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Policy Options Paper

Options for Trade, Finance and Development: Getting the Institutions Right

January 2016

The basic tenet of the present policy paper is that economic institutions are the key determinant of economic growth and development, and that policy-makers and developing country governments dealing with trade and finance must concentrate on “getting the institutions right.” In order to be implementable, policy recommendations must correct inefficiencies that the market system will not, implying that correcting market (and institutional) failures constitutes the crux of the policy options. These fall under four headings, informed by the standard list of canonical market failures. First, the widespread existence of externalities and coordination failure imply that: (i) strategic use should be made of official development assistance and blended finance; (ii) domestic resources in developing countries should be better mobilised through stronger domestic tax institutions and a more transparent international tax system; (iii) guidelines should be adopted for broadly-used private standards that affect trade; and (iv) duty-free and quota-free preferences, alongside liberal rules of origin with extended cumulation provisions, should be extended to all least developed countries. Second, standard public goods arguments imply a pressing need for: (i) development-led legal and regulatory reform; (ii) the implementation of a long overdue trade facilitation framework for services; (iii) the realignment of incentives that determine the sectoral allocation of Aid for Trade funds towards the services sector; (iv) ensuring the availability of correspondent banks in all low-income countries which are otherwise largely cut off from the trading system; and (v) contributing to the construction of a global coordination mechanism for trade and supply chain finance. Third, natural monopoly arguments at the regional level call for: (i) enhanced mechanisms for regional regulatory cooperation in general and financial services in particular; and (ii) enhanced regional aid for trade. Fourth, the existence of asymmetric information problems faced both by developing country governments and international investors suggest a pressing need to: (i) improve technical advice on international economic agreements (including public-private partnerships) available to developing country governments; and (ii) adopt model solvency schemes and debt restructuring approaches. The paper concludes with a recommendation on measuring progress on these policy options through the construction of an aggregate index of “institutional readiness.”

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Policy Option Paper

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