BOOK REVIEW

Free Trade Today
by
Jagdish Bhagwati

FUTURECASTS online magazine
www.futurecasts.com
Vol. 4, No. 10, 10/1/02.

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Lectures on globalization:

  In "Free Trade Today," Jagdish Bhagwati gathers material from a series of lectures to explain the benefits of international trade - of globalization - and the fallacies of protectionist assertions. This book has many fine points, but falls short of the clear and thorough defense of free trade in Douglas A. Irwin's "Free Trade Under Fire," reviewed in last month's FUTURECASTS. This is probably due to the limitations of an effort to turn lectures into a book.
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A lack of popular appreciation:

  Popular suspicion of and opposition to free trade remains strong despite the indisputable logic and actual experience supporting the benefits of free trade.
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  Bhagwati highlights two primary causes for this misperception of reality.

  • There is the counterintuitive nature of comparative advantage.

  • There is also the "infinite weight" accorded jobs lost to foreign competition, and the "zero weight" accorded jobs created by trade.

  The  jobs that may be lost are immediate threats to those who hold them - the jobs to be gained are future prospects for people who are not yet aware of them.

  Bhagwati also cites the psychology of change. The difficulties of change are almost always more apparent than the benefits.
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With the collapse of communism, free trade has become the target of a growing anti-capitalist and anti-globalization agitation among the young that derives from what Bhagwati likes to call "the tyranny of the missing alternative."

  Now, in addition, there are the vacuous reactions of the idealist young who have lost their ideological home with the collapse of the theoretical viability of socialism - but still hate capitalism and long for its failure.

  "Today, however, free trade is the target of a growing anti-capitalist and anti-globalization agitation among the young that derives from what I like to call the tyranny of the missing alternative. The collapse of communism, the ideological system that rivaled capitalism, and the rise of Fukuyama-led triumphalism about markets and capitalism have created an intolerable void among the idealist young whose social conscience is attuned to the conviction that capitalism is a source of injustice."

  The idealists are blind (indeed, frequently intentionally blind) to the reality that is capitalism. Capitalism offers opportunities to the many while socialism offers opportunities only to the politically well connected and the wealthy who can buy access. (Socialism also offers opportunity to the intelligentsia who can rise to positions of power and influence in the socialist bureaucracy.)
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Many left wing intellectuals who cannot bear the thought of their being wrong have simply rejected intellectualism.

  The fallacy of left wing economic systems is now indisputably demonstrated by both theory and practical experience. This has set left wing intellectuals and students adrift, without a viable alternative to the hated capitalist system. Many have fallen back on a modern "deconstructionist" philosophy that rejects all logic and political theory. Bhagwati attributes this philosophical movement to French philosopher Jacques Derrida.
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  A whole intellectual class has thus willingly descended into "a political wasteland where belief and action yield to cynicism and anarchism." In short, if you are indisputably wrong on the basis of both logic and the facts, there is nothing left to do but blatantly reject both logic and facts. Many left wing intellectuals who cannot bear the thought of their being wrong have simply rejected intellectualism.

  Capitalism has many weaknesses, as one would expect of any complex human undertaking. It is certainly not an utopian system in either practice or theory. It does not promise utopian results. It is merely by far the best system for producing goods and services and allocating scarce resources.
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  All government administered alternatives involving the complexities of providing goods and services or administering major complex programs ultimately crash upon the same rocks that destroyed socialism. Government can't manage. Government management is inherently inept. Because government lacks many of the essential tools of private management - because it must act without the guidance and discipline of profit driven, market directed commerce, and suffers from vastly greater political and bureaucratic influences - even the best managers in the world perform poorly in government managerial positions.
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  Trying to induce private businesses to perform welfare tasks by means of regulations and tax incentives can be somewhat more effective, but inevitably increases the rewards of cheating and corruption and political influence peddling - and ultimately can impose sufficient economic distortions and burdens to retard or even collapse affected portions of the economy.
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  These are realities that the idealist left often refuses to even think about.

