I was fortunate to get a H3 essay topic similar to what I had written on this blog before. And since I've had to type it out, here it is:
Q6. “..while it is true that trade is a positive sum game, the benefits of trade are never equally distributed.” To what extent does this undermine the case for free trade?
Free trade has provided a platform for growth for many of the developing countries, and the results are very visible when comparing an autarky, such as North Korea, with China and the newly industrialized countries. However, the developments of these countries see their Gini coefficient moving in the same direction as their Gross Domestic Product. Theoretically, this may be accounted for by economic theories such as the Stolper-Samuelson theory, but in reality the inequalities of many countries, including the developed, are much greater than can be explained. Yet this phenomenon should be taken as a case for free trade, instead of against, as much of the inequality arises from trade restrictions. Also, it is the role of governments to redistribute wealth and income, or “compensate the losers from globalisation”. Hence, free trade can benefit the whole population of countries, but only with addition action by governments.
In a two-good model of comparative advantage, trade can bring about benefits for the society as there may be a pareto improvement in the consumption of both goods. Fig. 1 shows that when a country moves from autarky to free trade, it changes production from point A to point B, producing more of good Y in which it has a comparative advantage. By trading, it is able to consume on the consumption possibility curve (CPC), and hence is able to consume more, pareto optimally if the new consumption is in the shaded region. Therefore, the benefits of trade to society on aggregate are undeniable.
However, using the Heckscher-Ohlin model of two factors of production, the Stolper-Samuelson theorem states that an increase in the price of a good will cause an increase in the returns of the factor that is used most intensively, and a fall in the returns of the factor that is used less intensively. To the extent that this theorem holds, free trade between a developed country and a less developed country may result in the worsening of wage and rent inequalities. Assuming that the two factors of production are skilled and unskilled labour, with the developed country being more abundant in skilled labour and the converse for the less developed country, free trade between the two countries would cause the price of the good, which is produced with more of the abundant labour, to increase to the extent that returns to scale are constant. Applying the Stolper-Samuelson theorem, wages for unskilled labour in the developed country would fall while wages increase for skilled labour. Hence, the inequality of a country may worsen due to the increased trading.
Despite the increase inequality caused by freer trade, there may still be a case for free trade benefiting society more. Free trade is able to reduce the price of many goods that a country can import due to comparative advantage. To the extent that the fall in prices of goods are significant, and the demand is price inelastic, the loss in wages of some may be compensated by the rise in utility of buying cheaper goods. There should not be a distinction between “Man as consumer and Man as producer”, as Ernst Schumacher warned against. While there is discontentment about free trade from globalisation due to the fall in wages of unskilled labour in developed countries, a less visible benefit of lower prices is seldom taken into account.
However, much of the benefits of free trade to the “Man as consumer” only exist if the assumption of perfect competition holds. Many developed countries constantly invoke the Special Safeguard Mechanisms, granted by the Doha talks, to subsidise on agricultural products or impose lenient controls on domestic production, such as automobiles in the USA. These subsidies may worsen the terms of trade of the subsiding country, in addition to the damage caused to countries exporting those goods. The subsidies do more harm than good as can be seen from the bankruptcies of US automobile companies, and the decline of Detroit state. Much of the blame is on free trade, but with freer trade, the bankruptcies could have been avoided if General Motors and Chrysler improved their efficient, but they did not have the incentive to do so because there was a lack of market signals. In the developing countries, advocates of “trickle-down” growth pushed for subsidies for local monopolies, in order to compete globally. However, once these monopolies have been created, barriers to entry are erected to prevent competition, hence worsening inequality between the oligarchs and the rest of the population. Much of such inequalities are a result of government intervention instead of free trade.
True free trade may be an ideal that can never be achieved, and it may not be desirable. But freer trade, relative to the situation currently, would help to alleviate the inequalities within a country and between countries. As economic theory anticipates that free trade may also bring about inequalities from factor endowments, there is a case for governments to redistribute wealth or income. However, this should only be done to the extent that it does not dull the incentives for hard work, as the success of the free market, and consequently free trade, is due to the incentives for improvement and development. As such, inequality may not be completely undesirable if it were to provide the incentive for economic agents to remain efficient.
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