Leonstein
14-10-2005, 03:15
Note: Here it is, my essay on globalisation. What do you think? Anything I forogt and should add? Any spelling errors?;)
Knock yourselves out.
Aid, Trade, Globalisation and Growth
"Leonstein"
The University of Queensland
This paper investigates the phenomenon of globalisation, and the issues that come along with it. Globalisation is defined, and the theory of comparative advantage outlined. This is followed by a brief explanation of the problems with globalisation and a more detailed investigation of the links between trade and economic growth. Additionally, the influence of aid is discussed. Finally, the specific case of Uganda is investigated and the implementation of Yoweri Museveni’s growth strategies is evaluated.
The author would like to thank his lecturers Dr. Bodman and Dr. Leeves, as well as his tutor, Mr. Joel Ickiewicz. Furthermore he wishes to express his gratefulness to his friends and colleagues, as well as the fellow participants of the “nationstates.net” internet forum for the wide variety of views that served as an inspiration.
Last but not least, some credit is due to Dr Alan Duhs and Dr Bruce Littleboy who provided more interesting food for thought in their Political Economy course.
Introduction
“I don’t want aid, I want trade.” When Uganda’s president, Yoweri Museveni spoke these words on his 2003 visit in the United States, it could be seen as a desperate plea to both the Western and African nations. As we proceed to move into the 21st century, technology has enabled mankind to form one cohesive whole, if not politically, then at least economically. But as is so often the case, in reality problems have to be solved which are not immediately apparent in theory.
This essay will try to bring light on the issues surrounding Museveni’s statement. It will outline the process of globalisation, and what can be gained from it, as well as its criticisms. Then a more meaningful linkage between the ability and willingness to liberalise and participate in world trade shall follow, after which Uganda’s specific situation will come under scrutiny.
Globalisation and Comparative Advantage
Globalisation is often assumed to concentrate entirely on economic issues, and when one looks for it in the dictionary, one will find it primarily related to the growth of industry to a global scale. Yet if one is to understand globalisation and its implications for humanity as a whole, one cannot underestimate the political and cultural integration of different peoples that is part of the process.
In general, the processes of globalisation ensue when people from different geographic areas make contact and begin to exchange goods and services but also ideas. When defined this way, it seems obvious that globalisation is not a new phenomenon, that ever since humans build communities, their horizons expanded with time as cultures built trade linkages. From ancient Greeks to Romans onwards, as history progressed the world has “grown larger” as societies’ horizons expanded to include first Spain, then Britain, India, Africa, China and then the New World and even Australia. Many other cultures developed this way too, although the sometimes aggressive way in which this exploration was conducted in later years could be argued to be uniquely Western. Indeed, we are already in the second modern period of globalisation. During the final years of the Industrial Age, around 1900, trade volume was already high and trade barriers had been dismantled. The two great wars of the 20th century brought this to a halt, and only after WWII did the second era of globalisation begin (Williamson, 2002).
But why would people do this? Why is it a good idea to trade with others? The answer lies in the concept of “comparative advantage”. Closely related to the specialisation observed in labour markets, comparative advantage explains what products a country is relatively better at producing, even though another nation may have an absolute advantage in any production process imaginable.
This concept is probably best illustrated by an example. Country A is a very advanced, modern economy, which can produce both food and computers at a very fast rate. Country B however is a poorer nation, which lacks technical facilities to produce many computers, and relies on labour-intensive, lower yielding agricultural methods. Both nations have a production possibility curve (PPC), as shown in figure 1. On this curve it can be seen that country A is clearly in such a good position that it can produce both goods better than B can, and that thus one could think that there is no need to trade with B. Yet when one assumes the two to trade, suddenly on aggregate both produce more than they did when they were autonomous. How is that possible? The answer lies in the relative costs of the two goods. Once one expresses these costs in terms of the other goods, ie the cost of a computer in A is 1.5 units of food, we can see that food can be produced relatively cheaper in B.
When one now assumes that both countries are part of one market, and there are no disincentives to trade, both nations combine their abilities to produce a better PPC, and thus to produce more goods on aggregate for their populations to enjoy.
This of course paints a very positive picture on free trade. Nonetheless, in the real world, not everyone benefits from a sudden economic liberalisation. Here we assumed that there were no negative effects in either country from the falling production of either food or computers, but in reality, industries could be destroyed, and potentially millions could lose their livelihood. Furthermore, if some nations specialise in goods or services for which demand is volatile, they will bear the brunt of any changes in demand.
