WORLD TRADE  
ORGANIZATION  WT/WGTDF/W/29 
11 April 2005 
 (05-1492) 
Working Group on Trade, Debt 
and Finance  
 
 
INTER-LINKAGES BETWEEN EXTERNAL LIBERALIZATION 
AND INTERNAL REFORM 
 
Note by the Secretariat  
 
 
 
   
 
I. INTRODUCTION 
1. This Note provides background material for the Working Group's examination of the issue of 
"Inter-linkages between external liberalization and in ternal reform".  It focuses on the linkages that 
are listed in the Working Group's mandate for this theme.
1 
2. Trade liberalization is widely acknowledged to be an important source of economic growth, 
but it is generally accepted that the linkage between liberalization and higher gr owth is not automatic.  
In an ideal world, real and financial resources would adjust quickly and costlessly to the new set of price signals and market conditions that prevail on ce trade restrictions have been removed, shifting 
into areas of production that offer the prospect of higher organic economic growth.  In practice this 
adjustment process is complex and it can be constraine d by a wide variety of factors.  Internal reform 
to reduce and remove as far as possible these cons traints is therefore a valuable companion to the 
process of external liberalization.   
3. The Marrakesh Ministerial Declaration on  Coherence recognized that support for 
governments to carry out internal economic reforms had an important multilateral dimension, but it 
stated also that the task of achieving harmony betw een structural, macroeconom ic, trade, financial and 
development policies falls primarily on governments at  the national level.  The Monterrey Consensus 
made a similar point:  "Each country has primar y responsibility for its own economic and social 
development, and the role of national policies a nd development strategies cannot be overemphasized.  
At the same time, domestic economies are now in terwoven with the global economic system and, 
inter alia , the effective use of trade and investment oppor tunities can help countries to fight poverty.  
National development efforts need to be supporte d by an enabling international environment".
2 
                                                      
1WT/WGTDF/2.  The full text of this theme is:  "The importance of the in terface between external 
liberalization and internal policies ha s been acknowledged.  To maximize the benefits of such liberalization and 
the integration of individual Members in world trade, Members' policies should also be geared towards 
stimulating the supply response to market opportunities, taking into acco unt their individual capacities and 
needs.  This could involve specific actions to raise domestic private savings and encourage foreign direct 
investment, in line with the Monterrey Consensus, and to remove obstacles that hinder the development of 
exports such as high transport and handling cost s and the poor state of tr ade infrastructures."  
2 Outcome of the International Conference on Financing for Development (Monterrey Consensus), 
March 2002, paragraph 6. This document has been prepa red under the Secretariat's own 
responsibility and without prejudice to the positions of Members 
and to their rights and obligations under the WTO. WT/WGTDF/W/29 
Page 2  
 
