The Effects of Fair Trade on the Third world Countries - Research Paper Example

The Effects of Fair Trade on the Third world Countries In the literature of economics there has been a long celebrated debate regarding the optimum trade policy that should be adopted to accelerate the growth and development of any country. In this context there are two major schools of economics each of who strongly oppose other. One is the group of economists who belong to the orthodox mode of thought, inspired by the works of Adam Smith, David Ricardo who think that the best policy a country can adopt is the free trade according to comparative advantage. Another group consists of those economists who dead against the free trade and plead in favour of protection. The former group or the group belonging to the orthodox though are known as the liberalist and the second group which are strictly against the free trade and in favour of protection are known as protectionists.. The orthodox economists like Marshall, J.S. Mill James E Meade, and Pareto etc always plead in favour of free trade. According to their view free trade is subject to the following benefits: 1. Free trade encourages the international division of labour. It implies that free trade promotes specialization according to comparative advantage and by this way there is international division of the workforce according to the efficiency. That implies free trade would bring about the global efficient allocation of resources. (Unger 2007,) 2. The free trade maximizes the income level of both the countries and thereby the global income and welfare would be maximized. 3. In his famous theory, “The Vent for Surplus”, Adam Smith has argued that the underdeveloped economies are generally having the problem of surplus labor. Trade would create higher demand for the product of the underdeveloped economies and consequently the room would be created for the utilization of the surplus labor. Hence free trade would solve the problem of unemployment and underemployment in the underdeveloped economies.(Chacholiades 2006) 4. It is often argued by the neoclassical economists that trade enables an underdeveloped economy to enjoy the fruits of the technological progress in its developed trading partner. The technological progress in developed country would be reflected in the reduced cost of production and enhanced quality of the product. That would enable the underdeveloped economy to reap the benefits of technological progress in the developed economy through better quality of imported goods at lower price. (Salvatore 2007) 5. It is often argued by the classical and the neoclassical theorists that free trade would be beneficial for the country. They opined that the opening up of domestic market would invite foreign producers to sell their commodity in the domestic territory. That would ensure higher level of competition and the consumers would be able to get the better quality of the product at lower price. So the consumers get the benefit of that system with higher level of consumer’s surplus. On the other hand the foreign competition is supposed to increase the efficiency level of the domestic firms. That would enhance the allocative efficiency of the economy. (Buffie 2001) 6. The opening up of the country for free trade would enable the domestic producers to sell their commodities at higher price in the global market. That would increase the level of benefit of the producers in the form of higher producer’s surplus. (Kenen 2000) On the other hand the protectionists have tendered the following arguments to discard the proposition of mutually beneficial nature of free trade as argued by the preachers of free trade: It is often found that the industrial sectors of the developed economies are much more efficient than that of their underdeveloped counterpart. In that case while an underdeveloped country is engaged in free trade with a developed country the flow of goods from the developed economies would capture the market and the industries of the underdeveloped country would be wiped out by the uneven competition. That would create unemployment in the underdeveloped economy. (Marjit 2008) The economists like Paul Baran, A.G. Frank, Dos Santos, Cardoso, Sunkel, Furtado etc have criticized the theory of free trade on the ground of dependency. They have argued that the trading relationship between a developed and an underdeveloped economy creates a dependent relationship. They argue that it will be a centre-periphery or metropolitan-satellite relationship. The developed country would take the place of metropolitan (centre) and the underdeveloped country will play the role of satellite (periphery). The periphery would be dependent upon the centre for this typical relationship. That would enable the centre to exploit the periphery. (Hunt 1989) The theoretical validity of the mutually beneficial nature of trade was vigorously shaken by the emergence of Prebisch-Singer Hypothesis. In this hypothesis it is proved that in the