Development Dialogue: How can emerging economies break free from the sidelines of global trade?

Transcript | Subscribe 

In this second episode of Development Dialogues, host Catherine Cheney is joined by Amit Khandelwal, Isabela Manelici and Arvind Subramanian to discuss the challenges that developing countries encounter when opening their markets to trade, the effectiveness of industrial policy and the implications of president-elect Donald Trump's administration for trade in these nations.

Development Dialogues, a collaboration between EGC and VoxDev, facilitates direct conversations between researchers and policy actors on pressing development issues. It builds on the VoxDevTalks podcast and Voices in Development, a podcast from EGC exploring issues related to sustainable development and economic justice in low- and middle-income countries.

The impact of opening up to trade is likely to vary significantly between developing and advanced economies due to fundamental differences in their economic structures. Research has examined the characteristics of these countries and how these factors interact with international trade, such as institutional quality, the strength of the rule of law, favoritism toward specific firms and market functioning, as covered in the VoxDevLit on International Trade.

An example of such favoritism was evident in China during the period of trade quotas between advanced and developing economies. Under these agreements, advanced countries committed to purchasing a fixed quantity of goods and the Chinese government allocated this production to specific firms. When the quotas were removed, the market shifted away from inefficient firms, encouraging competition based on efficiency and quality.

"That’s one thing that’s useful to think about in a developing country setting, where there may be favored firms who get access to special opportunities, where, in this case, free trade levels the playing field for everyone." - Amit Khandelwal

As developing countries started to open their economies in the early 1990s, there was a substantial increase in export growth, trade and overall economic growth. The immediate effects for these countries were significant and largely positive. However, the specific patterns of trade and export growth varied across countries depending on their underlying characteristics. For instance, India’s growth was more concentrated in high-skill services, influenced by constraints on firm size, whereas China’s expansion was driven by manufacturing and low-skill exports.

"The first order effects on Vietnam, Bangladesh, all these countries, they were actually positive and that has gotten lost in this whole retreat from globalization." - Arvind Subramanian

When countries open up to trade and foreign investment, this often includes encouraging multinational corporations to set up in their country. Many developing countries dedicate significant resources or offer favorable terms to attract multinationals, driven by the rationale that these corporations bring advanced know-how that can benefit the local economy.

One potential benefit comes from domestic firms joining a multinational's supply chain. Research from Costa Rica, for instance, has shown that integrating into the supply chain of a foreign multinational affiliate can enhance domestic firms' organizational capacity and reputation. Additionally, knowledge transfer can occur through worker mobility. Employees who gain experience working for a multinational may later bring their skills and insights to domestic firms or become entrepreneurs.

Multinationals can also influence local economies by promoting improved norms, such as better enforcement of labor standards and responsible sourcing practices. However, for these benefits to materialize, multinationals must be effectively integrated into the local economy.

The benefits of opening up to trade can often be amplified by attracting foreign direct investment (FDI). However, developing countries have displayed significant variation in their approaches to attracting FDI and the resulting impacts.

India, for instance, did not attract substantial FDI and has consequently been excluded from many global value chains, limiting its export potential. In contrast, Korea also did not rely heavily on FDI but climbed the global value chain through aggressive export-promotion policies.

This highlights the diverse policy approaches countries adopt to foster export growth and expansion, often through heterodox strategies. For example, China implemented a combination of policies, including aggressive exchange rate management and the establishment of free trade zones. India, by contrast, pursued relatively minimal industrial policy but still achieved growth in its export sector. These varied approaches underscore the importance of country-specific institutional features in shaping trade dynamics.

Both China and India had negative experiences with trade during colonial times, China was coerced into the Opium trade, while India faced de-industrialization. However, in the post-colonial period, the countries pursued divergent strategies with China using the opportunity to also change its domestic policy.

"In India, trade liberalization and domestic policy reform kind of proceeded orthogonally." - Arvind Subramanian

The use of industrial policy has been a topic of debate, as some countries have achieved export growth with it, while others have succeeded without it. This raises questions about whether industrial policy is advisable, particularly given concerns about state capacity in identifying and supporting "winners."

With the advent of more detailed administrative datasets, researchers are now better equipped to evaluate whether industrial policies have been effective in enhancing welfare.

Developing countries are also closely observing the experiences of advanced economies, many of which are adopting more nationalist approaches, and considering whether to follow suit. Even India, for example, has started using industrial policy, offering investment subsidies to attract foreign investment. Similarly, other developing nations are weighing the potential benefits of adopting nationalist economic strategies as seen in advanced economies.

