According to the law of comparative advantage, trade can benefit all countries if they export goods which they can produce at lower opportunity costs than their trading partners. Trade enables all countries to consume beyond their production possibility frontier. What is more, trade can increase competition, which encourages firms to be more efficient.
That trade is beneficial has been generally accepted by governments around the world since the Second World War, with the General Agreement on Tariffs and Trade (GATT) and then the World Trade Organization (WTO) advocating the dismantling of trade barriers. Countries have participated in a series of trade ’rounds’, such as the Uruguay Round (1986–94) and most recently the Doha Round (2001–15). But since the financial crisis of 2008, there has been waning enthusiasm for freer trade and growing calls to protect strategic and/or vulnerable industries. To some extent this mirrors the growth in protection after the Great Depression of the early 1930s as countries sought to boost their own industries.
After some progress in the Doha round talks in Nairobi in December 2015, the talks effectively marked the end of a fourteen-year road for the round (see also). There was a failure to agree on a number of items and chances of resurrecting the talks seem slim.
The classic response to calls for protection is that it can lead to a trade war, with a net loss in global output as less efficient domestic industries are shielded from competition from lower-cost imports. Consumers lose from no longer having access to cheaper imported goods. Trade wars, it is argued, are a negative sum game. Any gains to one country are more than offset by losses elsewhere. In fact, it is likely that all countries will lose.
One argument for protection recognises the efficiency gains from free trade, but argues that current trade is distorted. For example, countries may subsidise the export of products in which they have a comparative disadvantage and dump them on the rest of the world. The WTO recognises this as a legitimate argument for tariffs, if they are used to offset the effect of the subsidies and make import prices more reflective of the cost of production.
But increasingly arguments go beyond this. Industries that are regarded as strategic to a country’s future, such as the steel industry or agriculture, are seen as warranting protection. With protection, investment may flow to such industries, making them more efficient and even gaining a comparative advantage at some point in the future.
Then there is the question of income distribution. Trade with poor countries may help to close the gap somewhat between rich and poor countries. The reason is that poor countries, with an abundance of labour, are likely to have a comparative advantage in labour-intensive products. The demand for exports of such products will help to drive up wages in such countries. However, income distribution within the rich countries may become less equal. Cheap imports from developing countries may depress the wages of unskilled or low-skilled workers in the rich countries.
Another argument concerns the devastation caused to communities by the closure of plants which are major employers. Workers made redundant may find it hard to find alternative employment, especially if their skills are specific to the plant that has closed. At least in the short term, it is argued that such industries warrant protection to allow time for alternative employers to be attracted into the area.
Arguments such as these are being used today in many countries as they struggle with slowing growth in China, a glut of global resources and overcapacity in certain industries.
The steel industry is a case in point. The announcement by Tata Steel that it intends to close the Port Talbot steel works has been met with consternation and calls for protection against subsidised Chinese steel imports. The USA already imposes tariffs of 256% on corrosion-resistant Chinese steel. The EU has proposed raising tariffs on Chinese steel to the full amount of the subsidy, but the UK has blocked this, not wishing to trigger a trade war with China. In the meantime, China has announced the imposition of a tariff of 46% on a particular type of hi-tech steel imported from the EU.
On the other side of the Atlantic, there have been growing protectionist calls from presidential front runners. Donald Trump and Ted Cruz on the Republican side, and Bernie Sanders and now Hilary Clinton on the Democratic side, are opposed to the trade agreement that President Obama has been seeking with the EU – the Transatlantic Trade and Investment Partnership (TTIP). Donald Trump has proposed imposing tariffs of 45% on all Chinese imports.
The following articles look at the growing calls for protection, especially against China, and at the arguments about what should be done to protect the UK and EU steel industry.
