GUARDIAN (London) | August 30, 1999 | by Larry Elliott
Were a modern day Moses to come shuffling down off the mountain with the 10 commandments of economics, at the top of the list would be: thou shalt believe in tearing down all barriers to trade. There may be doubts in some quarters about whether it was wise to privatise the railways or remove all curbs on capital flows, but it is a truth universally acknowledged that trade liberalisation is good for growth.
Yet orthodoxies are there to be challenged and, with the World Trade Organisation about to embark on a new round of liberalisation later this year, it is worth testing the proposition that all policymakers should be gung-ho about embarking on further liberalisation.
As every tiro economist knows, the theoretical basis for trade liberalisation is David Ricardo's notion of comparative advantage: the idea that countries should specialise in what they do best (or least badly) and then exchange the fruits of their expertise through trade. Ricardo showed that all countries would benefit if they cut tariffs, which were widespread when he was writing in the first half of the 19th century.
Like any economic theory, Ricardo's comparative advantage was hedged around with assumptions and qualifications; so much so that it could be argued the preconditions for perfect free trade never apply in the real world.
No matter, say Ricardo's disciples, there is plenty of evidence that protection is bad for you, and if protection is bad for you then free trade must be good. QED. The most famous example of this is the Smoot-Hawley tariff in the United States in 1930, blamed for turning the stock market crash of 1929 into the Great Depression. What's more, countries that liberalised trade have grown much faster than those which have remained stuck behind tariff walls; witness North and South Korea.
Let's take the three points in turn. Even with all the qualifications, Ricardo was right to say that trade is better than no trade. There may be some ecological purists who argue for total self-sufficiency, but one has to assume that they never eat a Caribbean banana or enjoy a glass of French wine. More seriously, the economic historian David Landes notes in his book The Wealth and Poverty of Nations that one advance in health was the replacement of woollen underclothing - which was difficult to wash and trapped disease - by cotton garments. Wool was plentiful in Britain; cotton came from India or America.
It is, however, quite a jump from saying that trade can be beneficial to asserting that any attempt to regulate, manage or limit trade is harmful. Between 1920 and 1930 the average tariff on imported goods in the US was raised from 16% to 40%, so if protectionism is bad the result should have been sluggish growth. The 1920s in America saw manufacturing output rise 64% and output per worker up 40%. Between 1922 and 1927, the economy grew 7% a year.
The Smoot-Hawley act raised the average tariff still further, to 59%, but why should this have been disastrous for the economy when the increase in the 1920s was not? The answer is it was not higher tariffs that caused the depression but misguided monetary and fiscal policy. Between 1929 and 1933, US GNP fell from $104bn to $56bn, a huge reduction. Of this fall of $48bn, $47.3bn was the result of lower domestic spending and $700m came from a drop in net exports.
Still, that's ancient history. In the modern world the idea that trade liberalisation leads to higher growth looks empirically sound. The OECD, for example, said last year: "More open and outward-oriented economies consistently outperform countries with restrictive trade and [foreign] investment regimes."
In the light of this widely held belief, new work from two American economists - Francisco Rodriguez of the university of Maryland and Dani Rodrik of Harvard - is illuminating. They found scant evidence to support the view that cutting tariffs and removing protectionist measures boost economic growth.
The two argue in a discussion paper for the Centre for Economic Policy Research* that there are weaknesses in the seminal 1995 work by Jeffrey Sachs and Andrew Warner on the benefits of trade liberalisation. Sachs and Warner classified 79 countries in terms of lack of openness, but this was a composite measure which included important factors in addition to high tariffs and non-tariff barriers. Rodriguez and Rodrik say that it is these other factors - particularly the state monopoly on trade for African countries and the thriving black economy for the national currency - which were linked to growth rates.
"Our bottom line is that the nature of the relationship between trade policy and economic growth remains very much an open question. The issue is far from having been settled on empirical grounds. We are in fact sceptical that there is a general, unambiguous relationship between trade openness and growth waiting to be discovered."
Rodriguez and Rodrik do not say protectionism is good for growth but their findings are important in the light of the pressure for countries to liberalise, especially since many western nations industrialised behind high tariff walls.
There is a world of difference between the US in the 1920s, when a high tariff was combined with ferocious internal competition, and North Korea, where protectionism is combined with an absence of internal competition. Protectionism can be bad for growth but only if accompanied by other harmful economic policies.
However, even if there is no cast-iron link between trade liberalisation and growth rates, there could be benefits to consumers that make the process worthwhile and reasons to support a rules-based system which prevents powerful countries from riding roughshod over the weak and small.
Again, the reality falls short of the rhetoric. A report by Consumers International, an umbrella body for consumer organisations around the globe, concludes that the last package of liberalisation measures "reaped results only for a handful of multinational companies and has not improved consumer rights. Throughout the world, consumers are finding that the threat of trade sanctions is being used to dismantle consumer protection in favour of corporate rights."
The report cites the case of Thailand, which banned the import of foreign cigarettes on health grounds and then had the embargo challenged by the US. Despite evidence from the World Health Organisation that, once the market was opened, the US multinational tobacco companies would do their utmost to force governments to accept terms that undermined public health, a WTO disputes panel ruled against the Thai ban.
This is the Landes argument turned on its head, with the impact of trade being bad rather than good for health. It is easy to see why multinationals want to remove trade restrictions, and they see the WTO as the instrument for doing so. The last round of talks was skewed heavily in favour of rich western nations.
The Consumers International report says this is not the way it was meant to be and that before any further liberalisation there must be systematic reform of the WTO, including greater input by non-governmental organisations and an equal participation in negotiations by all countries, coupled with safeguards in areas such as food security, health and competition. As the furore over genetically modified crops indicates, the mood is changing. Consumers are getting wary. They don't believe that what is good for Monsanto and Philip Morris is necessarily good for them. They are right.
* Trade Policy and Economic Growth: a sceptic's guide to the cross-national evidence; CEPR, 90-98 Goswell Road, London EC1V 7RR; #5GUARDIAN (London):
