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Photo: Bloomberg
Photo: Bloomberg

The backlash against globalization

The discontent with mainstream economic wisdom has gone beyond the walls of university departments

The earliest and most lucid theory of trade was enunciated by a famous Englishman, David Ricardo. The crux of Ricardo’s theory of comparative advantage was this: if two countries, England and Portugal, produced two commodities, cloth and wine, and England was more efficient in producing both, it may yet pay both countries to trade if England was more efficient in the production of wine than in cloth—i.e., if it had a comparative advantage in one over the other. England should then specialize in wine and Portugal in cloth, and both would gain from trade.

Ricardo’s theories have been refined subsequently by succeeding generations of economists to explain the complicated nature of trade patterns in the modern world, which has moved far beyond the kind of trade patterns Ricardo tried to explain. Yet the basic kernel of this theory has become an integral part of economics: countries should specialize in their area of expertise and everybody can gain.

The consensus on the benefits of free trade has been one of the defining features of mainstream economics. Many economists within this tradition differ on several other things, such as on the desirability of free movement of capital, for instance, but they all agree on the desirability of free trade.

And yet, significant cracks seem to be appearing in that happy consensus. Two centuries after Ricardo first propounded his theory, his homeland has perhaps dealt the most serious blow to the ideas of free trade and globalization in the post-war period by voting to leave the European Union. As several commentators have pointed out, the “leavers" appear to be saying no to greater integration and trade.

“What Americans call the ‘takeaway’ from the referendum can be summarised in one short phrase: globalisation is not working," wrote Financial Times columnist Philip Stephens. “Big business has become bad political news. Yes, of course one can produce endless statistics showing how open global markets are a stimulus to growth and prosperity. But as true as they are, these are abstract, aggregate figures. They do not reflect the experience of the majority."

There is some merit in drawing general conclusions from the Brexit vote. In a report released last month, the World Trade Organization (WTO) noted that applications for new trade-restrictive measures by G-20 economies reached an all-time high since the organization started this monitoring exercise in 2009. There are tell-tale signs that protectionism may be gaining strength across the world, halting the march of globalization.

Why is free trade under siege if it is beneficial for everyone, as mainstream economic theory suggests? And why are poorer voters against trade integration even when national elites are convinced it is in the best interest of their countries?

A recent research paper by Sergey Nigai explains this puzzle by pointing out that elites may view trade favourably because they tend to benefit much more from it than the poor. Since high-income consumers spend a relatively larger share of their income on services and manufactured goods, they benefit more from international trade, Nigai’s research shows.

International trade benefits consumers through lower prices of imported goods. The magnitude of such gains, however, is heterogeneous for different income groups because of the large differences in how consumers allocate their incomes between food, manufactured goods and services.

This is why the gains from trade for the average consumer, which are routinely used as a measure of economic welfare for policy analysis, systematically overestimate trade-related benefits for the poor and underestimate them for the rich.

The paper builds a complex model to take into account change in welfare gains from trade across income groups using data from 92 large countries. In doing so, it does away with a key assumption in many theories of trade: that of the average representative consumer.

Nigai’s research shows that there are significant differences in how trade benefits people across the class divide. The paper shows that trade largely leads to a reduction in prices of manufactured goods, rather than of agricultural goods. Since the rich consume more of manufactured goods, they stand to gain more from trade liberalization.

Given the sharp differences in gains from trade across income classes, it is perhaps not surprising that poor and low-skilled workers constituted the majority of those who voted for exiting the European Union in the last month’s referendum in the UK.

The theory may apply even in the Indian case, where prices of goods like televisions and mobile phones have come down sharply after liberalization, but those of food items have risen faster than the average basket of goods and services. There is another route through which trade liberalization can harm the welfare of the poor. Trade liberalization often leads to a decline in government revenue because of lower import tariffs, which might lead to lower spending on anti-poverty schemes.

Nigai is perhaps the latest economist to warn about the distributional consequences of trade. But as The Economist pointed out in a recent issue, there were others who warned about the backlash against globalization.

One of the most prominent economists who sounded a warning on this is Harvard University economist Dani Rodrik, who argued that deeper economic integration may not be possible unless countries are prepared to lose sovereignty or democracy. The forces of economic integration create pressures to loosen national rules and regulations, and may often result in outcomes that dismay the popular will or mood, even if the world is better off materially because of these changes.

This led Rodrik to formulate an “impossibility theorem" for the global economy, which says that “democracy, national sovereignty and global economic integration are mutually incompatible: we can combine any two of the three, but never have all three simultaneously and in full".

The history of free trade has indeed been one of conflicts. One of the earliest clashes over free trade was in England in the first half of the 19th century. The English government, in which rural elites had a greater say, had imposed import tariffs on the import of corn and other foodgrains. This led to high food prices, and higher earnings for landowners.

But the urban folk—both workers and their employers—were not happy. After a prolonged struggle, the “corn-laws" were repealed and cheaper food imports allowed in Britain, no doubt a progressive step. Even the decision to repeal the corn-laws saw a government falling, as the incumbent prime minister, Sir Robert Peel, defied his own party’s opposition to the repealing of the import duties. David Cameron has a companion in history; both of them relinquished their power trying to defend free trade.

