The Economics and Politics of International Trade

Freedom and Trade: Volume Two

Gary Cook

• Publisher: Routledge
• Year: 2002
• eBook ISBN: 9781134731954
• Topic: Commerce
• Subtopic: Commerce Général

This volume is contemporary in focus, and explores key issues in current debates concerning international trade policy. The contributors are leading economists and political economists from Britain, Europe, the United States and Japan.

1 INTRODUCTION

Gary Cook

The conference ‘1846 Freedom and Trade 1996’ was convened to commemorate the repeal of the Corn Laws in 1846, an event of outstanding symbolic significance in the history of free trade. The history of the Corn Laws in England has been a long one and subject to three phases:

• the early period prior to 1660 when most regulation was of trade within the country and the emphasis was on protection of the consumer;
• the period from 1660 to 1814 when the emphasis, if anything, was on regulation of the exportation of grain and the aim was to maintain a balance between the interests of producers and consumers;
• the period from 1814 when the emphasis shifted firmly to the control of imports and the promotion of the interests of the landed classes.

There were two significant Acts which laid the basis for the shift to the third phase which generated such fierce debate. The Act of 1814 removed restrictions on the exportation of grain as well as removing a system of bounty payments on exports once prices fell below specified levels. Much more odious to its opponents was the Act of 1815 which imposed a ban on imports until the domestic price reached 80 shillings in the case of wheat. While this was relaxed by an Act of 1828 to a sliding scale of duties (the lower the price of grain, the higher the duty) and further relaxed by Peel’s Budget of 1842 through a reduction in the level of duty, this protection was anathema to many outside the landed classes.

The chief objection of Richard Cobden and the Anti-Corn Law League, who represented the interests of manufacturing, was that the raising of the price of wheat had a knock-on effect in raising the subsistence wage of manufacturing labour. This placed English manufacturers at a disadvantage to overseas rivals who had access to cheaper labour by dint of having to meet a lower subsistence wage (see Chapter 15 by Bliss for a more formal analysis of these arguments). While being primarily motivated by a narrow class interest, the Anti-Corn Law League appear genuinely to have believed that repealing the laws would be widely beneficial not only to themselves but also manufacturing and agricultural labourers and indeed the period following the repeal appears to have been one of general prosperity (Barnes 1965). The counter-arguments for protection were various and have a familiar ring: fear of over-reliance on foreign sources of food supply; the overwhelming of the domestic agriculture sector by cheap imports leading, among other things, to large-scale unemployment.

It is fitting in 1996 to reconsider the issue of free trade in the light of the Corn Laws debate. For one thing, we are still having fierce ‘Corn Laws’ debates as witnessed during the tortuous discussions on reduction of agricultural protection during the Uruguay Round of GATT. One of the paradoxical conclusions is that one of the chief beneficiaries from the reductions agreed will be the EU which has been a major exponent of protection. Second, there has been a clear trend of post-war trade liberalization yet there are both forces urging further progress and fresh arguments for protection, thus it is timely to take stock. Third, as suggested above, while the repeal of the Corn Laws brought in a period of free trade and the principle appeared firmly established in the second half of the nineteenth century the lesson of history is that a swift return to protectionism cannot be ruled out. Indeed Paul Krugman in his conference address suggested that there is a real danger of such an anti-free trade backlash, particularly in Europe. Nevertheless, if the case for free trade is to be forcefully presented, the validity of that case must be examined. Fourth, it is important to enquire how best to proceed if the path is to be one of increasing liberalization.

The chapters in this volume are generally supportive of free trade, either in the form of trade in goods or international movements of capital. They variously probe how confident we can be about the case for free trade (Hahn), explore ways in which we can proceed to improve international trade (Chrystal, O’Brien, Reinert), suggest how we can better advocate the case for free trade (Krugman), develop new insights into the potential gains from trade (Baldwin and Caves, Williams, Birdi, Wolf), examine the misguidedness of protection (Gruber, Bliss) or consider important current developments in the global trading system (Fidrmuc et al., Yamazawa). The remainder of this introduction will review in a little more detail some of the important recent trends in international trade, then provide a brief introduction to the chapters.

DEVELOPMENTS IN ARGUMENTS AGAINST FREE TRADE

Until the Great Depression the main arguments against free trade centred on infant industry protection and the optimal tariff. Protecting jobs has also had a long history as an anti-free trade argument. For example, in the interwar period Keynes changed his mind on free trade and argued trade restriction was a way to deal with unemployment, although he later came to believe that domestic reflation was superior to trade protection. Nevertheless, the Depression experience left a lingering doubt about free trade. The 1950s to 1970s were the heyday of free trade, when liberalization and income growth worked virtuously on one another. Subsequently, despite progress on liberalization, protectionist arguments have gathered pace.

