Trade Liberalisation: a Political Approach
Shortened version of paper presented to Symposium Copenhagen Consensus, 27 May 2004. Forthcoming
Trade is not an aim in itself. The ultimate objective of economic policy making is not to expand trade, but to increase income and welfare. Trade is an instrument. Its expansion should be assessed against the objectives. It is always the relationship that matters: trade and growth, trade and welfare, trade and development, trade and the environment. And because the objectives are manifold trade policy should be seen in relation to other instruments and policies: trade and investment, trade and finance, trade and competition, trade and labour, trade and technology.
Economic history shows that open economies grow faster and that autarkic economies tend to stagnation. So, policy makers and governments can safely assume that openness is better. However, that does not mean that openness is enough. Trade openness is a necessary, but not a sufficient, condition for sustained economic growth. In order to make good use of openness a country needs good institutions, functioning markets and macroeconomic and political stability.
These are important conditions. What if the domestic conditions are not fulfilled? Is more openness and more free trade always good under such circumstances? Moreover, do these conditions determine trade or does trade also affect the conditions? In other words: could more and open trade not result in a weakening of institutions, less stability and a deterioration of market relations? That complete openness is not always necessary is shown by the example of the Asian ‘tigers’. The newly industrializing countries of East Asia in the 1970s did experience unprecedented trade expansion and high economic growth with the help of much public intervention, aggressive policies, managed trade, gradual opening of markets.
Fast market reforms can also create problems. For a long period China has witnessed two-digit growth figures, among others facilitated by a speedy access to world markets. But within China this unprecedented growth rate gives rise to economic and environmental distortions. Pollution is enormous. Easy lending has resulted in a huge overhang of bad loans, threatening financial stability and people’s confidence. Moreover, in other countries Chinese competition on the basis of its comparative cost advantage may lead to rising unemployment that cannot easily be matched by increased exports to China. Without a comprehensive approach, integrating international policies concerning trade, investment, finance and money, this could violate the stability of trading partners and of the world economy.
That a gradual and conditional opening of markets can be a wise policy is shown by the EU. Long negotiations had to take place in order reach agreement with the accessory countries. These negotiations dealt with the consequences of European expansion for markets in both the old and the new Europe: agriculture, transport, internal migration, competition, environmental legislation. Nobody argued in favour of a prompt establishment of a fully free agricultural market within the enlarged EU. Countries were willing to further liberalise agriculture, because the allocation of resources was highly inefficient and subsidies could not be sustained. But at the same time there was fear for social consequences, as had also been the case during the negotiations to enlarge the then ‘old Europe’ with Spain, Greece and Portugal. The much worse position of farmers outside Europe would justify a removal of the barriers that those farmers have to overcome when they want to export to Europe. But this does not render the fears inside Europe itself irrational. Rural conditions within Europe are not only a burden on the European economy; they also reflect certain values. For similar reasons, Austria was afraid that a free transportation market would irreversibly violate the environment in the Alps. Not everything can be compensated through a reallocation of resources set free by expanded trade.
Many fears are related to specific interests. They can be addressed with rational economic counterarguments. However, are all such fears irrational? Anderson points out that the source of resistance to policy reforms is that ‘the expected losses in jobs, income and wealth are concentrated in the hands of a few who are prepared to support politicians who resist protection cuts, while the gains are sufficiently small per consumer and export firm and are distributed widely as to make it not worthwhile for those potential gainers to lobby for reform.’ This is often the case. However, resistance to reforms often also is based on more general considerations, instead of specific group interests. Anyway, whether the resistance were socially justified or not, it is a political fact, related to questions of distribution. Better information concerning the potential benefits from reducing trade distortions will not be sufficient. Many parties – consumers, labourers as well as producers – see trade barriers as mechanisms to restore, protect or sustain a socio-economic and political balance in the economy or in the nation. To inform them about the costs involved, for them as well as for others, and thus about the potential benefits of removing the costs, will not suffice. They will envisage the removal of the trade distortions as a source of uncertainty and instability. They will therefore weigh the costs and potential benefits differently. Is that irrational? Sometimes, but not always, because the initial situation preceding market liberalisation is one of inequality in welfare as well as in political power.
