Free Trade or Protectionism: Issue of Strategic Choice

At all stages of economic history, governments have used trade policies to try and strike a balance between the interests of local producers and the demands of global markets. They have sought to reap maximum benefits from external trade factors to achieve short-term, medium-term and long-term economic growth objectives. The competitive positions that businesses and their countries enjoy considerably depend on their mode of participation within forms of international economic cooperation. The scope and interests of the business sector, in turn, has a significant impact on governments and their choice of trade policies.

At all stages of economic history, governments have used trade policies to try and strike a balance between the interests of local producers and the demands of global markets. They have sought to reap maximum benefits from external trade factors to achieve short-term, medium-term and long-term economic growth objectives. The competitive positions that businesses and their countries enjoy considerably depend on their mode of participation within forms of international economic cooperation. The scope and interests of the business sector, in turn, has a significant impact on governments and their choice of trade policies.

Choice of Trade Policies: a theoretical framework

Trade policies cannot be absolutely free of government regulation while the economic growth of countries, particularly developing countries, depends both on their access to outside markets and the level of openness of their domestic markets. Of note is the critique of free trade in works by Erik S. Reinert and J. Stiglitz, which extends an ongoing discussion since the beginning of trade policy debates. In the academic literature, views on the advantages of protectionism versus free trade have been in constant flux. Long before Reinert or Stiglitz, mercantilists argued for the need to rely on protectionism, highlighting trade protection policies exclusively in terms of the need to accumulate domestic resources.

At the same time, proponents of free trade preach the use of external markets as an incentive for stimulating domestic economic growth and boosting production. Free trade as a basis of international commerce was proposed for the first time by the classical political economists, Adam Smith and David Ricardo, although Adam Smith in his work acknowledged subsidies and lobbying as a means of putting pressure on government. It is therefore difficult to fully accept Reinert’s criticism of Adam Smith’s theory, although some of his empirical conclusions are quite strong [1].

Georg Friedrich List, a German economist, writer and politician who authored the concept of protectionism and was a forefather of “enlightenment protectionism” as a set of government policies supporting emerging industries, criticized English classical political science for ignoring specific domestic patterns of business development. According to him, political economy, in contrast to international commerce, should build theories based on empirical experience, and match proposed policies to the needs of time and the unique position of each nation, with due attention given to the needs of the future and of mankind. It must, therefore, stem from philosophy, politics and history [2].

Photo: aquarianagrarian.blogspot.ru

In Russia, one of the pioneering studies has been the book by V. Vitchevsky “Trade, Customs and Industrial Policies of Russia From Peter the Great to the Modern Day”, published in 1909. In his book, the author employed two terms to describe policies - “conservative” and “protectionist”, where “conservative” measures are aimed at achieving security and cannot be accepted as promoting economic growth, whereas “protectionist” policies are those informed by interests of the national economy and domestic producers.

The link between trade and macroeconomic policies was highlighted in the Keynesian theory of economics. John Keynes argued that trade restriction policies may help promote short-term national aims but are neither efficient in a long-term perspective nor supportive of growth in world trade. One might argue, therefore, that long before Reinert and Stiglitz, individual countries and regions were considerably focused on trade policies.

As the world trade system evolved, new evidence was used to support free trade arguments, although it is difficult to declare that these principles had ever been applied in practice in the way they were formulated by Adam Smith or David Ricardo. This was mostly due to such patterns of economic development as growing competition, foreign exchange and financial imbalances and other issues which required measures to protect and support domestic producers and were viewed largely as examples of protectionism.

In modern economies, an increasingly greater role is being assigned to trade policies aimed at supporting national producers on external markets and setting priorities for attracting foreign goods and services. The 2008-2009 global financial crisis and continuing negative trends in many developed and emerging economies have showed quite graphically that of all the policies adopted to overcome or mitigate the effects of the crisis, special emphasis has been placed on trade policies and the regulation of the more sensitive markets. There seems to be much truth in what Reinert maintained when he argued that there is still a need to choose which businesses to protect and which not to [3]. One cannot help agreeing with Stiglitz and his criticism of tax breaks and other benefits offered to large agricultural and utility companies for they create additional losses which producers pass through onto the society [4].

Under this view, it is difficult to argue that the weak positions of developing countries are exclusively the result of free trade policies pursued in past years. However, one cannot but accept Reinert’s argument that it is better for any country to have inefficient domestic industry than no industry at all. This researcher argues that in order to first to allow it to grow (protecting it with various forms of government intervention) and then embark on free trade measures [5] , a country would have to mobilize, in the form of goods and services, the missing advanced knowledge and technologies to facilitate gradual development.

