Free Trade for Developing Countries - Essay Example

?Free trade has remained one of the most debated topics since the 18th century. On one end of the spectrum are supporters of free trade who justify it on economic, moral and social grounds. On the other end, however, are critics who claim that free trade is not justified on economic and socio-political grounds. A more interesting aspect of these debates, however, is the arguments that concern ‘developing’ countries in particular (as opposed to their developed counterparts). The paper explains both sides of the argument, with the balance tilting in favor of free trade as has been witnessed by economists over the years. Before delving into the arguments concerning free trade in developing countries, it is important to define what exactly free trade is. Free trade refers to unrestricted international trade. In other words, it is trade free from barriers such as subsidies, tariffs, quotas as well as NTB’s (Non-Tariff Barriers) (Neale, 2010). Thus, free trade is based on the principles of free markets and prices under free trade are determined by demand and supply. Furthermore, the principles of Comparative Advantage, as laid down by David Ricardo, govern free trade (Victor, 2002). Free trade assumes perfect information between buyers and sellers and free movement of labor and capital. The arguments that tilt in favor of free trade for developing countries are based on economic, social and moral grounds. This is best illustrated by the case of Jordan and U.S. Jordan is categorized as a developing nation with a limited local market and surrounded by various other developing economies, thus limiting opportunities for its market growth (Victor, 2002). Without exports, there is limited potential for market growth for the country. However, if it enters into free trade agreements with developed nations such as the U.S, it can enjoy access to a much larger market which shall lead to greater utilization of the Jordan’s potential source of comparative advantage than without trade where resources would lay idle (Victor, 2002). To this end, free trade encourages a fuller utilization of a developing country’s resources than would otherwise be possible. Research conducted by Frankel and Romer are suggestive of the fact that free trade brings about a rise in income or GDP whether it is within the region nor international (Victor, 2002). Countries that have large domestic markets tend to support large interregional trade, and thus have higher income levels compared to small countries. These researchers have justified free trade for developing countries on the grounds that the “exports” component of trade proves to be an engine of growth for the country (Victor, 2002). By gaining access to foreign markets, such countries can benefit from increased efficiency due to optimal size of the plant and gains from economies of scale that cannot be reaped from their local markets (Victor, 2002). The theory pertaining to international trade suggests that specialization ought to be done by countries in which they have a comparative advantage compared to their partners in trade. The Factor-Endowment theory proposed by the Heckscher-Ohlin (H-O) model incorporates the theory of comparative advantage (Victor, 2002). However, a potential disadvantage of this model is that it simplistically assumes that all countries have similar production technologies as well as similar customer tastes and preferences (Victor, 2002). Although true for nations at the same level of economic development or those enjoying similar cultural, religious affiliations, this assumption does not hold true for majority of the cases (Victor, 2002). The assumptions certainly do not hold true for trade between developed and developing nations. In case of developing countries, the concept of free markets is often aborted when forces such as corruption, bribery, uncertainty, lack of transparency and lack of opportunities can hamper productivity (Victor, 2002). However, to this end the H-O model, which forms the basis of free trade, has been reformed to incorporate differences arising from technology, labor skills, education as well as productivity (Victor, 2002). As per the comparative advantage theory, a nation’s reduction of trade and non-trade barriers towards its trading partners leads to specialization of resources that divert towards the goods in which the country has a comparative advantage over its trading partners (Victor, 2002). Through free trade and specialization, developing countries can reap the gains of increased consumption than otherwise. Through free trade, a developing country is able to import the products that it cannot produce, thereby enhancing the consumers’ standard of living by providing greater variety of goods for consumption. Also, free trade is associated with higher net welfare. This is possible because free trade eliminates inefficiencies existent in developing countries to a large extent. For instance, nationalized industries and protected infant industries that suffer from high level of inefficiency suffer heavy losses when free trade is enabled. The returns to labor and capital tend to fall in inefficient industries and rise in efficient ones, thereby adjusting the resources accordingly (Victor, 2002). Hence, relative price changes brought about by free trade tends to redistribute resources of developing countries from inefficient, weak performing sectors to efficient ones. Research has also shown that there is greater scope for gains from efficiency and welfare arising from free trade in developing as opposed to developed countries. This is simply because the ‘existing’ or pre-trade setup of developing countries has greater inefficiencies and trade barriers compared to developed ones. The profits accruing from trade often lead to enhanced efficiency in industrial sectors that were previously characterized by barriers to trade. For instance, the