Why trade supports rather than hinders sustainable development

Sustainability now has a high priority everywhere, and rightly so. Sustainable development is one of the greatest global challenges of our time. However, focusing solely on the environmental aspects of sustainability is insufficient. After all, sustainability also includes economic and social dimensions as well. Therefore, holistic solutions are required, and a strong involvement of business is the key to success in this area. After all, the UN considers international trade to be a driving force for sustainable development. 

Trade in goods and services and foreign direct investment reduce poverty, improve the quality of life of many people and have a long-term positive impact on the environment. This requires good governance in the individual countries and responsible companies. Thanks to their comparably high sustainability standards and premium products, Swiss companies contribute significantly to sustainable development in the world. They are among the most important foreign direct investors, especially in developing countries. This often involves a strong commitment to training and the transfer of modern technologies.

In order to be able to exert a positive influence in the future, Swiss companies must have unrestricted access to global markets. In a time of faltering multilateral trade liberalisation, countries increasingly rely on bilateral free trade agreements. These agreements are essentially economic agreements aimed at reducing trade barriers. Of central importance are also intergovernmental organisations (UN, OECD, WTO, etc.) which negotiate and develop sustainability standards. As in the past, Switzerland should continue to play an active role here.

Sustainable development is one of the greatest challenges our society is facing. According to the UN World Commission on Environment and Development, “sustainable development is development that meets the needs of the present without compromising the ability of future generations to meet their own needs”. In order to achieve globally sustainable development, the UN member states jointly defined 17 Sustainable Development Goals (SDGs) for the period up to 2030. The central elements include, for example, the promotion of inclusive and sustainable economic growth, the protection of human rights and the conservation of the planet’s natural resources. The UN member states agree that these challenges and commitments are interlinked and require integrated solutions. It is therefore necessary to take a holistic view of the SDG Agenda 2030 and to purposely intervene where the greatest impact can be achieved.

The SDGs also illustrate that sustainable development includes not only a consideration of environmental aspects, but social and economic dimensions as well.

These three dimensions are closely interlinked and mutually dependent. If, for example, one factor affects a particular dimension, sooner or later this may have positive or negative consequences for the other dimensions. These are measured by indicators. However, such measurement methods are the subject of heated discussions, as certain aspects are difficult to quantify. It is not possible to make a clear distinction between the three dimensions because they overlap to some extent and have common points of intersection. The interdependencies within the sustainability triangle can be illustrated using the following example.

If a multinational company creates new jobs in a developing or emerging country, it increases the material standard of living and purchasing power locally (economic dimension) by means of knowledge and technology transfers. This enables the local population to gain better access to education and health (social dimension). As income rises, consumption also increases, which is desirable from a social and economic perspective. In the short to medium term, more consumption and more production can indeed lead to an increase in CO2 emission. In the longer term, however, higher incomes allow the local population to invest in more environmentally sustainable goods, such as more efficient air conditioning systems. In addition, the introduction of new technologies by foreign companies often helps to make local production more resource-efficient (environmental dimension).

The business community has a strong self-interest in sustainable development. Only a sustainable and careful use of the production factors labour, soil and capital can ensure the economic capacity to act in the long term. Sustainability is therefore the basis of entrepreneurial action, as this is the only way to guarantee economic success in the long term. For this reason, far-sighted companies strive not only for a high short-term return on investment. They also have a fundamental interest in satisfied, healthy and well-trained employees. Such employees tend to be more productive and more willing to stay with the company. Furthermore, companies are dependent on an intact environment that will continue to provide relevant natural resources in the future. In addition, entrepreneurial solutions play a decisive role in overcoming environmental and social challenges.

In its 2030 Agenda for sustainable development, the UN made clear that business plays a central role in achieving sustainable development goals. In its view, international trade is a driving force for inclusive economic growth, poverty reduction and the promotion of sustainable development. 

