notable exception of the case of the United


States. That country was less affected by the crisis owing to a relatively low share of trade in its GDP, the


domestic expansionist policies of the Federal Reserve System and the compensatory impact of the


technological revolution, which created jobs and demand for investment. However, the impact of the world


financial crisis on the United States manifested itself in the magnitude of the country’s balance-of-payment


deficits and in the cost to the tax payers of the bailout of the crisis-stricken countries.


Finally, developing countries felt that they had made a greater commitment to liberalize trade than had


developed countries, through URAs and Structural Adjustment Programmes and Stabilization Programmes.


They also felt that implementation of the commitments made under URAs by developed countries had been


slow and unsatisfactory.


The reflection of these developments on the process of trade negotiations demonstrated itself in a series


of problems and deadlocks in agreements on issues discussed in WTO. In the first place, the appointment




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It seems that the story does not end at Seattle. There were further demonstrations at Davos during the1


meeting of the World Economic Forum in objection to trade liberalization and globalization. Similar demonstrations
took place during the joint meetings of IMF and the World Bank in April (International Herald Tribune, 27 January
2000: 17; Wall Street Journal, 6 April 2000: 1 and 12), as these institutions were perceived to have also been behind
trade liberalization through Structural Adjustment Programmes and Stabilization Programmes. More recently,
demonstrations took place in Sydney, prior to the opening of the Olympic games and in Prague during the joint
meetings of IMF and the World Bank.


of the Director-General of WTO became the subject of intensive negotiation and disagreement between


developed and developing countries. Subsequently, the member countries could not agree on the draft agenda


on the new round of trade negotiations for consideration by the Ministers at Seattle. More importantly, even


in Seattle, no agreement was reached on the agenda. The meeting took place in the midst of street


demonstrations, which were regarded by the press as unprecedented since those against the Viet Nam war.


Various groups, both from developed and developing countries – labour organizations, environmentalists,


NGOs, human rights activists, etc. – showed their dissatisfaction with the course of events regarding trade


liberalization and globalization. Notably missing in the list of demonstrators, however, were representatives


of TNCs and large businesses.1


Since then various views have been expressed on the impact of the failure of the Seattle meeting on the


future of trade negotiations, free trade and globalization. For example, Peter Kenan, a widely respected


economist at the University of Pennsylvania, believes that: “The grime message of Seattle is that not only we


won’t have a new round now, but we won’t have one for some time …” (International Herald Tribune,


9 December 1999: 4). Jeffrey Garten, another distinguished scholar at Yale University, stated that: “There’s


been a real democratization of the debate over trade and globalization … What Seattle showed was that there


is a lot more angst beneath the surface” (loc. cit.). A former Canadian trade negotiator was more pessimistic


expressing his feeling that: “I don’t know if the WTO system can survive. It is badly weakened right now”


(loc. cit.). According to Julius Katz, Deputy Trade Negotiator in the former President Bush Administration:


“Things are going to just limp along until there can be wholesale rethinking of the trade strategy” (loc. cit.).


What is wrong with the present trade strategy for it to require new thinking? While opinion might differ


on this issue, it is the intention in this study to show that, as far as developing countries are concerned, the


answer is related to the fallacies surrounding the theory and practice of trade liberalization. In fact, these


fallacies and contradictions are the reason for developed and developing countries remaining far apart.


According to Charlene Barshefsky, the US Trade Representative: “The developing world is not hearing what


we are saying and we’re not hearing what developing world is saying. We’re passing like ships in the night”


(K. Engelmann, Reuters, Yahoo Internet site, 20 January 2000). This study aims at shedding some light on


the reasons for such misunderstanding.




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According to Krueger (1980: 289): “… markets would function well and provide growth if only policy makers2


would abstain from unproductive intervention”. The doctrine of CA is implicit in the theory of universal and across-
the-board trade liberalization, even though some lip-service is paid to consideration of the dynamics, i.e. the infant
industry argument.


See Viner (1953: 15) for this distinction.3


In the Ricardo version of the theory of CA, production technology for a product differs from one country4


to another, but the factor endowment remains the same. In the H-O version, technologies of production vary
between commodities in each country, but are the same for any particular product in both exporting and importing
countries.


III. FALLACIES IN THE PHILOSOPHY BEHIND
UNIVERSAL TRADE LIBERALIZATION


It should be mentioned from the outset that the focus of the argument in the rest of this study is on the


manufacturing sector, although occasionally reference is also made to services and agriculture.


As it is currently viewed, the philosophy behind trade liberalization suffers from some fallacies. The


current perception of trade liberalization involves two pillars: “universality” and “uniformity”. Universality


implies that free trade is to the benefit of all countries irrespective of their level of development, industrial


capacity, technological capabilities and other structural characteristics. Uniformity implies that for each


country all industries and products should be subject to the same level of tariffs – ideally zero tariff rates.


A. The foundation of theory of trade liberalization


The foundation of the theory of universal trade liberalization consists of two main and interrelated


elements: the static version of the doctrine of CA and the implicit premiss that markets always function well.2


According to the theory of CA, in a simplified two-country, two-commodity model, given tastes and


demand conditions, the pattern of specialization and comparative cost advantage are (in the Ricardo version)


influenced by the differences in labour productivity (the quality of the factor of production), or by


differences in factor endowment (the quantity of factors of production in the Heckscher-Ohlian [H-O]3


version). In other words, each country will specialize in the production and export of those commodities4


that intensively employ the factor of production which is, relatively speaking, the most abundant in the


country. Despite differences between the Ricardo and the H-O versions concerning the source of CA, in both


versions each country allocates its resources on the basis of the present structure of costs. In other words,


CA is market determined; and (free) trade improves efficiency of resource allocation in both countries; a shift


in the production possibility curve is neglected, i.e. long-run capacity-building is not considered. Some


followers of the classical theory do not neglect dynamic consideration, but they assume that those


considerations are reflected in current costs and prices. According to this theory, developing countries should


specialize in the production and export of those labour-intensive products and/or agricultural goods and other


primary products (if one considers natural products as another factor of production) which are their most


abundant factor of production.




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The trade liberalization hypothesis advocates that export promotion leads to productivity improvement,5


as mentioned earlier. It neglects, however, the role of the many different factors which contribute to productivity
improvement at both the micro and macro levels.


Meaning that they can increase their consumption with the same (or less) productive resources, or that they6


can consume the same amount of goods while using less productive resources.


One implication of the H-O version of the doctrine of comparative cost advantage is that, since firms


play no active role, CA is achieved at the level of the national economy. Hence, present market-determined


factor costs (wages, interest rates, and raw materials) are the only source of international competitiveness.


Since the exchange rate converts national prices into international prices, it is influential in attaining


international competitiveness. By contrast, neither productivity nor non-price factors play any role in5


international competitiveness. Another implication concerns the terms of trade, which are established by the


forces of reciprocal supply and demand for exports and imports, and are not influenced by power relations


in international trade.


The doctrine of CA suffers from two main deficiencies: its restrictive and unrealistic assumptions, and


its limited explanatory power.


B. Unrealistic assumptions


The theory of static CA is based on a number of unrealistic assumptions. As one of the proponents of


free trade has emphasized: “Theory does not say – as is often asserted by the ill-informed or wrongly taught


– that ‘free trade is best’. It says that, given certain assumptions [original italics] it is best” (Corden,


1974: 7–8). In fact, Paul Samuelson, one of the founders of the modern theory of international trade, goes


further to warn “against a possible misinterpretation of the classical theory [of international trade]”


(Samuelson, 1938: 266), which is the basis of the neoclassical theory. According to him, first of all the


theorem says that free trade, or some trade, is better than no trade (autarky) but does not necessarily imply


that free trade is the optimum for any country (op. cit.). In a two country model “under free trade both


parties are better off than under no trade at all, but are not necessarily in the optimum position … The free6


trade equilibrium point very obviously is not the most preferred point to any one country” (ibid.: 265). He


further emphasizes that “it is not possible to demonstrate rigorously that free trade is better (in some sense)


for a country than all other kinds of trade” (Samuelson, 1939: 195), and that “it is not necessarily true that


free trade is the best trading policy” (ibid.: 203).


Secondly, he clearly mentions that even these results are based on abstract assumptions: “… much


more important than the carrying through of the formal steps of the argument [in applying general equilibrium


theory to international trade] is the realization that the theorems are true consequences of the premises, and


do not rest on presumptions or probability. For in pointing out the consequence of a set of abstract


assumptions, one need not be committed unduly as to the relation between reality and these assumptions”




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(ibid.: 205). He refers explicitly to some of those assumptions which serve the foundation of the general


equilibrium theory and the modern theory of international trade:


(i) If the laws of return were appropriate for perfect competition (no external effects,


indivisibilities, monopolies, dynamic uncertainties, learning processes, etc.), free trade and ideal


transfers could be used to give maximal global production, in the sense of the farthest outward


production possibility frontier;


(ii) Free trade and ideal transfers could give a similar maximal world utility frontier for all


individuals;


(iii) Free trade will not necessarily maximize the real income or consumption and utility possibilities


of any one country – even though by ideal bribes the international winning countries could bribe


the losers into a unanimous vote for tree trade.


(iv) For a given country, autarky cannot be optimal if ideal transfers are possible. Some trade is


better than no trade in the sense of making the nation better off, with a farther out consumption-


possibility frontier and farther out utility-possibility frontier (Samuelson, 1962: 829).


The H-O theory, in a simplified two-factor, two-commodity, two-country model (let us assume that


one country is a developing country or group of developing countries, and the other is a developed country


or group of developed countries), contains the following assumptions:


(i) Perfect competition and constant return to scale;


(ii) Full employment of resources;


(iii) Countries are similar in all respects except for factor endowments;


(iv) The two commodities show different factor intensities and use different technologies, but each


product is produced with the same technique in both countries;


(v) The technological know-how is costless, and is freely available to both countries.


