Container ships from international trunk lines such as Europe, Africa, India, Pakistan and Southeast Asia load and unload containers at the container terminal of Qianwan Port Area of Qingdao Port, Shandong province, China, April 4, 2024.

How non-economic objectives in trade policies impact low-income countries

Blog Trade, Firms and Sustainable Growth

Trade policy is increasingly driven by non-economic objectives, creating new risks and opportunities for governments and firms in low-income countries.

Trade policy is increasingly being used today to pursue non-economic objectives (NEOs)such as national security and environmental goals. While for many years, economic objectives such as liberalising trade and improving economic productivity were the driving forces behind trade policy. 

To explore how these non-economic objectives are shaping international trade, researchers and policymakers came together for the 2023 World Trade Forum, organised by the Robert Schuman Centre for Advanced Studies and the World Trade Institute. The research presented at the Forum highlights the increasing use of NEO-related policies. Growing geopolitical tensions and the nexus of climate change and trade are two of the most important examples of the growing importance of NEOs in shaping national trade policy, international trade agreements, and Global Value Chains (GVCs).

The rising importance of geopolitics for international trade

The latest UNCTAD Global Trade Update reveals a rise in trade between geopolitically-aligned countries in 2023, while trade between geopolitically-distant nations has declined. Western governments (in Europe and the US) are increasingly encouraging businesses to shift strategic manufacturing, like semiconductors, to geopolitically-aligned nations, a trend known as 'friend-shoring'. This may be slowing global FDI and causing a slowdown in productivity growth.

That said, not all is doom and gloom. Over the decades, trade has proven to be surprisingly resilient to geopolitical tensions, with the trade-to-GDP ratio increasing even during the height of the Cold War. Economist, Daniel Rodrik suggests the current shift might reflect a realignment towards national priorities post-hyper-globalisation.

Geopolitical uncertainty creates new risks and opportunities

The resurgence of geopolitics poses significant challenges for low-income countries (LICs), which must navigate complex relationships with major global powers. Their political alignments, particularly towards China or Russia, could affect their standing with Western countries. Consequently, middle-income nations like India and Indonesia are striving for neutrality. 

LICs must consider geopolitics in their trade and growth strategies, as access to US and EU markets might require significant concessions, including institutional and social reforms. Western countries should offer transitional support for implementing these reforms. Alternatively, LICs might prioritise gaining or improving their access to Chinese and Russian markets. 

At the firm level in LICs, the imposition of trade barriers for national security reasons leads to varied impacts. This can include organisational and geographical restructuring of GVCs with higher levels of vertical integration or fragmentation through offshoring and outsourcing. This restructuring will not be done based on economic considerations alone, but also geopolitical ones, and these developments might either benefit the individual LIC firm (by giving it new opportunities to join GVCs) or harm it (by cutting it out of a GVC it is already participating in). However, it might certainly limit firms’ avenues for buyer and supplier diversification and growth, as it could restrict their access to either the Chinese, Russian, US, or European markets.

The proliferation of environmental regulations in trade agreements

Environmental and climate concerns are dominating much of today’s economic discourse and have become policy priorities across the world. Many governments are looking to green their domestic production and the supply chains of products imported into their country by introducing stricter climate policies. One recent example includes the EU's Carbon Border Adjustment Mechanism (CBAM), which aims to prevent the outsourcing of carbon-intensive production to LICs (a phenomenon called ‘carbon leakage’).

These measures reflect a broader trend of integrating environmental provisions into trade agreements. Recent research from the 2023 World Trade Forum sheds light on the complex impacts of environmental provisions in PTAs on trade. (Meinhart et al., forthcoming) show that these provisions have an overall positive effect on bilateral trade, but are unable to restrict ‘dirty’ trade. In contrast, (Martínez-Zarzoso, forthcoming) finds that stringent environmental regulations can reduce exports of ‘dirty’ goods, particularly from non-OECD to OECD countries. This hints at the potential of such regulations to prevent the formation of pollution havens, which can have harmful health-effects on the local population.

Low-income countries may face additional burdens due to environmental regulations

Research by the World Bank (Brenton et al., forthcoming) shows that climate change mitigation policies have a disproportionate effect on low- and middle-income countries, with negative effects on trade. LICs often lack the bargaining power to engage effectively in negotiations, and hence find themselves ‘takers’ of an increasing number of comprehensive environmental regulations. 

These new policies often fail to account for dynamics intrinsic to the early stages of industrial development, which can imply a necessary increase in carbon content, and ignore that the share of global carbon exports by African countries is minimal. A more transitory adjustment process for LICs can give firms, with often relatively low financial and technical capacity, the necessary time to adjust production processes while not jeopardising growth within LICs. 

Growing international market integration and trade-cost reduction are also leading to diversified market opportunities for LICs. As previously touched upon, Chinese and Russian markets can offer LICs alternatives to accepting these regulations. At the same time, European and American reliance on resources predominantly found in LICs makes it likely that, in the long-term, the EU and the US must listen to the concerns LICs are raising about the growth-stifling effects of these regulations. In turn, this changing dynamic can potentially be leveraged by LICs to negotiate regulations, such as to allow for the above-discussed flexibility towards regulatory compliance.

Firms in low-income countries will have to bear adaptation costs

Businesses in LICs will have to consider adopting greener production and business practices to access markets in richer nations. Although aligning with tough environmental regulations presents challenges, it also offers firms a chance to enhance their competitiveness and climate resilience, and may offer opportunities for more exports to high-income markets. For businesses, this may mean reevaluating resource usage and investing in advanced production technologies. However, such investments demand capital. Green finance initiatives are crucial in bridging the access to finance gaps in LICs, enabling businesses to undertake the green transition.

In addition, international buyers are increasingly demanding evidence that their suppliers are certified by Voluntary Sustainability Standards (VSS). Unfortunately, becoming certified often involves substantial changes in production and management practices and high certification costs. To facilitate compliance and enhance market access, governments as well as international organisations (such as the WTO’s Aid-for-Trade initiative) should offer technical assistance and financial support for VSS certification, thereby boosting the export capabilities and productivity of firms in LICs.

Bringing equity into trade policy implementation

The international trade environment is seeing a shift towards policies and regulations that are motivated by non-economic objectives. A subsequent restructuring of GVCs may create risks for LICs through supply chain disruptions, but also opportunities through the exploitation of new market opportunities. Targeted policies are needed to reduce those risks, such as through strengthened market diversification, and to explore new windows of market opportunities.

At the same time, environmental concerns are at the forefront of trade policy, specifically in the EU. While it is critically important to reduce emissions in the fight against climate change, these policies should be designed so they do not unduly burden LICs. By emphasising European and American dependence on LIC resources and approaching negotiations as regional blocs (for example, under the AfCFTA), governments can strengthen their bargaining power when these new regulations are being designed. Initiatives like the WTO’s Aid-for-Trade can facilitate LIC regulatory compliance and foster a shift towards incorporating environmental thinking in development and business strategies, putting LIC economies on a greener path.

If you're interested in learning more, check out this policy paper.