Small Economies, Trade Negotiations and Poverty Reduction

by Prof. Gerry Helleiner*

Toronto, July 2001 — There is now an emerging new consensus as to the true meaning of poverty, and these extend far beyond the traditional earlier emphasis upon sheer material or income poverty, sometimes buttressed by special attention to access to education and health. When poor people are consulted about their concerns, they often emphasize other dimensions of their plight - vulnerability and exposure to the risk of negative shocks to their income and welfare; and voicelessness and powerlessness.

To policymakers in materially poor and small countries, these new interpretations of what it means to be poor should carry special resonance; since, for decades, they too have spoken, at length and repeatedly, of their own unique vulnerability and powerlessness in the global economy within which they must function.

At the international level, it is certainly true that small countries have only a very weak voice and very limited power. They cannot ever expect to have much influence upon the international rules system. On the other hand, the one-nation one-vote system in the United Nations, the WTO and other (but by no means all) international bodies gives them much more “voice” than their population size would, on democratic principles, seem to require.

The “voice” and “powerlessness” problems of small countries derive more from the difficulties they frequently experience, in light of their small governmental scale, in operating effectively within multilateral decision- making and implementation systems. Individually, they simply do not have the numbers to attend all the meetings on matters that may affect their welfare, or to monitor all the external developments that impact upon their rights, or, for that matter, as we have seen in recent years, to absorb and implement, within what other countries have considered a reasonable time frame, the domestic legal and other obligations that new international rules systems, like those of the WTO, formally require. One obvious response - epitomized by CARICOM, the Caribbean Regional Negotiating Machinery, and many of the activities of the Caribbean Development Bank - is for small countries to combine their forces and work closely together within the international arena. The international community can undoubtedly also play a role in assisting the smallest and weakest to function more effectively within the global legal and financial systems now being created.

The prospect of membership in an FTAA or, for that matter, the already existing facts of the WTO and Lome systems, raise major economic and political issues for the small countries of the Caribbean, issues far greater than the effects of trade liberalization. Economic integration of the kind now promoted everywhere involves far more than freedom of trade in goods, the issue upon which traditional trade theory and integration analysis has focussed. It is therefore likely to be quite misleading for prospective parties to such integration agreements to attempt to assess the benefits and costs, or opportunities and risks, exclusively, or even primarily, on the basis of their trade effects. Also at issue are the effects of altered rights and obligations of member countries in respect of such matters as foreign direct investment, portfolio capital flows, intellectual property, and trade in services. Members must contemplate the full implications of inter-country harmonization of innumerable laws and procedures, and a much “deeper” degree of economic and legal integration.

As already noted, poverty eradication is also ostensibly to be part of any hemispheric deal; and negotiators should not be permitted to forget it. It is therefore critically important that, for each prospective WTO or FTAA member, the benefits and costs of the non-trade elements of the negotiated integration arrangements be directly addressed within a holistic and integrated consideration of the overall benefits and cost of deeper integration.  Regrettably, this is an undertaking that the economics profession has been, for the most part, either unwilling or unable to provide.

Traditional trade theory, with its (obviously challengeable) assumption that adjustment costs are always and everywhere small, posits that small countries will gain disproportionately from integration with large ones. There is no such presumption, however, either in theory or in previous experience, in respect of the prospective gains from the non-trade elements of deeper integration. On the contrary, in the absence of compensatory measures or anti-poverty funding, there are grounds for considerable anxiety about the non-trade and overall effects upon the small of an FTAA or bilateral deals with the US or Canada and the small countries of the Caribbean and Central America.

The small countries of the Caribbean begin with certain inherent limitations on their ability to benefit from internationally liberalized flows of goods, services and capital. (They could benefit greatly from liberalized flows of labour but these do not seem as likely.) These are the product of a variety of influences: their relatively weak physical infrastructure, small scale, limited skill base, weak organizational and managerial capacity, limited capacity for independent technical progress, and, in most cases, severely limited resources.  Whatever their initial conditions, all countries, even those with such limitations, can benefit from drawing upon their comparative advantage in international exchange. However, the literature of modern economics abounds in warnings that reliance upon short-term comparative advantage may not be optimal in terms of longer-term productivity enhancement and growth. No country wishes to become “stuck” in low-productivity occupations, unable to participate fully in future overall growth. Both these small countries themselves and those with whom they are negotiating the FTAA or other hemispheric liberalizing deals therefore need to initiate policies and construct arrangements that will facilitate small and poor countries’ full and continuing utilization of the opportunities offered by the liberalized system.

