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Free Trade or Trade Management: Lessons from the failure of WTO

By: Dr.Dipak Basu
Aug-12-2008
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(The author is a Professor in International Economics in Nagasaki University, Japan)
 


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The recent failure of the World Trade Organization"s Doha Round of negotiations in Geneva on the issue of subsidies in the developed countries and tariff protections in the developing countries is the lesson for "free-trader" who has propagated the virtues of free trade to the developing countries to open up their economies to the unrestricted imports from the developed world. The debate is not about to go away but will intensify, thus, eventually forcing the developed countries to use increasingly protectionist measures, yet at the same time propagating the virtue of free trade for the developing countries.

From the debate the hypocrisy of the Europeans and Americans, who only promote the doctrine of free trade only for their victims, is now open and since 1995 when the World Trade Organization was formed, the developing countries are paying dearly for this unfair and unjust doctrine. However, there are more. There are two theories in Anglo-Saxon (i.e. American and British mainly) economics that rationalize the free trade: Theory of comparative advantages and Gains from Trade. The first one was developed by David Ricardo in early 19th century to prove that not through self-sufficiency but through specialization on production and trade of a commodity in which the country is comparatively most efficient every country gains. The second theory was due to Paul Samuelson during the early 50"s, demonstrating mathematically what Adam Smith said in the 18th century, that free trade benefits all nations. In both of these theories in line with the Anglo-American economics, we have to assume no government, no public investments, no trade deficit, that wages are equal in all industries and that capital stays at home rather than seeking out low wages abroad. Surprising of all consumers are not workers, they get their money from some unknown sources. Thus if there is unemployment due to specialization or imports, consumers are not going to lose their jobs; they still have money to spend. This is the unreal world of the Anglo-American economics that has dominated economic thought in the English speaking world today and it is the basis of the creation of the World Trade Organization to promote free trade.

There is another type of Western economics, unknown to the English speakers, like Indians: the economics of the European continent. Both Jean Baptiste Colbert, minister to Louis XIV and German economist Frederick List in 18th century have put forward realistic economic policies, based on trade protection, subsidies for important home industries, government intervention on the economy whenever needed. European Economic Community and its tremendous success to prosperity are based on the European economics, not on the Anglo-Saxon model. The determined fight of the European Economic Community pursuing in the W.T.O, not to remove subsidies and not to open its economy to the free trade, are based on these ideas.

Historical Evidence:

No country in the west (or Japan, Korea, China) got rich by laying itself open to unfettered international competition that could wipe out its nascent industries. Britain, the United States, Germany, Japan, the Soviet Union, Korea, Taiwan did not. All these countries grew first under protections from imports and with public supports for the industrial and agricultural investments. This type of policy is called "Mercantilism", a dirty word in the Anglo-American economics, but that was the foundation for economic development in the richer countries. The developed countries liberalized their markets much later but only to some limited extent. Growth leads to trade, rather than vice versa.

This view of the world fitted well with the era of social democracy and welfare state in the western European countries and socialism in the eastern European countries in the middle of the 20th century. That was influenced by the European continental economic philosophy that capitalism needed to be managed properly in order to maximize the rewards that were available from markets.

Free trade is one of the three foundations of the Anglo-American economic thought, the other two being price stability through the agency of independent central banks and free flow of capital. Faster growth is possible, so the theory goes, but only if democratically elected politicians are restrained from power to improve the living conditions of the people who have elected them but instead leave the destiny of the people to the market. However, there is no historical evidence to demonstrate that this doctrine had worked to uplift the people from their miseries.

Recently in the leading organ of the Anglo-American capitalists, The Financial Times, Kenneth Rogoff, the IMF"s chief economist, commented on the negative effects of the free flows of capital on the fortune of the developing countries, "The conclusions are rather sobering, suggesting that many developing countries have been unable to get the full benefits although they have borne the full weight of the risks".

The I.M.F found that it was hard to establish that financial integration by itself led to higher levels of growth, but that there was evidence that "financially integrated developing economies have in some respects been subject to greater instability than other developing countries ... it is precisely those countries that made the effort to become financially integrated that, in general, faced more instability".

However, the W.T.O is still insisting that integration of the capital markets, whereby multinational companies will be free to invest and own capital, natural resources and land anywhere they like, is the key for the developing countries to have higher economic growth.

In the recent Cancun conference of the WTO, it was expected that the developing countries would be forced to accept a deal, whereby in return for minor reductions in import tariffs and subsidies in the developed countries, they would be forced to accept a regime of the free flow of investments. The perceived fear was that otherwise the W.T.O will fail and such failure will spell doom for the developing countries. The "Cancun" conference has failed mainly because of the combined efforts of India, Brazil, and South Africa to standup against the protectionist developed countries. WTO along with developed countries are now trying to go through the backdoor to persuade the developing countries to accept that unequal and unfair treaty. The fundamental idea is still that, free trade is necessary for the developing countries to prosper. However there are alternatives, which the proponents of the W.T.O and the Anglo-American economics do not want to mention.