According to the first assumption, perfect competition prevails in both commodity and factor markets,


and markets are free and complete and function well. The market is complete in the sense that both present


and future markets exist for all goods and factors of production, the set prices of which are determined in


Walrasian general equilibrium. The assumption of perfect competition is in turn characterized by a set of


assumptions which are not all necessarily explicitly included in relevant writings on international trade. The


most important of these assumptions are directly, or indirectly, related to the size of the firms and include:


the atomistic nature of market – i.e. the small size of all firms involved in the market; constant return to scale,


which implies that as inputs increase by a certain proportion, output increases by the same proportion;


passivity of firms and absence of power in the market; free entry to and exit from the market; availability of


perfect information on supply and demand, and on prices for all products and factors of production;


homogeneity of goods and factors of production; lack of uncertainty and risk; given resources and


technology; and lack of intertemporal relations, i.e. independence of present costs and prices and future (or




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For more details on some of these assumptions see Haberler (1950) and Panic (1988).7


In the Ricardo version, labour is the only factor of production, while in the H-O version there are two factors8


of production: labour and capital.


past) costs and prices. Moreover, it is assumed that economic institutions and organizations are given and


are conducive to the operation of market forces.7


Assumption (ii) is clear; assumption (iii) would imply that all countries are similar in terms of level of


development, industrialization, technological capacity, taste, infrastructure, institutions, organizations, etc.;


assumption (iv) is implicit in assumption (iii); assumption (v) implies that no firm has monopoly over


technology and that patents do not exist.


In addition, the theory of CA is also based on the assumption of the perfect functioning of markets


elsewhere – i.e. not only in the country concerned but also in the importing countries – and on the absence


of political influence in the flow of international trade and international harmony of interests –


i.e. cosmopolitanism (Panic, 1988, chap. 7). Moreover, it is assumed that factors of production are8


homogenous and mobile within each country, but immobile between countries. Trade does not involve


transport costs and sales are not targeted at a particular market.


Most of the assumptions outlined above are unrealistic. We do not intend to review them in detail as the


literature on the issue is vast. Nevertheless, let us refer briefly to some of the most important ones which


have implications for our argument. These are perfect competition, constant return to scale, similarities of


countries, full employment and the absence of uncertainty and risk.


C. Perfect competition and constant return to scale


The assumption of perfect competition and well functioning of the market is not realistic, particularly


in the case of developing countries. First and foremost, the market for main manufactured goods is not


atomistic and the firms involved are not passive. In each industry, the international market is dominated by


a few large – in fact mega – global firms. The assets of the largest 100 TNCs amounted to $4.2 trillion in


1997; moreover, the top 25 of which accounted for about half of the assets of these firms, and the largest


five together owned a quarter of their total assets (table 1). To put the magnitude of activities of these


companies into perspective, the sales of some of them exceed the GDP of some middle-income developing


countries. For example, in 1997 the sales of General Motors exceeded the GDP of Norway and Thailand,


those of Ford Motors and Mitsui each exceeded the GDP of Saudi Arabia; while the sales of Sumitomo,


Exxon (before merging with Mobile), Toyota Motors and Wal Mart Stores each exceeded the GDP of


Colombia, Israel, Malaysia, the Philippines and Venezuela (UNDP, 1999, table 1.1). As shown in table 1, such


mega companies are present in all industries; they have developed over time through expansion or




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Table 1


Some indicators of the top 100 TNCs, 1997


Industry No.


Chemicals and pharmaceuticals 21a


Electronics/electrical equipment 18


Automotive 14


Petroleum refining/distribution and mining 13


Food and beverages 9b


Diversified 7


Telecommunications/utilities 4


Trading 3


Machinery and engineering 2


Metals -


Construction 3


Media 1


Others 5


Total (No.) 100


Total assets ($ billion) 4,212


Share of the largest 25 (%) 48.1


Share of the largest 10 (%) 32.6


Share of the largest 5 (%) 24.2


Source: Based on UNCTAD (1999a, tables 111–1, 111–3 and 111.5).
a Chemicals also include Montedison.
b Includes also British American Tobacco, Phillip Morris and McDonald.


mergers and acquisitions (M&A), which have become increasingly common in the last couple of years.


According to the Economist, the “1000 largest companies account for four-fifths of the world industrial


output” (International Herald Tribune, 20–30 January, 2000: 6).


The emergence and development of mega firms has an important economic reason with its significant


implications for the international trade of developing countries. The rationale for mergers is basically


economies of scale at the firm level. More recently, the production process in both industrial and services


sector is becoming more and more knowledge-based. Thus, R&D and technological progress have become




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more important. Moreover, the importance of brand names, and marketing and advertisement in the cost


structure has increased. All these activities, particularly R&D, involve significant economies of scale internal


to the firm; so does financing, as larger firms can borrow at lower interest rates. This should not imply that


economies of scale in production are no longer important. On the contrary, “Most high-tech companies have


both knowledge-based operations and bulk-processing operations” (Arthur, 1996: 103). What it means is that


the relative importance of know-how, R&D and marketing in the production and distribution process has


increased, as has the importance of internal economies of scale at the firm level. The mergers between such


companies as GM and SAB, Ford and Volvo, and Daimler and Chrysler may be seen in this light.


Contrary to the doctrine of CA, technology and know-how are neither costless nor do they move freely


from one country, or firm, to another; their development is costly and risky, and once developed they are


patented. Hence, those companies enjoying economies of scale in R&D are placed on the frontiers of


technology. These are large and established companies of developed countries which are neither passive nor


producers of homogenous products. Increasing return to scale provide them not only with market power and


cost advantage, but more importantly with the “power of creative destruction”.


Such power provides them with the ability to adapt constantly to new situations by developing new


technologies, new products and processes, placing them on a competitive edge in the international market.


In such a process, increasing return generate instability and constant “competitive disequilibrium” – and not


competitive equilibrium, as envisaged in the theory of perfect competition and doctrine of CA (Young, 1928).


It leads to dynamic competition and cumulative causation, in the process of which firms are active and


become the driving force in international trade.


To explain in more detail, the competitive advantage of firms is based on two elements: cost factors,


and other factors such as the ability to develop and design new products and processes, product differential,


time delivery, etc. Economies of scale at the plant and firm levels (per period of time) are one source of cost


advantage, but not the only one; hence, per se they may not necessarily provide cost advantage. Absolute cost


advantage may also result from patented production methods, entrepreneurship and favourable access to


cheap inputs. Economies of scope and learning-by-doing – that is, experience – are another source of cost


advantage. Learning-by-doing is a function of time and the amount of cumulative output (Scherer and Ross,


1990, chap. 10; Sawyer, 1991, chap. 4).


Product differential can provide a small- or medium-sized firm with a market niche, as does location


in a particular market. Similarly, when an industry – e.g. a semi-conductor industry – is subject to rapid


technological change, “the development of a completely new design often permits an initially handicapped


producer to jump to a new learning curve in a position of equality or even superiority” (Scherer and Ross,


1990).


Available evidence indicates that all the factors outlined above are important sources of cost and


competitive advantage, but the empirical results are not always conclusive about the relative importance of


each. Nevertheless, on the whole the established and large firms have by and large more advantage in relation


to young and small firms in developing countries. Apart from economies of scale, they are often better




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equipped, for example, to take advantage of product differential, and their scale of production contributes


to learning-by-doing over time through its contribution to accumulated output. Similarly, large established


companies are usually better placed to enjoy economies of scope. Consequently, they can create barriers to


the entry of new firms – thus increasing their risk of success. More recently, economies related to


globalization, particularly those resulting from networking and strategic alliance, have been providing another


source of cost and competitive advantage for established firms (for more details see UNCTAD, 2000).


One implication of increasing return to scale (internal to a firm) is thus to destroy the foundation of the


doctrine of CA and, therefore, nullify the recommendation to all countries to adopt free trade. The cost which


decreases with the scale of production is not the same as that determined by the abundance of resources.


The sources of the two costs are different. Moreover, every move made affects not only the structure of


current costs and prices, but also the structure of future costs and prices. Also, every decision by one firm


affects the position of other firms. Contrary to CA doctrine, there is intertemporal interdependence of


decision and interdependence of action between firms. In this sense, past or present decisions made by


businesses in developed countries will affect the current or future competitive position of those in developing


countries. Any established firm which enjoys increasing return creates additional markets for the products


of other firms, thereby contributing to a reduction in their cost through created externalities.


In this sense, trade is important in providing markets, as well as greater specialization and division of


labour; but it is the result of a dynamic process of disequilibria – not a tendency towards a “competitive


equilibrium” (for details see Streeten, 1990). In the language of Porter (1990), it is the result of the


“competitive advantage” of firms.


If this is the case, those developed countries which first started the process of industrialization have


gained from the increasing return, division of labour and experience, and developed “competitive advantage”,


particularly in certain lines of production-manufactured goods. Further, through their know-how and


technology they can now reap the fruit of “competitive advantage”. This analysis is not purely theoretical.


As will be explained below, in fact empirical evidence also shows that the explanatory power of the CA


doctrine is limited.


D. Full employment and similarities between countries


The theory of CA assumes that resources are fixed and fully employed and that all countries are similar,


i.e. are at the same stage of development, industrialization and technological development. Therefore, when


a country enters into international trade, resources will be reallocated in such a way that the increase in


production of one product (e.g. exports) will be at the cost of reduction in production of another product


(e.g. production for the domestic market); in practice, this is not the case. Developing countries, particularly


those at an early stage of development, have a reserve army of labour which cannot be absorbed productively


by the agricultural and/or mining sector. The lower the level of development, the higher this reserve – called


“unproductive labour” by Adam Smith. This labour reserve provides the country with surplus (productive)




- 12 -


For details of the discussion see Ethier (1982).9


capacity – “surplus over domestic requirement”. In the nineteenth century, some surplus labour was


transferred from subsistence agriculture to plantations and mining for exports, thus increasing the economy’s


overall productivity. So exports increased without a reduction in domestic consumption, and provided


resources for imports of additional goods which would not have been otherwise available to the country. In


other words, the expansion of exports was not the result of reallocation of resources, but was due to the


allocation of surplus resources (labour and land) to additional output in the newly established plantations


and/or newly discovered mines (Myint, 1958).


Nevertheless, this development involved serious limitations in absorbing fully the reserve of surplus


labour. As a large number of countries have gone through the same process, the possibility of allocation of


surplus productive capacity to mining and plantations has become limited as a result of limitations in the


expansion of external demand and/or limited land and mine reserves (Myint, 1958). Hence, the development


of other activities, including manufacturing industries, is required to absorb the productive capacity of surplus


labour. This argument applies so long as the economy is not fully employed (ibid.). However, the static


version of the doctrine of CA does not explain how an economy which has specialized in primary


commodities might develop productive capacity in manufactured goods.


