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Some stated objectives of governments for using subsidies
This Section discusses the main objectives governments claim to pursue with subsidies including industrial development innovation and support for national champions environment related objectives and redistribution. Under the broad category “redistribution” three more specific objectives are examined: the use of subsidies for regional policy purposes adjustment support for declining industries and universal service obligations. This selection does not pretend to be exhaustive but it covers some of the most important objectives pursued by governments in developing and developed countries.
Acknowledgements
The World Trade Report 2006 was prepared under the general direction of Deputy Director-General Alejandro Jara. Patrick Low Director of the Economic Research and Statistics Division led the team responsible for writing the Report. The principal authors of the Report were Marc Bacchetta Bijit Bora K. Michael Finger Marion Jansen Alexander Keck Clarisse Morgan Roberta Piermartini and Robert Teh. Trade statistics information was provided by the Statistics Group of the Economic Research and Statistics Division coordinated by Guy Karsenty Julia de Verteuil Andreas Maurer and Jürgen Richtering.
Executive summary
The World Trade Report 2006 begins with a short summary of salient trends in international trade based on the Secretariat’s earlier Report issued in April. We also provide brief analytical commentaries on certain topical trade issues which this year cover recent trends in trade in textiles and clothing an examination of the evolution of international royalty and fee payments developments in the trade of least-developed countries and an analysis of the effects of natural disasters and acts of terrorism on international trade flows. The core topic for analysis in WTR 2006 is subsidies. The Report explores this area of policy in terms of how subsidies are defined what economic theory can tell us about subsidies why governments use subsidies the most prominent sectors in which subsidies are applied and the role of the WTO Agreement in regulating subsidies in the context of international trade.
Recent trends in international trade
The world economy expanded by 3.3 per cent in 2005 less rapidly than in 2004 but still slightly faster than the decade average. Economic growth remained strong in most regions although less buoyant than in the preceding year. Only Europe’s economy continued to record low GDP growth – less than half the rate observed in North America. In contrast to Europe Japan experienced a strengthening of economic activity. In light of slower economic growth worldwide in 2005 and of oil market developments merchandise trade growth – like GDP growth – decelerated in real terms but still exceeded the average for the last decade.
The economics of subsidies
The purpose of this Section is to assist the reader to better understand the twin questions of why governments use subsidies and how subsidies impact international trade. As is frequently the case in economic analysis the starting point for what follows is a “benchmark” economy featuring perfectly competitive markets. This approach provides the basis for general insights into the impact of policy interventions such as subsidies. As discussed further below under the condition of a perfectly competitive market no case can be made for a subsidy. Introducing a subsidy or some other government measure within a perfect market framework will be inefficient and welfare-diminishing. But if the perfect market assumption is relaxed situations may arise where a government measure like a subsidy improves welfare. An efficient subsidy would correct a market failure bringing social and private costs and benefits into alignment.
Defining subsidies
At the origins of the GATT little attention was given to the trade impact of subsidies. However contracting parties soon appreciated the need to deal with subsidies in order to secure the value of their agreed tariff concessions. A country can undermine its market access commitments by providing subsidies to import-competing industries. In addition subsidies given to competing exporters in third countries can divert trade away from a country that had relied on negotiated market access to another market. These concerns led to the development of more stringent disciplines on subsidies than those initially provided for under the GATT (1947). A major step was the negotiation of the plurilateral “Subsidies Code” during the Tokyo Round and thereafter of the WTO Agreement on Subsidies and Countervailing Measures (SCM) and the Agreement on Agriculture (AoA).
The incidence of subsidies
This Section provides an overview of the use of subsidies both at the global level and at different levels of geographical and sectoral disaggregation. Given the quantity and quality of the available data it is not possible to provide a comprehensive and systematic picture of the incidence of subsidies.
Selected trade developments and issues
The Agreement on Textiles and Clothing (ATC) came to an end on 1 January 2005. Much interest not to mention concern was expressed about the likely impact on production and trade of the removal of quota restrictions. It was apparent to most observers that there would be winners and losers from the additional liberalization. It is too early to say how the market will look beyond the relatively short period upon which we can base our observations but this note looks at what we know so far about the pattern of trade that has emerged since the quantitative restrictions were (largely) removed. A caveat is in order here: there can be little doubt that the termination of the AT C affected the patterns of trade observed in 2005 but we have not developed a rigorous analytical approach to the question of what other factors might also influence the pattern of trade flows.
Foreword
The World Trade Report 2006 is the fourth in a series launched in 2002. As in previous years the present Report has taken up a current issue in trade policy. This year we have looked at subsidies. The contribution we hope to make with these Reports is to aid understanding of complex trade policy issues facing governments. This is not intended primarily as a prescriptive Report but rather as an invitation to deeper reflection and it is aimed not just at policy-makers but also the public they represent and the individuals and organizations that actively seek to influence government policies. In addition to the core topic the Report also takes a brief look at recent developments in trade and discusses some salient features of recent trade developments or a particular aspect of trade. This year the Report looks briefly at trade in textiles and clothing flows of international receipts and payments of royalties and license fees trends in the trade of least-developed countries and the impact of natural disasters and terrorist acts on international trade flows.
