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The politics of trade

The politics of trade

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A growing debate has sprung up in the blogosphere on international trade. John Aziz, discussing a widely read article by John Atkison and Michael Lind, argued in defence of protectionism, quickly sparking a rebuttal from Mark Harrisson. Meanwhile, Joe Stiglitz spoke about the ‘charade’ of free trade and how international trade deals tend to protect already wealthy and powerful western corporate interests, as Frances Coppola worried about destructive trade wars and neo-colonialism destablising the global economy.

As is common in economics, I can’t help but feel this debate is being conducted on a phoney dichotomy: between the state and the market; managed or non-managed trade; politics or economics. All too often there is the idea of an implicit ‘free trade’ baseline, and one side argues for it while the other suggests strategic interventions to steer trade in the right direction. Joe Stiglitz’ piece came the closest to exposing this dichotomy by recognising that western ‘free trade’ deals are not really 'free' at all, but he still appealed to the idea of a “genuine free-trade regime” as a meaningful and desirable concept.

The politics of trade

The reality of trade is that it is always, necessarily, regulated. There is no ‘free’ baseline, untouched by politics, history and culture, to which we can aspire. There are merely a series of political decisions, special interests and historical accidents, some of which are hidden, some of which are less so, but all of which have very real impacts on trade and specialisation. In my opinion, there are three major political choices that demonstrate this reality: 

First, contrary to the ‘free trade’ rhetoric, international trade generally does not take place between two people exchanging apples and chickens, but between corporations, governments and other institutions, all structured in different ways across the globe. These large trade deals will inevitably be subject to scrutiny to determine whether or not contracts are upheld, particularly if public money is at stake. Common rules of the game and guidelines help these processes to function more smoothly; merely letting corporations, themselves protected by law, determine the terms of deals is no less political than actively forming such rules. How corporations are structured also varies between countries: a trade deal in Germany is likely to involve union representatives at the negotiating table, while in the USA it's more likely to involve only management and shareholders. These differing institutional characteristics will surely alter the nature of trade deals. 

Second, the global economy is vast, and countries may be at different stages of development, at different stages of the business cycle, or have economies which specialise in different areas. Their tax, fiscal and monetary policies will therefore reflect this: we can see in the Eurozone that Germany’s strong export oriented economy demands higher interest rates, which are helping to drag down Greece’s far weaker economy, locked as it is to the common policies of the ECB and to the Maaschrict Treaty. Similarly, countries which have older populations may wish to use tax credits for pensioners, or countries with vast natural resources may levy a 'rent tax' on their extraction.

Third, countries may have specific non-economic characteristics that require certain trade policies. In many religious countries, the worker's right to pray at certain times throughout the day must be respected. Or think of Australia - being an island long separated from the rest of the world, it has developed a unique ecosystem and hence must manage the food, plants and animals that go into it carefully, lest its ecosystem – and therefore everything else – experience massive problems. It is easy to think of a small economy experiencing analogous problems if large capital flows flood its economy, or if a corporation with assets an order of magnitude larger than its economy sets up shop and drives out fledgling businesses. 

The theory of ‘free trade’ 

To understand further the irrelevance of the ‘free trade’ baseline, it is worth taking a look at its main theoretical underpinning: the theory of comparative advantage. This states that people - both within and across borders – should specialise in what they are best at, regardless of their productivity relative to others. This produces the biggest possible 'pie' possible, and everyone can then participate in mutually beneficial trade as they see fit, all undistorted by politics. 

However, although comparative advantage is - in the words of Paul Krugman - something of an “economist’s creed”, its relevance as a theory is incredibly limited: in fact, it has long been acknowledged that the theory explains a relatively small amount of international trade. For example, comparative advantage does not explain why electronics are produced in Southeast Asia; why the USA has Silicon Valley and a large airport industry; or why Germany produces great cars. Instead, these things are explained by government policies, luck and history. Believing that any new attempts to engineer competitive advantages disrupt the neutral baseline ignores this fact. 

The second complication is a point recognised by the originator of comparative advantage, David Ricardo: the international mobility of capital. If capital is mobile, it will flow to countries with the highest interest rates, causing imbalances that have less to do with 'underlying' specialisations and more to do with monetary policy. On top of this, international capital will not be invested according to comparative advantage, but to those areas which are the most profitable - areas with the greatest absolute, not comparative, advantage. These effects can be self-perpetuating as investment in the already dominant industries – usually the ones with a historical head start – causes them to grow even further. The result is that imbalances in country's Balance of Payments can persist, as has been the case with many western countries for the past few decades. 

