Immersed in the globalization era, the world has experienced important changes. There has been a significant increase in the number of traded products and materials, a higher degree of foreign direct investment, a faster diffusion of knowledge and information through communication technologies, free movement of financial capitals and so on. Referring specifically to trends in trade, there has been since the 20th century a considerable expansion of the volume and diversity of tradable goods (Ortiz-Ospina et al, 2018). It all sounds great and desirable. But has it really been so? For example, how much of all this trade been translated into economic growth? Have all countries, either big or small, developed or developing, been winners of an increase in the international trade? These are not new questions, economists have been trying to answer them for a long time, but there is still no definite answer and no consensus among authors. The fact that there is so much debate and a large amount of empirical research in this area, indicates that there is still doubt on the accurateness of the prevailing approaches. It is interesting that on one hand there is the theory, i.e trade models based on a different set of assumptions, that indicate that trade is beneficial, but on the other hand, there is full set of contradictory empirical evidence.
Even when there is empirical evidence, that has studied the relationship between openness and growth and has found a positive relationship between the two variables, it is important to be aware that there has been a lot of criticism to the different methodological approaches used in empirical papers, making some results not so convincing due to how the econometrical model was designed (for example because of the sample of countries selected, the indexes of trade restrictions and other indicators used, the control variables included and so on). The latter indicates that referring to the empirical evidence to defend that trade liberalization enhances growth it is not a strong argument, since an evaluation of the methodology used is also important. Skeptic authors such as Rodrik and Rodriguez (2000) did an exhaustive evaluation of some of the most influential papers on the topic such as Dollar (1992), Sachs and Warner (1995), Ben-David (1993), and Edwards (1998). The authors wish to show that “the strong results in this literature arise either from obvious mis-specification or from the use of measures of openness […] When we do point to the fragility of the coefficients,
it is to make the point that the coefficients on the openness indicators are particularly sensitive to controls for these other policy and institutional variables” (p.315).
The argument presented in this essay is not that trade liberalization will never enhance growth, there are cases in which it has without a doubt done so. Probably the best example would be China. This country opened to trade and experienced an important economic transformation since the 1980s and early 1990s, all of which was possible due to a strong competitive advantage in labor-intensive goods (Lardy, 2003). At first, the exports were concentrated on agricultural goods and petroleum and its products and then there was a shift to manufactured goods. Growth in exports has been due to labor-intensive manufactures such as textiles and apparel, footwear and in the last decade consumer electronics. This goes in line with what trade models, such as the Ricardian model, predict. This model, states that each country will specialize in those goods in which they have a comparative advantage.
Continuing with the case of China, it was evident how trade liberalization was a key element for economic growth. Just by observing income data, it is noticeable that their income has been increasing specially since the 1980s. Even when authors such as Feenstra and Taylor (2014) explain that one lesson derived from the Ricardian model is that “the only way that a country with poor technology can export at a price others are willing to pay is by having low wages” (p.45), they follow their argument by explaining that actually the wages will rise accordingly to the development of the technology and make reference to the example of China whose income per capita went from around $755 in 1978 to $7437 in 2010. This argument is also supported by Grossman and Helpman (1991) and Romer and Rivera (1990). They argue that there exists a positive impact of commercial liberalization on technology which at the same time has a long run impact on growth. The main reason why, is because it allows input import and therefore the introduction of new technologies, an increase in market size, in yields of innovation and in production in general.
But does this work for everyone? Can all countries be like China? Probably not. The fact is that no other country has China’s characteristics, specially when it comes to size. China accounts for 20% of the world’s population, it is more than four times the size of the United States and about three times the size of the European Union (Venales and Yueh, 2006). It is probably very hard to compete with such a large country. Different authors have addressed this issue, as Venables and Yueh (2006) in their article ‘the China Effect’. They provide an explanation of how China has benefited the globalization process but at the same time it has increased challenges for economic structures and competitiveness in many other countries. The authors continue by providing a very interesting explanation on how China’s growth has affected other economies. The argument is that as China shifts global supply and demand for goods, services and assets, making other countries fall into an adjustment process, where both ‘quantity effects’ and ‘income effects’ come into play. Among the quantity effects there is an expansion or contraction of certain sectors, implying that there will be a need of reallocation of workers, which happens to be costly (although temporary specially if the country is under full employment). Income effects on the other hand, involve changes in the terms of trade of a country, defined by the authors as the relationship between export and import prices. Particularly, there will be benefits if the prices of exports increase relative to those of their imports but if the opposite happens, then the country will be affected. This way, if China for example increases oil and other commodity prices and reduces manufactured goods prices, then the income of commodity exporting countries will rise and will decrease for commodity importing countries. Hence, the answer of which countries gain or lose from the changes caused by China will depend on whether they are exporting the same goods as they are or importing them. To mention an example, in some Latin American countries, namely Chile, Costa Rica and El Salvador, around 60-70% of exports are threatened by China’s rise, due to the similarities in their exports (Venables and Yueh, 2006).
