Is a policy of free trade the optimal strategy to pursue for developing states?
To effectively assess whether free trade represents an optimal strategy for developing countries, it's crucial to establish clear definitions of "free trade" and "optimal." Within the current trading regime, I contend that pursuing free trade may not be the most advantageous course for the vast majority of developing nations. I argue that free trade unfairly skews advantages towards developed states and forces developing states into an exploitative system.
Definitions
Free Trade
Usually, free trade is defined as having low-trade barriers (WTO, 2024). It is conceptually difficult to put a proper lower bound on what constitutes free trade in practice, but what is implied by neoliberal proponents of free trade is that trade barriers should be so low that trade specialization is possible (Siddiqui, 2015)[1]. To challenge the unequivocal support of free trade by neoliberals, I will delve deeper into the theories that underpin neoliberal ideology and their interpretation of free trade in subsequent sections of this paper.
What is optimal?
When considering whether free trade constitutes an optimal strategy for an actor, it is most important to consider the situation of the individual actor, as well as the configuration of the world around them. In other words, to optimally play the game you have to work with the cards you’ve been dealt, as well as the cards that other players might have. Luckily, the world economy is not as secretive and random as a card game, and to determine the optimal strategy it is possible to study the behaviors and capacities of other actors.
The neoclassical argument for free trade as a development strategy
It would be impossible to omit Adam Smith’s (1776) argument in Wealth of Nations when talking about free trade. Smith’s (1776) ideas have become one of the foundations of modern international political economy, laying the groundwork for the further development of the theory of comparative advantage by inspiring thinkers like Ricardo (1817) who ultimately provided the foundation for the Heckscher-Ohlin model of international trade. The mainstream neoclassical economists who dominate modern debates through institutions like the IMF, World Bank, ECB, as well having a sizeable presence in specialist media (Siddiqui, 2015) have co-opted these arguments to argue in favor of extensive global trade liberalization. The common belief shared by these agencies is that increased economic integration into the global economy will lead to superior conditions for growth and economic prosperity in developing countries. By these agencies it was emphasized that openness to international trade will stimulate economic growth and offer opportunities for developing nations to boost exports, thereby enhancing the living standards of their citizens (Pugel, 2016). The website of the World Trade Organization (2024), will enlighten us on “the basics”:
The economic case for an open trading system based on multilaterally agreed rules is simple enough and rests largely on commercial common sense. But it is also supported by evidence: the experience of world trade and economic growth since the Second World War. Tariffs on industrial products have fallen steeply and now average less than 5% in industrial countries. During the first 25 years after the war, world economic growth averaged about 5% per year, a high rate that was partly the result of lower trade barriers. World trade grew even faster, averaging about 8% during the period.
The WTO (2024) goes on to cite comparative advantage as a key argument underpinning their theoretical argument that the increase of global trade has been one of the key drivers of global economic growth.
The argument of this essay
The danger of this co-optation is that Smith’s very logical argument – greater productivity occurs when actors focus on specialized tasks – gets misused in discussions about modern trading regimes. I argue that the neoliberal interpretation of comparative advantage is an anachronism, which fails to place Smith’s arguments into modern contexts. Additionally, I do not necessarily argue against the theoretical concept of free trade contributing to economic growth, but I do argue against the argument that the contemporary trade environment would be conducive to such economic gains for most developing countries.
Analysis.
In the days of Smith and Ricardo it was unrealistic to think that anything other than raw materials and finished goods would be traded for long distances en masse due to the lack of technological innovations in communications and transport that allowed for coordinated geographically dispersed production; the same problem would limit foreign investments due to the risk caused by lack of investment-supervision, after all communication was based on carrier pigeons or couriers on horseback or sailing ship (Klein, Pettis, p. 11). This does not mean that the arguments Smith and Ricardo make are not valid anymore, it means that reliance on the simple authority of these theories are insufficient to argue for contemporary trade policies. Instead, their theories should be considered after more influential structural factors determining the welfare effects of free trade have been evaluated. Such factors could include technological disparities, demographic differences, and income inequalities in the home or foreign country. Additionally, the dominant trading regime is critical in the governance of what influences such factors can have.
Following this line of thinking, it is important to address the argument that free trade should increase opportunities for developing countries to gain wealth through export-based strategies by engaging in free trade. In the current dominant trading regime under the WTO, “free trade” is characterized by the Most-Favored Nation principle, which obliges members of the WTO to give all states the same treatment in terms of trade barriers. Additionally, there is very strict protection on intellectual property rights which effectively bars a lot of developing countries from the newest and most innovative technology, thus reducing their competitiveness in sectors benefiting from high-tech innovations. This sounds like a terrible deal – which it is – so why did developing states agree to this? De Souza (2013) argues that the WTO was “an offer developing countries could not refuse”. In short, the rules of the WTO were inherently beneficial to developed states, but due to the market power of developed states the costs of exclusion (under the logic that other developing states would join) would outweigh the costs of joining. According to De Souza, (2013, p. 22) the trade policies established by the WTO are influenced by the priorities of the world's top two trading entities (The US and the EU at the time of writing) and their most influential constituents. These policies include relaxed regulations concerning agriculture and textiles, limited liberalization in manufacturing and services, and stringent regulations regarding intellectual property (De Souza, 2013, p. 22). This analysis of the unequal distributional effects of the WTO fits quite well with the modern world system theory proposed by Immanuel Wallerstein (2011), in which he posits that technological advancements often originate in the core regions of the world system, where there is greater investment in research, development, and innovation. These technological advancements give core regions a competitive edge in various economic sectors, allowing them to dominate global markets, continuing unequal exchange and extracting surplus value from peripheral regions. As a result, according to Wallerstein (2011), core states can export manufactured goods to peripheral regions, while importing raw materials and agricultural products at lower prices, reinforcing the dependency of peripheral economies on the core.
