Towards a new generation of Aid for Trade

30 September 2013
ITC News
There is a need to shift focus from Aid for Trade to Investment for Trade.

At the World Trade Organization’s (WTO) Fourth Global Review of Aid for Trade held in July 2013, two main messages emerged. The first message is that global value chains and production networks matter and have implications on the effectiveness of Aid for Trade. The second message is that Aid for Trade cannot be seen as separate from a new financing context that involves the leveraging of other capital flows. This can be termed ‘third-generation Aid for Trade’.

Aid for Trade was first conceived as a transfer of resources to compensate for the erosion of trade preferences due to multilateral trade liberalization, according to the Hong Kong declaration of 2005. Since then, the focus on the original purpose has been lost and many trade and development experts have begun seeing Aid for Trade as just a standard aid flow. We will see another change in the near future: Third-generation Aid for Trade is expected to help bring together investment finance with trade and investment opportunities. The Ninth WTO Ministerial, which will be held in Bali, Indonesia, in December 2013, will need to recognize this new context in order for Aid for Trade to remain relevant and effective in the future.

Recent discourse among trade experts has highlighted the importance of value chains. Developing countries are increasingly taking part in global value chains – for example, those involving electronics, food products, garments or horticulture – which often require goods to be imported before they are processed and exported. This confirms the idea that import protection is self-defeating because it hurts the build-up of local productive capacity. It also shows the importance of building infrastructure that supports value-chain development, which facilitates trade in global markets. Another key point is that trade within value chains depends on the identification of an appropriate niche and good communication among firms in the chain. Therefore, finding the right institutional setting for effective industrial policy is more important than ever. Aid for Trade can promote opportunities for SMEs to take part in value chains and shift the focus from general trade rules to problem-addressing policies, which will be even more effective in the context of good relations between states and businesses.

Aid for Trade also needs to keep pace with rapid changes in the flow of international finance directed at developing countries. It has helped secure significant aid spending (see figure) and now accounts for one-third of official development-assistance spending, chiefly as a result of increased spending on infrastructure. Still, in 2011, overall funding for Aid for Trade (now at US$ 33 billion annually) declined – a fall that likely continued in 2012. Whereas aid prospects from the countries belonging to the Organisation for Economic Co-operation and Development (OECD) are faltering, aid from other regions looks more promising.

As countries grow and structurally transform themselves, they rely less on external aid and more on other capital flows (in addition to domestic sources). Hence, the key question is, how can Aid for Trade leverage other capital flows for capacity building, especially when aid flows are under pressure? For example, Cambodia’s aid-to-gross domestic product (GDP) ratio decreased from 11.2% in 2000 to 6.9% in 2010, while the foreign direct investment (FDI)-to-GDP ratio increased from 4.1% in 2000 to 7% in 2010. Likewise, Viet Nam’s aid-to-GDP ratio decreased from 5.5% in 2000 to 2.9% in 2010, while the FDI-to-GDP ratio increased from 4.2% in 2000 to 7.5% in 2010. Cambodia’s efforts are leading the shift away from a context in which aid alone is the solution, and towards an investment context in which aid plays a catalysing role. In both Viet Nam and Cambodia, institutions are increasingly taking on the new role of attracting and using international capital.

In Africa, Rwanda has received some
US$ 200 million each year in Aid for Trade over the past five years. But other forms of capital flows are becoming increasingly important as well. For example, FDI stood at US$ 75 million each year in the past five years, remittances accounted for US$ 100 million each year and, on top of this, a recent bond issue aimed in part at financing infrastructure yielded US$ 400 million. Other financial flows are also growing in relation to Aid for Trade.

What this shows is that there is a need to move from Aid for Trade towards Investment for Trade, which allows a country to make use of a combination of investment flows to build up trade capacity. Ghana and Nigeria were the latest countries in sub-Saharan Africa to issue bonds. In fact, in the last five years, 11 sub-Saharan African countries have raised more than US$ 10 billion from Eurobonds, which is equivalent to a quarter of the Aid for Trade funding in the region during the same period. In addition, 15 African countries (especially countries rich in natural resources) have either set up or considered setting up a state fund in the last two years. Aid for Trade needs to take this into account when finding an effective role in the future.

The shift from Aid for Trade to Investment for Trade has implications for research and policy. Experts are used to examining the impact of aid flows in isolation, but with Aid for Trade now a part of a new agenda that includes the leveraging of other flows, there is a need to examine how the leveraged investments can help build trade capacity and a need to determine how effective Aid for Trade is in leveraging other flows.

The Overseas Development Institute has carried out statistical analyses of development finance institutions, examining how much they leverage in additional investment, as well as how their investments can contribute to the framework for structural transformation and job creation. On the policy side, fora such as the G-20 should consider linking FDI and structural transformation to ensure adequate interaction between core G-20 areas (for example, finance and investment) and development. Clearly, WTO should also carve out a role in this rapidly evolving international-finance picture.

The new generation of Aid for Trade should take on new roles in complementing trade policymaking and in filling a niche in the international development finance architecture. By doing so, developing countries will be enabled to achieve their development goals in the future.

The sources for the data and analysis can be found in Razzaque, M.A. and D.W. te Velde (2013), Assessing Aid for Trade: Effectiveness, Current Issues and Future Directions, Chapter 16.