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The fiscal impacts of trade liberalization

Aldo Caliari1

Center of Concern

14 March 2007

SARPN acknowledges Center of Concern as the source of this document: www.coc.org
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The fiscal impacts of trade liberalization represent an important aspect that relatively recently has begun to gain relevance. The Monterrey Consensus (2002) with its call to achieve "Coherence and consistency of the international monetary, financial and trading system" establishes, undoubtedly a guideline to follow in the elaboration of policies in both areas of this relationship: trade and fiscal.

Center of Concern has actively promoted efforts of civil society groups working both in the area of trade, as in the area of finances, in order to examine the concrete consequences that trade and financial policies may have and make an integral analysis of both of them. Looking at it closely, important consequences for the design of policies in the trade and the financial areas can be drawn from this integral vision. The idea of this analysis, however, is beyond what is merely academic. The purpose is to evaluate whether what is being developed in terms of trade policy will have a positive impact in the area of finances, and viceversa. This presentation focuses specifically on fiscal policy, e.g. what type of fiscal policies should be defined to better support trade for development?, what type of unilateral and bilateral trade policies should be supported in order to improve fiscal revenue?, etc. This is an exercise of wide consequences.

The aspect of long term income

In the context of the neoliberal model, which predicates the long terms gains of trade and investment liberalization through a growth of GDP, there is no question that, even if there are some negative fiscal impacts in the short term, the liberalization will lead to compensate them and, eventually, larger fiscal revenue derived from growth of economic activity that serves as base for taxation.

A number of free trade agreement negotiations tend to be driven by the assumption that the financial consequences of liberalization of trade and investment will be a greater income through larger exports and attraction of FDI.

This type of analysis leads, for instance, to recommend borrowing in order to finance public fiannces adjustment that may become necessary when trade is liberalized. In order to implement this adjustment, which is deemed temporary, the International Monetary Fund (IMF) has launched three years ago an instrument, the Trade Integration Mechanism (TIM). Originally, this mechanism did not contemplate the loss of fiscal income, at least not explicitly, as one of the situations where it would be applicable. In a recent reformulation of the mechanism, made in the framework of the discussion on "Aid for Trade", this situation was explicitly added. The Trade Integration Mechanism would, thus, be a policy for countries to be able to borrow from an existing facility, or augment an already outstanding loan, with the purpose of financing fiscal revenue lost due to trade liberalization.

However, except for some facilities such as the PRGF (or ENDA which is not relevant to the case of fiscal reforms), the Fund facilities are not concessional. This means that a rate similar, or very close, to the market rate must be paid on the borrowed funds. Therefore the proposal is, basically, to increase debt in order to repair what is considered to be a temporary adjustment of the balance of payments. This only makes sense if it is true that liberalization leads to increased growth, hence enabling repayment. But the support to this assertion in reality is, until today, still uncertain. Several studies have shown that there is no systematic relationship between the average tariff and non-tariff barriers of a country and its economic growth. (Malhotra, K. 2004) Similarly, the evidence does not support the assertion that increased FDI leads to increased growth. (Milberg 1999; UNCTAD 2003, 76) And the very link between investment liberalization and increased FDI - or increased investment altogether-is not exempt from challenges.

So, this data are important in evaluating the possible long term impacts on fiscal revenue.


Footnote:
  1. Paper prepared for the Seminar/Workshop: Fiscal Policy in the New Political and Economic Scenario of Latin America. Organized by CEDLA, La Paz, Bolivia, March 14, 2007.


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