Resolving trade paradox
If we all are beneficiaries of trade, then why do countries go for trade wars?
What does one think when one hears the word 'war'? One tends to immediately associate it with armies, guns, bombs, and so on. But the current era is witnessing a different kind of war called the trade war. The weapons of this trade war are everywhere, whether it is the imported food that we consume, the components of the automobile that we drive or the device which we are currently using to read this article. As consumers, we are all consuming imports. Simply put, if countries get caught in a trade war and start slashing tariffs on the imports then the price of the imported goods that we consume will be higher. But if we all are the beneficiaries of trade; then why do countries even go for trade wars?
Global trade can be a complicated issue to deal with and therefore, requires a deeper understanding. Let us assume that in the HBO series, Game of Thrones, the kingdoms of Lannisters and Tyrells produce both swords and wine, with the existing labour force. However, due to their proximity to iron mines, Lannisters can produce swords at a much cheaper cost than the Tyrrells. Similarly, the Tyrrells can produce wine at a much lower cost due to its abundant agricultural lands. Therefore, both the Lannisters and the Tyrells would gain from trade through the complete division of labour. The trade theory suggests that Lannisters should specialise in the production and exports of swords in which it has a comparative advantage. Meanwhile, the Tyrells should specialise in the production and exports of wine. Thereby, both kingdoms would be able to maximise their national product and economic welfare.
The standard theory of trade predicts that free trade will bring benefits to both the exporter and the importer countries. But it is silent about the demand side and intra-country consequences of free trade. Empirical evidence suggests that globalisation generates both winners and losers. It has been good for millions of unskilled workers of developing countries and capitalists who derive their income from renting out capital and technology. However, for unskilled labourers of western countries who lose their jobs to other country's workers, its impact has been negative. The aggressive pursuit of globalisation since the 1980s has coincided with an era of job losses and wage stagnation in the western countries. With the dollar crisis of 1971 (the US suspended convertibility of the dollar into gold), the Bretton Woods system collapsed and the world adopted an era of globalisation with the floating exchange rate regime. The result was a massive increase in global trade and output growth. The rapid expansion of global trade along with technological advancement has substantially brought down the trade barriers like transportation cost, tariffs and restrictions on the movement of capital. Reducing trade barriers has resulted in the free movement of the factors of production across borders, mainly that of labour and capital. Such free movement of labour and capital contradicts the standard theories of trade under which the factors of production are intrinsic and cannot move out. The movement of labour and capital along with goods has created a trade paradox wherein instead of bringing in gains in terms of economic growth, it has brought about job losses and wage stagnation.
The trade paradox and wage stagnation have seeded the discontent against globalisation and liberal economic order. For most western critics of globalisation, free trade is a rogue, perpetuating inequalities and responsible for job losses. The populist leaders in the West have taken advantage of this and risen to power by claiming to be the messiah of the masses who have been left hurt through the process of globalisation. They attacked the liberal economic order and globalisation by arguing that free trade perpetuates inequality. Gains from trade are unevenly distributed in favour of developing countries. The right-wing leaders of European nations are particularly sceptical about trade; especially the free movement of labour across the countries. They argued that unregulated migration threatens their culture and political legitimacy.
They demonise globalisation because they fail to understand how it operates. In reality, free trade and globalisation bring efficiency gains. When each country specialises in producing the goods which it has a comparative advantage in, total production of the economy rises. This corresponding expansion in growth rates can be used to make everyone better off. However, if the gains from free trade are not distributed fairly and instead concentrated in a few hands, then the entire mechanism of free trade comes under attack. Therefore, the real problem is not free trade but the redistribution aspect of the gains from free trade. The western governments have failed to improve the living conditions of people who have been hurt by globalisation. They have failed to provide pensions, health care, education and minimum wages. They continued to promote policies that benefit the rich at the expense of the middle and lower-class citizens who are in direct competition with the low skilled workers of developing countries. Moreover, the current global trade rules have promoted intra-firm trade as opposed to inter-country trade, thus enabling few global multinationals to control the trade in goods and services. United Nations Conference on Trade and Investment Report highlights how top MNCs have increased their share of exports and now dominate the global trade.
Hyper globalisation has created a trade paradox and serious imbalances. By attacking free trade, one tends to completely miss the point. The real problem lies in the fact that free trade has enabled a few multinationals to secure market power. This, in turn, has given rise to massive inequalities and perpetuated the rent-seeking behaviour. The benefits of trade can be increased and distributed fairly by mitigating the weaknesses of the trading system. Accordingly, the aspect of redistribution will be taken care of, and the wealth channelised through globalisation will not be centred in few hands.