Two steps forward, one step back: LDCs and the challenges of South-South trade in times of ‘Shifting Wealth': By Andrew Mold and Annalisa Prizzon

4 November 2011

Despite the pessimism that reigns in many high-income economies since the financial meltdown of 2008-2009, for most of the developing world the outlook is much rosier. In a dramatic turnaround in their fortunes after the debt-crisis of the 1980s and the financial turmoil of the 1990s, for the first time in many decades emerging and developing countries are now converging to per capita income prevailing in advanced economies. In the 2000s, as many as 88 emerging and developing economies were growing at least twice as fast as advanced economies (Figure 1). This positive development took place in a global landscape characterized by a more propitious external environment (with high levels of global liquidity and high commodity prices), improved fiscal and monetary management and, pointedly, much stronger ties between developing economies themselves.  This phenomenon has been defined by OECD (2010) as Shifting Wealth, referring to the shift in the centre of economic gravity from West to East and from North to South characterizing the global economy since the beginning of the 2000s.

Notes: Authors' elaboration on the basis of World Bank (2011). Affluent denotes high-income economies. Converging countries are emerging and developing economies which grew at rate more than twice higher than the average GDP per capita growth in high-income OECD countries. Struggling and poor countries are middle-income and low-income countries respectively who failed to meet this condition.

A driving force behind the improved performance of most emerging and developing countries has been the growing importance of trade between developing countries, often termed South-South trade (somewhat misleadingly, as some of the most important drivers of this process are located in the northern hemisphere). The volume of South-South trade grew more than eleven times from 1990 to 2008 while North-North trade increased three fold only. The share of developing countries in global trade jumped from 22 percent in 1990 to 37 percent in 2010. Nearly half of that trade is now between developing countries themselves (e.g. South-South trade) rather than with a northern partner. South-South trade proved to be particularly important during the global financial crisis - in the face of a sharp fall in demand in the western economies and continued demand from the Asian giants, India and China which contributed to a quick recovery in commodity prices - something quite exceptional in times of a global recession.

Yet the benefits of Shifting Wealth have not been evenly shared. Only 23 out of 48 Least Developed Countries (LDCs) have been converging to OECD per capital levels, despite the fact that, in principle, income convergence should be easier to achieve starting at lower levels of per capita income. Many of these countries are small, open and vulnerable economies exposed to the volatility caused by the 2008-2009 financial and economic crises. Shifting Wealth presents both risks and opportunities for LDC countries.

Take, for instance, the case of commodity producers. Commodity prices bounced back in mid-2009 to pre-crisis level.  For some LDCs, in principle this implies higher export earnings - either soft commodities such as tea or coffee, or hard ones such as minerals and oil - but also new export opportunities in the rapidly expanding markets of other developing countries. So the new dynamism in South-South trade impacts positively on both volumes and prices of LDC exports. However, many other LDCs are net importers of commodities, particularly fuels and food, leading to a situation in which these countries are negatively impacted by the rise of commodity prices. Food riots which took place a number of LDCs over the last few years are one of the consequences.  In fact, a surprisingly high share of current LDC food imports comes from other developing countries - 69 percent in 2006-2007 according to figures by Aksoy and Ng (2010). So in a very real sense food security for LDCs is increasingly tied up with developments in the agricultural markets of other developing countries.

In principle, many LDCs are in a strong position to take advantage of the commodity boom, possessing as they do significant shares of the world's strategic minerals, oil and arable land. Large land deals in Africa and Asia are important signs of growing mistrust in world markets. Food importers that can afford to do so - i.e. Saudi Arabia, Kuwait, China - are increasingly opting to grow food on land they own or control abroad rather than importing it from international markets - LDCs such as Ethiopia, Madagascar, and Mali have been involved in major deals of this kind. While potentially offering resources and opportunities through capital flows and technology transfer, land deals also entail a series of risks and challenges, such as limited job creation, a lack of contractual transparency, and the displacement of local populations. Higher demand from the Asian giants for commodity exports could also potentially exacerbate what is popularly known as the "resource curse": Unable to manage the newfound bonanza effectively, greater demand for commodities could end up undermining already weak governance and lead to the contraction of employment-creating export sectors in manufacturing and agriculture.

