The Political Economy of International Trade

Ken Heydon

• Publisher: Polity
• Year: 2019
• ISBN:
  9781509534371
• Edition: 1
• Topic: Economía
• Subtopic: Política económica

With protectionist sentiment and economic nationalism on the rise, international trade and how it is governed is at the heart of some of the most important contemporary economic and political debates. Comprehensive and clear, this book skilfully outlines and analyses the dynamics of trade in the 21st century. Ken Heydon examines three broad themes: the nature and distribution of the gains from trade, the institutional and governance framework of the international trade system, and the contentious practical issues confronting policy-makers across the world. He considers pressing contemporary debates surrounding issues ranging from agriculture and food security to the links between trade and environment protection, core labour standards and intellectual property rights. He demonstrates the importance of a change of mindset in terms of how we see trade policy: it should not, he argues, be simply a question of international negotiation, but also a key component of sound domestic economic management. In short, we need to put commerce in context. Drawing on the author's experience as a policy practitioner, trade policy analyst and teacher, the volume is informed by an extensive analysis of the literature and by relevant case studies. It is designed for students and scholars of international political economy and trade policy, trade officials, and the general public.

Part I
The Gains from Trade: Winners and Losers

1
The Political Economy of Trade: The Domestic Setting

The legislature, were it possible that its deliberations could be always directed not by the clamorous importunity of partial interests, but by an extensive view of the general good.

Adam Smith The Wealth of Nations IV ii 44, 471–2

Trade theory, from the classical models to the New Trade Theory, posits that, with qualifications about the distributional effects, liberal trade brings net gains to welfare. Why then is it so hard to achieve? This chapter – after outlining the key theoretical work – will cover the challenge arising from the concentrated costs and dispersed gains of trade liberalisation and the widespread perception that trade is the primary cause of structural disruption and rising income inequality within the advanced economies. Other explanations of rising inequality will be considered. The chapter will also address the role of special interest groups, the collective action problem and the contrasting ways in which the United States and European Union have used governmental arrangements to try to limit the influence of special interests. Policy implications will be drawn.

The Political Economy of Trade: The Three Elements

There are three strands to the political economy of trade: trade and trade liberalisation yield net gains in welfare, but the gains are unevenly divided among winners and losers, leading to interest-group pressure among losers to resist market opening. Each of these elements has a strong theoretical¹ underpinning and a body of empirical evidence in support of the theory.

Trade yields gains: The theory and the empirical testing

A key analytical pillar in support of the gains from trade is still the theory of comparative advantage formulated in 1817 – in a fundamental break from the zero-sum logic of mercantilism – by David Ricardo.² The theory holds, somewhat counter-intuitively, that the gains from trade depend on comparative costs within one country – not, as Adam Smith had postulated, absolute costs between countries. A country will export the product in which, on the basis of domestic cost, it has a comparative advantage and import the product in which it has a comparative disadvantage. A country with zero absolute advantage can still benefit from trade, on condition that activities of comparative disadvantage cease (see Box 1.1).

Box 1.1 The Theory of Comparative Advantage

The Theory of Comparative Advantage, developed by David Ricardo, can be explained using a simple model

Production	US one man-week	UK one man-week
Wheat	6 bushels	2 bushels
Cloth	10 yards	6 yards

In the case shown above, while the United States has an absolute advantage, in production costs, over the UK in both wheat and cloth, it has a greater comparative advantage in the production of wheat and will thus gain by exporting wheat and importing cloth. This can be shown arithmetically. In the US, without trade, ten yards of cloth will exchange for six bushels of wheat. In the UK, by the same token, six bushels of wheat will exchange for eighteen yards of cloth. If the US can get more than ten yards of cloth for six bushels of wheat by selling wheat to the UK, it will gain by exporting wheat in exchange for cloth. Correspondingly, if the UK can get any more than three-and-one-third bushels of wheat for ten yards of cloth, it will gain by exporting cloth in exchange for wheat in international trade.

It was John Stuart Mill, the third great classical economist (after Smith and Ricardo), who later determined that the exact terms of trade in between the two cost ratios – in this case between wheat and cloth – depends on the strength of world supply and demand for the two commodities.

Though the highly stylised nature of Ricardo’s insight has been subject to considerable refinement over the years, its basic validity remains intact and relevant. As we shall see in Chapter 2, it is possible for countries, through their domestic policies, to influence their comparative advantage and thus the direction of their growth path.

Building on what Paul Krugman has described as Ricardo’s difficult idea, the New Trade Theory of Norman–Dixit–Helpman–Krugman recast the gains from comparative advantage in the framework of intra-industry trade, increasing returns to scale, network effects and monopolistic competition. Central to this approach – and of recurring importance in the study of the political economy of trade – is the notion of externalities (see Box 1.2).