conflict resolution objective of NAFTA led to an enhanced access to the services of legal bodies by Mexican manufacturers (Victor, 2002). The gains pertaining to efficiency from free trade are higher for the free trade agreement between Jordan and U.S as compared to Mexico and U.S simply because the level of integration for the economies of U.S and Jordan prior to NAFTA was significantly less compared to the U.S and Mexican economies (Victor, 2002). The infant industries that were being fed prior to NAFTA as well as the inefficiencies arising out of government ownership of corporations hampered the international competitiveness of potential export driven sectors (Victor, 2002). It has been proven with experience that state intervention in the area of export policy is not a sufficient condition for economic growth. Thus, economic growth entails the cohesive progress of all sectors in an economy, both export and non-export, in order to effectively combat barriers to growth. Hence, quite convincingly, advocates of free trade for developing countries argue that free trade maximizes the social welfare and efficiency gains to developing countries. However, critics oppose the same for a variety of reasons. One of these arguments pertains to the biased development of developed countries as opposed to developing nations. It is argued that developed nations are mostly engaged in the export of intangible products that involve intellectual property, including software, entertainment, and trademarks as well as newly developed medicines (Victor, 2002). This intellectual property possesses authorized protection against illegal reproduction. Free trade offers strong protection of these rights which indirectly favors the developed nations whose intellectual property is protected. Furthermore, developing countries lack the ability and the capacity to support the level of Research and Development that is necessary for such intellectual property due to financial and other resource constraints. This leads the developing countries into permanently disadvantaged positions which are sustained by the notion of free trade. Organizations that promote free trade (including WTO) include clauses that make it mandatory for developing nations not to produce generic duplicates of these intangibles such as lifesaving drugs (Victor, 2002). Considering that the generic versions of these life saving medicines are much cheaper compared to their non-generic counterparts, critics argue that free trade throttles the welfare of the developing world by eliminating low cost alternatives of expensive intellectual products. Furthermore, critics argue that free trade promotes the existence and settlement of transnational corporations in developing countries. These Multinationals are believed to be associated with the exploitation of resources in the developing world including low wage payments to locals and unrestricted use of the developing country’s environmental resources (Campbell, MacKinnon, & Stevens, 2011). This is also often linked with the notion of resource depletion and pollution in developing countries. Furthermore, the political setup in developing countries is weak and prone to inefficiencies including corruption, bribery and nepotism (Campbell, MacKinnon, & Stevens, 2011). It is argued that multinationals use their power to exert influence on the politicians and oblige them in cash or kind in order to grant them with unwarranted concessions such as tax rebates and paying less for real estate (Eden & Dobson, 2005). These allowances often defeat the very purpose of free trade which is to eliminate subsidies and other interventions. Thus, where infant industry protection often invites debate by free trade proponents, the protection provided to the Multinationals is perceived as rational. Furthermore, multinationals are known to become powerful and enjoy superior technology in production that further reduces the scope for local industries, thereby reducing their competitiveness and taking the market away from them (Eden & Dobson, 2005). It is believed that multinationals become so superior that they acquire other corporations, which helps them sustain their superiority. Thus, multinationals often tend to engage in monopolistic or oligopolistic behavior (Eden, Taxing multinationals: transfer pricing and corporate income , 1998). Free trade thus concentrates wealth in a few hands that are bestowed with the factors that are scarce in relation to their demand. For instance, OPEC successfully formed a cartel and exorbitantly increased prices in 1973 and 1974 simple because majority of the world was dependant on its resource endowment- oil supply (Shojai & Katz, 1992). Free trade fosters the outsourcing and subcontracting of supplies due to lax environmental and legal regulations in developing countries. Another line of argument pertains to the difference in relative factor endowments between the two countries. Thus, free trade tends to benefit the wealthy more than the poor countries. This is because the rich countries own greater capital compared to poor countries (Victor, 2002) . Due to the principle of comparative advantage, countries with greater capital enjoy greater capital gains such that their comparative advantage in capital is sustained by free trade (Victor, 2002). Perhaps, the most significant line of argument against free trade in developing countries pertains to the notion of infant industries. Developing countries are often characterized according to their ‘stage’ of development. It is argued that those countries that are in their early stages of development contain what are known as infant industries and that these industries may periodically require help from the government in the form of subsidies or tax rebates etc (Baumol & Blinder, 2010). It is believed that infant industries in certain sectors of the economy ought to be protected by the government in developing countries particularly