It is also worth noting that the significance of individual governments can be exaggerated, as history plays an undeniable role. The UK rose to power when it was more or less the only game in town, surely helped by the vast resources it accrued from its colonial power. The USA's industrialisation period saw it massively isolated, free to pursue its own policies and take advantage of its substantial resources and land (again, these resources were a result of conquest). More recently, the Southeast Asian ‘Tigers’ - though their policies were indeed well formulated and implemented - had the tides of history on their side: their rise coincided with the rise of consumerism in the west, and the western appetite for electronics fueled their export boom. Though Sub-Saharan Africa experimented with industrial policy at the same time as the Tigers, it had limited success - part of the reason was domestic, but it is also true that the world as a whole can only, logically, tolerate so many export-fueled booms at once. 

A different perspective

There is therefore a rationale for collective institutions in international trade that is similar to the rationale for collective institutions in domestic trade: coordination and a common set of rules. Managing international trade does not require those doing it to have divine powers; they would simply be managing flows and patterns of such a magnitude that no individual, corporation or government is responsible for them. Using capital and exchange rate controls, trade balances could be tilted toward those countries who require the demand from exports to develop their own domestic markets, fueled by already developed countries who can afford those levels of consumption. Countries could be insulated from global economic forces much larger than themselves when needs be. Most of all, granting governments some degree of autonomy to deal with their unique problems would prevent 'beggar-thy-neighbour' trade wars, usually conducted in desperation.

In fact, paradoxically, making trade management more overt may be less restrictive in the long run. First, it could increase international trade: the Bretton Woods era saw a remarkable growth in global trade, one that has not been paralleled since. Second, making sure trade management is transparent and that everyone has a say can prevent truly restrictive and destructive practices in the future, such as the onerous reparations imposed on Germany after World War 1, or the protectionist spirals during the Great Depression. Bretton Woods was created precisely to avoid the disastrous consequences of such policies, yet this lesson seems to have been lost. 

Some may object that such international arrangements are bound to be corrupted, and steered in the favour of the most wealthy, powerful countries. It is undeniable that this is a reality, but as Stiglitz and others have argued, it is already the case that the wealthiest countries have the power in trade deals. Democratic and transparent institutions can be designed to have a curbing influence over their power, and to be at least an improvement over where we are now. Furthermore, if these arrangements precipitate developments, they can bring the poorer countries more bargaining power over time.

In summary

Trade is always managed, implicitly or explicitly. We can pretend that this isn’t the case and pursue an ill-defined 'free trade' ideal, allowing powerful interests and luck to shape the nature of the global economy, perhaps to the detriment of many. Alternatively, we can bring the management of trade into the open, making trade decisions political choices subject to public and professional scrutiny, respecting each country's unique needs, and making sure that countries cooperate instead of descending into economic  - or worse, real - conflicts. 


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Unlearning Economics

@Ralph

That is not how I see CA; I was simply suggesting your characterisation was somewhat tautological as it wouldn't actually serve to explain what was produced and traded over time, but would be a static snapshot where the conclusion - what gets traded - is already implicit in the set up of the mode.

However, explanations of CA I've studied generally refer to 'innate' capabilities and resource endowments to explain differences in productivity.

"Another point is that while some countries have industrialised behind tariff barriers, others (e.g. India) have erected such barriers and failed to achieve rapid industrialisation in consequence."

Something I would never deny. One of my points here is that international trends are more important than individual government's policies.

Unlearning,

If you think there is nothing to comparative advantage other than the statement that some countries are better at producing some things than others, you cannot possibly have studied CA. For example one the really neat and counter intuitive insights of CA is that country X and Y can both benefit if country X exports a commodity to Y even where X produces the commodity LESS EFFICIENTLY than Y.

That is, country X should export to Y not what X can produce more efficiently than Y, but what X is “most best” at producing. And if any readers are not acquainted with the awkward phrase “most best”, that just proves they haven’t studied the subject.

There may well be valid criticisms to be made of CA, but I don’t accept your “tautology” point, nor your “fairy tale” point (in response to Arijit).

Another point is that while some countries have industrialised behind tariff barriers, others (e.g. India) have erected such barriers and failed to achieve rapid industrialisation in consequence.

As to what the normal or natural rate of interest is, I can’t put a number on it, but it’s the rate that would prevail given no government borrowing.

