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The World according to Economics. Part1: Free Trade

July 21st, 2008 · 1 Comment

We are interested in the space where politics and economics meet (as former students of both disciplines). Often, politics gets in the way of economics, even in the economically most advanced nations…

There was a nice piece from Greg Mankiw, celebrated author of economic textbooks on a platform a majority of economist would agree upon.

It has eight points:

  1. Support free trade
  2. Abolish farm subsidies
  3. Leave oil companies and speculators alone
  4. Tax the use of energy
  5. Raise the retirement age
  6. Invite more skilled immigrants
  7. Liberalize drug policy
  8. Raise funds for economic research.

This is an interesting list. Is it realizable? Well, some economics can also shed light on why it is so hard to get progress on.. We will kick off by discussing the first point.

Free trade.

Indeed, the great majority of economist support it. Apart from the fact that they are trained to do so, there are good reasons for supporting this. On the most basic level, trade allows specialization, and specialization allows increased productivity, the source of economic progress.

There is no a-priori reason to assume that these beneficial facts of trade and specialization should be limited within national borders (and in a next episode we will look into that a little more).

Although it seems that belief in free trade is universally held amongst economist, there are, in fact, some dissidents. A well known one is the Cambridge economist Ha-Joon Chang, who’s book, “Bad Samaritans, the myth of free trade” is causing something of a stir.

In very short summary, what he argues is

  • The rich countries didn’t get rich because of free trade, but because of strategic use of protectionism
  • Demanding (via IMF, GATT, later WTO negotiations) that developing countries dismantle their tariffs will keep them poor.

This is by no means the place to settle these issues (libraries have been filled on the topic, if we would settle these issues we could be in line for a Nobel prize fourty years from now or so), but just a few remarks:

  • There is a good deal to be said for the first point. Indeed, free-trade has been relatively rare in history, and the overwhelming majority of what are now the most economically advanced nations used some form of trade policy, even in Britain which was the country most wedded to the free trade doctrine in the second half of the 19th century.
  • However, Chang is less convincing in arguing that economic development would not have proceeded at a similar (or even faster!) pace if these countries would have practised what they preach today. This is, of course, impossible to answer
  • On the second point, there also seems to be a good deal of empirical evidence, like the fact that the developing countries used to grow at almost double the rate in the “bad old days” of protectionism in the 1960s and ’70s, compared to the next two decades of trade liberalization
  • As impressive as that statistic might sound, it’s by no means solid proof though. There was a whole lot going wrong in the 1980s, like the debt crisis and high inflation in numerous countries. In the 1950s and 60s, there was also something of a battle going on between export oriented countries (like the ‘tigers’ in South East Asia, like Taiwan, Hong-Kong, Singapore and South Korea) and other countries (mostly in South America) that pursued an ‘import-substitution’ policy, trying to grow domestic industry by keeping imports out. That battle is generally considered to have been ‘won’ by those export oriented Asian economies. Also, there are World Bank studies that show that openness of the economy is positively correlated with economic growth.

A little political economy show why those seeking protection usually enjoy advantages of those who would lose out from such policies. Say Detroit lobbies Washington to make it more difficult to import foreign cars, the results of such policies would be beneficial for US car manufacturers, but detrimental for consumers.

Using relatively simple economics, it can be shown that the loss to consumers normally outweighs the gains for producers. However, even though there is a net loss to society, situations like this are pretty common, because:

  • Those who benefit are few so they face bigger incentives and it’s easier to organize and lobby
  • Those who loose are many, making it more difficult to organize and the loss will be spread out more, so less noticed (if at all, ask the average European or American if he or she realizes how much extra he’s paying for his food as a result of market protection and few will be aware of that).

Tags: The World according to Economics

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