However, as trade is a broad concept, it includes an exchange of a wide range of goods (imports and exports). It serves both the production of new goods and their consumption, thus creating important benefits for people. But it is by no means limited to material things. It also includes foreign direct investment and the cross-border provision of services, for example when Swiss specialists repair a machine in another country or advise foreign companies on risk insurance.

The exchange of material and immaterial goods increases the prosperity of all countries involved, as each trading partner will only produce what it can do best in relative terms. This specialisation of individual countries leads to an international division of labour: goods are imported when their domestic production is too expensive. On the other hand, goods are exported if their production at home is cheaper than abroad. Imports also increase the choice of goods at home and lower prices for consumers. And exports have a positive effect on employment. This increases the income of the local population. The import and export of goods thus increases the overall prosperity of all trading partners involved. As a result of the global trade in goods and services, local companies are also integrated in international value chains.

The specialisation of countries means that certain sectors of the economy are increasingly exposed to greater competition, including from abroad. Individual domestic suppliers may be forced out of the market as a result. Nevertheless, the long-term effects of increased competition are generally positive. Companies are forced to undergo a constant process of renewal. The resulting improvements in production processes not only disrupt existing structures, but also drive economic and technical progress in the market. As a result, particularly innovative domestic suppliers are successful and, thanks to technological and methodological advances, are able to establish themselves in the market, thereby increasing their productivity. This in turn generates additional revenues, which can eventually be redirected to new investments and ultimately create new jobs.

Global trade also includes foreign direct investment. This category of investment is made by Swiss companies with the intention of acquiring a lasting share in a company abroad. Foreign direct investment has both direct and indirect effects. For example, a direct effect is generated when a company opens a branch abroad, employs staff locally and pays their wages. A number of studies have shown that foreign companies in developing and emerging countries tend to pay higher wages than domestic ones.  

Foreign direct investment has an indirect impact via so-called spillover effects, also known as externalities. In the case of spillover effects, certain influencing factors (such as the production or consumption of goods) have positive or negative effects on other factors. A positive spillover effect occurs, for example, when a Swiss company trains employees abroad, thereby increasing local knowledge about more efficient production methods. At the same time, air pollution caused by a factory abroad represents a negative spillover effect. In both cases, the advantages or disadvantages are not accounted for in the price, which is why they are external.

The figure below shows the four different types of spillover effects foreign direct investment can have. For example, foreign companies can bring new technologies and knowledge to a country (knowledge transfer). This increases the productivity of the local economy. Foreign companies can also train employees, who then move to local companies in the target country (labour mobility). New market entrants also increase  competition, which in turn increases productivity and efficiency in the market. In addition, the influx of foreign companies makes it easier for domestic firms to access export markets because they can use the infrastructure and networks of foreign companies for their own purposes.

Foreign direct investment also facilitates the integration of local companies in international value chains. Thanks to positive spillover effects, even companies that act as suppliers or customers of foreign subsidiaries benefit. 

Kofi Annan, former UN Secretary-General, once said: "Open markets offer the only realistic hope for lifting billions of people in developing countries out of poverty while maintaining prosperity in the industrial world". He firmly believed that the cause of poverty and underdevelopment is not too much trade, but too little trade, and therefore always advocated the dismantling of trade barriers. Science confirms this statement: open markets and trade have a positive effect on a country’s economic development. For example, they directly increase per capita GDP growth, equity investment and productivity. They also reduce structural unemployment and thus poverty.

Worldwide, the proportion of people affected by extreme poverty has fallen sharply in recent decades. Whereas, in 1981, 42.5 percent of all people lived in extreme poverty, this figure dropped to just 9.2 percent in 2017 (see figure below). Thus, the global poverty rate in 2017 was lower than ever before. For 2019, the global poverty rate is predicted to fall to 8.2 percent. Since the early 1990s, a total of more than one billion people has been lifted out of poverty.

At the same time, the share of trade in global economic growth has increased significantly since 1980. Between 2000 and 2018, the value of the exports of the least developed countries has increased more than six-fold (from 41 to 257 billion USD).

