University of Jordan

Faculty of Business
Department of International Business

The Economic Impact of Free Trade on Jordan's

Balance of Payments

Prepared By:

Nerin Abu-Keer
Mera Al-Horani
Aroob Tamimi

International Finance
Instructor: Dr. Mohammad Al-Abadi
January - 2009

1
Table of contents

Abstract
Introduction
• Problem studied
• Background Information
• Research objectives
WTO: an overview
Jordan accession to the WTO
Actions toward trade liberalization
The effect of free trade on Jordan's Balance of payment
•Current account
•Capital and financial account
Is the fixed exchange rate the best regime?
Conclusions
Recommendations
References

2
Abstract

Countries are not all the same in their production capabilities, which increases the
need for the international trade, without trade, each country must make everything
it needs, including things it is not very efficient at producing. However, free trade
has its impacts on the economy whether it is positive or negative.

Consequently we aim in this paper at studying the effect of free trade on Jordan's
balance of payment; observing the major effects among Jordan accession to the
WTO on the BOP main anchors: current account, capital account, and financial
account.

In sum, our study finds that Jordan has made great strides following its accession
to the WTO, in reforming its economy and liberalizing its trade regime, and yet has
many challenges to face to lead stabilization and economic reform in order to
direct FDI inflows to invest in export sectors given the new access to global
markets. And to support the development of high-value added industries to reduce
the effect of high import content of exports

Introduction

3
The Jordanian economy has undergone a remarkably positive transformation since the
exchange rate and banking crisis prior to 1993, which nearly halved the average
Jordanian’s living standard. Since then, export-led growth is higher, foreign direct
investment is increasing, and poverty and unemployment have been reduced. By all
accounts, a substantial portion of this transformation owes to the economic reforms
implemented by the Government of Jordan (GOJ) in the last decade, including
macroeconomic stabilization, liberalized foreign trade and domestic prices, reduced
public debt, and privatization of state owned enterprises (IMF, 2005).

The economy continued to expand at a healthy, though slower pace, At the same time,
the external current account deficit widened significantly, mainly reflecting a growing
trade deficit and a decline in external grants. International trade and integration with
the world economy has become one of Jordan’s primary strategies for continued
domestic economic growth.

The trade liberalization facilitated by the General Agreement on Tariffs and Trade
(GATT) and World Trade Organization (WTO) commitments and obligations, and
bilateral and multilateral agreements, brought about not only considerable growth in
exports and imports, but also a diversification of trade.

The continuing reforms by the Hashemite Kingdom of Jordan, centred on trade

liberalization, have resulted in real GDP growth of 5.9% and relatively low inflation
of 3.1%, on average per year during 2000-07. The reforms have also contributed to
reducing public debt from 98.4% of GDP in 2002 to 60.3% at the end of March 2008,
and increasing the average annual inflow of foreign direct investment (FDI) from
US$155 million during 1990-00 to US$3,121 million in 2006.

4
The business environment remains somewhat inhibited by, inter alia, administrative
hurdles, limitations on foreign participation in certain activities, such as road
transport, and costly transport infrastructure and utilities. State ownership remains
substantial. Moreover, the surge in world prices of fuel and food is exerting pressure
on inflation (6.3% in 2006 and 5.4% in 2007). To meet these challenges, Jordan is
improving education and health services, modernizing its infrastructure, and
addressing some structural problems, notably through the privatization of state-owned
enterprises. In addition, steps are being taken to improve the business environment
through, inter alia, the launching of the one-stop shop facility.

Therefore, we aim at achieving the following objectives in our study:

1. Investigate the importance of Jordan accession to the WTO.

2. Examine the effect of free trade on Jordan's balance of payment.

WTO, overview

5
An international organization designed to supervise and liberalize international trade.
It came into being in 1995, and is the successor to the General Agreement on Tariffs
and Trade (GATT).WTO deals with the rules of trade between nations at a global
level, and it is responsible for negotiating and implementing new trade agreements,

The WTO has 153 members and it is governed by a Ministerial Conference, which
meets every two years; and is responsible for implementing the conference's policy
decisions. The WTO's headquarters is in Geneva, Switzerland.

• Mission & function

The WTO's goal is to improve the welfare of the people of its member countries,
specifically by lowering trade barriers .Its main mission is "to ensure that trade flows
as smoothly, predictably and freely as possible".

