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Trading Up

Trading Up

Mini Teaser: Policymakers can break down regulatory barriers to trade by concerning themselves with consumer, not producer, welfare.

by Author(s): Shanker A. Singham

AFTER DECADES of progress, the process of trade liberalization seems to be in danger of grinding to a halt. Both the political elite and average citizens express waning enthusiasm for freer trade. The World Trade Organization's (WTO) Doha Development Round, which seeks to improve trade terms for developing countries, has yet to produce significant breakthroughs and has now missed countless deadlines. Anxious publics, in developed and developing countries alike, perceive that liberalization and globalization have brought insufficient benefits. Rather than recognizing that such problems arise from domestic regulatory barriers to further liberalization, consumers fault global economic integration. When this misguided economic frustration finds political expression, publics elect populist candidates who promise some form of economic nationalism or mercantilism.

Venezuelan President Hugo Chávez is one leader who has successfully manipulated public preoccupations about "foreign exploitation" and economic insecurity. "We have buried Adam Smith", he triumphantly announced in 2006. Chávez may be at the forefront of the economic-populist trend, but he is hardly alone. Ecuador and Bolivia have notably taken turns towards economic nationalism, as have some of the developing countries in Eastern and Central Europe.

The leaders of developed countries may not have followed Chávez's lead in attempting to re-inter the long-deceased champion of free markets, but they too have embraced the rhetoric of economic nationalism. In France, President Nicolas Sarkozy has promised sweeping economic reform, although he has exhibited protectionist impulses in the past. As finance minister, Sarkozy approved of the government's disbursal of favors to French firms designated as "national champions." In the United States, several Democratic candidates have railed against the president's free-trade agenda (describing themselves as supporters of "fair trade").

In all of these examples, both consumers and their leaders have failed to recognize that domestic economic liberalization, not higher barriers to trade, will spur the economic progress that, in turn, generates jobs and prosperity. When previously protected sectors of the domestic economy are exposed to greater international competition, it is true that specific groups of individuals-tied to relatively uncompetitive industries-may suffer. However, as long as these industries receive protection from foreign competition, consumers that purchase these industries' products must pay higher prices than they would in a more competitive market.

While freer trade can cause economic pain in the short run, international competition allows countries to specialize in the industries in which they have a comparative advantage in the long run. Ultimately, trade and specialization benefit a diffuse group of consumers by lowering prices of many goods and services. Trade-to quote Federal Reserve Board Chairman Ben Bernanke-allows countries to "transform what [they] have into what [they] need or want under increasingly beneficial terms." Trade liberalization, in spite of the economic dislocations it may create, is not a zero-sum game. The entry of foreign firms, products and services into the domestic market-an inevitable consequence of trade liberalization-need not be feared: It benefits the average consumer.

Free or Fair?

YET BOTH economic nationalists (some of whom are both against free markets and free trade) and fair traders are not convinced that freer trade is a desirable goal. Both concentrate on trade liberalization's perils, though fair traders often frame the issue in social-justice terms, rather than simply positing a link between restricted trade, job protection for domestic workers and a healthy domestic economy. Free trade's opponents note that a purely market-based approach to trade will have "unfair consequences" if domestic regulations-such as labor rules, internal taxes or laws affecting international distribution-between the trading partners differ. Unfortunately, the fair-trade approach is not the cure-all that its advocates claim it to be. Fair-trade policies undercut comparative advantage, the foundation of trade theory. If trade is only "fair" when domestic regulations in developing countries are identical to those found in developed countries, or if trade is only fair if labor costs are the same, then developing countries-which rely on low labor costs for continued economic growth-would be especially hard-hit. Thus, a new definition of "fairness" is needed-one that captures how domestic-market conditions affect international-trade patterns.

Publics that are skeptical about trade liberalization's benefits often presume that it is impossible to compete "fairly" on the world's economic playing field. As noted earlier, this current concept of fairness does little to truly level the field-and may even be detrimental to economic growth and consumer welfare. If trade liberalization is to continue, the term "unfair" must be applied to restraints and regulations that hinder competition-not the concept of competition itself. These "unfair", anti-competitive policies distort consumer choices, to the detriment of consumers and to the benefit of specific firms or industries. It is the anti-competitive restrictions on market activity, not trade liberalization, that impede economic growth and prevent the gains of trade from spreading to consumers.