Will technological change and the unilateral opening up of markets abroad contribute to a different understanding and weighing of the benefits and costs? Yes, in so far as trading costs are lowered and economic gains to be reaped come nearby. This is happening in the present era of globalisation. However, the perceived uncertainties and threats come closer too. Financial and monetary instabilities increase with globalisation, and economic inequality as well. Foreign control of investments, and thus of production, commercial and trade systems and sales, also increases with globalisation. This may retard the willingness to actively contribute to a further opening up. Such reluctance is not irrational. Even when it is clear that further liberalisation will contribute to growth and create more resources, it is uncertain who will reap he benefits and whether inequalities may not increase. It is too simple to conceive of this in terms of an ‘alarmist lobbying of protectionists’ alone. Such lobbies exist and do harm; however, there are also legitimate fears that cannot be taken away by better information. Such fears can be countered only through policies that go beyond creating expectations and beyond promises.
`World trade agreements, fully representative for all the interests concerned, would be the most credible way to address these fears. They form the best opportunity to bargain and exchange access and opportunities. The chances of success are greater the larger the number of countries involved and the broader the product and issues coverage of the negotiations. But here again, it will not be simple. All trade policy-making takes place in a context of both international and national inequality. Inequalities at home imply rigidity in the position of the negotiation partners. They may fear domestic instability resulting from different assessments and weighing of the outcome of the negotiation among various groups. For this reason, they cannot afford to be very flexible in the negotiations. Governments can try to introduce domestic compensation, but this is costly and will have to be financed out of the economic gains resulting from the expanding trade opportunities. Sometimes these opportunities have a different time frame. Often they cannot easily be taxed. All this will mean that governments will be cautious in instructions to their trade negotiators and that the negotiators themselves will exercise restraint.
This will add to a cautious approach that the same governments will choose because of the other inequality – that between the negotiating countries themselves. It is self-evident that this inequality leads to a lengthy negotiation process. The fact that previous rounds of negotiation have led to quite unequal results for the trading partners – the OECD countries benefited much more than most developing countries – and also the fact that many commitments resulting from these negotiations have not yet been implemented will add to a reluctance to engage themselves in further negotiations. Even if new rounds could be considered as beneficial to the world economy as a whole, weaker negotiation partners will hesitate. This, for instance, is the case for negotiations concerning services and investment.
It is also understandable that other countries are eager to speed up negotiations and action. They want to expand trade and boost the opportunities for growth. They are less afraid of an unequal distribution of the results. Because in their view multilateral negotiations become more and more cumbersome, they increasingly choose a different path: bilateral and regional negotiations, with free trade areas involving only a sub-set of countries. This is risky. Trade may be diverted from lower-cost developing countries, worsening the situation for non-participants in these talks.
Negotiations were limited to tariffs and to manufacturing sectors. These limitations constrained the capacity to liberalise fully among all countries, but they also made the negotiations manageable. During the Dillon Round, the Kennedy Round and the Tokyo Round the ‘low-hanging fruit’ was reaped. These negotiations also helped to counter inclinations to return to protectionism. But protectionist tendencies still had their way in the form of NTBs and restrictive business practices. Moreover, commodities and agriculture still were outside the scope of these rounds. These subjects were dealt with in different international fora. The Uruguay Round negotiators reached the limits of what was possible within the prevailing trading system. After about half a century, it was deemed necessary to broaden the scope. GATT was turned into WTO, which meant that investment, services and agriculture got a prominent place on the agenda, next to trade in goods. It also implied a broadening from tariff barriers to all barriers to trade. And it meant a widening of the partnership in the negotiations: with Russia and China as well as with developing countries. The latter had been followers of what basically were West – West negotiations. The entry into force of WTO as the successor of GATT increased their chances to become equal partners in the talks.
Since the early 1990s the broadened negotiation process slowed down. The reason was not that countries had become more protectionist. Governments had not become less aware of the potential benefits of trade liberalization. However, they found it difficult to cope with the uncertainties resulting from globalisation. They had to learn to deal with the complications resulting from the multiple broadening of the negotiations, as reflected in the mandate and the composition of the WTO.
Many governments resorted to alternatives to multilateral negotiations on a world scale. The 1990s saw a preference for regional reciprocal or non-reciprocal trade liberalization. Governments wanted to combine more free trade with more speed and more certainties than would be possible in a fully multilateral context.
