2. The GATT/WTO

Over the postwar period, the GATT helped facilitate the reduction in trade barriers in the United States, Western Europe, and Japan (Bown and Irwin, Reference Bown, Irwin, Elsig, Hoekman and Pauwelyn2017). Given this experience, the GATT would seem ideally placed to help developing countries reform their trade regimes.

As already noted, however, the GATT is a weak institution. It is mainly a forum for countries to discuss trade rules and negotiate tariff reductions. It did not have any independent power to affect policy in participating countries. It could not offer any financial incentives to promote policy changes. It did not advise countries as to what their policies should be or even promote research findings that might encourage policy reforms. It did not conduct any monitoring or surveillance of country policies, at least until the Trade Policy Review Mechanism was established in 1989 in the WTO. It had difficulty addressing violations of trade rules until the establishment of the dispute settlement system in 1995.

Despite these weaknesses, the GATT could have promoted reform through its rules on trade policy, multilateral negotiations to reduce import restrictions, and accession agreements. With some notable exceptions, none of these mechanisms played an important role in the trade reform wave of 1985–1995.

The GATT rules were ineffective because developing countries were exempt from key disciplines.Footnote ³ For example, Articles XII and XVIII(b) permitted these countries to impose quantitative restrictions (QRs) on imports to safeguard the balance of payments and promote economic development. These were enormous loopholes that allowed developing countries to justify almost any restriction on imports. As a result, developing countries maintained extensive nontariff barriers – including foreign exchange controls, import licensing, and other QRs – ostensibly on balance of payments grounds. Such measures were supposed to be temporary or transitional, but the GATT provided very little oversight and allowed them to persist for decades without challenge.Footnote ⁴

Developing countries were also exempt from reciprocity in trade negotiations.Footnote ⁵ They did not participate in the tariff reductions negotiated during the Kennedy Round of the 1960s and the Tokyo Round of the 1970s. Perhaps no deal could have been struck, given developed countries’ reluctance to open markets in agriculture and labor-intensive manufactures. But developing countries also insisted on special and differential treatment; that is, nonreciprocal and preferential treatment by developed countries.Footnote ⁶ Even if they had participated in the negotiations, tariffs were not the principal barrier to trade in developing countries, given the QRs they imposed.

When developing countries began to dismantle their import control regimes and reduce their tariffs in the late 1980s and early 1990s, they did so unilaterally without the GATT being much involved in the process. Two-thirds of the reduction in the weighted average tariff of developing countries, which fell from 29.9% in 1983 to 11.3% in 2003, came from unilateral action (Figure 1). Just one quarter came from multilateral negotiations, most of which was due to China, and one tenth from regional trade agreements, according to a striking calculation by Martin and Ng (Reference Martin and Ng2004).Footnote ⁷

Figure 1. Most developing economy tariff reductions between 1983 and 2003 were undertaken unilaterally.

Note: Developing countries defined using World Bank classification.

Source: World Bank (2005, 42), based in Martin and Ng (Reference Martin and Ng2004).

Developing countries did make tariff concessions in the Uruguay Round, agreeing to reduce their bound tariffs and increase the share of their bound tariff lines. However, the bound tariffs were much higher than the applied tariffs, which were left largely untouched in the negotiations. Figure 2 shows that the slight cuts in bound tariffs still left those rates considerably higher than the applied tariffs. Consequently, the reduction in bound tariffs by developing countries negotiated in the Uruguay Round had little impact on their trade flows.

Figure 2. Developing economies set tariffs below their obligations under the Uruguay round

Note: Developing countries defined using World Bank classification.

Source: Finger, Ingco, and Reinchke (Reference Finger, Ingco and Reincke1996).

Countries acceding to the GATT in the 1970s and 1980s did so without many demands placed on them. Mexico (1986), Morocco (1987), and Costa Rica (1990) joined while they were making, or after they had made, unilateral changes to their trade policy (Pastor and Wise, Reference Pastor and Wise1994). By contrast, countries seeking to join the WTO from 1995 on, mainly transition economies, were required to make significant concessions as part of the accession process, although this was largely after the reform wave of the late 1980s and early 1990s. The WTO accession process was vigorous and demanding in the cases of Bulgaria (1996), China (2001), Cambodia (2004), Saudi Arabia (2005), Vietnam (2007), and Russia (2012). China, for example, made extensive changes to its trade regime as part of a long, drawn-out process of gaining admission to the WTO (Lardy, Reference Lardy2002). These requirements were imposed so that these countries could not free ride on the previous tariff reductions made by others.