Similarly, different elasticities for demand and supply dictate that transportation costs (which were also assumed away in the above example) will be split unevenly between producers and consumers. This has happened in the case of primary industry exports from Australia, and it is somewhat likely that similar developing nations would face the comparable problems (Brazil, Kolsen and Evans, 1993)
At any rate, countries that specialise in agricultural produce, like country B, are faced with demand that flattens over time. As incomes rise, the demand for computers and other luxury goods my continuously increase, yet the demand for food will stay fairly constant as everyone has reached a level where more food would not make them any better off.
And to add further complications, countries A and B may not live in a vacuum, indeed a war or other conflict may be imminent, and neither A nor B may be able to trade with each other, such that they may lack critical resources.
Criticisms
It is thus not surprising that in practice globalisation, like any other phenomenon, has its dark sides. The way the world trade is currently set up there can be no doubt that it is a rather unfair arrangement. Developing countries are repeatedly urged to drop all protectionism, to open their markets to trade, in practice often meaning Western multinational corporations, and governments are required to stay out of the free market processes. However, Western nations, especially the USA and the EU, have for years refused to do the same. Especially goods in which developing countries would have a comparative advantage, such as agricultural produce, are kept out of the Western world with quotas, tariffs and other trade barriers (Oxfam, 2002). The WTO, the IMF and the World Bank have been following relatively orthodox recipes for growth, repeatedly forcing developing countries to abandon sensible subsidisation or even protection schemes which, only decades ago, have helped nations like Japan and South Korea build up a capital stock and thus to reach their current wealth levels. Instead many now witness countries overwhelmed with debt, with poor governance being exploited by large corporations which use free trade laws to extract much of the resources of the third world, and profit from the value-adding processes in other nations. Similar schemes have existed before: Colonial India was known for its raw materials, which were then shipped to Britain, processed for a profit, and then shipped back to India to be sold to the locals for high prices. Then, there were laws against spinning clothes for oneself in India, today global trade is set up to prevent it automatically. Groups like Oxfam in particular have been campaigning for years to make international trade fairer to developing nations (Oxfam, 2005).
However, such arguments would concern the way globalisation has been done so far, its practical application. There are people however who are opposed to the very idea of free trade itself. Incidentally, this camp both includes members of the far right, who oppose it because they see it as weakening of their national standing and power, and the far left, who see most private enterprise as an exploitation of workers – especially workers who they see as unable to defend themselves. Especially the Left (which includes Green groups and various Anarchist movements) has been vocal in its protests against free trade, and the organisations that organise it. They see the vast income differences between countries as immoral, and consider trade to be the cause of them. It is thus understandable that they are highly sceptical that trade should actually serve to reverse the situation (Engels, 1847). However, realistically there are few ways in which society could today be structured without increasing contact, culturally and commercially, between nations.
The Relationship between Trade and Economic Growth
Economic Growth is then central to the wellbeing of a population. It is thus of interest to any country to attempt to increase economic growth over time. As little as 6% growth per year, quite attainable for countries with a small capital stock and much capacity for increase, can double incomes in twelve years. No government can thus afford to ignore the issue.
Economists generally explain long term economic growth using models, of which the endogenous growth model is considered one of the most accurate. In this model it is shown that capital growth, attained through investment in the country, raises the capacity of the economy to produce and thus increases GDP. However, both population growth and capital depreciation need to be considered as well, as there is a certain level of investment that is required simply to hold standards of living on the same level (Dornbusch, Bodman, Crosby, Fischer and Startz, 2004).
One can see that the rate of savings in a country is integral to continued growth of the economy over time, as it usually provides a large part of the funds required for investment in new capital. This places low-income countries in a difficult situation, as people are often barely able to survive by spending their entire income. They are in no position to save any of it for the future. Empirical evidence underlines this, as saving rates in low income nations, such as in sub-Saharan Africa are as low as 8% of GDP, while saving rates in newly industrialised economies reach levels of 35% (Aryeetey and Udry, 2000). Third world countries have therefore no choice but to attract investment from foreigners in the short term, while hopefully encouraging saving as income increases.
It is in this context that the quality of the financial system in a nation is of the utmost importance. Both theory and empirical evidence suggest that the quality of the banking system fosters entrepreneurship by offering funds (through the attraction of funds), risk diversion and by generally revealing the potential rewards to entrepreneurial activity (King and Levine, 1993).
Both foreign direct investment (FDI) and the provision of money through the banking system are of interest, since FDI not only creates work that may increase income, but also introduces technology, education and skills to the locals which often has positive externalities with it, and indeed this is suggested by the endogenous growth model, which considers positive externalities to be vital for continued growth performance. One must keep in mind however that the attraction of foreign companies for FDI also requires the setting of certain guidelines regarding the conduct of such firms on the country, as there is some evidence suggesting that such policies greatly influence the actual effectiveness of FDI when it comes to the reduction of poverty (Sumner, 2005). One possible explanation could be that some corporations tend to extract resources from developing nations, and thus very little can “trickle down” to the local population.
