POVERTY THE WORLD BANK REDUCTION AND ECONOMIC MANAGEMENT NETWORK (PREM) Economic Premise JUNE 2010 · Number 18 55081 Trade and the Competitiveness Agenda José Guilherme Reis and Thomas Farole The global economic crisis has forced a major rethinking of the respective roles of governments and markets in the processes of trade and growth. Indeed, industrial policy seems to be back in fashion--or, at least, talking about it is. But a renewed "activism" by government in the trade and growth agenda need not mean a return to old-style policies of import substitution and "picking winners." Instead, it may mean a stronger focus on competitiveness by unlocking the constraints to private sector­led growth. This note discusses the renewed role of government in trade and growth policy from the competitiveness angle, and it suggests some priorities for the new competitiveness agenda. Export-Led Growth, the Crisis, and the End pacts of the crisis on the policy environment regarding trade of an Era and growth were becoming more apparent. Indeed, in addi- tion to raising concerns over the global commitment to trade The dramatic expansion in global trade over recent decades liberalization, the crisis has also led to some serious rethink- has contributed significantly to diversification, growth, and ing of some of the conventional wisdom regarding the poverty reduction in many developing countries. This period growth agenda--the most important result of which is the of rapid export growth has been enabled by two critical likelihood that governments will play a much more activist structural changes in global trade: (1) the vertical and spatial role in the coming years. There are three principal reasons fragmentation of manufacturing into highly integrated why governments are likely to be more actively involved in "global production networks," and (2) the rise of services industrial and trade policy in the coming years. trade and the growth of "offshoring." Both of these, in turn, First, the crisis has undone faith in markets and discred- were made possible by major technological revolutions; and ited laissez-faire approaches that rely simply on trade policy they were supported by multilateral trade policy reforms liberalization. Instead, governments and local markets have and broad liberalizations in domestic trade and investment been "rediscovered." In this sense, the demand for activist environments worldwide. government is likely to go well beyond financial markets and The global economic crisis came crashing into the middle regulation, and it will affect the policy environment in which of this long-running export-led growth party during 2008 trade and industrial strategies are designed. and 2009. Between the last quarter of 2007 and the second Second, the crisis has highlighted the critical importance quarter of 2009, global trade contracted by 36 percent. But of diversification (of sectors, products, and trading partners) as the recovery started to strengthen in 2010 (at least until in reducing the risks of growth volatility. The recent era of the clouds began to form over Europe), the longer-term im- globalization contributed to substantial specialization of 1 POVERTY REDUCTION AND ECONOMIC MANAGEMENT (PREM) NETWORK www.worldbank.org/economicpremise many economies. Whereas this specialization was predicted might this competitiveness approach look like? Much of it by trade theory, what perhaps was unexpected was the de- would be familiar. For example, it would recognize the fun- gree of vertical specialization that emerged through "task- damental roles of human capital, sound macroeconomic based" trade in global production networks. As the next era foundations, and basic institutions--like property rights, the emerges, diversification will be at the top of the policy rule of law, and effective regulation--as the bases for long- agenda in most developing countries. This will create further term growth. But it would go beyond these basic founda- demand for government activism. tions to address the microeconomic environment that shapes Finally, despite the dramatic rise of East Asia and India in individual firms' capacities and the incentives to which they recent years, many developing countries have failed to ben- respond. The competitiveness policy framework might be efit from the opportunities afforded by liberalized trade over described as one established on the following three pillars: the past quarter century. Even with the benefits of prefer- 1. Aligning macroincentives--for example, removing eco- ential market access, few exporters from low-income coun- nomic biases arising from tariff and nontariff barriers, tries are in a position to compete in internaitonal markets real exchange rate misalignment, and a distortive tax because of poor productivity, high trade costs, and the in- regime; and ensuring the overall fiscal health of the ability to benefit from internal and external scale economies. economy, efficient labor market operation, product