Trade Policy6 431 Basic Issues

Trade policy can confer powerful incentives or disincentives for production, through its influence on prices and quantities of competing products that are imported into the country and through its effects on domestic prices received for exports. Policies that make imports more expensive in the domestic market are said to provide economic protection. The main instruments of trade policy are tariffs and quotas on the side of imports and various kinds of incentives on the export side. In some cases, a combination of quotas and tariffs is used ('tariff-rate quotas' (TRQs)), under which tariffs rise when imports exceed a specified quantity.

Trade policy has been the subject of intensive international negotiation for decades. Ever since the disastrous tariff wars of the 1930s, the aim of the negotiations has been the progressive dismantling of barriers to international trade. There is an international consensus that high rates of protection not only invite retaliatory protection measures by trading partners but also lead to inefficiencies in a country's own productive structure, by removing pressure for productivity increases and for reallocating a country's productive resources to its more competitive product lines.

Many developing countries have benefitted substantially from increased international trade in recent decades. For example, Eugenio Díaz-Bonilla and Lucio Reca have pointed out that

5. H. Binswanger, Y Mundlak, M.-C. Yang and A. Bowers, 'On the determinants of cross-country agricultural supply', Journal of Econometrics, 36, 1987, pp. 111-131 (cited in Yair Mundlak, 'The Dynamics of Agriculture', The Elmhirst Lecture, The XIII International Conference of Agricultural Economists, Sacramento, CA, USA, August 10-16, 1997).

6. Some of the next few paragraphs have been adapted from the author's 'Critical Issues Facing Agriculture on the Eve of the Twenty-First Century', in IICA, Towards the Formation of an Inter-American Strategy for Agriculture, San José, Costa Rica, 2000. This section is written from a viewpoint of the economics of trade policy for development. Where WTO rules are relevant to the discussion, they are mentioned.

Latin America and the Caribbean have run a positive net agricultural trade balance for decades, and by 1996 it had increased to about US$20.2 billion.7

The benefits that derive from greater volumes of international trade give developing countries an interest in promoting it and in ensuring fairness in international trading rules. However, since the completion of the Uruguay Round (UR), developed countries have increased their exports more than developing countries have, and concerns have been raised about the continuance of agricultural protection measures in developed countries. Issues of this nature are figuring prominently in the latest round of trade negotiations.

Agricultural protection has been reduced much more slowly than industrial protection in the last decade. Timothy Josling has analyzed the prevailing patchwork of tariffs in the world and has written:

.. . manufacturing tariffs are now at modest levels in most industrial countries and in an increasing number of middle- and low-income countries. Many of these tariffs are around 5 to 10 percent. By contrast, agricultural tariffs average above 40 percent, with tariff peaks (megatariffs) of over 300 percent. . . which effectively block trade. . . .

Canadian dairy imports are a well-known example of such megatariffs: the tariff on butter is 351 percent and on cheese is 289 percent. Even by the year 2000, these will still be at 299 percent and 246 percent, respectively. .. . poultry tariffs are also above 200 percent in Canada. The United States has megatariffs for sugar and dairy products, as does Japan for grains, sugar and dairy products.8

In a detailed analysis of tariff developments after the Uruguay Round's Agreement on Agri culture, N. Hag Elamin explains in what ways the application of that Agreement has been unfavorable to developing countries:

Having in place the new set of rules on market access is a remarkable achievement of the Agreement on Agriculture (AoA) and a significant contribution to the predictability and security of trade. However, what is important for actual trade to take place ... is the level of tariffs and other access conditions which are country-specific. .. . High tariffs on temperate-zone food products and low rates on tropical products [is] a typical pattern of the post-UR tariff profile of many developed countries. The reason is simple - imports of temperate-zone products compete with domestic production while others do not. This difference is also reflected in reduction rates from the base to final levels - while tariffs on tropical products as a whole were cut by an average of 43 percent, the reduction rates on other product groups were lower, e.g. 26 percent on dairy products. The AoA rule required a 36 percent overall simple average reduction for agricultural products - the developed countries surpassed this target by one percentage point.

There is a catch here worth noting - tariffs on many tropical products were already very low (e.g. 5-10 percent) and so it was feasible to reduce these even more sharply (e.g. by 50 percent) without disrupting domestic markets. Some commentators have expressed doubts whether these relatively sharp reductions on tropical products added anything substantial in terms of access. In many cases, these levels have fallen to what is called 'nuisance tariffs' of 1-2 percent. On the other hand, the base period tariffs on temperate-zone products were very high - in many cases over 100 percent and so a further reduction of 20-25 percent from that level still leaves considerable border protection.

7. E. Díaz-Bonilla and L. Reca, 'Getting Ready for the Millennium Round Trade Negotiations, Latin American Perspective', Focus 1, Brief 2 of 9, 2020 Vision, International Food Policy Research Institute, Washington, DC, USA, April 1999.

8. Timothy Josling, Agricultural Trade Policy: Completing the Reform, Policy Analyses in International Economics No. 53, Institute for International Economics, Washington, DC, USA, April 1998, pp. 6-8.

There were a number of reasons why bound tariffs on these products turned out to be very high:

• The choice of 1986-88 as the based period was an important factor. At that time, world market prices were very low and as a result the computed tariff equivalents, or the gaps between domestic and world prices, were very high. These high tariff equivalents were used to set base period tariffs. A 15-20 percent or even 36 percent reduction from these high base levels would still result in high bound rates by the year 2000.

• There is some evidence that several [developed] countries set their base tariffs for some products at much higher rates than justified by computed tariff equivalents, particularly on temperate-zone products such as cereals, dairy, meat and sugar.

