When does a country benefit from trade? Many classical and neo-classical economists claim that countries benefit from “free trade.” Two British economists, Adam Smith and David Ricardo, are credited with developing the idea of free trade in its current form. Advocates of free-trade believe that trade is the singular reason why certain well-known civilizations prospered including Egypt, Greece, Rome, Bengal (East India) and China. Many classical liberals from the 19th and 20th centuries actively sponsored the ideology that free trade promoted peace and not just prosperity.
Countries committed to a free trade policy minimize restrictions on imports from, or exports to, other countries. However, most nations today despite being members of the World Trade Organization (WTO) impose protectionist policies (e.g., tariffs, quotas, taxes, and non-tariff barriers including regulation) with the intention of supporting local employment or limiting entry/exit of certain goods and services. The reality is that most countries do not practice free trade in principle.
When is Trade Beneficial
The major industrial nations, which includes the US and the majority of Western European countries, have benefited from trade because they have pioneered innovative products with high profit margins that are valued globally. Because of access to international markets, which are manifold times larger than their local markets, the benefits of trade have been immeasurably larger for the industrial nations. Encouraging the world to commit to free trade when a nation provides goods that are both profitable to produce and desired by others allows producer-nations to amass wealth because exports exceed imports.
There are at least two fundamental differences in the export lead growth adopted by the US and the approach implemented by the Western European countries including Japan.
- Outsourcing domestic production
The US-based producers have outsourced much their production internationally to exploit differential wage rates and lower their production costs which benefits US shareholders. However, in doing so, substantial jobs are lost to international markets which causes short term economic hardships locally. The economic hardships are more resilient unless displaced workers find alternative employment by relocating or investing in human capital through retraining programs. In sharp contrast, in much of western Europe and Japan, the model has been based almost exclusively on domestic production which implies fewer jobs losses to outsourcing.
The US, which founded the new information-based economy, has been the leader in cutting edge innovation by attracting “global talent.” Because of the attraction of high wages and a realistic opportunity to amass wealth in a relatively short period of time, there has been a large influx of legal migration. The economic prosperity has also been a haven for illegal immigration. As migrants offer comparable or better services at lower wages, one notable side effect of immigration (legal and illegal) is job losses for US citizens. Moreover, in an information-based economy, workers without necessary skills may be unable to harness the benefits from innovation which also adds to economic hardships.
In contrast, Western Europe until recently has been immune to migration problems because of stringent immigration policies and from having smaller territorial borders which are easier to patrol and ward off unwanted inflow of migrants. However, this convenient model has been tested lately. The inclusion of eastern European countries into EU increased the inflow of labor migration into the more prosperous western European economies. The political turmoil in middle east also contributed to both legal and illegal migration. The western European countries are also captive to an additional economic dilemma. Because of an attractive social welfare system, their citizens must pay for non-productive immigrants.
Outcome of the Geo-Political Shifts
A key consequence of the socio-economic shocks is a large wage gap and wealth disparity in industrial nations. In democratic countries, if the gains from production and trade are confined to the elite, the majority of the population are expected to vote opposing the status-quo and elect candidates who promise to usher in changes to existing growth models. Some prominent examples include Brexit decision, the US elections, and the shift in the socio-political debates in France, Germany, Netherlands, Denmark, and Italy (Scandinavian countries and Switzerland are relatively immune because they are not party to the EU block or EU monetary system).
As we continue to reap the benefits from trade and free markets, we are also at the vortex of their detrimental side effects. The recent political dialogue is a reminder that to preserve trade and economic co-operation, the gains from trade must accrue to all strata of society. The alternative is a protectionist and isolationist strategy which may generate near term benefits but may be harmful for a producer nation’s long term economic welfare.
December 31, 2016; 12.02Aby