Defiant China slaps steel tariffs on Britain as trade war looms The Telegraph, Ambrose Evans-Pritchard (1/4/16)
China’s soaring steel exports may presage a trade war, The Economist (9/12/15)
Trade, at what price? The Economist (30/3/16)
Free trade in America: Open argument The Economist (2/4/16)
Can the British steel industry be saved? Financial Times (2/4/16)
Steel crisis: UK government plays down China tariff fears BBC News (2/4/16)
The dogmas destroying UK steel also inhibit future economic growth The Observer, WIll Hutton (3/4/16)
UK accused of leading efforts to block limits to Chinese steel dumping The Guardian, Frances Perraudin (1/4/16)
There’s always an excuse to justify suspending free trade – Tata is the latest The Telegraph, Allister Heath (1/4/16)
Can one of the world’s top economies live without making steel? Bloomberg, Thomas Biesheuvel (1/4/16)
Trade policy is no longer just for political nerds: it matters in the UK and US The Guardian, Larry Elliott (27/3/16)
Steel shrivels while Britain’s balance of payments crisis grows The Observer, WIlliam Keegan (3/4/16)
Trump’s tariff plan could boomerang, spark trade wars with China, Mexico Reuters, David Lawder and Roberta Rampton (24/3/16)
Analysis: A Trump trade war could cost the U.S. millions of jobs Daily Herald (Chicago), Jim Tankersley (3/4/16)
- What is meant by the ‘law of comparative advantage’? Does the law imply that countries will always gain from totally free trade?
- Demonstrate the gains for each of two countries which choose to trade with each other (see, for example, pages 711–3 in Economics, 9th edition).
- What is meant by ‘strategic trade theory’? How would such theory relate to the case of steel production in south Wales?
- What are the arguments for and against the EU imposing tariffs on Chinese steel imports equal to the subsidy given by the Chinese government?
- Is protectionism always a negative sum game? Explain.
- Assess the validity of various arguments for protection.
- Why did it prove impossible to complete the Doha round?
- What is meant by the ‘Transatlantic Trade and Investment Partnership (TTIP)’? Why is there so much opposition to it?
- Are bilateral trade deals, such as the TTIP, the best way of moving forward in reaping the gains from freer trade?
The UK’s balance on trade continues to be sharply in deficit. At the same time, both manufacturing and overall production are still well below their pre-crisis levels. What is more, with a sterling exchange rate that has appreciated substantially over recent months, UK exports are at an increasing price disadvantage. The hoped-for re-balancing of the economy from debt-financed consumption to investment and exports has not occurred. Investment in the UK remains low relative to that in other major economies (see).
But other developments in the global economy are working in the UK’s favour.
Manufacturing globally is becoming more capital intensive, which reduces the comparative advantage of developing countries with low labour costs.
At the same time, the dividing line between manufacturing and services is becoming more blurred. Manufacturers in developing countries may still produce parts, such as chips or engines, but the design, marketing and sales of the products may take place in developed countries, such as the UK. Indeed, as products become more sophisticated, an increasing amount of value added may occur in developed countries.
The UK may be particularly well-placed in this regard. It can provide many high-end services in IT, business support and financial services to international manufacturers. It may have a comparative advantage in idea-intensive production.
Finally with a higher exchange rate, the UK’s terms of trade have been improving. The downside is that it makes UK exports more expensive in foreign currency terms, but it also makes commodity prices cheaper, which have already fallen in dollar terms, and also the prices of imported component parts. This helps offset the effect of the appreciation of the exchange rate on exports.
The following article by Jeremy Warner considers whether, despite its poor performance in traditional manufacturing, the UK might have hit an economic ‘sweet spot’ in its trade position.
Unbalanced but lucky, Britain hits an economic sweet spot The Telegraph, Jeremy Warner (8/9/15)
UK Trade (Excel file) ONS (9/9/15)
(See, for example, Worksheet 1. You can search for longer series using Google advanced search, putting www.ons.gov.uk in the ‘site or domaine’ box and searching for a particular series, using the series identifier found at the top of each column in the Excel file, such as BOKI for balance on trade in goods.)
Exchange rate data Bank of England Statistical Interactive Database
- Explain the difference between the balance on trade, the balance on trade in goods and the balance of payments on current account.
- Why has the UK not experienced a re-balancing of the economy as hope for by the Chancellor of the Exchequer, amongst others?
- What is meant by the ‘terms of trade’?
- What would cause an ‘improvement’ in the terms of trade?
- Are the UK’s terms of trade likely to move in the UK’s favour in the coming months? Explain.
- What current factors are mitigating against a recovery of UK manufacturing exports?
