Free Trade Is Superior to Protectionism

Thank you to Subutai for this lively debate. I will dedicate this closing argument to presenting a number of cases in which countries have seen a decreased rate of growth due to the implementation of free trade policy. The story of Mexico – poster boy of the free-trade camp – is particularly telling. If any developing country can succeed with free trade, it should be Mexico. It borders on the largest market in the world and has had a free trade agreement with it since 1995 (the North American Free Trade Agreement or NAFTA). Free trade economists argue that free trade benefited Mexico by accelerating growth. Indeed, following NAFTA, between 1994 and 2002, Mexico’s per capita GDP grew at 1.8% per year, a big improvement over the 0.1% rate recorded between 1985 and 1995. But the 3 decade before NAFTA was also a decade of extensive trade liberalization for Mexico, following its conversion to neo-liberalism in the mid-1980s. So trade liberalization was also responsible for the 0.1% growth rate. On top of that, NAFTA’s positive impact (in terms of increasing exports to the US market) has run out of steam in the last few years. During 2001–2005, Mexico’s growth performance has been miserable, with an annual growth rate of per capita income at 0.3% (or a paltry 1. 7% increase in total over five years). By contrast, during the ‘bad old days’ of import substitution industrialization (1955–82), Mexico’s per capita income had grown much faster than during the NAFTA period – at an average of 3.1% per year. In Zimbabwe, following trade liberalization in 1990, the unemployment rate jumped from 10% to 20%. It had been hoped that the capital and labour resources released from the enterprises that went bankrupt due to trade liberalization would be absorbed by new businesses. This simply did not happen on a sufficient scale. It is not surprising that growth evaporated and unemployment soared. Trade liberalization has created other problems, too. It has increased the pressures on government budgets, as it reduced tariff revenues. This has been a particularly serious problem for the poorer countries. Because they lack tax collection capabilities and because tariffs are the easiest tax to collect, they rely heavily on tariffs (which sometimes account for over 50% of total government revenue). As a result, the fiscal adjustment that has had to be made following large-scale trade liberalization has been huge in many developing countries – even a recent IMF study shows that, in low-income countries that have limited abilities to collect other taxes, less than 30% of the revenue lost due to trade liberalization over the last 25 years has been made up by other taxes. It is perfectly possible that some degree of gradual trade liberalization may have been beneficial, and even necessary, for certain developing countries in the 1980s – India and China come to mind. But what has happened during the past quarter of a century has been a rapid, unplanned and blanket trade liberalization. Just to remind the reader, during the ‘bad old days’ of protectionist import substitution industrialization, developing countries used to grow, on average, at double the rate that they are doing today under free trade. Free trade simply isn’t working for developing countries. Free trade economists find all this quite mysterious. How can countries do badly when they are using such theoretically well-proven (‘the economics is all there’) policy as free trade? But they should not be surprised. For their theory has some serious limitations. Modern free trade argument is based on the so-called Ricardian theory (named after David Ricardo) The conclusion of the Ricardian theory critically depends on the assumption that productive resources can move freely across economic activities. This assumption means that capital and labour released from any one activity can immediately and without cost be absorbed by other activities. With this assumption – known as the assumption of ‘perfect factor mobility’ among economists – adjustments to changing trade patterns pose no problem. If a steel mill shuts down due to an increase in imports because, say, the government reduces tariffs, the resources employed in the industry (the workers, the buildings, the blast furnaces) will be employed (at the same or higher levels of productivity and thus higher returns) by another industry that has become relatively more profitable, say, the computer industry. No one loses from the process. In reality, this is not the case: factors of production cannot take any form as it becomes necessary. They are usually fixed in their physical qualities and there are few general use machines or workers with a ‘general skill’ that can be used across industries. Blast furnaces from a bankrupt steel mill cannot be re-moulded into a machine making computers; steel workers do not have the right skills for the computer. This is a more serious problem in developing countries, where the compensation mechanism is weak, if not non-existent. In developed countries, the welfare state works as a mechanism to partially compensate the losers from the trade adjustment process through unemployment benefits, guarantees of health care and education, and even guarantees of a minimum income. In some countries, such as Sweden and other Scandinavian countries, there are also highly effective retraining schemes for unemployed workers so that they can be equipped with new skills. In most developing countries, however, the welfare state is very weak and sometimes virtually non-existent. As a result, the victims of trade adjustment in these countries do not get even partially compensated for the sacrifice that they have made for the rest of society. Few would now dispute that communism failed as an economic system. But it is a huge leap of logic to go from that conclusion to the proposition that all attempts at economic planning don’t work. [1] Sources: [1] – Chang, Ha-Joon. Bad Samaritans: The Myth of Free Trade and the Secret History of Capitalism. New York, NY: Bloomsbury, 2008. Print.