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The Tear Gas Ministerial

Free trade truck grinds theoretical gears

by Peter Costantini

Seattle - November 23, 1999

After debating free trade with protestors at a recent forum in Seattle, World Trade Organization (WTO) Director-General Mike Moore lamented: "I thought the case had been made, but I guess we have to back up the truck and explain how we got here."

Riding shotgun on Moore’s truck are the hordes of the dismal science. In the United States, at least, the benefits of free trade are virtually an article of faith for the economics profession. One study found that 97 percent of economists here agreed with the statement: “Tariffs and import quotas reduce general economic welfare.” Tariffs are taxes on imported goods and quotas are restrictions on the quantities of imports.

The theoretical underpinnings of free trade, however, may not be as rock-solid as that figure indicates. So far, no economic Luther has marched up to the Geneva cathedral and nailed heretical theses to the door. But in the wake of five years of crises in Latin America, East Asia and Russia, a growing number of voices are questioning the orthodoxies of bare-knuckle globalization.

The dissenters draw force from substantial empirical evidence that trade, straight up no chaser, is not a panacea. Historically, no nation has successfully industrialized under a regime of unrestricted trade; all have sheltered their nascent industries from foreign competition with tariffs or other barriers.

And in the post-war world, economic growth has tended to contract as free trade has expanded. In the past 25 years of liberalized global commerce, compared with the period prior to 1973 when it was more regulated, productivity and growth rates of industrialized economies have been cut in half. In the developing world, income growth has fared even worse.

Wine and Cloth

The classical case for free trade took shape in 1817 in British economist David Ricardo’s doctrine of comparative advantage. Ricardo argued that nations would reap the most benefits if they specialized in the products in which they had the greatest advantage or least disadvantage compared to other countries.

As England was better at weaving cloth and Portugal at making wine, for example, both would gain more if they concentrated on what they did best and then traded the products with each other than if each tried to produce both goods domestically. Ricardo’s successors elaborated his theory into what they called the “Pure Theory of Trade.”

Comparative advantage originally meant that those who were “relatively most efficient in industrial production (by good fortune Britain) would continue to industrialize,” notes historian Douglas Dowd, “while the most relatively efficient hewers of wood and drawers of water would go on doing just that.” Not surprisingly, the theory has been most popular in the dominant economic powers: Britain in the 19th Century and the United States in the 20th.

In the 1840s, Ricardo's followers promoted the opening of British grain markets in part as a way to alleviate the Great Famine in Ireland. But Irish peasants remained too impoverished to buy even cheaper grain. In free trade’s first collision with skewed income distribution, one million died of hunger and disease.

Even the paterfamilias of free-market economics, Adam Smith, recognized that restrictions on trade in critical sectors such as defense, navigation and public works were necessary for the development of national economies.

In practice, U.S. and German industries in the 19th Century grew behind protective walls constructed by Alexander Hamilton and Friedrich List. In this century, Japan rose to industrial preeminence by using its own brand of market leverage and managed trade. And the newly industrialized countries of East Asia subsidized their adolescent industries and protected them from foreign competition.

On the other hand, free-market nostrums indiscriminately applied have often wreaked havoc. In post-Soviet Russia, “reformers” relied on a draconian version of comparative advantage to eviscerate any industry that could not compete internationally. They managed to demolish half the economy and shorten male life expectancy by eight years. Mexico’s abandoned embrace of world markets helped bring on the 1994 crash of the peso and a savage depression.

Winners and Losers

Specializing according to comparative advantage often makes sense. But the Pure Theory of Trade is based on a bevy of what Dominick Salvatore of Fordham University calls “magnificent assumptions.” It presumes, among other things, that competition is perfect, capital cannot move between countries, and all resources are fully employed.

The benefits of comparative advantage presuppose full employment, says Mark Weisbrot, research director of the Preamble Center in Washington, DC. Otherwise “you can no longer say that each country is made better off through further opening up of trade,” because too many workers displaced from losing industries will end up in worse shape.

The Pure Theory asserts that trade creates enough economic gains so that, if these gains were widely redistributed, everybody would benefit. It never promises, though, that this redistribution will actually occur. “The neo-classical model itself predicts winners and losers in both countries,” Weisbrot insists. In a country like the United States, it would predict that unskilled labor—about 70 percent of the U.S. workforce in this model—would lose. Neo-classical economists do urge that the government step in and provide retraining and subsidies for displaced workers. But in practice, he said, the losers are rarely fully compensated. And what economists call the “negative externalities” suffered by society—families torn apart, communities hollowed out—are not fully captured by the statistics.

In a 1994 speech, President Clinton promised $1,700 more yearly income for the average American family if Congress ratified the WTO treaty. Clinton was finessing the difference between the mean and the median. Political analyst William Greider likens this to promising that if your next-door neighbor wins the lottery, everyone on the block will get richer. Instead, as international trade has grown, gains have gone heavily to the wealthy, while wages and benefits for the majority have stagnated.

Former Treasury Department official William Cline estimated in 1997 that trade was the cause of 39 percent of the increase in wage inequality over the past 20 years. Although he later revised the number downward, he affirmed: “There is in fact a respectable basis in economic theory for the proposition that free trade will undermine real wages of those toward the bottom of the distribution.”

