The Hindu Business Line : Why free trade does not deliver the goods

Mainstream economists may see free trade as a solution but there are certain problems with it, such as movement of natural persons, lower wages and national security. Therefore, the only option seems to be protection with domestic good governance. Good governance will ensure that the high tariffs are used to raise wages and not to extract bureaucratic rents.

When the World Trade Organisation was formed, industrial countries agreed in principle to reduce their domestic agricultural subsidies at some future unspecified time. The main demand of the developing countries in the current Doha Round was that the industrial countries deliver on that commitment. But the latter, in return, demanded steep cuts in import duties on manufactured goods and services by the developing countries.

The developing countries, however, did not agree to this because the livelihoods of millions would be adversely impacted by the indiscriminate opening to imports.

Many farmers from the developing countries will surely gain from open access to industrial countries but many others will be hit by cheap imports. Hence, the developing countries wanted special provisions to impose higher tariffs where the livelihood of a large number of persons was likely to be impacted. The talks broke down because the two groups could not agree on this issue.

Core reality

The crux of the matter is that both sides acknowledge that gains are to be made from free trade but are afraid that particular countries or people can be adversely affected. In other words, free trade is not a win-win situation for all the stakeholders. This is contrary to the thinking of mainstream economists who see free trade as a panacea for economic problems.

The first problem with the mantra of free trade is that of movement of natural persons. Economic theory tells us that free movement of goods and capital will lead to each country specialising in what it does best. Bangladesh will produce more jute and Malaysia more palm oil. This will provide good quality goods at low prices to the consumers across the world. More competition will lead to better products being available. The improvement in quality of cars, TV sets and computers in the country during the last 15 years of reforms is proof of this beneficial effect of free trade.

The problem, however, is that the consumer may not have the purchasing power to buy the things on the shelf. Say, an imported 25-inch flat screen TV set is available for Rs 5,000. The farmer needs to sell wheat in order to buy the TV set. But the cost of production of wheat in Australia is less.

Cheap Australian imports have flooded the country and the farmer is unable to sell his produce. The Haryana farmer decides to produce jute but finds that Bangladesh produces that cheaper than him. Similarly, Malaysia produces cheaper palm oil, Brazil sugar and Vietnam coffee. The farmer does not have a comparative advantage in any crop. What is he to do in a free trade regime?

Theory of free trade

According to the theory of free trade, the Haryana farmer should migrate to Australia where the climate is more suitable for the production of wheat. There was less restriction on such migration in the past. But such freedom to migrate is not part of the free trade model espoused by the WTO.

The poor farmer is hemmed in within the country while cheap imports are allowed to come in. The result is poverty for those who cannot produce to global standards. The theory of free trade falls apart in the absence of free migration of natural persons. The solution lies in protectionism.

The Haryana farmer can happily produce high-cost wheat and buy a high-cost TV set if the government imposes high duty rates on the wheat imported from Australia.

Surely, the urban consumer will be deprived of the inexpensive wheat and the farmer of the flat screen TV; but one will at least get the expensive ones. In the free trade model one will get nothing. Thus, protectionism, not free trade, is the route to people's welfare when free migration is not possible.

The second problem is that of lower wages. In free trade, one who produces goods cheapest is the winner. This translates into low wages to the labourers. The wage of an American software programmer is the equivalent of about Rs 8,000 a day against Rs 1,000 for his Indian counterpart. Companies find it profitable to employ Indian programmers. The American programmer can, however, save his job if he agrees to accept lower wages.

Protectionism, the solution

Similarly, advances in transport and communication technology have made it possible for companies such as Wal-Mart to buy goods produced by cheap labour in China. Thus, free trade necessarily means lowest wages. In such a situation, the welfare of the US workers is secured by protectionism, not free trade.

The third problem with free trade is that of national security. The US can indeed get cheap rice from India. But what happens in case of a war? What will the Americans eat? It may be better to produce expensive domestic wheat than buy cheap imported cereal, from this viewpoint.

The conclusion is that people's welfare can only be secured by protectionism in the absence of free movement of natural persons. Every country can then raise import tariffs such that inefficient production can survive and people can earn their bread.

The difficulty here is that protection is often used by the corrupt in the government to extract rents. For example, high import duties on imported TV can be a smokescreen behind which the government can impose high taxes on domestic producers. That was exactly the situation in India before the reforms.

Taxes totalled 60-70 per cent of the sale price of many commodities. These monies were being used by Ministers and bureaucrats to stash away ill-gotten wealth abroad. The collapse of the Soviet Union and the near disintegration of communism in China can be attributed to such rent seeking by the party bureaucracies.

Free trade prevents such rent extraction. But it also deprives people of livelihood. The solution to this predicament is protection with domestic good governance. Protection will ensure that people are protected from cheap imports and can earn their livelihood from inefficient production behind closed borders.

Good governance will ensure that the high tariffs are used to raise wages and not to extract bureaucratic rents. No wonder the kind of liberalisation of trade espoused by the WTO has come to naught.

(The author, a freelance writer, can be contacted at bharatj@sancharnet.in)