Of Its main objectives are the following:

1. Reviewing the national trade policies, and to ensure the coherence and
transparency of trade policies through surveillance in global economic policy-
making.
2. Assisting the developing, least-developed and low-income countries in
transition to adjust to WTO rules and disciplines through technical cooperation
and training.
3. Assessing the global trade annually through the economic research and
analysis; and producing scientific annual reports.
4. Cooperating closely with the IMF (International Monetary Fund) and the
World Bank.

• WTO and the developing countries

6
About two thirds of the WTO’s 150 members are developing countries. They play an
increasingly important and active role in the WTO because of their important role in the
global economy, and because they increasingly look to trade as a vital tool in their
development efforts. The WTO deals with the special needs of developing countries in
three ways:

1. The WTO agreements contain special provisions on developing countries,

which gives them special rights allowing them to be treated more favorably than
other WTO members; Like "extra time" to fulfill their commitments (in many of
the WTO agreements), providing them with techniques to safeguard their
interests when adopting some domestic or international measures (e.g. in anti-
dumping.
2. WTO has created a special entity "The committee on trade and

development" to deal with developing countries special needs including the

implementation of the agreements, technical cooperation, and the increased
participation of developing countries in the global trading system.
3. WTO secretariat provides technical assistance of various kinds for

developing countries. It organizes around 100 technical cooperation missions to

developing countries annually, trade policy courses, Regional seminars, and
Training courses organized in Geneva for officials. In addition to providing them
with legal advisers for assisting them in any WTO dispute and for giving them
legal counsel.

• Areas of improvement within the WTO regarding the least

7
 Developing Countries members
1. The accession to the WTO

The developing countries are facing the problem of being accepted in the WTO as a
member; moreover, a least developed country can hardly afford to remain outside the
global trading regime.

2. The degree of democracy practiced in the WTO

WTO supposedly operates on a consensus basis, with equal decision-making power for
all. In reality, The United States get involved to the extent that it almost dominates the
rules of WTO and developing countries are forced to change their laws rather than pay
for their own defense.

3. WTO neglects labor & Human Rights

WTO rules put the “rights” of corporations to profit over human and labor rights. The
WTO has ruled that it is illegal for a government to ban a product based on the way it is
produced, such as goods produced with child labor.

4. WTO privatizes essential services

The WTO is seeking to force national governments to privatize essential public services
such as education, health care, energy and water so that these sectors are open to
multinational corporations; which damages the developing countries the most.

5. WTO defenses TRIPs against Human Rights

The WTO’s fierce defense of ‘Trade Related Intellectual Property’ rights (TRIPs)—
patents, copyrights and trademarks—comes at the expense of health and human lives.

8
The WTO has protected pharmaceutical companies’ ‘right to profit’ against
governments seeking to protect their people’s health by providing lifesaving medicines
in countries like Africa, where thousands die every day from HIV/AIDS.

• Recommendations for the developing countries

To date, developing countries have played a minor role in setting the agenda for
multilateral trade negotiations. This has allowed developed countries to extract
considerable concessions from weaker trade partners.

Therefore, we recommend:

1. Developing and least developed countries need to draw up their own positive
agenda.
2. Developing countries need to mobilize scarce resources for technical preparation,
identifying areas of interest, rather than reacting to pre-set agendas presented by
others, and mounting a joint effort towards capturing the initiative from the very
beginning in the negotiation process.
3. The WTO should consider its top priority to be the development needs of its
members.
4. Sections of agreements that work to the disadvantage of developing countries must
be changed, including agriculture, TRIPS, textiles, and the dispute settlement
system.
5. U.S. domination should end, decision-making should be democratic, and each
government should consult regularly with its broader society on trade deliberations.

• Jordan accession to the WTO

9
Jordan became a member of the World Trade Organization in April 2000 as to be the
136th member of the WTO. Jordan has agreed to assume all its WTO obligations upon
accession, and undertook several reforms to bring its economic policies into
compliance with the WTO agreements, such as amending to existing laws and drafting
several new laws especially in the field of intellectual property rights.

The government enacted national economic reform procedures and new legislations in
preparation to Join WTO. It also liberalized a number of important services sectors
providing market access to foreign investors and service providers of WTO Members in
accordance with Jordanian laws and regulations. Whereas in goods' trade, Jordan
committed to reduce customs tariffs to reach 30% as a maximum in 2000, to be reduced
to 25% in 2005, and to reach 20% in 2010 with the exclusion of a limited number of
goods.

On the other hand, government improved the business environment resulting in high
rates of growth in gross domestic product as a result of steady growth in the volume of
Jordanian exports as well as attract a lot of Arab and foreign investments, also
commended the leading role of H.M. King Abdullah II in promoting trade and
economic relations through several royal visits to various countries and regions of the
world and his persistent effort in promoting and enhancing Jordan's trade and economic
relations with countries worldwide.