Opposition to free trade:

 

 

 

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  Ammunition for the opponents of free trade and capitalism is inevitably provided by every downward phase of the business cycle and every international financial crisis. (Since private and government policies are never without problems - frequently severe problems - the business cycle and periodic financial crises are inevitable.)
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  The 1994 peso crisis, for example, was immediately attributed to NAFTA (although its causes clearly predated NAFTA - and today Mexico clearly benefits from NAFTA and U.S. employment remains stronger than before NAFTA even during this recession period).
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  And theoretical justifications for particular trade restraints were produced by various economists.
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Imperfect markets:

 

 

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  Markets are seldom "perfect" - are often distorted - and suffer from periodic market failures as part of the normal business cycle. While free trade may provide optimal results for perfect markets, these seldom exist and are periodically disrupted even where they do exist.
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  Where sub-optimal, distorted markets are involved, some economists have argued that some "optimal tariff" can improve results and is thus justified.
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Infant industries:

 

 

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  There is also the "infant industry" argument in favor of protection for new industries that are still financially weak. In order to compete in international markets, it is asserted, such industries need time to grow and strengthen - free of import competition. This is something tariff protection can provide.
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  This concept was eagerly grasped after WW-II by newly independent undeveloped nations seeking to industrialize under an import substitution policy.
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Periods of deficient aggregate demand:

 

 

 

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  The Keynesian assertion is that - while unwise as a long term policy - in times of unemployment due to deficiency of aggregate demand, tariffs can divert aggregate demand from foreign to domestic goods, thus easing unemployment.

  During the 1930s, the Keynesian aggregate demand remedies - including substantial budgetary deficits, massive inflation of the money supply and historically low interest rates - and the greatest tariff barriers in U.S. history - all conspicuously failed to end the Great Depression or materially reduce its unemployment.

Monopoly competition:

 

 

 

 

 

 

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  During the 1980s, the "monopoly-competition" arose. Most markets are neither monopolistic nor perfectly competitive, but fall somewhere in between. There are usually some firms or some groups of firms or government assisted firms that can exercise some market power.
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  During the 1980s, the government directed economy of Japan was prospering while the U.S. economy was still struggling to recover from the aftereffects of the chronic inflation and stagflation of the 1970s. Left wing economists asserted that the U.S. economy was now "mature" and in a state of chronic natural decline. This provided grounds for an array of economic arguments against free trade and in favor of substantial government intervention in product markets.

  The failures of government policies - Keynesian policies - in the 1970s was thus used as a reason for increased government intervention in the 1980s. Fortunately - unlike in the 1930s - this line of left wing propaganda failed in the 1980s.

Non-economic objectives:

 

 

 

 

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  Industrialization was deemed essential by undeveloped nations not only for economic development, but also for the development of a modern society. This was put forward as a "non economic" objective for tariff protection. Even though tariffs were recognized as economically burdensome, the burden was justified by this non-economic objective. This shifted the debate to determining the kind of protection that would be least costly.

  The need to maintain certain domestic industries for national defense purposes is a familiar version of this view in the U.S. and Europe. The asserted benefits of a broad agricultural sector provides another familiar non-economic justification for tariffs and subsidies.

  Labor market imperfections:

 

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  Various kinds of labor market imperfections exist due to "sticky" wage rates and limits on labor mobility. This undermines the ability of producers to adjust to competition sufficiently to avoid economic contraction and unemployment.
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  Bhagwati has also dealt with and debunked the "immiserizing growth" argument that would at best be only narrowly applicable to certain inelastic supply situations.
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Practical limitations on theoretical advantages of protectionism:

  But economic theoretical advantages disappear on examination. Even as just a matter of theory - they are never more than slim or none. Even optimal departures from free trade would produce only slim advantages according to these theories - and would require constant precise adjustments beyond practical political capabilities.
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Even where the invisible hand is frail, Bhagwati cogently points out, "the visible hand is crippled."

 

Clearly, measures designed to reduce the market distortions themselves are far more likely to prove beneficial than restraints on trade.

  However, in the real world, where the art of politics dictates responsiveness to a wide array of powerful vested interests, optimal trade restraints - or anything remotely resembling them - are impossible. Political intervention will always make matters worse. Even where the invisible hand is frail, Bhagwati cogently points out, "the visible hand is crippled."
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  In addition, the losses from foreign retaliation must be taken into account. Clearly, measures designed to reduce the market distortions themselves are far more likely to prove beneficial than restraints on trade.