Developing countries should not put trade liberalization at the top of their list of priorities. They should consider that the history of the US in the 19th century shows that countries can be highly dynamic behind big tariffs provided there is vigorous domestic competition. They should ask themselves whether it would be better to have an industrial strategy before a trade strategy.

Free trade and poor countries:

Even if the Europeans remove all subsidies and import tariffs on agricultural products that would not imply prosperity for the farmers in poor countries. The other side of the coin of "free trade" is the free flow of imports from foreign countries, developed and developing.

Thus, Indian rice farmers would face competitions from the rice imports from Thailand. Similarly, wheat farmers in India would face competition from the European, Australian, American wheat farmer. Costs of imported rice and wheat can be less than the cost of production of the farmers in India, which would make the Indian farmers bankrupt.

In the industrial sectors, the situation would be just as pathetic. Indian steel producers are facing increasing competition from Korea already. Coal production has become unviable because of imports of cheaper coal from Australia and China. Free trade implies imports of cheaper machineries and other capital goods from China, Korea, and various south East Asian countries produced by the multinational companies. That would undermine Indian own machine building industries, public and private. No one can predict which industry will survive and for how long. The result will be continuous uncertainly and upheavals for the labour force.

During the second half of the 19th century when India was incorporated into the British Empire, a free trade regime was imposed upon India. That had destroyed the existing manufacturing industries. Farmers preferred not to cultivate due to unprofitable agriculture. India had to pay for her imports of both agricultural and manufactured products through exports of natural resources and increased taxation on her already impoverished population. The result of that free trade regime has turned India to one of the poorest countries in the world within fifty years in the beginning of the 20th century.

Let us go to a very recent example. Ghana has implemented "liberalized economic system" in the early 80"s, about ten years before India. Ghana was promoted during the 80"s, by the World Bank and the I.M.F, as the success story of Africa. The liberalized economy in Ghana has ruined its agriculture but failed to develop any substantial manufacturing industries.

For the poor consumers in Ghana, price stability is as important as the cost of goods. For them, ironically, free trade has meant less stability, as the government has bowed out of price setting to make way for the market.

Likewise poor producers face highly uncertain prices; they sell cheap in the harvest season and buy maize back for their own consumption later in the year, when prices have risen.

This situation is made worse by competition from cheap imports, which further limits the prices they can get in the harvest season. Local traders find that since markets have been liberalized, it is not worth their while buying from farmers in remote districts, as whatever they pay will be undercut by cheap imports.

Even local companies, who might be expected to enjoy the freedom to source from the cheapest place, argue that they would rather have long-term relationships with local suppliers - if those suppliers could be helped to increase their productivity and meet local demand. All these groups want some form of protection from the uncertainty and volatility of the market.

Poor producers want a chance to sell their goods first, before markets are flooded with cheap imports. Poor consumers want the government to set up storage systems, so that prices remain more stable throughout the year. Traders want a market where local products can hope to compete with imports. Moreover, local companies want Ghanaian producers to be supported. That way, they say, they can buy locally, rather than relying on imports.

None of these demands is unreasonable. Protecting local producers, and building up local capacity to supply domestic enterprises was a key part of the successful development of a number of countries, including Mauritius, one of Africa"s few success stories in the eighties and nineties.

There, to protect poor farmers and consumers, import quotas have been applied to some key crops, and government agencies are involved in the buying and storage of essential foods and other supplies, ensuring that poor people have access.

These polices, together with some other equally unfashionable policies, have led to spectacular results. Between 1975 and 1999, growth per head in Mauritius averaged 4.2%, by which time per capita GDP was US$ 9,107. Life expectancy has increased by ten years, and income inequality has declined.

Duplicity of the Developed countries:


Although the developed countries preach free trade doctrine, they hardly practice it. Tariffs and non-tariff barriers against the manufactured products from the developing countries are still very high. Processed agricultural products and textiles are prime examples. The average tariff rates in the developed countries may be low, but the variations around the average tariff are very high. In the U.S, the average tariff rate for imports of industrial goods is 4.9 % but the range of variation is 0 to 350 %. In Japan, the average rate of tariff is 4.3% in 1998 but the range of variation is 0 to 60 %. In the E.U, the tariff rate is 4.8% with the range of variation of 0 to 89%. The range of variations is due to specific tariffs on a range of products, which can hide the real degree of protection in the rich countries. Commodities subjected to high tariffs in the developed countries are those very products in which the poor countries have comparative advantages.


The table 1 gives the number of items of exports from the poor countries and the tariff rates in the developed countries against these items.


