Move Over Free Trade, Protectionism’s Back... Or, Is It

MOVE OVER FREE TRADE, PROTECTIONISM’S BACK... OR, IS IT?

By Andrea Fernandes

Once synonymous with prosperity, free trade today has evolved to be commonly seen as a “utopian evil”, drawing political heat and mounting backlash. Centered on the Theory of Comparative Advantage as advocated by David Ricardo, it was hailed as a philosophical achievement of the 18th and 19th centuries. However, in today’s dynamic world, the comparative advantage is viewed as being highly idealised, prompting nations to reinstall their trade barriers. Thus, if free trade is a ‘necessary evil’, why is protectionism surging again?

Embracing free trade

In theory, free trade policies allow for an efficient allocation of scarce resources, with countries being able to focus on producing products that they are best at. This relates to products which have a lower opportunity cost - essentially a “comparative advantage” that enables specialisation. Hence, promoting increased efficiency, output and employment which, ceteris paribus, should improve living standards and facilitate economic growth.

Free trade rewards risk-taking and process innovation by increasing sales and market share. The opportunity to invest in capital means that businesses may expand and hence, create job opportunities. For instance, the expansion of trade that occurred after the North Atlantic Free Trade Agreement (NAFTA) and then the subsequent establishment of the World Trade Organization (WTO), meant that since 1990, the U.S. economy has grown by almost a quarter and raised the wealth of the average American consumer by more than $5,500 (Froning, 2000).

Protectionism’s tit for tat

However, many opponents of free trade and the NAFTA - including U.S President, Donald Trump (who is leading NAFTA’s replacement with the USMCA), believe that it caused a growing loss of jobs in America’s manufacturing industry. The current U.S administration went on to bolster several protectionist measures ranging from signing into law tariffs of 25% and 10% on steel and aluminium respectively, in March 2018, to effectively creating a trade war with China in 2019 - when around $200 billion worth of Chinese goods were taxed. China retaliated by taxing $60 billion worth of American products (The New York Times, 2019). Their respective manufacturing and agricultural sectors were hit the most, as illustrated in Figure 1, with less trade affected by Chinese tariffs due to its huge bilateral trade surplus with the U.S (UNCTAD, 2019)

Free trade rewards risk-taking and process innovation by increasing sales and market share.

Figure 1. Source: (UNCTAD, 2018)

Figure 2. Trade interventions implemented during 2016-2918 (G20 countries only) Source: Global Trade Alerts (GTA) Database

This distinct rise in protectionism (interlinked with immigration and manufacturing concerns) was reflected elsewhere in the world- through Brexit within Europe, but also in developing countries like India, whose tariffs are now amongst the highest in the world (BBC, 2019). Figure 2 highlights the sheer number of trade distortions that favoured domestic firms instead of foreign rivals over 2 years. Trade dialogue was simultaneously consumed by accusations and retaliations about unfair trade practices, trade-distorting subsidies, and the exploitation of WTO exceptions.

Rising anti-trade sentiment?

Protectionism’s ‘comeback’ is partly due to how nations have grown weary with the fact that many of free trade’s purported advantages have not translated as effectively into the real-world. Adding in free trade’s dubious assumptions, a weakened argument in its favour emerges. Firstly, it is assumed that there are no capital movements which would affect the exchange rate. Globalisation, though, means that capital flows freely from high-wage countries to low-wage countries. Mainly because new investment is utilised to build production facilities that produce products for consumption in high-wage countries.

Secondly, production is assumed to be subject to constant returns to scale and hence, factors of production are moved between industries from less-valuable to morevaluable uses. However, this may not occur, as inflexibility due to geographical and occupational immobility exists within the labour market. Therefore, a change in an economy’s comparative advantage may not reallocate inputs into an industry with lower opportunity costs, but into unemployment. This is usually the case with countries that have rigid employment laws and high minimum wages like Western Europe (Fletcher, 2011). Even if retraining were used within the labour market to reduce friction, there would still be a time lag which could cause the loss of jobs.

Another point of contention is that the potential gains of free trade may not be fairly distributed within an economy and may only benefit a select few. So, while an economy may get bigger, individuals may lose income. Free trade may put downward pressure on wages due to the expansion of the world’s effective supply of labour being faster than the supply of capital. As a result, free trade strengthens the bargaining position of capital relative to labour. Growing capital mobility has exacerbated this process and hence, people whose income relies on returns on capital (the wealthy) gain, while people who rely on income from labour (everyone else) lose.