and factor market conditions, protection of property rights, The Coming Era of Government Activism: effective regulation, and ease of firm entry and exit. Old Industrial Policy or a New 2. Reducing trade-related costs--for example, improving Competitiveness Agenda? backbone services and inputs such as energy, telecom- munications, finance; improving the capacity and co- The demand for a more activist approach does raise the risk ordination of government agencies at the border, of going back to old-style industrial policy associated with international transit arrangements, regional and multi- the import-substitution era. One risk here is that the heavy lateral agreements; and making policy reforms that en- hand of government--in picking winners, in managing un- sure more competitive markets for international realistic exchange rates, and in attempting to derive demand transport, logistics, and other services that facilitate through import substitution--will distort the market and trade transactions. undermine private sector competitiveness in the long term.1 3. Establishing proactive policies for overcoming government Further, such demand for protection--which inevitably and market failures--for example, promoting technology would emerge through traditional industrial policies--even- creation and adaptation, developing product standards tually could undermine the gains made in trade liberalization and certifications, providing trade finance, supporting in- over recent decades. On the other hand, greater active gov- dustry clusters, facilitating special economic zones and ernment commitment also opens up the possibility of coun- other spatial developments, and ensuring coordination tries adopting a more comprehensive, competitiveness-based of economic actors as well as links and spillovers to the approach to trade and growth. As Klinger (2010) points out, local economy. firm productivity is determined in large part by public in- Many of the issues on the agenda within this broad frame- puts to firms' production and the good functioning of the work of competitiveness are not new; indeed, governments markets in which firms operate. Thus, government plays a have always played an important role in addressing some of critical role in overcoming market failures. If done effec- them. However, with the growing postcrisis emphasis on tively, government intervention can create the conditions more proactive policies, several issues are likely to emerge that enable the private sector to respond to market oppor- as priorities within the competitiveness agenda. These issues tunities. As discussed in Rodríguez-Clare (2005), Harrison are discussed in the remaining portion of this note. and Rodríguez-Clare (2009), and Klinger (2010), these in- terventions can include both policies to induce discovery (as Targeting Transport and Trade Facilitation to noted by Hausmann and Rodrik [2002]) and policies to pro- Reduce the Costs of Bringing Goods mote the benefits of agglomeration (inspired by the seminal to Market work of Porter [1990]). Thus, the demand for government activism need not lead For exporters in many developing countries, competitive ad- to a return to the days of old-style industrial policy. Instead, vantage at the factory and farm-gate is eroded step-by-step it can result in a deepening of the competitiveness agenda in the miles between production and markets. Distance aside, and a strengthening of support for private sector­led growth factors like transport and communications infrastructure, by unlocking the constraints that discourage innovation, in- border-related processes, and local logistics markets will play vestments, and export diversification; and, at the same time, critical roles in shaping exporters' competitiveness through facilitating the capacity for economywide adjustment. What their impact on cost, time, and supply chain reliability. Data 2 POVERTY REDUCTION AND ECONOMIC MANAGEMENT (PREM) NETWORK www.worldbank.org/economicpremise Figure 1. Relationship between Logistics Performance and Exports performance in developing countries (Lederman, Olarreaga, and Payton 2009). In light of the changing trade dynamics Logistics Performance Index score 4.5 discussed in this note, however, there is likely to be a need 4.0 for EPAs to shift from their traditional focus on finding new export market opportunities to supporting new and existing 3.5 exporters to increase survival rates during the first few years after beginning to export. Indeed, as illustrated in figure 2, 3.0 survival rates in developing countries can be dramatically lower than in high-income countries as a result of the many 2.5 additional barriers to competitiveness that they face (com- pare Brenton, Pierola, and von Uexkull 2009). 