One only needs to look at the WTO-mediated telecommunications dispute between the United States and Mexico to grasp the deleterious effects of the lack of competition. In 2004, the WTO concluded that Mexico's International Telecommunications Long Distance Rules unfairly disadvantaged U.S. telecommunications firms. These anti-competitive rules allowed TelMex, Mexico's principal telecommunications firm, to charge both U.S. and Mexican consumers artificially inflated prices for calls placed to and from Mexico. Estimates indicate that the anti-competitive rules cost U.S. consumers alone an extra one billion dollars between 2000 and 2004. Instead of taking the interests of Mexican consumers into account, the Mexican government used domestic regulations to benefit local producers.

Firms that benefit from anti-competitive restrictions are quite distinct from firms that simply make efficient use of their inputs. A firm that benefits from an "unfair" legal environment is at least partially shielded from competition, so it has little incentive to cater to consumer preferences. The offerings of the American automobile industry while it was protected from Japanese competition serve as unfortunate reminders of this phenomenon.

On the other hand, a cost-effective firm operating in a competitive environment will oblige other firms to engage in competition for profits. When these firms struggle for dominance, basic economic theory states that the average consumer benefits, usually in terms of lower prices for goods and services. Such highly competitive markets, though beneficial to consumers, are difficult to create in practice.

Moving from an "unfair" domestic market towards greater competition is a slow, politically fraught, easily derailed process. Firms that have much to lose from economic liberalization-like some of America's textile producers-will lobby to protect their interests. Meanwhile, the vast mass of consumers cannot effectively organize to counteract the influence of these industry-based interest groups.

When domestic economic deregulation is thwarted by such political maneuvering, the gains from trade liberalization become less apparent to consumers. Domestic regulation hinders the ability of foreign firms to enter what should have been an open market, so consumers in that particular market are unable to benefit from increased competition among firms. Instead of faulting domestic economic policies, consumers blame liberalization and globalization for the lack of improvement in their material circumstances.

Since the public does not recognize the connection between trade and domestic-market competition, it gives its support to leaders who enact crowd-pleasing but economically unsound policies. This scenario is almost a vicious cycle: When populations perceive that trade liberalization has not benefited them, they clamor for anti-competitive economic policies. When these domestic policies are enacted, they further prevent the disgruntled populace from benefiting from integration into the global economy.

SO WHY has the link between domestic regulation and trade liberalization been ignored during the formulation of international trade policy? This can be at least partially explained by the overwhelming producer bias in trade-policy negotiations. The fair-trade-versus-free-trade debate merely obscures the true dichotomy in trade: a producer-welfare orientation versus a consumer-welfare orientation. If consumers are to derive greater benefits from trade liberalization, trade-policy discussions must adopt a more consumer-oriented perspective.

A producer-welfare orientation sees only producers that make products in one country and that sell those products to people in another country. It is in the interests of these producers to block import competition in their home markets while securing market access abroad. Ultimately, this is a purely mercantilist outlook. This kind of approach leads to economic nationalism and protectionism, in which the state plays an ever-increasing role in the economy. It is a zero-sum world, where borders are important and consumers are not-and where people are encouraged to view themselves only in their producer roles.

A consumer-welfare orientation puts forward an opposing view: Trade is not a zero-sum game. The consumer orientation operates on the premise that the modern world is not one in which producers export goods from one country to another; rather, it is a world of closely connected global supply chains for goods, services and people. This is a world where national borders are less meaningful (with all that that entails for immigration policy and cultural identity). In this model, businesses are consumers too, so they also benefit from reduced prices. A consumer-oriented approach, then, calls for reductions in import costs for exporters, as well as for producers who sell their wares primarily in the domestic market. Cost reductions lead to greater efficiency and greater global-supply-chain integration, ultimately leading to lower prices for a product's final consumers.

Essay Types: Essay