Not all trade liberalization was progressive though. In the same century, British resorted to exporting opium to China to fulfil their growing trade deficit on account of increase in Chinese imports like tea. The Chinese considered the sale of opium illegal, and tried to resist. They were attacked, defeated in the so-called Opium Wars, and had to give up Hong Kong to the British and also surrender trading rights to a host of nations.

Heterodox Cambridge University economist Ha-Joon Chang terms the treaty of Nanking, a result of the Opium Wars, “a particularly shameful episode, even by the standards of 19th century imperialism".

Economists such as Chang have long questioned the belief in free trade that others share. In his book Bad Samaritans: The Myth of Free Trade and the Secret History of Capitalism, Chang argues that economists who point to the examples of the UK and the US to show how openness to trade leads to greater prosperity actually misread their history: both countries have used the policy of free trade selectively.

They grew on the back of protectionist policies and opened up only when it suited them, while at the same time denying colonies and less developed countries to protect and support the growth of their own industries, writes Chang.

Chang points to Alexander Hamilton, the first treasury secretary of the US, who in 1791 eloquently argued for protecting “infant industries" in his report on developing a manufacturing base in the newly independent country.

The author of the “Make in America" strategy proposed a series of measures to achieve the industrial development of his country, including protective tariffs and import bans, subsidies, export bans on key raw materials, import liberalization of and tariff rebates on industrial inputs, prizes and patents for inventions, regulation of product standards, and development of financial and transportation infrastructures.

“Although Hamilton rightly cautioned against taking these policies too far, they are, nevertheless, a pretty potent and ‘heretical’ set of policy prescriptions," writes Chang. “Were he the finance minister of a developing country today, the IMF and the World Bank would certainly have refused to lend money to his country and would be lobbying for his removal from office."

“Had the US rejected Hamilton’s vision and accepted that of his arch-rival, Thomas Jefferson, for whom the ideal society was an agrarian economy made up of self-governing yeoman farmers (although this slave-owner had to sweep the slaves who supported this lifestyle under the carpet), it would never have been able to propel itself from being a minor agrarian power rebelling against its powerful colonial master to the world’s greatest super-power," writes Chang.

Most theories which predict gains from free trade argue that the benefits accrue via a restructuring of the production structure in the economy in keeping with a country’s comparative advantage. So, a country efficient in production of cloth can produce more cloth and exchange it for more televisions which it might have been producing inefficiently in its autarky phase.

The crucial assumption involved is there can be a smooth movement of factors of production which were engaged in the traditional production activities to the new industries. In reality, this is hardly the case.

For example, after inking the North American Free Trade Agreement (NAFTA) with the US, domestic farm production in Mexico collapsed due to cheaper corn imports from the US. Much of the displaced low-skilled agricultural labour could not find jobs in the modern sector and ended up becoming street vendors, which can hardly be described as gainful employment. Unlike developed countries, which can afford to provide unemployment allowances or retraining to workers, the suffering is more acute in developing countries.

In a 2014 article published in The New York Times, Nobel laurate Joseph Stiglitz, one of the early economists to warn about the “discontents of globalization" wrote that the primary focus of trade agreements like the Trans-Pacific Partnership (TPP) is not on tariff reduction (which has already been achieved), but harmonization of regulations across countries.

Stiglitz terms this a race to the bottom, because in the name of promoting efficiency, it is a ploy by corporations to circumvent regulations which might have been brought in place to protect the environment, consumers, workers and the overall economy by democratic governments.

“These high stakes are why it is especially risky to let trade negotiations proceed in secret. All over the world, trade ministries are captured by corporate and financial interests. And when negotiations are secret, there is no way that the democratic process can exert the checks and balances required to put limits on the negative effects of these agreements," Stiglitz wrote.

To put things in context, US presidential candidates Hillary Clinton and Donald Trump have both promised to revisit the TPP in light of strong voter sentiment against it.

Stiglitz argued that what may be good for economic elites may not necessarily be good for the poor, or even for the middle class, a point that Nigai’s research also highlights. Instead, trade agreements such as the TPP may benefit elites at the cost of the rest.

“… The high level of inequality in the United States today, and its enormous increase during the past 30 years, is the cumulative result of an array of policies, programs and laws," wrote Stiglitz. “Given that the president himself has emphasized that inequality should be the country’s top priority, every new policy, programme or law should be examined from the perspective of its impact on inequality. Agreements like the TPP have contributed in important ways to this inequality. Corporations may profit, and it is even possible, though far from assured, that gross domestic product as conventionally measured will increase. But the well-being of ordinary citizens is likely to take a hit. And this brings me to the second point that I have repeatedly emphasized: Trickle-down economics is a myth. Enriching corporations—as the TPP would—will not necessarily help those in the middle, let alone those at the bottom."

In 2011, Harvard students walked out of the popular Economics 10 class of N. Gregory Mankiw to express solidarity with the Occupy Wall Street movement. The students also wrote an open letter to their professor, criticizing the biases of mainstream (and conservative) economics, of which Mankiw was a proponent.

Their refrain resonated across university departments. The growing resentment against free trade in the strongest bastions of capitalism only shows that the discontent with mainstream economic wisdom has gone beyond the walls of university departments.

Economics Express runs weekly, and features interesting reads from the world of economics and finance.

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