Trade plays a crucial role in poverty reduction. A study on African countries shows that trade openness and the structural change it triggers reduce poverty in the longer term and that the private sector contributes significantly to poverty reduction. The World Bank and the World Trade Organisation (WTO) draw the same conclusion: the expansion of international trade and the growth stimuli, productivity gains and income increases resulting from it are essential to reducing poverty worldwide. In 2018, the organisations published a joint report that provides eight case studies to show in concrete terms the contribution of trade to poverty reduction in developing countries. According to a World Bank study, per capita GDP in a country increases by one percent if its integration in global value chains increases by one percent.

Furthermore, open markets have predominantly positive effects on social sustainability. They increase the population’s access to education, especially for women. In addition, market openings go hand in hand with greater participation of women in the labour market and reduce child labour. Since 1990, life expectancy in the least developed countries has risen by an average of 13 years and the global mortality rate of children under five years has fallen by almost 60 percent.

The social aspects are part of the Human Development Index (HDI), which measures the social progress of countries. Various studies have come to the same conclusion: there is a positive correlation between trade and HDI. For example, it has been found that an inflow of foreign direct investment has a positive effect on the development of the HDI in Africa. A look at developing countries since 1991 confirms this positive relationship: the stock of foreign direct investment has increased substantially in these countries, while the HDI has also developed positively in the same countries.

The impact of increased trade on environmental sustainability is disputed. Critics of free trade claim that developed countries take advantage of trade liberalisation to shift their environmental footprint to poorer countries with lower standards. According to evaluations by the ETH, however, this hypothesis cannot be empirically proven. On the contrary, liberalisation through free trade agreements does not cause a shift of the ecological footprint to low-income countries.

Another approach to determine the cause-effect relationship can be found in the Kuznets curve (see figure below). The curve describes the relationship between environmental quality and per capita income. In the initial phase of economic growth, the curve shows that pollutant emissions increase and environmental quality decreases. However, this happens only up to a certain level of per capita income. After that, the trend reverses, so that environmental quality improves as per capita income rises. The applicability of the Kuznets curve has been confirmed for various environmental aspects, such as water or air pollution and the ecological footprint.

Thus, in the short to medium term, trading can lead to an increase in CO2 emissions as production and consumption increase. Negative spillover effects, such as a market price that does not reflect the environmental costs of production or consumption, can occur. In the longer term, however, the new technologies introduced by trade will help to make local production more efficient and more resource-efficient (positive spillover effect). In addition, with rising income, the consumption patterns of the local population change as well – after all, people do not buy twice as many refrigerators just because they earn twice as much. Demand for more environmentally sustainable products, such as more efficient air conditioning systems, increases in the longer term and the need for an intact environment becomes more important.

The economy is often not sufficiently considered when solving environmental problems, although pricing leads to more efficient production methods and new resources that can be tapped. A perfect example of this is the aluminium can which, in the 1950s, weighed 85 grams. Today it weighs only 13 grams. Thanks to innovation and recycling, it is now possible to save 85 percent of the material. Specifically, for industrialised countries with relatively high income levels, there seems to be a tendency to reduce the consumption of material. In Switzerland, per capita resource consumption has fallen by 30 percent since 1990, while economic output per person has increased by 25 percent. 

The positive impact of trade on sustainable development along all three dimensions depends to a large extent on the context. This includes the design of legal and political institutions in the country, legal certainty, infrastructure, financial markets, education levels of the population, etc. It also depends on the extent to which foreign companies are embedded locally through their investments and how much they interact with local firms and stakeholders. Through the instrument of international cooperation, Switzerland endeavours to make a positive contribution in the areas of economic foundations, education and infrastructure in developing and emerging countries. However, despite some success, international cooperation is unable to fundamentally change a misguided policy in the local context or an unfair distribution of local wealth gains. Nor can international trade and the associated free trade agreements do so. Institutional reforms must come from within, i.e. they must be politically pursued and called for by the people and decision-makers in the country concerned. This is often a long and difficult process. It is not without reason that the 16th SDG, which includes, among other things, the promotion of inclusive institutions at all levels and the rule of law, is considered the most difficult to implement.

