Tuesday, January 29, 2008

The State of Trade in the Union

Mr. Bush, like a number of other closet isolationists out there called tonight for us to "level the playing field" with respect to trade. Essentially what he means by this is that we should negotiate trade agreements and push other countries to open their own economies to us before we'd be willing to open our own. I think that this is a good idea in principle, and it is a well-documented fact that developing countries (those "cheap labor" countries Lou Dobbs reviles so) have higher levels of trade restrictions than the US and other high income countries. However, making the ultimatum that we will not open if you do not match us misses two important points: First, trade is not a zero-sum game and even unilateral openness improves welfare both at home and abroad, and second, his insistence that developing countries reciprocate ignores the historical foundations of GATT (now the WTO) and the provisions and principles of the treaties on trade entered into by the US since World War II.

I'll pass on the virtues of unilateralism versus multilateralism, because it will bore those who have read past posts on trade. The basic history of trade restrictions in developing countries goes roughly as follows. A lot of people rightly worry that export-biased growth can lead to lead to a secular decline in export prices (a deterioration in the terms of trade), especially for developing countries whose comparative advantage is typically in primary commodities like sugar, coffee, bananas, oranges, or even oil (before OPEC). This deterioration can lead to a welfare reduction for these countries, even when real output (physical quantity of goods) is increasing. This is the basic "Prebisch Thesis." It was thought that restricting trade, and therefore substituting industrial imports from rich countries for domestic production, would help in the industrialization and development process. It was a fancy version of the old "infant industry" argument for tariffs, but it was much more convincing and coherent because the Prebisch Thesis was well supported by empirical evidence. But as with the old infant industries, these babies essentially never grew up. In addition one thing that was neglected was that growth (even in a primary commodity sector) can have the potential of freeing up economic resources to expand and diversify the economy. The eventual result, in the best case scenario, can create enough momentum for a developing economy, that auto makers in India eventually begin outsourcing to the US and the UK (which actually happened a couple weeks ago, by the way).


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