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Trade Liberalisation: Can Restriction and Protectionism ever be a sound policy (Part 1)

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Guest post by Sumantra Maitra

Trade liberalization or free trade is a highly contested subject, especially in the current global financial scenario and ongoing economic recession and slowdown, which draws feverish support and equally violent condemnation. Whether trade liberalization hurts the poor or not is itself a matter of great debate and difference of opinion, one that can be seen in the recent latest move to allow Foreign Direct Investment (hereinafter FDI) by the Indian Government, and the varied reactions from both sides of the spectrum.  There are arguments that Trade liberalization helps in growth and growth ultimately helps in lowering poverty, but on the other hand the uniformity of the benefits of globalisaion and trade liberalization is questioned. Arguments against trade liberalization claim that it can cost jobs and even lives, due to cheaper goods not facing the stringent checks at the market, or due to the loss of livelihood due to competition.  Proponents and supporters, claim trade liberalization ultimately lowers consumer costs, fosters economic growth while maximizing efficiency.  In this essay an effort is made to point down the basic aspects of trade liberalization and free and open market, how they benefit, and how they hurt poor, if at all, and when.

Trade Liberalization: The Arguments

Trade liberalization or openness can be defined as “ The openness of an economy is the degree to which nationals and foreigners can transact without artificial (that is governmental imposed) costs (including delays and uncertainty) that are not imposed on transactions among domestic citizens. “  So, in other words, it is free exchange of goods between nations, and removal or reduction of restrictions and barriers in the borders and policies, and includes dismantling of tariff (duties and surcharges) and non-tariff obstacles (like licensing rules, quotas and other requirements). Trade liberalization can provide a massive shock to the economy, and one of the immediate micro effects would be a decrease in prices of imported goods, and a possible increase in the prices of the exports. Thus it would generally help in the overall standard of living for the poor people, as they would have saved income even after spending on consumerism. Also, low prices and greater competition keeps the domestic goods price low, and benefits the consumer. The increase in capital goods flow and competition influence the employment and wages. The benefits can be seen with a Stolper-Samuelson theorem, which states that a relative increase in the price of commodity will increase the real return to the factor used intensively in that industry. In a developing country, trade liberalization helps increase in relative prices of labour intensive products, and relative wages, demand for unskilled labour and employment. Stolper-Samuelson theorem is however based on perfect labour mobility, and zero policy distortion, which is not true in every developing country. Country studies as diverse as ranging from India to Poland, shows that labour mobility is also not similar or uniform, at times hardly mobile.

Competition is also a very important factor when it comes to trade liberalization and its effect on the poor. There is an argument that opening of the economy, benefits workers by making it possible to export more goods, at a higher price, which will in turn lead to higher profits and incomes, and better standard of living for the poor. But on the other hand there is also an argument, that if such sectors, which were protected by trade liberalizations, if they were opened up, it might hurt the poor badly, as a lot of domestic firms will die away in front of competition from firms from outside. Generally it is seen that in developing countries, the sectors which are traditionally protected, like manufacturing, textiles or fast food and drinks, suffer massively as they cannot compete with multinational brands. With loss of Government protection, like stoppage of subsidies, firms become uncompetitive, and shut down, thus in “short run” there might be massive unemployment and increase in poverty.

However, efficiency and competition in the long run increases productivity. And higher productivity increases the growth rate of an economy. Global Poverty Report of 2001 states that trade liberalization can be beneficial in the long term, as it helps in making investment more efficient, allows FDI, which in turn increases the participation of newer technologies, and more productivity. Overall productivity also increases overall growth, and FDI and foreign investment increases employment and business opportunities in different sectors, which balances the employment loss resulting from the removal of protectionism. The liberalization of Indian centralized and command economy during the early nineties led to quite a few public sector job losses, but subsequently with the opening and free competition and influx of Multi National Companies, the service industries notably IT and Telecom and Pharmaceuticals, led to massive employment and growth compensating for the earlier shock.

Open Trade and Poverty

If we exclude sub-Saharan Africa and parts of Eastern Europe, extreme poverty rates are lower today than they were 20 years ago, percentage of world population living under extreme poverty has fallen from 30 percent to 17 percent in the last two decades.   Two important and interesting examples of the benefits of trade liberalization are that of China and India.  China from 1980 to 1992, immediately after their liberalization per capita income grew by 3.6 percent per annum, Even though GINI coefficient increased from .32 to .38, which is a massive increase in inequality by international standards, the actual number of poor fell by around 250 million. In India, in two stages of liberalization, around 1991 and 1996, poverty fell “dramatically” from 35 percent in 1987/88 to 29 percent in 1993/94 and to 23 percent in 1999/2000.

