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Moment Of Reckoning Of Free Trade Theorists

The wake up call hasn’t come a day too soon. If the way China is seeking to use the accumulated gains of free trade for aggressive pursuit of military ambitions during Covid pandemic does not wake up the indoctrinated theorists nothing else will.

Photo Credit : Bloomberg

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Free trade theory has always had its flaws. It is just that some diseases take a long time to manifest. Noted votaries of free trade theory are switching sides of late and sure more will follow in the days to come or lose relevance. Sure specialization has benefits but to think it is limitless in its application and would hold its ground irrespective of rigid political borders and impediments to factor mobility across political boundaries, overcome man vs machine issues exacerbated by savings glut is being naïve at best.

Unresolved half way truth
An economy is a circular prototype with producers on one side and consumers on the other, salaries wages and factor payments from one side, market prices from the other, capacity utilization on the producers’ side translating into employment on the other.

Any escape from one side in this circular system to outside entities (say of purchasing power of consumers spent on imports) has to be compensated by inflow of purchasing power, if the economy is not to shrink in size. Businesses would need to compensate this loss with exports to maintain their capacity utilization or it needs to be compensated by inward investments. Otherwise the system would shrink at a lower level of GDP than without free trade induced imports and exports.

When all economies are expanding, there may not be any nation facing absolute decline in income but no one would notice any relative decline compared to true potential without free trade. Theoretically if there are 10 nations in free trade any number from 10 to 1 can be gainers. The others may be losers in relative or even absolute basis (GDP lower than previously). So there is a possibility that all the gains from trade are garnered by a single nation at the expense of all the others.

While there is a torrent of theories on how gains from trade can be generated from cross border specialization, they left the distribution question vaguely and naively to negotiations. In that sense, it is a mathematically well-reasoned theory till the half way stage – covering the first leg but not its consequences. It was time that its shortcomings manifested themselves.

Failure to notice breakdowns 
Any persistent trade deficits and current account deficit is sure a sign that trade is not beneficial and that any readjustment of skills and products to specialize in is not working. The country may be digging for copper since it is its comparative advantage by giving up digging for gold but the price of gold and copper may be such that the country becomes a net importer value wise. Unfortunately the prices copper or gold does not get decided only by costs for the theory to work perfectly.

There are twice as many losers due to trade (countries with persistent trade deficit) as gainers from trade (countries with persistent trade surpluses).

As consumers the citizens even in countries with persistent deficits will be happy with a wider of choice of goods and cheaper prices, but the same citizens have to face a slack job markets where businesses would not be able to provide them jobs to all those who seek it, unless the trade gets balanced at the country level. Little will they realize that their welfare comes at mounting debt at the country level which the future generations or they themselves have to settle in the future.  
China’s productivity levels for labour, industry and services are 30%, 33% and 29% (all figures for 2015) of frontier efficiencies of advanced economies, as per IMF studies (2019). That China was clocking 10-13% growth rates for years on end despite such huge gaps in its productivity levels should have alerted the free trade evangelists like Nobel Laureate Krugman. But they failed to look behind the smokescreen how despite such low comparative productivity levels, China was competitively pricing its products right across a spectrum far wider than such low%s would suggest. China could not have done that without manipulation of currency and factor (esp labour) markets. China’s labour markets are hardly free and the share of labour in the GDP is nowhere near what would have been if labour markets were free, leave alone a fair share similar to western standards. Instead its labour was saddled with loans to upgrade their prosperity and its private debt/income is at unprecedented levels perhaps in excess of private debt levels of US before 2008.

Deceptive Protectionism – key to gaining from free trade. 

The best negotiation strategy to maximize gains was very well being demonstrated by Japan in 1960s to 80s and later China even while the trade theory apologists kept believing in their half complete theories. The indoctrinated theorists watched naively as China manipulated its currencies, manipulated its own factor markets, violated IPRs, subsidized key inputs from the back end while Japan erected tight barriers to its distribution systems. Vietnam is the free trade theorists’ new poster boy; but little do they realize how with various non-tariff barriers they have zealously guarded their domestic market. ASEAN has emerged as the chief factory of non-tariff measures in the last decade (the NTBs by ASEAN outnumber India’s by 17 times as per TRAINS) and nearly half of Vietnam’s imports are subject to NTB of one form or the other.

