Trade has never been freer than it is today

Neither Brexit nor the election of Donald Trump nor the sealing of EU borders will result in a retreat from globalization. Free trade and international investments are flourishing, says Professor Douglas A. Irwin.
Trade has never been freer than it is today

(private archive of Prof. Douglas A. Irwin)

CE Financial Observer: One of your books is entitled “Free trade under fire”. I have ordered it at one of American online stores and no one will probably try to stop me from buying it. Isn’t this a proof that the attack against trade isn’t effective?

Professor Douglas A. Irwin: Indeed, the title of the book slightly exaggerates the scale of the attack against free trade or, more generally, globalization. The acceptance of free trade on the international level is common in most developed societies. That is why some of the important events of recent years, such as Brexit, or the election of Trump as president, are incorrectly identified as arising from the opposition to globalized trade. The British want a common market, but they have a problem with the European Union’s migration policy. Trump devotes a lot of attention to criticizing certain aspects of international trade, but he hasn’t withdrawn from the NAFTA agreement, even though he could have. Why? Because Americans, his voters, know that they are profiting from good relations with Mexico. He will not shoot himself in the foot.

So, you’re optimistic after all? In that case, why is the perception of global capitalism as a “besieged fortress” so common among so-called libertarian circles?

This may in part stem from the fact that people support the status quo rather than further progress and the creation of additional facilitations for trade. This is manifested in the resistance against new trade agreements, for example against the signing of the Transatlantic Trade and Investment Partnership (TTIP) between the United States and the European Union. This is due to the fact that such agreements regulate issues which are actually fairly distant from trade – intellectual property law, regulations concerning industries such as pharmacy, health care, resolution of disputes, etc.

Today trade agreements are no longer about reducing the already low tariffs, but rather about the governments reaching an agreement in complex regulatory matters. And people fear that these decisions may be disadvantageous to them, because they are supposed to benefit specific interest groups, and not the citizens.

In other words, resistance against further liberalization of trade is to a large extent the result of the excessive regulatory activities of the bureaucrats. Let’s not forget, however, that when it comes to the actual level of trade freedom, we’re living in an exceptional era. Never before, in the 200 years’ history of capitalism, has there been a period so open to international trade, investment or even economic migration as today. The process of opening up of national economies began after the World War II and still continues. And the places where this process hasn’t occurred are rife with poverty.

And yet, some are asking whether this is a good direction and pointing out that, for example, the United States applied import duties and practiced protectionism in the 19th century – a period when the country was developing so fast. If such a giant built its current strength in this way, then maybe it is worth learning from that instead of blindly following the free market trend?

Although the American economy grew fast in the 19th century, it was certainly not because of tariffs and protectionism. We were open to foreign investments and to immigrants, many of whom were specialists in their respective fields, bringing in the know-how and new technologies. If some innovation appeared in Great Britain, then within half a year it was also developed in the United States.

It is true that the United States imposed customs duties, but that only applied to a limited set of imported goods: the industrial goods that were also produced on the domestic market. However, no duties were imposed on the goods that we weren’t producing ourselves. Did this policy expand our GDP? No. The United States underwent industrialization in the 1840s and 1850s, that is, before the Civil War, when the tariffs were very low. The pace of industrialization did not change after the war, when the tariffs were high because the government raised them in need of funding for military expenses.

So the economists who claim that protectionism has turned the United States into an industrial power are stretching the truth?

Of course. At the end of the 19th century, the service sector in the United States grew, transport improved, banking developed – which became the driving force for enormous productivity gains in the economy and was completely unrelated to tariffs. Another thing that contributed to growth was very good education and that also had nothing to do with protectionism.

As a rule, customs duties are potentially harmful, and the ones that we imposed on certain products did not hurt us only because we were already a large developed market, and others did not really have much of a chance to compete with us, even without those tariffs. If you started to apply classical protectionism, for example in Poland, i.e. a country with a relatively small market, you would end up with stagnation and growth below your potential, and your companies would never achieve high competitiveness.

And what about non-classical, more subtle, modern type of protectionism, based on government support for selected industries? Some people believe that, for example, South Korea is evidence that such a model can work.

It cannot be ruled out that if the government starts transferring money from the economy to a selected industry it will make it strong – at least in terms of production and export volumes. Bu will it make it more competitive? In my opinion, the history of South Korea does not provide clear evidence that some claim. The economy of that country started opening up to the world in the 1960s and the industrial programs began to be launched on a larger scale only in the 1970s, that is, after the previous opening that gave Korea an impulse for growth.

What’s more, Korean economists claim, for example, that in the 1980s, when the authorities began to shift the economy from the production of labour-intensive goods towards heavy industries and capital-intensive goods, the country’s growth rate suffered, because these sectors were not particularly competitive.

But in the end they became competitive.

Yes, but that came at the expense of other industries that have not developed as much as they would have otherwise. In Korea, however, the authorities at least ensured that companies obtaining support from the state invested it in genuine modernization. In the context of South Korea we should also keep in mind that one reason why its industrial policy was not a complete failure was also the fact that for decades the country was run by the military. This minimized the influence of interest groups outside the military on the pursued industrial policy. This would not work in corrupt countries such as Thailand or countries of Latin America, or in democratic countries subjected to the influence of lobbying groups.

Many economists, such as Professor Dani Rodrik from Harvard, emphasize that in the 21st century it is clear not only that globalization has both winners and losers, but also that something must be done about it. Do you agree?

Well, this is not a particularly original thought. This has been clear for centuries. Let’s take, for example, the laws regulating grain trade in Great Britain in the 19th century. Adam Smith supported their abolition and the liberalization of trade, because he believed they harmed ordinary people, and not that their abolition would make everyone richer. On the contrary – the groups that were set to lose on these changes were the aristocracy and the landowners, i.e. the wealthiest that lived at the expense of ordinary people. Free trade was therefore supposed to help the poor.

