Reinvigorating free trade
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One of the principal concerns highlighted in the recent report on the Global Competitiveness Index 2016-17 (GCI) released by the World Economic Forum (WEF) is the growing reluctance of countries to be open and trade with one another. This inward-looking trend began with the financial crises of 2008, which led many economies to adopt some form of protectionism to insulate domestic industries and safeguard jobs.
In April this year, the World Trade Organisation (WTO) forecast global trade growing at 2.8% in 2016 and 3.6% in 2017. But it recently revised those numbers to 1.7% and 1.8%, respectively. WTO’s director-general attributed the reduced forecast to “growing anti-globalisation sentiment” in the world. This sentiment is evident in the anti-trade narrative offered by America’s presidential nominees on either side, the policy uncertainty looming over Britain’s businesses owing to Brexit, heated immigration debates in both Europe and America, China’s growth slowdown and consequent volatility in its demand for imports, or the social unrest resulting from state sponsored, cross-border terrorism.
Over the past four decades, trade has resulted in significant improvement in the economic welfare of trading nations. Starting in 1980s, trade reforms instituted by China’s Deng Xiaoping have emancipated millions of Chinese from poverty. India’s liberalisation in the 1990s has enabled its economy to escape the dreaded Hindu rate of growth, and Vietnam benefited immensely – according to one estimate (link: http://www.cid.harvard.edu/neudc07/docs/neudc07_s4_p06_mccaig.pdf), as many as seven million people were pulled out of poverty—when the US slashed tariffs on imported goods in 2001. US too has gained immensely after the establishment of North American Free Trade Agreement (NAFTA) and World Trade Organisation (WTO) in the 90s and after China’s accession to WTO in 2001. Cheap imports from China as well as Mexico resulted in significant windfall for American consumers. It also granted them considerably more choices. According to economists Robert Lawrence and Lawrence Edwards of the Peterson Institution for International Economics, trade with emerging economies, especially China after 2001, contributed to an increase in America’s per capita income by as much as $500.
Perhaps the most significant benefit of trade is reflected in its effect on innovation. Domestic industries under an open trade regime are forced to develop systems that lower their costs, raise the quality of their products, and make heightened efforts to attract consumers’ attention. In a 2015 research paper, Nicholas Bloom of Stanford University, Mirco Draka of University of Warwick, and John Van Reenen of London School of Economics demonstrated that “increased Chinese trade has induced faster technical change from both innovation and the adoption of new technologies, contributing to productivity growth” in America. Firms threatened with foreign competition created more patents, increased technology adoption, improved management quality and invested heavily in research and development.
This interconnectedness between trade and innovation has also been underscored in the GCI report. The report regards innovation as a crucial factor in enhancing the competitiveness of a nation. Having evaluated 138 countries, the GCI report shows that “economies that are more open to foreign competition are more innovative, suggesting the importance of openness for innovation.”
Innovation in turn leads firms to pass on their reduced costs to consumers. It is therefore not surprising that free trade typically favours the poor, who spend more on average on traded goods. Wealthy consumers, on the other hand, tend to spend more on services which are relatively less traded.
That said, there is also some truth to the claim that free trade has resulted in rising inequality. This, however, has happened primarily owing to the transfer of trade benefits from less efficient firms to more efficient ones. Trade tends to reallocate resources to the most productive uses. In that process, unproductive sectors of the economy often face unemployment, which in many cases may be transitory. Some displaced workers eventually get absorbed in new industries. More often than not, however, the job losses are permanent as old skills become obsolete or costly. The effective solution to labour displacement is not to keep inefficient sectors forever insulated, but to provide necessary safety net to unemployed workers through redistributing some of the gains from trade to them in the form of unemployment insurance, pensions, or initiatives such as skill development programmes. Any safety net that involves money transfer must be designed such that it does not disincentivise displaced workers from upgrading their skills or searching for work.
Prime Minister Narendra Modi’s Skill India Mission is a step in the right direction. It aspires to build 5000 Industrial Training Institutes (ITIs) in addition to the existing 13,000 such institutions. These institutes are expected to train as many as 15 million people in new skills this year. Such programmes, coupled with gradual dismantling of trade barriers, will help India become significantly more competitive than the current level.
Arguably, that is easier said than done. Intraregional trade in South Asia, for example, is less than 5% of total trade. According to a World Bank estimate, it is 20% easier for India to trade with Brazil than with Pakistan or Bangladesh. This is because of inadequate trade agreements, congested border crossings, and a general lack of transportation infrastructure. Reforming these structural, non-tariff barriers to bilateral or multilateral trade is therefore crucial for any successful leveraging of trade benefits.
For policymakers, there is also the problem of balancing public opinion and good economics. In making policies related to foreign commerce, politicians often respond to the prevailing mass perceptions about the benefits of trade. These public perceptions, whether favourable or unfavourable to trade, are shaped by various factors. A study conducted by University of Pennsylvania’s Edward Mansfield and Diana Mutz found that the anti-globalisation perceptions are fuelled in part by domestic ethnocentrism, out-group hostility, or isolationist foreign policy tendencies among the public.
These hostile perceptions may be largely created either through mass media coverage of economic downturns, or interpersonal conversations with acquaintances who have suffered those downturns, or simply personal experiences. This could not be truer for India. Several political as well as spiritual leaders with mass followers are actively engaged in instilling fear of multinational corporations, foreign products and services, and foreign finance. To an extent, their fear may be justified. Some multinational companies may indeed have engaged in unethical marketing in the past. But painting all foreign companies with the same brush is also unfair, not least because such xenophobic propaganda may ultimately end up harming consumers, who are the biggest beneficiaries of foreign competition.
Harsh Vora is an entrepreneur, investor, and trader. He writes frequently on issues relating to public policy and economics.