The third world and relative gains from global trade: an empirical comparative analysis of developed versus developing countries.

Author:Tarzi, Shah
  1. Introduction

    Proponents of free trade theory and trade liberalization maintain that despite drawbacks, the distribution of gains from trade is a win-win for all countries. In particular, developing countries that opt for trade openness are most likely to benefit, to generate growth, to experience a rise in standard of living and to create jobs. (1) For instance, in developing countries that are most open to foreign trade, the so-called "new globalizes," nearly 120 million people have risen above the ranks of absolute poverty, and an impressive 13% decline in poverty rates has been observed. This is partly due to the competitive advantages in the manufacturing sector the developing countries have realized as a result of trade liberalization. (2) However, critics of free trade argue that the gains from international trade disproportionately accrue to the developed countries, often at the expense of developing states. The Economics Online, a leading digital sources for economic scholars, has noted that "trade can lead to over-specialization, with workers at risk of losing their jobs should world demand fall or when goods for domestic consumption can be produced more cheaply abroad. Jobs lost through such changes causes, at least in the short run, severe structural unemployment." (3) Since adjusting to these structural imbalances takes years and because developing states have a weak social safety net, massive numbers of workers and the working age population at large suffer in the interim. (4)

    Existing literature offers rich theoretical analysis, and substantial global estimates of gains from trade. (5) What is often lacking in the existing body of literature, though, is a broad-based cross-section time series study that empirically maps the relative gains from trade liberalization on a comparative basis across two large groups of countries:

    DCs and LDCs. The study attempts to address this gap and in the process re-examine the competing theoretical perspectives, cited above, with help from fresh empirical evidence. Accordingly, the central objective of this study is to address the following question: how are gains from trade liberalization distributed across DCs and LDCs? Put differently, has trade liberalization benefited both DCs and LDCs, or do gains from trade liberalization disproportionately accrue to one group? To answer the question, this study will obtain data that offer an empirical profile of the consequences of trade liberalization. To measure the distribution of gains from trade liberalization, or the consequences of international trade openness, we identify trends and the magnitudes of change in key factors like total income, per capita income, and net per capita income. In the interest of accuracy and consistency and to facilitate comparative analysis, we group countries into DCs and LDCs, a classification that is also used by the International Monetary Fund and World Bank, and the United Nations. Typically, these institutions divide countries into broad categories: DC (Developed Countries) and LDC (Less Developed Country), based on a set of characteristics, including Gross National Product (GNP) per capita, level of unemployment, literacy rates, energy consumption, unemployment, communications and physical infrastructure. (6)

    This rest of the paper is organized as follows: A brief literature review clarifies the theoretical foundation of competing interpretations regarding the cost and benefit of international trade. Our main goal, however, is to explain how this study effectively bridges a gap in extant knowledge. Next, we present an overview of the study methodology. Thereafter, the paper focuses on the core objective: to quantitatively profile the economic consequences of trade liberalization using several key and widely acknowledged metrics. These include GDP growth, per capita income, and in particular, inflation-adjusted net per capita income, which account for the real rise in living standards in relation to trade liberalization. This section is followed by a summary of the findings. Finally, we highlight the theoretical and practical implications of the study.

    Note that this study does not aim to measure the magnitude of trade liberalization or the degree of integration into the world economy for the two groups: DCs and LDCs. However, in order to best highlight the core theme, a brief comparative synopsis of the magnitude of the liberalization of global trade will be presented.

  2. A Glance at the Literature

    The proposition that gains from free trade are widely distributed across states and society is rooted in a frame work proposed by Adam Smith and David Ricardo. (7) Over the years, the neoclassical Ricardian free trade doctrine was enriched by Benthamite utilitarians, notably Alfred Marshall who emphasized the effect of demand and marginal utility on the terms of trade. (8) The Austrian school, particularly Ludwig von Mises, also contributed by highlighting the 'opportunity cost' of government intervention in international trade. (9)

    The Heckshscher-Ohlin model (and later Heckshscher-Ohlin-Samuelson model) introduced resource endowments of nations as the key determinant of mutually gainful trade and comparative advantage, thereby defending free trade as Pareto-optimum. (10) World-renowned economists Hayek, Keynes, and Friedman have defended the free trade doctrine as a driver of productive efficiency, growth, jobs and consumer well-being. (11) Among contemporary scholars, Bhagwati and Mankiw have illuminated the relationship between trade and economic growth. (12)

    Many other contemporary advocates of free trade theory maintain that developing countries most integrated into the world economy tend to grow faster, as evidenced by the success of East Asia where tariff levels have dropped by two-thirds during the period 1980-2000, or from 30 percent to 10 percent. (13) Likewise, India, Vietnam, and select African countries that have opted for trade liberalization in the recent years have experienced faster growth and declining poverty. (14) Matusz and Tarr go so far as to maintain that the ratio of benefits to costs from trade liberalization is 10:1. (15)

    In short, proponents of free trade maintain that in the contemporary international economic system, no country has been able to generate economic growth, create jobs, or raise national output without opening their economy to trade and foreign investment. Accordingly, trade openness will enable developing countries to generate economic growth, and improve living standards for citizenry. Even income inequality is likely to decline as trade liberalization-propelled growth reduces income disparities. The policy implications of this line of reasoning include elimination of barriers to trade such as high tariff rates and protectionist measures in agricultural products and cessation of labor-intensive manufacturing in both advanced and developing countries. (16)

    Some critics of the free trade focus on the impact of politics and political institutions on the distribution of gains from trade within and across countries. They note that relative gains from trade are often channeled to privileged, powerful, domestic, rent-seeking political groups that use political influence to secure economic gains and socialize costs. They do so by orchestrating explicit or implicit protectionist measures and subsidies. (17) Friedan and Lake highlight the impact of political regime and differences in political institutions on the propensity toward pro-trade openness or protectionist policies. (18) They extend the debate beyond the "free trade versus protectionism" paradigm by recognizing political realities and questioning and critiquing how trade works in practice. The eminent economist Lester Thurow has highlighted a similar dilemma on the economics of free trade. According to Thurow, countries that exploit comparative advantages will see their incomes rise; however, some individuals and groups in the society will stand to lose. The comparative advantage theory is based on the premise that winners from international trade will use some of the accrued extra income to compensate those in the society who lose; however, that is rarely the case. Therefore, it is reasonable to say that losers from trade will oppose international trade. (19)

    Arguably, two of the most influential critics of the traditional free trade theory and the current state of trade liberalization are Nobel laureates Joseph Stiglitz and Paul Krugman. Stiglitz's critique is based on the existence of imperfect competition. Market malfunction due to asymmetric information and inequalities among market participants make the existence of genuine competition among states via international trade seem like an economic abstraction. (20) Stiglitz questions the assumption of a level playing field and notes that many advanced countries are not sufficiently committed to free trade. Thus, tariff levels, a key impediment to trade liberalization, by the advanced industrial countries against developing countries are four times higher than those of DCs. (21)

    Krugman, who formulated the "strategic trade" doctrine, along with other notable scholars of the alternative "new trade theory" (NTT), particularly Brander and Spencer, accepts the neoclassical trade theory's foundational premise that under conditions of free trade, Pareto-optimality can be achieved. Krugman questioned the validity of this and other restrictive assumptions of trade theory in the real world, and consequently the conclusions pertaining to the distribution of gains from trade. The orthodox theory excludes key variables such as "increasing return to scale, imperfect competition and product differentiation," (22) Krugman presents a "general equilibrium model of noncomparative advantage trade." He explains that economies of scale, which are internal to firms, influence trade and that the scale economies make markets imperfectly competitive. According to him,...

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