Box 1.2 Externalities

Externalities are the effects of economic activity not accounted for by those conducting the activity. Such effects can be positive or negative.

Positive externalities – a principal feature of New Trade Theory – can encompass: ‘learning by doing’ that facilitates innovation; agglomeration externalities that result from physically associated expansion of economic activity; technology spill-over from a new firm that benefits unrelated third parties in established firms; and so-called network externalities that arise, say, when a purchaser of a smartphone increases the benefit other users derive from having a phone.

Negative externalities can arise when, say, a polluting factory has detrimental effects on unrelated third parties or when the property rights associated with access to river water are unclear. Such externalities can be characterised as market failure, because the social costs of the activity exceed the private costs. In a seminal work on regulation, Ronald Coase postulated that when transaction costs are low (including access to information) it may be possible to address negative externalities by bargaining among those affected. In practice, the number of parties involved may well be too great for this to be feasible and government intervention will be necessary in order to ‘internalise the externality’ by taxing or regulating the activity.³

The New Trade Theory did not, however, fully account for the fact that only a minority of domestic firms engage in export following market opening. In response to this puzzle, models were developed that introduced firm-level differences to explain the observed export market participation asymmetries. These ‘firm heterogeneity models’, also referred to as New New Trade Theory,⁴ explain how trade liberalisation introduces uneven innovation responses among firms, reallocating resources to exporting firms with higher productivity levels and pushing weaker firms out of the market.

Recent empirical work⁵ has confirmed the continued relevance of Ricardo’s foundational insight, suggesting that a focus on areas of comparative advantage in US agriculture lifted real output per worker by 79 per cent between 1880 and 1997.

Because, as we shall see, preferential trade agreements (PTAs) have come to play the central role in trade diplomacy, much of the measurement of the potential gains from trade is focused on such agreements. It has thus been found, on the basis of computerised general equilibrium (CGE) modelling, that liberalisation under the Transatlantic Trade and Investment Partnership (TTIP) would yield a permanent increase in EU GDP of 0.5 per cent.⁶

Another way of measuring the gains from trade is through the effects on domestic prices. Other recent work suggests that imports from China have lowered the US manufacturing price index by eight per cent.⁷

If trade and trade opening are so demonstrably beneficial why do they face such resistance?

Trade involves winners and losers: The theory and the empirical testing

Trade causes domestic and international prices, including wages, to converge, thus changing relative prices within economies and the returns to different factors of production.

The most widely cited theoretical work building on this observation is the Heckscher–Ohlin–Stolper–Samuelson (HOSS) model. Elaborating on Ricardo’s theory of comparative advantage, Eli Heckscher and Bertil Ohlin postulated that countries will export products that use their abundant factor of production and import products that use the countries’ scarce factors. Building in turn on this work, Wolfgang Stolper and Paul Samuelson established that free trade increases the returns to the abundant factor within an economy and decreases the returns to the scarce factor.⁸ In practical terms, what this means is that trade will tend to favour skill- and capital-intensive activities in advanced economies and labour-intensive activities in developing countries. Like all theories, these propositions have not been without criticism; there has for example been some evidence of skilled labour making relative gains in developing countries, as we shall see in Chapter 2. Nevertheless, the broad lines of the theory hold firm as an indicator of the likely effects of trade and the expectation that unskilled labour in the advanced economies is likely to be among the losers from market opening.⁹

Elaborating on the distinction between winners and losers from trade liberalisation is the work of Vilfredo Pareto (Pareto 1971) within the framework of society-centred analysis.¹⁰ Pareto observed that the gains from trade opening tend to be delayed, dispersed and hard to measure while the costs are typically immediate, concentrated and easy to measure. A case in point would be the closure of a garment manufacturing plant in the face of intensified import competition set against the price advantage eventually passed through to a potentially vast number of consumers.

Consistent with the HOSS model of the theory and with the undisputed fact of a growing income gap within the OECD economies, a principal source of anti-globalisation sentiment derives from the perceived contribution of increased import competition ...

Table of contents

• Cover
• Contents
• Dedication
• Title page
• Copyright page
• Case Studies
• Figures
• Abbreviations
• Acknowledgements
• Structure: The Building Blocks
• Introduction: Echoes of Mercantilism
• Part I The Gains from Trade: Winners and Losers
• Part II The Institutional Framework
• Part III Confronting the Issues
• Conclusion: Putting Commerce in Context
• References
• Index
• End User License Agreement