How to Reform the International Trading System for Recovery, Development and Climate

By Katie Gallogly-Swan

The world economy is still reeling from the COVID-19 shock and the subsequent restrictions to social and economic activity. While in the developed world, governments have been able to mobilize a massive arsenal of monetary and fiscal measures to prop up their economies, estimated at between 20 and 25 percent of their GDP, the poorest developing countries have mobilized just one percent of their output to mitigate the damage from a vicious cycle of capital flight, plunging trade and investment flows, collapsing output and tax revenues and, in some cases, soaring debt service.

For some observers, the best strategy to build back better after the COVID-19 crisis is to double down on pre-pandemic policies: at the domestic level to increase competitiveness and at the international level to deepen integration through reforms at the World Trade Organization (WTO), including further reductions in industrial tariffs, liberalization of services (particularly those linked to the emerging digital economy), stronger intellectual property rules and ending “unfair” state support.

Such measures are tightly tuned to the demands of a hyper-globalized world and attached to the promise that supporting entrepreneurship, extending supply chains and strengthening competition will boost trade and investment and revive growth, particularly in developing countries. In reality, the revival of hyper-globalization after the global financial crisis coincided with sluggish investment demand, a marked increase in market concentration and rising corporate rents, exacerbated income inequalities and squeezed domestic markets, all of which contributed to a slowdown of trade over the past decade. As a result, many developing countries have been caught in a cycle of becoming even more dependent on attracting footloose capital inflows, on commodity exports or assembling low-skill manufactures and on remittances as sources of foreign exchange.

In a new research paper released by the United Nations Conference on Trade and Development (UNCTAD), co-authors argue that the economic crisis caused by the pandemic cannot lead to a prescription of more of the same. The paper, co-authored by Jeronim Capaldo and Katie Gallogly-Swan of the Boston University Global Development Policy Center, argues that a different reform agenda for international trade is urgently needed if developing countries (but also many in the developed world) are to recover better from this crisis, build resilience to future shocks and pursue transformative development strategies that can deliver the 2030 Sustainable Development Goals (SDGs). 

Below is a summary of key proposals in the paper, including four major trends and three key principles that should inform a more equitable trading system, and a broad sketch of core priorities for a reform agenda.

Four Major Trends

1. Trading more; earning less 

While developing countries have been trading more, including in manufacturing goods, the increase has been heavily concentrated in a small number of countries, principally from East Asia. Moreover, the developing country share of global value added has not risen in tandem with its share of exports and productivity growth has been weak even in countries that have increased their exports as a percentage of GDP. The continued reproduction of the division of labor established under colonialism has meant that almost all developing countries are firmly integrated into some global value chains, but in subordinate roles. 

2. Growing macroeconomic imbalances 

Stalled diversification along with the pressure for labor market deregulation as part of trade agreements have weakened the prospects of full-time, formal employment in many developing countries and have put downward pressure on the wage share everywhere, with a corresponding increase in the profit share. This approach to globalization, based on wage repression or “structural reforms,” undermines global growth and development. 

3. Rising market concentration 

On several measures – such as market capitalization, corporate revenues and asset ownership – market concentration has been rising in advanced economies and across the world, with the top 100 firms absorbing larger and larger shares. It has gone hand-in-hand with increasing mark-ups and rent extraction, linked, in particular to the ownership and control of intellectual property resulting in a “winner-takes-most” competition that has become a visible part of the corporate environment, most notably in developed economies. In 1995, the average market capitalization of the top 100 firms was 31 times higher than the bottom 2,000 firms. By 2015, the ratio had grown to a staggering 7,000 times higher, while these firms’ employment share was not rising proportionately. This lends further support to the view that hyper-globalization promotes “profits without prosperity” and that market power generates income inequality, splitting economies into a dynamic core and a stagnant periphery.

4. Booming (and busting) capital flows 

The relaxation of national controls on international capital mobility has led to an explosion of cross-border capital over the last three decades and has marked a fundamental break with the post-war Bretton Woods system. The highly volatile nature of these flows has had a direct bearing on the economic prospects of developing countries through boom-bust cycles in international financial markets. This has led to tax erosion undercutting public infrastructure projects, export strategies centered on cheap labor sectors and debt-fueled investment concentrating in sectors that contribute little to structural transformation and productivity growth. 

Three Principles for a Better Trade System 

Policy space 

In an interdependent world, a sustainable balance between domestic and global rules revolves around policy space: too little can make states incapable of responding to local needs and constraints, ultimately undermining the effectiveness of and trust in global rules. Different economic, social, environmental and political starting points mean developed and developing countries need different degrees of policy space to adjust to trade impacts and development priorities. 

Special and Differential Treatment 

In legal terms, WTO rules are equally binding for all participants, but in economic terms they are biased towards accommodating the requirements of developed countries and increasingly to the narrow interests of their large corporations. The principle of special and differential treatment (SDT) recognizes the need for developed countries to treat developing countries more favorably than other WTO Members to ensure a more level playing field in international trade and support the implementation of multilateral trade agreements. Recently however, developed countries have pushed to tighten the criterion for countries availing themselves of SDT, including the ability of countries to self-designate. 

