Topic: Global Economics on International Trade

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Date: Free trade theory and the protectionist theory

Back in the 1840s, Britain having innovated the industrial revolution and acquired absolute cost advantages, decided that policies of free, not protection, would better serve national interests. This is because Britain enjoyed broad industrial supremacy, and hence there was no longer the need to protect the economy from foreign manufacturing, but to rather open more global markets for expanding British industrial production. This was much of the beginnings of the practice of free trade where Adam Smith was widely credited with pioneering economic trade in support of the free trade, as well as his documentation of free trade policies (Lovett, Brinkman, & Eckes, 2004).

Adam Smith’s was for the idea that free trade should prevail as well as the notions that were backing nation building policies in the support of national defence being more important than opulence. The act of navigation and the wisest of commercial regulations also made concessions to the mercantalistic policy of regulation of foreign trade. In the 1770s, Smith wrote the wealth of nations in the wide spread of mercantilism and his advocacy of free trade was supported by the comparative cost theory and the cloth/wine arguments served as the foundation for what later came to be called the pure theory of trade. This theory has then made a turn to support the free trade theory and both Britain and the Unites States embarked upon policies allowing the extreme of one way or unilateral free trade.

According to Dunkey (2003), free trade economists often describe the goal of globalization as deep integration or the convergence of nations’ fundamental economic structures and policy systems, extending far beyond trade or strictly economic criteria. At the start of the twenty-first century, Americans deviated from living in a national market that was depending on its own resources. The American economy was isolated from the rest of the world by border restrictions and natural barriers, such as time, distance and lack of information. Decades of trade liberalization along with innovations in telecommunication and transportation, had integrated global markets – and exposed workers in high income countries to the pressures of global competition.

The superiority of an international trading system characterized by greater multilateralism and international specialization over a trading system based on protectionism, bilateralism and a division of the world into major trading blocs is by no means as clear cut today as it was a decade ago. This can be attributed to the many of the new non-tariff barriers considered as part of the arsenal of policies that a nation believes to be necessary in order to achieve some important domestic objectives. The other explanation could be that in recent years, the very theoretical foundation of the modern theory of international trade, which for nearly two centuries has been consistent based on the alleged superiority of free trade over systems based on trade restrictions, is being questioned.

The protectionism theory proposes that an economy formulates necessary protection policies that are intended to help the domestic industry maintain or increase its market share while foreign producers are expected to lose market share and sales revenues. Oddly enough, the record indicates that foreign producers sometimes benefit from certain protectionist policies as in the case of quotas, due to increases in their prices, which may offset the loss in quantity supplied. For a look at the costs of protectionism in the USA, Tarr and Morkre (1984) estimated the annual cost to the US economy to be $12.7 billion from protections on autos, textiles, steel, and sugar. Hickok’s (1985) analysis targeted the effects on consumers at different income brackets and discovered that protections punish low-income consumers much more than upper income consumers where there are trade restraints on clothing, sugar, and autos. These restrictions were found to be equivalent to 23 per cent income tax surcharge for households with low income and 3 per cent for households with high income which brings up the inequality ratios as really high.

The data point to an interesting finding with regard to the relationship between protectionism and employment where in every single case, the society paid a hefty price for each saved job per worker, and in the majority of cases, and the cost was in excess of $100,000 per job. These findings should raise serious doubt about the utility of the argument that protectionism is beneficial for employment as the benefits derived by domestic producers and government, and occasionally, foreign producers as well, constitute the efficiency losses to society when considering the costs they have to endure. These efficiency losses are a result of the interventions imposed by the government. Hence they result of production distortions, reduced consumption, and the many side effects on consumers’ purchasing power, industrial customers, and the added bureaucratic and government expenditures to monitor and enforce the policies which call for more policy formulations.

A similar finding was derived when the Organization for Economic Cooperation and Development (OECD) conducted studies to evaluate the effects of protectionist policies in manufacturing industries in the OECD member countries (OECD, 1985). The key findings of the OECD’s study point to the effects of protectionism as rise in domestic price stifled economic growth and depressed investment, drop in imports is accompanied by drop in exports, jobs saved are offset by job losses in export-oriented industries, overall employment does not increase and the jobs saved are publicized and the jobs lost are not; hence, the public is left with the impression than protectionist policies benefit employment.

Protectionism in developed countries impact developing countries and as realized from the OECD study concludes that reduced imports by developed countries reduce exports by developing countries and their earnings of foreign exchange, which they need in order to finance their external public debt. The multinational financial situation also gets hurt by trade protectionism and the impact of protectionism on developing countries was recently re-affirmed by US Government officials most intimately involved in international trade when six former US trade representatives affirmed that developing countries have benefited significantly with the reductions in protectionism by developed countries.

Further, other studies carried out by scholars clearly show that the costs of trade protectionism exceed the benefits and while domestic producers and possibly their workers may gain for a while, consumers and society lose. Inefficiencies inflict the entire economy and hamper growth, investment, employment, and ultimately even government revenues.

Influence of Global economics at Micro and Macro levels in Decision Making

Despite improved global financial conditions and reduced short-term risks, the world economy continues to expand at a subdued pace. There has been a marked downturn over the past two years and a review of the same has shown inflation has had a significant influence in the developing nations. On the other hand, global economic activity has been expected to slowly start rising towards the end of 2013 and 2014 which can be attained based on the back of accommodative and sound monetary policies in developed and developing economies globally. Most world regions that were highly affected by the economic crash are likely to see a slow upward growth in activity where growth will continue to be below potential and employment gains, especially in developed economies, which will remain weak at best.