The 1970s and 1980s were characterized by two phenomena. First, there was a substantial threat to free trade from the demands for protection from many developing countries which embraced extensive protection as part of their development strategy of import substitution. Second, the theory of imperfect competition undermined the belief that free markets lead to prices which reflect social cost and by association undermined free trade arguments. Chicago economists saw the threat and set out to show that the imperfections were not significant enough to warrant intervention. This did not, however, prove an effective counter. Strategic trade theory was not really used by those who attacked free trade until the 1980s. The developed countries, particularly the USA and the EU, lapsed into the use of non-tariff barriers such as voluntary export restraints, antidumping suits and countervailing duties, with economic adversity in the late 1970s and early 1980s being once more a proximate cause. Analyses of strategic trade protection met the needs of the protectionists and were quickly taken to the centre of policy debate.

While strategic trade theory has been blunted as a weapon by considerable analysis of its shortcomings, Bhagwati (1994) has identified the following more recent varieties of arguments against free trade, both of which he regards as erroneous.

Fair trade as a precondition for free trade

There have recently been calls to harmonize everything from distribution systems and technology policy to labour and environmental regulations. This has been associated with rapidly shifting comparative advantage. The effect has been in part to make companies very sensitive to sources of ‘unfair’ advantage.

Trade and wages

During the 1950s and 1960s the South tended to view trade with the North as a threat. It turned to protection just as the North was liberalizing. Now the North fears that trade with the South will depress wages. This fear has been underpinned by the Factor Price Equalization (FPE) theorem, which would suggest that Northern wages would be forced to the level of Southern wages. Yet at the time that it was set out, the theory was viewed as implausible. Now the FPE theory is taken as an inevitability in some quarters, despite the fact that its assumptions are extremely demanding. As Paul Krugman suggested, while there is a kernel of truth, low wage competition does not explain the whole of this phenomenon.

This issue of unfair trade has led to tension between the USA and the EU on the one hand which allege increased levels of unfair practices by other countries, including methods of circumventing their countervailing measures and the other countries who allege that the USA and the EU are using current ‘unfair’ trade provisions to discriminate unfairly against them.

Thus, despite considerable liberalization and palpable gains from freer trade, protectionist arguments are not only alive but developing. As ever, they find a receptive audience in quarters ideologically opposed to free trade.

THE URUGUAY ROUND

Despite sometimes considerable cynicism regarding the GATT, it has not proved moribund. The recently concluded Uruguay Round, while less than ideal, provides some important lessons regarding the feasibility and desirability of free trade. The impact of the GATT Final Agreement has been assessed by Nguyen et al. (1993, 1995) in the authors’ own calibrated global macro model. The two papers report respectively estimates of the gains from the draft final agreement (the Dunkel Text) and the Final Agreement, the latter containing more modest concessions than had previously been entertained. The effects are measured as the amount of income at today’s prices which would make a person as well off with the barriers as with the changes. The more modest final agreement is estimated to bring overall gains of only 0.4 per cent of world gross product compared to 1.5 per cent in the draft final act. While any calibrated model is open to methodological objections, the results are nevertheless indicative of the magnitude of the gains from liberalization and how much may potentially be lost when the process is impeded. What is more, all participating regions appear to have gained, albeit that the gains are unevenly distributed.

Yet the bottom line figures quoted may not do the agreement justice. The Uruguay Round was significant not only for the extent of the progress made in agriculture and textiles, newly brought within the GATT, but also in the progress made in the areas of services, trade-related investment (TRIMs) and intellectual property rights (TRIPs). Flows associated with services, intellectual property and foreign direct investment (FDI) are relatively small but have become more important. Some of the gains from these measures, such as the positive spillovers of foreign direct investment (see Chapter 9 by Williams and discussion by Petrochilos) and the extra innovation which may result from better protection of intellectual property rights are hard to gauge, but real nonetheless. Moreover, the agreements reached, while modest in scope, provide a platform for future liberalization; thus their importance should not be underestimated (Baldwin 1995). The Agreement has also grappled with the thorny issue of alleged ‘unfair’ trade and the remedies which may be imposed, although there are substantial fears that not enough has been done to prevent substantial abuse in the future which could nullify many putative gains from the round. Finally, the Agreement also took steps forward in strengthening dispute resolution machinery and in establishing the World Trade Organization (WTO) as a permanent institution and requiring members to sign up to all except its so-called plurilateral agreements. These things bolster the institutional underpinnings of free trade.

