This policy brief summarizes the key findings of a recent paper published in the Journal of World Investment and Trade that show how the shrinking of policy space is more than a theoretical concern at the World Trade Organization. Contrary to claims that nations can circumvent the WTO to promote development, new research finds that not only do many of the rules negotiated in the Uruguay Round constrict the ability of nations to put in place aggressive development policies, but these rules have been strictly enforced by WTO dispute panels. Indeed, more than 25% of all WTO cases between 1995 and 2005 dealt with dismantling policy space in developing countries. These findings imply that developing nations should exercise great caution in negotiating measures in the Doha Round that further restrict policy space, especially given the small gains projected to arise from a likely deal.

The need for developing nations to retain national policy space is grounded in both theoretical and empirical arguments. The persistence of market failures in the global economy, especially in developing countries, is cited as the theoretical justification for governments to play a supporting role in development. On the empirical level, the experience of many of the East Asian tigers such as Taiwan, South Korea, and contemporary China serves as testimony that state-facilitated development policy can be a success.

Economists have shown that liberalizing trade in one country that uses government policies to correct for market failures and another that does not correct for distortions can accentuate the distortions—both within the non-correcting country and between the two. Common market failures faced by developing countries in today\'s global economy are:

Information externalities where the private sector lacks the information about opportunities to make productive investments;

Coordination externalities where profitable new industries will not develop unless \"upstream and downstream\" industries are developed simultaneously;

Imperfect competition where highly concentrated sectors make entry into the industry and technological change extremely difficult; and

Environmental externalities where the environmental costs of production and consumption are not reflected in prices and lead to the under or over production of certain goods and services

Table 1 displays the different policy tools used by developing countries to correct for market failures and also displays the extent to which such instruments are still permitted by the rules of the WTO. An \"X\" indicates that GATT/WTO rules prohibit the measure, a \"*\" indicates that the measure is being considered for elimination in the Doha Round, and \"º\" indicates measures still permitted.

Table 1: Policy Space for Development and the WTO

Policy Instrument

Permitted

Agreement

Goods trade

Tariff sequencing

*

GATT

Tax drawbacks

º

Intellectual Property

Selective permission for patents

X

TRIPS

Short patent timelines with exceptions

X

TRIPS

Compulsory licenses

º

Subsidies

Export

X

SCM

R&D

*

SCM

Distribution

*

SCM

Environment

*

SCM

Cost of capital

º

FDI

Local Content

X

GATT, TRIMS

Trade Balancing

X

TRIMS

Joint Ventures

º

Technology Transfer

º

R&D

º

Employment of Local Personnel

º

Tax Concessions

º

Other

Human Capital

º

Administrative Guidance

º

Movement of People

*

GATS

Provision of Infrastructure

º

Source: Gallagher, 20051