Negotiators must take into account the likelihood of small countries’ relatively high adjustment costs, their need for a greater degree of policy “space” with which to pursue their longer-term interests, and their extreme vulnerability to external events as they gear their economic futures increasingly to the global or hemispheric economy. As emphasized earlier, the small countries of the Caribbean are already uniquely open to external influence, both in the current and capital account. Their weak initial conditions imply that reallocations in their production necessitated by liberalization are typically both slower and more costly, relative to GNP, than in more developed countries.

Precipitate further liberalization could engender significant early economic and social losses, in the form of increased unemployment and under-utilization of existing capital (both human and physical), before gains can be realized from the higher productivity activities that eventually may result.

Since these countries’ fiscal systems are heavily dependent upon trade taxes, there are likely to be further significant adjustments required in tax systems.  These too must be appropriately phased if they are not to risk the destabilization of public finances and thus the macro-economy. Effective and sustainable tax reform requires careful planning ... and time.

The short-term social and political costs of adjustment to liberalization can easily be seen as potentially great enough to dwarf the somewhat more distant prospect of eventual gains. These negative perspectives (and actual prospects) can be eased by slowing the required pace of immediate change, provision of extra finance to ease adjustment costs, and permission to deploy policies, either for a limited period or for much longer, that can ease the pains of reallocative processes.

The harmonization of laws and procedures that integration entails normally involves the surrender of a degree of policy autonomy on the part of member countries. A harmonized rules system, by imparting an increased degree of predictability to the international system, protects all member countries, particularly the smaller ones, against ad hoc actions on the part of the powerful. It can also both effectively signal the commitment of small countries to new policies and actually “lock them in”. An international treaty commitment may therefore be able to increase the credibility of governmental policies in small countries to economic decision-makers, particularly investors, both domestic and foreign. This can be important to governments with previous “reputation” problems.

However, harmonization of rules and procedures is also likely to mean the acceptance of rules and procedures over which the more powerful countries have disproportionate influence from the beginning. Moreover, there may be legitimate doubt as to the degree to which the harmonized rules will be enforced equally upon all members. It may be that only the small countries can actually be effectively disciplined. In the absence of appropriate incentives and enforcement or dispute settlement mechanisms, the commitments of the powerful countries cannot be fully credible to the small.

The developmental and poverty reduction needs of the small countries of the Caribbean - to develop new spheres of future comparative advantage, maintain macroeconomic stability, encourage productive new investments, accelerate technical change, and overcome the disadvantages of inevitably smaller-scale indigenous enterprises - all could require governmental policies that fall outside the range of the permissible, under newly harmonized “rules” set by more powerful players. A degree of policy autonomy may therefore be necessary to permit the longer-term encouragement of domestic innovation, technical change, learning and diversification into sectors that can benefit from continuing productivity improvement; and to permit appropriate policy response to sudden external shocks to the current and capital accounts. The “level playing field” to which integration agreements typically aspire have to allow for the weaker initial conditions of some of the players and their continuing risks and disadvantages, if it is to produce equitable gains for all. Full realization of small countries’ potential is likely to require a greater degree of policy freedom for them, at least for an initial period.

Small countries face a further continuing problem within the proposed WTO and other new multilateral trading and investment systems, including those proposed for the hemisphere. Litigation occupies a newly-prominent place in modern trade and trade-related policy practice. The size of their trade flows, particularly when conducted by smaller firms, cannot support the costs of endless defence against process protection, the litigation of disputes, and related transactions costs. The mere threat of legal action on the part of agents within large countries may be sufficient to discourage traders and export-oriented investors in small countries. Means must therefore be found to overcome the resulting potential inequities and trade distortions. As already noted, credible dispute settlement systems and enforcement mechanisms are critical to small countries’ confidence in the system. Arrangements for the provision of necessary technical and legal expertise to those firms or countries that cannot sustain their normal costs are necessary if there is to be any semblance of equity in emerging international legal systems.

Sound macroeconomic management will continue to be a prerequisite for effective participation in the global economy. No amount of liberalization and external support can overcome the domestic costs of deficient macroeconomic policy. On the other hand, sharp changes in the external terms of trade or surges of private capital may disrupt otherwise sound macroeconomic policies; and the prospects of such external shocks are particularly high in small countries. Any global or hemispheric trade and/or investment agreement that seeks to ensure development and poverty reduction among all its members must therefore also incorporate arrangements to assist those most vulnerable to such shocks. These should be seen as an integral part of whatever poverty reduction programmes accompany them, as all now agree they obviously must.

