Globalisation and Free Trade (ch 17)

MBA Session 5

Professor Dermot McAleese

Trinity College Dublin

OUTLINE

Trends in global trade

Gains from foreign trade

Quantifying the gains from trade

Why protection failed

Competitiveness and Globalisation

WHERE ECONOMICS BEGAN Adam Smith, Wealth of Nations, 1776

Productivity the key to wealth of nations (not gold, not balance of trade surplus)

Productivity enhanced by specialisation

Dexterity

Saving of time

Machinery invented by workmen

Specialisation increased by enlarging the extent of the market

Extent of market limited by

Trade barriers

Monopoly ‘Invisible hand’ will even look after the poor!

‘in a well-governed society, opulence extends itself to the lowest ranks of the people’

TRENDS IN GLOBAL TRADE

Growth in trade

Composition of trade

Trade regimes (GATT, Uruguay Round, WTO)

Two Core Principles of WTO

• Non-discrimination

• National Treatment (banks, insurance, gasoline stations etc)

Administration and implementation of the 29 multilateral agreements which make up the WTO ( incl agriculture, textiles, GATS, government procurement)

A forum for multilateral trade negotiations

Resolving trade disputes (200 cases outstanding)

Reviewing national trade policies (142 members to date)

Co-operating with other global economic policy institutions

THE FUNCTIONS OF THE WTO

Table 1. Trade and GDP, 1900-2000

(average annual percentage change in volume)

Source: WTO, Regionalism and the World Trading System (Geneva, April 1995); International Trade Statistics (1995); own estimates

1900-13 1913-50 1950-73 1973-00

Merchandise trade 4.3 0.6 8.2 4.7 Gross domestic product 2.5 2.0 5.1 2.8

Table 1a. Value of world exports, 2000 (US$ billion)

Source: WTO and own estimates

World merchandise exports 6180Commercial services 1415Total 7595

Table 2. Leading exporters and importers in merchandise trade in 2000

Source: WTO, press release, 6 April 2000.

Rank Country $US bn % share Rank Country $US bn % share

1 US 782.4 12.3 1 US 1,258.0 18.9 2 Germany 552.0 8.7 2 Germany 500.1 7.5 3 Japan 479.0 7.5 3 Japan 379.5 5.7 4 France 298.1 4.7 4 UK 331.7 5.0 5 UK 280.1 4.8 5 France 305.4 4.6 6 Canada 277.2 4.2 6 Canada 249.1 3.7 7 CHINA 249.2 3.9 7 Italy 233.3 3.5 8 Italy 234.6 3.7 8 CHINA 225.1 3.4 9 Netherlands 211.7 3.3 9 Hong Kong 214.0 3.1

10 Hong Kong 202.4 3.2 10 Netherlands 197.0 3.0

1 EU 15 855.4 17.2 2 EU15 959.2 18.2

Exporters Importers

Table 3. How important is trade?

Source: World Development Indicators, The World bank (2000).

CountryExports as a % of GDP

(1998)

The least trade-dependent nationsRwanda 5Brazil 7Albania 9Uganda 10Argentina 10India 11Peru 12Iran 13Bangladesh 14

Major industrial economies (G7 nations)US 12Japan 11China 22Germany 27France 27UK 29Italy 27Canada 41

The world's most trade-dependent nationsSingapore 153Hong Kong 125Malaysia 114Ireland 80Estonia 80Belgium 73

GAINS FROM TRADE

Traditional gains

comparative advantage

variety of products

Modern extensions

competition and contestability

economies of scale and scope

innovation and R&D (imports)

product and quality improvement

ON FOREIGN TRADE

‘No extension of foreign trade will immediately increase the amount of value in a country, although it will very powerfully contribute to increase the mass of commodities, and therefore the sum of enjoyments.’

David Ricardo, Principles of Political Economy and Taxation 1821, Chapter VII

The gains from trade liberalization should not only be seen through a narrow economic lens. Trade has also been a vehicle for promoting broader political objectives, especially peace and stability. Trade establishes mutually beneficial links among nations, creating interest in cooperation. It cements relationships among disparate peoples and societies, lessening the risk of conflict, and it strengthens the commitment of governments to rules in the place of realpolitik.

World Trade Organization, Annual Report, 1998

Table 4. Developing countries: trade orientation and economic performance

Source: IMF, World Economic Outlook (May 1993), p. 76.