As far as employment is concerned, a related issue concerns countries which have developed some of


their industries behind protective walls. In such cases, even the classical economists, who had advocated free


trade in principal, recommended slow and gradual liberalization, as explained in section IV.


E. Explanatory power of the theory


The doctrine of CA explains the pattern of trade between developed countries, specialized in the


production and exports of manufactured goods, and developing countries, specialized in the production and


exports of primary commodities. It does not explain, however, the bulk of international trade, i.e. trade


among industrialized countries which engage in trade in similar goods, manufactured products, and inter-


industry trade. More importantly, it does not explain how countries such as France, Germany, Japan, the


United States, and more recently the Republic of Korea and other NICs have transformed from primary


producers to manufacturing exporters, capable of competition in the international market. The process of


transition from one stage to another cannot be explained by the static nature of the theory.


Trade among developed countries is explained by increasing return to scale and/or product differentials.


In theory, a distinction is made between two types of scale economies: those internal to the firm and those


external it. Nevertheless, the literature is not always clear with respect to the interrelation between increasing9


return and international trade, as the concept of increasing return is a complex one. Scale economies can be


static or dynamic, they can be internal or external to an operational unit, and could be at various levels. They


can be product-specific, plant-specific, firm-specific or industry-specific (Scherer and Ross, 1990: 97). One




- 13 -


For more details on scale economies see Scherer and Ross (1990, chap. 4); Davis (1990: 137–138), Sawyer10


(1991, chap. 4) and Young (1928).


could think of scale economies at the level of the manufacturing sector as a whole. One may also distinguish


national economies from international ones at the level of industry. The sources of scale economies are also


diverse; they may be not only at the production level, but also in marketing and distribution, management and


control and R&D.


Let us first consider the sources of static scale economies. The source of product-specific economies


is indivisibilities. Plant-specific economies have their sources in: cost savings related to “bulk transaction”


for the purchase of inputs and sale of outputs; production engineering relationship; economies in keeping


inventories and parts; economies of management and overhead. Firm-specific static scale economies may


originate from financing, marketing and advertisement, R&D and management. Economies of scale at the


plant and firm levels may also be accompanied by “economies of scope” – resulting from the production and


sale of different products. The production of one line of products generates economies in the production of


other lines.


Learning-by-doing and experience is an example of dynamic economies which depend on cumulative


output, which is, in turn, a function of time, the size of the operational unit and the rate of growth of


production. Such economies can be internal and/or external to an operational unit. Linkages among industries


are examples of dynamic scale economies external to an industry.10


Division of labour is another source of scale economies. But the division of labour itself is influenced


by the extent – the size – of a market. The division of labour may take place within a plant or firm (as in


Adam Smith’s example of the pin factory, in which each worker specializes in a certain task), or within an


industry or industries. At the industry level, the economies of scale are national “if the average cost depends


on the size of the national industry. They are international if the average cost depends on the worldwide size


of the industry” (Ethier, 1988: 51).


What is considered in the literature as a base for trade is economies of scale external to a firm. In this


case, average costs of a firm decline with the size of the whole industry, so economies are external to the


firm; in the case of internal economies, average costs decrease with the size of the firm. As far as their


implications for international trade are concerned, these economies differ in an important respect. Internal


economies are inconsistent with perfect competition, thus with the doctrine of CA. By contrast, external


economies (to the firm) of scale may be consistent with perfect competition. As already mentioned, a firm’s


costs could decline because of an increase in the size of the industry, not in the size of the firm. Individual


firms are therefore still characterized by constant return to scale. A firm may be small, with no power on the


market. It is argued that when scale economies (external to the firm) are national, they could by themselves


be a base for trade. But in this case the pattern of trade would be indeterminate; free trade may be harmful


to an individual country, and complete specialization may take place. In these circumstances, it is argued, the


division of labour between developed and developing countries in the production of manufactured goods and




- 14 -


primary commodities is a historical accident which cannot be explained by the CA doctrine. Those countries


or firms which were established earlier on have an advantage over newcomers.


Even if one assumes the existence of perfect competition, it should be mentioned that the argument on


international external economies has been developed on the basis of Adam Smith’s often neglected


“productive theory of international trade” (Myint, 1958). There is interaction between the division of labour


and the extent of the market over time – thus the theory is a dynamic one. As the market expands, the


division of labour is facilitated, and reaping the economies of scale, at the industry level, is permitted. Thus


trade is a dynamic force. By expanding the extent of the market and furthering the division of labour, trade


contributes to increasing skills and innovation, and allows a country’s enterprises (which may be small) to


benefit more from increasing return, at the industry level.


In practice, international trade is dominated by large international companies, which enjoy substantial


internal scale economies. Two points should be emphasized here. First, large firms are not passive, and their


action affects the price, as well as the non-price attributes, of their products. As they produce more, they


can reduce the market price. Moreover, their large size allows them to compete better on product differential


and quality, and to create barriers to the entry of new enterprises and other countries. A bigger market in


developed countries and their experience over time have allowed such firms to achieve internal static and


dynamic economies. International trade allows even further realization of such economies.


While internal economies of scale facilitate international competition by established developed country


firms, it creates barriers to developing countries. In theory, a larger international market – thus trade – should


help them to reap internal economies. Nevertheless, as will be explained below, they face a dilemma because


in order to enter the international market in the first place they need to become competitive. In fact, it is


sometimes argued that to enter the international market developing countries should first protect their


industries, so as to reap a scale of production large enough to enable them to compete in that market. In other


words, the protection of industries characterized by increasing return is a prerequisite to entering the world


market (Krugman, 1984).


Moreover, the distinction between internal and external economies of scale is not clear. A large firm


may enjoy simultaneously both internal and external economies of scale. Consequently, there is interaction


between internal and external economies. According to Young (1928), there are two interrelated aspects of


division of labour: one caused by “roundabout” methods of production owing to the division of a task into


small “occupations” [within a firm], the other being the division of labour among industries (external to a


firm). But they interact. A firm “drives its external economies from such qualitative changes as appearance


of new products, new industries …”. This perception of business – shared also by Schumpeter – would


imply that a firm is never in equilibrium, and competition takes place not only on price but also on non-price


factors (ibid.: 528). The realization of “increasing return” is progressive and takes time. In this sense, the


extent of the market is an important element of economic progress over time, as is international trade.


Hence, in both cases, whether firms are small or not, international trade is important in economic


development; thus greater openness to trade should be the ultimate aim of all countries. Nevertheless, it is




- 15 -


not necessarily the immediate aim of countries at early stages of industrialization, as advocated by the doctrine


of CA. With the presence of increasing return – whether internal, external, or a combination of both – the


foundation of CA doctrine is shaken. There is a dilemma for a developing country at early stage of


industrialization, intending to benefit from the advantages of the extent of the market through international


trade. While entry into the international market improves productivity and competitiveness, by learning, etc.,


to enter the market one has to be competitive. Learning takes time, and the process of learning is specific to


each industry and activity. Skills are not homogeneous, and they have to be developed in each particular


industry; one cannot jump from one plateau to another without going through the learning process. Neither


CA doctrine nor the theory of division of labour, as introduced by Adam Smith, provides the answer.


Some economists (like J.S. Mill, F. List and Hamilton, inter alia) have shown how this transition can


take place through “infant industry” development. The fallacies surrounding such views, however, are not


less numerous than those surrounding the “philosophy” behind universal trade liberalization, as explained


below.


At this stage, it should be stressed again that the presence of large firms and internal economies of scale


create barriers to entry into international markets. The recent process of globalization, mergers, increases in


the importance of economies of scale, and changes in technology, have made entry of new- comer


developing country firms into the world market more difficult. As international competition has intensified


and the process of learning become more complicated, the need for support of infant industries has


increased. Yet, at the same time, the possibilities for such support have become limited by changes in


international trade rules.


F. Alternative views on comparative advantage


Some economists argue that, beyond the scope of agriculture and minerals, CA is arbitrary;


“comparative advantage is made, not given” (Cline, 1983: 155; Amsden, 1989). In other words, when one


is concerned with dynamic CA in manufacturing, “… for a broad range of manufactures the country’s


allocation of comparative advantage may be relatively arbitrary” (Cline, 1983: 156). A country can develop


CA in an industry of its choice. Accordingly, for the development of CA the need for government intervention


is implicit. In particular, rapid development, beyond what is feasible through the market forces, cannot take


place automatically. According to Marshal (1920: 6), “nature does not willingly make a jump: Natura abhorret


saltum”and “Natura non facit saltum” – i.e. economic evolution is gradual and continuous on each of its


innumerable routes. “Economics is concerned mainly with general conditions and tendencies, and these as


a rule change but slowly, and by small steps” (ibid.: 5). The market mechanism can deal with gradual and


marginal changes, but it is unable in itself to accelerate development. It should be mentioned that the concept


of market inadequacy is different from market failure. Even if there were no market failure, in its standard


sense, the market would still be inadequate to accelerate development (Arndt, 1984). It is true that


development of the market and market institutions may help its smooth operation, thus facilitating to some




- 16 -


List’s ideas were not all original, as he was strongly influenced by Hamilton. Nevertheless, he formulated11


those ideas and developed them into a theory. For more details, see Shafaeddin (2000).


extent the growth process. Nevertheless, beyond a point allowed by the market, acceleration of development


and industrialization requires government intervention. The question then is not whether government


intervention is required or not, but to what extent it should intervene, in what form and how the efficiency


of government intervention could be improved to minimize “government failure”. Examination of these issues


requires another study. Nevertheless, one important point should be mentioned here. Government intervention


is required to assist infant industries in new-comer countries to compete with established firms – often large


– in the international market. The problem is that the theory of infant industry protection is also surrounded


by fallacies and confusions.


IV. FALLACIES SURROUNDING THE THEORY
OF INFANT INDUSTRY PROTECTION


The theory of infant industry protection as presented by its founders is often misinterpreted or


malpresented. The literature is therefore heavily loaded with fallacies and confusions. For example, the


critiques of the theory often regard the founders of infant industry protection as being opposed to free trade


or even against international trade; perceive infant industry protection as being synonymous with import


substitution; attribute the failure of import substitution policies, as practised by most developing countries,


to deficiencies in the theory of infant industry protection; conceive “import substitution” as a permanent


feature, or strategy versus export orientation strategy (e.g. Little et al., 1970; Krueger, 1978); envisage the


application of infant industry protection across-the-board to the manufacturing sector as a whole, rather than


on selective basis (Corden, 1974); and, finally, restrict the infant industry argument to the production stage


– in fact, to production for the domestic market. As a result, not only do many scholars but also many policy


makers in both developed and developing countries tend to believe that, as infant industry protection has


failed, universal and across-the-board trade liberalization is the answer. The pendulum has shifted to the other


extreme.