To connect this back to the neoclassical argument that developing countries can gain wealth through export-based strategies, if you follow Wallerstein’s argument (like I do) you could technically argue that the periphery can develop to some extent, but if we would consider this a development strategy, it is a severely unfair one at best. While the core feasts at a lavish banquet, the periphery is left with mere crumbs from the table's edge. Additionally, in a review of the literature on the effects of free trade Siddiqui (2015, p. 5) cites a multitude of empirical studies that contrast the claim made by proponents of free trade as a development strategy. According to Siddiqui (2015, p. 5) the optimism of proponents is based on the Heckscher-Ohlin-Samuelson model of comparative advantage, which the author argues is based on unrealistic assumptions. The assumptions that I find particularly unrealistic – which ties into my previous critique – are the assumption of constant returns to scale, and the homogeneity of the factors of production. The constant returns to scale assumption implies that doubling inputs will double outputs, regardless of the scale of production. In reality, production functions may exhibit increasing or decreasing returns to scale. While constant returns to scale imply a flat long-run average cost curve, economies of scale can lead to a downward-sloping curve. The argument that constant returns to scale are unrealistic is interrelated with the false assumption of homogeneity in the factors of production, my logic is as follows: In the case of developing economies, scale is usually quite low. One of the reasons scale is often lower in developing countries, is because they lack advanced technologies which allow for higher productivity per factor of production. When we extrapolate the falsehood of these assumptions to the global economy it again fits neatly into Wallerstein’s modern world system theory (2011).
What are some ways developing states could overcome these hurdles?
One of the ways more efficient production and thus economic growth can occur is indeed economic integration. A key example of this is the European Union, as explained by Baldwin and Wyplosz (2003): Integration in Europe reshapes markets by eliminating the favored status of domestic firms within their own countries. This means that all companies face greater competition within their national markets but also gain improved access to markets across the EU. Efficient firms started benefiting from greater economies of scale, others went bankrupt. What remained however, was better prices for consumers and more competitive companies.
This last point does raise an interesting point for developing countries though, as they might benefit from an EU-style integration policy with common tariffs. This way, they can increase the size of their markets without being overwhelmed by the structural advantage of developed states. Next to driving economic growth between developing states, it could give developing countries a stronger bargaining position against large markets such as the EU, the US and China. Additionally, they could employ an economic model like that Alexander Hamiton drove the US to pursue in the 18th century (Klein, Pettis, pp. 13-16), which was later advocated for by Friedrich List who argued that higher external trade barriers would raise domestic production which would in turn require higher wages to sustain demand, thus creating a virtuous cycle.
Nevertheless, it would be difficult for developing countries to implement such policies due to lack of cooperation amongst each other. Additionally, List would argue that developing states often lack the institutions necessary for sustainable wealth creation (Klein, Pettis p. 16).
Conclusion
In conclusion, this paper contends that within the current global trading regime, pursuing free trade does not yield favorable outcomes for developing states. This assertion is substantiated by debunking neoliberal claims regarding the benefits of increased exports for developing nations, supported by an analysis of existing trade regulations and empirical evidence from various sources. Nonetheless, I acknowledge the potential for developing states to derive benefits from enhanced cooperation and intra-regional trade. While recognizing the limitations in addressing specific cases such as India and China, which are often heralded as successful examples of free trade, their unique circumstances warrant closer scrutiny. Especially, my suspicion is that these cases do not fall on the same definition of “free” trade as which is used in this paper as well as by neoliberals. Future research endeavors could explore these exceptions in greater detail, as well as investigate specific configurations that may offer insights into the nuanced dynamics of trade policy for developing countries.
Bibliography:
Baldwin, R., & Wyplosz, C. (2003). Economics of European integration. Choice Reviews Online, 41(04), 41–2283. https://doi.org/10.5860/choice.41-2283
De Souza, I. a. M. (2013). An offer developing countries could not refuse: how powerful states created the World Trade Organisation. Journal of International Relations and Development, 18(2), 155–181. https://doi.org/10.1057/jird.2013.18
Pugel, T. A. (2016). International economics. McGraw-Hill.
Ricardo, D. (1817). On the principles of political economy and taxation. London John Murray.
Siddiqui, K. (2015). Trade Liberalization and Economic Development: A Critical review. International Journal of Political Economy, 44(3), 228–247. https://doi.org/10.1080/08911916.2015.1095050
Smith, A. (1776). An Inquiry into the Nature and Causes of the Wealth of Nations
Wallerstein, I. (2011). The Modern World-System I. https://doi.org/10.1525/9780520948570
WTO | Understanding the WTO - The case for open trade. (2024). https://www.wto.org/english/thewto_e/whatis_e/tif_e/fact3_e.htm
[1] I just want to make clear I am not citing the late controversial Islamic activist, this is simply a professor with the exact same name.
I’m a student of Economics at San Marcos University (Peru). I just wanted to say, keep it going! It is really interesting to read your posts