1974-85 1986-92

Strongly outward-orientedReal GDP growth 8 7.5Real per capita GDP growth 6.1 5.9Total factor productivity 2.6 3.8

Moderately outward-orientedReal GDP growth 4.3 4.8Real per capita GDP growth 2.2 2.5Total factor productivity 0.9 2.4

Moderately inward-orientedReal GDP growth 4.4 2.4Real per capita GDP growth 1.8 -0.1Total factor productivity 1.3 0.3

Strongly inward-orientedReal GDP growth 2.3 2.5Real per capita GDP growth -0.3 -0.1Total factor productivity -0.4 0.3

All developing countriesReal GDP growth 4.1 3.8Real per capita GDP growth 1.7 1.5Total factor productivity 0.8 1.4

Estimated Annual Income Gains form the Uruguay Round ($bn)

US 122

EU 164

Japan 27

Developing economies 116

China 19

Chinese Taipei 10

Other 52

Total 510

COMPARATIVE ADVANTAGE

‘nations should concentrate on what they are best at producing’

International Trade Theory

A country can have an absolute disadvantage in all goods and yet gain from trade with the more efficient partner

The gain is realised through imports

Trade involves mutual gains (trade is a positive sum game)

The total gain from trade may be unevenly shared

X-EFFICIENCY AND FREE TRADE

Wine

Clothing

T

T T’

T’

0

QUANTIFYING THE GAINS FROM TRADE

gains from free trade vs. autarky

gains of incremental movement towards freer trade

comparative analysis

TRADE POLICY AND PROTECTION

Sources of possible distortion:

Unemployment and the capacity to adjust

Foreign monopoly power

Failure of prices to signal future changes in comparative advantage

Neglect of environmental effects

WHY FREE TRADE MIGHT NOT ALWAYS BE BEST POLICY

(Adam Smith, Box 17.4)

Defence of the country

Level playing field

Retaliation

Transitional protection

optimum tariff

infant industry

income distribution

strategic trade theory

MODERN ARGUMENTS FOR PROTECTION

WHY PROTECTION FAILED

• Protected industries started well but became inefficient

• Downward pressure on prices for food products (bad for farmers, good for the consumer)

• Protection discouraged exports, thus missing out on economies of scale

• Protected industries were poor innovators

• Protection gave incentive to corruption

What determines comparative advantage? What can we export?

‘Comparative advantage is no longer seen as divine inheritance…

…nor are market structures and rivals’ behaviour set in tablets of stone’

Cecchini, P., The European Challenge 1992, (Aldershot: Wildwood House, 1988), p. 85

PORTER’S DIAMOND

Source: Michael Porter, The Competitive Advantage of Nations (London: Macmillan, 1990)

Firm StrategyStructure and Rivalry

Factor Conditions

Related and Supporting Industries

Demand Conditions

Chance

Government

TRADE POLICIES AND NEW TRADE ISSUES

how to cope with the losers (Box 17.5)

how to maximise the gains

trade agreements and the WTO

new forms of protection

Case Study: Effects of China’s entry into WTO (Dec 2001)

• Some concessions on agriculture

• Improved access to global market

• Textiles and clothing agreement

• Strong foreign investment effect

• Spur to efficiency in import-competing firms

• Underpins market reform process

Effects of China’s entry into WTO – Short run costs

• Job losses in state operated enterprises

• Pressure on agriculture

• Cost of intellectual property agreement

• Exposure to any downturns in the world economy

China’s trade by area 2000

• Exports $bn %

US 52 21

Hong Kong 45 18

Japan 42 17

Korea 11 5

EU 18

• Imports $bn %• Japan 42 18• Taiwan 26 11• S Korea 23 10• US 22 10• EU 15

High tech Exports (% of total exports to OECD)

• China 20 Thailand 34

• Hong Kong 30 Taiwan 50

• Indonesia 9

• Korea 41

• Malaysia 58

• Philippines 60

• Singapore 77

Higt tech= computers, telecom,electronics Sitc 77

BIS annual report 2001 p.43

Higt tech= computers, telecom,electronics Sitc 77

BIS annual report 2001 p.43

China and WTO – the view from Geneva

There is no doubt that China’s decision to join the WTO is particularly momentous. Opening its markets to foreign trade and investment will make China more prosperous, and commtting China to world trade rules will foster and consolidate market-based reforms. WTO Members stand to gain by better access to an economy of 1.3 billion consumers, which was growing at 8% in 2000. WTO Annual Report 2001

Class Exercise

What has the WTO done for the developing countries?

NEW TRADE ISSUES

Services (GATS) Intellectual property (TRIPS) Environment Direct foreign investment Fair trade and competition Labour standards Bribery and corruption Trade and development in the least developed

countries

FREE TRADE AND UNEMPLOYMENT

Note: If free trade brings the economy from A to P* instead of to P, there will be unemployment. P* is certainly a worse point than P: it could also be wore than A

Wine

Clothing

P

A

T

P*

‘In the past comparative advantage was function of natural-resources endowments and factor proportions (capital-labour ratios). Cotton was grown in the American south because the climate and soil were right. Slavery provided abundant labour. Cotton was spun in New England because it had the capital to harness available waterpower. Each industry has its natural location.Consider what are commonly believed to be the seven key industries of the next few decades – microelectronics, biotechnology, the new materials industries, civilian aviation, telecommunications, robot plus machine tools, and computers plus software. All are brainpower industries. Each could be located anywhere on the face of the globe. Where they will be located depends upon who can organise the brainpower to capture them. In the century ahead comparative advantage will be man-made.’

Lester Thurow, Head to Head: The Coming Economic Battle Among Japan, Europe and America (1992).