long term trading relationship between a developed (north) and an underdeveloped (south) the terms of trade of south vis-à-vis the north shows a secular declining trend. At the initial stage the explanation provided by this hypothesis was based on the nature of commodities traded. It is obvious that in a north-south trading pattern the north would play the role of an importer of primary and exporter of secondary goods and vice versa for south. The demand and supply of the primary goods are highly inelastic while those of the secondary goods are highly elastic. That’s why the cyclical fluctuations in market cause a sharp decline in the price of the primary products and vice versa for secondary product. That’s why the Prebisch-Singer hypothesis prescribed for inward looking industrialization. However, the failure of inward looking industrialization has caused a shift in the theorization of this hypothesis and there has been a transfer of the central point from the nature of commodities traded to the nature of the countries involved. It has always been proved that the economically stronger country exploits the economically weak countries. (Sarkar 1986) The theory of unequal exchange framed by French economist Emmanuel has shown that whenever a trading relationship is found within an underdeveloped and a developed country though the absolute price of the same commodity is equalized in both the markets it is found that due to the uneven situation the effort of one hour of the worker of the developed country commands more than one hour of effort of the worker of the underdeveloped economy. (Ross 1976) The secular decline in terms of trade has another implication on the economic situation of the underdeveloped economies. That gradual decline in terms of trade creates a volatility in the export earning of those economies to finance the gradually increasing import expenditure for the development projects of the underdeveloped economies and consequently they have to borrow from outside and that burden of debt motivates them to conduct further export drive and that’s why there is a further decline in the terms of trade. This is known as the secondary burden of the debt that the underdeveloped countries have to face in the course of the trading relationship with the developed economies. (Sarkar 1991) When we are going to consider the impact of fair trade on the less developed countries or third world countries we have to consider the concept of economic liberalization that gained the momentum at the 1980s and 1990s gradually. The background of such liberalization should be considered before the analysis of the liberalization process. Two important phenomena that took place in recent past were: the collapse of the long celebrated Bretton Woods System and the International Debt Crisis. The collapse of the Bretton Woods System brought about an end to the fixed exchange rate regime and the debt crisis compelled many of the countries to adopt the policy of economic liberalization. (Many of the less developed economies had to take the aid of IMF/WB and along with aid those were prescribed to adopt the structural adjustment policies as the long term solution.). (Caves, Frankel and Jones-2002) The structural adjustment policies called for more flexibility of the economic system characterized by the decline in the government intervention in the functioning of the economy to solve the problems of balance of payments deficit. This structural adjustment policy was based on the famous Mundell Fleming model of open economy macroeconomics which prescribed for a more flexible approach of the economy. According to the Mundell Fleming model a country which is facing unemployment as well as a balance of payments deficit should adopt the hands off policy. (We know that unemployment is a basic feature of underdevelopment. that high level of unemployment and balance of payments crisis would act as the stabilizer of the economy. The balance of payments deficit in a floating exchange rate regime would cause a depreciation of domestic currency in global market. On the other hand the unemployment, if not corrected by government intervention, would make the worker unions to bid down the wage rate and hence there would be a fall in domestic price level due to cost reduction and hence the domestic product would become more competitive in market and there would be a rise in aggregate demand for the domestic product in global market. That would cause huge export drive following the higher level of competitiveness. The balance of trade situation would improve and there would be a consequent rise in aggregate demand which would pull up the level of employment, ( Rivera Batiz and Rivera Batiz -1984) The trade liberalization policies that initiated in the last quarter of the 20th century could be promoted as a success story of the developed economies and a few handful of the developing economies. The best example of the developing economies that reaped the benefit is China. However