Trade

Why open markets matter

 

There is growing evidence that with the worst of the economic crisis behind us, recovery is finally getting underway in many countries.

Trade is already playing a catalytic role in the recovery, and open trade is an essential component of any realistic policy framework for continued, sustainable development.

After the trade collapse
Trade fell by more than 12% in 2009. However, in their March 2010 report to the G-20, the OECD, WTO and UNCTAD noted the resumption of growth in trade, and the WTO subsequently forecast an expansion of world trade of 9.5% for 2010. While this annual rate of growth still does not bring trade volumes back to their pre-crisis levels, it is still among the highest over the past two decades.

The economic recovery remains fragile in most OECD countries and in many cases government stimulus continues to play a large role in propping up demand. On the other hand, many emerging markets are growing at or above the pre-crisis rates. As the OECD Interim Economic Assessment noted in April 2010, OECD countries have already benefited through trade linkages from strong activity growth in major emerging-market economies, including China, India and Brazil.

 

Why trade matters
The results of trade openness can be tangibly measured in terms of economic growth, productivity, a higher standard of living, further innovation, stronger institutions and infrastructure, and even promotion of peace. Open economies grow faster than closed economies. The World Bank has reported that per capita real income grew more than three times faster for developing countries that lowered trade barriers (5.0% per year) than other developing countries (1.4% per year) in the 1990s.

In East Asia and the Pacific, where virtually all countries have embraced outward-oriented development strategies, both trade and GDP have grown hand-in-hand (see graphic below). This impressive performance was accompanied with equally impressive poverty reduction.  According to World Bank data, while in 1981 some 93% of the population in this region lived with income of less than 2 US dollars per day, by 2005 this figure had fallen to 38%.

 

Evolution of per capita GDP and trade intensity (trade as % GDP), East Asia and Pacific Region

 

Source: World Bank (2010), World Development Indicators, on-line edition.

 

Trade and jobs
The relationship of trade to employment is complex. Processes that enhance productivity are often associated with labour market adjustment: for instance, where new jobs that are created replace more traditional roles and skills. OECD studies confirm that globalisation and openness are associated with high employment levels provided that openness is accompanied by a coherent policy framework that facilitates structural adjustment and addresses labour market and social concerns.

Today, many jobs depend on both imports and exports. Imported inputs are increasingly used in local value-added production, with the output often destined for export markets. In fact, most trade is in intermediate products and services which are used to produce other products: over 50% of goods trade and almost 75% of services trade.

Take the example of the Boeing 787 Dreamliner, the production of which is creating significant new employment in a number of countries. To build this aircraft, the wings are produced in Japan, the engines in the United Kingdom and the United States, the flaps and ailerons in Canada and Australia, the fuselage in Japan, Italy and the United States, the horizontal stabilizers in Italy, the landing gear in France and the doors in Sweden and France. The production involves 43 suppliers spread over 135 sites around the world collaborating for their mutual benefit.

More broadly, whether used for domestic production, consumption or re-export, imports can give firms access to new technologies and critical inputs at competitive prices, making it possible for these firms to become more competitive.

As markets open, the distribution of income can be affected as an increased number of workers benefit from higher-paying trade-related employment while some workers may face income loss as a consequence of the adjustment process. However, a recent Harvard University working paper by Helpman, Itskhoki and Redding concludes that while gradual trade liberalisation may initially increase inequality it eventually leads to decreased inequality as a greater share of firms engages in the international economy and become more productive, paying better wages.

 

Liberalise or “protect”?
Experience has shown the high cost of policies aiming to avoid trade-related structural adjustment with the goal of “protecting” jobs. Such policies are counterproductive, temporarily saving jobs in vulnerable sectors often at the expense of higher paying jobs in competitive sectors of the economy.

For example, one study of the quantitative restrictions in autos, steel and textiles in the US in the mid-1980s put their annual cost at $242,800 (in 2009 US dollars) per protected job.  Removing these restrictions could have led to large employment gains in other sectors and even in the auto sector, whose domestic competitiveness was penalized more by these restrictions than it was helped.

Delaying inevitable adjustment almost invariably translates into greater longer-term hardship than would be the case if policies of market openness were pursued.

 

Complementing an open trade policy
While trade is an essential component of sustainable economic growth, complementary policies are also needed in order to realise full benefits. In other words, the positive results from trade liberalisation are not automatic; other policy choices matter as well.

Among the most fundamental is the establishment of an adequate system of economic governance, including institutions and rule of law, which are crucial for property rights and for lowering transaction costs. Further policy complements (such as a sound regulatory framework and appropriate labour market, macroeconomic and investment policies) together can facilitate the allocation of resources to increasingly productive employment while ensuring an adequate social safety net and adjustment assistance.

OECD analysis points to policy areas that appear likely to play an important role in realising “dynamic gains from trade”. These include: removal of barriers to entrepreneurship and competition; promotion of science, technology, education and R&D; and regulation and other measures to ensure adequate availability of factors of production (capital and labour).

The World Trade Organization (WTO) initiative on Aid For Trade operates with OECD support and is working to ensure that developing countries are able to realise the benefits of market openness by building their capacity to trade.

 

What next for trade?
With appropriate complementary policies, trade can contribute on a sustained basis to productivity growth, quality job creation and increased consumer choice. Protectionism simply cannot deliver the goods – or the services – in any of these areas.

An immediate opportunity for further trade liberalisation already exists: conclusion of the WTO Doha Development Agenda (DDA). Action to conclude the DDA would increase business confidence, solidify the essential role of a rules-based, multilateral trading system that promotes the interests of all trading nations, and deliver new economic opportunities.

Governments today are confronted with sceptical publics who, in the face of economic shocks and future uncertainty, quite naturally look for “protection” and greater security for themselves and their families. The benefits of a policy mix that provides short term relief through active labour market and social policies, alongside medium and longer term opportunities through more open economies, must be better articulated.

The OECD is also looking beyond the recovery, with a view to preparing for the “new normal”. The post-crisis environment is not likely to be a return to “business as usual” – but what will that new environment look like? How will global trade imbalances be addressed? How will global production networks evolve? How will economic, environmental and social interests be pursued by governments? These are some of the questions that the OECD is examining, with the overriding objective of ensuring that trade plays its vital role in the recovery, and beyond.

 

Further reading:

For more detailed analysis and data on this subject, please see the report:

 Trade and the Economic Recovery: Why Open Markets Matter (pdf, 470 KB)

 

See also:

 How imports improve productivity and competitiveness

 Trade, policy and the economic crisis

 

 

 

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