trade to invest and invest to trade—to the point where both activities are increasingly part of a single strategy to deliver products across borders.”6
This chapter discusses the postwar global trade regime and the changing role of the North and South in the regime. A major theme relates to the competing pressures for trade liberalization and protectionism.
TRADE THEORY
Liberal theorists view trade as a positive-sum game that provides mutual benefits to states, whereas realists see trade as more competitive, with each state striving to increase its exports and decrease its imports. Historical materialists view trade as a form of unequal exchange, in which advanced capitalist states in the core export manufactured and high-technology goods and import raw materials and less processed goods from the periphery. Although liberal trade theory has evolved, the ideas of Adam Smith and David Ricardo are still central to the defense of free trade. Smith argued that the gains from free trade result from absolute advantage, in which all states specialize in the goods they produce best and trade with each other. For example, if France produces wine more cheaply than England and England produces cloth more cheaply than France, both states can benefit from specialization and trade. Ricardo’s theory of comparative advantage is less intuitive and more powerful because it indicates that trade is beneficial even in the absence of absolute advantage. In his Principles of Political Economy and Taxation, Ricardo argued that England and Portugal could gain from trading wine for cloth even if Portugal produced both goods more cheaply than England.7
Central to Ricardo’s argument is the concept of opportunity cost, which refers to the cost of producing less of one product in order to produce more of another product. If Portugal produces wine more efficiently than cloth, it has a lower opportunity cost if it produces more wine and trades it for cloth. If England produces cloth more efficiently than wine, it has a lower opportunity cost if it produces more cloth and trades it for wine. This is the case even if Portugal produces both wine and cloth more efficiently than England.
Tables 7.1 and 7.2 use arbitrary figures to demonstrate Ricardo’s theory of comparative advantage. Table 7.1 shows the bottles of wine and yards of cloth that England and Portugal produce in one day using the same number of labor hours for wine and cloth production. Ricardo assumed that labor productivity
TABLE 7.1
Production of Wine and Cloth in One Day Without Trade
Bottles of Wine Yards of Cloth
England 3 6
Portugal 16 8
TABLE 7.2
Production of Wine and Cloth in One Day With Specialization and Trade
Bottles of Wine Yards of Cloth
England 1(-2) 10(+4)
Portugal 20(+4) 6(-2)
Total 21 16
was the only factor determining comparative advantage. As Table 7.1 shows, Portugal produces 16 bottles of wine and 8 yards of cloth, while England produces 3 bottles of wine and 6 yards of cloth. Portugal produces more of both products than England; but Portugal is relatively more efficient in wine (16) than cloth (8) production, and England is relatively more efficient in cloth (6) than wine (3) production. Table 7.2 shows how many bottles of wine and yards of cloth England and Portugal can produce if each specializes in producing the product with the lowest opportunity cost (wine for Portugal and cloth for England), and engages in trade. As Table 7.2 shows, if England produces two less bottles of wine, it can produce four more yards of cloth; if Portugal produces two less yards of cloth, it can produce four more bottles of wine. By specializing and engaging in trade, England and Portugal can produce two more bottles of wine (21) and two more yards of cloth (16) using the same number of labor hours. Thus, countries can benefit from specializing according to comparative advantage and engaging in trade.
