How to foster growth through trade

Governments need to create an institutional framework that provides a fertile ground for trade to flourish.

Weekly Government Cabinet Meeting
German trade polities have helped the country's economy weather the crisis with relative success [GALLO/GETTY]

London, United Kingdom –
Governments across the world have been feverishly looking for ways out of the deep economic malaise we still find ourselves in. Generating growth through trade has been a central pillar in the policy strategy of many countries. What is too seldom recognised, however, is that focused policy programmes are a necessary but insufficient condition for trade success. Governments, moreover, need to create a comprehensive “trade polity”, an institutional framework that provides a fertile breeding ground, for trade to flourish.

Small and medium-sized enterprises (SMEs) in particular are dependent on such a support framework. And given their critical role for employment, and as drivers of innovation, structural help for these businesses is crucial for economic success. Take Germany as an example. Germany’s 3.7 million SMEs represent more than 99 per cent of all businesses, produce roughly 40 per cent of taxable turnover and account for approximately 50 per cent of total net value added by companies. The renowned Mittelstand is evidently one of the key drivers of Germany’s economy.

What are the challenges small and medium sized businesses currently face? For SMEs to perform well they require reliable credit lines to finance essential Research & Development (R&D) investments, obtain working capital and secure their commodity supplies in often volatile market conditions. Due to inadequate liquidity and allocation issues in financial markets these essential credit lines are often unavailable. SMEs also require insurance cover for risks linked to export transactions, most typically arising from non-payment through different types of political or commercial risks.

So what can governments do to help? First of all, state investment banks – government-backed institutions – directly operating in financial markets, are an important provider of SME liquidity in many countries and thus fulfil a vital economic function. The German Kreditanstalt fuer Wiederaufbau (KfW) is a good example for how such a state investment bank can nurture the vital SME sector and also transmit government policy agendas – such as environmental protection and energy efficiency – into the economy by creating corresponding incentives and instruments.

Second, governments themselves should provide financing facilities too. Such facilities are typically based on contingent liabilities, which means they are no subsidies, but cover default risks with liquidity coming from financial institutions. Through such mechanisms, governments are able to strengthen industries without generating new fiscal burdens as guarantee instruments are typically self-supporting. For some instruments, government support is also linked to conditional repayments with equity equivalents and rating advantages for companies. These programmes include, for example, investment guarantee schemes, export credit insurance, contingent liabilities for bonds and working capital facilities, untied loan guarantees as well as R&D schemes.

It is important for governments to realise that very focused and often temporary policy initiatives work best when embedded in a permanent framework that nurtures important sectors of the economy. The German economic model, which has proven to be relatively resilient in the current economic crisis, is at the heart of many policy discussions in Europe and beyond. Of course, one cannot just copy or transplant an institutional structure that has grown over decades from one place to another. But some of the basic principles and functions of Germany’s government-enabled trade polity could also be adapted to the specific requirements of other economies.

Enhancing trade polities is certainly not the only necessary reform to bring economies back onto the growth path. But given the importance of trade in the economic strategies of many governments and given the fiscal neutrality of many trade-supporting measures, such reforms could make a significant contribution to growth in very challenging circumstances. It is certainly an area governments should seriously look into.

Andreas Klasen is Partner and Head of the Export and Investment Finance Practice at PwC Germany.

Henning Meyer is a Senior Visiting Fellow at the London School of Economics and Director of New Global Strategy Ltd.