Free-Trade in a Global Economy: Addressing the Concerns of Key Stakeholders
Author: Cole Abugov
Few topics are as divisive in the modern political context as the issue of free-trade. Many see it as a method to achieve prosperity for consumers, corporations and governments. However, during the 2016 presidential election in the United States (“US”), both Democrats and Republicans rallied against the Trans-Pacific Partnership (“TPP”) deal and other arrangements that they viewed as unfavourable to the US. This vocal opposition was also radically represented by the protesters of the G-20 Summit in Seattle in 1999 and Toronto in 2010. Detractors believe that free-trade increases poverty, destroys cultural legacies and takes away domestic jobs. To truly understand the issue of free trade, one must reconcile its effects on multiple key stakeholders.
Background on Free Trade
The argument for the economic strengths provided by free-trade is rooted in David Ricardo’s theory on comparative advantage. His model explains that agents who can produce a good or service at a lower marginal price have a comparative advantage. This relative productivity incentivizes countries to specialize in a particular economic activity. Through increased focus on a more limited scope of goods, an industry will improve productive efficiency, in turn lowering costs. Moreover, it allows countries to access resources that may not be available domestically. Since Ricardo’s magnum opus, political economy has become increasingly globalized. When looking at the economic ramifications of implementing a free-trade agenda, one must balance the short-term adjustment costs (displaced workers and obsolete industries) and long-term productivity gains (for consumers, governments and businesses) leading to rising real GDP.
A notable case of developed countries entering into a mutually beneficial free trade agreement (“FTA”) is the agreement between Canada and the United States, which was implemented in 1989 and later morphed into the North American Free Trade Agreement in 1994. According to Daniel Trelfer, both American and Canada benefited in economic terms thanks to the creation of a FTA. Real GDP in both countries grew sustainably starting in 1992 until the 2008 recession, where most world markets declined. Reduced tariffs allowed businesses and consumers to engage in cross border transactions, which increased private consumption (consumption) and business capital expenditures (investments). Perhaps as a function of increased capital expenditures by businesses, labour productivity grew by a compounded annual rate of 2.1% from 1989-1996 due to rising technical efficiency. There was, however, reduced employment in certain manufacturing sectors due to the ease of moving jobs across borders, but any negative impacts were largely recovered by 1996. Consumers on the whole benefited from free trade, as James Langefeld and Jim Nieberding estimate that US households gained about $2,500 in increased income since the implementation of NAFTA.
While free trade had economic benefits for both Canada and the United States as developed countries, free trade can have an even greater impact on developing countries. South Korea (“Korea”) is perhaps the best example of a country that embraced trade to become a leading economic force. The country, which was historically an agrarian economy and had a GDP per capita of US$155 in 1960, embraced market-oriented reforms and specifically an export-oriented trade strategy in the 1960s. Through trade liberalization, Korea began focusing on sectors of the economy that could offer goods and services other nations needed. This was done through coordination between the government and the private sector, as they both invested in industries that had potential to service the international market and create a comparative advantage for Korea. Richard Doner argues that the public-private relationship benefited businesses while also improving other institutions such as education and infrastructure that encouraged economic productivity rather than government wastefulness. By embracing free-trade ideals, Korea moved from a developing country to a developed country, and now has a GDP per capita of US$27,222, which is above the GDP per capital of Spain and only slightly lower than that of Italy’s GDP per capita.
With that being said, free trade is not always a boon for developing nations. As discussed by economist Ha-Shoon Chen, developing economies that enter into FTAs with developed nations are often put in subordinate positions that result in developed nations using them for their own unilateral economic gain. A fair analysis would involve looking at the outcome if those developing nations who adopted free-trade agendas maintained autarkic (non-trade) policies. Unfortunately, any conclusion that one could make would be highly speculative. Looking at empirical evidence, emerging economies now constitute half of the world’s GDP and account for a growing share of foreign direct investment. There is a clear signal that, by the growth in GDP per capita, there has been an increase in jobs for workers and more funding for businesses in developing countries as a result of free trade. It is the role of the government to realize that investing additional income, earned from the increase in GDP, in key resources like education and infrastructure will help to raise worker productivity, morale and create a workforce that enhances firm innovation.
Although there are clear economic benefits, the act of proposing and enacting free-trade legislation is not without its obstacles. Mainly, politicians from both developing and developed countries must expend a great deal of political capital to pass any legislation. To look at the political ramifications for a developed economy attempting to engage free-trade, Barni Ito investigated the relation between the embracement of protectionism by candidates in the 2012 Japanese election. His findings show that candidates facing close elections favor protectionist trade policies. This can be explained by the role of short- and long-term costs and benefits of trade. In the short-term, free trade can result in job loss as countries adjust to global competition. In the long-term, these job losses tend to be resolved. Politicians, however, have frequent elections and are often only in office for a short period of time, so they only see the short-term costs of free trade rather than the long-term gains. Therefore, in the Japanese example, politicians may be opposed to trade liberalization because in the short-term their constituents will lose jobs and that will result in a loss of votes. However, politicians realize that there are long-term gains, so when in office they may change their position. This gives rise to potential democratic consequences, as a politician’s disregard for the mandate he or she was elected to creates mistrust between voters and their representative. Politicians must therefore work to become more transparent regarding the benefits of trade liberalization in order to fairly represent their constituents and implement positive change.