Although Ricardo provided a powerful argument for free trade, he assumed that comparative advantage results only from differences in labor productivity. In the 1920s, the Swedish liberal economists Eli Heckscher and Bertil Ohlin developed a theory to show that comparative advantage also results from other factors of production such as capital and natural resources. The Heckscher–Ohlin theory posits that a state has a comparative advantage in producing goods that involve intensive use of its most abundant factor of production. For example, labor is a less expensive input in a state with an abundant supply of labor and this gives labor-abundant states a cost advantage in producing labor-intensive goods; capital-rich DCs have a comparative advantage in producing capital-intensive goods, and states rich in arable land have a comparative advantage in agriculture. Building on the Heckscher–Ohlin theory, two U.S. economists (Wolfgang Stolper and Paul Samuelson) developed a theory to explain why some domestic groups are protectionist and others are free-trade oriented. According to the Stolper–Samuelson theory, trade liberal- ization benefits abundantly endowed factors of production and hurts poorly endowed factors. For example, if state A has an abundance of labor, workers in A will favor freer trade because A is competitive in producing labor-intensive goods for export. Although workers’ wages in A will initially be low because of the abundant labor supply, as A shifts its production toward labor-intensive goods the demand and wages for labor will increase. If state A has a shortage
Trade Theory 171 of arable land, farmers in A will favor agricultural protectionism vis-à-vis states where arable land is more abundant. Thus, owners of abundant factors of production in a state support freer trade and owners of scarce factors oppose it. The Stolper–Samuelson theory helps explain why U.S. and Canadian blue- collar labor opposed NAFTA (Mexico has many more less skilled workers) and why French wheat farmers oppose agricultural trade liberalization in the WTO (the United States, Canada, Australia, and Argentina have more land for wheat production).8
Although the theory of comparative advantage and its offshoots provide powerful arguments for interindustry trade, they do not explain the rapid increase of intraindustry and intrafirm trade. For example, the Heckscher– Ohlin assumption that trade is most beneficial between states with different factor endowments does not explain the rapid rise of intraindustry trade among DCs with similar factor endowments. Whereas traditional trade theory assumes that goods are homogeneous, in intraindustry trade differentiated products are traded within the same industry group. For example, Germany and Japan produce automobiles and trade with each other because consumers value product differentiation and have product preferences.9Liberals theorize
that intraindustry trade provides benefits such as economies of scale, the satisfaction of varied consumer tastes, and the production of sophisticated manufactured products. The Stolper–Samuelson theory is also less applicable to intraindustry trade. It is harder to find owners of scarce factors opposing intraindustry trade because DCs often trade products that use similar factor intensities. Thus, trade negotiations have been most successful for manufactured products in which DCs engage in intraindustry trade. Trade barriers are more persistent for agricultural products traded between DCs and LDCs with different factor endowments. Much present-day trade is also
intrafirm trade between MNC parent companies and their subsidiaries.
Theories of the firm best explain why trade occurs between MNC affiliates (see Chapter 9).
The liberal theories to explain interindustry, intraindustry, and intrafirm trade are prescriptive as well as descriptive, because they assume that all states benefit from specialization and trade (even if they do not benefit equally). However, realists and historical materialists do not accept this assumption. Although realists accept trade liberalization as a part of the capitalist system, they assert that free trade is not beneficial if it jeopardizes a state’s national security. Dependence on foreign states for imports of strategic goods or basic foodstuffs can become a national security threat, especially if the imports come from unfriendly or nonallied states. The national security concern is evident in practice as well as theory. For exam- ple, Article 21 of the GATT provides an exception to trade obligations for certain national security reasons such as the regulation of traffic in arms; and U.S. law permits the president to limit imports of products for national security purposes.10Realists also argue that free trade may prevent LDCs
from promoting industrialization. Because LDCs are late industrializers, they must limit DC industrial imports until their infant industries become
more competitive internationally. Looking at the relative gains of trade based on comparative advantage, realists also believe that Ricardo’s advice to Portugal did not serve its long-range interests. Portugal may have gained some short-term advantages from specializing in wine, but it became less competitive than England in the long term because cloth production was a higher-growth, higher-technology industry. In the realist view, Portugal should have created a comparative advantage for itself in cloth through government assistance, even if it had a “natural” comparative advantage in wine. Strategic trade theory focuses on a state’s creation of comparative advantage, referred to as competitive advantage, through industrial targeting. Although efforts to gain competitive advantage in trade are not new, the growing emphasis on high-technology industries provides “a fertile breeding ground for interventionist policies.”11 Strategic trade theorists argue that
interventionist policies can improve a state’s economic position, and they point to Japan and the East Asian NIEs as states that mobilize a limited amount of resources to create competitive advantage. However, liberals see the risks of strategic trade policy as outweighing the benefits. When
individual rationality causes a state to increase its competitive advantage at
the expense of others, other states retaliate and everyone is worse off as a result (see prisoners’ dilemma in Chapter 4).12Despite the liberal warnings,
the temptation to engage in strategic trade policy remains strong in an age of global competition.