A. Infant industry protection versus import substitution (Frederick List)


Frederick List is the founder of the theory of infant industry protection, and Raul Prebisch the founder11


of the theory of import substitution. Let us look briefly at what they actually said. To begin with, List was


not by any means against international trade or in favour of autarky. He believed that international trade had


an important role in economic development:


International trade by rousing activity and energy, by the new wants it creates, by the propagation
among nations of new ideas and discoveries, and by the diffusion of power, is one of the mightiest




- 17 -


instruments of civilization, and one of the most powerful agencies in promoting national prosperity (List,
1856: 70–71).


Nevertheless, he stressed that trade is only an instrument of development. It is not an end. Moreover,


he regarded “universal association” and free trade as the ultimate aim of every nation when all countries will


have achieved the same level of development. While nations are in different stages of development, infant


industry protection should be used as an instrument of industrialization by those who are still in the early


stage of development. Over time, development would ultimately lead to universal association, allowing free


trade. He argued that free trade is suitable to the advanced countries which have already established their


industrial base. But for non-industrialized countries, industrialization would only be possible through free trade


if all countries were at the same level of industrialization – an assumption made by the proponents of


universal free trade.


In advocating infant industry protection for Germany, List stressed that “if the author had been an


Englishman, he would probably never have entertained doubts of the fundamental principle of Adam Smith’s


theory. It was the conditions of his own country [Germany] which begot in him the first doubts of the


infallibility of that theory …” (List, 1856: 69–70).


Secondly, in this respect, List did not consider infant industry protection to be a means of import


substitution per se. Infant industry protection would ultimately aim at massive exports of manufactured


goods. According to him, there would be four phases in the development of international trade and


industrialization: (i) the expansion of imports of manufactured good; (ii) the starting up of domestic


production with the help of protection; (iii) satisfaction of the domestic market; and (iv) finally the massive


expansion of their exports. To expand on List, the infant industry argument does not apply only to the


production stage; nor is it confined to production for the home market alone. Production for exports also has


to go through an infancy period, which is, in fact, longer than the infancy period for production for the


domestic market. This is because manufactures for export involve a chain of infancy in: production,


marketing and distribution, development of brand names and reputation, technological adaptation and


development, etc.


Thirdly, List did not consider protection as a permanent feature. In fact, he argued for the introduction


of competition and free trade after the attainment of a certain stage of development. He advocated that


protection should be temporary. After a while, pressure on protected firms should first be introduced through


domestic competition in exchange for incentives provided. “Having reached the highest degree of skill, wealth


and power by a gradual return [our italics] to the principle of free trade and free competition in their own


and foreign markers, they keep their agriculture from inaction, their manufactures and their merchants from


indolence, and stimulate them to wholesome activity, that they maintain the supremacy which they have


acquired” (List, 1856: 188). Nevertheless, as List argued against premature and excessive protection, he also


emphasized – using the example of the United States, which at a certain point attempted trade liberalization


too early, therefore causing damage to its infant industries – that liberalization should not be premature and


sudden, as that would ruin infant industries.




- 18 -


Ricardo made a similar argument (ibid.).12


See UN (1950); for a short description of the evolution of Prebisch’s thinking on trade and industrialization13


policy see Singer (1986), Dell (1986), and Prebisch (1984).


It should also be mentioned that even Adam Smith and Ricardo warned against sudden trade


liberalization. “Adam Smith recognized, for instance, the possibility that a country may develop behind high


protective walls ‘particular manufactures’ on such a scale that they ‘employ a great multitude of hands’ …”.


In such a case, Smith argues:


Humanity may in this case require that freedom of trade should be restored only by slow gradations, and
with a good deal of reserve and circumspection. The reason for this is that if “those high duties and
prohibitions [were] taken away, all at once, cheaper foreign goods of the same kind might be poured so
fast into the home market, as to deprive all at once many thousands of our people of their employment
and means of subsistence” (Panic, 1988: 123–124) .12


Fourthly, List did not advocate protection of all branches of industry as was sometimes attributed to


him (Corden, 1974). On the contrary, he argued for selectivity in each point in time. In fact, he also outlined


the criteria for choosing industries which included, inter alia, contribution to knowledge and experience and


provision of linkages (Shafaeddin, 2000).


Finally, List does not regard trade policy as a panacea; by contrast, he regards the theory of commercial


policy as an element of a comprehensive package which includes a host of other socio-economic policies:


industrial, financial and educational, as well as a large number of complementary factors such as


infrastructure, institutions, science and technology, inventions, entrepreneurial development, etc. But policies,


including trade policies, should be country-specific, as there are no universal rules which can be applied to


all countries (ibid.).


B. Import substitution versus export expansion? (Raul Prebisch)


The views of Raul Prebisch are also often misinterpreted. It is true that at a particular point in time he


advocated import substitution, but this was a specific strategy for a specific period. His proposal was by no


means intended to be at the cost of export expansion; in fact, it was regarded as a means to it. In practice,


however, his views were badly implemented – or were not implemented at all, as will be explained shortly.


Let us first discuss what he advocated.


Raul Prebisch composed his theory of import substitution in the early 1950s. Emphasizing the need13


for industrialization, he believed that import substitution, even though costly, was inevitable at the time


because of the lack of an industrial infrastructure and of unfavourable external market conditions for exports


of manufactured goods (Prebisch, 1984). At that time, such terms as inward-looking industrialization, import


substitution and infant industry protection were used interchangeably. Nevertheless, he never said export


expansion was unnecessary; he said it was difficult.




- 19 -


This was the case when the easy stage of import substitution of light consumer goods reached its limit and14


continuation of such policy would require substitution for imports of intermediate and capital goods. See Dell (1986).


Prebisch argued in favour of export subsidy and provision of preferences (GSP) for imports of developing15


countries to the industrial countries, as selective measures, as against devaluation as a means of providing uniform
incentives to various products (Prebisch, 1959: 256–257; UN, 1964: 74–75).


Moreover, Prebisch soon made it clear that import substitution should be a step towards export


expansion, and not a permanent feature of industrial strategy. In the late 1950s, Prebisch began to refer to


the limitations of import substitution, the costs of excessive and across-the-board protection, its adverse


impact on exports, and the absolute necessity of building up trade in industrial exports (Prebisch, 1959: 259,


265, 268). Subsequently, in his report to UNCTAD I in 1964, Prebisch developed his views on the defects


of “inward-looking industrialization”, as practised and experienced by developing countries. These included,14


he explained: frequent and considerable waste of capital; the adverse effects on exports of manufactured


goods owing to high costs of production and a slow rise in productivity related to the smallness of national


markets; the lack of a programme to develop industries on a selective basis; the reduced capacity and


flexibility to deal with periodic shortfalls in export earnings; and, finally, the detrimental effects on the quality


of output and production costs caused by the insulation of the national market due to excessive protection


(UN, 1964: 20–23). Accordingly, he added:


The development of industrial exports, in addition to counteracting the potential trade gap, will make it
possible gradually to increase the advantage of industrialization by correcting its defects. This applies
not only to the developing countries which have already started this process …, but also to others [our
italics], especially those which have emerged with the colonial system (ibid.: 22).


At this stage in Prebisch thinking, industrialization was not confined to import substitution, and infant


industry protection was not limited to production for the domestic market. It could also apply to export


activities, through selective subsidization of exports in order to face cost differential with the “centre”


(Prebisch, 1984: 181).15


Finally, in the early 1970s, Prebisch argued for “a gradual reduction in the protection afforded to


industry in order to introduce the stimulus of competition” (Dell, 1986: 13). In the mid-1980s, while Prebisch


emphasized the importance of indigenous technology and domestic food production through import


substitution, he also referred to the need for a mixture of export promotion and import substitution to increase


the domestic value added in export activities (see Singer, 1986, for details).


Dell emphasizes correctly that the founder of the theory of import substitution was 20 years ahead of


his critics; “he had been fully aware of the pitfalls [of import substitution] before these studies [by his critics]


appeared” (Dell, 1986: 10). The important difference between Prebisch and the neoliberals, however, is that


the latter misinterpreted Prebisch’s theory and often regarded outward orientation, or export promotion, as


synonymous with “trade liberalization”.




- 20 -


C. Implementation problems


Another fallacy is the attribution of the failure of an import substitution strategy in many developing


countries to the theory of infant industry protection. The reality is that, with the exception of East Asian


economies, hardly any other developing countries have followed infant industry protection, as proposed by


its founders. Moreover, many developing countries, in fact, did not undertake “import substitution” as an


element of infant industrial policy. On the contrary, in many of them some sort of across-the-board import


substitution took place in reaction to import restrictions imposed as a result of various balance-of-payment


crises. For example, in Latin America, the Middle East, North Africa and independent Asian economies,


severe import restrictions were imposed on imports during the Great Depression of the 1930s, which


continued during the Second World War. During the post-war period also the majority of developing


countries faced boom and bust cycles in their economies caused by changes in world demand and prices for


primary commodities, which were their main export products. Each bust was accompanied by tightening of


import control. Similarly, the oil price rise of the 1970s contributed to such import restrictions for balance-of-


payment purposes rather than as a means of industrial policy. If any criticism is to be made of developing


countries, it is that the majority of them did not have an industrial strategy, or did not have a clear one.


Today, they still suffer from the same problem, as across-the-board trade liberalization cannot be a substitute


for a trade and industrial policy.


As mentioned earlier, infant industry should be an element of a dynamic industrial strategy, which at


each point in time should aim at selective support of certain industries, while reducing or eliminating support


for others (for more details see Shafaeddin, 1995).


V. CONTRADICTIONS IN THE GATT/WTO RULES


Let us assume for a moment that there is a theoretical justification for universal trade liberalization and


the theory of static CA is accepted as the philosophy behind such liberalization. The theory would indicate


that developing countries should specialize, inter alia, in production and exports of primary commodities and


labour-intensive goods for which they have abundant production factors. The GATT/WTO rules suffer from


contradictions in their design and in their implementation by industrial countries, as far as trade liberalization


is concerned.