2.0 4 5 6 7 8 9 10 Addressing the agenda of sustainability will require gov- log exports ernments to address a much wider set of issues. For example, competing in high-value (usually perishable) agricultural ex- Source: Authors' calculations, based on data from World Bank (2010) and the ports may require support to ensure that standards and cer- United Nations Commodity Trade Statistics database (US$ exports, 2008). tification requirements are met on an industrywide level to facilitate market access for new exporters. In the services from the World Bank's Logistics Performance Index (World sector, which suffers from notorious information asymme- Bank 2010) show a clear relationship between logistics per- tries, collective action on licensing and accreditation may be formance and exports (see figure 1). Empirical literature trac- necessary to enable competitiveness. Across virtually all sec- ing the effect of transport and trade facilitation constraints tors, access to trade finance is critical to enable exporters to on trade flows shows unequivocal impacts of time and costs enter and sustain participation in international markets. All on developing-country exports (Djankov, Freund, and Pham of this is likely to imply significant institutional changes in 2006) and on the composition of trade (Li and Wilson 2009). the approach of EPAs--in particular, taking on a greater co- Taking up the competitiveness agenda, governments will ordination role and working more closely with other public play an increasingly active role in trying to overcome trans- and private sector actors. port, trade facilitation, and logistics constraints. This action will start by putting in place the hard and soft infrastructure Using Special Economic Zones and Clusters to facilitate the movement of goods. But it will also involve to Facilitate Externalities more active efforts to identify and develop transport corri- dors, to improve coordination across border clearance agen- As task-based trade and investment patterns have become cies (both internally and in concert with trading partners), engrained in the global production system and the sources to strengthen competition in local logistics markets, and to of competition are highly globalized, addressing the chal- work with the private sector to overcome coordination fail- ures in export logistics and facilitate greater scale and pre- Figure 2. Comparison of Survival Rates of Exporters in Pakistan dictability. In addition, given that export of services is a key and Germany element of the trade diversification strategy in many devel- oping countries, an expanded trade facilitation agenda also 100 export relationships surviving (%) must contemplate telecommunications and connectivity be- 80 cause maintaining and upgrading both the quantity and quality of communications infrastructure are crucial for en- 60 suring the possibility of engaging in services trade. 40 Retooling Export Promotion to Support Improved Export Survival 20 Government support for export promotion is based on the 0 significant information externalities and coordination fail- 0 1 2 3 4 5 6 7 8 9 10 ures that affect the private sector with respect to export analysis time (years) markets. Export promotion agencies (EPAs) have a long his- Pakistan Germany tory in both high-income and developing economies. Al- Source: Authors' calculations, based on data from the United Nations though they often have been criticized, recent research Commodity Trade Statistics database, using the World Bank's World shows they have generally had a positive effect on export Integrated Trade Solution software. 3 POVERTY REDUCTION AND ECONOMIC MANAGEMENT (PREM) NETWORK www.worldbank.org/economicpremise lenge of upgrading in developing countries will require fa- Aghion and Howitt (2006) show to be the primary channel cilitating better links between foreign direct investment and through which economic adjustment processes occur in a the domestic private sector. This will require a greater em- Schumpeterian growth paradigm. But competition, al- phasis on skills development. Beyond skills development, though generally acknowledged as an important element of however, there is an important role for governments to fa- the growth agenda, is often relegated to a kind of second- or cilitate spillovers by promoting collaboration between local third-priority level. And industrial policies that engage in producers and foreign buyers and by overcoming gaps in co- building "national champions" are frequently at odds with ordination between the local private sector and institutions. competition policy--thereby contributing to their long-run In this regard, governments are likely to put greater empha- welfare deficits. sis on spatial industrial policies in the years ahead. Finally, delivering on the competitiveness agenda will rely One such policy instrument that has been used in many on the existence of effective institutions, including those of the developing countries are special economic zones, most com- state, of the private sector, and of civil society. Acemoglu, John- monly export processing zones. Such special economic zones son, and Robinson (2004) argue that institutions--the "rules have played a valuable role in