Accession to WTO provides Jordan's goods and services with market access to more
than 150 countries within clear and transparent trade procedures and laws and
regulations in accordance with WTO rules and agreements. It also helps reduce the cost
of production requirements i.e. customs on inputs will be diminished. Furthermore, the
WTO membership will open the way to more export opportunities for competitive

10
products.

Jordan continues to take steps to transform itself into an outward-oriented,

internationally competitive market-based economy, and has made considerable progress
toward compliance with WTO obligations as it finished with success the first review of
its trade policy within the framework of the World Trade Organization during the period
10-12/11/2008, which is first review since Jordan's accession to the WTO in 2000.

• Actions toward trade liberalization

US - Jordan Free Trade Agreement

On October 24, 2000, the United States and Jordan signed the US-Jordan Free Trade
Agreement (FTA). By wining US congressional and Jordanian parliamentary approval
for the FTA, Jordan became only the fourth country in the world to have a bilateral free
trade agreement with the US, and the first in the Arab state.

The agreement is the capstone of growing US Jordanian collaboration in economic

relations, which began with close bilateral cooperation on Jordan's accession to the
World Trade Organization (WTO) and was followed by the conclusion of a trade and
investment framework agreement and a bilateral investment treaty. The FTA serves as
an example for Arab region of the benefits of peace and economic reform as it is an
expression of America’s commitment to, and confidence in Jordan’s economic future.
Jordanian investors, exporters, consumers, and workers all stand to benefit from the
agreement.

US-Jordan FTA is designed to attract investment to Jordan by offering improved access

to US markets, and to benefit Jordanian exporters in specific industry sectors by

11
achieving significant and extensive liberalization across a wide spectrum of trade
issues. It will eliminate all tariff and other commercial barriers to bilateral trade in
goods and services between the United Stated and Jordan in virtually all industrial
goods and agricultural products within ten years.

The FTA also includes substantive provisions addressing trade and environment, trade
and labor, and electronic commerce, a step that should help advance a global free trade
agenda in a sector critical to American high technology and multimedia companies.

Intellectual property provisions occupy a large part of the US-Jordan FTA. The
agreement’s provisions incorporate the most up-to-date international standards for
intellectual property right, including prospects for technology-based industries,
copyright-based industries and pharmaceutical companies.

EU - Jordan Free Trade Agreement

The EU Association Agreement with Jordan was signed in November 1997, was
ratified by the Government of Jordan in September 1999, and has come into force in
May 2002. The agreement was signed with the aim of creating a free trade area by
2010. The objectives of the Association Agreement are:

12
 1- Provide an appropriate framework for the political dialogue, allowing for the
development of close political relations between the Parties.
2- Establish the conditions for the progressive liberalization of trade in goods,
services and capital.
3- Foster the development of balanced economic and social relations between the
parties through dialogue and cooperation.
4- Improve living and employment conditions and hence productivity and financial
stability.
5- Encourage regional cooperation with a view to the consolidation of peaceful co-
existence and economic and political stability.
6- Promote cooperation in other areas which are of reciprocal interest.

Therefore, and in light of the objectives of the Barcelona Process, the agreement
revolves around three major themes: political, economic and financial, and social and
cultural.

Some of the commitments within the context of the Euro-Jordanian Association

Agreement are:

1. Trade in Industrial Products. The agreement entails that exports into Jordan are

exempted from duties, over a transitional period of twelve years upon entry into
force of the agreement, in accordance with a specific arrangement.
2. Removing Non-tariff Restrictions. The agreement sets out the provisions that
relate to requirements regarding non-tariff restrictions between Jordan and the
EU.
3. Rules of Origin. In terms of the rules of origin requirements, the third protocol

attached to the agreement specifies the minimum requirements of working or

13
 processing that has to be carried out on non-originating materials to confer
originating status in Jordan.
4. Trade in Services. In terms of trade in services, the EU Member States and

Jordan commit to use their best endeavors to allow the progressive liberalization
of the trade in services.
5. Competition. Jordan’s commitment regarding competition entails the prevention

of monopolistic practices, state monopolies of a commercial character, public

enterprises and enterprises to which special or exclusive rights have been
granted.

The Agreement allows entry of Jordanian industrial exports into EU-member countries
free of customs duties and other charges having equivalent effect from date of entry
into force of the Agreement. Also, EU industrial exports are allowed entry into Jordan
free of customs duties and charges having equivalent effect over a transitional period of
12 years starting from date of entry into force of the Agreement, except for a list of
specific products.

