The classic 1952 monograph by economist James Meade beautifully and systematically exposits the propositions of modern trade theory through geometric methods
Readers with professional expertise in the theory of international trade will recognize the headline of this column: It is the title of a classic 1952 monograph by economist James Meade, which beautifully and systematically exposits the propositions of modern trade theory through the geometric methods then in vogue.
I recalled this Meade masterpiece—it is long since out of print, and I have a coveted copy, bought at a used bookshop, in my library—while reading a fascinating recent conference discussion by economist Dani Rodrik. (As with many of the sharpest economists, Rodrik’s commentary is more insightful than the paper he is ostensibly commenting on.) While commenting on trade policy reform, Rodrik observes that when tariffs are already low, the main effects of further tariff reduction are more redistributive than they are efficiency enhancing. While not often pointed out in a policy context, as Rodrik does, his argument is immediately apparent to those familiar with the geometry of international trade, and can be argued more broadly than he does.
In particular, the efficiency costs of distorting taxes, subsidies, tariffs, or quotas, show up in the geometry of demand and supply analysis as a pair of triangles—known as “Harberger triangles" in jargon, or, in today’s less felicitous usage, deadweight loss triangles. By contrast, the redistributive effects show up as rectangles (or trapezoids, essentially the union of a rectangle and a triangle). Now, the crux is that the triangles are small, while the rectangles are large, and this is true in a very strict geometrical sense. To be more precise, as the distorting tax (or other instrument) goes to zero, the welfare costs become vanishingly small (disappearing to a point), while the redistributive effects do not (disappearing to a line which is the base of a rectangle). Put in reverse, as classical theory tells us, the welfare costs of a small tariff are second order of smalls, while the revenue gain is first order of smalls. In the limit, an infinitesimally small tariff creates an infinitesimally small welfare loss.
What does this somewhat arcane lesson in analytic geometry tell us about the real world of trade policy? Indeed, a very great deal. As Rodrik reminds us, one useful metric for studying whether a trade agreement (or any tax policy reform, more generally) is more about redistribution and transfer (collectively, call it “income capture") than efficiency gain (call it “income creation") is the ratio of the rectangle of transfer to the triangles of efficiency gain.
In the simple world of linear demand and supply analysis, and in the case of tariff reduction, simple algebra shows this ratio to be (1/uet), where u is the share of imports in domestic consumption, e is the absolute value of the price elasticity of import demand, and t is the quantum of the tariff (in percentage terms).
In a benchmark case in which u is set at 0.25 and e is set at 2, this ratio rises from a low of 5 when t is 0.4 to a high of 20 when t is 0.1. As Rodrik acerbically remarks, “The ratio of redistribution to efficiency gains is not only very large, it rises to ridiculous heights as the tax/policy distortion that is removed gets smaller."
So if trade policy negotiations are mostly about wealth and income capture rather than creation, because barriers are already low, what is the fuss about? The truth is that contemporary bilateral and plurilateral trade agreements are mostly not about trade at all, but about a whole host of non-trade-related issues which are cunningly called trade-related—everything from intellectual property and domestic procurement demands coming from the right to social, labour, and environmental issues coming from the left.
Economists in hock to American industry (many perched at key positions in Washington, DC think tanks) claim that these ostensibly trade-related, non-trade reforms are about “deeper integration" and “beyond the border issues". Stripped of the Orwellian language in which they are garbed, such demands amount to an infringement on the national sovereignty of one’s trading partners. That is why this author has always steadfastly argued that India should refuse to participate in the Trans-Pacific Partnership (TPP) or any other trade deals which attempt to foist someone else’s intellectual property norms on us.
Equally problematic are the attempts from social activists on the left to foist their chosen social agenda on to trade policy. Such folks, for instance, have evidently captured the current Canadian government, as Prime Minister Justin Trudeau has articulated that, henceforth, Canadian trade policy must be “progressive" and attach gender, aboriginal and other social issues on to trade negotiations. While perhaps well-meaning and not venal, unlike those shilling for industry, this is equally problematic, as it involves an equally egregious breach of other countries’ national sovereignty. And it is just as likely to torpedo the ongoing renegotiation of the North American Free Trade Agreement (Nafta) between the US, Canada and Mexico as American corporate-driven mercantilism.
The fact that non-trade-related issues have moved to centre stage in bilateral and plurilateral trade negotiations is yet more evidence that such agreements are not really about trade any more. That makes it even more pressing to revivify the multilateral trade regime, and soon.
Vivek Dehejia is a Mint columnist and resident senior fellow at IDFC Institute, Mumbai. Read Vivek’s Mint columns at www.livemint.com/vivekdehejia