Salvaging multilateralism

Following this, it is easy to see why some may consider free trade to be evil. However, all economic theories have drawbacks - consequences that must occur and can be mitigated in the future. Despite all the negatives associated with free trade at present, there are undeniable benefits. Nations that enact free trade policies allow for the emergence of a more dynamic economy that fosters opportunity and prosperity amongst businesses and consumers. Developing countries too can break through poverty cycles by allowing for a more export-orientated growth strategy in the short run. Furthermore, as Figure 3 demonstrates, a positive correlation emerges between economic growth and trade which Ortiz-Ospina and Beltekian (2018) underpin as being a causal relationship due to the possible growth-enhancing factors and efficiency gains global integration provides.

The allure of free trade is still visible in the way countries like Japan are undertaking trade negotiations with the UK post-Brexit to protect foreign interests and how Africa is considering a 54-nation continental free-trade zone – the world’s largest aspirational single market (World Economic Forum, 2019). With free trade driving competitiveness, businesses and the workforce are required to adapt to any shift in global demand to maintain their competitive edge, which in turn fuels long term growth and dynamism. In the long run, free trade along with other market mechanisms shift resources to more productive resources – increasing efficiency, wages, and investment in infrastructure, possibly allowing for a better functioning economy.

Figure 3: Source (Ortiz-Ospina and Beltekian, 2018)

Engine of growth

Free trade ushered in a new era of market globalization and innovation, one with its problems. From being viewed as a milestone breakthrough centuries ago to a ‘necessary evil’, the magnitude of its positive impact has now seemingly diminished as nations fight to keep industries and jobs at home. Present strategies mostly revolve around retaliating with protectionist measures. Economics and history, however, will prove again that free trade (or some degree of open trade) is at the heart of kickstarting economic growth and sustained development.

With free trade driving competitiveness, businesses and the workforce are required to adapt to any shift in global demand to maintain their competitive edge, which in turn fuels long term growth and dynamism.

References

BBC. 2019. “Trade Wars, Trump Tariffs and Protectionism Explained.” BBC. Available at: https://www.bbc.co.uk/news/world-43512098

Cloete, Kim. 2019. “Africa’s New Free Trade Area is Promising, Yet Full of Hurdles.” World Economic Forum. Available at: https://www.weforum.org/agenda/2019/09/ africa-just-launched-the-world-s-largest-free-trade-area/

Fletcher, Ian. 2011. “Why the Theory of Comparative Advantage is Wrong.” International Journal of Pluralism and Economics Education 2, no. 4: 421-429. Available at: https://doi.org/10.1504/IJPEE.2011.046029

Froning, Denise. 2000. “The Benefits of Free Trade: A Guide for Policymakers.” The Heritage Foundation. Available at: https://www.heritage.org/trade/report/thebenefits-free-trade-guide-policymakers/#_ftn33 Kwatra, Nikita. 2019. “Protectionism Should Worry India.” LiveMint. Available at: https://www.livemint.com/news/india/rising-protectionism-not-rcep-withdrawalshould-worry-indians-11573540972497.html

Ortiz-Ospina,Esteban and Diana Beltekian. 2018. “Trade and Globalization”. Our World in Data. Available at: https://ourworldindata.org/trade-and-globalization

Sorscher, Stan. 2011. “Free Trade: Flawed Theory and Bad Policy.” HuffPost. Available at: https://www.huffpost.com/entry/free-trade-flawed-theory- _b_682707?guccounter=1

Swanson, Ana and Jeanna Smialek. 2019. “Trump Says Mexico Tariffs Worked, Emboldening Trade Fight with China.” New York Times. Available at: https://www. nytimes.com/2019/06/10/us/politics/trump-mexico-tariffs-china.html

The Economist. 2018. “A Healthy Re-examination of free trade’s benefits and shocks.” The Economist. Available at: https://www.economist.com/openfuture/2018/05/04/a-healthy-re-examination-of-free-trades-benefits-and-shocks

The Economist. 2018. “What is the Future of Free Trade?” The Economist. https:// www.economist.com/open-future/2018/06/27/what-is-the-future-of-free-trade

UNCTAD. 2019. “Key Statistics and Trends in Trade Policy 2018.” United Nations Conference on Trade and Development. Available at: https://unctad.org/en/ PublicationsLibrary/ditctab2019d1_en.pdf