This accession process created a two-tiered system of insiders and outsiders. Nothing was asked of the insiders, the developing countries that were already part of the GATT, whereas much was asked of the outsiders seeking to join. They had to undertake far-reaching trade reforms to gain admission to the club. Subramanian and Wei (Reference Subramanian and Wei2007) and Dutt (Reference Dutt2020) provide empirical support for this insider–outsider view. They find that developing countries already in the GATT did not see their imports increase significantly as a result of the Uruguay Round because they did not liberalize their trade within the GATT. Countries that joined the WTO saw a significant increase in their imports because they had to undertake substantial trade reforms.

In sum, the GATT was not the driving force behind the trade reforms of 1985–1995. But it was not entirely irrelevant to the liberalization process either. Countries outside the system, such as China, had a strong incentive to join the organization as the benefits of receiving most favored nation status in the global institution were growing. Given the importance of China to the world economy, this example alone suggests that the GATT/WTO played an important role in the reform process of developing countries.

3. The World Bank

The World Bank was not always a champion of trade reform. In its first few decades, it focused on project loans and infrastructure lending, with economists taking a back seat to engineers. The Bank was inclined to support open markets, but it also sought to promote industrialization, which sometimes entailed financing projects whose goal was import substitution.Footnote ⁸

Economists began to play a larger role in the Bank in the 1970s under President Robert McNamara. The world economy was rocked by two oil shocks and other macroeconomic turbulence during that decade. There was also a growing sense that Bank-sponsored projects would not generate high rates of return or help increase growth and reduce poverty when recipient countries had poor economic policies.Footnote ⁹ In 1979, McNamara (Reference McNamara1979, 20) proposed new loans to assist developing countries in making ‘structural adjustments for export promotion in line with their long-term comparative advantage’. In 1980, the Bank began offering structural and sectoral adjustment loans conditional on policy changes, including trade policy. Sectoral adjustment loans for trade policy amounted to $7.4 billion over the 1980s (mostly 1986–1989), about 5% of total Bank lending (World Bank, 1992, 18).Footnote ¹⁰ The Bank also provided technical assistance and advice to countries seeking to reform their trade policy.

The results of the trade policy loans were mixed, according to assessments inside and outside the Bank. Examining 40 countries that received trade policy loans in 1980–1987, Thomas (Reference Thomas, Thomas, Chhibber, Dailami and de Melo1991, 57) concluded that ‘direct examination of the conditions in trade adjustment loans and their implementation records suggests that import protection on average has fallen only modestly in most of these countries’. Countries may have adjusted their exchange rates and removed export restrictions, but the reduction of import protection ‘has been modest at best’.Footnote ¹¹ The report found that weak macroeconomic performance and inadequate government commitment to reform were responsible for the failure to fully implement or sustain the changes. Even strong reform advocates (e.g., Edwards, Reference Edwards1997; Nogués, Reference Nogués and Krueger1998; Krueger and Rajapartirana, Reference Krueger and Rajapartirana1999) concluded that Bank lending did not produce much change in the trade policies of loan recipients.Footnote ¹²

Why was the track record so mixed? The Bank identified the lack of country ‘ownership’ of the reforms – i.e., the reluctance of policymakers to undertake reforms – as the key problem. If a country's political leaders did not want to reform, offering them financing was not going to persuade them to do so. Studies found that domestic political considerations usually determined whether a country was willing to reform, not the presence or absence of Bank-provided loans.Footnote ¹³ However, in some cases, loans gave a political boost to reformers in governments that were divided over whether to reform or not, tipping the balance in favor of making an attempt at reform.Footnote ¹⁴

The Bank was particularly disappointed in its efforts to promote policy reform in Africa. The basic problem was that many countries were happy to take the loans but not change their policies. In a damning report, Devarajan et al. (Reference Devarajan, Dollar and Holmgren2001, 34–35) wrote: ‘In the pre-reform phase in which the government is not committed to reform, conditional loans have generally been a farce in which the government agrees to measures it does not believe in as a way to get funding, fails to carry them out, and then receives the funding from donors anyway.’ This led to a repeated cycle of lending and noncompliance, in part because of institutional incentives in the Bank to continue providing loans. Breaking this cycle by withholding funds sometimes proved more effective at promoting reform because it forced countries to face a tighter budget constraint. As Michael Bruno, former chief economist at the World Bank, said: ‘We did more for [reform in] Kenya by cutting off aid for one year, than by giving them aid for the previous three decades’ (Devarajan and Khemani, Reference Devarajan, Khemani, Basu and Cordella2018, 216).

