3.4 How are trade policies that favour investment in some industries and discourage it in others reviewed with a view to reducing the costs associated with these distortions?
Governments sometimes use trade policy instruments, such as import tariffs (including tariff peaks and escalating tariffs) and subsidies (investment incentives) to promote investment in targeted industries. Considerable care must be taken to ensure that such measures do not distort resource allocation and damage the overall investment climate. Favoured industries, typically domestically-controlled, compete for resources with foreign and other domestic enterprises, and any policy-induced favours can crowd out investment and production in more productive activities. Moreover, where the output of the targeted industry is an input to others, competitiveness in final products and in world markets may be harmed, reducing firm profitability and hence further investment in export-oriented sectors. These costs are typically long-lived, since they are often non-transparent and spread among many producers which reduces the incentive for governments to reform such practices.
The promotion of investment in specific industries through trade policies should be both transparent and consistent with existing international obligations. A first-best approach is to maintain a trade regime that allows competitive industries to develop and flourish as much as possible without discrimination, rather than to try to nurture competitiveness behind trade policies that tilt competitive conditions in favour of incumbents (be they domestic or foreign). This does not necessarily imply removing all forms of import protection, nor does it assign a completely passive role to domestic policy. What it entails, however, is a keener sense of the costs and benefits of using trade policy to achieve objectives that other domestic policy instruments may be more suitably equipped to pursue, such as labour market, education, innovation and SME development policies.
Related PFI questions:
PFI users should examine the economy-wide effects of proposed trade measures favouring particular industries and ensure that the terms of reference of reviews of existing measures pay proper attention to potential effects on trade and investment activity. These reviews should also help to minimise the risk of nullifying or impairing liberalisation commitments scheduled under international trade agreements.
Reviews can apply regulatory impact assessment (RIA) analysis, a tool used today in most developed countries and in several developing countries to measure better the economic and social welfare impacts of regulation and to identify the most efficient and least trade- or investment-restrictive alternatives. RIAs are widely recognised as contributing durably to improving the business environment and to promoting regulatory efficiency.
Question 3.4 is particularly relevant for highly-regulated sectors, such as electricity, energy, telecommunications, transportation and financial services, which have historically been subject to various trade, investment and broader competition restrictions on the grounds of market failure. Technological advances and far-reaching reassessments of the shifting borders between the market and the state (resulting in increasingly liberal and competitive environments) have seen trade restrictions come under increasing challenge resulting in an unprecedented wave of pro-competitive regulatory reform, privatisation and market liberalisation in most parts of the world. Several key infrastructure services sectors that were until recently state-owned monopolies are today supplied competitively in markets governed by independent regulatory authorities whose decisions and rules affect domestic competitive conditions, consumer choices and prices.
The PFI user should consider the following measures:
Several WTO Members, particularly developing countries, worry that possible requirements to conduct RIAs under the WTO’s various transparency provisions could represent a heavy administrative burden in light of limited governmental capacities and resources. These concerns are legitimate, but lighter approaches – such as a simpler requirement to publish the rationale for new or proposed regulations rather than engaging in extensive stakeholder consultations – might not help host countries durably to improve governance in their regulatory institutions and decision-making processes. Targeted technical assistance and capacity strengthening in this area could yield large dividends.