Nonetheless, investment is of great importance, so the link between trade and investment should be investigated further. Wacziarg and Welch (2003) suggest in their findings that mean investment in low-income countries has increased after trade liberalisation occurred by as much as 1-2%. It is suggested that in the short term, the increased investment attracted through liberalisation is the main channel through which growth follows, although this effect weakens over time.
However, empirical evidence still suggests that open countries grow at a faster rate than closed ones, even after a number of years have passed. This is most likely due to the greater market available to local firms as the economy establishes itself in world trade. Shortly after liberalisation, it is probable that much of the initial trade will consist of imports, which will force the domestic economy to adjust structurally until industries are established that can survive in the new competitive environment. Once it can be estimated where a country’s comparative advantage lies, it may be a good idea to help these sectors of the economy along. This policy has successfully been introduced by Japan after World War II, when industry councils, trade barriers and subsidies restructured the Japanese industry composition quite radically a number of times.
It is however unlikely that in the present climate Western countries would agree to such policies, and the WTO would thus step in and put a stop to any such cooperative agreements between government and industry in developing countries.
Developed economies however have reached a higher equilibrium point, in which growth is relatively stable on a higher level. Factor productivity is high, and both depreciation and population growth could easily be paid for by the higher savings rates. For these countries the question of free trade is thus one of increasing factor productivity through specialisation and attracting international investment to keep the economy at a steady growth path through the accumulation of additional capital. Both Mahadevan (2002) and Gaston (1998) have investigated the impact on liberalisation on Australia, and the results are more or less expected. Total factor productivity in the manufacturing industry increased as overseas competition became a threat to local industries, and industries which were unable to compete shrunk. However, it was also clear that industries in which Australia enjoys a comparative advantage, such as primary industries and some service industries have profited from liberalisation. Wall (1999) estimates the welfare costs to GDP from protectionism in the United States to be as high as 1.45% of GDP in 1996. Considering that this constitutes a dollar value of about US$110 billion, it is obvious that such a waste of resources is unlikely to benefit anyone in the long run.
Economic Aid in the Ugandan Case
Perhaps Yoweri Museveni’s statement was directed at such ineffective trade policies, for it was likely primarily directed at the audience he was speaking to, that being the American public. His emphasis on trade may very well have been meant to re-emphasise the need for the US Government to drop its trade restrictions on Ugandan exports, which include materials like tobacco, cotton, beef and maize.
Indeed Museveni has long worked on an economic policy that is founded on improving trade performance and greater liberalisation. It has been established that economic aid works best in conjunction with openness and institutional and structural reform, and he is likely looking for help to achieve such reforms (Burnside and Dollar, 2000). Furthermore, he may perhaps wish to underline his ownership of the economic strategies that Uganda is attempting to implement, thus increasing Western confidence in his government. Ownership of policy strategies has long been considered an absolutely vital part of successful implementation (Dijkstra, 2005)
When a government has run out of funds, economic aid may often seem like an easy way out of current fiscal crises, enabling governments to continue policies which could have been too expensive otherwise. In some nations, such as the Democratic Republic of the Congo, aid was channelled directly into the personal wealth of the leadership, which consequently provided no benefit to the population at all. Burnside and Dollar have investigated the usefulness of aid to low-income countries and have found that aid works best if it is combined with sound economic policy, such as liberalisation and attraction of foreign investment. Furthermore, the total amount of economic aid received from multinational institutions like the World Bank is likely to increase as policy improves as well (Burnside and Dollar, 2000).
Instead Museveni presumably aims to attract foreign aid that will translate into a better trade performance by using it to restructure the government and the major industries. He hopes that open trade relationships and the pressures of the free market will force government institutions to remain efficient and sensible, and that this can provide an incentive for firms to locate value-adding industries in Uganda.
As Burnside and Dollar also found that the quality of economic policy alone is no significant factor of how much bilateral aid is received, Museveni’s statement may also have the aim of increasing US aid specifically by underlining his relatively responsible government policies, and so convincing US politicians that they would get “value for money”.
He also fears that the wrong type of aid, used for the wrong purposes can cause nations to become dependant on it, such that economic policy becomes impossible to administer and the country remains in a poverty trap. This is presumably what he means by saying that “aid cannot transform society”. Uganda is currently relying on aid largely for the formation of new capital, which is a positive arrangement, yet a threat remains that aid receipts could become an integral part of day-to-day government spending as has been the case in a number of Central Asian countries (World Bank, 2005).
