Aid or Trade - Alternatives for Poverty Reduction?

Table of Contents

1. Introduction: The debate of aid vs. trade

2. Does trade cause growth and lead to poverty reduction?

3. Internal and external trade barriers in developing countries

4. Aid for Trade as a means to promote developing countries´ gains from trade

5. Conclusion

List of References

1. Introduction: The debate of aid vs. trade

Since the end of colonialism the quest of the newly born countries in the south was to catch up with the development of the industrialized countries and to become equal players in a new world order. Different approaches and theories about development and poverty alleviation have shaped the discourse over time. From the onset, both, questions of international trade and development aid have been and remain central elements of the North-South dialogue. Some regarded fair trade in a new and more just world economic order as the key solution to development, while others advocated that increased development assistance by the richer countries were necessary to assist the poorer countries in acquiring wealth and alleviating poverty. The followers of the dependency theory, which dominated the development discourse during the 1970s amongst critical thinkers in north and south, had the conviction that the global market order was systematically disadvantaging the poorer countries and leading to a neo-colonial aid dependency on the rich countries. Hence, they preached the total dissociation from the world market and aid structures as the only way to break out from the circle of underdevelopment (cf. Nuscheler 2005: 308). However, after the East Asian Tigers experienced an economic boost in the 1980s exactly by opening up and integrating into the world market, neo-classic foreign trade theories (i.e. Smith or Ricardo), pleading trade liberalization, were prevailing again: global free trade increases the wealth of all nations participating as each country can capitalize on its comparative advantage, was the credo. Henceforth, IMF and World Bank were imposing liberalization measures within their Structural Adjustment Programs and believed them to create economic growth that would solve the debt crisis, boost industrialization and ultimately reduce poverty (ibid. P. 308f.).

Today, as trillions of Dollars have been transferred as development aid from the north to the south and most developing countries have opened their markets and engaged in free trade under the GATT and WTO regime, the gap between the rich nations and the poorest has become even wider. Though some emerging economies have managed the take-off to industrialization and profited from globalization, the least developed countries, particularly in Africa, are left far behind. Apparently neither increased financial and technical aid nor free trade have lead to profound growth in those countries, not to speak of poverty alleviation. Accordingly one could ask: Has the north not been generous enough in its aid efforts or are the structures of the international trading system and the economy of the poor countries the reason for the persistence of underdevelopment and poverty?^[1]

For a long time aid and trade have been viewed as two antagonistic concepts or, if at all, as complementary. While scholars like Jeffrey D. Sachs called for an unseen effort by the wealthy countries to increase aid transfers as a means to end poverty, others like William Easterly argued that aid and the implicated dependencies creates the problem that it actually seeks to solve. Dambisa Moyo, a famous Zambian economist and rigorous aid opponent, holds: “If the West wants to be moralistic about Africa´s lack of development, trade is the issue it ought to address, not aid.” (Moyo 2009: 119). Aid versus trade has been a popular notion to summarize these different schools of thinking in the global development discourse.

However, in the last years and in the context of the current WTO´s Doha Round a new approach has loomed that understands both aid and trade as two closely linked aspects of a holistic development approach aiming at enabling poor countries to increase their benefits from trade. This concept called aid for trade currently enjoys high recognition. It acknowledges fair trade as a central key to development, however, considers foreign aid to be necessary to create the capacities for facilitating successful trade.

In its first part, this paper analyses the benefits of free trade in general from a theoretical and empirical point of view. In the second part, it explains why these benefits do not materialize in specific, namely the poorest, countries due to internal and external structural barriers. In a subsequent part it will be examined if aid for trade might be a means to overcome some of these obstacles and empower developing countries to engage in more profitable trade. The genesis, objectives, forms and principles of the aid for trade concept will be reviewed with regard to their relevance and efficiency in trade-related poverty reduction.

2. Does trade cause growth and lead to poverty reduction?

The arguments in foreign trade theory why trade promotes economic growth and is to the benefit of all participating parties are abundant. The most outstanding argument dates back to the models of comparative advantage developed by Ricardo and Heckscher / Ohlin. According to these theories under free trade a country will specify in the production of the goods that it produces relatively cheaply compared to other goods (due to different factor endowments or technological advantages). Therefore it exports these goods and imports the goods that were produced relatively inefficiently while the price at the international market settles somewhere between the autarkic price ratios. The striking aspect here is that even if a country had an absolute disadvantage in every product, it could still profit by specializing in and exporting the products in which it has the least disadvantage and importing the goods that are produced comparatively cheaper elsewhere (cf. Debraj Ray 1998: 627ff.; 635).