  Frequently, market distortions are caused by government policies rather than anything inherent in the markets. Education, reductions and simplifications of taxes and regulations, antitrust policies and financial disclosure policies are examples of proactive government efforts to reduce market imperfections. This is a far more effective approach than creating additional imperfections - protectionist imperfections - in response to market imperfections.

Indirect costs of trade restraints:

  Moreover, there are an obvious array of indirect costs of protectionist policies. These, too, must be taken into account.
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  Protectionist policies could also:

  • Reduce access to essential components. (Maintenance of machinery in Communist and third world nations often suffer visibly for lack of components.)
  • Reduce the ability to realize economies of scale.
  • Reduce the variety of goods and equipment available. (Yes! Variety has value.)
  • Reduce competitive pressures that drive domestic productivity growth. (Think of the U.S. auto industry in the 1980s if there had not been any Japanese and European competition.)
  • Reduce access to foreign know how. (The cheapest way to benefit from foreign technological advances is to buy it as part of the new products and services it makes possible.)
  • Reduce the marginal efficiency of capital by restricting integration into world markets.
  • Increase the level of "directly unproductive profit-seeking" made possible by political and bureaucratic interventions in market processes. (Bureaucratically hamstrung nations like India suffer vastly from government interventions and the unproductive efforts - the corruption - they engender.)

Free trade and growth:

  The many theoretical studies on the effects of free trade on growth are noted by Bhagwati. Many of these studies cast doubt on whether free trade leads to greater growth in all instances. These studies are based on a variety of macroeconomic growth models leading to a variety of results.
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Free trade tends to lead to greater growth.

  The author cuts through this theoretical fog by pointing out that the preponderant evidence on the issue during the post WW-II period "suggests that free trade tends to lead to greater growth after all."
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Fair trade:

 

 

 

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  New challenges to free trade target trade practices of foreign nations. These include unfair trade practices, social justice concerns - especially about growing levels of inequality, environmental impacts of international trade and World Trade Organization ("WTO") dispute resolution proceedings, and allegations that international trade undermines real wages in rich countries and further impoverishes the poor in poor countries.

  All of these assertions are essentially just makeweights for ideological and/or protectionist interests - aside from being clearly invalid except in a few very narrow circumstances.

  The "fair trade" challenge is driven by several factors. The author identifies:

  • Fairness - a "level playing field"-  is the overriding competitive ethic in the U.S., as opposed to an ethic of egalitarianism in Europe and many other countries. Thus, complaints that foreign competitors operate under different conditions that give them an "unfair" competitive advantage is used to justify remedial action to "level the playing field."
  • Competition has intensified worldwide due to a "thinning" of comparative advantage, driving domestic producers to examine all pertinent foreign policies and institutions that might give some advantage to their foreign competitors.
  • Sluggish economic conditions in the 1980s and early 1990s fostered a defensive attitude towards Japan, which for some time was believed likely to displace the U.S. as the dominant commercial nation. This was a strong influence on Clinton administration attitudes. The Clinton administration was dominated by "Japanophobes who cried foul at every opportunity."
  • Preferential trade agreements like NAFTA gave opponents a fixed target - the other nation to the agreement - to examine for defects in labor or environmental standards or political flaws.

  More likely, NAFTA just happened to be the target of the moment. NAFTA - a preferential trade agreement - drew the bulk of the ire of protectionists in the 1990s because the political split in Washington blocked further multilateral trade negotiations. But Bhagwati doesn't like preferential trade agreements like NAFTA, and spends considerable space condemning the victim - NAFTA - for the protectionist attacks upon it. See "Preferential trade agreements," below.

  The result was the establishment of "fair trade" remedies, broadened through the "infamous Section 301" in the Omnibus Trade and Competitiveness Act of 1988. Remedies were imposed based on unilateral determinations of what practices constitute unfair trade. This "aggressive unilateralism" is, Bhagwati charges, "a practice that has been condemned worldwide; and today the use of Section 301 in this unilateral and discriminatory fashion outside of an existing trade obligation has been practically declared WTO-illegal."
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  As an example, Bhagwati notes the ridiculous assertion of the Clinton administration that fair trade remedies were justified for U.S. steel producers because European macroeconomic policy and economic performance was so poor that it caused European steel prices to decline.