 II. USING EXTERNAL LIBERALIZATION TO PROMOTE INTERNAL REFORM 
4. It is sometimes noted that one of the most  valuable spin-offs from trade liberalization 
conducted multilaterally through reci procal Rounds of WTO negotiati ons is to help governments 
break down opposition domestically to internal economic reform.  In this sense, external liberalization 
can act as a catalyst for internal reforms.  It can  help generate domestic support for the removal of 
institutional and policy-based barriers to competition in  local product and factor markets, since these 
barriers raise production costs for domestic invest ors and entrepreneurs and impede their ability to 
respond effectively to increased foreign competition. 
5. Recognizing that a tax on imports is also a tax on domestic producers and on exports, an 
increasing number of countries have placed trade libe ralization at the vanguard of their policies to 
develop more competitive and diversified industries with greater export potential.  High tariffs on 
imported inputs of intermediate a nd capital goods, particularly when coupled with inefficiencies in 
customs and tax administration, increase the direct costs of producing and exporting and can make the 
difference between a profitable or a loss-making inv estment.  Some countries have tried to correct for 
this through reimbursing tariff duties on inputs ( duty drawback schemes), providing exemptions on 
duties for exporters (duty exemption schemes),  and setting up export processing zones where 
intermediate inputs can enter duty free.  Howeve r, these systems can be come complex and they 
require considerable administrative resources, bot h from the government and the private sector, to 
ensure that they run quickly and fairly.  Empi rical evidence from Africa, Latin America and the 
Caribbean in the 1990s suggests that attempts to  establish these systems by low income countries 
were generally not successful.
3  Broad-based trade liberalization that reduces tariffs for all importers 
avoids these administrative difficulties. 
6. Tariff revenues can constitute an important prop ortion of fiscal revenue, particularly in low 
income countries.  As a result, some countries have  taken the opportunity to carry out domestic tax 
reform when liberalizing their import tariffs, with a view to replacing trade taxes by more progressive forms of taxation that are less distorting for the tr adable goods and services sectors of their economies 
and that also raise more fiscal revenue.   
7. This linkage between tariff reduction and domes tic tax reform has been discussed in the 
Working Group and in General Council meetings on Coherence.
4  Recent empirical work by the IMF 
has confirmed that trade taxes amount to between on e-quarter and one-third of total tax revenue in 
some low- and middle-income developing countries.5  However, through timely and complementary 
fiscal reform programmes, middle-income developing countries as well as several low-income 
developing countries (e.g., Pakistan and Uganda) ha ve largely succeeded in recovering tax revenue 
lost from reducing trade taxes.  Their experience suggests that reform of the domestic tax system 
should be carried out in parallel with trade liberalizat ion – not delayed until afterwards – and that this 
carries with it the opportunity to increase the credib ility of  the liberalization process and reduce the 
likelihood of its reversal.  Typically, revenue rec overy requires a committed and continuous effort to 
broaden the tax base by purging exemptions , simplifying rate structures and improving 
administration, and strengthening domestic consum ption taxes such as excise taxes or VAT.  
Consumption taxes have the advantage of incr easing government revenue since total domestic 
consumption offers a much broader tax b ase than simply its import component.   
8. Liberalizing trade in financial services can also he lp to underwrite internal economic reforms.  
It can encourage greater efficiency in the prov ision of financial services and help to promote 
complementary financial sector regulation, especially  in the prudential area and the supervision of 
                                                      
3 World Bank Global Economic Prospects  (2001), p. 64. 
4 See, for example, "Liberalizing trade and sa feguarding public revenues" (WT/TF/COH/16). 
5 IMF, "Dealing with the revenue conseque nces of trade reform", December 2004.  WT/WGTDF/W/29 
 Page 3 
 
 
 financial institutions.6  The linkage between domestic financial sector reform and external 
liberalization of trade in financial services has b een examined in the Working Group as well as in the 
GATS Committee on Trade in Financial Services.  Sustainable financial services liberalization needs to be designed within a supportive macroeconomic framework and accompanied by the strengthening 
of prudential policies, the upgrading of regulatory an d supervisory systems, the resolution of bad-loan 
problems and the deregulation of in terest rates and credit controls.
7  In this regard, the Working Group 
has noted in the past the value of countries pa rticipating in the Financial Sector Assessment 
Programmes of the IMF and the World Bank, and that  financial sector strengthening is one area where 
cooperation between the WTO, the IMF and the Worl d Bank could usefully be strengthened in order 
to help WTO Members assess their readiness to benefit from opening their financial services sector.8 
III. MOBILIZING RESOURCES TO SUPPORT EXTERNAL LIBERALIZATION 
9. A country's capacity to increase its supply of trad able goods and services to take advantage of 
new market opportunities that are created by trade liberalization will depend on many factors.  Two 
that are given particular weight in the literature  are its ability to mobilize productive resources, both 
domestically and from abroad, and to encourage their long-term investment in the tradable goods and 
services sectors of the economy. 
10. The Monterrey Consensus on Financing for Deve lopment viewed as vital the creation of an 
enabling domestic environment to mobilize resources,  increase productivity, reduce capital flight, 
encourage the private sector and attract and make effective use of international investment and 
assistance.   
11. It considered that a crucial task, in this re gard, was to enhance the efficacy, coherence and 
consistency of macroeconomic policies.  Domestic price inflation and an exchange rate that is 
seriously over- or undervalued, or particularly volatil e, will distort the relative price signals that are 
critical for taking advantage of a period of trade liberalization to reallocate resources more efficiently into the tradable goods and services sectors of an  economy.  Along with unsustainable levels of 
foreign or domestic debt, they can lead to the lo ss of investor and consumer confidence, reducing the 
stimulus to growth from trade liberalization throu gh both the supply side and the demand side of the 
domestic economy.
9  A competitive and stable real exchange rate and domestic price stability 
underpin investor confidence in establishing a long- term export capability and ensure that producing 
tradable goods and services can be profitable and re mains so over time.  Empirical evidence shows a 
particularly strong correlation between overvalued or  volatile exchange rates and low growth in GDP 
and in exports.10  Ideally a programme of macroeconom ic stabilization needs to precede trade 
liberalization, or at least to be conducted aggressi vely in conjunction with it.  Experience has shown 
that inconsistent or erratic macroeconomic po licies can reduce the credibility of the reform 
programme and lead to a reversal in trade policy as a result of political resistance.11  
12. Other factors cited by the Monterrey Consensu s as important for the mobilization of domestic 
resources for development, particularly financia l resources, are good governance, appropriate policy 
and regulatory frameworks, fighting corruption at all levels, investments in basic economic and social 
infrastructure, and strengthening and deve loping the domestic financial sector.   
                                                      
