International trade between poor developing countries and advanced developed countries can bring great benefits to both sides, when such trade is based on comparative advantage.  Government can make an important contribution to facilitating such trade by providing both hard and soft infrastructure.  And what’s more, this trade can be an important driver of economic development.  These are some of the arguments laid out by World Bank Chief Economist Justin Lin in his paper “New Structural Economics: A Framework for Rethinking Development”.

Broadly speaking, advanced developed countries are operating at or near the “global technological frontier”.  That is, they are employing the best of technology, physical capital and human capital.  Sometimes, this is called best practice.  These countries have a comparative advantage in skill- and capital-intensive economic activities.



Economic development is a process of climbing a development ladder toward the global technological frontier.  Industry is upgraded through using better technology, more capital and improving human capital.  The economy is transformed from low-skilled, labour-intensive (or natural resource intensive) to more high-skilled capital intensive industries.  It results in a process of sustained increase in per capita income as wages rise and the exchange rate appreciates.



International trade can facilitate upgrading.  Exports finance imports which embody technology and knowledge.  And selling on global markets obliges exporters to lift their product standards to global levels.  The economic growth generated by international trade provides the wealth for financing the accumulation of human and physical capital, thereby upgrading the resource endowment structure.



While a country’s comparative advantage is determined by its resource endowments (human capital, physical capital, technology, and natural resources), as the economy upgrades these resources, its comparative advantage also changes and moves upscale.  Since World War 2, Japan has gone from a low-tech country to a high tech one.



The past half century has seen just a handful of countries enjoy such rapid economic development -- countries like Brazil, Chile, China, Indonesia, India, Japan, Korea, Malaysia, Mauritius, Singapore, Thailand and Singapore.  These countries have implemented development strategies in line with their comparative advantages, guided by market forces.  In the case of former closed economies like China, Mauritius and Vietnam, gradual dismantling of previous policies, rather than shock therapy, has proved to be an effective approach.    



And as these countries have developed, they have undergone economic upgrading, and their comparative advantage has evolved in consequence.  Singapore and Japan have basically made it to the global technological frontier, and Korea is heading that way.



As countries move closer to the global technology frontier, they can no longer just rely on importing technologies and knowledge from mature economies.  Once you have hit the frontier, continued growth depends increasingly on innovation, and new technologies and products.



While market forces are the best guide for economic development, government has an important role to play in facilitating such development by providing the necessary hard and soft infrastructure for development.  Hard infrastructure includes highways, port facilities, airports, telecommunication systems, electricity grids etc.  Soft infrastructure consists of institutions, regulations, social capital, value systems and other social, economic arrangements.



At each stage of development, the production structure is different and the necessary infrastructure is also different.  With the upgrading in factor endowment and industrial structure, infrastructure must be improved in parallel.  A smooth upgrading process therefore requires simultaneous improvements in educational, financial and legal institutions, and also hard infrastructure.  Governments often do not do this, and infrastructure becomes a bottleneck to economic development.



At early stages of development, the infrastructure requirements are more simple and rudimentary – basic physical infrastructure, law and order, openness to trade and investment, open framework for doing business, basic education.  Governments can also coordinate related investments across different firms in the same industries.



As countries approach the global technological frontier, more sophisticated hard and soft infrastructure are necessary.  These advanced countries are relatively abundant in technology, capital and skilled labour, and have a comparative advantage in capital and skill intensive industries.  The hard infrastructure (power, telecommunications, road and port facilities) and soft infrastructure (regulatory and legal frameworks, cultural value system) must comply with the necessities of the global market.  As they rely technological innovation for upgrading, government policies need to focus on innovation policies (funding basic research, IPR etc), higher education, sophisticated financial markets.



The curious thing looking back over the past half century is that only a small number of developing countries have achieved convergence with advanced economies, even though these success stories have show the way.



Countries that have not developed rapidly have basically defied their comparative advantages.  They invested in heavy industry, rather than natural resources, agriculture or labour intensive manufacturing, the obvious areas of comparative advantage for most of Africa, Latin America and South Asia.  Following the great depression, there was also a mood of export pessimism and a belief that commodity prices were on a long term downward trend.   