In addition to elimination of tariffs and reduction of non-tariff barriers, the Agreement

contains comprehensive provisions on the conduct of trade in agricultural and industrial
products, right of establishment and services, payments and movement of capital,
competition, intellectual property rights, financial co-operation, economic co-operation
in the field of industry, standards, transportation, telecommunications, energy, science
and technology, environment and tourism, statistics, and the fight against illegal drugs.

Moreover, within the context of the Agreement, the EU has pledged to set up a Special
Fund to assist in improving the export capacity and competitiveness of Jordanian
industries.

14
Greater Arab Free Trade Area

Jordan, along with sixteen other Arab countries, signed the Greater Arab Free Trade
Agreement and its implementation commenced on March 9, 1998. According to the
agreement, all Arab products moving among member states have been awarded the
status of national goods in accordance with the principle of gradual liberalization,
leading to duty-free movement of goods and the establishment of the Arab Free Trade
Zone since January, 2005. It is expected that the other Arabian countries will join this
agreement in the near future.

The GAFTA includes in its membership 17 Arab countries:

15
1- Jordan
7- Morocco
13- Kuwait

2- United Arab
Emirates
8- Syria
14- Tunis

3- Bahrain
9- Lebanon
15- Libya

4- Saudi Arabia
10- Iraq
16- Sudan

5- Oman
11- Egypt
17- Yemen

6- Qatar

12- Palestine

16
GAFTA is
 1. The effect of free trade on Jordan's Balance of payment
Current account
Trade in goods and services

Jordan's external current account, as percentage of GDP, moved from an increasing

surplus during 2001-03 (12.2% in 2003) to deficits of 17.4% in 2005, and 17.3% in
2007, due mainly to strong
import growth: the trade
deficit jumped from
US$1,423 million
in 2001 to
US$4,497.7 million
in 2007. In recent

17
years, the current account deficit has been financed by FDI and other long-term
capital inflows, with gross official international reserves increasing from US$4,745
million (4.8 months of imports) in 2005 to US$6,870 million (5.5 months of imports)
in 2007. An external current account deficit of 15.6% of GDP is expected for 2008.
The external current account deficit widened significantly, mainly reflecting: a
growing trade deficit and a decline in external grants.

The strong growth in

Exports-Imports
domestic exports was 10000.0

largely offset by surging 9000.0

imports, reflecting: the 8000.0

7000.0
increased industrial
6000.0

production and high

JD/Millions

Exports, f.o.b.
5000.0
Imports, c.i.f.

import content of 4000.0

exports, continued 3000.0

2000.0
pickup in domestic
1000.0

economic activity and 0.0

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

consumer demand, and Years

rising world oil prices.

Jordan's economy is increasingly dependent on international trade: the ratio of

merchandise trade (exports and imports) to GDP averaged 108% during 2004-06. In
2006, Jordan ranked 70th among world merchandise exporters (considering the
countries of the EC together and excluding intra-EC trade), and 53rd among importers.

18
In commercial services trade, Jordan ranked 49th among exporters and 51st among
importers.

Jordan has a relatively diversified export base, with manufactures accounting for
about 70% of total merchandise exports, on average, during 2000-07. Chemicals are
the main exports (26.3% of manufactured exports in 2007, up from 22.2% in 2000),
followed by textiles and clothing products, and machinery and transport equipment.
The contribution of food products (led by tomatoes and other vegetables) to total
merchandise exports remained stable at around 14% on average over 2000-07, while
the share of mining products declined from 11.1% in 2000 to 6.5%.

Jordan's imports have increased in line with its significant economic growth over the
last few years. Total merchandise imports more than tripled from US$4,013 million in
2000 to US$13,531 million in 2007. Almost 60% of total merchandise imports are
manufactures, led by machinery and transport equipment; chemicals, office machines
and telecoms equipment, automotive products, and textiles also represent a sizeable
share. Fuels represented 21.7% of total merchandise imports in 2007 (up from 4.8%
in 2000), whereas the share of food imports decreased from 21.2% to 15% during the
same period.

Balance of payments data indicate that Jordan is a net importer of services, with a
deficit averaging JD 89.4 million per year during 2001-07. The deficit of
transportation services went from JD 339.5 million in 2001 to JD 823 million in 2007,
partly offsetting an increasing surplus of travel services, which went from JD 228.4
million to JD 1,013.1 million during the same period.