However, many low- and middle-income countries face a critical challenge: their domestic markets are often too small to rely solely on internal markets for sustained economic growth and poverty alleviation.

"I think strengthening international alliances, continuing to invest in economic diplomacy with partners that are predictable, that have large, prosperous domestic markets, that are technologically advanced, I think, remains the winning strategy." - Isabela Manelici

With Donald Trump's recent election to a second term, there is increased scrutiny on globalization and the shift away from free trade. By examining his first term, we can glean insights into what his next term might entail for US trade policy and its potential impact on developing countries.

During his first term, the US imposed tariffs on approximately $450 billion worth of trade, affecting about 20% of US imports. In response, trade partners, particularly China, retaliated by raising their own tariffs. This trade conflict may have created opportunities for other countries as American consumers reduced their purchases of Chinese goods, turning instead to alternative low-cost suppliers from countries like Vietnam or Cambodia.

This pattern suggests that while protectionist policies may disrupt established trade flows, they can also open up new opportunities for developing nations to position themselves as competitive suppliers in global markets.

"By and large, you find on average, this result that countries did step in and start to export more to the US…but it’s actually quite heterogenous. Countries like Vietnam and Cambodia, they’re really strong responders to the tariffs..., but other countries, India being one of them, it’s not the case." - Amit Khandelwal

While many countries had to scale back trade with other partners to redirect flows toward the US, a subset of countries managed to also grow their trade with other nations. This variation raises important questions about the domestic policies and characteristics that enabled some countries to seize this opportunity effectively while others did not. Factors such as institutional quality, infrastructure, labor market flexibility, trade facilitation policies and integration into global value chains likely played a critical role in determining these outcomes. Understanding these dynamics is key for countries aiming to capitalize on similar trade opportunities in the future.

Although lessons can be drawn from the experiences of 2018 and 2019, the current context under Trump's second term may present different challenges. A potentially harsher stance on trade could involve targeting even close partners of China, such as Vietnam, which had previously benefitted during the earlier trade tensions. Policies might include stricter rules of origin and limitations on goods produced using Chinese inputs or technologies. This could, however, open up opportunities for countries like India, which are less integrated into China's global value chain.

To maximize the benefits of any opportunities arising from shifts in global trade policy, developing countries must address persistent frictions within their economies.

Globalization in the West has often been criticized for contributing to rising inequality in advanced economies. This narrative has influenced discussions about trade and globalization in developing countries, where similar language around inequality is frequently used. However, the effects of globalization differ significantly between low- and middle-income countries and advanced economies.

For many developing countries, trade has actually been expanding in recent years. For instance, trade between the Gulf states and parts of Africa has been growing rapidly. Moreover, while trade in goods experienced a slowdown following the financial crisis, trade in services has continued to expand. This growth in the services sector presents valuable opportunities, particularly for those with the capacity to engage in and export services. Recognizing these differences is crucial to framing conversations about globalization in the context of developing countries.

"I think, frankly, we're being ostriches in the sand here with the US, China and EU basically at loggerheads with each other. The prospects for any meaningful cooperation, at least on a multilateral level, are pretty dim, and so it's going to be each country opportunistically trying to figure out what we can do." - Arvind Subramanian

A complete restructuring of the multinational trade framework seems highly improbable, especially given the tensions between major players like the US and China. Instead, reform efforts might be better directed toward improving existing institutions, such as the WTO, so they can more effectively address unfair trade practices. Strengthening these mechanisms could reduce the tendency of nations to resort to unilateral actions, which have previously undermined multilateral cooperation.

For smaller countries, including many developing nations, unilateral actions pose significant challenges, as they lack the leverage of major powers like the US. Evidence from the UK’s Brexit experience highlights the negative consequences of "going it alone," reinforcing the importance of collective approaches to trade and international relations.

Even in the absence of robust international cooperation, understanding the feasibility of achieving international public goods is essential, particularly for addressing global challenges like climate change. A potential avenue for progress lies in technological innovation, which could lower the cost of renewable energy. China's experience with subsidizing solar panel production offers valuable lessons, demonstrating how subsidies can help support the shift towards renewable energy.

Amit Khandelwal is the Dong-Soo Hahn Professor of Global Affairs and Economics at Yale University. He holds affiliations at the National Bureau of Economic Research and Abdul Latif Jameel Poverty Action Lab.

Isabela Manelici is an Assistant Professor in the Department of Economics of the London School of Economics and Political Science. 

Arvind Subramanian is an Indian economist and the former Chief Economic Advisor to the Government of India. Subramanian is currently a senior fellow at the Peterson Institute for International Economics.