Saturday, August 27, 2016

The problem with unfettered free trade

An unequivocal acceptance of free trade has been a central theme of mainstream macroeconomics for decades. It is argued that factor markets adjust over time to generate superior outcomes. Among all the tenets of the Washington Consensus, this alone continues largely intact. 

But in recent years, as the dynamics unleashed by the emergence of China has played itself out, some influential voices, including those from the right, have started questioning the conventional wisdom. In fact, David Autor, David Dorn, and Gordon Hanson have even claimed that import growth from China caused 2.4 million jobs in the US over a dozen years. 

At a conceptual level, for the world as a whole, there is no doubt that free trade leads to better outcomes. But there are at least two problems with this line of reasoning. 

1. The world is politically organized as countries and regions. The world as a whole matters little in political terms, and is largely an academic construct. When seen in terms of individual countries or even more so among regions, there is very little evidence to suggest that free trade leads to superior outcomes - increased output and more jobs - even in the aggregate. Labor market adjustments take time and a large share of those displaced end up with inferior jobs and lower lifetime incomes. And there is nothing to suggest that comparative advantage in certain sectors offsets the loss in output and jobs due to lower competitiveness in other tradeables.

2. Then there is the fairness argument. Even the most ardent free traders accept its adverse distributional consequences. But they rationalize this by saying that governments can enact policies to mitigate this by facilitating labor market adjustments (re-trainings and re-skilling etc) and through transfers by appropriating from the winners and giving to the losers. But here too, there is scarce evidence of such hopes materializing. In fact, given the reality of the political economy in developed or developing countries, especially in the present times, the winners are far more likely to resist and prevail over any attempts to appropriate a share of their gains. To paraphrase Machiavelli, the greed of the influential few is most certain to overcome the requirements of the powerless many! In other words, not only is there little evidence of re-training and transfers, political economy militates against its realization. 

Given this, all arguments for unfettered free trade are essentially faith-based arguments. This assumes significance since India is in the process of negotiating free-trade agreements with many countries. Yes, we need to embrace free trade. But we should be aware of its consequences and negotiate hard to obtain adequate safeguards for those sectors most likely to be vulnerable to trade-induced disruptions. This has to be complemented with a re-skilling programs and robust enough social safety net that rehabilitates and cushions the losers. 


Anonymous said...

The biggest dynamic in global trade in the last 10 years is China. It is not free politically or economically To think that free trade with China is possible when it won't free its currency market let alone it's equity or debt markets is delusional. Free trade requires freedom in these key markets for market balancing to function.

Tirumala Venkatesh Kaggundi said...

Analysing effects of free trade agreements, beforehand, in order to be aware of the consequences and negotiate hard to obtain adequate safeguards for vulnerable sector, requires deep understanding of the models and data analysis. India seems to lack both the depth and analytics, given the fact that not a single FTA that she has signed has shown any benefit (in fact, with all the FTAs that India has signed, the terms of trade has deteriorated for India vis a vis the partners, just one measure). Somewhere, I have a hunch that the bunch that sits on the negotiating table needs to shape up.
Secondly, re-skilling a significant part of labor force that is affected due to poorly negotiated trade deals is something of a chimera that even the US couldn't achieve. The less said about our social safety net the better. We have reaped the benefits of post 91 reforms and WTO (incidentally, as both came almost together, its natural to get the causality mixed up, and give all credit to free trade post WTO). Probably its time for a hiatus, and put our house in order, given that we are the ones who would lose most in RCEP if it comes through.