Thus, the developed countries have not yet reduced their tariff protections; most of the items of exports are under higher tariff rates. These higher tariff rates are also for exports of other developed countries using materials from the developing countries. Recently U.S.A has imposed prohibitive tariff rates on exports of clothing from Portugal using textiles from India, as these are categorized as exports of textile products from India, not from Portugal. India took this matter to the W.T.O dispute settlement body but lost the case against the U.S.

Table 1: Number of Export Items facing Higher Tariffs.
Tariff Rates 12-19% 22-29% 32-99% 100-299% >300%
Number of Items
European Union
Agriculture & Fishery 544 331 313 31 2
Textile,Leather, Clothing 6 0 0 0 0
Industrial Products 27 8 0 0

U.S.A
Agriculture & Fishery 138 70 99 15 11
Textile, Leather, Clothing 374 110 40 0 0
Industrial Products 407 127 45 0 0

Japan
Agriculture & Fishery 204 299 111 81 65
Textile, Leather, Clothing 42 39 15 28 7
Industrial Products 44 39 15 28 7

Source: W.T.O

High tariff against the exports of industrial goods from the poor countries cover 63 % of all export items of the poor countries. High tariff rates against the exports of agricultural products from the poor countries constitute 97.7 % of all agricultural export items of the poor countries. That is not all. Tariff rates escalate along with the number of processing of a natural product. Table 2 shows the final effects of tariffs in the developed countries for some selected export items of the poor countries.

Table 2: Tariffs(%) on Selected Export Items of the Poor Countries .
Product EU Japan U.S.A
Wheat 65 290 2
Maize 84 70 0
Rice 71 900 0
Wheat Flour 44 200 2
Cane Sugar 73 100 90
Grape Juice 215 30 14
Coffee 8 130 27
Tea 0 100 91
Tobacco 52 30 310
Woven Fabric of wool 12 8 25
Babies Garments 11 22 16
Women"s blouses 11 11 32
T-Shirts 11 11 32
Footwear with leather upper 6 140 10
Sports footwear 13 8 58
Diesel Trucks 15 0 25
Watch 2 0 33
Source: W.T.O

Thus, the idea that the developed countries have already reduced their tariff rates is a myth; they did only for those products, which are not going to cause unemployment. If there is a little tendency for any export item from the poor countries to cause unemployment in the rich countries, anti-dumping measures are followed vigorously by the developed countries. Nearly 50 percent of all anti-dumping measures approved by the W.T.O are by industrialized countries. Thus, the developing countries do not have much market access but they are forced to open their markets for the rich countries.
The rich countries have developed their economies under tariff-walls and still protecting their economies with various measures of tariffs and non-tariffs restrictions. Thus, their advice, that the growth prospects of the poor countries will be magnified if they remove all trade restriction, means that the poor countries should not do what the developed countries done to prosper.


Conclusion:


If India wants to the jobs created by the "business process outsourcing", it must accept agricultural imports from the United States and remove all restrictions on foreign financial services industries. The developing countries are in a trap. If they press for removals of subsidies and import tariff, they themselves need to do the same on a reciprocal basis. That would imply acceptance of the "free trade" regime that would ruin their own agriculture and prospects for any industrial development. In addition, the developing countries would have to accept a new investment regime of free flows of capital, which would give total unrestricted access for the multinational companies to dominate and control all most all investment programmes in the poor countries. The people of the poor countries will not have any freedom to determine their own economic future, which will be dictated by the corporate plans of the multinational companies. Thus, by pressing upon removals of subsidies in agricultural and improved market access for industrial goods, developing countries are digging their own graves.


The alternative is not a total destruction of the international trading system either, as the developed countries are saying, but a more tolerant economic system for the developing countries. For the last twenty-five years, developed countries are being persuaded by the World Bank, I.M.F and now W.T.O to abandon economic planning and a managed foreign trade regime, but to accept an unplanned economic system or a liberalized economy. Although India came into this picture quite late in 1991, other developing countries in Africa and Latin America have introduced the liberalized system much earlier. We are yet to see any success story so far.


On the other hand, since 1945, European countries, both western and eastern, along with Japan, have made rapid economic progress through systematic economic planning, industrial policy, and in general a protected and managed foreign trade regime, which are abhorrent for the Anglo-Saxon economics. That is the reason neither the European Economic Community nor Japan is willing to part with a system, which has provided them so much for the last fifty years. They are in a very strong position to withstand any pressure. The poor countries, rather than accepting the failed doctrine of "free trade" of the unreal Anglo-American economics, should, in this situation, follow the European countries and impose a managed and balanced foreign trade system.

Having a lot of jobs for telephone operators for foreign companies is not a development strategy for a self-respecting nation. Building up huge foreign exchange reserve, buying US government bonds and in effect lending money to the United States cannot develop Indian economy. Policy makers in India must think about a nationalistic economic and trade policy, which may create the developed countries and the WTO angry, but will be beneficial for the majority of the Indian people who are poor.


Dr.Dipak Basu

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