Quarterly Bulletin

TRADE AND FINANCING FOR TRADE: THE HIDDEN LINK IN CONTEMPORARY ECONOMIC DEVELOPMENT

It is undisputable that trade, either within regions or globally, will not solve all socio-economic challenges faced by poor countries. It is also clear that negotiation capacities of poor countries’ governments have not fully developed to a level where they can assertively secure enough resources to finance national development plans.

Even though trade remains on top of many national development strategies, major linkages that complement successful trade between and among nations have remained ambiguous, unexplored and veiled especially in low income countries.

While there seem to be a dichotomy between the formulation of development strategies and financing for these strategies in Low Income Countries, trade and trade finance are intrinsically interrelated. Imagine a successful economic development strategy without a trade component! But if trade is important, how do you finance for this important aspect? In addition, it is essential to realize that trade and financing for trade are an important aspect in the achievement of Goal 8 of the Millennium Development Goals. 

The inability to link these two aspects has contributed significantly to the near stagnation of economic activities in many poor countries. For Zambia, total trade has remained basically unchanged since the 1990s. The share of imports to Gross Domestic Product (GDP) has increased overtime as opposed to the share of exports. In 1995 for example, the share in GDP was 35.6%, it declined to 25.2% in 2003.

This scenario implies that Zambia’s contribution to the world economy is meager and its participation continues to decline. According to the 2006 United Nations Conference on Trade and Development (UNCTAD) report on exports, Zambia’s share in world exports declined from 0.024% to 0.014% in 2003.

The saga of undelivered pledges on increased Official Development Assistance (ODA) by the international community continues to drag down progress as far as financing for trade is concerned. In addition, the fact that LDCs’ leaders have no audacity to demand the fulfillment of these promises puts these low income countries, including Zambia, in a precarious situation as regards trade financing and trade capacity development. 

With the above information in mind, how can Zambia best finance for its trade? Is it possible for Zambia to get a good deal from existing sources of trade finance?

This piece of writing analyses the performance of two instruments of international trade financing namely: Aid for Trade and Foreign Direct Investment (FDI).

AID FOR TRADE

The case of Aid for Trade is remarkable. Aid for Trade involves the flow of development finance from rich to poor countries for the purpose of enhancing the world trading system. Aid for Trade is a proposed package by the IMF and World Bank for the provision of financial and technical assistance to developing countries for two related objectives. The first is to address supply-side constraints in developing countries (maximization of benefits) and the second is to assist developing countries to cope with adjustments in trade liberalisation which is presumed to be transitional (minimization of cost).

But is Aid for Trade the way forward for Zambia? The answer largely depends on initial conditions and macroeconomic fundamentals, domestic reforms which accompany the aid, delivery mechanisms, and their effectiveness and timeliness.

Zambia’s current macroeconomic climate, domestic reforms, trade, and export performance, make it a potential candidate for a robust Aid for Trade package. However, the design of an Aid for Trade framework involves the following three key questions, “What should be funded?”, “In what form should the aid be given?” and “Who should manage the transfer?”

On the ‘what should be funded’ question, official documents including the national budgets have from time to time shown that significant amounts of aid flows go into recurrent expenditure. Even when aid resources are channeled to capital expenditure, the country lacks efficient instruments to manage resources and eventually assess the impact of these resources on human development.  

There should be a realization that the attainment of benefits of aid for trade requires a three-pronged approach which focuses simultaneously on three pillars: Pillar 1 – harmonization with national development strategies, e.g., the Fifth National Development Plan (FNDP); Pillar 2 – improvements in the international trade regime; and Pillar 3 – increased and effective international       financial        and technical assistance (Aid and FDI). Aid is only one of the three pillars in actualisation of benefits of Aid for Trade, focusing selectively on aid and mobilizing resources and commitments from the international community.

As emphasized in the Hong Kong Ministerial Declaration of 2005, Aid for Trade should aim at helping developing countries like Zambia, to build the supply-side capacity and trade-related infrastructure that they need to assist them to implement and benefit from WTO agreements and more broadly to expand their trade.

FOREIGN DIRECT INVESTMENT (FDI)

The second source of trade finance is FDI. This is a financial investment in a domestic enterprise by which a foreign investor gains a significant equity stake in the firm. In most national accounting systems, FDI is defined as an equity share of 10 percent or more.  Besides selling equity, enterprises finance their operations through debt, including loans from banks and other financial institutions. It must be noted that the major players in FDI are Transnational Corporations (TNCs).

Given the predominance of TNCs, a conventional definition of FDI is a “form of international inter-firm cooperation that involves significant equity stake and effective management decision power in, or ownership control of, foreign companies.”

FDI, in short, is more than a flow of capital. It is a cross-border expansion of production undertaken primarily by large corporations.  FDI takes place in two ways:  “Mergers and Acquisitions” (M&As),  that is, the purchase by TNCs of existing domestic companies, in whole or in part; and “Greenfield Investment,” that is, additions to the capital stock and the creation of  new productive capacity.

In Zambia, FDI has been manifested in several forms. The purchase in part of state owned companies such as the Zambia National Commercial Bank (ZANACO) by Rabo Bank of the Netherlands and in whole, the Zambia Consolidated Copper Mine (ZCCM) by Vendetta of India. We have seen an influx of insurance companies such as Professional Insurance Company which is an example of Greenfield Investment.

However important FDI can be to a country, it is worthless if it cannot improve the welfare of the general citizenry. The expectation from FDI is that it will bring capital accumulation which leads to job and wealth creation. The 2008 National Budget Address shows that copper production increased by 1.5 percent to 523,435 metric tones in 2007 from 515,618 metric tonnes in 2006. At the same time, reports reveal that more people were employed in 2004 compared in 2006. This reflects an inverse relationship between FDI flows in Zambia and employment creation. 

Perceiving FDI as an engine of growth is a formula prescribed by mainstream economic theory, the International Monetary Fund (IMF) as well as other global development organizations. These hold that given the appropriate host-country   policies and a basic level of development, FDI triggers technology spillovers, assists human capital formation, contributes to international trade integration, helps create a more competitive business environment and enhances enterprise development. All of these contribute to higher economic growth, which is the most potent tool for alleviating poverty in developing countries. In reality, to capture the benefits of FDI, a country must already have reached some kind of “development threshold.”

However, a more feasible, sustainable development strategy should be the development of endogenous capacities for production and innovation, rather than embark on policies skewed towards attracting foreign investment.  

Macroeconomic policies should aim to enhance the overall climate for investment, both domestic and foreign. Instead of encouraging FDI to flow towards export platforms for the assembly of imported inputs, industrial and technology policies should aim to develop local skills, local markets, and solid, world-class domestic firms.

Trade and financing for trade are important engines of growth in today’s economies and the government should be endeavour to explicitly mainstream these two aspects in economic policy plans.  In working towards sustained human and economic growth, and especially the achievement of MDG 8 - develop a global partnership for development , major reforms in both the national and global financial architecture is necessary.

Let existing forms of trade finance work for the benefit and not the oppression of the poor countries

 

Tina Nanyangwe
JCTR Staff