Free Trade: A Dead End for Underdeveloped Economies

Abstract

Critics of the free trade doctrine tend to argue that the theory of comparative advantage is not wrong in itself, but that its assumptions are not generally fulfilled in the real world, and hence that free trade is desirable under ‘ideal conditions.’ By contrast, this paper argues that the theory of comparative advantage does not hold even under ‘ideal conditions.’ The theory, a variation on the story of static efficiency, pays no attention to dynamic considerations, such as long-term technical change and productivity growth, which are essential in economic development. Starting from the ‘growth laws’ of Verdoorn and Kaldor, this paper argues that dynamic efficiency is intimately related to industrial growth. Moreover, because industrial goods have higher income elasticity of demand than agricultural goods, there is a positive feedback mechanism from international and domestic demand for industrial goods to the Verdoorn-Kaldor ‘laws’ of productivity growth. The empirical evidence indicates that poor countries do not have a comparative advantage in agricultural goods, and that they have an absolute disadvantage in the trade of agricultural as well as industrial goods. Further liberalisation of trade in agricultural goods will therefore harm rather than help the poorest countries. To achieve economic development, those countries need the freedom to implement a strategy designed for that purpose, just as the now-industrialised countries did.

Acknowledgments

The author is indebted to Amit Bhaduri, Ådne Cappelen, Olav Fagerlid, Kjell J. Havnevik, Anders Skonhoft, Robert Wade and Audun Øfsti, as well as to a referee of this journal, for useful comments on earlier drafts.

Notes

¹‘By emphasizing the virtues of free trade, we also emphasize our intellectual superiority over the unenlightened who do not understand comparative advantage’ (Krugman, 1993a, p. 362).

²It is worth noting that Ricardo wrote his pamphlet An Essay on the Influence of a low Price of Corn on the Profits of Stocks in 1815, the same year as the British parliament adopted strong restrictions on imports of corn, the so-called Corn Laws. These laws were abolished only in 1846.

³Since a lower price of corn was Ricardo's great concern, it is bit strange that he used wine in his example. He may have wished to avoid provoking unnecessarily the aristocratic landowners in England.

⁴For this reason, the so-called Leontief paradox came as a big surprise to neoclassical economists. In work first published in 1953 and 1956, Leontief found that the United States, presumably the most capital-endowed country in the world, was exporting labour intensive goods and importing capital intensive goods (see Leontief, 1966, pp. 68–133).

⁵See Verdoorn (1949, originally published in Italian under the title ‘Fattori che regolano lo sviluppo della produttivitá del lavoro’) and Kaldor (1967, pp. 3–23, 73–83; 1978, pp. 100–138). For an overview and critical assessment, see McCombie & Thirlwall (1994, pp. 155–222).

⁶Here ‘manufacturing industry’ should be understood in a broad sense, nowadays including, for example, the software industry.

⁷This is reflected in a confused and twisted manner in discussions of the so-called ‘natural resource curse’.

⁸That this is the case for the relationship between industrialised and underdeveloped economies has been shown by Paul Bairoch (1975, pp. 111–134; 1993, pp. 111–118). In an important article, Paul Krugman has reached the same conclusion with respect to trade among industrialised countries: ‘the surprising thing about long term trends in real exchange rates is their absence’ (Krugman, 1989, p. 1045).

⁹The label is unjustified because the relationship is simply a dynamic version of Harrod's foreign trade multiplier, dating as far back as 1933 (Harrod, 1933). As far as I know, the relation in Figure 1 was first used by Prebisch (1959). Krugman cites neither Harrod nor Prebisch. It may be noted that Krugman actually rejected Engel's Law and reversed the causation, postulating that faster growth in a country leads to greater supply of exports which causes what he calls the ‘apparent’ income elasticity of demand for exports to be higher and the ‘apparent’ income elasticity of imports to be lower: ‘I am simply going to dismiss a priori the argument that income elasticities determine growth, rather than the other way round’ (Krugman, 1989, p. 1037). For a critique of Krugman, see McCombie & Thirlwall (1994, pp. 388–391).

¹⁰Among influential US economists who argued against free trade in the 19th century and the early 20th century, were Henry Clay (1777–1852), John Rae (1796–1872), Henry Charles Carey (1793–1879), Richard T. Ely (1854–1943) and Wesley C. Mitchell (1874–1948). Today, the situation is quite the opposite. Poll data from 1990 indicated that 97% of academic economists in the US are in favour of free trade. And in the early 1990s, the appointment of the free trade sceptic Laura D'Andrea Tyson to the Council of Economic Advisors was met with a ‘shrill response’ from the economics profession (Prasch, 1996, p. 37).

¹¹However, the table conceals the fact that there was a strong increase of import duties from the late 1870s until around 1885. Mainly the iron and steel industry and parts of agricultural production were protected by high customs duties (see Hallgarten & Radkau, 1981, pp. 49–50).

¹²In spite of this, agriculture was a source of ‘unlimited supplies of labour’ (Lewis, 1954). For example in Japan, the labour force in agriculture declined from 17.8 million (53.4% of total labour force) in 1947, to 11.1 million (23.5% of total) in 1965, and 6.7 million (12.9% of total) in 1974. Correspondingly, the labour force in industry increased from 7.4 million (22.3% of total) in 1947, to 22.5 million (43.3% of total) in 1974 (see Tsuru, 1994, pp. 87–88).

¹³One of the studies in fact uses a ‘direct measure of trade restrictions,’ i.e. average (ad valorem) duty, but on imports and exports combined: ‘The coefficient on average duties is now insignificant and has the ‘wrong’ sign [i.e. negative. R.S.]. If we introduce import and export duties separately, import duties in fact get a positive and significant coefficient (contrary to the expected negative coefficient) and export duties are insignificant’ (Rodríguez & Rodrik, 2000, pp. 41–42).

¹⁴Outstanding examples of such export subsidies are the subsidies of sugar exports in the EU and cotton exports in the US. Owing to subsidies, the EU's export price for sugar in 1999/2000 was 70% lower than the production costs (Rice, 2004, p. 262; Oxfam, 2002, p. 17). In 2000/2001, the 25,000 cotton farmers in the US received subsidies amounting to US$3.9 billion for a production value of about US$3.5 billion, and were paid a price which was 70% higher than the world market price (Oxfam, 2002, pp. 21–22).