Economists, by and large, love trade. In 2018 the IGM booth panel asked expert economists how they felt about introducing tariffs concerning the trade war. A tariff or duty (the words are used interchangeably) is a tax levied by governments on the value including freight and insurance of imported products. The majority strongly disagreed, while the rest just disagreed. Remarkably no one agreed to the statement. Public opinion, however, paints a different picture. A survey conducted in the same year revealed that only 37% disagreed, while 33% agreed that the new tariffs were necessary. Is it just that most people aren’t fully educated about the economic consequences of trade, or are economists missing something?
Let’s try and dissect why economists love trade. To do that, we need to understand the absolute advantage. A simple example would be country A not extracting oil and country B not growing certain fruits effectively. A, which is good at growing fruit, would trade with B, which has abundant oil. Everybody is satisfied and Gross produce increases. However, what about countries like China. These countries outperform other countries in many industries, so does that mean other countries only buy from China and do not sell anything in return? The buying government would soon run out of money. It simply isn’t possible. What this implies is that in the presence of free trade, industries that are relatively more productive than other industries in the same country will stay. This shift is called comparative advantage and is the central idea behind trade theory.
The Stolper-Samuelson theorem is based on this and has a few clear and encouraging implications. Opening up to trade should increase gross produce in all countries. Inequality should go down in developing countries that are often labour-dependent as labour demand and wages go up. Rich countries will witness increased inequality, but everyone can be better off if the state taxes the winners and distributes that money to the losers. This looks great on paper, but evidence in the real world refuses to cooperate.
Economists often bring up India when they talk about the benefits of free trade. India until 1990 was relatively closed off to trade. However, the Gulf War ignited an oil crisis that forced them to be bailed out by the IMF(International Monetary Fund) on the condition that they open up to trade. The government had no choice. The import and export licensing scheme was abolished and import duties came down really quickly from an average of nearly 90 % to 35 %. For many leading members of the ministry, they had been wanting to do this for a while and they finally had the opportunity to do so.
There were many who predicted this wouldn’t work. The Indian economy being raised behind tall tariff walls was considered too inefficient to compete with the world’s powerhouses. What followed was a temporary drop followed by a return to previous GDP(Gross Domestic Product) growth levels, which went even higher years down the line. On the one hand, the growth weathered the transition smoothly, etching the predictions of trade optimists, but on the other hand, that development took more than a decade to accelerate.
The thing is, there is no ideal control group to compare against. There is only one India with its history and many factors that could have led to such growth. It’s worth noticing that inequality did go up dramatically during this period as well. So when it comes to questions like “Would India getting rid of existing tariffs benefit the economy?” the answer is quite complicated.
Economists have tried using other countries that liberalized around the same period as control groups to compare against. There is plenty of research on this approach and even relevant results. However, it also has its shortcomings. For example, it could be that India liberalized trade when another similar country didn’t because India was prepared for that transition and would have grown irrespective of the trade policy changes. Trade liberalization is one of many contributing factors, making it hard to study its distinct contribution.
Looking at regions within countries reduces the number of possible things going on at the same time. There were some key negative observations in addition to the obvious positive ones.
Districts exposed to trade were more likely to have reduced rates of poverty reduction. Child labour, for instance, diminished lesser in more exposed states. Inequality increased in these districts as well.
However, districts that were negatively affected as a result of trade had it bad in other ways. The China Shock would be a relevant example. This affected many industries in the USA. Leading to the creation of zones called commuting zones. Places whose industries couldn’t compete with their Chinese counterparts. Ideally, you would want people to migrate and skill themselves for other jobs. However, labour markets are sticky. People just don’t move around without good reason. A lot of the basis of comparative advantage just doesn’t hold. The findings here disturbed economists because they indicate that resources and people just don’t move fast enough. Wages aren’t near the same everywhere. What ended up happening was that the working-age population barely decreased in these areas. They just were jobless. Firms kept trying desperately to stay afloat in industries where opening up to trade meant those industries wouldn’t survive. Loan defaults, rising debt, reduced consumer spending, all in all, the entire area becomes unfavourable for business. New firms don’t want to step foot in the place, and many have been reduced to shadows of their former selves tragically.
Public programs should be working at these instances to help the people. But this isn’t the case. Comparing the residents of the most affected commuting zones in the USA to those of the least affected, incomes per adult went down by $549 more in the former. In contrast, government welfare payments went up by only $58 per adult. Programs like the TAA(Trade Adjustment Assistance) in the US work towards this goal by providing financial help to those who need to relocate, retrain or get healthcare, and data shows that they have been surprisingly successful. However, it is severely underfunded and needs to take it to a larger scale.
Two key measures to gauge trade gains for a country are how much is imported and how much tariffs affect this. For a large country with various industries, it’s often the case that aggregate gains from trading are quantitatively relatively small. Countries with a lower import share will naturally be less dependent on trade. With large countries, this can be the case with the right policy. India and China can massively develop their trade gains through better internal integration. The USA and India are shining examples of how extensive railways paved the way for a massive positive shift in trade networks and supply chains. However, trade plays a significant role for smaller nations like Belgium, where the import share is around 30%. When it comes to tariffs, if a product loses demand on a slight increase in tariffs, that’s an indication that there exist suitable alternatives within the country. There isn’t a heavy dependence on the said foreign product. However, if demand doesn’t cease when prices increase, it’s a case of trade giving people access to a product that wouldn’t ordinarily be available.
Trade for all its benefits is a massive shift from the status quo, and we need to address the pain that goes with this need for change, to move, to lose one’s understanding of what is a good life and a good job. Comparative advantage and the shift that ensues is difficult for many people. For larger established countries like the USA, the gains from trade are quantitatively relatively small indeed. More about this can be read in the book Good Economics for Hard times by Abhijit Banerjee and Esther Duflo.
– By Stafan Kuttikal Santhosh, Third Year Department of Information Technology