Trade Policy

International trade is critical to the World Bank Group’s twin goals of eliminating extreme poverty and increasing the welfare of those in the bottom 40 percent of the income distribution in all countries. It is also an oft-cited concern of many governments that are clients of the World Bank Group. Policymakers around the world want to know how they can increase their firms’ chances on the global market, create more jobs through international trade, and make their countries attractive to foreign investors.

Research shows that, in the long run, increased international trade is associated on average with higher economic growth. Indeed, no country has ever developed sustainably without trading extensively with others. Trade allows countries to specialize in the production of the goods and services that align with their comparative advantage. It also enables consumers and producers to access a wider range of products at lower prices.

In the short run, trade policy matters for poverty and shared prosperity. Certain goods that are important to the poor – food items, for example – are also likely to face the highest import tariffs and non-tariff barriers in many countries. Reducing prices by eliminating tariffs and lowering barriers helps to reduce poverty and increase real incomes in the bottom two quintiles of the population. Trade liberalization also means access to cheaper imported consumables and/or access to cheaper or higher quality inputs to household production, both of which raise household welfare. Finally, it can lead to increased demand for labor-intensive exported goods, which increases labor demand (through more jobs and higher wages). Thus, trade liberalization has a direct and measurable pro-poor impact. 

At the same time, trade liberalization may have negative consequences, too. Changes in trade policy are likely to have winners and losers who may be situated differently in the income distribution. For example, broad trade liberalization may expose some workers to import competition. This can lead to decreased demand for uncompetitive domestic production of consumables or inputs, followed by layoffs and costly labor adjustment. It is important for countries to understand, anticipate and, if possible, try to mitigate these impacts when they hit the most vulnerable.

The extent to which poor households and workers in the bottom 40 percent of the income distribution are hurt by changes in trade policy will depend on which products are affected by trade integration or trade shocks. Countries that understand the impact of trade policy can address shortcomings in the social safety net: is it strong enough to accommodate the needs of displaced workers? How can it set the stage for broader political acceptance of further trade policy reforms?

The general-consensus trade agenda has evolved significantly since the early 1990s when trade liberalization was the focus of policy debate; twenty years later, although average import tariffs are generally low, new challenges have emerged. For example:

• Non-tariff measures (NTMs) have increased sharply to protect domestic industries
• Services play an increasing (and heretofore under-reported) role in trade
• The financial crisis revealed significant vulnerability to external shocks from globally integrated markets
• Commodity markets continue to suffer from volatility, creating risk for commodity exporters
• The proliferation of regional and bilateral preferential trade agreements creates complicated incentive frameworks that do not necessarily mesh with multi-lateral trade arrangements
• Logistics costs represent a significant share of trade costs
• Other non-tariff regulations create de facto barriers to trade

Identifying key challenges

In this modern context, World Bank Group economists work to help policymakers identify the main trade-related constraints to achieving sustainable poverty reduction and shared prosperity. They might first examine the country’s specific environment, pinpointing what sectors currently benefit from trade agreements and patterns of trade, and look at how those sectors contribute to economic growth. Other questions to ask include:

• What has been the impact on employment and wages in these sectors compared to other sectors?
• Are these sectors competitive and sustainable in the long run?
• To what extent is the country’s export model based on high value-added products that incorporate innovation or technology adoption, and is the incentive framework effective in enabling innovation/adoption?
• How concentrated or diversified is trade with respect to product mix and destination markets?
• Are there barriers to diversifying further (tariffs, NTMs, education policy, services inputs, trade/logistics constraints, regulatory environment)?
• Are current patterns of trade sustainable from the environmental, social and fiscal perspectives?
• What is the country’s capacity to weather trade/macro/current account/competition shocks?

Methodologies for diagnosing constraints

The World Bank Group’s trade experts have developed a range of analytical tools to answer these policy-related questions.

1. Assessment of trade policy/RTAs/WTO accession/PTAs on international trade flows
2. Regulatory Assessment on Services Trade and Investment (RASTI)
3. Streamlining Non-Tariff Measures: A Toolkit for Policy Makers
4. Trade Competitiveness Diagnostic Toolkit
5. Toolkit For the Analysis of Current Account Imbalances
6. Conflict, climate change, food security and gender-related trade analysis

Possible remedies

Experts in the field and in Washington then use a range of instruments to address clients’ trade-related challenges, and publish possible remedies in various forms, including stand-alone trade analyses, Diagnostic Trade and Integration Studies (DTIS), and Country Economic Memoranda. Trade analysis informs some policy-based lending operations, and technical assistance plays a crucial role in enhancing countries’ ownership and understanding of trade-related reforms. This assistance sometimes addresses specific policy questions, such as the impact of joining a regional trade agreement, or more general objectives such as improving clients’ capacity to perform trade monitoring and policy evaluation.