Nevertheless substantial problems remain. Specialization in production with associated FDI flows has increased the visibility of differences in national regulatory regimes. This has led in turn to calls for deeper integration at the multilateral level ranging from coordinated application of national policies to the harmonization of regulatory regimes pertaining to product and process standards, professional certification, environmental and social policies. This is seen as necessary to provide fair trade or equality of opportunity for domestic and foreign firms. There is a problem that harmonization can be expected to be aligned on industrial country standards, with common rules likely to be enforced through countervailing trade restrictions. The experience with anti-dumping (see Chapter 17 by Gruber) and other measures to offset ‘unfair’ trade suggests that it is important that these measures should not be expanded to address environmental or social dumping as this is a recipe for rent seeking and protectionist capture. Given the vitality of protectionist forces and the vested interests of powerful firms this is a considerable cause for concern.

REGIONALISM IN THE WORLD SYSTEM

The growth of regional trade areas has been an important trend and one which has led some to fear that the world trading system may be in danger of fragmenting into autarkic regional trade blocs. The prime example is the post-war widening and deepening of economic integration within Europe. As Sapir (1992) argues, this has been associated with a net stimulus to trade and trade liberalization through the GATT. Brown et al. (1992) also suggest that the North America Free Trade Agreement (NAFTA) will be trade enhancing with relatively little effect on third parties. The Asia Pacific Economic Co-operation (APEC) does not have a comparable role within South East Asia, although in Chapter 23 Yamazawa suggests that it might. In any event, the sheer dynamism of many South East Asian economies and the strong belief that openness to trade has been an important ingredient make trade arrangements in the Asia-Pacific region of great interest. Whether and how far these regional agreements contribute to closer integration in the world economy as a whole is a much-debated issue. Henderson (1993) argues that the common belief that three inward-looking trade blocs are being created is mistaken. There is no reason why regional integration agreements should result in a reduction in trade and investment flows vis-à-vis the rest of the world. As the arrangements are now emerging they appear likely to have a net positive influence on integration with the rest of the world and there is a substantial amount of trade between the three blocs.

Potentially far-reaching developments are now underway in Central and Eastern Europe. In the wake of transition to market economies in this region, of which greater openness to trade is a dimension, there is potential for rapid increase, albeit from a small base, in trade with the Organization for Economic Co-operations and Development (OECD) (see Fidrmuc et al., Chapter 21). However, Enders and Wonnacott (1996) have expressed concern that liberalization among the former centrally planned economies has proceeded on a piecemeal bilateral basis which has resulted in a distortionary and inefficient trading system. They suggest a major challenge is to work towards a European free trade area.

In sum, there has been a long history of anti-free trade arguments including: infant industry protection; countering unemployment; the optimal tariff; preventing unfair competition in various guises and defending wages. Despite the persistence and prevalence of anti-free trade arguments, substantial progress has nevertheless been made in the post-war period in liberalizing trade. Some gains have come through the GATT and others through regional agreements to liberalize trade. As liberalization extends into new areas such as services and capital flows there is the prospect of important future gains. Nevertheless there are question marks regarding not only whether we can achieve these gains but whether we can maintain progress made to date. As with the original Corn Laws debate there are concerns as to whose interests are being served both by liberalization and protection. Thus issues of freedom and trade are very much alive.

INTRODUCTION TO THE CHAPTERS

In Chapter 2 Frank Hahn puts forward a persuasive case that economists ought to be more circumspect in their arguments for free trade. Indeed, the leitmotif of his comments throughout the conference was that we ought to be candid about admitting that much of the time, despite our confident assertions in favour of free trade, we simply do not know for sure. There is some paradox in his observation that economists too often ignore the fact that there will be losers from free trade since they typically argue that the gains are too imperceptible, whereas the losses are concentrated on particular interest groups which allows lobbies to form against free trade. Yet, as he rightly points out, some of the costs are rather subtle and difficult to quantify. Greater job insecurity and the costs of excess variety are two cases in point where individuals suffer but face probably insuperable difficulties in terms of lobbying in favour of policies to mitigate these effects. Moreover, he argues that these weaknesses of the classic free trade argument need to be brought fully into the public domain in order that policy-makers can address the redistributions that free trade entails.

In Chapter 3 Paul Krugman provides an insightful analysis into why intellectuals do not understand Ricardo’s idea of comparative advantage and what is more why they do not want to do so. First, he identifies that in the US cultural milieu being avant-garde is more important than being right and that since everyone loves to hate economists attacking one of their most cherished totems is a popular thing to do. Second, and perceptively, he argues that what seems to the professional economist simple and self-evident is, in fact, a sophisticated theory assuming knowledge of an interrelated set of other economic theories. In other words, the idea is more difficult than it looks, which presents a problem when people are not even disposed to try to understand it. Third he suggests that there is a popular aversion to mathematical modelling, which is an inalienable feature of economic reasoning. To combat these obstacles he suggests that as economists we need to take ignorance seriously, to adopt the stance of the rebel and not to take what seems obvious for granted. This is timely advice, since as he argued elsewhere in the conference, there is an ever-present danger of sliding back into more protectionist ways.