Photo: www.iglobalexports.com
Go Global or Go Home

It appears that today’s discussion on protectionism versus free trade should focus not so much and not only on defending the thesis of preserving the level of development of various countries, as on two issues of principal significance. First, the question remains whether the globalization of the world economy and the emergence of a global system of regulation will undermine the independence of national trade policies. Given this level of economic interdependence, the efficiency of each country’s trade policies depends largely on its commitment to apply these regulations. One cannot rely exclusively on protectionist measures. In addition, abandoning protectionism should go together with an elaboration of adequate strategies to promote domestic producers’ interests.

The other issue is whether close links between states, stemming from liberal trade policies and related instruments, will intensify conflict between individual national economies. In other words, will one’s own domestic goals be achieved at the price of forcing other countries to lose their economic position and competitiveness? It was this last issue that came to the fore during the discussions in the run-up to the December 2013 Bali Ministerial Conference, which, contrary to the expectations of many, was a success and led to the adoption of a full package of agreements.

The trade facilitation agreement, which may become the first legal instrument adopted since the WTO was established in 1995; a package of agreements restricting export subsidies and agricultural support programmes; agreements on food security, including those relating to restrictions on food procurement by government – these are the key issues which may, going forward, underpin future growth in international trade.

“Freedom” of International Trade Under Globalisation

How truly free is modern trade? The current system regulating the international exchange of goods is based on the General Agreement on Tariffs and Trade (GATT) whose aim after the war was to restore trade links based on universally accepted and reciprocal principles, of which the most-favoured-nation (MFN) status and the national trade status were the most key.

According to the founders of that multilateral trade system, these two principles were called upon to ensure that free trade could help restore the world economy after the devastation of WWII. And although there is really no objection to the freedom of trade principle as it stands, one should remember that at the time when the GATT agreements were negotiated, they reflected the predominant positions of a few individual countries, most importantly the US, since obviously not all countries were in a position to actively contribute to the international exchange of goods and offer industrial products to world markets.

Hence, ever since GATT became the basis for international trade negotiations, the MFN status had to be interpreted rather narrowly, with the advantages of free trade not fully available to all participants in international trade.

With growing competition, the emergence and consolidation of a few global hubs of competition (the EU, the US, Japan, newly industrialized economies, and China) has inevitably led to a new and diversified range of protectionist tools. The history of protectionism in world trade suggests a number of characteristic patterns:

• selective protectionism — policies targeted at individual countries or individual goods;
• sector protectionism — policies to protect individual sectors, predominantly agriculture;
• collective protectionism — policies pursued by groups of countries against outsiders;
• hidden protectionism — measures of domestic economic policies which, not infrequently, are unrelated to trade regulation;
• superprotectionism (offensive or aggressive protectionism) – protecting the developed, powerful and highly monopolized industries;
• private monopolistic protectionism – relying on trade barriers resulting from various agreements on markets, prices and terms of sales, as well as trademarks and patent protection at an intercompany level. Such arrangements set up obstacles to imports which are no less tangible that those created by regular trade policy measures.

The growing arsenal and changing nature of trade policy tools have impacted on the nature of free trade. The modern concept of liberalization of international trade regulation, apart from lowering and removing barriers as far as possible, also appears to provide for the harmonisation of trade policies and the unification of their rules. This has given rise to an ongoing search for relevant, efficient trade policies, and a new approach to their role and objectives, taking into account the direction and pace of growth. It also proceeds from the need to strengthen competitiveness both of firms and of national economies. In this complex world of global competition, today’s protectionism is also fundamentally different from that of a few decades ago, since it combines protective measures with hidden protectionism and policies promoting national producers.

The drastic change in the implementation of protectionism and free trade has also affected the so-called value-added chains. Since global production is established through contributions from companies from both developed and developing countries, it is no longer possible to argue in favour of straightforward protection of domestic markets. A more flexible approach is required, and effective trade policy strategies need a very elaborate set of macroeconomic and industrial policies.

Russia’s Strategic Choice

Photo: The Portrait of Ekaterina the Second,
by D. Levitskiy
In foreign trade Catherine the Great changed
protectionism for full liberalization of export
and import

For Russia, the highest priority at the moment is to enhance competitiveness through greater efficiency in domestic producers and stronger state regulation. Such competitive advantages as Russia’s geographic position, its rich natural resources, existing scientific potential, and leads enjoyed by some high-tech industries, could help the country move up into the upper half or even the upper third of the competitive rankings of the world economies. The low competitiveness of this country is attributed to market patterns specific to Russia, and policies pursued by firms and the government.