  "Would the U.S. policymakers have been happy if the EU and Japan had accused them similarly of unfair trade in the 1980s when it was the Americans who were guilty of incompetence at macroeconomic management? Of course, this  reversion to the rhetoric of unfair trade, flying in the face of economic logic, made the politics of both demanding and supplying protection to the ailing steel industry a lot easier." (The deceptive use of makeweight arguments is a prominent characteristic of the anti-trade - anti-capitalist left. But these are the only arguments they have.)

  Today, many politicians "have turned into an unfair-trading-obsessed, cynically manipulative lot." (The current Bush administration  has its own obvious problems with protectionism.) Fair trade rhetoric, the author asserts, has "nurtured an electorate that thinks of the United States as a fair-trader and others, in varying degrees, as unfair traders." This encourages the illusion that free trade is "both economically unwise and politically naive."

  Bhagwati is here forgetting the forest while examining some particularly diseased trees. The U.S. still maintains the most open markets of any major nation, and the world still depends on the U.S. for commercial leadership and leadership in trade liberalization. Although inevitably far from perfect, the U.S. will hopefully continue to live up to that leadership position.

Unequal environmental and labor standards:

  Lower environmental and labor standards permit foreign producers to lower their costs. This is called "social dumping" - an illegitimate advantage that should be offset by a countervailing tariff. Otherwise, it is argued, there will be a "race for the bottom" as various nations seek to give domestic producers the cost advantages of low standards.
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  Bhagwati points out weaknesses in several of these objections - such as the complaints based on lower levels of environmental protections - and notes that there is little evidence to support the existence of any "race to the bottom" in the real world.

  "A great deal of empirical evidence suggests that multinationals do not choose environmentally unfriendly technologies, for example, or even locations because the environmental regulations are less stringent. Moreover, the race to the bottom occurs far more in another space: in tax concessions offered by governments (including local and state governments in federal countries) to attract multinationals."

  Multinationals account for the vast bulk of U.S. foreign direct investment. Moreover, if an effective remedy is really sought - rather than just a rationale for protectionism - Bhagwati asserts that it would be far more effective simply to extend U.S. standards to the overseas operations of U.S. multinationals than to load trade treaties with conditions. He also advocates "voluntary codes," such as the Social Accountability Label, SA 8000.
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There are many examples of trade restraints worsening working conditions in poor nations and environmental problems.

  Ultimately, however, it is indisputable that blocking poor nation exports does nothing for either their environment or labor standards - and by reducing their resources, may make matters much worse. Indeed, there are many examples of trade restraints worsening environmental problems - especially in agriculture. Protected and subsidized European (and U.S.) agriculture is far more heavily reliant on pesticides and fertilizers than agriculture in developing nations with comparative advantages in agriculture.
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  The author recognizes that there are some opposite examples - as in the spread of shrimp farming in S.E. Asia. However, instead of banning trade, the appropriate policy is for the exporting nations to impose "polluter pays" taxes and other appropriate environmental policies.

  Bhagwati's treatment of this subject is nowhere near as complete, clear - or convincing - as might be desired. There are weaknesses in merely wrapping some lectures - even when supplemented - between two covers and calling it a book.

Social agendas:

  Altruistic efforts to use trade treaties and the WTO to advance social agendas draws severe criticism from Bhagwati. Trade treaties and the WTO are  ineffective tools for social agenda purposes, and by attempting to use them to achieve a variety of social objectives in addition to trade liberalization, you risk failing at both.
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Bhagwati convincingly summarizes the weaknesses of relying on the WTO for social agenda purposes and the advantages of addressing those problems through the agencies designed to deal with them and having the appropriate expertise.

  As the author points out:

  "[I]f we wish to advance several objectives, we will generally need an equal number of policy instruments. So both social and moral agendas and trade liberalization cannot be efficiently pursued through one instrument, that is, trade treaties and institutions that subject market access to fulfillment of a menu of social agendas such as those sought to be put into a Social Clause at the WTO."

  Instead, separate appropriate means should be pursued for each objective, such as "the WTO for trade liberalization, the International Labor Organization for labor standards, the United Nations Environment Program for environmental issues, UNESCO for cultural preservation, and so on." The author convincingly summarizes the weaknesses of relying on the WTO for social agenda purposes and the advantages of addressing those problems through the agencies designed to deal with them and having the appropriate expertise.
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  The author recites the cautionary tale of the trade sanctions against products produced with child labor. These undoubtedly hurt those they were (ostensibly) intended to help by forcing them "into worse occupations, with female children winding up even in prostitution."