A. Contradictions in design


While the objective of GATT/WTO is trade liberalization, the related rules suffer from a number of


contradictions. These include, for example, issues related to trade in agriculture, main labour-intensive


products of export interest to developing countries, and coverage of the infant industry clause.




- 21 -


Introduction to the text of the General Agreement on Tariffs and Trade (GATT) in 1949.16


For a short history of regulations on trade in agriculture see McGovern (1986, chaps. 14 and 15).17


For details see McGovern (1986).18


1. Agriculture


International trade should be free, but not for agricultural goods. This was the message of the


introduction to the original article of the GATT: “… [by] entering into reciprocal and mutually advantageous


arrangements directed to the substantial reduction of tariffs and other barriers to trade and to elimination


of discriminatory treatment in international commerce [our italic] … have … agreed …”. In other words,16


international trade should not be the subject of discriminatory treatment. Nevertheless, agricultural goods,


which were of interest to many developing countries, were not covered by the Agreement.17


Furthermore, in 1955 the Contracting Parties granted the United States a waiver in respect of its


obligations under articles II and XI, when these were in conflict with its Agricultural Adjustment Act of 1933,


which provided for the imposition of import fees and quotas (McGovern, 1986: 453–454). Regulation of the


agricultural sector was raised at the Tokyo Round, but was strongly opposed by the European Community,


which refused that its Common Agricultural Policy (CAP) be called into question.


Occasionally (as in 1978 and 1980) issues related to various processed agricultural products have been


the subject of dispute in GATT panels. FAO attempted to regulate disposal of surplus agricultural products


in order to prevent harmful interference with normal patterns of production or international trade, or with


prices caused by sales of government-held stocks in exceptional volume or at exceptional pace. For this


purpose, FAO developed the concept of the Usual Marketing Requirement (UMR). Otherwise, trade in18


agricultural products has escaped international regulations – except for a number of commodities which have


every now and then been subject to international commodity agreements – which have mostly been


ineffective (McGovern, 1986, chap. 15). Nevertheless, both the United States and EEC/EU (European


Economic Commission/European Union) have heavily intervened in production and trade in agricultural


products through their support and stabilization programmes. For example, in the United States, there were


programmes on wheat, maize, cotton, soya beans, rice, wool, barley, oats, sugar and a number of other


products. Similarly, the EEC/EU has intervened in the production and trade of agricultural goods through


CAP, mainly in the form of price support and subsidies. The legal base of such intervention is the EEC


Treaty, which provides for an individual policy stance for nearly all agricultural products. Once again, while


particular aspects of CAP have now and again been examined by GATT, by and large it has escaped


international regulations (op. cit.). Heavy subsidies paid to the farmers through CAPs in Europe and the


United States and tariff and quantitative restrictions applied to agricultural goods by many developed countries


during the post-war period have continued. Governments in most industrial countries have protected


agriculture through tariffs, quantitative restrictions, prices and direct income support of the producers and


input subsidy.




- 22 -


Based on WTO (1998, tables 44 and 45).19


According to OECD estimates, consumption expenditures on domestically produced [agricultural]
commodities was 34 per cent higher than at world market prices. Total support to OECD agriculture from
consumers and taxpayers (TSE) was estimated at US$ 362 billion in 1998 (Cahill, 1999: 31).


Note that this amount is, on the basis of UNCTAD data, about five times higher than the total exports,


including petroleum, of sub-Saharan Africa, 3.7 times that of exports of the African continent, over 14 times


higher than exports of least developed countries, and nearly a quarter of all exports of developing countries


as a whole in 1996.


The URA aimed at some reduction in subsidies on agricultural goods over time, but agricultural trade


liberalization is still one of the stumbling blocks in the proposed new round.


2. Textiles, clothing and footwear


According to GATT rules, international trade in manufactured good should be subject to reductions in


tariffs and other barriers, but not for the main labour-intensive products of export interest to developing


countries. Moreover, according to GATT rules, tariffs are preferred to quantitative measures, but not for the


same articles. Textiles and clothing fall into an important labour-intensive product category, which accounted


in 1997 for about 60 per cent of total exports of manufactured goods from developing countries.19


Nevertheless, while the GATT rules were supposed to govern manufactured goods, textiles and clothing were


excluded, contrary to the spirit of GATT in trade liberalization. These products were subject to import


barriers through Multi-fibre Arrangements (MFAs). Under MFAs, which came into operation in 1974,


restrictive quotas were imposed by developed countries on imports of such products from the main


developing countries.


Under URA, textiles and clothing became subject to the Agreement on Textiles and Clothing (ATC).


Nevertheless, once again there was a contradiction. While developing countries, with the exception of the


least developed ones, were supposed to implement rapidly most URA provisions, the MFA was to be phased


out gradually in different steps within 10 years, i.e. by 2005. Moreover, integration of clothing, which


involves higher value added and which is subject to higher protection (tariff peaks), has been left to the final


stage of the phasing-out period. Above all, even when MFA is phased out, the tariffs on textiles and clothing


in some industrialized countries, such as EU members, will remain higher than those for other commodities


(IDS, 1999: 4).


In addition to textiles and clothing, imports of a number of other products of export interest to


developing countries have been subject to quantitative restrictions in industrialized countries; these include,


among others, footwear and jute (Das, 1999).




- 23 -


If, however, subsidy is provided to an enterprise without being made legally contingent upon export20


performance, it would not be prohibited: “The mere fact that a subsidy is granted to enterprises which export shall
not for that reason alone be considered to be an export subsidy …” (ASCM, para. 3.1.a, footnote 4).


3. Infant industry protection


Another contradiction under URA is allowing, in a certain sense, infant industry protection for the


development of specific industries of main interest to developed countries, but not those of essential interest


to developing countries. This is a step backwards as far as the latter are concerned. To explain, article XVIII


of GATT allows, under certain conditions, the use of protective measures for the “protection of particular


industries” in the case of countries in early stages of development. In other words, not only was infant


industry protection allowed, but the principle of “selectivity” was also accepted. Thus, developing countries


could eventually apply a dynamic trade policy for the development of their industrial base by selecting specific


industries for protection and others for liberalization at each point in time.


Under URA, developing countries are, in effect, denied such privileges. Subsidies provided for R&D


on specific activities is allowed, but those provided for the expansion of exports and export supply capabilities


are not (Agreement on Subsidy and Countervailing Measures [ASCM], articles 3 and 8).


To explain the contents of these articles: article 3 prohibits subsidies to be paid to firms (except for


agricultural products) “upon export performance” and “upon the use of domestic over imported goods”


(inputs). Definition of subsidies for export performance includes “direct subsidy”, currency retention,


preferential internal transport and freight charges on export shipment, as against domestic shipment and


preferential provision of “imported or domestic products or services for use in the production of exported


goods” (ASCM, annex I).20


As far as article 3 is concerned, there is a contradiction on the definition of specificity contained in


article 2. According to paragraph 2.1.a, a subsidy is prohibited if it is “specific”: a subsidy is specific when


the authorities limit it to specific enterprises or industries; otherwise, it would not be specific. By contrast,


according to para. 2.3, all subsidies falling under the provisions of article 3 are regarded as specific. In other


words, even if all industries were provided with subsidies tied to export performance or which favour


domestically produced goods, the subsidy would be regarded as specific. The implication of this article is


that a country cannot support its infant industries, whether or not for exports, either across-the-board or on


a selective basis, when the subsidy is tied to export performance – a practice common until very recently,


particularly in East Asian countries.


Para. 8.2.a provides exceptions to the specificity clause, even if assistance is given to specific


enterprises or industries. It covers research activities undertaken by firms and/or research and educational


establishments, up to 75 per cent of costs of industrial research, or 50 per cent of the costs of pre-


competitive development activity. Para. 8.2.b allows for “non-specific” assistance to a country’s


disadvantaged regions, provided that clear and objective criteria is used in the definition of such regions. The


criteria should be based on development indicators, which should at least cover a measure of income or




- 24 -


employment. Accordingly, the income per capita of the region should be at least 85 per cent of the average


for the country. The unemployment rate should be at least 110 per cent of the country average. In this case,


even though the subsidies are non-specific, export activities located in the region could benefit from them.


Hence, there is room for manoeuvring. Currently, there is discussion on granting subsidies to British Rover


for regional equality.


Para. 8.2.c allows assistance for the adaptation of existing facilities to new environmental requirements


of up to 20 per cent of the related cost on a one-time basis, provided it is available to all firms concerned.


There are certain general conditions attached to article 8 concerning prior notice to WTO, provision of


information, etc.


R&D activities are concentrated in developed countries for the development of new technologies, new


products and new processes – a development which is, in a sense, an “infant” activity involving risks and


requiring provision of extra incentive to those firms engaging in it. In developing countries, by contrast,


“application” rather than “development” of a new technology or a new process is important in the elaboration


of supply capabilities and export expansion. The transfer and efficient application of technology for the


expansion of export capacity takes time and involves costs and risks, as does development of marketing,


brand names, etc., before an industry can mature and export products become internationally competitive.


During this period, infant industry protection is often required. Incidentally, in the agricultural sector,


subsidies used by developed countries (as in R&D, crop insurance, and so on) are allowed, but those most


used by developing countries (e.g. input and land improvement subsidies) are subject to countermeasures


(Das, 1999: 157).


B. Contradictions in implementation of commitments


The main advantage of trade liberalization under WTO for developing countries is providing them not


only with market access but also with “security of market access” by subjecting the trading partners to


established and agreed procedures. While access to markets could contribute to export expansion, and thus


exports proceeds, the security of market access could reduce uncertainty and risks involved in exportation


to developed countries, thereby preventing arbitrary decisions by member countries. The reduction in risk,


in turn, would contribute positively to the process of decision-making and planning for investment in


production and export capacity.


The experience of recent years, however, indicates that there are contradictions between the way


commitments to URAs are fulfilled in developed countries. Such contradictions have been particularly


noticeable in the areas of ATC, anti-dumping clauses and safeguard mechanisms – all contributing to


increased uncertainty, and therefore risks, of market access for main exports of interest to developing


countries.