In a much-discussed study, Dani Rodrik of Harvard University focused on “the damage inflicted by global economic integration on broad sectors of the labor force.” Tension has grown between global markets and social stability, Rodrik wrote, because globalization has exposed many workers to competition from labor forces around the world. Meanwhile, international pressures have impeded governments from providing social insurance.

Bananas and Toyotas

Another important problem with comparative advantage is that it is static: it accepts the current balance of power and wealth between countries as a given. Developing nations, it implies, should simply adjust to existing conditions. Dynamic development strategies, by contrast, would attempt to change those conditions.

The way comparative advantage is often applied to poor countries, says Weisbrot, is like telling recent high-school graduates that their comparative advantage lies in flipping burgers at Macdonald’s for the rest of their life. It ignores their potential for growth and transformation.

After World War II, Weisbrot recounts, prominent Western economists told Japan that its comparative advantage did not lie in heavy industry, as it lacked important raw materials like coal and iron. Japanese planners wisely ignored this advice.

Exporting commodities like coffee and bananas or providing cheap labor for assembly plants may be the present comparative advantage of some less-developed countries. But relying exclusively on these sectors can be a trap, according to Richard Brinkman of Portland State University, stunting an economy’s capacity to grow in more productive directions.

The International Monetary Fund constrains many poor countries to concentrate on agricultural exports. But this may reflect what economists call a “fallacy of composition”: what’s good for one is not necessarily good for all. If too many producers try to increase their exports of the same commodity at the same time, the market becomes glutted and prices fall.

A further problem with neoclassical theory, Brinkman asserts, is that it tends to equate simple statistical growth with development. But even when poor countries attain positive growth rates, the majority often remains poor and the economy dependent. By contrast, Gunnar Myrdal, the Swedish Nobel laureate, defined development as “the movement of the whole social system upward.” Even Adam Smith held, in his “productivity doctrine,” that trade ought to raise the level of technology and worker skills.

A more fundamental criticism levied against free trade is that it is not socially or environmentally sustainable. Critics like David Morris of the Institute for Local Self-Reliance argue for local self-sufficiency. They propose giving up some marginal economic efficiency in order to promote more basic human and ecological values.

Managed and Free

Theories aside, say some critics, the most powerful nations and corporations dominate world markets so much that, like high mountains, they make their own trade weather.

“Transnational corporations, particularly the largest, control directly or indirectly over two-thirds of world trade,” asserts French commentator Susan George. “What we call trade is at least one-third IBM trading with IBM or Ford with Ford, and a further third is transnational corporations trading among themselves.” Business consortia like Transatlantic Business Dialogue exert tremendous leverage over government trade decisions and negotiations, she says.

And some of free trade’s strongest proponents practice it only when it suits them. At the same time that the Clinton administration was selling the North American Free Trade Agreement (NAFTA) and the WTO, Greider observes, it was also helping to create a worldwide aluminum cartel that curtailed production and propped up prices.

Unrestricted trade is also intertwined with capital mobility. As Weisbrot points out, multinational firms like General Motors prefer to invest in countries like Mexico where they can easily move parts in and products out. But in the wake of the Asian crashes, prominent economists have singled out financial tsunamis as a contributing factor.

Free-trade luminary Jagdish Bhagwati of Columbia University jarred his coreligionists with a 1998 article arguing that most of the economic justifications for free trade do not apply to international capital movement. And other heavy hitters like Joseph Stiglitz of the World Bank and Paul Krugman of Massachusetts Institute of Technology called the unregulated flow of investment a threat to stability. They even suggested government intervention to discourage short-term capital flows, as some countries like Chile had done. British conservatives John Williamson and John Gray both had public second thoughts about financial laissez-faire, recognizing the power of global capitalism to wreck social cohesion.

This debate came to a head later in 1998 when a Multilateral Agreement on Investment to protect international investors was proposed within the Organization for Economic Cooperation and Development, the club of rich countries. The plan was shelved after a wave of international protests that the treaty would trample on the ability of citizens to control their own economies. But the European Union reportedly plans to introduce revised foreign investment rules at the WTO Seattle ministerial meeting.

Rules and Referees

Beyond direct critiques of comparative advantage, groups concerned with the environment, public health, labor and human rights have criticized GATT and the WTO for the slope of the playing field as well as the fairness of the rules and referees.

“Capitalism is a dynamic system, it produces productivity gains, and eventually people will capture some of those”, says Weisbrot. “The question is: do we want to make the rules of the game such that it takes half a century for them to do so like it did during the Industrial Revolution.”

Is child labor a defensible edge in competitive labor markets or a violation of basic human rights? Are restrictions on hormone-treated beef a restraint of trade or a legitimate consumer protection? These questions cannot be decided on the basis of economic efficiency: they are about what root values should be incorporated into the trading system, and whether standards should be harmonized up or down.

At the crux of the debate are conflicting conceptions of democracy, of how much power citizens should have to regulate their living conditions when they intersect with international trade.

As Jeffrey Garten, former Under Secretary of Commerce for International Trade, asked recently in the New York Times: “How does a sovereign nation govern itself effectively when politics are national and business is global? When the answers start coming, they could be as radical and as prolonged as the backlash against unbridled corporate power that took place during the first 40 years of this century.”

Peter Costantini covered the WTO Seattle Ministerial for Inter Press Service, a newswire based in Rome. An edited version of this piece went out on the Inter Press Service newsire December 1, 1999 without a byline under the headline "TRADE: Free Trade Theory Takes a Beating."



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