  "To make a dent on the problem, we need to do 'heavy lifting': for example, work with local NGOs, ensure that children go to school when taken off  work, and guarantee that the poor parents' incomes do not shrink below the survival line when the children's income disappears. By contrast, the trade sanctions approach, ---, is likely to be counterproductive (e.g. by pushing children into worse occupations) and therefore, while inspired by good intentions, could well be wicked in effects." (Those "good intentions" assume a fact not always in evidence.)

For several reasons, there is no interest in rich nations to strengthen the appropriate international agencies so that they can act impartially within their spheres as the WTO does with respect to trade disputes.

  Of course, such social agenda items must be enforced against rich nations as well as poor nations if they are to be considered properly established. Bhagwati notes that U.S. labor laws are far less congenial to workers rights to organize and strike than those of many other nations, and could be deemed in violation of international labor standards dealing with workers freedom of association.
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  For this and several other reasons, there is no interest in rich nations to strengthen the appropriate international agencies so that they can act impartially within their spheres as the WTO does with respect to trade disputes. Nevertheless, Bhagwati challenges the objection that the Social agenda agencies "have no teeth." Shame, guilt, and the activities of NGOs all have the ability to create political pressures in favor of reforms. He cites "the Dracula effect: expose evil to sunlight and it will shrivel up and die."
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  On the other hand, trade sanctions are resented and frequently harden opposition. Remedial agreements forced by threat of trade sanctions will likely be less than enthusiastically implemented. Moreover, "since the sanctions are used by governments that are themselves morally imperfect, the credibility of their actions in behalf of morality is necessarily suspect and breeds cynicism and evasion."

  Of course, these social and trade issues are joined not because dealing with them jointly is effective as a matter of substance, but because of the political effectiveness of the traditional log rolling tactic. By joining a variety of social agenda causes together and adding powerful protectionist interests, causes that will fail on their own have a chance to achieve some gains - even if those gains are of limited utility and cause vast economic harm.
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  These are practical alliances for political purposes - of which the stated social aims are in reality widely recognized as subordinate to the restraint of international trade.

Agricultural restraints:

 

 

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  Agricultural trade restraints are also defended on social agenda grounds. The "multifunctionality" of agricultural land as providing greenery as well as food is a favorite argument in France and elsewhere in Europe in support of subsidy and tariff protection for agricultural interests.
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  Bhagwati convincingly demonstrates the irrationality of this argument. If greenery is important, a far more effective and efficient way of providing it is to simply buy up the surplus agricultural land and leave it green.
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Trade impact on real wages:

  Trade unions fear that foreign competition is driving down the real wages of domestic unskilled workers. Their response is either to promote policies that restrain labor-intensive imports or intrude on the productive processes in exporting nations by requiring various labor and environmental standards that raise their costs of production.
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"Instead of hurting real wages of workers, the effect of trade with poor countries is likely to have been even favorable, moderating the decline that would have occurred otherwise from unskilled-labor-saving technical change."

  Labor-intensive product imports are especially targeted for restraints by rich nations since they have long since "lost comparative advantage in these industries to the poor countries," Bhagwati points out. (We import labor-intensive goods from poor countries because those are frequently the only kind of goods they produce.) As imports drive down the costs of such goods, they presumably undermine the real wages of domestic unskilled labor.
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  The author refers to a variety of theoretical studies supporting various views of the impacts on real wages from various types of international trade and trade policies. However, he asserts that "instead of hurting real wages of workers, the effect of trade with poor countries is likely to have been even favorable, moderating the decline that would have occurred otherwise from unskilled-labor-saving technical change."
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  He points out that reality has refused to conform to the prevalent Stolper-Samuelson theorem on trade impacts on labor-intensive goods. The relative price of labor-intensive goods apparently rose in the U.S. in the 1980s when real wages fell or suffered significantly lower rates of growth, and apparently fell in the 1970s when real wages kept increasing.
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  One reason for this was the increasing wealth of many poor nations during the 1980s, which moved them up the "comparative advantage ladder." "They had become net importers of labor intensive goods, absorbing the new exports of labor-intensive goods from countries poorer than themselves."
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  He refers to experience with the development first of Japan and then with Taiwan, S. Korea, Singapore and Hong Kong. The net imports of labor-intensive products by Japan in the 1970s amounted to almost as much as the net exports from the other four combined, which in turn became net importers in the 1980s sufficient to offset China's exports of such products.
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  Indeed, actual results support the theory that "capital accumulation and technical change in the rapidly growing economies have put downward pressure on the production of labor-intensive goods," thus raising world prices for these goods.
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The contention that trade impoverishes poor nations is obviously absurd.