Voice and solidarity 

Since the era of the new international economic order of the 1970s, Southern solidarity has ebbed and flowed, and developed countries have so far continued to dominate the WTO agenda with their resource advantages for negotiation and bureaucratic procedures. The COVID-19 crisis has again exposed the vulnerabilities of the Global South to external shocks, but it has also revealed the need for South-South solidarity at the WTO as a means of harnessing international trade for development. 

Economic Recovery for the Global South

In the face of tightening fiscal and balance-of-payments constraints, developing countries need significant external financial support to mitigate the economic damage from the shock and sustain recovery. Yet, the response to date has been wholly inadequate. UNCTAD has laid out a menu of possible options for the international financial system involving the scaling up of liquidity provision (through an allocation of Special Drawing Rights by the International Monetary Fund) and long-term financing (through grants and concessional lending by the World Bank and increased official development assistance flows), as well as substantial debt relief. The three regionally based multilateral development banks, which have a high equity-to-loan ratio, also have considerable room to scale up lending without hurting their credit ratings.

The strongest stimulus for economic recovery is global vaccine access. To eradicate the virus everywhere, the world needs additional vaccine manufacturing capacity at an affordable price to meet the unprecedented global demand. A first step toward ensuring the adequate supply and equitable distribution of vaccines, medicines and medical technologies, is to remove some of the legal barriers created by intellectual property rules (IPRs) at the WTO and other trade agreements. The joint proposal by India and South Africa, supported by the majority of developing countries and the recent backing of the United States, urges the WTO to grant a time-limited waiver for specific provisions of the Trade-Related Aspects of Intellectual Property Rights (TRIPS) Agreement for the prevention, containment and treatment of COVID-19. This waiver would ensure IPRs do not restrict rapid scaling up of manufacturing and do not hinder an equitable and affordable access to vaccines and treatments throughout the globe.  

Trade, Development and Climate Action

What is needed now is an enhanced role of the state in terms of employment, social protection and climate action for a more equitable recovery than the one that followed the last global crisis. Increased public investment, minimum wages reflecting living costs, stronger collective bargaining institutions and universal comprehensive social protection are needed at the same time as rapid decarbonization. This will not happen without multilateral governance that promotes and coordinates a global program of redistribution and recovery. It is of utmost importance that the rules of the trading system do not obstruct these efforts.  

Initial priorities for developing countries should be to secure a “Peace Clause” to suspend restrictions on policy space during the COVID-19 pandemic and its fallout, allowing state support of small and medium enterprises in export-oriented sectors. This should be accompanied by a permanent exclusion of all proceedings and actions against government measures implemented in the context of COVID-19 and an immediate moratorium on Investor-State Dispute Settlement (ISDS) cases by international corporations against governments. 

The European Union’s announced desire to achieve “strategic autonomy” is indicative of a wider move to forge new supply relations in the Global North to strengthen local resilience. In this uncertain landscape, developing countries will need to re-engineer their existing production and distribution systems to strengthen their own local resilience and ‘strategic autonomy.’ The unprecedented challenges posed by COVID-19 open an important window of opportunity for South-South cooperation to help build resilience to future pandemics and economic shocks, including strengthening regional value chains and intra-regional trade and investments in health and food-related goods and services.

While massive financial subsidies are being rolled out in the Global North to sustain its businesses, developing countries, who cannot afford comparable bailouts, will need to revive strategic trade and industrial policies to manage the stresses resulting from the pandemic and its aftermath. This will mean a rethink of the restrictions on policy space that have accumulated over recent decades, particularly considering the urgent challenge of achieving deep decarbonization to tackle climate change. 

With a shrinking timeline to stabilize climate and achieve the SDGs, it is crucial that all countries find ways to discipline trade and investment in the pursuit of these higher ambitions without undermining other development goals. The coherence between SDT and the United Nations Framework Convention on Climate Change principle of ‘common but differentiated responsibilities’ offers a starting point for understanding a development-sensitive approach to the trade-climate nexus.

Many proposed approaches to linking climate change and trade, however, have neglected the development dimension. These initiatives will deepen North-South asymmetries if they do not simultaneously support development and reduce high-emitting overconsumption in advanced economies. Any future WTO climate initiative must not be taken out of the multilateral rules-based system and decided between a small group of developed economies, undermining the trust of Southern WTO members who stand to be most impacted. Moreover, any such measures must be sensitive to the historic reasons why developing countries have been locked into carbon-intensive and extractive industrialization. Any requirement on governments in the Global South must be contingent on more effective policies, such as green technology transfers and new sources of financing to avoid a catastrophic impact on development initiatives. 

A limited climate waiver of WTO trade and investment rules combined with preferential space and financing for developing countries could be a first start. A narrowly defined waiver would give countries assurance that they will not face disputes for climate and development-friendly initiatives, like prioritizing a transition to renewable energy, green procurement and green jobs programs. 

The paper concludes that moving forward, given the serious tensions hampering the workings of the international trading system, now is an ideal time to establish an independent commission to examine whether the WTO’s 25 year negotiating record has fulfilled the principles of the Marrakesh Agreement, which established the WTO. The preamble to this agreement bears the unmistakable signs of a pact as yet unfulfilled. It speaks of “ensuring full employment” and the importance of “sustainable development” consistent with different levels of development.

It is time to reflect on why the world has not lived up to those ideals and revive their quest in the common interest.