Another issue confronting LDCs is the extent to which it is becoming increasingly difficult to break into value-chains. China, in particular, is in the middle of a complex network of subcontracting, importing raw materials and elaborated inputs and exporting final consumption goods. Low-income and middle-income countries need to gradually move up the value chain towards higher-quality or differentiated products and integrate into these value-chains if they wish to remain competitive over the long run. But around 70 percent of South-South trade in manufactured goods is intra-Asian trade, and few LDCs have managed to break into those value-chains. For the rest of the LDCs, particularly outside of Asia, trade outside of commodities is still very limited. Indeed, many LDCs have seen their dependence on commodities increase over the last decade. Unless one believes that the ‘commodity supercycle' will continue unabated (as some observers seem to believe), this is a worrying development, implying short term gains from greater volumes of commodity exports at the cost of long-term developmental potential.

Greater South-South trade has also been associated with growing competition in many international markets. In parts of Africa, for instance, local markets have been flooded by cheaper consumer durables from other developing countries, particularly China. To be sure, this has had some positive impacts, in terms of reducing the costs of these goods to relatively poorer consumers. But it also threatens the existence of any nascent consumer goods industries in these countries. Some LDCs have thrived in this new environment. Bangladesh, for example, has sustained a vigorous export industry in textiles, despite the phasing out of the Multi-Fibre Agreement. Other LDCs have, however, fallen by the wayside - Lesotho, for instance, lost many jobs in its textile industry in 2005-2006, as a result of increased competition from India and China in its export markets.

The policy implications of this new global scenario for LDC governments are various:

A major challenge is making sure the dynamism of South-South trade is sustained. Despite its dynamism, tariffs on S-S trade are still surprisingly high. Mold and Prizzon (2011) estimate that average tariffs on South-South manufacturing trade are seven times higher than on North-North manufacturing trade. This is also true of capital goods - high tariffs are often applied on the import of machinery and equipment when LDCs could be reaping the benefits of the lower costs of capital goods (i.e. equipment and machinery) provided by other developing countries. It is little wonder in these circumstances that most South-South trade outside Asia is based on primary commodities. And, as one of John Maynard Keynes's disciples, Joan Robinson, once said, ‘just because your trading partner throws rocks into his harbor does not mean that you should do the same'.

In this context, at a time when the Doha Round is looking increasingly moribund, LDCs should not use this as an excuse for inaction. They need to be actively involved in processes such as the São Paulo Round - the UNCTAD initiative which involves developing countries discussing among themselves ways in which they can usefully reduce their barriers to trade.

Another rather obvious implication for LDCs is the growing need to ‘make regional integration schemes work' - a long-standing objective, to be sure, for many LDCs, but one which now has added urgency. How can small LDCs expect to compete with the rising giants - Brazil, with nearly 200 million consumers, India and China with 1.2 and 1.3 billion respectively? Small LDC markets are becoming anachronistic in a global economy which is becoming, through the processes of Shifting Wealth and globalization, more and more integrated. The rapid development of regional integration processes like the East African Community, which has now removed all tariffs on internal trade, is encouraging, but LDCs in other region need to take up the gauntlet themselves.

Finally, in the case of mineral and/or fuel exporting LDCs, a critical issue is to channel efficiently the windfall gains derived from Shifting Wealth into investment in infrastructure and education, as well as for specific measures to spur the diversification of the economy. Indeed, Shifting Wealth brings to the fore the need for all developing countries to develop national innovation strategies if they are to remain competitive. The enormous technological efforts of the large Asian economies bring this challenge into sharp relief. China has expanded its expenditures on R&D rapidly, and measured in PPP terms is now second only to that of the United States. India's R&D expenditures have been increasing at around 20 percent per year. Although they obviously face serious constraints, LDCs cannot afford to completely ignore these questions. Rwanda, which has laid out plans to become the ICT-hub of East Africa, is a notable example that even LDCs can articulate ambitious policies to enhance competitiveness.

Authors:

Andrew Mold is a Senior Economist at the OECD Development Centre, and has previously worked for the United Nations in Chile, Costa Rica, and Ethiopia. He has worked extensively on issues related to international economics and development policy.

Annalisa Prizzon is an Economist at the OECD Development Centre and holds a PhD in Economics from the University of Pavia (Italy).

References

Aksoy, M.A. and F. Ng (2010) "The evolution of agricultural trade flows," Policy Research Working Paper Series 5308, The World Bank.

Mold, A. and A. Prizzon (2011), "South-South trade liberalization as a way out of the financial crisis? - An exploratory CGE simulation", mimeo.

OECD (2010), Perspectives on Global Development - Shifting Wealth, OECD, Paris.

World Bank (2011), World Development Indicators, World Bank, Washington DC.

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