  While properly condemning rich nation restraints on poor nation exports, Bhagwati fully acknowledges that protectionism is generally far greater among the poor nations than among the rich nations - plays a major role in keeping them poor - and is just a part of the vast governance problems these nations must begin to resolve to finally begin to achieve some real development progress.
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  The author properly dismisses the absurd notion that trade impoverishes poor nations, noting that India was kept impoverished for a quarter of a century by its smothering protectionist policies, and has since significantly increased its growth rates as it began to lower its trade barriers. This result has been repeated in many nations.

  The Economist reports that the developing nations that are most open to international trade experienced 5% annual GDP growth per person during the 1990s. Those most closed suffered declines.

  This is not to deny that the removal of trade barriers may cause some difficulties - as any change, no matter how beneficial, inevitably will. This is also not to deny that there will be occasional business recessions as is usual in the capitalist business cycle. (However, the frequency and harshness of these downturns will vary between nations in relation to the degree of good governance established to facilitate profit driven, market directed commerce.)
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  There are also fears that U.S. foreign direct investment costs domestic jobs and reduces wages. But such investment is a two way street. The author offers the example of N. Carolina, where low wage jobs were lost in textiles, but higher wage jobs were gained in plants constructed by German multinationals.
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Unilateral and reciprocal trade liberalization:

 

 

 

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  Imports help the importing nation as well as the exporting nation, Bhagwati emphasizes. The imposition of tariffs is like shooting yourself in the foot. Thus, the "fairness" argument is absurd. Just because some other nation shoots itself in the foot by keeping out your exports or by some other government economic policy, why should other countries compound the injury by shooting themselves in the foot by raising retaliatory tariffs.?

  Of course, tariffs are a tax and can be viewed as any other tax as a revenue raising measure. But optimal levels for revenue raising are of course much too low to provide much protection from import competition.

Reciprocal trade negotiations also have the practical benefit of mobilizing export industries to provide political balance against protectionist pressures from import-competing industries.

 

Bhagwati cites theoretical support for the possibility that unilateral trade liberalization will induce imitation by demonstrating success and increasing the influence of exporters in other nations.

  Indeed, unilateral reduction in trade barriers - like Prime Minister Robert Peel's repeal of the British Corn Laws in 1846 - is always a wise policy.
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  However, as Bhagwati correctly notes, exports help too. Both exports and imports are win-win activities. Thus, if negotiations can lead to reductions in trade barriers on a reciprocal basis in many nations, the benefits will be correspondingly broader.
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  There are also benefits if reciprocal trade liberalization is sufficiently balanced that it doesn't disturb the terms of trade of the negotiating nations. However, this is difficult (indeed, probably impossible) to achieve. Making this a goal of the negotiations supports mercantilist thinking that can cause political leaders and bureaucrats to lose sight of the larger primary benefits of trade liberalization.
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  Reciprocal trade negotiations also have the practical benefit of mobilizing export industries to provide political balance against protectionist pressures from import-competing industries.
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  Bhagwati cites theoretical support for the possibility that unilateral trade liberalization will induce imitation by demonstrating success and increasing the influence of exporters in other nations. Indeed, such nations as Australia, New Zealand, Chile, India, Singapore and Hong Kong have amply demonstrated the success of unilateral reductions in trade barriers. Although they had previously refused to negotiate reciprocal reductions, both the EU and Japan unilaterally lowered barriers protecting their financial and telecommunications sectors in response to the success of U.S. unilateral reductions in those sectors.
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Preferential trade agreements:

  The EU and NAFTA and a host of other bilateral and regional free trade areas ("FTAs") around the world were established by "preferential trade agreements" that Bhagwati sharply criticizes.
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Trading blocks - especially small trading blocks - that result in raised tariffs against nonmembers can result in a reduction of efficiency and welfare for member states.

