Jon Lomoy: Aid for Trade - A Success Story?

By Jon Lomoy, Director, OECD Development Cooperation Directorate

Aid for trade constitutes the most successful initiative that has hitherto emerged from the multilateral trade negotiations under the Doha Development Agenda.

Donor commitment to aid for trade remains strong, even as the Members of the OECD Development Assistance Committee face financial difficulties in the wake of the 2008/9 Great Recession. Over the past decade donors have consistently supported aid for trade with the value of their assistance increasing by 60% in real terms from the 2002-05 benchmark to approximately USD 41.5 billion in 2011. Similarly, gross disbursements while declining by USD 1.3 billion in 2011, were still 53% above the benchmark. Increasingly, providers of South-south cooperation and the private sector are stepping up their support to address trade-related constraints in partner countries.

There is now abundant evidence that aid for trade is lowering trade costs through additional infrastructure, better institutions such as customs and standards authorities, as well as more trade-friendly policies and regulations. Aid for trade is particularly effective when recipient countries have stable macroeconomic policies and a supportive business environment that encourages private investment.

The evidence on the positive impact of aid on trade and development is buttressed by the results of 269 case stories submitted by partner countries, bilateral and multilateral donors and providers of South-South co-operation and regional economic communities.  Although not always easy to attribute cause and effect, the stories show the tangible results of how aid for trade in action is helping developing countries build the human, institutional and infrastructural capacities they need to benefit from trade opportunities.

Results reported range from increased trade volumes, to more employment, additional foreign and domestic investments, gender empowerment, and impacts on poverty, economic growth and the attainment of the MDGs (see figure 1).

Beyond the abundant albeit subjective evidence, our econometric analysis suggests that aid for trade is broadly correlated with improvements in trade performance. In fact, 1 USD in aid for trade is associated with an 8 USD increase in exports for all developing countries, 9 USD for the low and lower-middle income countries and 20 USD for the LDCs. These results confirm the findings of other empirical studies and clearly signal  the effectiveness of aid for trade.

In short, the Initiative has delivered on its promise of additional and effective aid. But is it also apt for a world in which value chains dominate trade and investment?

The whole process of producing goods, from raw materials to finished products, is increasingly carried out wherever the necessary skills and materials are available at competitive cost and quality.  Our analysis shows that success in today’s international markets depend as much on the capacity to import high-quality inputs as on the capacity to export; intermediate inputs account for over two-thirds of the final goods and 70% of the services we trade.

These value chains provide developing countries with access to global markets, capital, knowledge and technology. They offer a step towards economic development that is easier to take than the leap of creating an integrated production process. For instance, even a small country such as Samoa canbenefit from value chains (through producing automotive components for Toyota or high quality products for the Body Shop). Participating in value chains can also provide big dividends: developing countries with the fastest growing value chain participation have GDP per capita growth rates of 2% above average.

To integrate into value chains, developing countries need to have an open, transparent and predictable trade and investment regime. If every country improved just two key supply chain barriers – border administration and infrastructure and related services-  global GDP could increase by nearly 5% and trade by 15%. With intermediate goods crossing borders multiple times trade facilitation is a key factor in accessing markets: a 1% reduction in trade costs could potentially increase global income by USD 40 billion. Reforms negotiated in the WTO could reduce trade costs by as much as 16% in some developing countries.

But integration into value chains is indeed only a first step.

To strengthen the benefits that developing countries can derive from their value chain engagement, governments should support investment in knowledge assets, such as R&D and design, to enable firms to differentiate their products.  They should also strengthen the services sector and foster the development of key economic competencies, notably skills. Such domestic policies can help countries climb the global value chain ladder and prevent them from getting stuck in low-value activities.

These measures may be difficult for the poorest developing economies, but aid for trade is helping developing countries tap into the power of markets and connect to new growth poles in the global economy. Much has been achieved since the start of the Aid-for-Trade Initiative in 2005. The proliferation and the deepening of value chains and the concomitant widening of trade opportunities for developing countries underscores the case for and value of aid for trade.

Still there is room for improvement, such as further engaging providers of South-South co-operation and the private sector, expanding the focus from ODA to development finance, improving the conditions for regional projects, and better managing aid for trade and development results. The Global Review on Aid for Trade - the pre-eminent forum for discussing trade and development issues - must continue to put a spotlight on aid for trade and in particular these issues. Finally, with inclusive economic development becoming a central theme of the post-2015 development debate, there is a clear on-going role for aid for trade to contribute to economic inclusion.

Editor's Note:

This blog is part of an Aid for Trade special with the Overseas Development Institute, the OECD and the WTO.