There is no level playing field, free trade not always benign

A book by two US academics disputes the view that free trade always produces mutually beneficial outcomes, contending that inherent conflicts do exist between the national interests of countries engaged in global commerce.

by Chakravarthi Raghavan

GENEVA: As international trade has been developing over the last century-and-a-half and as the postwar institutions of trade (the old GATT and the 7-year-old WTO, which, with the help of the IMF and the World Bank and their conditional lending, is working to change developing-country policies) try to bring more and more of the global economy under their domain and the banner of "globalization" and level playing fields, two irreconcilable positions have emerged which are shaping the public debates and the outcomes.

   On one side are the proponents of  "free markets" and "free trade", who invoke models based on  Ricardian comparative-advantage theories that conjure up a vision of everyone benefiting from liberalization and free trade, with win-win situations within and among nations. The proponents of this view have over the last few decades been busy putting add-ons to the theory to explain away the contradictions, with the result that the patchwork quilt that has emerged is more full of holes and stitches than cloth.

   The other view that is spreading is that there is no level playing field in international trade; that free trade is producing, within and among countries, winners and losers; that such trade is impoverishing and marginalizing the developing world, and increasing  inequalities and inequities everywhere and straining and tearing apart the fabric of societies; and that there is rising corporate power that is corrupting and influencing, non-transparently, governments and international institutions to further corporate  monopolies and oligopolies at public and consumer expense.

   Two US academics, Ralph E. Gomory and William J. Baumol (in Global Trade and Conflicting National Interests, Cambridge (Massachusetts) and London: MIT Press), in working out a theory to reconcile these two views, say that in terms of "effects", the truths dear to the hearts of economists clash with the "practical intuition" of non-economists, and that in fact free trade can produce multiple outcomes, including those where the overall welfare of one country can be at the expense of another.

   Free trade, they say, isn't always and automatically benign and there are both inherent conflicts as well as mutual gains for those engaged in global trade.

   Unlike in historical models of international trade, postulated on Ricardian theories of comparative advantage based on natural resources (e.g., England producing woollen textiles and Portugal growing vines and producing sherry wines, and the two exchanging them to mutual benefit), in today's world, much of industry and modern technology (to increase productivity), efficiency and ability to compete require huge capital and start-up costs and very large-scale operations and create significant entry barriers for new entrants. While natural resources still matter, many of the advantages can be acquired.

   Even in terms of the Ricardian historical model, the Portuguese wines were transported on English bottoms and bottled and marketed by the Bristol sherry companies, a services trade benefit; England, via the textiles manufacturing path, went up the industrial ladder, gaining over time by technology and the resultant capital accumulation and prospering; while Portugal, as a result of the agricultural choice, remained stuck, without much scope for technological and capital accumulation.

Multiple outcomes

   Free trade in today's world, Baumol and Gomory say, could have multiple outcomes, including benefits to one developed country coming at the expense of the other; in some limited situations, such trade could benefit both the advanced developed country and the less-developed partner, by enhancement of real incomes.

   According to the two academics, a zero-sum game outcome (gain to one and loss to the other) can come in 'free trade' among two equally placed developed nations, while, up to a point, there can be a "real symbiosis between the enhancement of the real income of a less-developed country and that of its more developed partner, with both gaining if the less-developed partner becomes more highly industrialized."

   In today's global economy, there is no single best outcome arrived at by international competition,  but many possible outcomes depending on what countries actually choose to do and the kind of natural or human-made capabilities that they choose to develop. Some outcomes may be good for one and some good for the other, and with some beneficial to both. But the outcome that is best for one could become poor for its trading partner.

   "In a modern free-trade environment, a country's welfare is critically dependent on success of its industries in international trade. The country as a whole has a vital stake in the competitive success or failure of its industries."

   A developed country like the US can however benefit if a "very underdeveloped" trading partner acquires new industries and generally improves productivity. The developed country will continue to benefit until the partner reaches a level of development enabling it to play a more substantial role in the global marketplace. Such a level of development will still be lower than that of the industrialized country, but nevertheless a significant turning point.

   To bring about such a positive-sum game, the developing country has to adopt industry-specific approaches in "retainable" industries (those involving high startup costs and difficulties for small-scale entry) to enable it to increase its incomes, and adopt a focussed approach (involving active governmental policies, including state aid and, to a point, infant-industry protection), concentrating on gaining entry into a small number of industries and meeting subsequent challenges to it by other ambitious nations, such as the next low-income country.