- 25 -


1. Agreement on Textiles and Clothing


The contradictions in the implementation of URA are best explained in the words of the Secretary-


General of UNCTAD in a letter to the Financial Times (11 December 1999) concerning textiles and clothing:


What does it mean to have a market-driven, multilateral trading system if it is not to allow those
countries that have a comparative advantage in certain sectors to exploit those strengths to the hilt
[italics added]? Over half a century after the birth of the GATT, a few industrial countries continue to
drag their feet on liberalizing their textiles industries, claiming they need still more time to adjust.
Meanwhile, they insist that weak developing countries swallow the bitter medicine of adjustment to
agreement on issues such as TRIPS as quickly as possible – preferably in under five years …


According to the text of ATC, MFA is supposed to be completely eliminated by 2005, and trade in


textiles and clothing integrated into WTO rules. The phasing-out, however, is intended to take place in four


stages; 1995, 1998, 2002 and 2004. So far, the implementation of the commitments by developed countries


has been slow. By integrating unimportant items into WTO rules first while postponing items which are


important for developing countries, the implementation of ATC has been slowed down. For example, in the


case of both the United States and the European Union (EU):


The way in which integration targets have been met runs contrary to the spirit if not the letter of the
ATC. Included in the integration schedules of the EA [EC] and the USA are a large number of non-textile
and non-clothing products that happened to contain textile components, such as umbrellas, car seat
belts and parachutes. Such items accounted for a full 58% of the EA’s first-stage integration schedule,
but were less evident in second stage (IDS, 1999, Briefing No. 4: 2).


According to the same source, in the cases of both the United States and EU about two thirds of their


ATC imports remain to be integrated into WTO rules – which might not happen until 2005.


To explain in more detail, according to paragraphs 6 and 8 of article 2 of ATC, at least 16 per cent of


textile products were to be integrated in January 1995, 17 per cent in January 1998, 18 per cent in January


2002, and 49 per cent by the end of 2004. According to the integration programmes so far developed for


stages 1 and 2 (1995–2002), the products selected were concentrated in less-value-added items, with only


a small share being allocated to clothing. For example, the percentage share of clothing was 3.9 out of 33.24


(a percentage of 1990 imports of textiles and clothing, which is supposed to be integrated into WTO rules


by the end of stage 2, i.e. end of 1992) for the United States, and 2.53 out of 33.31 for EU. Moreover, the


contribution of integrated items to the value of imports of textiles and clothing items has been small. The


annual share of freed items in the value of imports during the period 1995–1997 was around 6 per cent for


the United States and 4 per cent for EU (ITCB, 2000a: 6–9).


Paragraphs 13 and 14 of article 2 of ATC also provide “for additional increase in quotas access”.


Restraining countries were required to “increase existing growth rates of quota” by at least 16 per cent during


stage 1, another 25 per cent during stage 2, and a further 27 per cent during stage 3. For the period


1995–2001 the total increase in access by EU has been only 4.49 per cent, by the United States 6.36 per cent,


and by Canada 7.53 per cent (ibid., table 6).




- 26 -


There are also a number of other areas where the implementation of ATC has fallen short of


commitments (ibid.). Furthermore, a recently proposed plan for EU’s integration programme for stage 3 of


ATC would indicate that by the end of the phase-out period, i.e. end 2004:


(i) although 51 per cent of trade will have been integrated, a large bulk of it comprises products


which are not under quota restriction;


(ii) only 52 out of 219 quotas will have been liberalized by the end of the 10-year transitional period;


(iii) 79 per cent of restrained trade will remain under quota restriction right up to the end of the ATC


period unless, in the remaining years of ATC, EU undertakes further liberalization steps; this


would involve virtually all main traded products.


The constraining effect of continued restrictions is also apparent from the European Commission’s own


findings that, whereas total EU imports increased by 31 per cent between 1995 and 1999, imports from WTO


members under quota restriction expanded by only 20 per cent during the same period (ITCB, 2000b: 5).


2. Applying anti-dumping rules


Many developing countries feel that the way anti-dumping rules have been used in practice is in


contradiction with the spirit of WTO rules governing trade liberalization. These rules allow a country to take


countermeasures if dumping takes place and “causes or threatens material injury to an established industry”


in the importing country (article VI of GATT). Anti-dumping measures have been used by some developed


countries as a pretext for protectionism, for example against imports of textiles, clothing and steel (Das,


1999).


The conceptual issues involved in anti-dumping measures make their use to some extent arbitrary.


Article VI of GATT and article 2 of URA on implementation of article VI define dumping as selling a product


to another country below its “normal value”. The normal value is defined as the sale price in the exporting


country or, in its absence, the sale price in a third country, after allowing for various sale and transport costs


(transaction costs) or for the differential transport costs. In calculating the normal value, the “unit cost” plus


a reasonable margin is allowed for. Such definition of normal value and unit cost suffers from two practical


problems. First, in business, particularly in exportation, marginal cost-pricing is often a normal practice. in


particular, when an industry is subject to significant scale economies (e.g. steel), marginal cost-pricing takes


special importance. The presence of economies of scale would allow export prices to be lower than domestic


sale prices because as sale increases the unit cost declines.


Second, as far as comparable prices in a third country are concerned, differential pricing is another


practice. An exporter prices its products in different countries at different prices, depending on the tastes,


level of income and size of the market which affects its average marketing cost. One can find many examples


of such practices in the case of electric and electronic appliances in Europe, the United States and developing


countries, by exporters from Germany, Japan and the United States.




- 27 -


It should be mentioned that some developing countries were also very active in using anti-dumping21


clauses. For example, Argentina, Mexico and South Africa figured among the 10 main countries initiating anti-
dumping cases in WTO (UN, 1998).


Article VI of GATT would imply that the necessary condition for action by the country experiencing


dumping is that dumping takes place, and the sufficient condition is that it causes or threatens material injuries


to an established industry. Let us assume that a country possesses an efficient export industry and has CA


in exporting products of that industry (e.g. textiles, steel, etc.), or is capable of competing better owing to


devaluation (devaluation changes export prices in the international market without necessarily affecting


domestic prices, at least in the short run); assume now that the course of events is the opposite to what is


envisaged in article VI. An inefficient industry in an importing country complains that it is injured due to


imports as a result of dumping. This complaint is submitted, according to the normal procedures, to the


government which decides whether or not to consider the case as dumping and pursue it in WTO. (Since


the definition of dumping is somewhat arbitrary, the government will have considerable latitude as to whether


to refuse a claim or accept it and refer the issue to WTO). Usually, this decision is influenced by political


lobbies by industrialists and trade unions in the importing countries. Moreover, the fact that the government


of the importing country has some discretionary power to levy countervailing duty on imports under


exceptional circumstances (para. 6 c of article VI) before the issue is settled by WTO is enough to create


disturbances, uncertainty and risks for the firm of the exporting country.


Developing countries claim that the fact that anti-duping complaints are often used essentially against


products in which they have CA (such as textiles, clothing, base metals, steel, etc.) is an indication of using


anti-dumping through implementation of article VI as a pretext for protectionism. Developed countries


accounted for 68 per cent out of 2,196 cases of dumping investigations by GATT/WTO between 1987 and


1997. Out of 1,501 cases investigated by developed countries, 591 (39 per cent) cases were against


developing countries and 340 (23 per cent) against countries in transition (Financial Times, 29 October


1998), based on WTO data.21


The arbitrary nature of dumping allegations is evident by the fact that many of the investigations


undertaken did not prove the act of dumping. Nevertheless, the very nature of successive investigations has


been detrimental to exports of developing countries. For example, in the case of cotton fabrics, the total


imports of EU from non-EU countries dropped by 6.52 per cent in 1997. In the same year its imports from


six countries targeted for investigation declined by over 33 per cent. For 1993–1997, when investigations


were in progress, the imports of targeted countries declined by an annual rate of 7 per cent (ITCB, 2000a).


Similar evidence is available regarding the arbitrary nature of safeguard action. For example, in an


examination by Textile Monitoring Body of WTO, restrictions imposed by one restraining country on imports


of textiles and clothing during 1995–1998 indicated that most of them “were not justified and that the


restraining country had not complied with obligations under the Agreement” (ibid.:15).




- 28 -


3. Differential treatment of developing countries


When unequal partners engage in negotiations on trade liberalization, for a fair outcome the weaker party


might expect some differential treatment, as in a process of give-and-take the weaker partner has less to give.


In other words, freer trade should accompany fair trade. In GATT this principle was to some extent


accepted, for example, for infant industry protection, inter alia. URA still contains some special and


differential treatment, particularly for least developed countries. Nevertheless, in practice, developed countries


have done little to implement their commitments, such as, for example, a commitment to give priority to the


removal of trade barriers on products of interest to least developed countries, to refrain from introducing new


barriers on these products, or to encourage imports from these countries (Das, 1999: 158–59).


The governments of developed countries are evidently under pressure to liberalize trade in agriculture


and labour-intensive products slowly for social reasons. However, here again there is a contradiction. Why


should developing countries liberalize rapidly? Social and employment issues are also important in developing


countries. Developing countries expect to be given time and assistance to make their inefficient industries


efficient, or to reallocate resources from those industries to other activities if they are unlikely to become


efficient. Nevertheless, many developing countries have been under pressure through WTO rules, the World


Bank and bilateral financial arrangements to liberalize their industries prematurely and/or sharply. The result


in many least developed countries, in particular, has been the destruction of their existing industries without


any significant replacement; the outcome has been severe unemployment, lower income, social deprivation


and marginalization. In most of these countries some simple processing of raw materials has been


encouraged; otherwise, they become locked in production and exports of primary commodities.


One argument sometimes used as a justification for pressure laid by the United States on developing


countries to liberalize their trade regime is an increase in the US current account deficit in recent years.


However, as explained in section VI, the development of the deficit in the current account of the United States


is not caused by developing countries, nor can it be remedied by trade liberalization in such countries; it will


lead to worsening of their current account deficits with possible financial crisis, as has been the case in


recent years. Moreover, there appears to be another contradiction in this argument: if large current account


deficits are problematic for developed countries, why should they not be so for developing countries too, as


explained below?