  Preferential trade agreements are proliferating massively, recently reaching over 400 in number. The author points out that the procedural problems created by this crazy quilt of overlapping trading blocks is formidable - especially with respect to the "rules of origin" needed to prevent nonmembers from gaining market access through the member with the lowest applicable tariffs.

  "While they remove tariffs for member countries, they also increase the handicap (for any given external tariff) that nonmembers suffer vis--vis member-country producers in the markets of the member countries, implying therefore protection against them. So, FTAs are two-faced: they free trade and they retreat into protection simultaneously."

  These preferential trade agreements can actually reduce efficiency and welfare not only worldwide, but among member nations as well. By the process of "trade diversion," a member nation may cease importing from a lower-cost nonmember in favor of more expensive but tariff free sources within the trading block.

  "In that case, there is clearly a loss that may (or may not) be offset by the gain that consumers derive from the lower prices they pay and from the fact that some higher-cost domestic production may also be reduced as domestic prices fall and move closer to the cheapest prices in world markets."

  However, policy makers ignore this view, and treat all forms of trade liberalization as favorable.

  Bhagwati is correct only if the PTA agreement results in an increase in trade restraints against outsiders. For nations whose national trade barriers remain the same or were higher than those of the trading block, they can only benefit from access to an enlarged market. Even where some tariffs are in fact increased against outsiders, that may be outweighed for member states by access to the enlarged market.
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  Mexico, for example, should realize massive benefits from NAFTA. Indeed, despite being initially enmeshed in the 1994 peso crisis due to causes that predated NAFTA, all indications are that Mexico is in fact benefiting - currently exhibiting remarkable stability as financial crises sweep many other Latin American nations. Somewhat disingenuously - in analyzing Mexico's experience under NAFTA - Bhagwati treats the impact of the 1994 peso crisis as if it were a feature of Mexico's NAFTA  experience.
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  The author points out that Mexico in fact raised 504 of its tariffs against nonmember exports as a result of its peso crisis - but does not consider how many - or how much - tariffs would have been raised as a result of the peso crisis in the absence of NAFTA. Of course, Mexico still suffers from many other weaknesses in its economic governance.

  However, Bhagwati correctly points out that trading blocks - especially small trading blocks - that result in raised tariffs against nonmembers can result in a reduction of efficiency and welfare for member states. He also correctly points out that "regional agreements inevitably politicize trade more than multilateral trade agreements do."
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  After formation of a trading block, another form of trade diversion can occur. Import-competing industries under pressure from lower cost producers in member nations may cause tariffs to increase against the lowest cost producers of nonmember states - thus diverting trade to higher cost producers in the lowest cost member state. This results in a loss of efficiency and welfare in the higher cost member state even as the lower cost member state benefits from the trade diversion to its producers.
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  While such tariff increases are prohibited by GATT, there are substantial loopholes in that prohibition.

  This argument is considerably less than convincing. Is there any doubt that any member state that raised such tariffs to protect its higher cost producers would also have raised its tariffs regardless of its membership in a trading block?

  These preferential trade agreements are self replicating - in the sense that their creation forces nonmember states to join other agreements as a defensive measure. They are also the route of least resistance, as they are far easier to negotiate than the vast multilateral accords.

  "We are thus reproducing in the world trading system, in the name of free trade but through free trade areas that spread discrimination against producers in nonmember nations, the chaos that was created in the 1930s through similar uncoordinated pursuit of protectionism that discriminated in favor of domestic producers. In both cases, the preferred solution would have been nondiscriminatory pursuit of freer trade." (The last sentence in indubitably true, but the current system of preferential trade agreements and trading blocks - all mediated by GATT - is light years away from the trade war protectionism of the 1920s and 1930s.)

  In addition, Bhagwati correctly notes that it is the poorer nations that "are least able to manage a trading system riddled by complex preferences and rules of origin."
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  The author fears that these complex discriminatory trading blocks will overwhelm multilateralism "and its central tenet of nondiscrimination." If trading block agreements displace multilateral agreements, this would clearly lead to a poor economic result. (Now that Pres. Bush has at last been given "fast track" negotiating authority, this truly disturbing possibility will be put to the test.)

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Copyright 2002 Dan Blatt