   Baumol is an economist and Gomory a mathematician. The book is based on Baumol's 1994 annual Lionel Robbins lecture at the London School of Economics (where the theories the two were working on were presented).

   Unfortunately, though finalized and published six years later, it does not take account of the further complications introduced by the WTO and its annexed agreements, including those on trade in services and on intellectual property protection, or the rules on government support to industry and a host of other rules - all of which have been designed to hobble and come in the way of developing countries trying to industrialize, become competitive, expand exports and increase their incomes.

   Nevertheless, the book  provides a good  basis for challenging the constantly repeated dogma from the Bretton Woods institutions and the WTO about the positive-sum game outcomes and win-win situations of liberalization, deregulation and privatization based on free trade.

   In today's world economy, the classical models (Ricardo's world of agriculture, slow-moving technology and tiny businesses) have been replaced by a world dominated by manufactured goods, rapidly evolving technologies and huge firms. The old trade models need to be re-examined, but the classical models can be adapted to the new conditions of the global economy, Baumol and Gomory say.

   The central conclusion of the two authors about "development abroad" and when it helps and harms, is that a developed country like the US can benefit in global trade by assisting the substantially less developed countries to improve their productive capacity, while at the same time competing vigorously with other nations that are at a comparable stage of development to avoid being hurt by their progress.

   An industrialized country will benefit if a very underdeveloped trading partner acquires new industries and generally improves its productivity, and will continue to benefit until that trading partner reaches a level of development (usually very substantially lower than that of the developed country) that enables it to play a more substantial role in the marketplace. After this significant turning point, the acquisition of more industries by the newly developing partner becomes harmful to the industrialized country, and its interests are best served by maintaining undiminished its still substantial advantage over the newly emerging rival.

   Citing the example of the US and Japan trading in semiconductors, automobiles and aircraft - with the US dominating in aircraft and semiconductors and Japan in automobiles (but depending on circumstances a situation that is the other way round or any combination of them too could be imagined) - the authors say that such a position (reached deliberately by choice or otherwise) would not break down overnight. Market forces would preserve it, because of difficulties of entry for new competitors.

   In today's world, market forces do not produce a single predetermined outcome, but tend to preserve the established pattern, whatever it may be. If different industry-country combinations have different economic consequences for different countries, there is no reason to think that a country would be satisfied with its current position and not do things that would change its position.

   Economic textbook theories proceed on the basis that where trade between individuals is voluntary (except when they are deceived by facts), every trade exchange is for mutual benefit. And from this, a conclusion is also reached that such a situation must also exist in exchanges between nations and (given the respective productive abilities of each country and no difficulties in the way of entry) that it is better to trade than not trade. And if a developing country cuts itself off from trade and remains undeveloped in industries which it is not now producing, the argument goes, the country would be worse off. Such a view, Baumol and Gomory contend, misses the point that when technology has high startup costs, there could be other achievable and sustainable outcomes in which industries that may not get started in the presence of foreign competition can get started if there is no such competition and produce outcomes that could be better.

Hamstrung by international rules

   Does all this have implications for developing countries?

   The two authors point to the experience of the economies of the Far East which followed a pattern of rapid growth in productivity (state aid and infant-industry protection to help establish and bring onstream competitive new industries), focussing upon a small number of industries rather than spreading over a large number of sectors through a fairly uniform increase in the overall productivity. The latter course results in a situation where a dribble of resources made available to each industry is too small to enable it to overcome entry barriers into a retainable field.

   The difficulties of entry, once overcome in a few industries selected for expansion (by a state's industrial policy), would provide a substantial degree of protection against subsequent challenges by other ambitious nations, such as the next low-wage country to develop.

   This path becomes impossible for today's developing nations, however, because of  the international rules (of the WTO, and its incoherence with money and finance systems) that have been framed to restrict access to technology and cheap capital, deny the country infant-industry protection policies even for limited periods, and force any poor country to thinly spread its entire resources over a large range of industries, too thin to make a difference or help establish new industries.

   Thus, it is necessary, by rules (and not forbearance of the powerful to the weak that could be given or taken away for  trade or other considerations), to provide "space" within the system for the developing countries to develop and enhance  national  and per capita incomes.

   Such pleas and challenges have been and continue to be ignored despite proclamations about the emergence of a "development agenda" out of the WTO's Doha work programme.

   But unless the changes come, the clamour of civil society voices outside the system will grow and cannot be dismissed as futile arguments in a debate between pro- and anti-globalizers. (SUNS5144)                                    

From Third World Economics No. 283 (16-30 June 2002).