Often it is seen that Trade liberalization is not enough for the economy to grow. A lot of African countries liberalized their economy, during or around the same time when China, Indonesia and India opened their market, starting from the early eighties to early nineties. But the African countries didn’t experience the same benefits. Similarly all the Eastern European formerly communist countries liberalized their highly centralized economy during the same period, but their growth pattern was not the same, it was highly uneven. One of the reasons for that maybe that trade liberalization only helps create opportunities but to sustain them massive structural and institutional reforms are needed along with. For example, infrastructure, education, technological know how, appropriate exchange rates are needed alongside trade reforms, to make the benefits from the reforms more sustainable. For example, Poland, or any East European country benefited hugely from trade liberalization, as although they were communist before, they had the base for good industrial investment, like roads and hospitals. Countries from Sub Saharan Africa like Zambia for example, lacked in these regards.

An effect which is more or less regarded to be backed by solid empirical evidence is that countries see a decline in poverty, regardless of their position in world trade. The inequality gap may rise, but there is overall a decline of poverty. Examples as diverse as Zambia, Poland and Colombia, with completely different socio-economic background, prove that Globalization and trade liberalization basically helped in the lowering of poverty. “The study on Zambia suggests that poor consumers gain from falling prices for the goods they buy, while poor producers in exporting sectors benefit from trade reform through higher prices for their goods. In Colombia, increasing export activity has been associated with an increase in compliance with labor legislation and a fall in poverty. In Poland, unskilled workers – who are the most likely to be poor – have gained from Poland’s accession to the European Union. “  Harrison/McMillan claims in their analysis. It doesn’t mean that the prosperity came from the same working solutions though. For example in the case of Poland, it was due to easy labor mobility across Europe, whereas in the case of Zambia and Colombia, it was due to competition and exports. Also, notably it is a common factor that poor countries would grow faster than comparatively rich countries, if they are well integrated and they have proper functioning institutions. There can be over time, absolute convergence, the literature on growth theorizes. Foreign investment has different effects on different countries though, depending their macroeconomic stabilization policies, and exchange rate flexibility. Factors like infrastructure can be the determining factor behind the success or failure of trade liberalization in a country. Also massive internal market can neutralize the shock of trade liberalization, like India, Indonesia and China could absorb the shocks comparatively better than Colombia or Argentina, being domestic consumption driven economy, being dependent on domestic markets more than less export sector performance.

There is ample evidence that Globalization and trade liberalization produces both winners and losers, but it is highly difficult to corroborate them into a solid hypothesis, as the data colection is extremely difficult and varied. Even in a single region, two different outcomes can be found for two different factors, depending on their two completely varied approaches to trade liberalization. “The heterogeneity in outcomes associated with poverty– globalization linkages is one theme that emerges from a number of the different country case studies. “  as per Harrison/McMillan. Also, different measures and degrees and approaches to trade liberalization can have different results. The difference of data, the difference of statistics, and the generalization of different approaches can give highly unsatisfactory answers to the impact of trade liberalizations, but according to Berg/Krueger some common factors can be derived, as increase in competition leading to lower prices and better quality of goods, leading to general betterment of poor consumers. Also, trade liberalization helps poor farmers, as generally in the developing countries, a major percentage among the poor are engaged in small scale agriculture.

(This is part 1 of a two part post. Part 2 will be posted shortly.)

(Sumantra Maitra is a freelance journalist, currently a post grad scholar of International Studies, and a tutor of New Zealand Foreign Policy and Theories of International Relations, at the University of Otago, New Zealand. He would like to thank Prof. Robert Patman, Politics Dept. University of Otago, and Prof. David Fielding, Economics Dept. University of Otago, for their support and guidance.)

India-US Relations Blog

Retail Reverberations

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India’s retreat on economic liberalization has broad consequences for the country’s international standing and for U.S.-India relations specifically

Just when it looked like Prime Minister Manmohan Singh would make something out of his second term, he beat an ignominious retreat on opening up India’s huge retail sector to foreign companies. The stunning turnabout — actually more of a debacle –has a number of significant implications for the domestic economic and political landscapes. In particular, it confirms what many have increasingly suspected: Regardless of whether he manages to hang on through the Uttar Pradesh state elections early next year or miraculously serves out his allotted term, Singh is very much a lame duck presiding over a government that is hopelessly adrift and ineffectual. He and his long-time Cabinet associates, once lauded as the “economic dream team,” have proven themselves incapable of making the bold decisions many believe are crucial for India’s future.