The experience of China as indeed several others would only suggest that to win this game, one needs to know how to manipulate the rules cleverly at least as much or perhaps even more than increasing cost competitiveness. India was a naïve practitioner (perhaps free trade’s chief adherent), not clearly aware of where it’s enlightened self-interest laid and much less how to achieve it.  

Flawed foundation

Even without manipulation by any of the players, the theoretical foundations underpinning free trade would suggest that there are equal chances of being a losing country as much as being a gaining country. If your country’s comparative advantage is in commodities or products with flat demand and supply curves, payoffs would be far less than resources consumed; you will most likely end up losing if the particular commodity has high point elasticity of price.  

Even if the country as a whole gains, if one’s skills are in such industries as above, one is more likely to lose than gain. Unfortunately more of the poor, less skilled have their skills predominantly in such industries even in advanced countries. And the biggest threat they face is atomization of low skill jobs at rapid pace.  

Even within same corporate entity production can sometimes be reallocated between various centres for reasons of efficiencies. But allocating portions of the profit of the more efficient to the one who has to accommodate is generally an impossible task. There are simply no mechanisms for doing it across countries.

Alternative 
Much of the potential benefits from Free Trade can be achieved without necessarily being subject to the ill effects and distorted distribution of its gains due to machinations of rogue players. Largely similar results can be achieved by freeing domestic production and investments from controls, encouraging inward FDIs, freeing or even encouraging technology transfers and skill development i.e. promoting cost competitiveness within the economy including where necessary dismantling size related restrictions.  India can easily clock a couple of additional % of growth if only its administration and law making bureaucracy sheds its audit and suspicion mindset which erects so many detailed rules and regulations which unfortunately favours only the crooks and those confident of several sieves of the leaky judicial systems.      

An evil worse than free trade
The far more dangerous offshoot can be that the anti-trade gang would equate free trade with free markets and seek to throw the baby with the bathwater. Free market within the economy negates very many troubles and lacunae of free cross border trade especially where factor mobility is not an issue or constraint. It will be easier for a plumber to move from Dibrugarh to Delhi than to Dacca which is at one third the distance. Inter trade mobility is easier within one’s own country – the plumber can more easily become an electrician within India than migrate to
Australia for a different trade even if so mandated by free trade comparative advantages.

There is a fatal risk of socialists and communists making a grand re-entry given that neither in China nor in any of the countries which have suffered due to its brand of aggressive free trade, has Labour gained – in China due to its policies of allocating much more to investments through the government and other countries due to shift in many low end industries into China which have thrown many low wage earners out of jobs resulting in heightened inequalities. If such a twist does come about, it would be an unfortunate case of replacing a minor curse with a confirmed catastrophe like socialism or communism. At least free trade works with only minimal conflict with democracy unlike socialism and communism which seek to decimate free markets.  

The wake up call hasn’t come a day too soon. If the way China is seeking to use the accumulated gains of free trade for aggressive pursuit of military ambitions during Covid pandemic does not wake up the indoctrinated theorists nothing else will.

The writer is the Author of Making Growth Happen in India (Sage Publications)

Disclaimer: The views expressed in the article above are those of the authors' and do not necessarily represent or reflect the views of this publishing house. Unless otherwise noted, the author is writing in his/her personal capacity. They are not intended and should not be thought to represent official ideas, attitudes, or policies of any agency or institution.


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V Kumaraswamy

Kumaraswamy is a Corporate CFO and contributes regularly to various economic dailies on matter concerning economy. He is author of Making Growth Happen in India (Sage publications). He is a frequent speaker at talk shows on corporate affairs, economy and development issues.

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