The failure of conditionality to guarantee policy reform was apparent by the late 1980s. By the mid-1990s, the World Bank shifted its financial support for trade policy from subsidizing policy reform to supporting trade facilitation and infrastructure.

The Bank also provided technical assistance to help with the process of trade reform, particularly in dealing with sequencing and implementation issues (Thomas and Nash, Reference Thomas and Nash1991). The Trade Expansion Program, funded by the United Nations Development Programme and administered by the World Bank, began in 1987 to provide independent technical expertise in designing and implementing reform programs without conditionality. The goal was to have independent assessment teams (rather than World Bank staff) provide advice and thereby increase local ownership of reform. But even this provision of technical assistance was not a clear success. Berg (Reference Berg, Nash and Takacs1998, 318) offered the sobering conclusion that ‘local officials, economic interest groups, and political classes saw these policy reform programs as an outside imposition, a perception reinforced of course by the dominance of conditionality in the dialogue, and by the limited extent of genuine bureaucratic and political participation in the process. Therefore, adoption of reforms was slow and local commitment to them lukewarm.’Footnote ¹⁵

Arguably more important to reform than conditional lending was the Bank's role in disseminating research on economic policies that contribute to growth and development.Footnote ¹⁶ The Bank helped shift the intellectual consensus among policymakers toward an understanding of the benefits of a liberalized trade and payment regime (Irwin, Reference Irwin2020). The prodigious writings and travels of Bela Balassa, a long-serving consultant at the Bank in the 1970s and 1980s, helped change prevailing views – inside and outside the Bank – away from import substitution toward openness and export orientation. He forcefully and consistently argued that exports were a source of growth, that a market-appropriate exchange rate was critical to export expansion, and that import restrictions were often arbitrary and costly. Anne Krueger's intellectual leadership as chief economist at the Bank (1982–1986) put a spotlight on trade research, especially the distortions caused by excessive trade restrictions. This effort, including the famous 1987 World Development Report on trade, added to the growing body of evidence that a more liberal trade policy could improve economic performance. The change in intellectual mindset about trade and development is hard to measure or even explain to anyone who did not live through the 1970s and 1980s.Footnote ¹⁷

A more concrete way the Bank contributed to trade reform was by serving as a training ground for officials who would return to their home countries, take high-ranking positions in government, and become important players on reform teams that brought about policy changes.Footnote ¹⁸ The rise of Western-trained economists, many with World Bank experience, to high-ranking government positions has been tied to the spread of trade liberalization around the world (Weymouth and Macpherson, Reference Weymouth and Muir Macpherson2012).

In sum, the effectiveness of the World Bank's efforts to promote trade reform through conditional lending is generally viewed as mixed: countries that wanted to reform did not need the loans to do so and countries that had no intention of reforming were happy to take the loans, although some countries may have been persuaded to undertake reforms that otherwise might not have been done. The Bank may have had a bigger impact on trade policy through the dissemination of research findings about the benefits of a more liberal trade policy and its technical expertise about how to implement such reforms.

4. The International Monetary Fund

At first glance, the IMF appears to be the institution with the least relevance to a country's trade policy. Its primary focus is macroeconomic stability, for example through inflation control and fiscal deficit reduction. But in its attention to exchange rates and foreign exchange controls, the Fund played a very important role in enabling countries to take the first step of the ‘trade policy three-step’.

