With the speed of lightning the international order for economic and security co-operation painstakingly built since the Second World War has been exposed to great uncertainty threatening to unravel it. The shock and surprise to observers have been not the least because the assault has come from within. There being no early earning about this potential catastrophe everyone except the architects working surreptitiously outlining the new architecture of the world order of their design, the changes, when announced took the unwary by storm.
First was Brexit, the referendum in the UK in which a slim margin of euro-skeptics voted for withdrawal from the European Union (EU). Shattering as it was for the solidarity of the continent, more ominous was its potential impact on other members nursing their own grievances over EU's overarching goal of ever closer economic and monetary union. No sooner had this shock been reckoned with then came the gadfly of a president in the most powerful country in the world. Donald Trump behaved like an iconoclast from the very beginning of his unconventional presidential campaign threatening to dismantle the existing international arrangements and agreements on trading and security system including climate change on the ground that those were working against his country's interests.
Much to the relief of allies, Donald Trump after becoming president seems to have had a change of heart, perhaps at the nudging of the powerful military-industrial complex and has reiterated his country's commitment to North Atlantic Treaty Organisation (NATO) and other bi-lateral security arrangements though still harping on the old tune of equitable financial contribution by allies.
As of now there has been little sign of any policy shift from the focus of his other bugbear, free international trade. Apart from mild remonstrance to Germany, China, Japan and South Korea to address their huge trade surplus chalked up against America and withdrawing from Trans Pacific Partnership (TPP) Agreement, Trump administration has not yet unleashed a trade war through protectionist measures as was apprehended from his campaign rhetoric. He has, of course, coaxed, even cajoled American companies to shift their operations from other countries back to America and to stop buying parts and materials from other countries following his slogan `Buy American hire American'. As of now the rule-based free trade system is still in place and imposition of protectionist tariff remains a campaign rhetoric. But regaining the lost ground of homegrown employment in many hollowed out sectors from cheaper producers abroad being still an obsession, Donald Trump is not likely to beat a hasty retreat into maintaining status quo. His appointment of bigoted anti-free traders to posts of Trade Representative and Trade Counselor is not indicative of any compromising attitude in this area.
With the threat to the established world order in trade and economic co-operation looming menacingly in the horizon it may be useful to re-visit the theory behind free trade that underpinned trade policy and trading regime in the post-war world. Proving the relevance of theory to policy may modify, if not totally changed the anti-free trade policy of president Trump. The basis of hope is that even though mercurial and idiosyncratic by temperament, he has also proved to be pragmatic when faced with reality. For instance, he no longer maligns China as a `currency manipulator'!
As all economists know free trade theory goes back to the days of Adam Smith ands David Ricardo who argued that countries should specialize in the production of goods on the basis of comparative advantage and trade with each other freely to gain from exchange of goods. But though the Smith-Ricardo demonstration of gains from free trade own approval from majority of economists, it did not always carry conviction with public leaders. To them the argument that free trade based on comparative advantage leads to greater good was counter-intuitive. At present, however, free trade is the target not of intuitive feelings but of growing doubts over the benefit from globalization exemplified mostly by free trade.
There is widespread belief that globalization is the cause of suffering of those who have been left behind and free trade lies at the heart of this malaise. Faced with the critique of free trade, economists have generally reacted with indifference, not too keen to defend its cause. Even Paul Krugman, the Nobel laureate who had earlier been a supporter of free trade has of late expressed his misgivings in one of his news paper column. Jagdish Bhagwati, Krugman's teacher and an ardent free-trader, believes that unless economists confront the misguided (`untutored' in his language) critics, the public policy making will be dominated by the ill-informed and intuitive-minded. Defending the theoretical and empirical evidence in favour of free trade has now become an urgent task, according to Bhagwati. Joseph Stiglitz, another Nobel laureate, and Prof. Jaffry Sachs are doing their bit writing in media but they are out-numbered by critics both among economists and policy makers converted by the former. Bhagwati has lamented, there are not too many of pro-free trade publicists, fighting the polemics for free trade. To complicate the situation the recent international financial crisis and capital flows have become grist to the argument against free trade, conflating the two to-gether.
According to Bhagwati, the original theory behind free trade is irrefutable and as solid as ever. What the critics have missed is that the basic cause of the crisis for free trade is the presence of `market failure' or distortions. He has pointed out that the case for free trade rests on market-determined allocation of resources. If market do not follow the price signal, then its 'invisible hand' may point in the wrong direction and free trade cannot then be the best policy to reap from comparative advantage. If the distortion is in domestic markets that means that a domestic policy, suitably designed and targeted to off-set the distortions could be combined with free trade to produce the best outcome. Bhagwati believes that if the distortion or market failure occur in the external markets, then the suitable policy to off-set it would involve trade (tariff and subsidy) policy.
Though in the later case Bhagwati has conceded to the use of a narrow margin of protection involving a production tax-cum subsidy plus free trade, he has ignored a third possibility. His second prescription (he calls it 'proposition') is not now necessary or even the only option because of the presence of the rule-based trading system established under World Trading Organization (WTO). If a country exports at a price that is lower than its cost of production, not only in its own country, but in countries with similar factor productivity, charges of dumping can be brought to WTO for remedy. This rules out the need for taking protectionist measures by the importing countries.
The theory of comparative advantage as the basis for international trade advocated by Adam Smith and Ricardo can still underpin trade policy if domestic market distortions are addressed by the concerned countries and distortions in external markets are brought up before WTO for arbitration and settlement. The policy makers have to blame market distortions and not free trade par se, and resort to measures available at its disposal domestically and through international arbitration (WTO), depending on the case. The gains and losses from protectionism, on balance will prove the superiority of free trade, provided the market distortions are addressed through available means.
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