Recent developments in trade policy reflect not so much a tendency towards more protectionism as well as towards trade liberalization in stages. Countries seem to prefer a ‘two-track’ approach: a slow WTO process in combination with an intensification of bilateral and regional trade negotiations, both with the objective to enlarge trade, but in such a way that the economic and social consequences of that enlargement can be managed. The problem, however, is that the second track renders the first track less and less feasible, because it undermines the rule-based character of a global system, eroding principles which in earlier stages had been agreed by all countries. It is not enough to address such a tendency by highlighting the wonders of trade liberalization. I agree with Anderson that in present circumstances a multi-pronged approach has to be chosen: unilateral reform at the national level and multilateral reform at the WTO level, supplemented by regional support for both, in a form of open MFN regionalism. I consider this politically feasible. In such a multi-pronged approach there is no place for an expansion of regional preferential trade arrangements. These would harm third parties, erode an efficient allocation of resources at home and undermine efforts to achieve a better multilateral agreement later. Temporary preferential treatment, enjoyed by initially less developed countries and granted to them on the basis of infant-economy considerations in order to overcome time-bound handicaps, turns out to stay. It is difficult to reduce preferences, let alone to remove them, because beneficiaries see them as established rights. It is nearly impossible to replace them by other measures intended to assist the integration of the country into the world economy at equal footing.
However, to choose in favour of a multi-pronged approach is more easily said than done. It certainly cannot be confined to trade measures only. A multi-pronged approach should be constructed in such a way that the real impediments can be removed: unequal treatment, social instability, transition costs, financial constraints and increasing foreign debt. Impediments to trade should be dealt with in conjunction with other macroeconomic constraints. The answer to the fears lies in elaborating a world trading system that (1) is truly rules-based, (2) guarantees equal treatment of all partners, (3) is comprehensive and in tune with the world financial system and (4) ensures sustainability. After the end of the Cold War and in response to the international economic stagnation and adjustment of the 1980s the world trading system has been reformed, in order to render it more adequate to address the needs that could not be taken care of by GATT. However, the new impetus to globalization since then demands a more far reaching reform of the world economic system (investments, trade, technology, debt, money and finance), without which claims to further open up economies will not easily be honored by all participants.
Additional dynamic gains will be higher the wider the coverage of trade liberalisation. Reducing only tariffs will produce less additional endogenous economic growth than reducing tariffs and subsidies and NTBs. The latter will provide more certainties to entrepreneurs and a greater incentive to investment. Including services and investment will lead to further dynamic gains, because new investment opportunities will arise and new markets will open up. Anderson assumes that trade reforms may boost economic growth in developing countries by one-third and in developed countries by one-sixth. In his view, this is a conservative assumption in the light of the experience of successful reformers such as China, India, Korea and Chile. I agree. I have no reason to dispute the summary estimates presented by him: GDP growth in 2015 of 3.1 per cent for developed countries, 6.1 per cent for developing countries and thus 3.8 per cent for the world as a whole. However, I wonder whether it is justified to assume that those rates will continue until 2050. The dynamic gains from trade will gradually diminish, sustaining them may require new initiatives.
The growth rate of 6.1 per cent for developing countries is in line with internationally agreed policy targets for GDP growth of developing countries that since 1960 have been laid down in the subsequent Strategies for the United Nations Development Decades. However, such rates will not easily be achieved. Why not? There are three reasons. First, the benefits are not distributed equally among trading partners. Research shows that agricultural liberalisation offers a mixed set of results, even against expectations: positive for Europe, Asia and Northern Africa, negative for SSA, potentially negative for the Asia-Pacific region and North America, neutral for Latin America. China will be hurt by a liberalisation of manufacturing. It will meet stiffer competition from other developing countries and experience a decreasing terms of trade. Moreover, unlike the Asian experience, export-led growth in Latin America has proved so far to be anything but a ‘development miracle’. For some Latin American countries free trade can have a negative impact on agriculture which is not compensated by sufficient employment and income growth in other sectors, So, for good reasons, different negotiation partners will have different expectations. Many countries, aware of the unequal distribution of the benefits of trade liberalization, will remain reluctant.
The second reason is that the benefits per country are also distributed unequally. The benefits of international trade liberalization so far have been utterly unequal. It was free trade à la carte, selective and characterized by a fair amount of arbitrariness in the granting of preferences and the mix between reciprocity and non-reciprocity. The benefits were bought at the cost of many poor countries and many poor people, within both more and less advanced economies. Europe, for instance, in combining ACP free trade with the continuation of its Common Agricultural Policy has done much harm to farmers both in many developing countries. Poor farmers world-wide have suffered from the functioning of international commodity markets (sugar, bananas, cotton, rubber, cocoa and others) with decreasing terms of trade, overproduction, subsidies to commodity producing farmers in the USA and the EU, preferential treatments, unilaterally set rules of origin, market speculation and the development of technologically new substitutes. International talks to remove all of these and other barriers will create a new perspective for the victims of these practices. But the winners of today will be the losers of tomorrow and it is not only a matter of rich versus poor. It is more complicated. Negotiations in the field of trade will have to be complemented by internationally harmonised domestic policies that can result in a fair balance in all countries.