- Is de-industrialisation necessarily a ‘bad thing’?
- Does the development of new capital-intensive technologies in manufacturing mean that the UK could become a net exporter of manufactures? Explain why or why not.
A deal has just been signed between 26 African nations to form a new free trade area, the Tripartite Free Trade Area (TFTA). The countries have a population of 625 million (56% of Africa’s total) and a GDP of $1.6 trillion (63% of Africa’s total). The deal effectively combines three existing free trade areas: the Common Market for Eastern and Southern Africa, the Southern African Development Community and the East African Community.
Although the deal has been signed by the nations’ leaders, it still needs parliamentary approval from each of the countries. It is hoped that this will be achieved by 2017. If it is, it will mark a major step forward in encouraging intra-African trade.
The deal will involve the removal of trade barriers on most goods and lead to a reduction in overall tariffs by more than 50%. The expectation of the leaders is that this will generate $1 trillion worth of economic activity across the 26 countries through a process of trade creation, investment, increased competition and the encouragement of infrastructure development. But given the current poor state of infrastructure and the lack of manufacturing capacity in many of the countries, the agreement will also encourage co-operation to promote co-ordinated industrial and infrastructure development.
Up to now, the development of intra-African trade has been relatively slow because of poor road and rail networks and a high average protection rate – 8.7% on exports to other African countries compared with 2.5% on exports to non-African countries. As a result, intra-African trade currently accounts for just 12% of total African trade. It is hoped that the development of TFTA will result in this rising to over 30%.
Much of the gains will come from economies of scale. As Kenyan academic Calestous Juma says:
“By having larger markets, it signals the possibility of being able to manufacture products at a scale that is cost-effective. For example, where you need large-scale investments like $200m to create a pharmaceutical factory, you couldn’t do that if you were only selling the products in one country.”
The question is whether the agreement signed on the 10 June will lead to the member countries fully taking advantage of the opportunities for trade creation. Agreeing on a deal is one thing; having genuinely free trade and investing in infrastructure and new efficient industries is another.
Videos and audio
African leaders ink trade deal Deutsche Welle (11/6/15)
African leaders sign pact to create ‘Cape to Cairo’ free trade bloc euronews (10/6/15)
Africa Free Trade Analysis BBC Africa, Calestous Juma (9/6/15)
African Leaders To Sign Free Trade Agreement To Create Common Market International Business Times, Aditya Tejas (10.6.15)
EAC, COMESA and SADC Blocs Ink ‘Historic’ Trade Deal allAfrica, James Karuhanga (11/6/15)
Tripartite Free Trade Area an Opportunity Not a Threat allAfrica, Sindiso Ngwenya (9/6/15)
Africa a step closer to free trade area Business Report (South Africa), Rob Davies (11/6/15)
The Cape to Cairo trade ‘super bloc’ is here; 15 surprising – and shocking – facts on trade within Africa Mail & Guardian (Kenya), Christine Mungai (8/6/15)
The tripartite free trade area agreement in Africa is bound to disappoint Quartz Africa, Hilary Matfess (10/6/15)
Africa creates TFTA – Cape to Cairo free-trade zone BBC News Africa (10/6/15)
Will the Cape to Cairo free-trade zone work? BBC News Africa, Lerato Mbele (10/6/15)
African free trade still some way off BBC News, Matthew Davies (10/6/15)
Zambia not to benefit from Africa’s TFTA Medafrica, Geraldine Boechat (10/6/15)
- Distinguish between a free trade area, a customs union and a common market.
- What does the law of comparative advantage imply about the gains from forming a free trade area?
- Distinguish between trade creation and trade diversion.
- Why is it likely that there will be considerable trade creation from TFTA? Would there be any trade diversion?
- Why are small countries with a relatively low level of economic development likely to experience more trade creation than larger, richer ones?
- What barriers might remain in trade between the TFTA countries?
- Why might smaller, less developed members of TFTA be worried about the removal of trade barriers?
- Why might concentrating on developing local capacity, rather than just lowering tariffs, be a more effective way of developing intra-African trade
- What ‘informal’ barriers to trade exist in many African countries?
