Trade

Do open markets matter or is protectionism the answer?

 

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Trade - separating fact from fiction

In the wake of a profound slowdown in the global economy and with heightened public concerns about globalisation, free trade is under threat.

Governments face increasing pressure to take protectionist measures that would restrict open trade between countries.

Why open markets matter...

Open markets for goods, services and investment help countries to use their resources, human and physical, in the most efficient way, thus concentrating their production where it is most competitive. Over time, this will also bring “dynamic” gains as trade fosters technological improvement and increased productivity.

 

It follows that an important part of the gains from trade comes from a country’s own liberalisation. But the benefits are magnified when access to others’ markets is also improved in the framework of multilateral trade negotiations.

 

OECD estimates that a 10% increase in trade is associated with a 4% rise in per capita income.

Video: Protectionism means that "nobody wins: everybody loses", explains Ken Ash, OECD Trade and
Agriculture Director.

The key link in the chain between trade and growth is the contribution of trade to innovation.

 

Trade and trade reform stimulate competition and the incentive to innovate

Reduced subsidies to Australian shipbuilding triggered industry revival through a shift in production from steel to composite materials and New Zealand’s agriculture became much more diverse and competitive following the removal of subsidies and protection.

 

Trade and foreign direct investment foster the transfer of technology

The Kenyan cut flower industry has benefited and flourished from imported technology embodied in investment from Holland.

 

Trade fosters economies of scale and helps defray the costs of R&D

Nokia’s global presence has been driven by the exploitation of trade opportunities beyond the small local market in Finland.

 

Trade and trade reform help foster the globalisation of value chains

Thanks to the harmonisation of product standards, IBM is able to source its components from three diverse locations: in China, Hungary and India.

...and protectionism is not the answer

 

Compared with the 1930s, opportunities for protectionism are more limited, thanks to the progressive strengthening of World Trade Organization (WTO) rules, now demonstrating its worth, the lowering of the maximum tariffs that countries are allowed to charge as a result of successive rounds of trade liberalisation, and the growth of global supply chains which mean that countries are reliant on unimpeded movements of inputs across borders.

 

Nevertheless, there is a risk that barriers and distortions to trade will become more prevalent. Some cases of higher tariffs, import bans, discretionary licensing, limits on labour movement and increased resort to WTO trade remedies (such as claiming that a trading partner is “dumping” into your market)  have been reported. The risk from ‘behind the border measures’, via subsidies, state aids and buy-local requirements, may be greater. In some countries, trade restrictions may be compounded by competitive devaluations, whether achieved through benign neglect or active intervention.

 

Many if not most of these measures are within WTO rules. Nevertheless they are potentially very damaging to the economies taking the measures and to those on the receiving end. This serves to underline the urgent need for further strengthened multilateral disciplines through early completion of the Doha round of trade negotiations, backed by a transparent and effectively monitored  commitment by countries not to take any new protectionist measures at this point in time. According to the leaders of the G20 countries meeting in April 2009, a successful conclusion to the Doha Round could boost the global economy by $150 billion.

Protectionism is not the answer. Why? Here are three reasons why protectionism may backfire and have the opposite effect to what was intended:

 

1. A tax on imports is a tax on exports, both directly, as the cost of inputs increases, and indirectly, as the reduced incentive for import-competing industries to contain costs spreads to the economy at large.

  • But exporters are generally unable to pass on any cost increases. They will either lose export sales or become less profitable. Either way jobs will be lost.

2. Protection is unlikely to meet fully its own stated objectives. A clear demonstration of this is in agriculture where trade restrictions intended to help the small farmer simply create benefits for a few big and wealthy farms.

  • In the United States, EU and Japan, over 60% of farm support goes to just 25% of farms. And because of leakages, for each dollar spent on price support only 25 cents finds its way into the farmer’s pocket and the rest goes to input suppliers, or landowners who don’t farm or others outside the sector.

3. Retaliation by trading partners is likely to cancel out any benefits that might be derived, leaving everyone worse off.

  • It was “beggar thy neighbour” policies in the 1930s that turned a global recession into the Great Depression. And it was the fact that markets stayed open that helps explain the generally brisk recovery from the acute financial crisis that struck Asian economies in 1997-98. These are lessons that we cannot afford to forget.

» More from OECD on protectionism

Governments have an important role to play

Reaping the gains from trade does not mean that governments can simply sit back and let the market work - they have important jobs to do:

 

Creating the right policy framework

Open markets work best, and maybe only work at all, when accompanied by sound macroeconomic settings, a well-functioning labour market and strong institutions that, together, allow labour and capital to move from declining to expanding areas of activity. Again, in the face of global recession and “debt deflation”, as indebted firms sell off assets in order to service their debts, calls are being made to bring greater rigidity to wages and employment conditions in order to preserve purchasing power. Such calls should be resisted. Firms must be allowed to respond flexibly if resources are to be most effectively deployed.

Helping those who need to adjust

There will be losers, as well as winners, from market opening and they need assistance. Such assistance may need to be targeted to particular sections of the workforce, and it should be provided in a way that is transparent, time-bound and encouraging of adjustment.

 

Providing the right regulatory environment

Trade liberalisation is not the same as deregulation. This is a lesson with particular relevance to trade in services, as we are learning in the face of the global financial crisis. The WTO General Agreement on Trade in Services (GATS) preserves the right of governments to regulate in sensitive areas like health or education.

The “politics” of trade is not easy. The gains from trade liberalisation are often dispersed and hard to measure while the costs are often concentrated and only too easy to measure. But experience shows that the benefits exceed the costs and that fostering adjustment to trade is better than forgoing the undoubted opportunities that open markets have to offer.

See also:

 Does trade kill jobs ... or create them?

 Is trade good or bad for the environment?

 Do developing countries need to protect their infant industries?

 What is the link between trade, innovation and growth?

 

 

 

 

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