The foibles and follies of freetrading fanciers, or how and why economists get overexcited about free trade: Part three

When first drafting I’d intended this to be a one part post. But by the time the first post went up it had became a two part post. But when I got to writing up part two I continued and extended the discussion with Damien Eldridge which had begun in part one. Now it’s time to move on to meet the challenge I threw out at the end of part one – which was this:

“In our next exciting episode we show how the same thing has happened in the area of trade negotiation. Youll laugh, youll cry. And youll find out why this sentence taken from an old Australian Financial Review in the 1990s is bollocks.

NAFTA is second best. It is trade liberalisation, but it is discriminatory liberalisation. . . . First best would have been a better GATT.”

So here goes.

In economists’ discussion of trade liberalisation, unilateral trade liberalisation has generally occupied the ‘high ground’ with trade negotiation between countries being correspondingly deprecated as either wholly inexplicable or at least paradoxical from an economic point of view. From an orthodox economic perspective it is hard to understand why countries negotiate to open their markets to each other because they are trading ‘concessions’ which are unilaterally beneficial in their own right.

And when it comes to trade negotiation, multilateralism has occupied the high ground against regionalism and bi-lateralism.[1] There may be ‘practical’ wisdom in these rankings – related to the domestic and international political tendencies of different approaches to liberalisation – but it is hard to justify them within economic theory.

Putting aside the usual imperfections in competition, two effects should be taken into account in trade negotiation – a country’s access to imports and the access its exporters enjoy in foreign markets. Other things being equal, unilateral trade liberalisation offers the best possible result with regard to the first of these objectives, and nothing with respect to the second.

Both regional and multilateral trade negotiation may compromise the first of these objectives because paradoxically, in ‘trading concessions’ countries surrender to some extent their freedom to act unilaterally. (If other countries know a country will embrace its own interests unilaterally and remove its trade barriers in any event, this cannot be described as ‘negotiation’).

On the other hand, a country participating in regional and multilateral trade negotiations can often have some effect on its own access to foreign markets. The net result of these two effects in any scenario is an empirical question. It can’t be established ‘in-principle’. Yet these approaches to trade negotiation are not neutral in their appeal or lack thereof to the mercantilist intuition. For the gains from traditional unilateral trade liberalisation emerge only after the contraction of protected industries. These are the gains which are all but invisible to the lay public and which economists are trained to see. By contrast, the expansionary first round effects attending improved access to foreign markets are not only easily accessible to commonsense mercantilism, but highly influential in motivating it.

The economics profession appears to have given considerably more attention to the effects which justify the form of trade liberalisation which seems most perverse to those untrained in economics. And correspondingly less attention to the effects which justify trade negotiation.

The benefits of access to foreign markets were recognised in various ways in the literature – such as Harry Johnson’s exploration of trade wars using offer curves. Yet despite this, since the 1960s, it has been argued by many economists – including Johnson! – that the only economic motive for a country to engage in trade negotiation is to provide the domestic political circumstances to enable it to reduce its own trade barriers.

As Ronald Wonnacott observed in the early 1990s, despite occasional recognition of the importance of foreign tariffs “it is surprising how much life remains in the contrary 1960s-1970s view of free trade as being almost synonymous with unilateral elimination of [one’s] own tariff” with reductions in foreign tariffs seldom in view. Thus in standard textbook treatments of trade liberalisation, for instance, there is much on the elimination of the triangular deadweight losses associated with tariffs on the import side but little if anything on the elimination of the analogous deadweight losses accruing to the domestic (exporting) country where its trading partners liberalise.[2]

As Wonnacott explains, this lacuna existed not just within economic pedagogy but even at the level of empirical estimation:

Thus those working in trade became split between those like Harris and Whalley who, in the course of their empirical estimation of issues such as the cost to developing countries of the multi-fibre agreement, recognised the importance of foreign trade barriers, and those who were silent on this issue. While most in the silent group were not working on empirical estimation, there were some in this group who were, such as those who were evaluating the various effects on a country of joining an economic union and were taking into account the cost of trade diversion on the import side but not the benefit of preferences acquired on the export side (Wonnacott, 1993: 18-20).[3]

In apparent exasperation, Wonnacott asks rhetorically “How did this happen?” without providing a satisfying answer. Whether or not it provides a complete explanation, the facts certainly square with the hypothesis that there is a particular psychic payoff for economists in registering and signaling their rejection of the naïve mercantilism of what David Henderson has called the economics of everyman.

References

El-Agraa, A. M., 1985. “International Economic Integration”, in Greenaway, D. (ed), 1985. Current Issues in International Trade: Theory and Policy, Macmillan, London, pp. 183-206.

Wonnacott, R. J., 1993. “Trade Liberalisation: Canadian Contributions since the 1960s”, The Canadian Journal of Economics, 26, pp. 14-25.



 

[1] The preference for multilateralism is expressed in the following passage from the Australian daily press. “NAFTA is second best. It is trade liberalisation, but it is discriminatory liberalisation. . . . First best would have been a better GATT”. For an example from academia, see eg El-Agraa who claims that “the evaluation of any regional scheme of economic integration should incorporate a consideration of the validity of the view that . . . constraints do exist to justify the pursuit of second-best rather than first best solutions”. Both statements imply that the alternative to regional free trade is global free trade – the only thing which will remove the situation from the world of the second best. The relevant question is, “Given that global free trade is not on offer, is greater liberalisation offered by regional or multilateral approaches?”

 

[2] Wonnacott goes on:

This is particularly surprising, since other things being equal, a country might expect to gain more from a reduction of a partner’s tariffs on its own exports than from reducing its own tariff on its imports, because 1) the former involves a terms of trade gain while the latter involves a loss (with both generating efficiency gains) 2) in bilateral or plurilateral reciprocity in which preferences are created there is a special cost of own tariff elimination in the form of trade diversion, whereas there is a special benefit from partner’s tariff elimination in the form of preferential treatments received in [the] partner’s market.

(Wonnacott, 1993: 18-20)

 

[3] Wonnacott goes on to outline a similar intellectual phenomenon with regard to the ‘unilateral tariff reduction’ (UTR) theorem which demonstrated the superiority of UTR over the formation of a customs union by assuming away the very thing which a customs union can provide which UTR cannot – terms of trade gains. And see footnote 2 on p. 20 where Wonnacott details a similar ‘double standard’ in favour of the consideration of the import side advantages of UTR and, in analogous circumstances, against the consideration of the terms of trade benefits offered by foreign tariff reductions.

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