The third reason is that for all negotiation partners there are costs involved. Anderson argues that these costs – private costs of adjustment for firms and workers and social costs in the form of social safety nets, unemployment schemes and retraining and reintegration – are minor. They are one-off costs, transitional, and should be weighed against the non-stop flow of economic benefits from reform. Anderson presents an estimate of the costs up to 40 per cent of the gross static benefits under full liberalization. He also assumes that these costs will last no longer than five years. In my view, however, the costs are higher and will last longer. In macro terms the costs may be far less than the benefits, but per sector or region this is different. In some cases, for instance when full liberalisation threatens the continuation of an industry, these are higher than the benefits. The benefits will accrue elsewhere and will not easily be used to finance compensation or restructuring benefiting the industry or region concerned. For a number of traditional sectors one cannot speak of one-off costs. They will have to be borne by a whole generation consisting of people that can no longer be retrained and reintegrated in the economy. In such cases one may have to take into account a period of twenty-five rather than five years. Often the next generation – the children of workers laid off in extractive industries or in traditional manufacturing enterprises that are downsized or closed – will also be affected. In agriculture the costs will also be borne by others: people living in rural areas, not only in the less productive agricultural sectors in Europe and the USA, but above all in developing countries. For many of these people small-scale subsistence agriculture is more than an economic activity; it is a means to survive, a living, a culture, a way of life. Some of these people can be hired as farm laborers, others as unskilled laborers in industry. Many would be fully uprooted, they themselves as well as their families and the next generation. The economic, social, psychological and cultural costs are neither minor, nor one-off or transitional. They are long-term, structural and major.
In theory, policies to redress and compensate this ought to be financed out of the benefits resulting from reform. However, not all costs are of an economic character, lending themselves to compensation. Moreover, the losses in jobs and asset values are often concentrated, for instance in declining industries, whereas the gains in terms of new jobs and investment opportunities are thinly spread, taken up by people other than those losing from the reform. This holds true for Western as well as for developing countries such as India, where the middle class is benefiting from new opportunities due to the opening of markets such as in information services. In agriculture in less advanced Northern economies and in the Third World, it is the other way around: the losses are widely spread and cut deeply into the existence of people while the initial concrete benefits are concentrated in the hands of a new class. In both cases those who loose will be politically more vocal than those who gain. The latter often do not realize that their progress is attributable to trade reform. Governments will remain reluctant to engage themselves in opening up their economies. Moreover, potential losers are always more easily identified than potential winners. And the benefits often accrue to population strata that cannot easily be taxed by the government, in particular because the reforms take place in the framework of an economic philosophy that emphasizes the market and demands a retreat of the public sector. The economic costs last longer than a transition period of five years, but whether there will be long-term benefits in the form of structural employment opportunities for many people is unclear. New industries, often financed with foreign capital, are inclined to choose capital-intensive production technologies. In a more and more globalized economy, the ample availability of labor becomes a relatively less important factor in decisions to invest and to choose a particular location. This is, for governments, an additional reason to go slow with reforms.
I am also less positive than Anderson about the relation between trade reform and poverty alleviation. Trade reform can reduce the income gap between developed and developing countries, provided that it takes place within a comprehensive approach. In doing so, trade reform will enhance the capacity and help increase the resources necessary to implement pro-poor policies within poorer countries. It will also contribute to higher economic growth within developing countries. Whether the increased capacity will be used for that purpose, however, remains to be seen. In the past that was not the case. The 1990s witnessed much economic liberalization and market reform, resulting in substantial growth rates of world trade and income. However, despite official commitments to use the additional resources set free by reforms and growth to finance anti-poverty programs in the fields of water, health, education and food and agriculture, world economic inequality and poverty increased. The promises have not been kept.. No wonder that poor countries are suspicious with regard to the promise that new trade negotiations will lead to less poverty.
They may even lead to more poverty. Market reforms can lead to new distortions and new inequalities, to the detriment of the poor people. Some market liberalization in the field of agriculture, for instance, will lead to increased consumer prices in food-importing developing countries. Other reforms will result in upsetting traditional agrarian systems and land use patterns, depriving the poor of the use of essential resources. Market reforms aiming at price liberalization, a retreat of the public sector and more incentives for private enterprise in essential sectors such as health and education have similar consequences. Criteria of good governance accompanying market reform and applied in international policies concerning trade, finance, aid and debt have often produced counterproductive effects. Governments were more or less forced to diminish public efforts to decrease poverty. Expectations concerning the number of poor people in rural areas who could find a better living after reforms, because there would be an increased demand for both farm products and their off-farm labor have not been fulfilled. China was an exception, but in Africa and in South Asia urban and rural poverty increased, despite a certain degree of liberalization. One could argue that these reforms did not go far enough, However, those who realize how much policy change has been implemented since 1980 – first as a necessity due to adjustment policies, later on the basis of the universally applied ‘Washington Consensus’ – will understand the scepticism regarding the acclaimed future speed, depth and benefits of further reforms.