Such reckless use of aid money, which is originally meant to set a nation up for economic growth in the future (one could say to provide a cure for the illness, not the symptom) is an example of bad governance. It is immediately obvious that continued economic growth, particularly if supported by receiving aid in the short term, can only be sustained if institutions and the government are effective and efficient in what they do.
Institutional Quality in Uganda
Institutional quality is a central factor in attracting foreign investment, since things like stability, a lack of corruption and the quality of regulatory frameworks are vital if investors are to make decisions on what the future values of their investments will be.
As Burnside and Dollar have illustrated, good governance is vital if aid is to be used to its full effect, and the quality and effectiveness of government institutions are a vital criterion for good governance.
Some economists, like Joseph Stiglitz, have argued that handing out credit should be conditional on good governance as well, in that creditors should be responsible for any negative effects that ensue if their money is used to fund negative policies. (Stiglitz, 2003). If debt relief is indeed a policy option in the future, the risk to creditors may increase somewhat, such that effective governance becomes even more important.
Uganda has had a turbulent past. After independence, the first president, Milton Obote created a dictatorship, which was overthrown and changed time and time again until President Museveni took control in a guerrilla war in 1986. Since then he has instigated institutional reforms and furthered a free trade agenda, all of which culminated in the allowance of fairly free elections in 1996. In July 2005, the so called “movement” system, which prevented political parties from running in elections directly, was abandoned.
However, Uganda remains a dangerous place at times. In the North, the “Lord’s Resistance Army” (LRA), a religiously inspired guerrilla force has yet to agree to a lasting peace, and Uganda has been known to support similar movements in the Democratic Republic of the Congo, which it also invaded twice.
This uncertainty is reflected in the World Bank’s assessment of the institutional quality in Uganda. Compared to its neighbours, in the category “Voice and Accountability” Uganda’s performance is mediocre, and thus it stands in the lowest quintile worldwide (figure 2). This is unlikely to improve, since there have been concerns for the validity of Uganda’s democracy due to a proposed change in the constitution that would allow Museveni to run for President a third time, as well as the government closure of a news station after the death of the Sudanese vice-president in a crash with an official Ugandan presidential helicopter (Reporters sans frontiers, 2005).
Political Stability is understandably low, due to the continued crisis in neighbouring DR Congo and the conflict with the LRA, which is poised to continue for some time. The same goes for the rule of law, which is severely strained by the internal strife, as well as the poor control of corruption which, while slightly better than in neighbouring countries, is nonetheless in the bottom 20% worldwide.
However, as far as government effectiveness and regulatory quality are concerned, Uganda takes the lead in the region. Government effectiveness is ranked at 43.8, and regulatory quality (no doubt due to Museveni’s focus on liberalisation) even makes it into the top 50% worldwide at a rank of about 55 (World Bank, 2003).
According to the World Bank, Museveni should be encouraged with his economic policies, but in other key areas Uganda has yet to leave the past behind it. The International Criminal Court has recently issued arrest warrants for the LRA leadership, but this would nonetheless require Joseph Kony and his group to be captured first (BBC, 2005). As the LRA has reportedly moved into surrounding nations, Uganda may have to rely on more international cooperation if the situation is to be stabilised.
Furthermore, Museveni himself may soon become a risk to his vision of Uganda. If indeed he gets a third term in office (terms in Uganda are already five years long), the democratic process in the country will be severely strained. Perhaps it would be a better option to use his popularity in the US to achieve multinational support for his security policy, while designating a successor to him to run in the 2006 elections. He could stay in an advisory role (the prime minister of Uganda is in such a position) if necessary, and so continue to oversee the progress that is being made.
The alternative may be a collapse of Uganda’s government and a return to dictatorship, which would surely scare away investors and damage relations internationally.
Conclusion
In conclusion, the sometimes stark differences between theory and practice have been made obvious by the past 50 years or so. Despite similar starting positions, Asian countries have been able to grow at high rates through adhering to sensible economic policies, while nations from Sub-Saharan Africa, perhaps faced with more political and ethnic diversity from the start, have failed.
In theory, trade will bring increased growth through the accumulation of more capital, through the greater size of the market domestic firms can access, and in the long term through the concept of comparative advantage. Once a reasonable income can be created and distributed, savings rates will likely increase and further enable locals to invest in the capital stock, thus lifting nations out of poverty for good.
In practice however, global trade is still unfair, in that developing nations, reliant on agricultural and other primary exports face severe protections from the Western world. While in theory bodies like the WTO should prevent this from happening, in practice no meaningful improvement has been achieved so far.
For Uganda in particular this means a continued reliance on Western goodwill if its free trade policies are to succeed in the long term. Nonetheless, empirical evidence suggests that Museveni’s policies are likely to improve income growth, and thus standards of living over time, provided that the President himself provides a framework of stability and accountability in the country, on which future growth can be based.