It might sound odd to claim that governments should not borrow, but in fact the arguments for government borrowing don’t stand inspection. E.g. see this paper by Milton Friedman (p.250, para starting “Under the proposal…” in particular):

http://nb.vse.cz/~BARTONP/mae911/friedman.pdf

Also see 2nd last paragraph of this by Warren Mosler:

http://www.huffingtonpost.com/warren-mosler/proposals-for-the-banking_b_432105.html

And this by me:

http://mpra.ub.uni-muenchen.de/23785/

A great piece, which is borne out by my experience in the Pacific. I blogged about it here: http://emergenteconomics.com/2013/07/25/trade-is-about-politics-not-just-economics/

Unlearning Economics

@Ralph

"The answer to that is that free trade theory never claimed to explain the latter phenomena: free trade theory simple takes as a starting point the fact that some countries are better at producing some things than others. "

In this case comparative advantage is tautological: countries are good at producing whatever they end up producing, and therefore has no real use.

My reading, however, is that due to innate resource endowments or abilities, people industries appear at certain places in the globe, largely independent of government policy.

"In contrast, IN AS FAR AS differences interest rate differences are caused by changes in monetary policy (e.g. interest rate adjustments) I quite agree that the effects are bizarre. But that’s the fault of monetary policy, not the fault of free trade theory."

We seem to be in agreement here, but I ask: what is the 'normal' rate of interest, if one exists, that means that monetary policy is not 'disrupting' the flow of capital?

@Arijit

Thanks. It's incredible how comparative advantage only really seems to have fairy tale stories to back it up. For example, in Paul Krugman's book 'Peddling Prosperity', he starts attacking the left for not supporting free trade. Yet in his earlier attacks on the right, he had relied on statistics and facts; with the left, statements of comparative advantage combined with just-so stories seemed to suffice. I'd like to see a clear statement of how comparative advantage has translated into real world benefits.

The above article criticises free trade theory because it doesn’t explain why “electronics are produced in Southeast Asia” or why Germany “produces great cars”. The answer to that is that free trade theory never claimed to explain the latter phenomena: free trade theory simple takes as a starting point the fact that some countries are better at producing some things than others. Certainly the ideas about comparative advantage set out in the text books adopt the above “starting point”.

Next, the article complains about the fact that differing interest rates in different countries will cause capital to move to countries with the highest interest rates. My answer to that is that IN AS FAR AS those interest rate differentials are caused by fundamentals (e.g. the fact that capital can be more usefully employed in one country than another), I see nothing wrong with such movements of capital.

In contrast, IN AS FAR AS differences interest rate differences are caused by changes in monetary policy (e.g. interest rate adjustments) I quite agree that the effects are bizarre. But that’s the fault of monetary policy, not the fault of free trade theory.

For example, an interest rate cut in country X is supposed to stimulate economic activity in that country. However, as the article rightly suggests, one effect is for capital to flee the country, the effect of which is anti-stimulatory! You couldn’t make it up.

One of the best submissions to the Vickers Commission attacked interest rate adjustments. See:

http://www.positivemoney.org.uk/wp-content/uploads/2010/11/NEF-Southampton-Positive-Money-ICB-Submission.pdf

I’ve also attacked interest rate adjustments on my own blog:

http://ralphanomics.blogspot.co.uk/2013/06/not-only-is-qe-nonsense-so-is-rest-of.html

Unlearning, this is a welcome and long overdue piece from you as we tend to take the notion of 'free trade' as uncontested gospel and a 'do as I say not as I did' icon of Washington consensus economic development.
I ask rhetorically, why it is that orthodoxy asks students to embrace comparative advantage without illustrating what actually in economic history. For example, the Alexander Hamilton prescription for the United States should be evidence that development can come in many forms as can Germany catching up to and surpassing Britain and France in terms of industrialization and capital stock. In contrast, 'free trade', in the manifestation propagandized by Ricardo, didn't help India but aided in its de-industrialization over the span of 200 years.
To return to the thrust of your argument (and as you are well aware), Ha-Joon Chang has written about "a vast gap in intellectual and negotiation resources between" developed and developing nations and of the manner in which developed nations "can threaten and bribe developing countries by means of their foreign aid budgets or using their influence on the loan decisions by the IMF, the World Bank and ‘regional’ multilateral financial institutions." This illustrates further that power matters and politics of vested interests (e.g. trans and multi national corporations) trumps the national interest through an alphabet soup of trade obscurantism (TRIMS, GATS, BITS).

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