there remains the controversy while China could be called an underdeveloped economy is a matter of dispute. The matter of fact is that Chinese economy has kept even the most developed economies far backward and perhaps China is the major beneficiary of this type of liberalization programme, what is the secret of the success story of China? Different researches have been made regarding the history of success of China in capturing the US market. According to many researchers Chinese policymaking is the major factor that has made it a great exporter in the market of USA. It has been claimed in a survey article in “The Economist” that Chinese government has adopted the policies like export subsidies and pegging the exchange rate. The government is alleged to adopt the policy to restrict the Chinese currency from appreciating much. According to the author the accumulation of foreign exchange reserve in china is the major proof of the government intervention in pegging the exchange rate. (Economist, June 25, p. 76) According to some economists, the rise in supply of Chinese goods in the global market there is a decline in the global price of the goods in the market. The matter of fact is that Chinese policy is bringing about a decline in the price level of goods that make Chinese goods cheaper in the global market as well as American market. That is certainly a reason for the increasing demand for Chinese goods. The business environment in China is relatively more flexible. According to a report by the World Bank the cost of starting a business is china is 9.3% of the average per capita income which is relatively much lower than that in other countries. Moreover, the huge supply of Chinese labour is a major cause of a declining cost of production. Moreover, the duty free import of raw materials and inputs causes a declining average and marginal cost of production. All these things together have made the Chinese myth successful. (Amiti and Freund 2007) On the other hand we have found that though the liberalization is preached by the developed economies at the time of liberalization the developed economies adopted the hidden and distorting policies like the policy of protecting their domestic import competing sector by usage of some tricks such as hidden subsidies. The main threat that lies behind that is the logic that the cheap labor intensive product from the developing economies would hamper the interest of the workers of the import competing sector. The threat was not real but the action taken against the entry of the goods from the less developed countries was real enough to hamper the interest of the exporters from the developing economies. That’s why while the LDCs were making effort to enter the market of the developed economies they had to face such burdens. So what they had to do, just to decrease the price to offset the effect of the protective measure adopted by the developed economies. That always led towards export desperation i.e. the continuous decline in the terms of trade of the exportable of the developing economies vis-à-vis the price of their importable. Moreover, the strategies prescribed by the IMF WB such that decline in cost and hence price or real devaluation are subject to some fallacies of composition. These policies, of course, could be used by the less developed economies to capture the market, but the problem is that such policy prescriptions are country specific in the context that while such policy would be used by any less developed economy to promote import it would not be considered how it could affect on the market of the substitute products used by the other less developed economies.; on the other hand these types of policies are not country specific in the sense that every country having the balance of payments deficit are prescribed with the same set of policies irrespective of any concrete judgments about the structure of the country and the root of then problem. There should be more analysis before prescribing such policies, in the World Development Report published by the World Bank it was revealed that the good boys of the bank have remained backward than the bad boys of the bank i.e. the less developed countries which adopted the structural adjustment policies are far behind than those who have not adopted the structural adjustment policy regarding the terms of trade as well as the balance of payments. (Sarkar and Singer 1992) It is surprising to see how China in that situation escaped all the protective policies and managed to earn a huge amount of export earning despite the restrictive policies played by the OECD countries. In an economic survey made by a committee of the Congress, United States has revealed that the Chinese policy of regulating the domestic economy towards an outward oriented path has been the major lynchpin of the success. There are a constellation of facts and reasons for the export boom faced by this country. The major contributory fact to the success of China as a global player is