Knock yourselves out.
Aid, Trade, Globalisation and Growth
"Leonstein"
The University of Queensland
This paper investigates the phenomenon of globalisation, and the issues that come along with it. Globalisation is defined, and the theory of comparative advantage outlined. This is followed by a brief explanation of the problems with globalisation and a more detailed investigation of the links between trade and economic growth. Additionally, the influence of aid is discussed. Finally, the specific case of Uganda is investigated and the implementation of Yoweri Museveni’s growth strategies is evaluated.
The author would like to thank his lecturers Dr. Bodman and Dr. Leeves, as well as his tutor, Mr. Joel Ickiewicz. Furthermore he wishes to express his gratefulness to his friends and colleagues, as well as the fellow participants of the “nationstates.net” internet forum for the wide variety of views that served as an inspiration.
Last but not least, some credit is due to Dr Alan Duhs and Dr Bruce Littleboy who provided more interesting food for thought in their Political Economy course.
Introduction
“I don’t want aid, I want trade.” When Uganda’s president, Yoweri Museveni spoke these words on his 2003 visit in the United States, it could be seen as a desperate plea to both the Western and African nations. As we proceed to move into the 21st century, technology has enabled mankind to form one cohesive whole, if not politically, then at least economically. But as is so often the case, in reality problems have to be solved which are not immediately apparent in theory.
This essay will try to bring light on the issues surrounding Museveni’s statement. It will outline the process of globalisation, and what can be gained from it, as well as its criticisms. Then a more meaningful linkage between the ability and willingness to liberalise and participate in world trade shall follow, after which Uganda’s specific situation will come under scrutiny.
Globalisation and Comparative Advantage
Globalisation is often assumed to concentrate entirely on economic issues, and when one looks for it in the dictionary, one will find it primarily related to the growth of industry to a global scale. Yet if one is to understand globalisation and its implications for humanity as a whole, one cannot underestimate the political and cultural integration of different peoples that is part of the process.
In general, the processes of globalisation ensue when people from different geographic areas make contact and begin to exchange goods and services but also ideas. When defined this way, it seems obvious that globalisation is not a new phenomenon, that ever since humans build communities, their horizons expanded with time as cultures built trade linkages. From ancient Greeks to Romans onwards, as history progressed the world has “grown larger” as societies’ horizons expanded to include first Spain, then Britain, India, Africa, China and then the New World and even Australia. Many other cultures developed this way too, although the sometimes aggressive way in which this exploration was conducted in later years could be argued to be uniquely Western. Indeed, we are already in the second modern period of globalisation. During the final years of the Industrial Age, around 1900, trade volume was already high and trade barriers had been dismantled. The two great wars of the 20th century brought this to a halt, and only after WWII did the second era of globalisation begin (Williamson, 2002).
But why would people do this? Why is it a good idea to trade with others? The answer lies in the concept of “comparative advantage”. Closely related to the specialisation observed in labour markets, comparative advantage explains what products a country is relatively better at producing, even though another nation may have an absolute advantage in any production process imaginable.
This concept is probably best illustrated by an example. Country A is a very advanced, modern economy, which can produce both food and computers at a very fast rate. Country B however is a poorer nation, which lacks technical facilities to produce many computers, and relies on labour-intensive, lower yielding agricultural methods. Both nations have a production possibility curve (PPC), as shown in figure 1. On this curve it can be seen that country A is clearly in such a good position that it can produce both goods better than B can, and that thus one could think that there is no need to trade with B. Yet when one assumes the two to trade, suddenly on aggregate both produce more than they did when they were autonomous. How is that possible? The answer lies in the relative costs of the two goods. Once one expresses these costs in terms of the other goods, ie the cost of a computer in A is 1.5 units of food, we can see that food can be produced relatively cheaper in B.
When one now assumes that both countries are part of one market, and there are no disincentives to trade, both nations combine their abilities to produce a better PPC, and thus to produce more goods on aggregate for their populations to enjoy.
This of course paints a very positive picture on free trade. Nonetheless, in the real world, not everyone benefits from a sudden economic liberalisation. Here we assumed that there were no negative effects in either country from the falling production of either food or computers, but in reality, industries could be destroyed, and potentially millions could lose their livelihood. Furthermore, if some nations specialise in goods or services for which demand is volatile, they will bear the brunt of any changes in demand.
Similarly, different elasticities for demand and supply dictate that transportation costs (which were also assumed away in the above example) will be split unevenly between producers and consumers. This has happened in the case of primary industry exports from Australia, and it is somewhat likely that similar developing nations would face the comparable problems (Brazil, Kolsen and Evans, 1993)
At any rate, countries that specialise in agricultural produce, like country B, are faced with demand that flattens over time. As incomes rise, the demand for computers and other luxury goods my continuously increase, yet the demand for food will stay fairly constant as everyone has reached a level where more food would not make them any better off.