Currently, however, globalization is also hurting those less affluent. Let’s take taxi drivers who compete with companies like Uber. Their earnings have to fall, and no one would say that taxi drivers are a wealthy ones, right?

Yes, and that’s why it is important to compensate people for the shocks caused in the labor market by access to the global market. Internal social policy is important in this regard.

Which ties in with what Rodrik is saying.

Yes. However, the fact that global free trade does not always provide equal and immediate profits for all, and that sometimes it even results in temporary relative losses for some, should not lead us to the conclusion that it should be somehow limited. We should focus on creating an environment for the growth of a healthy and dynamic global economy and assist its participants when they need temporary help. All this should be done in a sensible manner and at the right pace. Even the aforementioned Adam Smith warned in “The Wealth of Nations” that excessively rapid liberalization of trade may negatively affect certain groups of workers. He recommended caution, but he did not support withdrawing from trading. He knew that in the long-term it is beneficial to everyone.

By the way, it’s good that you mentioned Uber. It seems that we too often blame globalization for certain problems, such as wealth inequalities, while in reality new technologies should be “blamed”. It is not trade, but the new technologies that are currently causing the most painful shocks for some employees. They have more influence than trade with regards to how much money people are making. Therefore, even if we were to limit trade, the technologies would not cease to affect the labor market. Their transfer takes place in a way that cannot be stopped.

Another widely criticized aspect of globalization is that it promotes an unethical way of getting rich. To explain this, Professor Rodrik gives an example of someone who has worked hard all life and achieved success. We accept that. But this person may lose in competition with someone who is outsourcing their hard work, for example, to Bangladesh, and is reaping all the benefits. According to Rodrik, that is difficult to accept.

This view of the world is a little distorted. The global economy is a two-way street and some people tend to forget about that. If some group of people lose their jobs in some country, then at the same time some other group of people find jobs in that same country. If your industry outsources jobs to Bangladesh, then someone else, like the United States, is outsourcing jobs to you, e.g. in services. If we only look at one side of the equation, then our image will always be distorted.

In discussions about globalization we often raise the issue of ethics, saying that workers are getting “hurt” and asking for someone – usually the government – to do something about trade. The problem is that in such a case the government would have to set criteria defining what sort of trade or investment is appropriate, and what sort is inappropriate from the point of view of social costs.

Each product or investment would have to be analyzed in this respect before being introduced to the domestic market. This would lead to absurdities. Trade regulations are necessary, but they cannot turn into arbitrary decisions as to what people should and shouldn’t be doing.

On the other hand, if the regulations are too vague, isn’t there a risk that the domestic economies of smaller countries will suffer? In Poland, it is often pointed out that foreign companies may exploit the openness of our economy in order to transfer their profits abroad. Isn’t this true?

Again, it’s a two-way street. If some foreign, let’s say German, company sells something in your country, then it means that people want to buy it. Let’s assume that the profits from these sales will be invested in Germany. Is it really that bad? After all, there are Polish companies doing exactly the same thing in Germany and other countries: they earn money there and invest it in Poland, right? We cannot judge the functioning of the economy on the basis of individual enterprises or the relations with one country.

In the United States we’re seeing similar arguments. President Trump claims that Americans are losing on the trade with Mexico, because the US has a trade deficit with that country, but he doesn’t notice that America has a positive trade balance with other countries. We should also remember that a country with a healthy economy should be able to attract investments and to encourage companies to reinvest profits there. If that is not the case, then we should think about what is wrong with the economy and not with these companies. After all, we’re not assuming they’re doing it maliciously?

There are many foreign investments in Poland. However, many of them are investments with a relatively low added value, such as assembly plants or call centers. How can we change this model?

We have to think about what the government policy should be in order to make these investments more advanced. The simplest answer is: to raise the qualifications of the workforce through education reform. We cannot force companies to stay and to invest in a given market through regulations or orders. They have to be encouraged by the vision of profits, and that vision becomes real in a favorable environment. I don’t think there is anyone in Poland, any country of the EU or in the United States, who doesn’t know that it is precisely the real answer to most economic ills, rather than trade restrictions or protectionism.

You sound like an economical universalist: one size, one solution for all. Are you one of them?

Of course not! This is a misleading impression. It is always necessary to understand the local context to develop good economic recipes. Take the example of Chile. I have recently returned from there and I have some fresh observations. When it comes to trade policy, it is a very modern and open state, which has signed many trade agreements. However, it has a big problem with social inequality. Can we blame globalization for that? No. It’s a matter of the local education system. Although the Chilean higher education is ranked very high, there is a problem with the low quality of primary education. This impairs the economic prospects of the poorer people from the very beginning.

And yet you’re giving quite general recommendations when it comes to the desired attitude towards global trade.

Well, let me explain again. Economics provides us with a way of thinking about the world, but it does not give us ready solutions to all problems. As emphasized by Keynes, economics is not a doctrine that can be applied immediately, but rather an apparatus for the understanding of the world. So even when I say that the law of supply and demand is so fundamental that it can never be ignored, or that free trade is a great thing, then at the same time I say that every country should apply it in a way that is consistent with its own circumstances at a given stage of development.

Professor Douglas A. Irwin is an economist and a lecturer at Darmouth College in New Hampshire. He is the author of several books: “Clashing over Commerce: A History of U.S. Trade Policy, “Free Trade Under Fire, or “Trade Policy Disaster: Lessons from the 1930s.

(private archive of Prof. Douglas A. Irwin)

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