Historical materialists have stronger objections to free trade than realists. As discussed in Chapter 5, Raúl Prebisch argued that LDCs in the periphery suffer from declining terms of trade with DCs in the core because of their dependence on agricultural and raw material exports. He advised LDCs to adopt import substitution policies, imposing trade barriers and producing manufactures domestically to satisfy demand previously met by imports. Dependency theorists go further, arguing that DCs either underde- velop LDCs or prevent them from achieving genuine, autonomous develop- ment; thus, LDCs should decrease or sever trade ties with the core. Arghiri Emmanuel also critiques free trade in his theory of unequal exchange. He argues that wages are higher in the core because labor is not inter- nationally mobile and DCs specialize in producing higher value-added goods. The higher wages in DCs create a larger local market for goods, encourage mechanized production, and elevate the prices for DC goods. Thus, North–South trade is an unequal exchange, with LDCs paying more for imports from high-wage DCs than they receive for their exports; that is, there is a transfer of surplus from peripheral to core countries. Although Emmanuel provides some insights on the effects of a lack of labor mobility on international prices, he fails to consider the effects of different productivity levels between core and peripheral labor or to explain why capital does not flow to low-wage areas.13
Despite the wide range of theoretical perspectives on trade, most DC economists and international economic organizations have adhered to liberal trade theories.
Global Trade Relations Before World War II 173
GLOBAL TRADE RELATIONS BEFORE WORLD WAR II
Throughout history, states have shifted between trade liberalization and protectionism. In the nineteenth century, mercantilist trade restrictions gave way to freer trade: Britain lowered its import duties in 1815 and opened its borders to food imports by repealing its Corn Laws in 1846; Britain and France then signed the Cobden–Chevalier Treaty in 1860, which resulted in a network of treaties lowering tariff barriers throughout Europe. However, Britain’s declining hegemony, France’s defeat in the Franco-Prussian War, and the 1873–1896 depression lowered the enthusiasm for free trade; and the outbreak of World War I completely disrupted the European trade treaties.14After WorldWar I, efforts to remove trade restrictions were unsuccessful as states reacted to harsh economic conditions by increasing their tariffs, or taxes on products that pass through a customs border. Tariffs rose not only in European states recovering from the war but also in the United States, which had become a net creditor nation and the world’s largest industrial power. Thus, the U.S. Congress increased import duties with the 1922 Fordney–McCumber Tariff, and after the stock market crash Congress passed the 1930 Smoot–Hawley Tariff Act, which increased average ad valorem rates on dutiable imports to 52.8 percent, the highest U.S. tariffs in the twentieth century.15
The question arises as to why the United States as the top economic power did not stem the rise of protectionism. Some hegemonic stability theorists argue that the United States was able but unwilling to become a hegemon until its position became more firmly established after World War II.16Others point to
Britain’s continuing influence and question whether the United States was able to establish an open economic system during the interwar period.17 Some
theorists explain U.S. protectionism in terms of domestic rather than global politics. Although the United States was the largest industrial power during the interwar period, U.S. industries feared a renewal of European competition, and U.S. agricultural groups were concerned about lower agricultural prices. The U.S. Constitution gives Congress the sole power to regulate commerce and impose tariffs, and members of Congress were susceptible to protectionist pres- sures from these groups because (unlike the president) they do not have national constituencies. Protectionist producer groups were politically organized and concentrated in specific industries, whereas consumer groups benefiting from freer trade were more diffuse and had little influence. Party politics also played a role in the Smoot–Hawley tariff because the Republicans who were more protectionist than the Democrats had a Senate majority at the time.18
The Smoot–Hawley tariff had disastrous results as other states retaliated with their own import restrictions: World trade declined from $35 billion in 1929 to $12 billion in 1933, and U.S. exports fell from $488 million to $120 million.19To reverse this damage, the U.S. Congress passed the 1934
Reciprocal Trade Agreements Act (RTAA), which transferred tariff-setting
authority to the president who could lower tariffs by up to 50 percent in bilateral trade negotiations with other countries. The RTAA was signifi- cant because for the first time it linked U.S. tariff levels to international
negotiations instead of having Congress set tariffs on a unilateral, statutory basis.20From 1934 to 1945, the United States concluded bilateral trade agree-
ments with 27 countries and lowered its tariffs by an average of 44 percent; but tariffs were so high in the early 1930s that these agreements mainly corrected earlier excesses. The Roosevelt administration’s decision to lower tariffs only in exchange for similar concessions by other states (hence the name
Reciprocal Trade Agreements Act) also limited the scope of the agreements,
and many states refused to lower their tariffs. Thus, protectionism continued to affect trade relations throughout the interwar period.21