6 See WT/WGTDF/W/4 for a more detailed analysis of linkages between trade and financial reforms. 
7 IMF Working Paper 00/31, "Trade Policy in Financial Services" (2000), and IMF Occasional Paper  
211 "Capital Account Liberalization and Financial Sector Stability" (2002). 
8 WT/WGTDF/M/2, andWT/WGTDF/W/4 and W/7. 
9 WTO World Trade Report 2004:  Exploring the Linkage between the Domestic Policy Environment 
and International Trade  (2004) and OECD The OECD Report on Regulatory Reform  (1997). 
10 WT/WGTDF/W/4. 
11 WTO "Adjusting to Trade Liberalization.  The Ro le of Policy, Institutions and WTO Disciplines", 
Special Study No.7, Marc Bacchetta and Marion Jansen.  WT/WGTDF/W/29 
Page 4  
 
 13. The World Bank provides an analytical framework  that links many of these factors together, 
in describing what it considers to be key elements  of a positive domestic investment climate that will 
help developing and least-developed countries unlock opportunities to compete more effectively on world markets, accelerate growth and reduce poverty.
12   
14. First, sound enabling policies – good governance,  institutions, and property rights – can help 
attract more private investment, both domestic and fo reign.  In this regard the World Bank attaches 
particular importance to the transparency both of  government policies and regulations and of the 
broader business environment.   
15. Second, policies that promote competition and entrepreneurship increase the efficiency of 
investment.  Among the policies that typically act most decisively to r estrict competition and 
entrepreneurship, and that therefore need priority a ttention in the reform process, are border controls 
and regulations on imports and on foreign investment, and inside-t he-border administrative barriers to 
the entry and exit of firms.   
16. Third, complementary public investment further contributes to overall productivity growth, 
particularly investment in effective infrastructur e and human capital which have an especially high 
return in terms of economic growth and poverty reduction. 
17. With regard to the mobilization of foreign direct investment and other private flows, the 
Monterrey Consensus recommended that countries con tinue their efforts to achieve a transparent, 
stable and predictable investment climate, with proper contract enforcement and respect for property 
rights, embedded in sound macroeconomic polic ies and institutions that allow businesses, both 
domestic and international, to ope rate efficiently and profitably  and with maximum development 
impact.13 
18. The Monterrey Consensus viewed Official Development Assistance (ODA) as playing an 
essential role in complementing other sources of fi nancing for development, especially in those 
countries with the least capacity to attract private FDI.  It felt that ODA can, inter alia , help a country 
reach adequate levels of domestic resource mob ilization over an appropriate time horizon, while 
human capital, productive and export capacities are enhan ced.  It can also be critical for improving the 
environment for private sector activity and can thus pave the way for robust growth.   
19. Within the World Bank's framework described a bove, ODA can be particularly important in 
providing supplementary resources with which to he lp finance public investment that enhances the 
domestic investment climate.  Wo rld Bank data show that assistan ce provided by major bilateral and 
multilateral donors for investment climate improve ments averaged $21.1 billion per year between 
1998 and 2002 (about 26 per cent of all ODA) of whic h about half went directly to investment in 
infrastructure.14 
IV. TRANSPORTATION AND TRADE-RELATED INFRASTRUCTURE 
20. Trade-related transaction costs have come to be recognized as a crucial determinant of a 
country's ability to integrate into the global econo my.  If its investment climate is poor and its 
institutions, infrastructure and ancillary services are weak, simply changing relative price incentives 
through liberalizing import tariffs  and non-tariff barriers at home, and removing restrictions on its 
                                                      