the success of the authority to stabilize the price by lowering the cost through wage control and labour efficiency. By these facts the price level of china is gradually declining making its product more competitive in the global market. (United States: Congress. Joint Economic Committee, 1992) The recent stage of trade related functioning of the Latin American countries also reveals a repercussion against the liberalization. It was the pesos crisis in the Argentina and the international debt crisis faced by Mexico made these two countries compelled to adopt the structural adjustment policy. But over the due period they also became the victim of the problem of the export desperation and that’s why they wanted a shift of the regime from the liberalized to a restricted path of economic development. The Latin American countries have formed their own regional trading block. They have moved towards a regime of regionalization of trade. The matter of fact is that the process of liberalization has become a story of failure for the Latin American countries and that caused a return from the globalization to the older form of partial form of regionalization. (Stallings 2001) Here we have taken three underdeveloped economies as our sample to examine the impact on trade liberalization through the usage of the economic indicators like GDP at market price, annual rate of change in GDP and the current account balance which is a major indicator of economic performance. As we are here to discuss the impact of globalization and economic liberalization on the third world countries we have chosen the three countries which are at the floor of economic situation. According to the core term of economics the countries which have minimum national income and per capita income are described as the third world countries. Moreover they are characterized by many other social variables also such as high infant mortality rate, low level of education, high level of involuntary unemployment, high income gap, concentration of social and economic power in the hand of few etc. (Nations Online) Though all the social variables are concerned with the definition of third world we are not considering those indicators as free trade is concerned mainly with the economic indicators and we have the shortage of space. For the sake of simplicity we have considered some of the poorest countries for the sake of simplicity. According to the categorization of the United Nations 10 countries have been marked as the poorest ones of the world. Those are: Sierra Leone, Tanzania, Burundi, Malawi, Ethiopia, Niger, Guinea Bissau, Republic of Congo, Congo Democratic Republic and Mali. (Economy Watch). In our analysis we have taken the 3 of them in random selection. Those are Sierra Leone, Ethiopia and Congo Republic. As our target time span we have chosen 1991 to 2008 as the peak hour of liberalization. We have obtained the data of GDP at market price and the current account balance of Sierra Leone is given. The currency is based on UD $. Actually we measure the statistics at billion dollars. Here from the site we have obtained the GDP from GDPs we obtain corresponding GDP growth rate. Similarly by using the current account balance in each year we get the rate of change in current account balance. year GDP Sierra Leone GDP growth rate CAB Sierra Leone CAB growth rate 1991 $0.78 -0.005 1992 $0.68 -12.8205 -0.015 -200 1993 $0.77 13.08824 -0.06 300 1994 0.912 18.59558 -0.042 -30 1995 $0.87 -4.38596 -0.058 -38.0952 1996 $0.94 8.027523 -0.101 -74.1379 1997 $0.85 -9.76645 0.013 112.8713 1998 $0.67 -20.9412 0.034 -161.538 1999 $0.67 -0.44643 -0.053 -255.882 2000 $0.64 -4.93274 -0.056 -5.66038 2001 $0.81 26.72956 -0.051 8.928571 2002 $0.94 16.12903 -0.019 62.7451 2003 $0.99 5.876068 -0.048 -152.632 2004 $1.07 8.27447 -0.062 -29.1667 2005 $1.22 13.23392 -0.086 -38.7097 2006 $1.42 17.20165 -0.05 41.86047 2007 $1.67 16.92416 -0.063 -26 10008 $1.97 18.37838 -0.124 -96.8254 Table 1: Source: Economy Watch Fig 1. GDP at market price for each year. The bar diagram we have represented signifies the corresponding year at the horizontal axis and the vertical axis measures billion US $ in form of GDP. We can find that GDP in market price had risen substantially over this period. Fig 2 represents the growth rate of GDP in Sierra Leone. We find that though there are massive cyclical fluctuations there is ultimately an upward trend. That definitely implies that there is a trend of rising GDP. But one thing has to be remembered that the GDP is calculated in market price and that’s why that may be caused by chronic inflation faced by the country not by positive growth. Fig 3: this represents the current account balance of Sierra Leone over the time period. We find that Sierra Leone is suffering from chronic current account balance deficit. The current account balance is in surplus only in the year 1997 and 1998. the current account balance is measured in billion US $. Figure 4: this represents the trend of change in the