Openness, deficits and lack of development

A report from UNCTAD highlights the role that greater trade openness may have played in worsening growth prospects in much of the developing world.

AT last, it's official. Although many economists and analysts in developing countries have been emphasising it for some time now, most multilateral economic agencies have tended to steer clear of noting the uncomfortable consequences that greater interna tional economic integration has already implied for most developing countries. The latest Trade and Development Report (TDR) just released in Geneva by UNCTAD (the United Nations Commission for Trade and Development), however, finally does look closely a t this issue.

In doing so, it has come to accept that both financial and trade liberalisation can have undesirable consequences not just for the balance of payments but also for domestic economic growth. The current received wisdom in the mainstream literature, especi ally from the World Bank, is rather different, and can be briefly summed up in the mantra "trade liberalisation good; financial liberalisation bad". But this is a simplistic view. More perceptive observers have noted that trade liberalisation can play a role in building up to crises like those in East Asia, or in causing recessions or declines in domestic manufacturing industry in several other developing countries, or even in limiting the possibilities of major shifts in the international divisi on of labour.

Thus, the TDR '99 admits that "developing countries have striven hard, and often at considerable cost, to integrate more closely into the world economy. But in the face of deep-seated imbalances in economic power and systemic biases in the international trading and financial systems, their expectations of the gains from such integration in terms of faster growth, greater employment opportunities and reduced levels of poverty have been disappointed... the downside risks have proved far greater than was g enerally expected... the twentieth century is closing on a note of crisis and a growing sense of unease about the policy advice that was proffered in the past decade" (page V).

On the basis of a slightly longer look at the experience of growth and external imbalance in developing countries, the TDR points out that growth in developing countries as a group in the 1990s has been at an annual average of around 4.3 per cent. This d oes represent a recovery from the levels of the 1980s, but it is still well below the average of 5.7 per cent per annum of the 1970s. Moreover, this partial recovery in economic growth has been accompanied by a significant worsening of external deficits. Indeed, if China (whose performance was exceptional for a variety of specific reasons) is excluded, then it turns out that the average developing country trade deficit for the 1990s is higher than that for the 1970s by almost 3 percentage points of GDP , while the average growth rate is lower by 2 per cent per annum.

Of course, low oil prices in the 1990s (compared to high oil prices in the 1970s) have played some role in this average since a number of developing countries rely on oil exports. But the same pattern is evident, to almost the same degree, even for non-o il exporting developing countries, indicating that the basic problem lies elsewhere.

The pattern is also the same across regions. In Latin America, growth has been lower while trade deficits as a share of GDP have been the same. In sub-Saharan Africa, growth has fallen but trade deficits have risen. Countries in Asia have on average run greater external deficits in the 1990s without achieving faster growth.

The general tendency among the majority of developing countries over the 1990s, therefore, is of widening external deficits combined with stagnant or falling growth rates. This is precisely the opposite of what had been promised by the proponents of libe ralisation at the start of the decade.

Two forces were supposed to create a virtuous cycle of growth and (eventually) lower deficits for developing countries: the Uruguay Round of the General Agreement on Tariffs and Trade (GATT), which was supposed to bring about a dramatic increase in marke t access for developing country exports; and the greater freedom accorded to international capital flows in the wake of financial liberalisation, which would allow developing countries to finance deficits easily and increase their domestic growth rates.

Obviously, neither of these forces has acted quite in the manner predicted by their votaries. What explains the more depressing reality? To its credit, the TDR eschews the simplistic explanations which have been all too readily advanced in the recent pas t, which tend to blame everything on "over-hasty financial liberalisation" or domestic problems like "crony capitalism".

Instead, it seeks to find some common features which apply to all or most developing countries, and which also reflect the general conditions of the world economy. It thus isolates two important factors behind the adverse combination of payments deficits and lower growth: terms of trade losses and rapid trade liberalisation.

Both of these stem directly from the attempts of developing countries - pushed by public international institutions like the International Monetary Fund (IMF) as well as private ones like the World Economic Forum - to integrate more closely with the worl d economy in terms of both trade and finance, to make their economies more "open" and to rely more heavily on exporting activity as an engine of growth.

Thus, the terms of trade losses reflect the growing numbers of developing country exporters crowding into already saturated markets, pushing down prices further, and reducing the income gains from additional exports. Interestingly, the process of relativ e price decline occurred for both primary and non-primary goods exported by developing countries.

The decline in commodity prices (both oil and others) is well-known by now, reflecting both slow growth of aggregate demand in industrial countries as well as substitution away from the use of such commodities because of technological change. But standar d adjustment policies continue to promote reliance on these traditional exports for most developing countries, further worsening the problem.

But even for manufactured exports by developing countries, relative prices fell. In fact, since the beginning of the 1980s, the terms of trade of developing countries relying mainly on manufactured exports have fallen by as much as 1 per cent per annum o n average. This reflects the increased concentration of developing country interest on certain labour-intensive or natural-resource based manufactured products, including low-technology inputs to the electronics industry.

The TDR points to the concern that such manufactures may be acquiring the characteristics of primary commodities in world markets. The fear that several analysts had expressed earlier, that all countries cannot play the same game of aggressive export pro motion in labour-intensive manufactures without affecting international prices, now appears to have been justified.

The problem has been aggravated by inadequate market access for developing country exports in developed markets. This has turned out to be one of the major false hopes raised by the Uruguay Round and the formation of the World Trade Organisation (WTO). T he TDR is emphatic that increased market access for developing country exports should form the basis of negotiation in GATT, since it may turn out to be more important than capital inflows for development prospects.

While developed country markets have not become more open for developing exporters, the markets of developing countries have been significantly liberalised. Many developing countries opted for "big bang" forms of trade liberalisation which drastically ch anged the structure of domestic demand in favour of imports, but even the more gradual liberalisers have seen imports make big inroads into their markets and erode the viability of domestic manufacturers.

In the past, it used to be felt that trade liberalisation combined with currency devaluation would ensure that trade deficits would not get too large. Indeed, the inability to finance such deficits typically ensured that trade would eventually be brought into balance, even at the cost of domestic contraction. But the possibility of using private capital markets to finance such deficits, even if only for short periods, has meant that deficits now continue for slightly longer periods. More significantly, because trade liberalisation has often been accompanied by financial liberalisation, it has broken the link between the current account and exchange rate movements, which now get determined by the behaviour of capital flows at the margin. So the new sce nario is one of exchange rate instability and currency "misalignment" driven by capital flows that further cause trade balances to deteriorate.

Often the imbalances can be sustained for some time because of continued capital inflow. But the story of the 1990s has been one of increasingly rapid reversal of such capital movements, leading to boom and bust cycles. The Asian crisis and the ongoing d ifficulties in Russia, Brazil and elsewhere, are evidence of this. In the process, there is also significant damage to domestic industry, in many cases leading to effective de-industrialisation because nascent manufacturers simply disappear in the face o f severe and cheap external competition.

This is portrayed by some determined advocates of indiscriminate liberalisation as being bad for workers but good for consumers in the country. But it can only be good for consumers if domestic economic expansion is somehow sustained sufficiently to ensu re that there is more purchasing power in the hands of consumers. The pattern of terms of trade movements along with effects on domestic economic activity and employment suggests that this has not been the case for most developing countries.

So the greater openness of developing countries in the 1990s has been associated not only with higher volatility and larger payments deficits, but even with inferior economic growth performance.

Clearly, it is time for those in developing countries to revise the now-hackneyed policy prescriptions which see liberalisation as the universal panacea, and take a more sophisticated and realistic view of the economic challenges ahead. To push for any r eal change in economic reality, ideas must change first.