In order to comprehensively assess the impact of trade on sustainable development, it is not enough to focus on individual aspects. The causal chains involved must be considered as well. For example, trade liberalisation can have a positive impact on different SDGs over several steps, as the example of a Swiss manufacturer in the figure below illustrates. The company has a programme that promotes women at its foreign branch according to the standards of the headquarters and thus makes a positive contribution to several UN sustainable development goals.

The timing and impact an effect has can vary as well. For instance, the effect can be negative in the short term, but positive in the long term. This can be seen in African countries, for example. There, parts of the local population may earn less after the market has been opened up because they do not yet have the skills that are now required. However, since the market opening also improves local training opportunities, this will change over the longer term and more local workers will benefit from the new jobs and thus increase their income.

Switzerland is an export nation. It generates a considerable part of its added value by exporting goods and services, and 40 percent of total value added is exported. Nevertheless, in absolute terms, Switzerland does not occupy a leading position when it comes to international trade in goods and services. The situation looks quite different for foreign direct investment: according to UNCTAD (United Nations Conference on Trade and Development), Switzerland is one of the ten largest economic powers. Correspondingly, the influence that Swiss companies exert on global sustainable development through direct investment is large. There is hardly a multinational company from Switzerland that has not committed itself to an international standard regarding social or environmental sustainability – whether through the Global Compact, the Principles for Responsible Investments, the Equator Principles, the UN Principal Guidelines on Business and Human Rights or the OECD Guidelines for Multinational Enterprises.

Switzerland occupies top positions in various sustainability rankings. For example, it ranks second in the Green Economy Index and in Robeco’s sustainability ranking. In addition, several Swiss companies achieve top rankings in the renowned Dow Jones Sustainability Indices, a family of stock indices that consider not only economic, but also environmental and social criteria. Consequently, the high sustainability standards of Swiss companies have a positive impact on the sustainability of their branches abroad, especially when compared to those of other countries.

Swiss companies also contribute to sustainable development in their partner countries by exporting innovative, technologically advanced and high-quality products. For example, drugs developed by Swiss pharmaceutical companies improve healthcare in other countries. At the same time, Swiss industrial companies export resource-efficient machinery abroad, thus making an important contribution to more sustainable local production.

Apart from this, the preferences of consumers are increasingly shifting towards greater sustainability. As a result, Swiss companies are offering an increasingly differentiated range of products and services in response to the growing demand for more sustainable products and production processes. At the same time, Swiss import and export companies already meet a large number of standards and product regulations. Accordingly, sustainability considerations are of great importance for the Swiss economy.

With capital stock of almost CHF 1.5 trillion, Swiss companies create over two million jobs outside Switzerland. The economic footprint of Swiss companies in developing countries is equally impressive. The capital stock here amounts to CHF 202 billion, with more than 660,000 related jobs. If this stock is put in relation to the size of the Swiss economy and compared with the global ratio of foreign direct investment to GDP, it is striking that Swiss business is almost four times more involved in these regions than the rest of the world (see figure below). This often includes, for example, a strong commitment to training and the transfer of modern technologies. 

The Center for Corporate Responsibility and Sustainability (CCRS) at the University of Zurich has been investigating the question of the extent to which Swiss direct investments in developing countries are locally anchored and how they contribute to sustainable development. The case studies provide an impressive illustration of the positive contribution made by Swiss companies to sustainable development on the ground.

As part of its foreign policy, Switzerland is committed to greater social, economic and environmental sustainability through a variety of multilateral, plurilateral and bilateral instruments. In this context, the benefits of free trade agreements are first described below and then compared with those of other instruments.   

