Tuesday, November 15, 2005

Free trade isn't fair

Tim Worstall's praise of today's Guardian leader is in need of some tempering. He rightly talks of European and US subsidies ad "both immoral and economic madness". What would be more madness, however, would be a world in which no trade barriers exist.

While I applaud any anecdote combining dog's piss and Peter Mandelson, Ricardo's often-peddled arguments for free trade are obsolete, due to their reliance on perfect mobility of capital and labour as well a complete disregard for the existence of time (see here for another example of what bad consequences this can have).

Economies have a history. There are industries which make them tons of cash today, which could be dead ducks tomorrow as technological advances abroad overtake domestic competencies. Trade barriers give countries useful breathing space to sustain their economies during this transition and hopefully allow the domestic market to find something better to do. In the meantime, consumer confidence can be sustained as protected industries can let workers down gently instead of creating mass employment that can paralyse regions and cause widespread misery.

The other part of the free trade argument is that it ignores all concepts of power. A developing country faced with a multinational with an annual turnover worth twice its GDP will not be able to keepit in check. Of course good governance is a (perhaps THE) major issue in development but one mitigating factor is surely that legal institutions aren't allowed to develop when the economic incentives distort them so much. What is more, studies of knowledge spillovers from multinationals to domestic industry have shown the latter does not gain from the presence of the former. (China's tactic was to use trade liberalisation to actively guide technology into domestic hands, a luxury not open to say Chad or Bangladesh) . Trade controls are therefore a check on the tremendous power faced by developing countries, which hampers their development of technical knowledge and appropriate legal/economic institutions.

Of course the CAP and its equivalents are completely mad; as Blair pointed out, half the EU budget is spent on 3% of its population. Personally, I'm often on the more liberal side of the argument, but to dismiss trade barriers entirely is to exclude an extremely important tool of development policy.

3 comments:

Anonymous said...

Trade barriers give countries useful breathing space to sustain their economies during this transition and hopefully allow the domestic market to find something better to do.

This is a testable hypothesis and there is substantial evidence your proposition is wrong. Domestic rivalry does raise international competitiveness. The breathing room protection provides has been found to damage not enhance performance. Porter and Sakakibara have studied this in depth. See for example their "Competition in Japan," JEP 18(1), 2004.

What is more, studies of knowledge spillovers from multinationals to domestic industry have shown the latter does not gain from the presence of the former.

This is simply wrong. Many studies have investigated and found domestic productivity improvements from FDI spillovers. For example, Haskel, Pereira and Slaughter (NBER working paper 8724) say, "a 10 percentage-point increase in foreign presence in a U.K. industry raises the TFP of that industry's domestic plants by about 0.5 percent." FDI spillovers also occur in wages and these spillovers are strongest in the third world. Wolf (2004:236) writes: "total compensation [in Indonesia] was about 60% higher [at foreign owned firms]...their presence raises wages in domestic plants as well."

You also make at least two other elementary errors. Turnover and GDP are incomparable, since one statistic refers is value added. Were you to compare value added by the firm to GDP your ratio would fall to something in the order of a few percent at most. Secondly, the whole argument that revenue or profit equals the power to be above the law is highly questionable, even in developing countries. Corporations do not employ standing armies, and must and do obey government directives.

AJE said...

The economic case for free trade does not rest on Ricardo's assumptions of fixed capital/mobility/whatever...

That's a straw man

My fist of flounce said...

I would argue that even a on the basis of hastening 'creative destruction', the argument still relies on the ability of resources to be seamlessly reallocated.

Of course, Schumpeter who coined the phrase, would have objected to this line of argument given his belief in the need for gradualism in institutional change.

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