VI. INTEREST OF DEVELOPED COUNTRIES


So far, we have discussed the needs and interests of developing countries. However, it is important to


examine the question: is universal, premature and sudden trade liberalization by developing countries always


in the interest of industrialized countries? This question arises because in 1996, according to UNCTAD data,


developing country markets accounted for 24 per cent of exports of developed countries, 15.2 per cent of




- 29 -


exports of EU (39.6 per cent when intra-EU trade is excluded), 52 per cent of exports of Japan and over 42


per cent exports of the United States. In this context, it is sometimes argued that trade liberalization in


developing countries contributes to access by developed countries to developing country markets, particularly


in Asia, which has been growing faster than world trade over the past decade.


For example, according to Larry Chimerine of the US Economic Strategy Institute, the principal


economic interest of the United States Government seems to be to open up other markets in order to reduce


its trade deficits: “without some mechanism to open up markets for US products and services, particularly


in Asia, there is no prospect of controlling US trade deficits that is approaching $300 billion a year. In his


view that is an economic and political time bomb waiting to explode at the first sign of an economic


downturn in the United States” (International Herald Tribune, 9 December 1999: 4).


Here again there is a fallacy for a number of reasons. First, it is true that the United States runs


worldwide current account deficits. Nevertheless, such deficits are not due to import restrictions in


developing countries. Nor could trade liberalization in developing countries necessarily contribute to resolving


that problem. Developing countries, with a few exceptions, do not run surpluses in their current accounts;


they spend the last penny of their foreign exchange earnings on imports of goods and services. In fact,


except for periods during which they have to run surpluses to pay for their debts, they show deficits in their


current accounts. As may be seen in table 2, Singapore and Kuwait are the only two developing countries


with some current account surplus for the period 1988–1999. Both countries have almost absolutely free


trade regimes. Otherwise, the surplus countries are exclusively among industrialized countries, with the


exception of China. It is interesting to note that even oil-exporting countries, as a group, have been running


deficits in their current accounts since 1985, except for the two periods 1989–1990 and 1996–1997 (see


table 3): the surplus during the first period was due to a sudden increase in the price of petroleum during the


Persian Gulf crisis; during the second period, the surplus was created for the repayment of debts. Developing


countries usually import in excess of their foreign exchange earnings by financing their deficits through


various capital inflows and borrowing on international markets. Although capital inflows are unstable – so


that a part has to be allocated to increases in reserves – various financial flows have generally been significant


in determining the import capacity of developing countries (UNCTAD, 1999b, chaps. IV and V).


With respect to the above-mentioned statement by Larry Chimerine, it should be noted, however, that


liberalization efforts can change the structure of imports of developing countries, which in essence may


benefit some developed economies more than others. For example, it is possible that liberalization of services,


particularly financial services, may benefit the United States more than other countries.


Secondly, since developing countries do not run surpluses, any increase in their imports – unmatched


with increases in exports – caused by liberalization would lead to increase in their current account deficits


(as shown in table 3). The current account deficits of non-oil exporting countries increased nearly threefold


between 1990 and 1994, when a large number of developing countries undertook trade liberalization through


World Bank and IMF Structural Adjustment Programmes and Stabilization Programmes. The UR trade


liberalization was accompanied by almost doubling of the current account deficits of those economies




- 30 -


See UNCTAD (1999b) for more details.22


between 1994 and 1997. Note that over the same period industrialized countries as a group considerably


increased their surplus. In other words, while trade liberalization resulted in significant increases in imports


of developing countries, the expansion of their imports was not accompanied by sufficient liberalization in


their main export markets. To continue, the debts of developing countries resulting from deficit financing


have ultimately to be paid through exportation or debt forgiveness. Hence, when their export market is not


expanding sufficiently, a financial crisis will evolve, as occurred in Asia and Latin America in 1997–1998.


Table 2


Indicators of the current account surplus of various countries, 1989–1998


Country Surplus ($USA billions) Number of years with surplus
(1998) (1989–1998)


Japan 12.1 10


Belgium 12.1 10


Netherlands 27.7 9a b


Switzerland 23.7 9a b


France 40.2 71


Italy 20 6


Denmark 0.9 8a b


Sweden 4.6 5


Norway - 2.1 9c


Ireland 1.5 8


Singapore 17.6 10


Kuwait 2.9 9


China 29.7 7a b


Source: IMF (1999).
a 1997.
b 1989–1997.
c The surplus for 1997 was $8 billion.


Thirdly, the emergence of such financial crises involves significant costs for the industrial countries


in terms of lower growth and greater instability in trade and GDP overtime and the expenses related to the22


bailout of debtors. This is exactly what happened in the case of Asian crisis. The financial crisis led the crisis-




- 31 -


It should be mentioned that the United States was exceptionally less affected by the crisis because of the23


lower share of trade in its GDP – a coincidence of the crisis with the technological revolution in the United States
and serious countercyclical measures taken by the Federal Reserve Bank. Nevertheless, the country’s current
account deficits expanded significantly.


stricken countries to take macroeconomic measures to limit their imports and expand their exports, although


at the cost of losses in their terms of trade. As a result, the industrialized countries’ exports to these Asian


economies – as well as to other developing countries affected by the crisis – was negatively affected. Hence,


although exports of industrialized countries to developing countries initially expanded fast as a result of the


once-and-for-all effect of trade liberalization through UR, over a longer period it resulted in a slower average


growth rate of their exports to these countries. Consequently, growth in their GDP was negatively affected


as well (with the exception of the United States). Taxpayers were also affected by the loss of employment23


and income.


Table 3


Current account deficits and surpluses of developing and developed countries, 1985–1998


Developed ($USA billions)
countries


Developing countries


All Oil exporters Non-oil China Non-oila


exporters exporters
– China


1985 - 65.8 - 18.2 - 0.9 - 17.6 - 11.4 - 6.2


1986 - 41.7 - 34.1 - 28.6 - 5.4 - 7.0 + 1.6


1987 - 75.5 + 11.1 - 11.3 + 22.4 0.3 + 22.1


1988 - 65.6 - 8.5 - 20 + 11.5 - 3.8 + 15.3


1989 - 83.6 - 10.7 + 1.8 - 12.4 - 4.3 - 8.1


1990 - 106.2 - 13.2 + 19.5 - 32.7 + 12.0 - 20.7


1991 - 38.4 - 83.7 - 60.2 - 23.5 + 13.3 - 36.8


1992 - 36.3 - 74.7 - 25.5 - 49 + 6.4 - 53.4


1993 + 40.2 - 115.2 - 22.1 - 93 - 11.6 - 81.4


1994 + 18.3 - 67.4 - 6.1 - 61 + 6.9 - 67.9


1995 + 51.9 - 96.8 - 2.8 - 94.2 + 1.6 - 95.8


1996 + 39.4 - 82.1 + 26.0 - 108.1 + 7.2 - 115.3


1997 + 70.5 - 79.8 + 20.5 - 100.3 + 29.9 - 130.0


1998 - 37.6 - 46.3 - 12.9 - 33.3 N/A N/A


Source: Based on IMF (1999).
a Includes China.




- 32 -


Based on IMF (1998).24


Fourthly, one may argue that trade liberalization has been to the benefit of TNCs in their attempt to


globalize. It is true that these companies will enjoy greater freedom in movement of goods across boarders


and in their commercial presence. It is also true that they have benefited temporarily from the expansion of


their markets in developing countries. Moreover, they have further benefited through the acquisition at low


prices of the fixed assets of some developing country firms (TDR, 1990, chap. V). Nevertheless, they have


been also affected negatively by the economic crisis of recent years. This may be seen, for example, by the


performance of such global firms as Coca-Cola, Disney and Gillet. If “financial crisis” are repeated – and


they will be – they will also suffer in the long run from lower growth and instability in their earnings.


Finally, it is true that the United States’ current account deficit has increased by approximately 40 per


cent from about $168 billion in 1987 to about $234 billion in 1998. Nevertheless, as a percentage of the


country’s exports (of goods and services), it has declined from about 45 per cent to 24 per cent over the


same period; in relation to its GDP, it has declined from 3.5 to 2.8 per cent. Here two points may be added.


The first is that, taking into account in particular the strength of the US economy, such a deficit ratio is far


less worrisome than that of the developing countries; for example, in 1996, the corresponding ratio was


respectively 8.4 for Malaysia, 8.1 for Thailand, 4.7 for the Philippines, 5.4 for Chile, 5.5 for Colombia, 17.1


for the Dominican Republic, 38 for Malawi, 45 for the Congo, and 15.4 for the United Republic of


Tanzania. The second point, as put by a developing country official, is the contradiction that “when24


developing countries run deficits, they have to adjust and liberalize trade; when industrial countries run


deficits, ‘others’ should adjust”. But even if others are supposed to adjust, “others” should refer, according


to J.M. Keynes, to countries with a surplus, not to those in deficit. It should also be mentioned that part of


the reason for the increase in US deficits in recent years is the country’s high rate of GDP growth, which


necessitates increases in imports, including petroleum and other raw materials.


VII. CONCLUDING REMARKS: TRADE NEGOTIATION
AND DEVELOPING COUNTRIES


An attempt has been made in this study to discuss some causes of the failure in setting the agenda for


the next round of trade negotiations under the auspices of WTO. The study has focused on frictions between


developing and industrialized countries in the particular area of trade in manufactured goods, which is the


main concern of developing countries (but developed countries did not wish to include it on the agenda of


the coming round). It was argued that as regards the interests of developing countries, two prime factors


have contributed to the failure: fallacies surrounding both the theory of universal and across-the-board trade


liberalization, and the theory and practice of infant industry protection – and a contradiction in the design and


implementation of GATT and WTO rules to the detriment of the interests of developing countries. It was also




- 33 -


shown that rapid and across-the-board liberalization is not in the interest of developed countries – let alone


that of developing ones.


Taking into account the prevailing fallacies and contradictions in trade policy theory and practice and


bearing in mind the experience of trade policy and diplomacy in recent decades, one is led to conclude that


there is a need to design a new trade policy for developing countries as well as to revise international trade


rules. In this respect, in preparing themselves for trade negotiations, developing countries need to draw up


a clear strategy; the elements of such a strategy could entail the following. First, developing economies need


to be clear as to whether they prefer to play a “passive”, a “defensive” or a “proactive” role in the


negotiations. In the past, they have been passive on some issues and defensive on others. By the latter stance,


they opposed what was put on the table by developed countries, as they were either sceptical of the goodwill


of the industrialized countries or unsure whether the proposed issue was in their interest. It should be


emphasized, however, that negotiation involves a process of give-and-take, which in turn entails bargaining.