The capitulation also has far-reaching consequences for the country’s international standing and for U.S.-India relations specifically. The retail liberalization was hailed as a landmark economic reform, evidence that New Delhi had finally overcome the chronic leadership paralysis and policy contradictions that have made foreign investors wary. This leeriness is the reason India is perpetually unable to lure in the levels of global capital that have fuelled China’s stratospheric economic ascent. It accounts for the marked withdrawal of foreign investment that has caused the rupee’s rapid depreciation in recent months. And it explains why the business community felt it necessary to launch a “Credible India” marketing campaign to address India’s image problem. Yet the retail retreat will only solidify international skepticism.  After the rescindment, the chairman of Microsoft India announced that the country could no longer even be regarded as a magnet for technology investment.

The backtracking similarly reinforces the growing perception that India is the Godot of great powers – its arrival in the top tier of countries is much heralded but never quite happens. The country’s elites speak assuredly of the coming “Indian Century” and yet are haunted by the shadow of the long-defunct East India Company, a corporate entity that is in any case now owned by an Indian entrepreneur. The contrast with China is instructive. Even with its own history of foreign exploitation, Beijing was confident enough about its strengths to allow Walmart, Ikea and other foreign retail enterprises to set up shop more than 15 years ago.

India possesses a multitude of latent resources necessary for national greatness but is conspicuously bereft of strong political institutions capable of mobilizing them in a purposive direction. This absence habitually condemns India to punching far beneath its strategic weight. A few days ago, Jim O’Neill, the progenitor of the now ubiquitous BRICs saga, pronounced India the “most disappointing” member of the quartet and ranked it on par with Russia in terms of governance and corruption. And Jyoti Thottam, Time magazine’s South Asia bureau chief, warns that the reversal “may be remembered as an inflection point in the ‘rising India’ story, a moment when skepticism about India’s future finally started to overshadow optimism.”

The episode will also have repercussions for relations with the United States. It will ensure that bilateral commercial ties remain far below their potential and that U.S.-India trade levels continue to be eclipsed by U.S.-China economic interactions. This is most unfortunate since, as Raymond E. Vickery, Jr. points out in his new book, The Eagle and the Elephant, private-sector linkages are a key driver of the overall U.S.-India relationship.

Many have proposed that Washington launch negotiations on a free trade agreement with New Delhi, while others criticize the Obama administration for dragging its feet on crafting a bilateral investment accord. But the logic of these measures is now in severe doubt. Given the obvious inability of Indian leaders to make the bold decisions that would be necessary, there is no reason why a beleaguered U.S. president would spend precious political capital on ventures that promise so little chance of success.

On the geopolitical level, Singh’s retreat further undermines the seriousness with which Washington views with the current Indian government. From the political soap opera that accompanied the parliamentary debate over the nuclear cooperation agreement three years ago to last year’s nuclear liability law that effectively locks out U.S. involvement in the nuclear energy sector, and from this spring’s rejection of American entrants in the lucrative fighter aircraft competition to this week’s retail rollback, doubts have been steadily rising about New Delhi’s capacity for strategic engagement. It is little wonder why, six months after Ambassador Timothy Roemer departed New Delhi, the Obama administration has yet to bother nominating a successor.

A chorus of critics accuses Washington of being derelict in relations with India. In a just-published article, for example, the Wall Street Journal’s Mary Kissel rebukes the administration for “neglecting” and “ignoring” New Delhi. She’s right that the Team Obama was too slow in distilling rhetorical professions about “indispensable partnership” into meaningful policy initiatives. But even if the administration had been more pro-active and creative, would it have made much of a difference? Sadly, the record of the past few years indicates that leadership dysfunctions in New Delhi would have precluded any sort of serious response.

Ever since President Obama’s inauguration, Indians have vocally complained that he has forsaken them in favor of the Chinese. The grievance has some justice, though many in New Delhi are oblivious to how they too bear some of the blame (see here and here). They would be wise, however, to heed the warning just issued by Ashley J. Tellis, one of the architects of the Bush administration’s strategic entente with New Delhi. In the coming years, he cautions, Washington may become “hard-pressed to justify preferential involvement with India at a time when U.S. relations with China – however problematic they might be on many counts – are turning out to be deeper, more encompassing, and, at least where the production of wealth is concerned, more fruitful.”