And to add further complications, countries A and B may not live in a vacuum, indeed a war or other conflict may be imminent, and neither A nor B may be able to trade with each other, such that they may lack critical resources.
Criticisms
It is thus not surprising that in practice globalisation, like any other phenomenon, has its dark sides. The way the world trade is currently set up there can be no doubt that it is a rather unfair arrangement. Developing countries are repeatedly urged to drop all protectionism, to open their markets to trade, in practice often meaning Western multinational corporations, and governments are required to stay out of the free market processes. However, Western nations, especially the USA and the EU, have for years refused to do the same. Especially goods in which developing countries would have a comparative advantage, such as agricultural produce, are kept out of the Western world with quotas, tariffs and other trade barriers (Oxfam, 2002). The WTO, the IMF and the World Bank have been following relatively orthodox recipes for growth, repeatedly forcing developing countries to abandon sensible subsidisation or even protection schemes which, only decades ago, have helped nations like Japan and South Korea build up a capital stock and thus to reach their current wealth levels. Instead many now witness countries overwhelmed with debt, with poor governance being exploited by large corporations which use free trade laws to extract much of the resources of the third world, and profit from the value-adding processes in other nations. Similar schemes have existed before: Colonial India was known for its raw materials, which were then shipped to Britain, processed for a profit, and then shipped back to India to be sold to the locals for high prices. Then, there were laws against spinning clothes for oneself in India, today global trade is set up to prevent it automatically. Groups like Oxfam in particular have been campaigning for years to make international trade fairer to developing nations (Oxfam, 2005).
However, such arguments would concern the way globalisation has been done so far, its practical application. There are people however who are opposed to the very idea of free trade itself. Incidentally, this camp both includes members of the far right, who oppose it because they see it as weakening of their national standing and power, and the far left, who see most private enterprise as an exploitation of workers – especially workers who they see as unable to defend themselves. Especially the Left (which includes Green groups and various Anarchist movements) has been vocal in its protests against free trade, and the organisations that organise it. They see the vast income differences between countries as immoral, and consider trade to be the cause of them. It is thus understandable that they are highly sceptical that trade should actually serve to reverse the situation (Engels, 1847). However, realistically there are few ways in which society could today be structured without increasing contact, culturally and commercially, between nations.
The Relationship between Trade and Economic Growth
Economic Growth is then central to the wellbeing of a population. It is thus of interest to any country to attempt to increase economic growth over time. As little as 6% growth per year, quite attainable for countries with a small capital stock and much capacity for increase, can double incomes in twelve years. No government can thus afford to ignore the issue.
Economists generally explain long term economic growth using models, of which the endogenous growth model is considered one of the most accurate. In this model it is shown that capital growth, attained through investment in the country, raises the capacity of the economy to produce and thus increases GDP. However, both population growth and capital depreciation need to be considered as well, as there is a certain level of investment that is required simply to hold standards of living on the same level (Dornbusch, Bodman, Crosby, Fischer and Startz, 2004).
One can see that the rate of savings in a country is integral to continued growth of the economy over time, as it usually provides a large part of the funds required for investment in new capital. This places low-income countries in a difficult situation, as people are often barely able to survive by spending their entire income. They are in no position to save any of it for the future. Empirical evidence underlines this, as saving rates in low income nations, such as in sub-Saharan Africa are as low as 8% of GDP, while saving rates in newly industrialised economies reach levels of 35% (Aryeetey and Udry, 2000). Third world countries have therefore no choice but to attract investment from foreigners in the short term, while hopefully encouraging saving as income increases.
It is in this context that the quality of the financial system in a nation is of the utmost importance. Both theory and empirical evidence suggest that the quality of the banking system fosters entrepreneurship by offering funds (through the attraction of funds), risk diversion and by generally revealing the potential rewards to entrepreneurial activity (King and Levine, 1993).
Both foreign direct investment (FDI) and the provision of money through the banking system are of interest, since FDI not only creates work that may increase income, but also introduces technology, education and skills to the locals which often has positive externalities with it, and indeed this is suggested by the endogenous growth model, which considers positive externalities to be vital for continued growth performance. One must keep in mind however that the attraction of foreign companies for FDI also requires the setting of certain guidelines regarding the conduct of such firms on the country, as there is some evidence suggesting that such policies greatly influence the actual effectiveness of FDI when it comes to the reduction of poverty (Sumner, 2005). One possible explanation could be that some corporations tend to extract resources from developing nations, and thus very little can “trickle down” to the local population.