Why did other countries follow comparative advantage defying strategies?  These countries were newly independent, had strong nationalist sentiments and wanted to become economically independent.  Developing heavy industry seemed like a path to economic independence.  So, they launched programs of industrialization through protectionist, import substitution policies to achieve economic development.  They also believed that economic development was a state responsibility, more than a market responsibility, so governments chose the development path.



There are a few issues that Lin does not go into on which I would be interested in his views:



.  As a country upgrades its economic structure, it is natural for the exchange rate to rise in consequence.  Look at what happened to Japan’s exchange following the mid-1980s.  This pushed Japanese manufacturers to offshore labour intensive parts of their manufacturing to China and South East Asia, and to upgrade its own manufacturing capacity.  In this context, does Justin Lin believe that China should substantially revalue its exchange rate?  (Justin Lin is of course Chinese himself).



.  Many East Asian countries have gone beyond comparative advantage in that they have actively promoted and subsidized exports in which they have a comparative advantage.  This may have been a useful policy in accelerating economic upgrading and catchup.  After all, exports provide many external benefits – learning from global markets, and financing imports which embody knowledge and technology.  But such a policy can provoke trade tensions, as these subsidized exports from big countries like flood other markets.  Also, export promotion policies can lead to unbalanced growth, as we have had in the lead-up to the global financial crisis.  Both China and Japan have had export-dependent growth, and relatively weak domestic economies.  Does Justin Lin support export-promotion strategies?  And if so, at what point in the development process should they be unwound?



.  The gradual liberalization that Justin Lin favours in the case of countries like China, has often taken the form of creating special economic zones or export processing zones.  These zones give preferential treatment to (usually foreign) companies through tax holidays, free land, duty-free imports, etc.  Such zones are a simple way to start opening up an economy.  But while they can attract new investment, they can also distort investment activity away from the most efficient use.  While these zones may be a good way to get economic development launched, it can be difficult to gradually dismantle them due to resistance from the investors.  What does Justin Lin think of special economic zones or export processing zones?  Are they an effective way of launching market based development?



But we must also go beyond Lin's message.   While international trade can be a powerful tool for economic development, this logic does not always apply to the very poorest, least developed countries.  Indeed, these very poor least developed countries often face capacity and supply-side constraints which limit their ability to benefit from trade.  They might lack the physical infrastructure in terms of roads, ports, airports, telecommunications etc, or even lack the human capacity.



Indeed, a recent World Economic Forum event in Vietnam highlighted the skills shortages that are holding back Cambodia’s capacity to develop its export sector.  While Cambodia is an important garment exporter, it does not produce buttons, zippers, and fabric, it only does cuts, make and trim because of skills shortages.  A greater supply of technical experts and effective middle and upper management is needed.  80 percent of middle and upper management in Cambodia’s garment factories are foreign expatriates.



This problem of the lack of capacity to take advantage of trade has given rise to the “aid for trade” movement.  This refers to development assistance designed to help these developing countries address supply-side bottlenecks and boost their capacity to take advantage of expanded trade opportunities. It comprises aid that finances trade-related technical assistance, trade-related infrastructure, and productive capacity building.



The 2005 Hong Kong WTO Ministerial Declaration called for the expansion and improvement of aid for trade and set in motion a process to achieve this: the Aid-for-Trade Initiative.  The OECD and the WTO have established an aid-for-trade monitoring framework. The objective of the framework is to promote dialogue and encourage all key actors to honour commitments, meet local needs, improve effectiveness, and reinforce mutual accountability.



According to the OECD, Aid for Trade commitments reached US$ 41.7 billion in 2008, an increase of US$ 16 billion from the 2002-05 baseline.



The Asian Development Bank has been active in Aid for Trade since 2006, as a member of the WTO Advisory Group, and as co-host for Regional Review Meetings in Manila in September 2007 and in Siem Reap, Cambodia in May 2009.  The ADB continues to support increased trade within the Asia and Pacific region. In the Greater Mekong Subregion (GMS), for example, it has financed roads across the six-country region and also standardized border regulations. ADB also earlier this year expanded its Trade Finance Facilitation Program from $150 million to $1 billion. The program, which extends loans and guarantees to support trade in frontier markets, could generate $15 billion in trade finance through 2013.






Reference:

New Structural Economics: A Framework for Rethinking Development, Justin Yifu Lin.  World Bank Policy Research Working Paper 5197.  February 2010.

www.worldbank.com

Aid for Trade

www.oecd.org ; www.wto.org ; www.adb.org