Subsidies and the WTO
We have discussed the economic arguments for and against different kinds of subsidization earlier in the Report. Economic analysis tells us that market failures of various kinds can sometimes be addressed efficiently with subsidies. It also tells us that subsidies can distort trade flows if they give an artificial competitive advantage to exporters or import-competing industries. Whether a subsidy is viewed as a desirable intervention for correcting a market failure or as an undesirable trade distortion depends sometimes upon who is making the judgement. But economic analysis ought to be able to help both in determining the desirability of an intervention from a welfare perspective and in assessing the merits of alternative forms of intervention. Governments may however decide to grant certain kinds of subsidies that have little to do with efficiency considerations and in such cases economic analysis based on a simple welfare analysis may be of limited use. Also in these cases the analysis is probably most helpful in ensuring that policy-makers are aware of the costs of pursuing particular objectives and of alternative lesser-cost ways of doing so. We also know that judgements about what to subsidize by how much and for how long are complex technical questions on which governments frequently lack adequate information.
World Trade Report 2006
The annual World Trade Report focuses on trade policy issues - the core topic addressed in 2006 is subsidies. The Report also takes a look at recent trade developments and examines a range of trade topics including trade in textiles and clothing flows of international receipts and payments of royalties and license fees trends in the trade of least-developed countries and the impact of natural disasters and terrorist acts on international trade flows. The World Trade Report is useful for policymakers and for any individuals or groups interested in global trade policy.
Introduction
Subsidies are one of many policy instruments subject to rules in the multilateral trading system but they present more complex issues for policy-makers than many other instruments subject to GATT /WTO rules. One reason for this is that subsidies can be defined in different ways. Another is that that they are used in pursuit of a wide array of objectives. Even where they are not aimed at trade they can affect trade flows. The kinds of subsidies of primary concern to this Report are those that impart an advantage to some domestic producers and thereby affect trade. The challenging task of determining which sorts of subsidies are problematic from the perspective of the trading system and what might be done about them has occupied an important place on the agenda of the WTO /GATT system.
Services Trade Liberalization at the Regional Level
This paper discusses the opportunities and challenges for Southern and Eastern African ACP countries of services negotiations in the context of European Partnership Agreements. The paper provides an overview of existing flows in services from and to Southern and Eastern Africa an overview that suffers from the paucity of relevant data. Given the significant differences among services sectors the paper provides a separate discussion for several of them including financial services tourism and business services. The latest developments in each sector are described and the issues that are at stake in trade negotiations. In this context the competitive position of Southern and Eastern African countries is compared with the position of the European Union and other global players. The paper attempts to identify possible export opportunities for Southern and Eastern African ACP countries and discusses the advantages and disadvantages of giving preferential access to EU suppliers in those services sectors where African countries are likely to import. Particular attention is paid to the role of mode 4 in the discussed services sectors.
Forecasting Trade
This paper develops a set of time series models to provide short-term forecasts (6 to 18 months ahead) of international trade both at the global level and for selected regions. Our results compare favourably to other forecasts notably by the International Monetary Fund as measured by standard evaluation measures such as the root mean square forecast error. In comparison to other models our approach offers several methodological advantages inter alia a focus on import growth as the core variable the avoidance of certain difficulties affecting the performance of structural models the selection of variables and lags on the basis of theoretical considerations and empirical testing as well as a full documentation of the modelling process.
The Impact of Disasters on International Trade
In this paper we examine the impact of major disasters on international trade flows using a gravity model. Our panel data consists of more than 170 countries for the years 1962-2004 yielding approximately 300000 observations. We find that the driving forces determining the impact of such events are the democracy level and to a lesser extent the area of the affected country. The less democratic and the smaller a country the more are its trade flows reduced in case it is struck by a disaster. We are also able to distinguish between the effect of a disaster on an importing and an exporting country.
Non-Reciprocal Preference Erosion Arising from MFN Liberalitzation in Agriculture
This paper estimates the risk of preference erosion for non-reciprocal preference recipients in the agricultural sector as a consequence of MFN tariff cuts. It is based on a simulation of a single tariff-cutting scenario. The measure of preference erosion risk is the difference in preference margins enjoyed by individual suppliers to the QUAD (Canada EU Japan United States) markets before and after a MFN tariff reduction multiplied by the associated trade flow. The paper does not attempt to determine how losses in preference margins translate into trade outcomes but it does highlight which products and which non-reciprocal preference beneficiaries are the most vulnerable to erosion effects in the major developed country markets. Overall the paper finds that the risk of preference erosion is small but some countries are strongly affected in particular product lines (notably sugar and bananas).
Liberalizing Financial Services Trade in Africa
This paper analyses the possible gains from regional and multilateral liberalization of financial services trade for African countries taking into account the implications of such liberalization for financial regulation and capital account liberalization. It also describes existing efforts to integrate financial markets within four African regions (WAEMU CEMAC SADC and COMESA) and discusses the existing GATS commitments of the relevant countries with respect to financial services. Although the regions differ significantly there is scope for further regional integration in all of them. Significant scope also exists for further multilateral liberalization of financial services in particular with respect to Mode 3.