Nonetheless, investment is of great importance, so the link between trade and investment should be investigated further. Wacziarg and Welch (2003) suggest in their findings that mean investment in low-income countries has increased after trade liberalisation occurred by as much as 1-2%. It is suggested that in the short term, the increased investment attracted through liberalisation is the main channel through which growth follows, although this effect weakens over time.
However, empirical evidence still suggests that open countries grow at a faster rate than closed ones, even after a number of years have passed. This is most likely due to the greater market available to local firms as the economy establishes itself in world trade. Shortly after liberalisation, it is probable that much of the initial trade will consist of imports, which will force the domestic economy to adjust structurally until industries are established that can survive in the new competitive environment. Once it can be estimated where a country’s comparative advantage lies, it may be a good idea to help these sectors of the economy along. This policy has successfully been introduced by Japan after World War II, when industry councils, trade barriers and subsidies restructured the Japanese industry composition quite radically a number of times.
It is however unlikely that in the present climate Western countries would agree to such policies, and the WTO would thus step in and put a stop to any such cooperative agreements between government and industry in developing countries.
Developed economies however have reached a higher equilibrium point, in which growth is relatively stable on a higher level. Factor productivity is high, and both depreciation and population growth could easily be paid for by the higher savings rates. For these countries the question of free trade is thus one of increasing factor productivity through specialisation and attracting international investment to keep the economy at a steady growth path through the accumulation of additional capital. Both Mahadevan (2002) and Gaston (1998) have investigated the impact on liberalisation on Australia, and the results are more or less expected. Total factor productivity in the manufacturing industry increased as overseas competition became a threat to local industries, and industries which were unable to compete shrunk. However, it was also clear that industries in which Australia enjoys a comparative advantage, such as primary industries and some service industries have profited from liberalisation. Wall (1999) estimates the welfare costs to GDP from protectionism in the United States to be as high as 1.45% of GDP in 1996. Considering that this constitutes a dollar value of about US$110 billion, it is obvious that such a waste of resources is unlikely to benefit anyone in the long run.
Economic Aid in the Ugandan Case
Perhaps Yoweri Museveni’s statement was directed at such ineffective trade policies, for it was likely primarily directed at the audience he was speaking to, that being the American public. His emphasis on trade may very well have been meant to re-emphasise the need for the US Government to drop its trade restrictions on Ugandan exports, which include materials like tobacco, cotton, beef and maize.
Indeed Museveni has long worked on an economic policy that is founded on improving trade performance and greater liberalisation. It has been established that economic aid works best in conjunction with openness and institutional and structural reform, and he is likely looking for help to achieve such reforms (Burnside and Dollar, 2000). Furthermore, he may perhaps wish to underline his ownership of the economic strategies that Uganda is attempting to implement, thus increasing Western confidence in his government. Ownership of policy strategies has long been considered an absolutely vital part of successful implementation (Dijkstra, 2005)
When a government has run out of funds, economic aid may often seem like an easy way out of current fiscal crises, enabling governments to continue policies which could have been too expensive otherwise. In some nations, such as the Democratic Republic of the Congo, aid was channelled directly into the personal wealth of the leadership, which consequently provided no benefit to the population at all. Burnside and Dollar have investigated the usefulness of aid to low-income countries and have found that aid works best if it is combined with sound economic policy, such as liberalisation and attraction of foreign investment. Furthermore, the total amount of economic aid received from multinational institutions like the World Bank is likely to increase as policy improves as well (Burnside and Dollar, 2000).
Instead Museveni presumably aims to attract foreign aid that will translate into a better trade performance by using it to restructure the government and the major industries. He hopes that open trade relationships and the pressures of the free market will force government institutions to remain efficient and sensible, and that this can provide an incentive for firms to locate value-adding industries in Uganda.
As Burnside and Dollar also found that the quality of economic policy alone is no significant factor of how much bilateral aid is received, Museveni’s statement may also have the aim of increasing US aid specifically by underlining his relatively responsible government policies, and so convincing US politicians that they would get “value for money”.
He also fears that the wrong type of aid, used for the wrong purposes can cause nations to become dependant on it, such that economic policy becomes impossible to administer and the country remains in a poverty trap. This is presumably what he means by saying that “aid cannot transform society”. Uganda is currently relying on aid largely for the formation of new capital, which is a positive arrangement, yet a threat remains that aid receipts could become an integral part of day-to-day government spending as has been the case in a number of Central Asian countries (World Bank, 2005).
Such reckless use of aid money, which is originally meant to set a nation up for economic growth in the future (one could say to provide a cure for the illness, not the symptom) is an example of bad governance. It is immediately obvious that continued economic growth, particularly if supported by receiving aid in the short term, can only be sustained if institutions and the government are effective and efficient in what they do.