• The simple average formula used in the UR allowed countries to make smaller (the 15 percent minimum required) cuts on some commodities (e.g. the so-called 'sensitive' products) combined with larger cuts on others (e.g. tropical products) in order to arrive at the simple average [reduction] of 36 percent. . . .

A recent OECD study. . . showed that actual border protection to agriculture was higher in 1996 compared to 1993 in eight of the ten OECD countries (EU as one) covered by the study, the two exceptions being Australia and New Zealand.9

Another major concern of poorer countries is the prevalence of agricultural export subsidies in the richer nations. They have the effect of reducing prices for farmers in poor countries, and therefore they tend to aggravate the problem of rural poverty. In Josling's words:

The use of export subsidies in agricultural markets poses serious problems for countries trying to develop competitive agricultural sectors.10

This effect arises not only from explicit export subsidies. Agricultural production subsidies of various types in richer nations contribute to over-supply of agricultural outputs, exacerbating the downward trend in real agricultural prices on world markets.

Developing countries can respond to these circumstances with a two-pronged approach: by strengthening their joint participation in international trade negotiations (as they are now doing), and by implementing domestic policy measures to limit the economic damage caused by policy distortions in other countries. The greatest source of resistance by farmers to trade liberalization is fear that low-priced imports will drive down domestic prices to unprofitable levels or, for subsistence farmers, to levels that mean privation for their families. These concerns are legitimate, especially for developing countries with already serious problems of rural poverty. The challenge for policy is to respond to these concerns without falling into the self-defeating trap of protectionism.

Staple crops that are the main source of food and income for poor families have a claim to special treatment in trade policy. The benefits of liberalized trade arise from the ability of workers to learn more efficient ways to produce and to learn new occupations. Poor rural families are generally the least well educated and would have the greatest difficulty in learning new occupations. In addition, well-known deficiencies in rural credit and land markets make it difficult for them to invest in improved agricultural technology. These families have no social safety net to assist them in making adjustments, as they would in more developed countries. Partly for these reasons, Mexico negotiated a 100% tariff on corn for 15 years in the context of NAFTA, and in the

9. N. Hag Elamin, 'Market Access I: Tariffs and Other Access Terms', Multilateral Trade Negotiations on Agriculture, A Resource Manual, Vol. II, Agreement on Agriculture, Module 4, Food and Agriculture Organization of the United Nations, Rome, 2000, pp. 58-60.

period 1999-2001 El Salvador, Nicaragua and Panama raised tariffs on imported grains after several years of moving tariffs only in a downward direction.

Central Asian agriculture also has experienced difficulties during a process of market liberalization. With movement toward a market system in regard to marketing, trade and prices, sector performance has been poor and productivity low, many farms have become financially unviable, irrigation systems have fallen into unusable condition, and rural poverty has increased.11 Perhaps with these kinds of issues in mind, Dani Rodrik has articulated a thoughtful and pragmatic approach to trade policy for developing countries in which the stage of a country's development should be a factor determining the rate of liberalization:

.. . the nature of the relationship between trade policy and economic growth remains very much an open question. The issue is far from having been settled on empirical grounds. There are in fact reasons to be skeptical that there is a general, unambiguous relationship between trade openness and growth waiting to be discovered. The relationship is likely to be a contingent one, dependent on a host of country and external characteristics. The fact that practically all of today's advanced countries embarked on their growth behind tariff barriers, and reduced protection only subsequently, surely offers a clue of sorts. Moreover, the modern theory of endogenous growth yields an ambiguous answer to the question of whether trade liberalization promotes growth. The answer varies depending on whether the forces of comparative advantage push the economy's resources in the direction of activities that generate long-run growth

(through externalities in research and development, expansion of product variety, upgrading of product quality, and so on) or divert them from such activities.

Indeed, the complementarity between market incentives and public institutions that I have repeatedly emphasized has been no less important in trade performance. In East Asia the role of government in getting exports out during the early stages of growth has been studied and documented extensively. . .. Even in Chile, the exemplar of free market orientation, post-1985 export success has been dependent on a wide range of government policies, including subsidies, tax exemptions, duty drawback schemes, publicly provided market research, and public initiatives fostering scientific expertise. After listing some of the pre- and post-1973 public policies promoting the fruit, fishery and forestry sectors in Chile, Maloney12 . .. concludes that 'it is fair to wonder if these, three of the most dynamic export sectors, could have responded to the play of market forces in the manner they have without the earlier and concurrent government support'.

The appropriate conclusion to draw from all this is not that trade protection should be preferred to trade liberalization as a rule. There is no evidence from the past 50 years that trade protection is systematically associated with faster growth. The point is simply that the benefits of trade openness should not be oversold. When other worthwhile policy objectives compete for scarce administrative resources and political capital, deep trade liberalization often does not deserve the high priority it typically receives in development strategies. This is a lesson of particular importance to countries in the early stages of reform, such as those in Africa.13

11. See Francesco Goletti and Philippe Chabot, 'Food policy research for improving the reform of agricultural input and output markets in Central Asia', Food Policy, 25(6), December 2000, p. 662.

12. Reproduced from William F. Maloney, 'Chile', in L. Randall (Ed.), The Political Economy of Latin America in the Postwar Period, University of Texas Press, Austin, TX, USA, 1997, pp. 59-60, with permission of University of Texas Press.

13. Dani Rodrik, 'Development Strategies for the 21stCentury', in B. Pleskovic and N. Stern (Eds), Annual World Bank Conference on Development Economics, 2000, The World Bank, Washington, DC, USA, 2001, pp. 102-103.

Among the 'other worthwhile policy objectives' alluded to by Rodrik, reduction of rural poverty would figure high on the list. The following sections discuss specific issues in trade policy and review policy options that would help secure the benefits of liberalized trade while at the same time contributing to poverty alleviation.

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