The choice between unilateral and multilateral trade liberalization strategies

Policy, Planning, and Research WORKING PAPERS International Trade International Eoonomics Department The World Bank July 1989 WPS 239 The Choice Between Unilateral and Multilateral Trade Liberalization Strategies Julio Nogues Developing countries would gain far more from unilateral trade liberalization than from multilateral trade liberalization negoti- ated over many years. Industrial countrfes could increase both economic and political incentives for reform by granting credit when developing countries undertake unilateral trade libernliza- tion. The Policy. Planning, and Research Cxnplex distributes PPR Working Papers to disseminate the Findings of work in progrcss and to encourage the exchange of ideas among Bank ataff and all others interested in development issues. These papers carry the names of the authors. reflect oniy their views, and should be used and cited accordingly. The findings, interpeutations, and conclusions are the authors' own. They should not be attributed to the World Bank, its Board of fkectors, its management, or any of its member countries.  Plc,Planning, and Research | Intornallonal Trad Under plausible assumptions applied for Argen- Those conclusions are based on economic tina, Nogu6s calculates that a strategy of anaiysis, however, and developing countries are unilateral trade liberalization in Argentina would increasingly driven by politics - and only produce significantly more in exports (net marginally by economics - to participate in the present value) than would similar liberalization MTNs. negotiated multilaterally over a period of 15 years. If industrial countries were to give develop- ing countries credit for unilateral liberalization Waiting to negotiate multilaterally entails a programs, both economics and politics would tirue cost (loss of exports because of continued shift in favor of faster reform programs. If misallocation of resources) and an uncertain credit were given, negotiating in the MTN benefit (the market access a country expects to would never be preferable to unilateral trade gain bv waiting to negotiate a reciprocal reduc- liberalization. tion of trade barriers). Liberalizing unilaterally implies a fast increase of exports from improved The net present value of increased ports resource allocation but could imply a loss from a from unilateral trade liberalization in Argentina lower degree of market access. would increase from US$19 billion (if no credit were given) to US$33.4 billion (if credit were Generally, Nogues concludes, as long as the granted in increasing amounts for the first 15 costs a country suffers from its barriers are years and remained constant thereafter). And higher than those from other countries' barriers, the political excuse for not liberalizing unilater- it pays that country to liberalize unilaterally. ally would suffer a major blow. Developing countries tend to have more Waiting for multilateral negotiation of trade protectionist trade policies than the industrial liberalization is certainly preferable to maintain- countries. To the extent that this is so, it proba- ing protection, however. Nogues estimates that bly doesn't pay for developing countries to wait the present value ot forgone exports would be to negotiate in the multilateral trade negotiations US$53 billion if the present degree of protection (MTNs) - because to the extent that conces- were to remain unchanged. sions are balanced, developing countries are not likely to end up with liberal trade regimes. This paper is a product of the International Trade Division, Intemational Economics Department. Copies are available free from the World Bank, 1818 H Street NW, Washington DC 20433. Please contact Salome Torrijos, room S8-033, extension 33709 (20 pages with charts and tables). The PPR Working Paper Series disseminates the findings of work under way in the Bank's Policy, Planning, and Research Complex. An objective of the series is to get these findings out quickly, even if presentations are less than fully polished. The findings, interpretations, and conclusions in these papers do not necessarily represent official policy of the Bank. Produced at the PPR Dissemination Center  The Choice Between Unilateral and Multilateral Trade Liberalization Strategy _/ I. Introduction This paper develops a framework for analyzing the economic costs and benefits of unilateral and multilateral trade liberalization strategies. The interest in this topic is sparked by the apparent dilemma faced by some developing countries in the ongoing Uruguay Round of multilateral trade negotiations (MTNs). An active participation in the MTNs implies that wh&c developing countries have to bargain away is worth something there. If so, it might pay to delay the introduction of unilateral measures in the hope of se..uring increased access to foreign markets. Deciding on the merits of unilateral and multilateral trade liberalization strategies should involve economic and political factors. This note will address the economics of this decision. Section II will present and discuss the conceptual framework. Section III will apply this framework to the case of Argentina. I estimate that under plausible assumptions, the net present value of higher exports under a unilateral trade liberalization strategy is US$23 billion higher than a similar liberalization negotiated mul..ilaterally during a period of 15 years. Section IV will assess the extent to which the findings for Argentina can be generalized. This section also stresses the importance of the credit issue. 1/ I appreciate comments to a preliminary draft received from Bela Balassa, J. Michael Finger and Patrick Messerlin and research assistance from Ms. Azita Amjadi.  -2- II. Conceptual Framework Ideally, the benefits and costs of alternative trade policies should refer to resource allocation and their impact on GNP. Previous quantitative studies on the Argentine economy have focused on the export effects of alternative trade policies. Therefore, I will base the discussion on the impact of trade liberalization on this variable. Throughout I assume that liberalization does not affect the trade balance, i.e., changes in exports equal changes in imports. Graph I depicts the two alternative trade liberalization strategies under consideration. At to a decision needs to be taken on whether to liberalize or wait until t1 when the first among the future MTNs will be negotiated. Waiting entails a true cost and an uncertain benefit. The cost is given by the loss of exports (X) as a consequence of continued resource misallocation. This loss diminishes over time as the country bargains away its trade barriers. The uncertain benefit is the market access that a country expects to gain by waiting until t, and negotiating a reciprecal reduction of trade barriers. In the graph, I represent this by a shift of the time path of exports from C to C' i.e., from line I to line II. I assume that there are no dynamic gains from trade liberalization but only static resource allocation effects which result in a parallel upward shift of the export growth line. Thus, the net economic return of an MTN liberalization strategy is given by the difference between the present value of ABCD--cost of delaying a unilateral trade liberalization--with the present value of the difference between C and C' from t1 to infinity, i.e., the export benefit from the increased market access negotiated at tl. Note that I have assumed that:  - 3 - raph 1: TIME PATH OF EXPORTS UNDER UNILATERAL AND MULTILATERAL TRADE LIBERALIZATION STRATECIES LnXt Ln t C ;; ~~~~~~~. III to t I. Time path of exports under unilateral trade liberalization with no credit and no free ride. II. Time path of exports under multilateral trade liberalization. III. Time path of exports under unilateral trade liberalization with less- than full credit and/or free riding of the MTNs.  (a) the country will not free ride the MTN negotiated at tl; (b) that a unilateral trade liberalization at to receives no credit; and (c) the trade liberalization implemented at t, is similar to the one that would have been implemented at to. It is also assumed that there are no policy reversals. In regard to the first assumption, previous research has shown that although there has been some internalization of the trade gains negotiated by the active participants, the MTNs have provided spillover effects or free ride gains (Finger, 1976). Thus, assuming no spillover effects introduces a bias in favor of the multilateral trade liberalization strategy. Likewise with the credit issue. If countries were to receive full credit for unilateral reduction of trade barriers, the economic gains from these actions would clearly be superior to those of multilateral actions. For example, in Graph 1, if other countries would provide credit for the unilateral trade liberalization program, exports could shift to say line III. Thus, the gains from unilateral trade liberalization strategy would include the PV of the difference between A and B from to to infinity plus the PV of the difference between line I and line III from to to infinity. Granting no credit for unilateral actions is tantamount to enticing developing countries to delay their liberalization. This is not in the interest of the multilaternl trading system in general, nor of industrial countries in particular. Hence, the crucial importance of agreeing oin the credit issue in the Uruguay Round. The last assumption is controversial. The nature of the MTNs is to exchange trade concessions. Taken to its ultimate consequence, liberalizing in the MTNs implies that as long as a participant views that other trading  - 5 - countries have some trade barriers, it will have an incentive to keep some in place in the hope that in the future, they could be negotiated away in exchange for greater market access. In graph 1 this implies that if the liberalization that a country is considering at to is a shift to free trade, then this will take place at t if, and only if, the concessions given by other countries are at least of equal value. There is no reason to expect that this balance of concessions will always exist. A country can be so protected that a shift to free trade will increase trade more than what other countries can offer in exchange if they would also shift to free trade. Tn this situation, seeking balanced concessions in the MTNs will not result in free trade. This appears to be the case in Argentina, which will be assessed in the next section. Another consequence of following the MTN strategy is that unlike the case depicted in Graph 1, trade barriers will most likely be negotiated over several MTNs. This, for example, has been the experience of industrial countries (Bhagwati, 1988). Graph 2 depicts this situation. Once again at to a decision needs to be taken between a unilateral liberalization or waiting to negotiate reductions of trade barriers in successive MTNs. The graph assumes that it takes four MTNs to achieve the same trade liberalization as the one considered to be implemented at to. Again, the benefit of negotiating in the MTNs has two components. The first is the increased market access gained by negotiating. This is represented by the sum of the rectangles a, b and c, and the difference between lines I and II for the periods extending from t4 to infinity. The second component is the benefit to the country of removing its  -6- Craph 2: TIME PATH OP EXPORTS U11)ER UNILATERAL AND SEQUENTIAL MULTILATERAL TRADE LIBERALIZATION STRATEGY LXn t nt~~~~~~~~~~~b I$ _ _ _ _ _ _ ._ _ V t0 t t2 t3 t4 I. Time path of exports under a unilateral trade liberalization strategy with no credit and no free ride. II% Time path of exports under a sequential MTN liberalization strategy. III. Time, path of exports under no liberalization and no