Another political consideration is the geopolitical implications of engaging in a FTA. Geopolitical considerations often arise from an imbalance of power between developed and developing economies. Developed nations often have the upper hand in FTAs with developing nations, though part of the rationale behind this is for political oversight rather than economic subordination. An instance of a government vying for geopolitical influence in a proposed FTA is the Trans-Pacific Partnership (“TTP”). The TTP deal would eliminate trade barriers for a number of East Asian countries to trade principally with the US, with the goal of lessening China’s influence in the region. With the TPP’s negotiations having been strongly influenced by the US, countries that adhere to it must follow American notions regarding trade, intellectual property, and other provisions. This has the effect of eroding national cultural and legal traditions in some non-Western signatories to the TPP, while further limiting domestic sovereignty and the ability of politicians to represent their own interests or the interests of their electorate.
The most poignant criticisms of trade liberalization relate to the labour impact that it causes. For a developed nation, the most impacted demographic are those employed in industries that other countries specialize in. As outlined above, specialization derives from a nation being able to produce a good or service at a lower marginal price. Therefore, individuals employed in jobs that could be performed by labourers in another geography at a cheaper price are at risk of losing their jobs to foreign markets. The movement of capital to find the lowest-priced labour is a significant shift from historic practices as labour markets were traditionally isolated from intense competition, which gave rise to unions and the large amount of influence held by organized labour. Today, union subscriptions at their lowest since the 1930s and organized labour has much less bargaining power as the threat of jobs being shifted abroad is much greater.
In 2016, there was a backlash against free trade as seen with the United Kingdom’s decision to leave the European Union (one of the largest free-trade zones in the world) and Donald Trump’s election as American President following a campaign founded on anti-trade sentiment. While other factors contributed to these events, a backlash against free trade was an element. Many people felt that free trade had led to the destruction of millions of well-paying jobs, many of which have never been replaced. While it is true that many jobs were destroyed, many others were added. Since NAFTA was signed in the US, for example, 31 million payroll jobs have been added. Many of these jobs, however, had not gone to the same people that lost their jobs to globalization. The people impacted by free trade have been vocal, and Mr. Trump and the Brexiters helped give them a voice. Free trade comes with consequences; some people will lose their jobs. But the benefits outweigh the detriments—the economy as a whole will benefit, and reverting to protectionism would be even more destructive and have an even greater negative impact than the introduction of free trade had. While governments could arguably do more to help people impacted by free trade, protectionism and isolation as sought by the United Kingdom and the US are not the answer.
Environmental & Cultural Impacts
In the developing world, there can be strong environmental and cultural disincentives for adopting FTAs for the common citizen. The negative ramifications of trade liberalization broadly affecting the population can be neatly identified in the experience of Bangladesh. Environmentally, the “Green Revolution” dramatically increased the amount of crops the nation-state could produce, which increased GDP. Yet the citizenry was horribly affected by pesticide laden water or herbicides that destroyed vegetables that had provided nutrition in the region for centuries. The government is benefiting from GDP growth that poorly affects the health of people living on arable land. There is also a cultural conflict with modern business practices in Bangladesh. One of the benefits of free-trade is that there is a flow of knowledge as well as capital resources into a developing country. However, in the case of Bangladesh, business expertise does not always lead to equitable solutions for the developing country. Bill McKibben alludes to companies and governments using formulaic solutions to solve business and infrastructural issues without cooperating with local populations. This policy is problematic and disempowering for two reasons. Firstly, if companies or governments directly engaged with local populations, any proposition would garner greater acceptance because it would respect the input of local people. Secondly, there are functional benefits to understanding the historical methods used by the local populations. Richard Manning notes that only now are Western researchers starting to focus more intensely on traditional practices. Techniques developed by local people can be used to find innovative solutions to business problems. Often hubris on the part of businesses and governments in developed countries gets in the way of collaboration. In the case of Bangladesh, environmental issues and a sense of cultural superiority, leading to poor business and social outcomes, negatively affect the average citizen.
Free Trade as a Method of Poverty Reduction
Lastly, the most ardent criticism of trade liberalization is that it does not reduce poverty. Unfortuantely, there is no academic consensus on this topic; however, the undisputed belief held by international financial institutions that free-trade always eliminates poverty is unjustified. One can conclude that there may not be a systematic relationship between an increase in trade volume and poverty reduction. Nonetheless, the fact remains that trade liberalization has been a very efficient way to grow GDP and generally increase the wealth of average citizens. In developing nations, free trade is perhaps more beneficial than it is to developed nations. By the 1990s, developing countries that adopted free-trade grew by 5% compounded annually compared to 2.2% for developed nations. With increased income, these nations have the ability to invest in infrastructure and social programs to reduce poverty. Granted, if the governments that adopt free-trade are not representative democracies the wealth brought by free trade may not be equitably allocated. Although irresponsible governments may act against the interest of citizens, it is also unfair to say that trade liberalization and poverty reduction are negatively correlated.
It is clear that by most indications trade liberalization is advantageous economically to governments, corporations and average citizens. Politically, leaders must find a way to ethically navigate changing public sentiments and geopolitical jockeying of dominant powers. Socially, unionized labour and the working poor are feeling the burden of structural changes to the economy. By addressing the interests of stakeholders who are negatively affected by trade liberalization, governments around the world can begin improve policy outcomes for all stakeholders.
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