Institutional Quality in Uganda
Institutional quality is a central factor in attracting foreign investment, since things like stability, a lack of corruption and the quality of regulatory frameworks are vital if investors are to make decisions on what the future values of their investments will be.
As Burnside and Dollar have illustrated, good governance is vital if aid is to be used to its full effect, and the quality and effectiveness of government institutions are a vital criterion for good governance.
Some economists, like Joseph Stiglitz, have argued that handing out credit should be conditional on good governance as well, in that creditors should be responsible for any negative effects that ensue if their money is used to fund negative policies. (Stiglitz, 2003). If debt relief is indeed a policy option in the future, the risk to creditors may increase somewhat, such that effective governance becomes even more important.
Uganda has had a turbulent past. After independence, the first president, Milton Obote created a dictatorship, which was overthrown and changed time and time again until President Museveni took control in a guerrilla war in 1986. Since then he has instigated institutional reforms and furthered a free trade agenda, all of which culminated in the allowance of fairly free elections in 1996. In July 2005, the so called “movement” system, which prevented political parties from running in elections directly, was abandoned.
However, Uganda remains a dangerous place at times. In the North, the “Lord’s Resistance Army” (LRA), a religiously inspired guerrilla force has yet to agree to a lasting peace, and Uganda has been known to support similar movements in the Democratic Republic of the Congo, which it also invaded twice.
This uncertainty is reflected in the World Bank’s assessment of the institutional quality in Uganda. Compared to its neighbours, in the category “Voice and Accountability” Uganda’s performance is mediocre, and thus it stands in the lowest quintile worldwide (figure 2). This is unlikely to improve, since there have been concerns for the validity of Uganda’s democracy due to a proposed change in the constitution that would allow Museveni to run for President a third time, as well as the government closure of a news station after the death of the Sudanese vice-president in a crash with an official Ugandan presidential helicopter (Reporters sans frontiers, 2005).
Political Stability is understandably low, due to the continued crisis in neighbouring DR Congo and the conflict with the LRA, which is poised to continue for some time. The same goes for the rule of law, which is severely strained by the internal strife, as well as the poor control of corruption which, while slightly better than in neighbouring countries, is nonetheless in the bottom 20% worldwide.
However, as far as government effectiveness and regulatory quality are concerned, Uganda takes the lead in the region. Government effectiveness is ranked at 43.8, and regulatory quality (no doubt due to Museveni’s focus on liberalisation) even makes it into the top 50% worldwide at a rank of about 55 (World Bank, 2003).
According to the World Bank, Museveni should be encouraged with his economic policies, but in other key areas Uganda has yet to leave the past behind it. The International Criminal Court has recently issued arrest warrants for the LRA leadership, but this would nonetheless require Joseph Kony and his group to be captured first (BBC, 2005). As the LRA has reportedly moved into surrounding nations, Uganda may have to rely on more international cooperation if the situation is to be stabilised.
Furthermore, Museveni himself may soon become a risk to his vision of Uganda. If indeed he gets a third term in office (terms in Uganda are already five years long), the democratic process in the country will be severely strained. Perhaps it would be a better option to use his popularity in the US to achieve multinational support for his security policy, while designating a successor to him to run in the 2006 elections. He could stay in an advisory role (the prime minister of Uganda is in such a position) if necessary, and so continue to oversee the progress that is being made.
The alternative may be a collapse of Uganda’s government and a return to dictatorship, which would surely scare away investors and damage relations internationally.
Conclusion
In conclusion, the sometimes stark differences between theory and practice have been made obvious by the past 50 years or so. Despite similar starting positions, Asian countries have been able to grow at high rates through adhering to sensible economic policies, while nations from Sub-Saharan Africa, perhaps faced with more political and ethnic diversity from the start, have failed.
In theory, trade will bring increased growth through the accumulation of more capital, through the greater size of the market domestic firms can access, and in the long term through the concept of comparative advantage. Once a reasonable income can be created and distributed, savings rates will likely increase and further enable locals to invest in the capital stock, thus lifting nations out of poverty for good.
In practice however, global trade is still unfair, in that developing nations, reliant on agricultural and other primary exports face severe protections from the Western world. While in theory bodies like the WTO should prevent this from happening, in practice no meaningful improvement has been achieved so far.
For Uganda in particular this means a continued reliance on Western goodwill if its free trade policies are to succeed in the long term. Nonetheless, empirical evidence suggests that Museveni’s policies are likely to improve income growth, and thus standards of living over time, provided that the President himself provides a framework of stability and accountability in the country, on which future growth can be based.