Trade Beats Aid As A Way To Help Poor Countries Expand Their Exports

Export promotion is a central goal of many development assistance programmes, particularly to countries in Africa. One way of doing this is to offer preferential market access, but instead donors have tended to provide large volumes of aid conditional on the recipients removing export taxation and reducing import barriers.

Research by Christopher Adam and Stephen O''Connell, published in the January 2004 issue of the Economic Journal, suggests that the strategy of export promotion would be far more effective if instead of providing assistance as government-to-government grants and concessional loans, the donor countries were to improve preferential access for low-income countries to their own markets.

The research shows that for a ''typical'' African country, a temporary reallocation of donor assistance away from grants sufficient to finance a 10% improvement in trade preferences for manufactured goods for a period of five years could lead to a permanent increase in consumption per capita of as much as 5%.

The results are driven by two empirical features of aid and trade:
· First, large foreign exchange inflows tend to produce strong local currencies and strong currencies undercut the competitiveness of the export sector. This latter effect, referred to as the ''Dutch disease'' after the contraction of the manufacturing sector that accompanied the discovery of natural gas in Holland in the 1970s, is present regardless of the source of the inflow – whether from aid or export earnings. But when assistance is delivered as trade preferences, it is overwhelmed by the directly export-promoting impact of the expanded preferences. It follows that grants reduce exports, while trade preferences expand exports.
· Second, this clearly matters if exports matter for growth. As the Asian development experience suggests, ''learning by doing'' is an important source of long-run productivity gains in the export sector. Recent evidence suggests that exporting delivers dynamic efficiency gains for African manufacturing firms as well. It is these gains that generate real growth and hence permanent increases in GDP and consumption from the temporary reform of donor practices.

If trade preferences are superior to aid, why are they not employed more aggressively, particularly when export-led growth is a clear aim of many development assistance programs? One answer is that the preferences that matter, those that stimulate the largest potential productivity gains to the recipient, are in highly sensitive import-competing sectors in developed countries.

Another answer is that aid accrues to the public sector, where it is spent according to the priorities of the incumbent government, and export promotion is only now beginning to achieve the urgency in many low-income countries that it achieved among the Asian tigers starting in the 1960s. Historically, therefore, the demand for preferences has been weak, relative to the demand for aid.

The irony is that just as poor-country governments are becoming convinced of the benefits of outward orientation, global trade liberalisation is eroding many of the preference margins they have enjoyed relative to powerful developing country competitors.

One implication of this study, then, is that the effectiveness of donor assistance could be enhanced either directly, by explicit use of targeted trade preferences (as is the case in the United States'' African Growth and
Opportunity Act
) or indirectly by recognising the value to the recipient of using some part of an aid flow to finance temporary production or export subsidies in order to replicate the effect of donor financed trade preferences and thereby offset the potentially adverse side-effects of the aid inflow.

''Aid versus Trade Revisited: Donor and Recipient Policies in the Presence of Learning by Doing'' by Christopher Adam and Stephen O''Connell is published in the January 2004 issue of the Economic Journal. Adam is at the University of Oxford; O''Connell is at Swarthmore College, Pennsylvania.