Liberating trade – Economics focus

MERCANTILISM has been defunct as an economic theory for at least 200 years, but many practical men in authority remain slaves to the notion that exports must be promoted and imports deterred. Over 40% of the European Union’s budget is dedicated to defying Ricardo’s theory of comparative advantage, subsidising picturesque farms in Burgundy at the expense of efficient farms elsewhere. Tariffs of 500% on rice imports indulge Japan’s nostalgia for its lost agricultural past. And protectionists do not stop at subsidies and tariffs. To repel imports of Vietnamese catfish, American legislators were prepared to rewrite the laws of marine biology, the New York Times reported. Only the American variety could henceforth count as “catfish”, they ruled.

Because of such protectionist follies, many potential gains from trade pass unrealised. In a new paper for the Copenhagen Consensus project*, Kym Anderson of the University of Adelaide attempts to count the costs of the barriers that block international trade and the subsidies that distort it.

Subsidies are a naked transfer from taxpayers to corporate mendicants; they are also an indirect transfer to overseas consumers, who enjoy artificially depressed prices as a result of the handouts. Tariffs on the other hand raise money for the treasury’s coffers at the expense of foreign exporters and home consumers, who face higher prices as a result of the restriction on trade. Do the gains to one group offset the losses to another? Emphatically not. Tariffs and subsidies drive a wedge between demand and supply, imposing “deadweight” costs on an economy. Tariffs discourage worthwhile production (of goods that would cost less to make than consumers are willing to pay), while subsidies encourage worthless overproduction (of goods that would cost more to make, sans the subsidy, than consumers are prepared to pay).

Eliminating such distortions would allow prices to resume their proper job of equating supply and demand. As a result, capital and labour would be reallocated across industries to reflect a country’s comparative advantage. The gains to the world economy would be sizeable: $254 billion per year (in 1995 dollars), according to a recent paper by Mr Anderson and his colleagues.

The bulk of the gains come from agriculture, which also carries the heaviest distortions. If the rich countries stopped intervening on behalf of farmers, the global economy would gain by $122 billion—and the rich world would benefit most of all, collecting $110 billion of those gains. Poorer countries, on the other hand, stand to gain the most, $65 billion, from liberalising their own trade regimes, not waiting for rich countries to free theirs. Indeed, some analysts fear that a repeal of agricultural handouts in the rich world could actually hurt the 80 or more poor countries that are net agricultural importers. Their terms of trade would deteriorate if the removal of subsidies raised the world price of agricultural goods. Mr Anderson, however, points out that poor households, if not poor countries, tend to be net sellers of food.

The economic case for seizing these gains is compelling; the political logic less so. The benefits of trade liberalisation are spread widely but thinly; the benefits of protectionism, on the other hand, fall heavily on small groups, such as Mississippi catfish farmers, prepared to lobby hard to retain their privileges. The World Trade Organisation (WTO) acts as a counterweight to such lobbying, and seeks to harness mercantilist tendencies for free-trade ends. In WTO talks, countries negotiate for better access to overseas markets in return for letting imports move more freely past their own borders.

Unfortunately, the current round of trade talks at the WTO has stalled. What does the world stand to gain by reviving it? Estimates vary widely. An ambitious round that halved the legal limits for subsidies and tariffs might yield $188 billion per year, according to one estimate, provided some economies of scale remain to be exploited and some industry rents remain to be squeezed. But other calculations come out considerably higher. If the round sparked a thriving trade in services and a boom in foreign direct investment, the gains could be as great as $1 trillion, according to one model. Without standing on statistical ceremony, Mr Anderson simply splits the difference between these two estimates.

The handmaiden of growth

Free trade, Ricardo showed, ensures that an economy makes best use of its resources, deploying labour to its best advantage. But open markets might also unleash the forces of accumulation and innovation, adding to and augmenting those resources. Trade, in other words, may raise an economy’s rate of growth as well as boosting its level of income. According to Ricardo’s intellectual predecessor, Adam Smith, foreign trade liberates an economy from the “narrowness” of the domestic market, opening it up to the broader opportunities of world commerce. This encourages any branch of art or manufacture to “improve its productive powers, and to augment its annual produce to the utmost”. Latterday economists have elaborated on this argument, and many have sought to demonstrate it empirically, with mixed success. Mr Anderson draws on such studies to make an educated guess about the impact of trade liberalisation on growth. Cutting trade barriers by half could raise the rate of growth by a third in developing countries and one-sixth in richer countries, he reckons.

Such bold assumptions raise the benefits of trade liberalisation by several orders of magnitude. They could scarcely do otherwise: even small increases in the rate of growth, compounded over many years, make a huge difference to the size of the economy. This quicker growth, compounded over 50 years, combined with the static efficiency gains from trade, adds more than $23 trillion to the present value of the world economy. Of this total, poor countries would reap $11.5 trillion. These totals do not translate directly into gains in welfare: not all of the added output will be consumed if some is devoted to higher rates of investment inspired by open markets. And adjusting to a more liberal trade regime will not go as smoothly as many models, with their perfectly flexible labour markets, assume. But even if the transition period is protracted and painful, lasting five years and costing $243 billion per year, the ratio of global benefits to costs would exceed 20.

For policymakers keen to make the most of the world’s scarce resources, an investment in the ideas of Ricardo and Smith yields rich returns.

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