12 World Bank Ibid (2003), pp. 77-115. 
13 The literature on foreign direct investment and foreign portfolio investment flows to developing 
countries was reviewed in WT/WGTDF/W/4. 
14 World Bank Ibid (2005), p. 191.  WT/WGTDF/W/29 
 Page 5 
 
 
 exports abroad, may do little to promote sustaine d growth in a country or improve its export 
performance.   
21. The São Paulo Consensus of UNCTAD XI stated th at "the development of efficient transport, 
communications and logistics infrastructure and serv ices requires priority attention in developing 
countries", and that "particular attention is n eeded to mitigate challenges posed by locational 
handicaps of landlocked countries a nd small island developing States".15 
22. Some of the problems that developing and least-developed countries face in providing 
adequate trade infrastructure and supporting ser vices are the result of geographical location, 
technological deficiencies, and lack of investment capital.   
23. UNCTAD has an extensive progra mme of research and analys is underway in this area, 
promoting efficient transportation and trade fac ilitation to improve partic ipation by developing 
countries in international trade.16  One focus of its work is on lowering international transport costs 
which, for a variety of reasons, can be disproporti onately high for developing countries, particularly 
low income countries and landlocked countries.  UNCTAD figures show, for example, that the 
international transport costs for imports of landl ocked African countries account for an average of 
20.7 per cent of the value of their imports, compared to the world average of 5.1 per cent and the 
average for African countries of 12.7 per cent.17  UNCTAD notes that access to frequent, reliable and 
low-cost regular liner shipping services largely determines a country's connectivity to overseas 
markets and thus also its competitiveness in global markets.  The World Bank notes too that the costs 
of international transport services are a crucia l determinant of a developing country's export 
competitiveness, and that liberalizing public trade barriers and private commercial practices – through 
improved competition policies, for example – that a ffect the provision of international maritime and 
air transport services has the potential to yield large benefits to the trade performance of developing 
countries.18 
24. Other causes of high trade-related transacti on costs include inadequate trade-related 
infrastructure and restrictive regulatory policies that limit competition in the countries themselves.19 
25. Most infrastructure services in developing countries are supplied by governments or public 
departments with administrative barriers to entry.   Poor internal transportation, communications, 
finance and energy services can seriously constrain e xport potential.  The lack of competition leads to 
higher costs and lack of maintenance and investme nt in technological upgrading.  Unreliable service 
can be even more damaging to competitiveness than simply high costs.  Opening up these services to 
competition under a transparent regulatory regime can lower costs, attract foreign and private capital, 
and improve the quality and delivery of the services.  In this regard, the African Development Bank 
has provided examples of recent privatization and de-monopolization efforts and their positive impact 
on performance.20 
26. The potential gains from liberalizing internal tr ansport policy regimes – public shipping lines, 
port monopolies, national flag carriers, and controlled freight forwarding, agency and third party 
logistics markets – and attracting private sector investment to improve the level of transport and 
logistics technology and efficiency are very large.21  Levels of protection in infrastructural services 
                                                      
15 UNCTAD document TD/412. 
16 UNCTAD document TD/B/COM.3/67, December 2004. 
17 UNCTAD document TD/B/COM .3/EM.22/3, December 2004. 
18 World Bank Ibid (2002), Chapter 4. 
19 World Bank Ibid (2001), p. 64. 
20 African Development Bank, African Development Report 1999:  Infrastructure Development in 
Africa , (New York, Oxford University Press). 
21 World Bank Ibid (2001), p. 65. WT/WGTDF/W/29 
Page 6  
 