catalyzing industrialization and of the game" in a society (North 1991)--are the fundamental trade integration, particularly in East Asia. However, the tra- "deep determinants" of economic growth and development ditional export-processing-zone model that was imple- differences across countries because they ultimately shape in- mented in most countries 2 --one reliant on low wages, trade centives for innovation and entrepreneurship and set the main preferences, and substantial fiscal incentives--paid too little constraints for societies to adapt. Indeed, the fundamental role attention to facilitating dynamic links with the local private of institutions in a society--to facilitate cooperation and col- sector. A more innovative approach to using spatial industrial lective action among individual (economic) agents--is to ad- policy will be part of the new agenda to support industrial dress the market and coordination failures that are the bases upgrading in developing countries. This approach will involve for the "new" competitiveness agenda discussed in this note. the use of more flexible and integrated zones that combine But institutions are endogenous, and so can also act as barriers cluster-based development models with a host of policies de- to adjustment by blocking reform (Aghion, Alesina, and Trebbi signed to facilitate links between foreign investors and the 2002; Acemoglu and Robinson 2006). And weak institutions local private sector. It will also involve support for the devel- may have negative influence on the provision of public goods opment of public-private institutions that promote public and on the development and delivery of policies aimed at im- goods (for example, training, joint research, certification, and proving skills or innovation capacity or other potential sources market information) linked directly to local clusters. of growth. Therefore, the development of "thick" networks (Amin and Thrift 1994) of flexible and reform-minded insti- tutions that promote cooperation and knowledge sharing Strengthening Competition Policy and across the public and private sectors will be the key to estab- Institutions to Support Adjustment lishing a governance framework that is suited to the new era of competitiveness. Central to the aims of the trade policies discussed in this note are facilitating and managing the dynamic process of Notes economic adjustment that is inherent in capturing the ben- efits of trade. This requires redeploying resources (capital, 1. Noland and Pack (2003) survey a series of studies labor, institutions) to higher-value activities. The ability of showing that, contrary to popular belief, industrial policy in economies to adapt to a changing environment depends on East Asia was not successful in supporting high-growth sec- their degree of flexibility, not only at the more conventional tors. The sectors that received the most support in terms of macroeconomic level, but also at the microeconomic level. subsidies, tax breaks, and protection in Japan, the Republic The foundations of long-run adjustment are, of course, of Korea, and Taiwan, China, were not the ones that later human capital and innovation.3 But beyond this agenda showed the most growth. (and, indeed, intrinsicly linked to it), governments will focus 2. It is worth noting that many of the successful East their industrial and trade policy increasingly on competition Asian countries (most notably Korea and Malaysia) did im- and other actions to promote firm entry and exit. They also plement much more dynamic models of special economic will support adjustment capacity more broadly by building zones, with an explicit focus on facilitating spillovers. and sustaining dense networks of high-quality and flexible 3. See Glaeser (2003, 2008) for an ample discussion of economic institutions. the role of human capital in cities' recovery from and adap- Competition policy plays a critical role in facilitating tation to external shocks--particularly, how it helped entry and exit (both in product and factor markets), which Boston, Massachusetts, reinvent itself. 4 POVERTY REDUCTION AND ECONOMIC MANAGEMENT (PREM) NETWORK www.worldbank.org/economicpremise About the Authors ------. 2008. "The Economic Approach to Cities." Discussion Paper 2149. 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Connecting to Compete 2010: Trade Logistics in the Global Glaeser, E. L. 2003. "Reinventing Boston: 1640­2003." Working Paper Economy. The Logistics Performance Index and Its Indicators. Washington, 10166. National Bureau of Economic Research,Cambridge, MA. DC. The Economic Premise note series is intended to summarize good practices and key policy findings on topics related to economic policy. It is produced by the Poverty Reduction and Economic Management (PREM) Network Vice-Presidency of the World Bank. The views expressed here are those of the authors and do not necessarily reflect those of the World Bank. The notes are available at www.worldbank.org/economicpremise.