because such countries do not possess large domestic markets, thereby eliminating the scope for economies of scale for developing countries (Baumol & Blinder, 2010). Furthermore, history has proven that many countries have progressed to the industrialization stage under the privilege of tariff barriers. For instance, the U.S.A witnessed the highest tariff barriers in the period 1816-1945 (Sabillon, 2008). According to various researchers, various newly industrialized nations have, at some time in their history, witnessed some form of infant industry protection. A stronger line of criticism is related to the socio-political arena and is titled as the “dependency theory” (Miller, Vandome, & McBrewster, 2009). This theory states that free trade is a covert form of colonialism or imperialism (Miller, Vandome, & McBrewster, 2009). This has its roots in the British expansion in the 19th century, whereby free trade was perceived as a means of exploitation of the developing nation’s resources including raw materials and labor (Miller, Vandome, & McBrewster, 2009). It was believed that these imperialists controlled the capital stream in a way so as to maintain their superiority over the less advantaged, developing nations (Ghosh, 2001). Thus, free trade merely sustained the status quo- the existing superiority of wealthy states. The behavior of these colonialists was classified as oligopolistic in that they behaved like one entity since they had more choice of raw materials from developing countries, which they bought to their advantage (Miller, Vandome, & McBrewster, 2009). The flow of resources from the rich to poor countries eventually led to sharper inequalities; the rich countries became richer and the poor became poorer. Cheap goods were produced in developing countries under the authority of the developed countries and these goods were then exported back to their home countries at higher rates (Miller, Vandome, & McBrewster, 2009). The profits earned this way by the wealthy nations was never transferred or shared with the developing nations, thus depriving them of their due share (Miller, Vandome, & McBrewster, 2009). Towards this end, on ethical grounds, free trade has been classified as morally unjust and a means of right deprivation of those in the developing world. Thus, both sides convincingly present their arguments as far as free trade for developing nations is concerned. However, advocates counter the claims made by critics by claiming that the arguments proposed by the latter have little to do with free trade itself. It cannot be negated that by reducing tariff and non-tariff barriers the standard of living of people in developing countries has and can be further improved. A research conducted in Australia claims that by merely reducing existing tariffs by 50%, an output equivalent to $450 can be increased (BBC, 2003). Just the way each of us would end up being poor if we tried to achieve self-sufficiency at an individual level, we would be worse off if we constructed boundaries around states in an attempt to achieve self sufficiency at regional or national level (Bostaph, 1994). It can be undoubtedly claimed that self sufficiency is the enemy to progress; it throttles the progress in standards of living especially for people in the developing part of the world. If given a choice between high and low standard of living, none of us would willingly prefer the latter. The adoption of free trade does not necessarily translate to increased jobs; in fact, it merely means that jobs in high-cost sectors will elaborate and those in low-cost sectors will further diminish as producers strive to compete with imported goods (Bostaph, 1994). The standard of living does increase as prices fall in an attempt to stifle competition; however, without effective government policies it would be impossible to distribute the benefits of trade equally among all. This is because only those with sufficient incomes shall be able to afford the increased variety of goods. Furthermore, as jobs in low-cost sectors decrease, those who are unemployed shall find it difficult to survive without any source of income. Government intervention is thus extremely necessary to provide jobs to those who have been rendered unemployed by free trade. Ideally, a mix of free trade and protectionism ought to be adopted. Just like the ideal market is one which is between a purely command economy and a perfectly competitive market, free trade also ought to be controlled by some government intervention. References: Baumol, W. J., & Blinder, A. S. (2010). Economics: Principles and Policy. Mason: South Western Cengage Learning. BBC. (2003, February 12). The argument for free trade. Retrieved December 9, 2011, from BBC News World Edition: http://news.bbc.co.uk/2/hi/business/533208.stm Bostaph, S. (1994, October). The Forgotten Argument for Free Trade . Retrieved December 8, 2011, from Freedom Daily: http://www.fff.org/freedom/1094c.asp Campbell, P. J., MacKinnon, A., & Stevens, C. R. (2011). An Introduction to Global Studies. New Jersey: Wiley-Blackwell. Eden, L. (1998). Taxing multinationals: transfer pricing and corporate income . Toronto: University of Toronto Press. Eden, L., & Dobson, W. (2005). Governance, multinationals, and growth . Cheltenham: Edward Edgar Publishing. Ghosh, B. N. (2001). Dependency Theory Revisited. Ashgate: Chesterfield. Miller, F. P., Vandome, A. F., & McBrewster, J. (2009). Dependency Theory. VDM Publishing House Ltd. Neale, J. A. (2010). An Enquiry Into the Principles of Free Trade. General Books. Sabillon, C. (2008). On the causes of economic growth: the lessons of history . New York: Algora Publishing. Shojai, S., & Katz, B. S. (1992). The Oil market in the 1980's: a decade of decline. New York: Praeger Publishers. Victor, G. (2002). Free trade agreements between developing and industrialized countries. Washington DC: Office of Economics- U.S International Trade Commission. Read More