In Chapter 5 Alec Chrystal provides a lucid guided tour through the difficult terrain of asking what monetary arrangements would best support international trade. One of the contributions of Chrystal’s chapter is to show that some well-rehearsed arguments are not as valid as is often assumed and in consequence the answer to the question is highly uncertain. For example, he argues that whether fixed or floating exchange rates are preferable, at least from the narrow interests of the national economy, reduces to the issue of whether domestic or foreign economic shocks are more important, which is not known. Furthermore, he cautions that we cannot simply rely on historical evidence regarding how different regimes performed in the past. For example, the Bretton Woods system emerges as having the best record on real growth, yet this may have had nothing to do with the system itself but rather with other post-war economic factors. One area where there does appear to be reasonably clear evidence is that real exchange rate volatility reduces the volume of trade. In addition Chrystal argues that even worse detriments to trade may arise from the distortion of price signals which real exchange rate volatility brings in its wake. He offers tantalizing suggestions that a single global fiat currency may be the best arrangement, yet concedes that, whatever the theoretical merits, it is likely to remain moribund due to political infeasibility. The theme of practical impediments to achievement of improved international monetary arrangements is taken up by Parmjit Kaur in her discussion (Chapter 6).

In Chapter 7 Baldwin and Caves present evidence on a relatively unexplored consequence of increased international competition: its effect on the degree of turbulence faced by domestic firms. Turbulence in their study is taken to be proxied by ...

Table of contents

• COVER PAGE
• ROUTLEDGE STUDIES IN THE MODERN WORLD ECONOMY
• TITLE PAGE
• COPYRIGHT PAGE
• FIGURES
• TABLES
• CONTRIBUTORS
• GENERAL EDITORS’ PREFACE
• ACKNOWLEDGEMENTS
• 1 INTRODUCTION
• 2 RECONSIDERING FREE TRADE
• 3 RICARDO’S DIFFICULT IDEA: WHY INTELLECTUALS DON’T UNDERSTAND COMPARATIVE ADVANTAGE
• 4 COMMENTARY ON CHAPTER 3
• 5 INTERNATIONAL MONETARY ARRANGEMENTS AND INTERNATIONAL TRADE: DOES THE MONETARY REGIME MATTER?
• 6 COMMENTARY ON CHAPTER 5
• 7 INTERNATIONAL COMPETITION AND INDUSTRIAL PERFORMANCE: ALLOCATIVE EFFICIENCY, PRODUCTIVE EFFICIENCY AND TURBULENCE
• 8 COMMENTARY ON CHAPTER 7
• 9 THE REGIONAL IMPACT OF INWARD DIRECT INVESTMENT: SOME REFLECTIONS ON THE ISSUE OF MEASUREMENT
• 10 COMMENTARY ON CHAPTER 9
• 11 SHALLOW FOUNDATIONS: LABOUR AND THE SELECTIVE REGULATION OF FREE TRADE
• 12 COMMENTARY ON CHAPTER 11
• 13 RICHARD COBDEN AND THE DEMOCRATIC PEACE
• 14 COMMENTARY ON CHAPTER 13
• 15 THE CORN LAWS AND THE CAP
• 16 COMMENTARY ON CHAPTER 15
• 17 ANTIDUMPING ACTIONS IN HIGH TECHNOLOGY INDUSTRIES: THE CASE OF SEMICONDUCTORS
• 18 COMMENTARY ON CHAPTER 17
• 19 SUBSIDIES, EXCHANGE RATES AND JOB PROTECTION IN THE BRITISH STEEL INDUSTRY, 1967–85
• 20 COMMENTARY ON CHAPTER 19
• 21 EAST-WEST TRADE IN TRANSITION: THE CASE OF AUSTRIA
• 22 COMMENTARY ON CHAPTER 21
• 23 FREE TRADE MOVEMENT IN ASIA PACIFIC: APEC’S OSAKA ACTION AGENDA AND ITS IMPLICATIONS FOR MULTILATERAL TRADE LIBERALIZATION
• 24 COMMENTARY ON CHAPTER 23
• 25 KNOWLEDGE, TRADE AND GROWTH
• 26 COMMENTARY ON CHAPTER 25
• 27 RAW MATERIALS IN THE HISTORY OF ECONOMIC POLICY: OR WHY LIST (THE PROTECTIONIST) AND COBDEN (THE FREE TRADER) BOTH AGREED ON FREE TRADE IN CORN
• 28 COMMENTARY ON CHAPTER 27