In comparison to China, the countries mentioned before are very small. It is therefore interesting and important to analyze if trade liberalization is the best strategy a small economy can follow. Rodriguez and Rodrik (2000) make reference to this matter and they explain that the theory of trade policy for a small country has particular characteristics. First of all, under externalities or other market failures, the effect of a trade restriction can in fact be an increase in real GDP. Also, in standard models where the technological change is exogenous and there are diminishing returns to reproducible factors of production, there is no long-run effect of trade restrictions over the rate of output growth, which holds regardless to the presence of market imperfections. However, there might be growth effects as the economy moves into the steady state, which could be either positive or negative (which means that having restrictions is not necessarily harmful). Lastly, even when models with endogenous growth conclude that less trade restrictions enhances output growth in the world economy as a whole, a subgroup of countries could go through diminished growth, depending on the technological development and the initial factor endowments. In fact, under endogenous growth, trade restrictions can even lead to higher growth rates if the restrictions imposed encourage technologically dynamic sectors (Rodriguez & Rodrik, 2000).
What the latter implies, is that there is not automatically an unambiguous and negative relationship between growth rates and trade barriers. As the authors argue,
in the presence of certain market failures, such as positive production externalities in import-competing sectors, the long-run levels of GDP (measured at world prices) can be higher with trade restrictions than without. In such cases, data sets covering relatively short time spans will reveal a positive (partial) association between trade restrictions and the growth of output along the path of convergence to the new steady state (Rodriguez & Rodrik, 2000,p.268).
Relevant to mention as well is what happens to innovation. Several authors state that trade liberalization does not always increase innovation. The latter probably means, that trade liberalization’s positive impact on technology is not as high as expected in certain cases and the consequence of the Ricardian model that technological progress will benefit workers through higher wages might not always hold. An increase of innovation in fact only happens if the forces of comparative advantage lead the country’s resources towards activities that generate long-run growth (achieved through better quality and more variety of products, more research and development), authors such as Grossman and Helpman (1991), Feenstra (1990) and Matsuyma (1992) (all mentioned by Rodriguez and Rodrik 2006) specify cases where a country with low technological development can be pushed by trade to concentrate in certain traditional goods and can as a result experience a decrease in its long-run growth rate.
This argument can be complemented by what is known as the Prebisch-Singer hypothesis, which refers to how the relative price of primary commodities (with respect to manufactures) have a downward trend. Prebisch and Singer were mainly concerned about the gap in per capita income between developed and developing countries and the relationship this problem had with international trade. One important conclusion is that “international specialization along the lines of “static” comparative advantage had excluded developing countries from the fruits of technical progress that had so enriched the industrialized world” (Cuddington, Ludema and Jayasuriya, 2002, p.2). The latter means that because developing countries tend to specialize in the production and export of primary commodities, the technological progress tends to be concentrated in this industry. These two elements combined with a decreasing relative price of primary commodities, will give these countries only a small benefit from the technological progress and will make them lag behind the industrialized ones. As one of the most relevant conclusions, Prebisch states that the only way Latin American countries (as it was the region he concentrated on) can fully benefit from technological progress is by industrialization (Cuddington, Ludema and Jayasuriya, 2002, p.1). It is interesting to notice that this was a conclusion made in 1950 and now, 68 years later, growth in Latin America still leaves a lot to wish for and that maybe it would be a good idea to re-think a model similar to the Import Substitution Industrialization model as an alternative to the neo-liberal policies that have been applied ever since, because it can be argued that there have been only relatively small benefits for the region. The application of the “good policies” that the developed world recommended have not been as fruitful as expected.
According to Chang (2003), among these “good policies” we have the liberalization of trade, investment, privatization and deregulation, as well as conservative macroeconomic policy. Quite ironic as this author explains, is the fact that when the now developed countries were going through the developing phase, they did not use the policies that they now recommend. An example of strategies that they did use back in the day was the infant industry promotion. Britain in the period 1721-1876 “actively used infant industry protection, export subsidies, import tariff rebates on inputs used for exporting and export quality control by the state”(Chang, 2003, p.24). It was just after this period that free trade came in, but it is important not to forget that the country’s technological lead, which came after a period of high and long lasting protectionism, allowed the successful shift towards a free trade regime. So why is then the idea of free trade as a key element for growth and development so diffused and believed? List wrote in 1885, that
Any nation which by means of protective duties and restrictions on navigation has raised her manufacturing power and her navigation to such a degree of development that no other nation can sustain free competition with her, can do nothing wiser than to throw away these ladders of her greatness, to preach to other nations the benefits of free trade…
(List, 1884, pp. 295-296 in Chang, 2003, p.25)
Over a century later, it seems like it is exactly what the developed world has been doing. There are good reasons to believe that they have actually benefited from the developing countries. It is important to keep in mind that free trade is not the same as fair trade. All the under-priced goods that are to find in developed countries, often come from a developing country with real people receiving low unfair salaries. There is certainly no “catching-up” process happening, which indicates that trade liberalization has not meant for many countries ‘miraculous growth’ as it did for China, specially when the country is behind in technological development and if their initial comparative advantage is in non-dynamic sectors.
The benefits that trade brings depend on the characteristics, both internal and external of the country in consideration. It doesn’t imply be any means that developing countries should be closed to trade, but that before countries are able to benefit fully from the benefits free trade can bring, there has to be a strong and clear development strategy that will probably require at first, certain degree of protection, for example to infant industries, in order to start a proper catching up process and start closing gaps between countries.