Thursday, November 8, 2007

Fair trade

Charlton and Stiglitz's Fair Trade was an interesting counter-point to advocates who favor opening up all markets. For instance, Stiglitz and Charlton distinguish between trade openness and trade liberalization:

There is a difference between trade openness (the state of having low barriers to imports) and trade liberalization (the process of reducing those barriers). Trade liberalization is supposed to deliver gains as resources are transferred from protected sectors, in which a country does not have comparative advantage, to those sectors where it is more efficient and where it can export more successfully. But in developing countries, the lack of resources (labor and other production inputs) available to new industries is not usually the constraint which prevents the growth of new export sectors. Developing countries have vast reserves of resources, particularly labor, which are already unemployed or underemployed. Thus trade liberalization is not required to 'free up' these resources for use in new industries. (p. 6)

They also note why gains from liberalization are likely to be small:

The fact that implementation and adjustment costs are likely to be larger in developing countries, unemployment rates are likely to be higher, safety nets weaker, and risk markets poorer, are all facts that have to be taken into account in trade negotiations. For some of the smallest and poorest states, the adjustment costs of trade liberalization may significantly outweigh the benefits available. (pp. 8-9)

Surprisingly, they attack the gains from free trade not in terms of its effects on growth (which I consider the econometric evidence to be weak in the first place) but in terms of its purported efficiency gains:

Most traditional arguments for free trade are, however, based not on growth but on efficiency, i.e. liberalization leads to a change in the level of welfare rather than any change in the long-run rate of growth. ... However, the underlying assumptions which yield that conclusion are highly restrictive and often fail to capture relevant features of developing countries' economies. The standard argument in favor of trade liberalization is that it improves the average efficiency in a country. Imports from foreign producers may destroy some inefficient local industries, but competitive local industries are supposed to be able to absorb the slack as they expand their exports to foreign markets. In this way, trade liberalization is supposed to allow resources to be redeployed from low-productivity protected sectors into high-productivity export sectors. But that argument assumes that resources will be fully employed in the first place, whereas in most developing countries unemployment is persistently high. One does not need to redeploy resources to put more resources into the export sector; one simply needs to employ hitherto unused resources. In practice, trade liberalization often harms competing local import industries, while local exporters may not automatically have the necessary supply capacity to expand. ... Unfortunately, most of the models which attempt to address questions of welfare gains from trade liberalization assume full employment, and therefore provide no answers to this key question: the impact of liberalization in economies with underutilized resources. (pp. 25-26)

A second assumption of the model underlying the conclusion that trade liberalization is welfare enhancing is the existence of perfect risk markets. ... Without trade, producers are insulated from the full force of output fluctuations by built-in insurance: if there is a reduction in the quantity of output firms can produce, then they can charge a higher price for it. Thus their incomes vary less than output. Because their incomes will be more variable, risk-averse firms will invest less in some sectors with high returns but high variability; and as the economy moves into lower return, less variable activities, total output will decline. Under quite plausible conditions, one can show that free trade is Pareto-inferior to autarky - everyone is worse off - which is just the opposite result to that of the conventional wisdom (Newberry and Stigltiz 1984). (p. 26)

Not unexpectedly they also attack the use of CGE models:
Most of the tools used to analyse general equilibrium effects of trade liberalization are static models. They describe the movement from one 'steady state' to another but do not incorporate the costs associated with transition of the consequences for economies which are initially out of steady state. (p. 69)

This book has plenty more including arguments against TRIPS and TRIMS which while interesting in their own right made for rather dry reading. It felt as though the more "colourful" parts of the books were written by Stiglitz (few passages) and the more technical aspects of WTO, TRIPS and TRIMS (substantial amounts) were written by Charlton.

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