In view of the positive effects of trade on sustainable development, a generally binding and liberal international trade regime is of central importance. Trade liberalisation is most efficient if it takes place within the framework of the WTO, i.e. multilaterally. In this way, they apply to all WTO members and business can plan worldwide with a single, uniform set of rules. However, due to increasing international trade disputes and protectionist measures, Swiss trade diplomacy is also increasingly focusing on the conclusion of preferential free trade agreements. Currently, Switzerland has 32 such treaties with a total of more than 40 countries. Of these, 29 were negotiated within the framework of the European Free Trade Association (EFTA), of which Switzerland is also a member. These free trade agreements reduce customs duties, which in turn reduces trade costs for Swiss companies and their local customers. They also reduce non-tariff trade barriers, such as different product requirements.

However, international trade is about much more than just reducing customs duties. Free trade agreements create binding rules so that all partners can benefit from the advantages of trade. Since 2010, for example, every free trade agreement concluded by Switzerland contains a chapter on trade and sustainable development. In this chapter, the signatory states agree to binding provisions on environmental and social aspects in accordance with international conventions. These pursue a cooperative approach, which is why they cannot be enforced through arbitration. This does not mean, however, that these regulations cannot be monitored and enforced. Trade-related sustainability issues are discussed in joint committees. This does not mean that the cooperation approach is ineffective. Evaluations of the provisions on labour standards in trade agreements, for example, show that the cooperation approach is more effective in pursuing social sustainability goals than coercive measures.

A review of the model chapter on trade and sustainable development was undertaken by EFTA in 2019, both in terms of the content of the provisions and the approach to dispute settlement. The new provisions cover issues such as the sustainable management of forest and fisheries resources, biodiversity, climate change, inclusive trade and corporate social responsibility. EFTA also strengthened its approach to dispute settlement with its free trade partners. The new approach allows partners to set up a panel of independent experts if problems cannot be solved through the traditional consultation channel.

Free trade agreements demonstrably increase the international exchange of goods. It has been shown that Swiss companies also increased their investments in partner countries significantly after such agreements came into force. Furthermore, exports to these countries have more than doubled in comparison to the overall growth of Swiss exports. The figure below also shows that, as the number of international economic agreements increased, so too did Switzerland's exports.

Free trade agreements must remain first and foremost economic agreements and minimise trade barriers. They must therefore not be overburdened. The primary objective of a free trade agreement should be to provide Swiss companies with non-discriminatory access to foreign markets. In this way, exports, imports and direct investments enable Swiss companies to make a positive contribution to economic growth and the achievement of SDGs in the target markets.

To make this growth accessible to as many people as possible and to minimise the resulting negative spillover effects, true-cost pricing is an important factor. This means that, in accordance with the polluter pays principle, all costs incurred as a result of actions or omissions are borne by those responsible. At the same time, however, further accompanying measures need to be implemented. These cannot be achieved through bilateral free trade agreements, but with the help of targeted instruments via the relevant multilateral platforms such as the UN, OECD or WTO. Switzerland actively participates in these instruments and the further development of global regulations. It is represented in all important organisations and helps shape standards wherever possible (see figure below). Switzerland incorporates the decisions taken by these bodies in its free trade agreements, thus taking account of its multilateral obligations.

A coherent foreign policy must take this division of responsibilities into account. Free trade agreements must primarily focus on their core function in order to intervene where they have the greatest impact: the removal of international trade barriers. However, in the interests of policy coherence, the concerns of sustainable development should also be considered in free trade agreements. In this respect, Switzerland is not creating new rules, but is instead referring to existing international environmental agreements as well as to the instruments of the International Labour Organization (ILO), for example, in the case of standards for social labour rights abroad. However, the basic standards for sustainable development must continue to be negotiated and developed in the relevant international organisations. This is the only way to ensure that there is a uniform understanding and that the same rules apply in all participating countries. Bilateral free trade agreements are not an effective instrument for further developing rules on labour standards or environmental concerns – after all, no one is asking the International Maritime Organization to dismantle customs duties. If divergent sustainability provisions are laid down in free trade agreements, this weakens the efforts of intergovernmental organisations responsible for developing internationally applicable standards. Nevertheless, free trade agreements reinforce sustainability provisions and contribute to their implementation.