Trade controls and import restrictions often stem from balance of payments difficulties, which in turn arise from an overvalued currency (Shatz and Tarr, Reference Shatz, Tarr, Hoekman, Mattoo and English2002). An overvalued exchange rate reflects a failure to adjust the nominal exchange rate when a country experiences more rapid inflation than its trading partners or a significant terms-of-trade shock. An overvalued currency depresses exports and leads to excessive imports, putting pressure on foreign exchange reserves. Governments that fear devaluation as a remedy are led to impose exchange controls and foreign exchange rationing as a way of limiting imports.Footnote ¹⁹

The Fund's work in this area has been important because exchange controls and foreign exchange restrictions have been a considerable impediment to trade (see Wei and Zhang, Reference Wei and Zhang2007; Eichengreen and Irwin, Reference Eichengreen and Irwin2010). The problem with the license raj in India, for example, was not the high tariffs but the exchange control regime that produced a complex maze of bureaucratic regulation that prevented imports from entering the country, ostensibly to conserve foreign exchange. The GATT was considered so ineffective in this area that in the 1970s IMF officials considered (but rejected) a proposal giving itself the authority to approve or disapprove of restrictions on current account payments (de Vries, Reference de Vries1985, 704–705).

From the start, the Fund encouraged countries to establish currency convertibility for current account transactions. It opposed illiberal payment regimes that included multiple exchange rates, exchange controls, and foreign exchange rationing. Although it was founded to promote exchange stability, the Fund grew to see the merits of exchange rate flexibility to ensure that the exchange rate was set at a realistic level.Footnote ²⁰

The IMF began to play a more important role in developing countries in the 1980s, advising them on how to reduce external deficits while keeping payments systems open (Boughton, Reference Boughton2001). IMF officials were in frequent contact with central bankers and finance ministers, pressing them to work toward a greater opening of the economy. By quietly encouraging countries to devalue, the Fund was laying the groundwork for dismantling exchange control regimes and establishing current account convertibility. As Paul Collier (Reference Collier1993, 510) put it: ‘The heart of liberalization is the conversion from using trade policy for payments balance to using the exchange rate.’ That is precisely what the Fund was trying to do. Countries could not begin to convert quantitative restrictions on imports to tariffs and then reduce those tariffs without first undertaking a devaluation to eliminate the excess demand for foreign exchange.

The Fund's work in this area has been unheralded in part because it is very hard to measure or even document because every country's experience is unique. As a result, there is no systematic evidence on its impact on policy (Johnston, Reference Johnston1999). What is known is that the share of countries with nonunified exchange rates fell from about 50% in the mid-1980s to about 15% by 2000 (Figure 3). During the 1993 review of surveillance, the managing director of the IMF, Michel Camdessus, told the executive board that the Fund was not doing enough to get countries to eliminate exchange restrictions and accept the obligations of Article VIII (Boughton, Reference Boughton2001, 128–129). An increasing number of countries accepted those obligations throughout the 1990s.

Figure 3. The number of countries with nonunified exchange rates plummeted after the mid 1980s.

Source: Ilzetzki, Reinhart, and Rogoff (Reference Ilzetzki, Reinhart and Rogoff2019).

While the IMF was deeply involved in exchange rate discussions with countries, it was less concerned about trade policy. In the 1980s, in cooperation with the World Bank, the Fund began to incorporate trade policy reforms in its lending programs. IMF conditionality is generally much tougher than the Bank's and therefore might be more effective at inducing policy change. But the Fund's trade reform conditions were never a key part of its structural adjustment programs.Footnote ²¹ In a self-assessment, the IMF (1998, 6) found ‘programs that targeted a reduction in restrictiveness generally succeeded in achieving their trade reform objectives’ but ‘medium-term trade reform targets although mentioned often were generally insufficiently specific and comprehensive’ to be effective. Therefore, ‘longer-term Fund involvement in countries during 1990–1996 does not seem to have promoted greater trade liberalization in the programs reviewed’.Footnote ²²

Many countries joined the IMF in the early 1990s, but stringent entry conditions were not applied, unlike the WTO accession process. However, members that fell into arrears with the IMF (i.e., they did not repay its loans) were cut off from international capital markets and had to negotiate a tough package to escape from purgatory. The Fund helped several countries – notably Peru, Cambodia, Vietnam, and Zambia – move out of arrears by adopting more realistic exchange rates and greater openness to trade.

In sum, the IMF has played a quiet and somewhat underappreciated role in the reform of developing-country trade policy. The IMF historian Margaret de Vries (Reference de Vries1994, 229) once chided economists for failing to appreciate ‘how the gradual lifting of exchange controls enabled world trade and services to increase, and how real exchange rate depreciation by developing countries helped integrate them into the world economy’. The IMF, she points out, ‘was instrumental in persuading countries of the need for noninflationary macroeconomic policies and in pushing countries to lift trade restrictions in line with their improving external payments situations.’