- Why is it that ‘Ordinary Africans are most probably not holding their breath’ about the gains from TFTA?
The 159 member countries of the World Trade Organisation have reached an agreement on liberalising trade. The deal, which was reached on 6 December 2013 at a meeting in Bali, is the first substantial agreement since the WTO was formed in 1995 (see Timeline: World Trade Organization for other agreements).
It involves simplifying customs procedures and making them more transparent, limited reductions in tariffs and quotas and allowing greater access to WTO members’ markets for exporters. It also permits developing countries to continue subsidising their agriculture in order to promote food security, provided the practice does not distort international trade. According to the WTO:
The trade facilitation decision is a multilateral deal to simplify customs procedures by reducing costs and improving their speed and efficiency. It will be a legally binding agreement and is one of the biggest reforms of the WTO since its establishment in 1995. …The objectives are: to speed up customs procedures; make trade easier, faster and cheaper; provide clarity, efficiency and transparency; reduce bureaucracy and corruption, and use technological advances. It also has provisions on goods in transit, an issue particularly of interest to landlocked countries seeking to trade through ports in neighbouring countries.
In a report published by the Peterson Institute in Washington, it is estimated that the extra trade will add some $960bn to world GDP and create some 20.6m extra jobs. But how fully does it meet the objectives of the Doha Development Agenda, the yet-to-be-concluded trade round started in Qatar in November 2001?
According to the EU’s trade commissioner Karel De Gucht, about one quarter of the goals set for the Doha Round have been achieved in this agreement. This, of course, still leaves a long way to go if all the Doha objectives are to be met. World trade, although now likely to be somewhat freer, is still not free; developing countries will still find restricted access for their agricultural products, and manufactures too, to many markets in the rich world; rich countries will still find restricted access for their manufactured products and services to many markets in the developing world.
A ‘lifeline’ to the world’s poor: Cameron hails WTO historic global trade deal Independent, Kashmira Gander (7/12/13)
Timeline: World Trade Organization BBC News (7/12/13)
WTO Seals Deal for First Time in 18 Years to Ease Trade Bloomberg, Neil Chatterjee, Brian Wingfield & Daniel Pruzin (7/12/13)
WTO agrees global trade deal worth $1tn BBC News, Andrew Walker (7/12/13)
WTO: Government’s tough stand helps clinch deal in its favour Economic Times of India (7/12/13)
India Inc, exporters welcome WTO pact on trade The Hindu, Sandeep Dikshit (7/12/13)
WTO: Pact will help poor Bangkok Post (7/12/13)
WTO overcomes last minute hitch to reach its first global trade deal NDTV Profit (7/12/13)
WTO reaches ‘historic’ trade deal in Bali Aljazeera (7/12/13)
WTO agrees global trade deal worth $1tn BBC News, Karel De Gucht (7/12/13)
Why the WTO agreement in Bali has finally helped developing countries The Guardian, Paige McClanahan (6/12/13)
WTO agreement condemned as deal for corporations, not world’s poor The Guardian, Phillip Inman (7/12/13)
Bali trade agreement: WTO set the bar high but has achieved little The Guardian, Larry Elliott (6/12/13)
Reports and documents
Payoff from the World Trade Agenda, 2013 Peterson Institute for International Economics, Gary Hufbauer and Jeffrey Schott (April 2013)
Days 3, 4 and 5: Round-the-clock consultations produce ‘Bali Package’ WTO (7/12/13)
Draft Bali Ministerial Declaration WTO (see, in particular, Agreement on Trade Facilitation) (7/12/13)
- According to the law of comparative advantage, there is a net gain from international trade. Explain why.
- What are the likely gains from freer trade?
- Is freer trade necessarily better than less free trade?
- Who is likely to gain most from the WTO deal reached in Bali?
- What were the goals of the Doha Development Agenda?
- In what ways does the Bali agreement fall short of the goals set at Doha in 2001?
- Why is it so difficult to reach a comprehensive international deal on trade liberalisation that also protects the interests of poor countries?
- Do you agree with the World Development Movement (WDM) that the Bali Package is “an agreement for transnational corporations, not the world’s poor”?
- Would it now benefit the world for individual countries to pursue bilateral trade deals?