Gains from trade liberalization

I had blogged earlier on the impact of trade liberalization on inequality has been discussed here. Dani Rodrik outlines three issues that determines a society's gains from trade liberalization

1. "Economic theory tells us that the gains from removing a tax or subsidy rise with the square of the wedge. So sectors where there are large policy interventions are particularly ripe for liberalization, everything else held constant."
2. Activities and sectors that employ lots of highly skilled workers exhibit technological externalities. Prof Rodrik contends that "liberalization that results in the contraction of sectors that employ such workers is unlikely to generate much gains, and may even be harmful".
3. Any potential efficiency gains from liberalization "will have to be traded off against potentially adverse movements in income distribution".

When subjected to this test, liberalization of services by way of outsourcing - both of low-skilled and high-skilled services and activities - fails. He writes, "outsourcing of low-skilled labor is on the whole bad for income distribution, while out-sourcing of high-skilled labor may run against... the need to keep sectors that are the likely depositories of technological externalities at home". Trade liberalization in the conventional areas of manufactures too does not achieve much since "the barriers are already extremely low, and the efficiency gains to be had are correspondingly small".

This, Prof Rodrik reasons, leaves the US trade policy with two areas where further trade liberalization can yield benefits - elimination of subsidies and other trade-distorting measures in agriculture and removal of visa restrictions on highly-skilled foreign workers. This assumes significance as the global trade, hit by weakening demand and investments and contraction in trade finances, has declined dramatically.

Trade liberalization by developing countries can be subjected to Prof Rodrik's three tests to examine the areas where such liberalization is beneficial. Liberalization of technology intensive sectors will generate positive externalities, and is generally beneficial. But here too, as Dani Rodrik explained in another post, the importance of industrial policies cannot be overlooked.

Further, in the aftermath of post-WTO era liberalization of trade, which has sharply cut tariffs across the board, there are very few sectors where large gains are to be had from further tariff reductions. This, though, is not to deny the need for tariff reductions and liberalization in at least a few sectors. Of greater importance, especially in the context of trade in foodgrains and other commodities and small and medium industries, is the need to balance concerns of its impact on certain vulnerable categories of the population and general income distribution among them.