What measures can countries take at national level to attack domestic poverty?  These have to be placed in the appropriate context. What can be done domestically is severely constrained by the performance of the overall domestic economy and its own aggregate “poverty”, including its external constraints and its overall susceptibility to external shock. There are early limits to what can be achieved through public policy if the public purse is empty and/or subject to sharp pro-cyclical fluctuation.

Yet the new approaches to the concept of poverty include some elements that offer hope for “poverty” alleviation even in the most straitened of economic and fiscal circumstances. In particular, the new emphasis upon voicelessness offers the possibility of remedial measures in the sphere of empowerment of the materially poor. There remains a wide gap between the official rhetoric on the key importance of poverty reduction (not just “development”) and the need for widespread domestic participation and ownership of poverty reduction programmes in poor countries, and the actual practice of aid donors and recipient governments. But the new official consensus on these issues suggests an appropriate direction for change. Surely it is time for more concerted and coordinated efforts to address poverty problems directly and to do so with the full involvement and ownership of those to whom the efforts are directed.  So-called “Poverty Reduction Strategies” can be put together in an inclusive and participatory fashion, and the inputs, processes and results of attempts at their implementation carefully and independently monitored. Experience with such approaches is accumulating in other parts of the world, and it can be drawn upon here. The Caribbean Development Bank can be a leader, instigator, mobilizer, and monitor in this sphere if it chooses to be ... and I hope it does. The planned strengthening of its analytical and research capacity in this sphere, made possible by a recent technical assistance grant from a donor, is an encouraging step.

Domestically, empowerment of the poor is probably, in principle, easier in small, geographically compact countries than in large ones, although smallness is obviously no guarantor that such empowerment occurs. High literacy rates, such as are typical of the Caribbean, should also help. But domestic power structures and political differences obviously often still complicate the stated aspirations to attack poverty, as the new conventional wisdom suggests, by providing greater voice to the poor. That should not prevent public servants, and technocrats more generally, from using the new “mandate” offered by the new conceptual understanding of poverty to attempt, as rarely before, to draw upon and employ “grass roots” actors in the development and implementation of national and community-level anti-poverty activities. National poverty reduction strategies that are widely “owned”, supported and understood can be part of such efforts, as already noted; but, as in other spheres, the bureaucratic and technocratic inputs typically required to develop, use and monitor such approaches elsewhere in the world may be too much for small poor countries, and adaptations to their special circumstances are likely to be necessary.

To summarize, poverty reduction, as perceived by the disadvantaged themselves and as now more widely understood, requires not only improvements in material income but also increased security and empowerment or voice. This is as true for the reduction of poverty of nations as it is for that of families or individuals. Small countries are uniquely vulnerable to external shocks, now emanating from the capital account of the balance of payments no less than the current account; and so, it follows, are the people who live in them. To reduce poverty in small countries therefore requires internationally supportive measures to buffer them more effectively against such shocks. Special funds and arrangements are urgently needed for this purpose; they should be integral elements in any future global or hemispheric financial or trading agreements.  The unique vulnerabilities and weaknesses of small countries also argue for the provision to them of special legal and technical assistance as well as flexibility in the application of universal rules to permit them fully to realize their economic opportunities within emerging multilateral trading arrangements. At the same time, at the national level, efforts should be made, where they have not previously been, to develop and implement poverty reduction strategies in a fully participatory manner that provides “voice” to the disadvantaged. Through such improved processes, one can begin to address an important element in the current conceptualization of the poverty problem, even before one deals with the basics of material income poverty. In all of these matters, through advocacy, both at the international and regional levels, and through finance and technical assistance for its members, I am confident that the Caribbean Development Bank can play a major leadership role. The memory of William Demas whose commitment to poverty reduction, the welfare of all of the people of the Caribbean, and to the CDB demands no less. Let me wish the Bank’s new President every success as he carries forward the aspirations and achievements of all of his distinguished predecessors.

[* Prof. Helleiner is at the Department of Economics and Munk Centre for International Studies, at the University of Toronto. The above is the second of a two-part excerpt from the Second Annual William Demas Memorial Lecture delivered by him at the 31st Annual Meeting of the Board of Governors of the Caribbean Development Bank, Castries, St. Lucia, West Indies, 24 May, 2001). – SUNS4929

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