 (transport, finance and telecommunicati ons) have been found to approximate ad valorem  tariff 
equivalents of 50 to 100 per cent, and protection is  considerably higher in developing countries than 
in industrialized countries.
22  Lack of competition in the provision of port services in Egypt, for 
example, has resulted in handling and storage charges 30 per cent higher than in neighbouring countries.
23  Similarly, port delays and inefficiencies  account for the most of the reason that the 
transportation costs associated with shipping a cont ainer of textiles to the United States from India are 
more than 20 per cent higher than from Th ailand and 35 per cent higher than from China.24   I n  
contrast, liberalizing and privatizing port services in several countries in La tin America has lead to 
higher productivity and lower handling costs.25   
27. It might be noted, in this regard, that measures listed in Members' GATS schedules under 
transport services include quotas such as cargo reserva tion policies, foreign ownership limitations of 
service providers, requirements regarding the legal fo rm of commercial presence, discriminatory taxes 
and subsidies, restrictions on the hiring of forei gn crew members, and the terms of access to port 
services and other essential infrastructure and fac ilities such as computer reservation systems. 
28. High internal and international transport costs are particularly burdensome for exporters from 
low-income countries, and can be a more important trade barrier than the trade restrictions these 
countries face in their main export markets.  Wo rld Bank figures suggest that for 168 out of 216 U.S. 
trading partners, transport costs outweigh tariff barriers.26  Countries in Africa, for example, normally 
absorb all, or most, of their own transport costs of exporting.27  Africa's net freight and insurance 
payments in the early 1990s were about 15 per cent of the total value of the region's exports, and for 
Africa's landlocked countries the figure was 40 per cen t.  For developing countries as a whole, the 
equivalent figure is nearer 5 per cent, implying that  in order to be competitive an average producer in 
Africa has to be 10 per cent more efficient than firms in other developing countries, and 35 percent 
more efficient if the producer is in a landlocked African country – such margins are exceedingly difficult to realise.   
29. Other domestic policy-induced obstacles to the provision of efficient and low-cost trade-
related infrastructure are often grouped under the term "trade facilitation" .  This term tends to be used 
(by UNCTAD and the World Bank, for example) to cover a much larger area of domestic regulatory 
reform and investment in trade-related infrastructure than is apparently covered by the mandate of the 
WTO negotiations on Trade Facilitation.  Nonethel ess, complicated and costly customs clearance 
procedures, complex and non-transparent administrative requirements, high costs of processing information on goods and services crossing borders, and uncertainty about the enforceability of legal 
trade documents are all regarded as being high on the list of problems that can add significantly to the 
transaction costs of engaging in international trade.   
30. One World Bank study has tried to measure the benefits of carrying out investments and 
reforms to four separate aspects of trade facilitati on:  port efficiency, the customs environment, the 
regulatory environment, and trade-related services infrastructure.  The study estimates the potential 
increase in trade for 75 countries, following improvements in each of these areas that would raise the 
efficiency of trade facilitation in below-average c ountries halfway to the average for the whole set of 
countries.  The findings suggest that better trade facilitation would increase trade among the 75 countries by about 10 per cent, or $377 billion.   Of this total, $116 billion would result from 
                                                     
 
22 WTO "Opening Markets in Financial Services and the Role of the GATS", Special Study No. 1 
(1997) and WTO op cit  (2004). 
23 World Bank Ibid (2002). 
24 World Bank Ibid (2003), p. 95. 
25 WTO op cit  (2004), p. 128. 
26 World Bank Ibid (2004) p. 181. 
27 World Bank Ibid (2001) pp. 64-5.  WT/WGTDF/W/29 
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 improved customs and regulatory environments, $107 billion from more efficient ports, and 
$154 billion from enhancing infrastructur e in the trade-related services sector.28   
V. COOPERATION BETWEEN THE WTO, THE IMF AND THE WORLD BANK 
31. This theme of the Inter-Linkages between Exte rnal Liberalization and Internal Reform is 
included in the Working Group's mandate as one of th e themes that covers the remit of the WTO, the 
IMF and the World Bank.  In this regard, two in itiatives involving all three organizations are worth 
recalling, and may be relevant to any eventual conclusions of recommendations that the Working 
Group may wish to make under this theme.   
32. One is the Integrated Framework for LDCs (IF).  In the Doha Declaration, Ministers urged the 
relevant organizations, including the WTO, IMF a nd World Bank, in coordi nation with development 
partners to explore the enhancement of the IF with  a view to addressing the supply-side constraints of 
LDCs – the kind of constraints that the Work ing Group is examining under this theme.   
33. The second is the IMF and World Bank Poverty Reduction Strategy Paper process (PRSP), 
under which member countries are encouraged to "m ainstream" trade issues – including external 
liberalization – into their broader policy mix of macroeconomic policies, structural reforms, and 
anti-poverty measures.  Typically, a PRSP is a crucia l element for a low-income country to use when 
seeking concessional financial support for its devel opment programme.  Assistance from the IMF and 
the World Bank, and where appropriate also the WTO Secretariat, is available to Members to help 
them design their PRSPs in such a way as to match internal reforms with external liberalization.  
 
__________ 
 
 
                                                      
28 World Bank Ibid (2004) pp. 193-4.