In bargaining, one needs to play a proactive role.


Secondly, in a proactive role, developing countries both as a group and individually need to adopt a clear


position about the type of trade policy they wish to follow – as was stressed by the Secretary-General of


UNCTAD in the Positive Agenda for Development. The philosophy behind the “positive agenda” is that


instead of opposing whatever is proposed by developed countries in the WTO round of trade negotiations,


developing countries should come up with their own trade negotiation agenda. It is maintained that such an


agenda should be designed from a development perspective, and that developing countries should make the


necessary preparations for the negotiations (UNCTAD, 1997: 1–8). This approach implies that before entering


the negotiation process, individual developing countries should be clear about their trade strategy; that such


a strategy should be linked to their development objectives in general and their industrial policies in particular.


Moreover, they should be able to analyse the impact of present international rules and regulations on their


development prospects. Furthermore, if they choose to be proactive, they also need to request, in cooperation


with each other, changes in the present rules. However, as developing countries are not a homogeneous


group, instead of agreeing on a “least common denominator”, they should attempt to cooperate with one


another in a strategy aimed at the trading rules that differentiate countries, in accordance with some agreed


criteria. Such criteria might include a number of indicators such as per capita income, the degree of


dependence on primary commodities, the share of manufacturing in GDP, etc.


Thirdly, unless they accept being locked in the production and exports of primary commodities, simple


processing and “traditional light manufacturing goods” or rather “manufacturing commodities”, developing


countries need in the long run to have a dynamic trade policy geared to their level of development, industrial


capacity and structural characteristics, as well as to changes in world economic conditions and competitive


situation. Although there is no general formula on trade policy because each country’s is different, the reader


may refer to Shafaeddin (1995) for a proposed outline of such a trade policy. It should be emphasized that


trade policies also require a clearly defined industrial and development strategy, as mentioned above, and


should allow developing countries some flexibility as they develop.




- 34 -


Fourthly, as each country or group of countries tries to look after its own interests in the process of


negotiations, it is a myth to believe that concessions will always be made to developing countries on “moral


grounds”. In fact, according to the Financial Times (2 December 1999: 14): “The EU and the US are still


at loggerheads, and still intend on bullying developing countries, without offering much in return”.


“Bargaining” is the name of the game. Bargaining requires bargaining chips, information about the issues


under negotiation and bargaining skills. Bargaining chips are the net sum of bargaining assets and liabilities.


One should bear in mind that the bargaining chips of developing countries are smaller than those of developed


ones. Hence, the issue boils down to the best use of whatever bargaining chips they possess by its proper


mobilization. Such a process requires knowledge, information about the issues concerned and training for


undertaking negotiation. In such a context, at the country level there is a need not only for policy formulation


and for strengthening the capacity of commercial diplomacy so as to enhance the country’s bargaining skills,


but also for strengthening the capacity for trade and industrial policy formulation within the context of its


general development objectives and strategies.




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UNCTAD Discussion Papers


No. 94, January 1995 XIE Ping Financial services in China


No. 95, January 1995 William W.F. CHOA The derivation of trade matrices by commodity
groups in current and constant prices


No. 96, February 1995 Alexandre R. BARROS The role of wage stickiness in economic growth


No. 97, February 1995 Ajit SINGH How did East Asia grow so fast? Slow progress
towards an analytical consensus


No. 98, April 1995 Z. KOZUL-WRIGHT The role of the firm in the innovation process


No. 99, May 1995 Juan A. DE CASTRO Trade and labour standards: Using the wrong
instruments for the right cause


No. 100, August 1995 Roberto FRENKEL Macroeconomic sustainability and development
prospects: Latin American performance in the
1990s


No. 101, August 1995 R. KOZUL-WRIGHT Walking on two legs: Strengthening democracy
& Paul RAYMENT and productive entrepreneurship in the transi-


tion economies


No. 102, August 1995 J.C. DE SOUZA BRAGA Financing the public sector in Latin America
M.A. MACEDO CINTRA
& Sulamis DAIN


No. 103, September 1995 Toni HANIOTIS & Should governments subsidize exports through
Sebastian SCHICH export credit insurance agencies?


No. 104, September 1995 Robert ROWTHORN A simulation model of North-South trade


No. 105, October 1995 Giovanni N. DE VITO Market distortions and competition: the particu-
lar case of Malaysia


No. 106, October 1995 John EATWELL Disguised unemployment: The G7 experience


No. 107, November 1995 Luisa E. SABATER Multilateral debt of least developed countries


No. 108, November 1995 David FELIX Financial globalization versus free trade: The
case for the Tobin tax


No. 109, December 1995 Urvashi ZUTSHI Aspects of the final outcome of the negotiations
on financial services of the Uruguay Round


No. 110, January 1996 H.A.C. PRASAD Bilateral terms of trade of selected countries from
the South with the North and the South


No. 111, January 1996 Charles GORE Methodological nationalism and the misunder-
standing of East Asian industrialization


No. 112, March 1996 Djidiack FAYE Aide publique au développement et dette
extérieure: Quelles mesures opportunes pour le
financement du secteur privé en Afrique?


No. 113, March 1996 Paul BAIROCH & Globalization myths: Some historical reflections
Richard KOZUL-WRIGHT on integration, industrialization and growth in


the world economy


No. 114, April 1996 Rameshwar TANDON Japanese financial deregulation since 1984


No. 115, April 1996 E.V.K. FITZGERALD Intervention versus regulation: The role of the
IMF in crisis prevention and management


No. 116, June 1996 Jussi LANKOSKI Controlling agricultural nonpoint source pollu-
tion: The case of mineral balances




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No. 117, August 1996 José RIPOLL Domestic insurance markets in developing coun-
tries: Is there any life after GATS?


No. 118, September 1996 Sunanda SEN Growth centres in South East Asia in the era of
globalization


No. 119, September 1996 Leena ALANEN The impact of environmental cost internalization
on sectoral competitiveness: A new conceptual
framework


No. 120, October 1996 Sinan AL-SHABIBI Structural adjustment for the transition to dis-
armament: An assessment of the role of the
market


No. 121, October 1996 J.F. OUTREVILLE Reinsurance in developing countries: Market
structure and comparative advantage


No. 122, December 1996 Jörg MAYER Implications of new trade and endogenous
growth theories for diversification policies of
commodity-dependent countries


No. 123, December 1996 L. RUTTEN & Collateralized commodity financing with special
L. SANTANA-BOADO reference to the use of warehouse receipts


No. 124, March 1997 Jörg MAYER Is having a rich natural-resource endowment
detrimental to export diversification?


No. 125, April 1997 Brigitte BOCOUM The new mining legislation of Côte d'Ivoire:
Some comparative features


*No. 126, April 1997 Jussi LANKOSKI Environmental effects of agricultural trade lib-
eralization and domestic agricultural policy
reforms


No. 127, May 1997 Raju Jan SINGH Banks, growth and geography


No. 128, September 1997 E. COSIO-PASCAL Debt sustainability and social and human devel-
opment: The net transfer approach and a com-
ment on the so-called "net" present value
calculation for debt relief


No. 129, September 1997 Andrew J. CORNFORD Selected features of financial sectors in Asia and
their implications for services trade


No. 130, March 1998 Matti VAINIO The effect of unclear property rights on environ-
mental degradation and increase in poverty


No. 131, Feb./March 1998 Robert ROWTHORN & Globalization and economic convergence: An
Richard KOZUL-WRIGHT assessment


No. 132, March 1998 Martin BROWNBRIDGE The causes of financial distress in local banks in
Africa and implications for prudential policy


No. 133, March 1998 Rubens LOPES BRAGA Expanding developing countries' exports in a
global economy: The need to emulate the stra-
tegies used by transnational corporations for
international business development


No. 134, April 1998 A.V. GANESAN Strategic options available to developing coun-
tries with regard to a Multilateral Agreement on
Investment


No. 135, May 1998 Jene K. KWON The East Asian model: An exploration of rapid
economic growth in the Republic of Korea and
Taiwan Province of China





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No. 136, June 1998 JOMO K.S. & M. ROCK Economic diversification and primary commodity
processing in the second-tier South-East Asian
newly industrializing countries


*No. 137, June 1998 Rajah RASIAH The export manufacturing experience of Indo-
nesia, Malaysia and Thailand: Lessons for
Africa


No. 138, October 1998 Z. KOZUL-WRIGHT & Becoming a globally competitive player: The case
Lloyds STANBURY of the music industry in Jamaica


No. 139, December 1998 Mehdi SHAFAEDDIN How did Developed Countries Industrialize?
The History of Trade and Industrial Policy: The
Cases of Great Britain and the USA


No. 140, February 1999 M. BRANCHI, Traditional agricultural exports, external
G. GABRIELE & dependency and domestic prices policies: African
V. SPIEZIA coffee exports in a comparative perspective


No. 141, May 1999 Lorenza JACHIA & Free trade between South Africa and the European
Ethél TELJEUR Union – A quantitative analysis


No. 142, November 1999 J. François OUTREVILLE Financial development, human capital and poli-
tical stability


No. 143, November 1999 Yilmaz AKYÜZ & Capital flows to developing countries and the
Andrew CORNFORD reform of the international financial system


No. 144, December 1999 Wei GE The dynamics of export-processing zones


No. 145, January 2000 B. ANDERSEN, Copyrights, competition and development: The
Z. KOZUL-WRIGHT & case of the music industry
R. KOZUL-WRIGHT


No. 146, February 2000 Manuel R. AGOSIN & Foreign investment in developing countries: Does
Ricardo MAYER it crowd in domestic investment?


No. 147, April 2000 Martin KHOR Globalization and the South: Some critical issues


No. 148, April 2000 Yilmaz AKYÜZ The debate on the international financial archi-
tecture: Reforming the reformers


No. 149, July 2000 Mehdi SHAFAEDDIN What did Frederick List actually say? Some
clarifications on the infant industry argument


No. 150, August 2000 Jörg MAYER Globalization, technology transfer and skill
accumulation in low-income countries


No. 151, October 2000 Bernard SHULL Financial modernization legislation in the United
States – Background and implications


No. 152, December 2000 Dilip K. DAS Asian crisis: Distilling critical lessons


**********


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