current account balance of the economy of Sierra Leone. Here we find that the change in the current account balance is irregular. But overall it shows a negative trend. So we can predict that situation would deteriorate in future. year GDP Ethiopia GDP Growth Rate CAB Ethiopia CAB Growth rate 1991 $13.36 -0.261 1992 $14.10 5.516054 0.04 115.3257 1993 $8.77 -37.7855 -0.204 -610 1994 $7.80 -11.025 -0.092 -54.902 1995 $8.09 3.639159 0.19 306.5217 1996 $4.71 -41.7409 0.068 64.21053 1997 $8.55 81.36672 -0.191 380.8824 1998 $7.75 -9.326 -0.104 45.54974 1999 7.604 -1.87121 -0.51 390.3846 2000 $7.90 3.892688 -0.335 34.31373 2001 $7.88 -0.26582 -0.234 30.14925 2002 $7.43 -5.71138 -0.347 -48.2906 2003 $8.03 8.089918 -0.109 68.5879 2004 $11.99 49.30262 -0.402 -268.807 2005 $13.79 15.0221 -0.738 -83.5821 2006 $15.17 9.992748 -1.386 -87.8049 2007 $19.43 28.10522 -3.776 -172.439 10008 $25.08 29.07725 -1.26 66.63136 Table 2: Source: Economy Watch Fig 5 GDP at market price for each year The bar diagram we have represented signifies the corresponding year at the horizontal axis and the vertical axis measures billion US $ in form of GDP. We can find that GDP in market price had risen been more or less increased. Fig 6: represents the growth rate of Ethiopia. We find that though there are massive cyclical fluctuations there is ultimately an upward trend. That definitely implies that there is a trend of rising GDP. But one thing has to be remembered that the GDP is calculated in market price and that’s why that may be caused by chronic inflation faced by the country not by positive growth. Fig 6: This represents the current account balance of Ethiopia over the time period. We find that Sierra Leone is suffering from chronic current account balance deficit. The current account balance is in surplus only in the year 1995 and 1996. The current account balance is measured in billion US $. 2007 has witnessed a severe current account balance deficit. Figure 8: this represents the trend of change in the current account balance of the economy of Ethiopia. Here we find that the change in the current account balance is irregular. But overall it shows a negative trend. So we can predict that situation would deteriorate in future. The process of liberalization was mainly prescribed to solve the balance of trade problems of the underdeveloped economy. In these two cases we have found that the trade liberalization is a total failure in this perspective. So better to say that liberalization is a hype, made by the IMF/WB to serve the interest of the developed nations. References: 1. Amiti, M. and Freund , C. September 2007, , China's Export Boom Finance and Development, Volume 44, Number 3 2. Buffie, E. F. 2001, Trade policy in developing countries, Cambridge University Press 3. Caves. R.E. Frankel J. A. and Jones R. W. 2002 World Trade and Payments; An Introduction : Pearson Education 4. Chacoliades, M. 2006. The Pure Theory of International Trade, Revised Edition, Transaction Publication 5. Economist Newspaper Limited, 2005, “Precisely wrong: China’s currency may not be as cheap as is commonly believed,” Economist, June 25, p. 76. 6. Economy watch: (N.S). Available at: http://www.economywatch.com/economic-statistics/economic-indicators/Inflation_Average_Consumer_Price_Change_Percentage/ Accessed on -15th May, 2009 7. Economy Watch: Poorest country in the World.: http://www.economywatch.com/economies-in-top/poorest-countries-of-world.html 8. Hunt, D. 1989. Economic Theories of Development, Rowman & Littlefield Publishers, Inc 9. Kenen, P,. B. 2000, The International Economy;. Cambridge University Press. 10. Marjit, S. 2008. International Trade and Economic Development: Essays in Theory and Policy, Oxford University Press 11. Nations Online: http://www.nationsonline.org/oneworld/third_world.htm 12. Rivera Batiz, F.L and Rivera Batiz, L. 1984. International Finance and Open Economy Macroeconomics 13. Ross, A. C. 1976. Emmanuel On Unequal Exchange: A Marxist Contribution On Trade Relations Between Rich and Poor. Journal of Economic Studies, Volume 3, Issue 1, pp-42-60 14. Salvatore, D. 2007. International Economics (Hardcover). Willey 15. Santiago, B. 2001 Globalization and Liberalization: An Impact on the Developing Countries, Economic Development Division, Chile. 16. Sarkar, P, (1986) Singer-Prebisch Hypothesis: A Statistical Evaluation. Cambridge Journal of Economics. Vol 10, No-4. pp-355-371 17. Sarkar, P, and Singer, H.. 1992, Debt Crisis, Commodity Prices, Transfer Burden and Debt Relief, IDS Sussex Discussion Paper  18. Sarkar, P. 1991. Debt Crisis of the Less Developed Countries and the Transfer Debate Once Again, Journal of Development Studies .Vol-27, Issue-4, pp-84-101 19. Unger, R. M.. Free trade reimagined: the world division of labor and the method of economics, : Princeton University 20. United States. Congress. Joint Economic Committee, 1992, China's economic dilemmas in the 1990s: the problems of reforms, modernization, and interdependence, M.E. Sharpe Read More