A similar line of reasoning applies to the relation between trade reform and the environment. Rather than assuming that trade does have a direct impact on the environment, be it positive or negative, I prefer to discuss environmental effects as resulting from economic activities in the real sphere, such as investment, production and income growth, transportation, consumption and exploitation of natural resources, including energy. All such economic activities in the real sphere are linked through trade. It is trade that facilitates their combination and provides them with more opportunities to create value added. So, environmental consequences result not from trade in isolation, but from trade in combination with one or more of the other economic categories.
Not all expanded trade in combination with increased investment and production results has negative consequences for the environment. Trade, in so far as this does lead to poverty alleviation, can result in less harmful land use patterns (less slash-and-burn agriculture). It may also result in a substitution of non-renewable sources of energy (wood-cutting, for instance) by other sources. The same is true for a substitution of coal by environmentally less harmful sources of energy that could result from the removal of coal subsidies. However, trade in combination with activities in the real sphere of the economy has other environmental effects as well: increased energy use, increased use of other scarce natural resources, risking depletion, loss in animal welfare, spread of animal diseases, loss of landscape and biodiversity, climate change, depletion of fish resources, over-utilization of water resources, land degradation due to overgrazing and so on. Trade reform and modernization of the economy may also result in a loss of traditional production techniques in harmony with the natural environment and with scarce natural resources. All this may easily translate into political costs: more poverty, less cohesion, more turmoil. Trade itself is not the culprit, production and consumption are. But specific trade policies, including trade liberalization, have consequences for investment, production and consumption patterns, for land use systems and transportation systems. Trade policy rules to a great extent determine the use of the world’s resources. It is also the other way around: trade and the opportunities for trade policy-making are influenced by developments and decisions in other areas and by technological change. The combined effects for the environment cannot be neglected when choices in the field of trade itself are on the agenda.
The main challenge is to create new jobs for ever-more new young people without unduly destroying jobs for others. Failing to do so will have social and political consequences, world-wide. When expectations are not met, when aspirations are violated, when unemployed young people are denied a fair perspective, economic instability, social unrest, political strife and violence may result. People without a stake in the labor market, in particular the young among them, may feel themselves excluded not only from the economic system, but from society as a whole. In reaction to this they may turn against society.
Presently the process of globalization seems to strengthen economic forces that are in favor of trade liberalization. But there always will be an inclination to protect. Where fear prevails, protectionism will be on the rise. Presently, stemming a return to protectionism as an unintended result of a combination of policy reactions – out of fear, or in order to guard specific interests – is more important than to enforce further liberalization. But a defensive approach will not suffice. It is important to keep the economy dynamic and oriented towards innovation. A standstill can easily turn into regression. Rendering trade policy making more comprehensive can be a contribution towards such a dynamic approach.
The stakes are high. I do not dispute Anderson’s estimates. I agree with his estimates of gross economic benefits from reducing subsidies and trade barriers. Both the static gains and the dynamic gains as presented by him are reasonable, given the assumptions made. Maybe these benefits will take more time to accrue and not last as long as assumed, but this is a minor consideration. In my opinion the economic costs will be higher than Anderson assumes. They will last longer. Still, in macro terms they are much less than the benefits.
I do not share Anderson’s optimism with regard to the social benefits and costs. Anderson argues that the net social benefits from trade liberalization for poverty reduction, the environment, diseases, education, nutrition, governance, stability and conflict management are most likely positive and large. I have argued for two of them – poverty and the environment – that this is only true under specific conditions, which will not easily be met. If not, the effects may on balance be negative rather than positive. The most important caveat with regard to Anderson’s figures is that their theoretical validity may be politically less relevant. The figures can be turned into reality only through political negotiations. In these negotiations, the conditions underlying these figures will also have to be met. Many of these conditions concern the distribution of the benefits and costs. Who will benefit – which countries, which sectors, which people? Who will have to bear the burden? Can they be compensated? Yes, because the macro benefits are very high. Will they be compensated? That is uncertain, and this uncertainty adds to the costs. The question is not whether the stakes are high, or how high they are, but how to share them. It is the distribution of the costs and benefits, rather than the size, which will determine action.
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