There are short-term risks associated with the situation in the euro area as well as the changes in the dollar rates in buying and selling among the international firms where this gives the impression of a call for fiscal adjustments in the United States and the economic slowdown in large developing countries to restore the necessary balance. At the same time, new medium-term risks have emerged, including possible adverse effects of unconventional monetary measures in developed economies on global financial stability and hence bringing about high inflation and unemployment rates. These risks have the potential to once again derail the feeble recovery of the world economy and hence the main priority for policy makers worldwide should therefore be to support a robust and balanced global recovery, with a focus on promoting job creation.

The enhancement of International policy coordination needs to be enhanced to mitigate negative policy spill-overs, curb protectionism, promote cooperation in reforming the international financial system, and ensure sufficient resource flows to developing economies, and in particular the least developed countries of Asia and Africa.

Theory of two level games in decision making

The politics of many international negotiations can usefully be conceived as a two-level game where at the national level, domestic groups pursue their interests by pressuring the government to adopt favorable policies, and politicians seek power by constructing coalitions among those groups. Though economies are operating at the international level, national governments have the priority of maximizing their own ability to satisfy domestic pressures, while minimizing the adverse consequences of foreign developments at the cost of their economies. Neither of the two games can be ignored by central decision-makers, so long as their countries remain interdependent, while at the same time trying to maintain their sovereignty

The theory proposes that there be a platform for each of the political leaders with their diplomats and international advisors negotiating against a number of foreign counterparts. Around the domestic table behind him sit party and parliamentary figures, spokespersons for domestic agencies, representatives of key interest groups, and the leader’s own political advisors to give the necessary support and enable wise decision making consultatively.

There are powerful incentives for steadiness between the two games where economic players will tolerate some differences in rhetoric between the two games, but in the end either energy prices rise or they don’t. On occasion, however, clever players will spot a move on one board that will trigger realignments on other boards, enabling them to achieve otherwise unattainable objectives that are beneficial to their own team and hence their home economy

Benefits of Adjusting International trade Restrictions

The 2008 index of Economic Freedom published by the Heritage Foundation ranks the USA as the fifth freest economy in the world; a dimension in the index showing the extent to which international trade is free of government interference. USA can be regarded as a world leader when it comes to facilitating free trade but it is still not top ranking. For the purposes of the promotion of political cooperation and stability within its states, USA made free trade part of its foreign policies after WWII.

However, the commitment to international trade by the US government has seen a pattern of repeated forms of protectionism in free trade that has had negative effects both domestically as well as with the international community. Protectionist sentiments in the USA seem to be propagated again and this is manifested by the many bills before the Congress that are viewed in a way to reduce laissez faire. The Congress is looking to curtail free trade in different industries and with different countries and the stalling debate and ratification of free trade agreements (FTAs) that the administration had laboriously negotiated with key trade partners in Latin America and Asia is a sign.

Furthermore, Congress is putting the final touches on a $300 billion farm bill that is proving to be the “costliest in history” and that WTO trade partners consider the main obstacle to completing the Doha Round of multilateral trade negotiations. All this while the rest of the world is moving forward and negotiating FTAs with or without the USA. There are currently 380 FTAs worldwide and the USA is a member of only about ten and this is reason for concern considering that about half world trade takes place within FTAs (Trading Without America, 2007). Nations of the world have been trading in goods and services with each other since the dawn of history; in modern times, and especially since the establishment of General Agreement on Tariffs and Trade (GATT), multilateral trade has flourished and produced economic prosperity and political stability among trading partners.

The end result of the trade has seen the interest of many countries wanting to be a part of the trading nations as they are beneficial to only involved economies. They thus intend to petition for membership in international trading blocs having the considered the benefits against the level of control that they are subjecting themselves to the rules developed by foreign nations governing the operations of international trade. There are some considerations where trade has not been deprived of indescribable outcomes, inadequate cooperation with regard to certain protected industries, and painful socio-economic dislocations within domestic economies, yet, in spite of these shortcomings, trade has advanced steadily. At times the trade has advanced at a higher pace than expected and hence created an awesome outcome where the growth of world trade outpaced the growth of world economy.

Growth in trade and economic output proliferated to developing countries whose economies actually grew faster than the developed countries strengthening investor confidence, elevating stock market values to historic levels, and lowering the spread in interest margins between emerging market bonds and those of developed countries. Foreign direct investment capital flows reached $1.23 trillion in 2006, the second highest ever, and global liquidity increased foreign exchange reserves and enabled governments to expedite public debt re-payments. Recent data show that the situation in the USA is equally attractive where in 2007, US exports reached a record $1.6 trillion. This is up 12.6 per cent from 2006 and the 2008 numbers are equally impressive with a third of agriculture output and 20 per cent of manufactures exported internationally due to the economy’s competitive advantage.

References

Dunkley, G. (2003). Free trade: Myth, reality, and alternatives. London: Zed Books

Hickok, S. (1985). The consumer cost of US trade restraints. Quarterly Review, Federal

Reserve Bank of New York. New York, NY, pp. 1-12.

Lovett, W. A., Brinkman, R. L., & Eckes, A. E. (2004). U.S. trade policy: History, theory,

and the WTO. Armonk, NY

OECD (1985). Costs and Benefits of Protection, Organization for Economic Cooperation and

Development. Paris.

Tarr, D.G. and Morkre, M.E. (1984). Aggregate costs to the United States of tariffs and

quotas on imports: General tariff cuts and removal of quotas on automobiles, steel,

sugar, and textiles. Bureau of Economics Staff Report to the Federal Trade

Commission. FederalTrade Commission, Washington DC.

Trading Without America (2007). Review and outlook. Wall Street Journal. August 7, p. A10