Trade as a compass for LDCs structural transformation

15 May 2013

Least Developed Countries (LDCs), which currently number 49, are the weakest segment in the international community. They typically have very concentrated economic structures; rely heavily on primary production for income and jobs; and face daunting challenges to integrate global markets. LDCs exports remain small in relative terms - both because their comparative advantages are confined to a narrow set of products, and because their exports are subject to numerous supply-sifde constraints. Moreover, LDCs export to just a few countries, and are consequently vulnerable to external shocks.

While a number of LDCs have performed well recently by carrying on with business as usual - that is, by exploiting their traditional exports buoyed by rather exceptional conditions - this strategy may not be sustainable over the long term. As such, there is an urgent need for structural transformation in these economies. Structural transformation can be defined as a process of structural change and economic diversification through which an economy shifts from low-productivity, low-value-added activities and sectors (such as traditional agriculture) to higher-productivity sectors (such as manufacturing and services).

Why structural transformation?

There is strong evidence that a well-diversified economy is resilient to external shocks and creates enhanced opportunities for inclusive growth through better jobs. For example, Mauritius and Tanzania - two of Africa's most diversified economies - effectively weathered the financial crisis of 2008 and their economies bounced back faster after the crisis. Moreover, there is a growing body of evidence that links export diversification to economic growth. The seminal work of Hausmann, Hwang and Rodrik (2005) suggests that more prosperous countries tend indeed to be more diversified than other countries. It is also clear that countries that produce and export more sophisticated products tend to grow faster.

Some trends in LDC trade

Increasing exports but stagnating share in world trade

LDCs exports increased 5-fold between 2000 and 2011, causing their share of world merchandise exports to almost double from 0.6 percent to 1.12 percent (figure 1). In absolute terms, however, this performance remains dismal; and the fact that an increase in exports of such magnitude caused such a small increase in the global share means that LDCs have fared worse than other developing countries.

In services, LDCs are not just insignificant players; their share has actually declined progressively over the years - from a peak of about 22 percent of LDCs total exports to 12 percent in 2011. What is more, LDCs have failed to take advantage of the booming global services market, estimated to be worth US$4.2 trillion in 2011.

Increasing concentration of exports...

Beyond aggregates, LDCs merchandise exports are dominated by mineral fuels making up about 25 percent of LDC exports in 1991. This share increased over the years to reach a peak of 64 percent in 2008 before falling off to 55 percent in 2011. Thus, while LDCs have managed to increase their exports significantly over the past decade, they have failed to broaden their export base.

Resource-rich African LDCs have simply ridden the wave of increased demand for the raw materials and commodities they export, benefiting from improved terms of trade. Indeed, much of the increase in LDC exports in recent years is attributable to rising prices rather than to higher export volumes. These developments have aggravated Sub Saharan Africa's structural deficit and have caused the share of manufacturing in GDP - a simple but useful indicator of the scale of industrialization - to shrink from about 18 percent in 1990 to 12 percent in 2011. For African LDCs, this share is even lower, and has shown no progress either.

Export diversification is more than just exporting bigger volumes of manufactures. For a country specialised in manufactures (e.g. Bangladesh), diversification should entail a broadening of the export base beyond the products it currently exports. Inevitably, this means that the country produces new products or improved varieties of existing products. For LDCs whose exports are concentrated in oil or raw materials, or a specific agricultural product, diversification will probably mean producing and exporting manufactures. In all cases, export diversification can also manifest itself through expanding shares of services in a country's total exports.

Even using the narrow definition of diversification - that is, changes in the share of manufactures in merchandise exports - it is evident that LDCs as a group failed to achieve export diversification on a lasting basis since 2000. LDCs share of manufactures in merchandise exports has declined from 35 percent in 2001 to 22 percent in 2011 (figure 2). However, this aggregate trend masks significant achievements in export diversification in several LDCs. Bangladesh, for example, progressively increased its share of manufactures in exports from an already-high level of 80 percent in 1990 to 94 percent in 2011. In Cambodia, much of the success was achieved in the 1990's; in the past decade, the country has struggled to maintain its share of manufactures around 90 percent. Outside of Asia, Haiti stands out as a success story in diversification into manufactures. Its share of manufactures in merchandise exports increased from about 67 percent in 1995 to over 90 percent in 2011.

Unfortunately, no African LDC can boast a similar performance. Madagascar, one of the largest manufactures exporters in sub-Saharan Africa, saw its share of manufacturing in exports eroded by various episodes of political crisis in recent years. After reaching a peak of around 58 percent in 2007, this share has plummeted to 37 percent in 2011. In Lesotho's case, it witnessed a reversal of industrialisation in the run-up to the end of apparel quotas in January 2005: its share of manufactures plunged from a peak of 99 percent in 2003 to 47 percent in 2011.

But more export markets

Product diversification is one side of the bigger diversification story; the other side is market diversification. The current economic crisis has highlighted the importance of entertaining a broad range of export partners. A recent study shows that African countries that export primarily to the EU and the US, are more vulnerable to economic shocks than those exporting to a larger set of countries, including developing economies. If this was true of LDCs generally, then there is good news: LDCs have significantly reduced their reliance on traditional markets since 2000.

LDCs merchandise exports to non-OECD countries have increased twice as fast as to OECD countries, driven mainly, but not exclusively, by emerging economies like the BRICS .Developing countries' share of LDCs exports rose from 31 percent in 2000 to a peak of 55 percent in 2010 before falling off to 49 percent in 2011. However, an unwelcome by-product of this trend is that it is accentuating concentration of LDCs exports into low value-added, unprocessed goods. This is because oil and raw materials make up a significantly bigger share of LDCs exports to emerging economies than to traditional partners. Mineral fuels and crude materials represented 77 percent of LDCs exports to non-OECD countries in 2011, compared to 51 percent for OECD countries.  Thus, while South-South trade is welcome as a means for LDCs to diversify their export markets, it may actually have the opposite effect on export products.

Conclusion

On the whole, structural transformation has lagged behind economic growth in the majority of LDCs and, in the absence of drastic measures - including several of the actions identified by the Istanbul Programme of Action (IPoA) for LDCs and their development partners (DPs), - these LDCs, even if they manage to graduate out of LDC status, will remain extremely vulnerable and fragile economies for the foreseeable future.

Istanbul Program of Action recommendations:

1) Trade in LDCs should be mainstreamed into national development strategies, as well as improving competitiveness and diversify production base and exports. Trade should also be facilitated through better institutional processes.

2) DPs should support LDCs through Aid for Trade and technical assistance in order to engage more effectively in trade negotiations and by implementing obligations in the areas of SPS and TBT.

3) Joint measures should focus on addressing supply side constraints as well as trade distorting measures and provide enhanced trade preferences.

However, given the uncertainty surrounding the Doha Round and the lack of progress on the "LDC package" - The "LDC package" refers to a set of LDC-specific issues ( duty-free, quota-free market access, rules of origin, LDC services waiver, and cotton subsidies ) that were slated for an early harvest at the WTO Ministerial Conference in December 2011. -  LDCs should not pin their hopes for economic growth and structural transformation on preferences that may not come soon. LDCs can do much to help themselves. LDC governments should continue with policy reforms; improve their absorptive capacity through appropriate human resource and institutional development; address a range of supply-side constraints and provide the right incentives, through judicious use of industrial policy instruments, to steer the economy in the direction of higher value-added industrial diversification.

Authors:

Vinaye Ancharaz is the Senior Development economist for ICTSD.

Anne-Katrin Pfister is the Program Officer for competitiveness and development at ICTSD.

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