Is trade liberalization good for the Democratic Republic of Congo?

In the 1960 at the time of independence, the Democratic Republic of Congo (DRC) was one of the most industrialized countries in Africa – only surpassed by South Africa. After two major wars and five million deaths, its economy is devastated, it lost its leading position and fell back to place twenty in GDP (PPP) ranking in 2010 in Africa. Should the government adopt strong trade liberalization policies now to return to its leading position in Africa? Although trade theory claims that no country can get worse off by allowing free trade, this conclusion depends on crucial assumptions. For the DRC, imperfect capital and prohibitively high transportation costs suggest that trade liberalization can have adverse effects. Rather, measures of protection for selected industries would allow the creation of a competitive manufacturing sector ensuring sustainable long-term growth – similar to policies in Asia in the last decades.

In theory, free trade leads to a more efficient allocation of resources increasing global wealth. In addition, larger markets allow for more specialization yielding better products and a higher variety to choose from for consumers. Countries will specialize in the production of goods where they have a comparative advantage. In the DRC, a big pool of unskilled workers demand work. The high demand and low supply of work decreases the price of labor. Lower wages for unskilled labor is a comparative advantage in developed countries. In a free and open market, DRC would therefore specialize in low-skilled labor-intensive production like agriculture.

Export of products however requires transportation to ports. With agriculture located in rural areas, transportation is very expensive and time consuming in many areas of DRC despite many waterways. The number of roads and railways decreased since the Belgians left the country. Although massive infrastructure projects inject money for road construction, it would take years – even in a conflict-free time – to transport rural products for export. Therefore, gains from export of agricultural products would be limited. In addition, a vivid agricultural sector might be a prerequisite step for industrialization but specialization in agriculture widens the technological gap to advanced countries. Therefore, specialization in agriculture to achieve an efficient allocation of resources counteracts the long-term goal of sustainable high growth to close the gap to advanced countries. The manufacturing and the service sector exhibit internationally significantly larger growth than the agricultural sector. A sole focus on agriculture would undermine any long-term high growth strategy.

At the same time, imports would destroy the limited local industry. High-skilled labor-intensive products with demand in DRC are manufactured goods. Manufacturing is often agglomerated at hubs, which have access to international transportation. With higher wages for the few higher skilled workers and a lack of technology, these local industries would not be able to compete with international manufacturers. Trade liberalization can potentially destroy the local manufacturing sector.

The DRC has a rich reservoir of several highly demanded resources like timber, cobalt, copper and diamonds. These finite resources will be depleted one day. A direct export without a refining and post-processing industry creates one-time profits, which are not sustainable in the long-term. With liberalized trade, DRC will not gain a comparative advantage in more sophisticated processing industry than simple refining. Instead, resources will be exported and if they are depleted no (human) capital would have been accrued and no industry would have been nurtured to compensate the gap in national income. In contrast to a liberalized trade regime, limited export of resources and protection of an infant industry for advanced processing of those resources could indeed lead to a sustainable industrialization of DRC. High import tariffs as well as export subsidies for products from this industry would allow the industry to cover costs and invest in research as well as accumulating human capital to decrease production costs. Of course, one would need to minimize any distortionary effects especially on other domestic industries by focusing on consumer products.

Does infant industry protection lead to a non-competitive industry? First, strong local interest groups will argue for upholding the protection for their industry keeping inefficient plants alive. However, there is nothing inevitable in this argument and, for example, Korea has impressively shown how to create a highly competitive car industry by early protection. Second, free trade protagonists argue that an economically reasonable protection is a subsidy of production costs in the ‘infant’ years, which will be compensated by sufficiently high profits when the industry is mature. Therefore, capital markets are sufficient to supply capital for the subsidy while a government protection is not needed. The argument assumes perfect capital markets, which simply do not exist in the developing world. Firms have substantial problems to access capital and if they can access capital it is very expensive.

Finally, trade liberalization deprives governments of important revenue streams. Especially developing countries profit from this revenue because it is easy to collect. A developed country can substitute the revenue by other taxes. With income taxes, corporate taxes and value-added taxes being notoriously more difficult to collect, developing countries without an appropriate tax compliance infrastructure have no means to compensate the loss of tariffs. Especially the DRC with its weak governance structures would have to accept such losses. In turn, it becomes impossible to compensate domestic losers of trade liberalization and invest in human capital. In summary, the effect of trade liberalization can be harmful for sustainable growth in severely under-developed countries like the DRC. Instead, protection of infant industries would make it possible for the DRC to participate in industrial high growth sectors in the future.

Advertisement