Free trade is good, for the poor too

Trade has a pro-poor bias, and any barriers to trade can quickly degenerate into barriers to reducing poverty

The European Union headquarters in Brussels. Protectionist measures should be avoided or limited to exceptional situations only. Photo: Reuters
The European Union headquarters in Brussels. Protectionist measures should be avoided or limited to exceptional situations only. Photo: Reuters

In a global trading landscape that is being increasingly influenced by protectionist narratives, the approval of the landmark European Union-Canada trade deal Comprehensive Economic and Trade Agreement (Ceta) by the European Parliament comes as a breath of fresh air. Trade between the two economies amounts to about $63 billion presently, and reports say Ceta could increase this by 20% to as much as $76 billion.

Realizing these gains from trade would require dismantling not just tariffs but also non-tariff barriers as envisioned in Ceta. While the former has finally been voted upon in the EU parliament and about to be enforced after more than seven years of negotiation, the latter still hangs in the balance. Reducing non-tariff barriers would require ratification by EU member states, a task that is both formidable and time-consuming. Last year, the tiny Wallonia region of Belgium, with a population of about 3.5 million, held the entire deal hostage to its concerns about the loss of welfare due to trade. Foreign competition induced by Ceta was particularly feared to hurt Wallonia’s farmers, who were increasingly facing higher production costs in their region. To be sure, such concerns are legitimate and are shared by a host of countries, including the US.

But that narrative fails to take into account the huge welfare gains that accrue to consumers of cheaper imports. A 2016 paper by economists Holger Breinlich, Swati Dhingra, and Gianmarco Ottaviano of the London School of Economics analysed the effects of free trade agreements (FTAs) negotiated by the EU in the past two decades. They concluded that these agreements not only improved the quality of the UK’s imports by 26%, but also lowered the quality-adjusted price of those imports by 19%. For EU-12 countries, which include Belgium, FTAs enhanced the quality of imported goods by 28%, while reducing the quality-adjusted prices by 11%.

In value terms, cheap imports resulted in savings of as much as $5.6 billion for UK consumers every year. Furthermore, the authors also predict that treaties such as the Transatlantic Trade and Investment Partnership between the EU and the US could save EU consumers $4.45 billion, while the Economic Partnership Agreement between the EU and Japan could save them $2.23 billion by way of lower import prices.

Even among those consumers, the poor tend to gain more through freer trade. This is because tradable goods constitute a large portion of their overall expenditure, and lower import prices of these goods feed into greater savings for them. A 2014 working paper by Pablo Fajgelbaum of the University of California and Amit Khandelwal of the Columbia University, published in the National Bureau Of Economic Research, found that the “real income loss from closing off trade is 63 percent at the 10th percentile of the income distribution and 28 percent for the 90th percentile.”

In simpler terms, trade has a pro-poor bias, and any barriers to trade can quickly degenerate into barriers to reducing poverty. That is not to downplay the distributional consequences of trade or engage in trade fundamentalism. Trade hurts uncompetitive businesses and causes unemployment. But as long as the losers are compensated from the aggregate welfare gains resulting from trade, there is a strong case to be made in favour of liberalizing restrictions. This compensation should be in the form of robust safety nets—such as unemployment insurance benefits or income support payments—that are combined with skilling programmes to retrain displaced workers for new employment opportunities.

There could also be a legitimate argument in favour of imposing anti-dumping or countervailing duties on certain items if the cheap import happens to be a result of market distortions created by the foreign trade partner in its home country. In its high growth years, for example, China witnessed heavy state-led investments in its steel industry. This led to industrial overcapacity in the subsequent low growth years when domestic demand faded. Consequently, Chinese producers engaged in price discrimination by exporting steel to foreign markets at prices far lower than those prevailing domestically. The importing countries naturally witnessed damage to their domestic steel industries, but not necessarily due to their own inefficiencies or weaknesses. They lost out owing to market distortions or failures induced by their foreign trade partner’s state policy. This could justify appropriate domestic measures.

The problem with such measures, however, is that it is often difficult to distinguish clearly between cheap imports induced by market distortions and those taking place as a result of genuine comparative cost competitiveness of the foreign producers. And the result is a flagrant misuse of anti-dumping measures to thwart even genuine imports. A 2015 working paper by economists Chad Bown and Rachel McCulloch of the European University Institute found that even though anti-dumping measures in the 1980s were originally employed to prevent anti-competitive behaviour, they gradually ended up being misused to create collusion and cartelization by domestic producers.

Given their potential for misuse, protectionist measures should be avoided or limited to exceptional situations only. Where such effects are unclear, trade should be allowed to take its own course.

Harsh Vora is an entrepreneur, investor and trader.

More From Livemint