The free trade myth, explains IIFT’s Rakesh Mohan Joshi

September 11, 2020 7:15 AM

Trade decisions taken and implemented by political leadership are primarily based on an overall assessment of geo-political and economic situation

Therefore, all countries must promote free trade and barriers of all sorts must be eliminated at all costs.Therefore, all countries must promote free trade and barriers of all sorts must be eliminated at all costs.

By Rakesh Mohan Joshi

Most erudite economists and trade theorists would love to hate my concept even if I am spared, as they have spent their life researching free trade doctrines; making use of complex mathematical modelling and econometric tools to prove that free trade is beneficial for the ‘welfare’ of the economies, the ‘world’ or the ‘nation’. Ever since British economist David Ricardo spelt out the theory of comparative advantage in the early 1800s, most economists believed that countries gain more than they lose when they trade with each other and specialise in which they are most efficient or comparatively more efficient. Therefore, all countries must promote free trade and barriers of all sorts must be eliminated at all costs.

Initially, trade theories were employed to justify the production and marketing of the output of mass-production following the industrial revolution in Britain, other parts of Europe and the US. These deliberately kept the rest of the third world agrarian, labour intensive, low skilled production bases that largely benefitted industrialising nations so that their products may be sold at relatively higher prices in foreign markets.

The whole phenomenon of high-tech production in developed countries and labour-intensive low- end mass production in developing and third world countries was further justified by robust theoretical concepts of ‘life-cycles’, ‘product life cycles’ and ‘technology life cycle’. This ensured mighty economic powers such as the US, the UK, Japan, France, Germany, etc, could reap hefty margins based on their skills, innovation and brand value.

Fundamental economic trade theories of absolute advantage, comparative advantage or factor endowment, promulgate free trade to achieve factor efficiencies and promote free trade for economic welfare and growth. A considerable rise in the cost of production in high-income countries, including the US and Europe, led to a shift of manufacturing facilities in locations with a relatively cheap cost of factors of production, especially labour, such as China, India, Vietnam, Malaysia, Bangladesh etc. These developing countries could carry out labour-intensive production activities more efficiently, as they possessed comparative advantage due to the abundance of a less-educated workforce. In return, these countries would buy more of the high-value goods made by skilled labourers for which the US and other high-income countries have a comparative advantage. The shift of production locations from high-income countries to lower-cost locations led to considerable job-cuts in high-income countries. But such lost jobs are more than offset when countries specialise, leading to more robust exports and lower prices on imported goods. But, in reality, the trade deficits of the US and the UK in 2019 burgeoned to $923 bn and $224 billion, respectively, whereas China became the world’s largest exporter with $2.5 trillion exports, accounting for 13.3% of the global share in exports and an impressive trade surplus of $430 billion. On the other hand, India’s exports hovered around $300 billion, and the share has been 1.7% in the world exports for the past decade.

China, despite historically being a non-market economy grew at a double-digit rate since 1961 for 22 years with a peak of 27.27% in 1970. China’s share in world exports grew from merely 0.9% in 1948 to 13.3% by 2019. China virtually emerged as the ‘Factory of the World’ with 28.4% share in world manufacturing in 2018, far ahead of the US (16.6%), Japan (7.2%) and Germany (5.8%). In contrast, India’s has a meagre share of 3% in global manufacturing.

The US and other countries are now beginning to feel the heat of imported Chinese products that have flooded their markets. In Times Square, the iconic hub of economic activity in the city of New York, it is extremely difficult to find mass-merchandise with a ‘Made in America’ label.

Despite much-hyped free-trade doctrines, since independence, beginning from the Nehruvian era, India’s trade strategy has largely been inclined towards import substitution rather than export promotion. India followed a strong inward-oriented policy to preserve foreign exchange. The prime objective of India’s industrialisation revolved around the fundamental objective of import-substitution to become self-reliant. The policymakers believed that this would make India the world’s leading exporter with a comfortable balance of trade.

Moreover, right-wing political parties across the world have historically thrived on ‘making their countries great’ by following nationalistic protectionist trade policies. India is already on the path of being ‘Atmanirbhar’ (self-reliant) under the leadership of prime-minister Modi. The political leadership of Europe is not far behind in competing against each other to protect their national interests and curb the imports. China has long been a closed, non-market economy, far from transparency.

Trade decisions taken and implemented by political leadership are primarily based on an overall assessment of geo-political and economic situations of their counties and national interests, rather than the research outputs based on complex mathematical models emanating from a theoretical framework. This unambiguously brings out an explicit disconnect between theory and practice, which calls for introspection.

The author is Chairperson (Research), Indian Institute of Foreign Trade

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