In 1960 less than one-sixth of the countries in the world had open trade policies. Most countries had various types of trade restrictions such as high tariff rates (taxes on imports) and extensive nontariff barriers (such as quotas that restricted the physical quantity of specific imports allowed into a country). In addition, the official exchange rate often exceeded the black-market exchange rate, and governments exercised monopoly controls on exports and other trade-related matters. Yet by 2000 three-quarters of the countries in the world had removed many of these impediments and were now open to international trade. This is a remarkable transformation and highlights the importance of trade liberalization in the global economy.
What precipitated the extensive trade liberalization that occurred? Much of the credit is usually given to the sixty years of multilateral trade negotiations that has resulted in ever-lower trade barriers under the auspices of the General Agreement on Tariffs and Trade (GATT). Since GATT’s inception in 1947, manufacturing tariffs in industrialized countries have fallen from 40 percent to 4 percent, and world trade has increased eighteenfold. Initial GATT membership of 23 countries expanded to 148 countries and the trade rounds became the international forum in which member governments agreed on rules for the conduct of international trade. The multilateral trade agreements involved nondiscriminatory tariff reductions so that all countries benefited—the “most favored nation” clause—and the tariff cuts were “binding” and could not be restored at a later date.
Countries would not have agreed to lower levels of import protection unless there were good arguments in their favor. Trade liberalization allows countries to specialize production and export in their areas of relative strength and to import products that other countries can make at lower cost. It enables access to a wider range of products, and access to foreign products helps diffuse innovations and new technologies. Openness to trade provides additional competition that can spur local firms to greater efficiency and keeps domestic prices low.
In the context of developing countries, a series of country studies sponsored by the World Bank, the Organization for Economic Cooperation and Development (OECD), and the National Bureau of Economic Research demonstrated that trade barriers imposed significant costs, whereas trade openness appeared to be associated with improved economic performance, although the underlying empirical research has not gone unquestioned (Rodrik 1999). For these countries, import substitution using high effective rates of protection had been the dominant vehicle by which industrialization has proceeded. Initially, local suppliers would have to be nurtured and protected from the competitive pressures applied by long established foreign producers. Over time, domestic inefficiencies would decline as these “infants” learned from experience and were able to reduce costs of production. The end result would be a far more diversified and self-reliant industrial structure less dependent on the vagaries of international commodity prices. In the 1970s increasing disenchantment with this strategy emerged, and an alternative approach, identified as outward- (or export-) oriented and associated with East Asian development, became more popular and trade barriers fell (Edwards 1993).
While trade barriers in manufacturing have fallen extensively, the trade liberalization agenda has expanded its scope and consequently run into considerable difficulties. In 1995 GATT’s successor, the World Trade Organization (WTO), became operational. Whereas GATT focused on trade in goods, the WTO concentrates on trade in services, intellectual property, and agricultural subsidies. According to the OECD, rich countries spend $280 billion a year on agricultural producer support; agricultural price support amounts to 20 percent in the United States, 50 percent in Europe, and 80 percent in Japan. These agricultural subsidies are trade-distorting, encouraging supported farmers to produce more, and this in turn lowers world prices and hurts farmers in poor countries that have a comparative advantage in the production of these subsidized commodities. Poor countries want agricultural liberalization in rich countries, yet there has been little progress in persuading richer countries to dispense with these subsidies. This leads credence to the claims about unfairness in trade negotiations made by Kevin Watkins and Penny Fowler in Rigged Rules and Double Standards (2003).
Trade in services, especially related to issues of labor mobility across national boundaries, and TRIPs (trade-related aspects of intellectual property rights), which are of special interest to the pharmaceutical and software industries, are equally contentious issues. The latter is related to the manufacture of generic drugs and their sales to poor countries. Claims for “fair trade” rather than “free trade” cloud trade negotiations even further, because nongovernment organizations have been advocating “social clauses” in trade liberalization agreements relating to child labor, human rights, the environment, wages, and conditions. Their position is that trade sanctions should be imposed against countries that do not meet international standards in these areas.
Given these stumbling blocks and complications, it is not surprising that there has been a move away from multilateral forums to negotiated bilateral or regional trade agreements outside the WTO framework. More than 300 such preferential trade agreements exist as of 2007. Whether these agreements assist global trade liberalization or hinder the process is not clear (Bhagwati 2002).
Trade liberalization is only part of a broader globalization movement and it needs to be carefully sequenced with other policy reforms. In general, trade liberalization should precede financial liberalization, domestic financial liberalization should precede external financial liberalization, and direct investment liberalization should precede portfolio and bank loan liberalization (capital account liberalization). Free inflows of foreign financial capital should only be allowed at the tail end of a liberalization program, and controls on suddenly increased inflows of short-term capital may be warranted. The purpose of these controls is to quarantine economies from excessive “hot” money inflows and outflows that disrupt economic stability and lead to exchange rate misalignments.
Overall, the welfare effects of trade liberalizations fall within the realm of second-best economics. There is still dispute about the direction of causation in the association between openness to trade and East Asia’s rapid growth. What role have trade liberalization packages played in the performance of outward-oriented economies? A number of these countries, such as Japan, Korea, Singapore, and Taiwan, have promoted exports, but in an environment where imports had not been fully liberalized. The success of the East Asian countries with export-led growth suggests that some selectively determined degree of government intervention played a key role. Imports and lower tariffs may stimulate productivity, but import competition may have little impact on productivity growth if the domestic producers are technologically backward: Benefits accrue only to domestic producers that are roughly comparable to their foreign counterparts. This, then, suggests a role for trade-adjustment packages and safety nets for those disadvantaged by trade liberalization.
SEE ALSO Barriers to Trade; Quotas, Trade; Tariffs
Bhagwati, Jagdish. 2002. The Wind of the Hundred Days. Cambridge, MA: MIT Press.
Edwards, Sebastian. 1993. Openness, Trade Liberalization, and Growth in Developing Countries. Journal of Economic Literature 31 (September): 1358–1393.
Rodrik, Dani. 1999. The New Global Economy and Developing Countries: Making Openness Work. Baltimore, MD: Johns Hopkins University Press.
Watkins, Kevin, and Penny Fowler. 2003. Rigged Rules and Double Standards: Trade, Globalization, and the Fight Against Poverty. Oxford: Oxfam.