Capital and financial account

19
The deficit in the portfolio investment current
account is offset by the
800.0

continuous surplus in 600.0

the
capital and financial 400.0 account
which can be

JD/millions
200.0 portfolio investment

attributed to: Portfolio

0.0

investments has been

2001 2002 2003 2004 2005 2006 2007

-200.0

increasing, but is still a very

small part of total -400.0
years
foreign
investment, Jordan's average annual inflow of FDI jumped from an annual average of
US$155 million during 1990-00 (37.1% of GDP in 2000) to US$3,121 million in 2006
(114.2% of GDP). This was largely the result of the positive developments in the
economy over the period, the steps taken by Jordan to improve the investment climate
(e.g. enactment of the FDI

Investment Promotion 3000.0

Law, and launching of the

2500.0

one-stop shop facility),

2000.0
and some privatizations
JD/millions

carried out through 1500.0 direct investment

FDI. 1000.0

th
Jordan ranked 8 out of
current account VS capital and financial account
500.0
141 economies in 2006 1500.0

(19th in 2005) in 0.0

1000.0 2001 2002 2003 2004 2005 2006 2007
years
UNCTAD's Inward 500.0

FDI Performance 0.0

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

Index. Nonetheless, capital and financial accounts

JOD

-500.0
current account

Jordan's vast potential -1000.0

-1500.0

-2000.0
20
-2500.0
years
for attracting foreign investors and fostering domestic investment remains somewhat
untapped. Its position in UNCTAD's Inward FDI Potential Index was 59th in 2005
(61st in 2004). This is mainly because, in general, FDI in Jordan has been inhibited by,
inter alia, administrative hurdles for starting a business. As a result, Jordan ranks 80 th
(out of 178 economies) in the World Bank's Ease of Doing Business 2008 Index (79 th
in 2007). In addition, limitations are maintained on foreign participation in certain
activities

Is the fixed exchange rate is the best regime?

The economic developments recorded in a country’s balance of payments (BOP) reflect

the interplay of forces in the domestic economy and the global economy. If home prices
rise faster than world prices, and the exchange rate is held constant, home goods will
tend to: lose competitiveness on world markets, and the volume of exports will decline;
foreign goods will become increasingly attractive on the domestic market, and imports
will increase.

In general, the pegged exchange rate arrangement has served the Jordanian economy
well; it has lent stability and credibility to the investment environment, and provided a
credible anchor for price stability. Nonetheless, the depreciation of the U.S. dollar
against other major currencies since 2006 has contributed to the rise in Jordan's
inflation rate. To manage liquidity in the financial system, the CBJ basically relies on
indirect instruments of monetary control, notably the purchase and sale of certificates
of deposit. Core inflation has remained below 3% over the last few years. To contain
inflationary pressures, the Government recently eliminated import duties and sales
taxes on certain products considered essential, while the CBJ has tightened its

21
monetary policy. The annual average inflation rate in Jordan, as measured by the
consumer price index (CPI), was 3.1% during 2000-07 (5% during 1990-99).
However, it reached 6.3% in 2006,5.4% in 2007, and 15.6% in 2008.

Conclusion

The growth in trade that results from lowered trade barriers is generally beneficial
regardless of its effects on the balance of trade for the following reasons; for example
it brings capital, modern technology, and improved skills for domestically hired labor,
it reduces poverty and unemployment rate, it modernizes the infrastructure, and
attracts larger foreign direct investment (FDI) inflows, in addition to reducing public
debt, and increasing the role of the private sector in the economy

However, it is the growth in both exports and imports of each country that allows
production to shift to the most efficient producers and thereby expands output. No
country would export if it could not import.

For a trade agreement to have much effect on the trade balance, it would have to
significantly alter either aggregate saving or gross domestic investment. Only
substantial changes to barriers that affect large amounts of trade and investment
(relative to the size of the economy) might do that.

Even if an agreement were to significantly worsen the balance of trade with the world;
that would not undermine the benefits of the agreement. Trade deficits with the world
are not generally harmful, and trade surpluses are not generally beneficial.

reports concluded that such deficits normally have a small positive effect on gross
domestic product (GDP) and little if any effect on aggregate employment (although

22
some redistribution of employment among industries may occur, and some individual
workers may be made better or worse off).

Recommendations

We recommend at the end of this study to continue with the policy of

macroeconomic stabilization and economic reform (i.e. commitments to protect
intellectual property rights IPR), and to direct FDI inflows to invest in export sectors
given the new access to U.S. markets.
Further efforts should be headed to diversify exports and support the development of
high-value added industries to reduce the effect of high import content of exports

23
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