Hence, resources are allocated to where they can be used the most efficiently. Moreover, the specialization leads to economies of scale as commodities produced in higher quantities can be produced more efficiently, i.e. at lower prices (ibid.: 638ff.). More arguments add to the picture of trade as an engine for growth: the higher competition at the international market is said to boost technological efficiency and trade again leads to an exchange in knowledge and faster progress in technology. Also the consumer profits by having a wider range of products of a higher quality and at lower prices available at his disposability. Accordingly, the rates of consumption rise in all trading partner countries. Hence, this theory of foreign trade clearly advocates a neoliberal policy in regard to free trade and development: open up your markets, trade and you will win! Empirically, however, there is still a debate if trade causes growth or not. Though it can be easily observed that all countries with high GDPs have broadly engaged in international trade, the problem is that the causality between trade and income is difficultly to be measured due to many other relevant factors and to not knowing which causal direction the correlation implies. Frankel and Romer (1999) have approached this issue in their empirical study “Does Trade Cause Growth?”. In their regression analysis they managed to circumvent the problem of unknown causality and came to the conclusion that trade indeed has a strongly positive (though only slightly significant) effect on income. As a vague estimate they figured up that “a rise of one percentage point in the ratio of trade to GDP increases income per person by at least one-half percent” (ibid.: 394). Also a World Bank study of the year 2002 entitled “Globalization, Growth and Poverty ” proved a correlation between a country´s integration into the world market and its economic growth. Furthermore it found that the poverty rate decreased in most of the globalized countries and thus claimed trickle-down effects of economic growth. Going in another direction, the United Nations Conference on Trade and Development (UNCTAD) prompted a report in the same year that contested the World Bank´s findings and the neoliberal foreign trade theory in general by putting it into perspective of developing countries. In its Trade and Development Report (2002) it establishes that the increased participation of developing countries in world trade did not automatically lead to an equally corresponding growth in income. Also to date the least developed countries do not seem to have profited from trade as their incomes are more or less stagnating (UNCTAD 2008: 3). Obviously the positive effects predicted by foreign trade theory and observed in most of the western industrial countries and emerging nations of Asia and Latin America do not apply to the poorest of the countries. The share of LDCs in world exports declined from 3% in the 1960s to only about 0,5% to date (Nuscheler 2005: 312; 329). This is the more startling taking into consideration that the least developed countries (LDCs) even profit from non-reciprocal preferential market access – they can already export virtually all products tariff free into the European Union under the Everything-but-Arms initiative and into the United States under The African Growth and Opportunity Act (AGOA). Also other developing countries, particularly the ACP (Africa, Caribbean, Pacific) countries under the Lomé / Cotonou- Agreement, profit from preferential trade agreements with the EU.

3. Internal and external trade barriers in developing countries

To explain why, despite theoretical market access, free trade does not lead to significant growth and sustainable industrial development in low income countries or may even have negative consequences one has to look (1) at the production structure and capacities of their economies, (2) at non-tariff trade barriers that distort fair trade and (3) at the negative implications of the process of trade liberalization itself.

1.) Most developing countries are rich in resources (gold, copper, diamonds etc.) and poor in capital and skilled labor. Moreover, they inherited mono-cultural production structures (coffee, bananas, cotton, cacao etc.) from their colonial rulers. Their comparative advantage thus lies in the production of primary goods whereas high tech and industrial goods are produced elsewhere. Hence, to make use of this potential advantage most developing countries, under the advice (or pressure) of the Bretton Woods institutions and after their import-substitution policy largely failed,expanded the production of the primary commodities in which they have a comparative advantage for serving an export market and gaining foreign currency to import consumer goods (cf. Nuscheler (2005): 315f.).

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^[1] The author is aware that the concept of underdevelopment has more dimensions than the two exogenous factors aid and trade. However, elaborating on the diverse endogenous reasons would go beyond the scope of this paper.