As lessons from Russia have graphically shown, any restructuring of the national economy and its effective integration in the world economy are impossible without a modern system of regulation in the area of foreign trade. Laws passed in the early 1990s were, in the vast majority, in conflict with the world’s prevalent system of regulation of foreign trade in goods and services, foreign investment or foreign exchange regulation.

Enhancing competitiveness currently requires creating an enabling setting (a competitive business environment) and setting priorities in support of potentially promising areas of economic growth. In completing these objectives, Russia will benefit from a more active integration in the world economy and “free” trade to help promote Russian goods on world markets.

One might argue that removing certain protectionist policies will not lead to the preservation of Russia’s positions as a producer and exporter of exclusively mineral resources or other natural products but will, instead, create additional incentives to modernize basic domestic technologies through the inflow of new goods and services. One example is Russia’s car industry, which has benefited from the liberalization of trade for assembly plants. There is little ground for fears that production in Russia would fall as a result of liberalized access to Russian markets for foreign goods. Russia has a very large consumer market, and there is a consumer segment for every type of goods. In addition, the lack of competition deprives Russian producers of the incentive to improve and enhance their goods and services, to the detriment of consumers.

On the other hand, each country has some industries that serve as a bulwark of economic security: strategically important mining industries, defence sector, agriculture, and others. These industries should be subject to extremely cautious and well-reasoned policies. This is particularly true of support offered to national producers on domestic markets or facilitating their entry to foreign markets. For that, there is a huge inventory of means and methods which, if applied efficiently, will not prejudice or violate key WTO principles but allow for the combination of liberalized access to Russian markets for foreign goods with the protection of national interests.

There is also a major and positive role for the so-called “green box support” subsidies to national producers which come as part of government policies to promote innovative processes, improve social conditions, equalize the level of development across regions, as well foster a reliance on non-financial methods for organizing firm exports.

***

Russia’s accession to the multilateral trade system, based on the principles of liberalized and broad global trade, coincided with some monumental developments. The lack of progress in international trade negotiations following the Doha Round, and their almost complete failure at the Geneva Ministerial Conference in 2008 were offset by important achievements at the 2013 Ministerial Conference. The agreement to offer duty-free access to goods from the poorest developing countries may boost trade from these countries and lay the foundation for increasing agricultural subsidies there.

According to Karel De Gucht, the European Commissioner for Trade, such policies will help boost investment in these countries’ infrastructure. In addition, one of the key negotiated breakthroughs was the agreement on trade facilitation, which is expected to considerably reduce costs involved in foreign trade operations and cause trade to grow by USD 1 trillion.

WTO Director-General Roberto Azevêdo argues that the WTO is in a good position to uphold the true meaning of “world” in its title, since this time the outcome of the conference will benefit all WTO members. They are in Russia’s interests, too, since, for Russia, participation in international economic institutions is a zero-option factor of economic growth and enhanced political influence. However, broadly speaking, membership in a major international organization will not result, in and of itself, in the desired benefits or improved welfare. Participation in international organizations, and, importantly, in the WTO, and balancing between open markets and their protection and promotion of domestic producers, requires substantial and sophisticated efforts, ongoing analysis and forecasting of trends, and flexibility in adjusting national economic strategies in line with the challenges of globalization.

1. Erik Reinert, a Norwegian businessman and who has advised the UN and scores of national governments over the past 40 years. He founded the international foundation The Other Canon and formulated his views in the book “How Rich Countries Got Rich ... and Why Poor Countries Stay Poor” published in 2011. His conclusions in the book are based predominantly on empirical observations of some countries over different periods of time, which led him to argue that at the current stage of economic development, free trade policies are not efficient and work against the interests of less developed countries.

2. Friedrich List. The National System of Political Economy. Translated from German (into Russian), ed. by K.V. Trubnikov, with his introduction, notes and a biography of F. List. St. Petersburg, 1891, pp. 452+хх. 2nd abridged edition, 2005. Moscow: Europe, 2005.

3. Erik S. Reinert. How Rich Countries Got Rich … and Why Poor Countries Stay Poor http://coollib.net/b/228312/read#t45 (Russian translation)

4. Stiglitz, J. “The Price of Inequality”. How Today’s Divided Society Endangers our Future http://m.friendfeed-media.com/6aae71c4dc4cef55d0a64c01ebf3322f9a45181a

5. Erik S. Reinert. How Rich Countries Got Rich … and Why Poor Countries Stay Poor. http://coollib.net/b/228312/read#t45 (Russian translation)