The Free Trade-Off
Balancing Global Efficiency and Pockets of Poverty
by Anna McEntire
In Fall 2008, the U.S. sub-prime mortgage crisis brought the national economy to its knees. Though lending freezes, bank failures, and recession still have a chilling influence on the economy, there was deep concern that the situation would be far worse.
“During the financial collapse, economists were quite worried that countries worldwide would panic and introvert themselves, withdrawing from the global economy,” said John Gilbert, Utah State University economics researcher. “When the international trading system collapses, the proverbial economic pie can shrink significantly, leaving less for everyone. If we think we have problems now, we’d be in much worse trouble in that situation.”
Economics and Finance
Gilbert’s research focuses on this issue, both in terms of multilateral trade liberalization and regional trade liberalization through free trade agreements. A New Zealand native, Gilbert grew up seeing this issue at the forefront of his small country’s economy, with 60 percent of its GDP coming from trade. Although the issue is not as visible to the average consumer in the United States, it’s still a major component of U.S. economic health.
“There are big aggregate benefits to keeping trade barriers low,” said Gilbert. “Free trade is advocated by the World Trade Organization, which is kind of like a global club for countries that sets the ground rules on international trade for its members, rules that are designed to make sure that trade stays as open as possible.”
Those rules come partially in the form of limiting tariff and subsidy levels, which vary from nation to nation. Most nations impose some type of barrier to ensure that lower import prices do not undercut those of goods produced within their own country. Artificial reduction or inflation of prices may temporarily benefit individual nations or regions, but, overall, trade liberalization gives trading partners larger mutual gains.
“Of course the ideal is complete free trade, and trade reform is something that we know is good in the aggregate, but it often doesn’t happen that way,” said Gilbert. “Even though we know it’s wise to avoid McDonalds, that doesn’t mean we still don’t go get a Big Mac once in a while. Each country experiences different consequences of free trade, some better and some worse. No country, especially a power player, wants to ‘take one for the team,’ even if they know it will advance the greater good.”
Therefore, each time there is a proposal for a further reduction of tariffs, a series of WTO multilateral discussions, called rounds, are convened to define the terms of agreement. Each set of talks can last for years before all the member nations reach a consensus. The most recent set of talks is the ninth round, the Doha Development Agenda, named after its initial meeting place, Doha, Qatar.
“The Doha Round began in 2001, but negotiations have essentially broken down,” said Gilbert. “One of the major points of contention comes from developing nations, especially India and China, two central members. They have expressed concern that trade reforms would significantly hurt rural and poor populations in Southeast and South Asia.”
One of the main reasons that trade liberalization could hurt parts of Asia is that food prices will likely rise slightly. This is good news for countries that export a lot of food products, but for those that have net imports, there could be a negative effect as they pay more for food without reaping the profits.
Individually, rising food prices could affect poor people disproportionately, as they spend a larger percentage of their meager incomes on food. This might equal out for the small crop farmer who pays more for his food but sells his own produce at a higher price. A factory worker, though, would have no way to compensate for rising food prices, unless he or she got a higher paying job.
That transition is called an adjustment cost, and it is another price a country’s poor workforce must pay when the nation as a whole moves toward greater economic efficiency.
“The process of getting from A to B might take some time,” said Gilbert. “Prices change and outputs change, and you have to move people around to make that work. Even if trade reform eventually results in overall poverty reduction, it might be difficult in the interim.”
Adjustment costs mean that a factory worker may have to move to the countryside or a farmer may have to change to a more lucrative crop. This could translate into difficult periods of reduced profits and unemployment for some people.
The only way to move past these genuine concerns in the Doha discussions, said Gilbert, is to try to quantify what the actual impacts of trade liberalization will be, so that they can be addressed, defused, and compensated for. To do this, Gilbert took sabbatical leave last year and spent seven months working with the Poverty and Development and Trade and Investment divisions of the United Nations in Bangkok, Thailand. Using past simulation studies and new economic models, Gilbert evaluated the possible impacts of the proposed Doha agricultural trade reform.
“The main problem is that the linkages between poverty and trade aren’t clear-cut,” said Gilbert. “Most economic theory is very ‘big picture’ and can’t address the multiple factors that will act on a single household’s well-being. Theory can address guiding principles and major changes, but something else is needed to effectively apply the theory and understand its implications to the real world.”
Gilbert helped to fill those information gaps using computable general equilibrium modeling, combined with data from the Global Trade Analysis Project, a economic database documenting worldwide trade patterns, production, consumption, and intermediate use of commodities and services.
“When I have numbers that show me what the economic system looks like now, I can combine that information with a computer system that captures the salient features of the economies,” said Gilbert. “By introducing the new proposed tariff levels, I can predict what the effects are going to be.”
When Gilbert ran all the numbers and completed his study, he found that the reforms recommended under Doha may indeed hit the poor disproportionately in some countries in the region, especially Malaysia, the Philippines, the Republic of Korea, Thailand, and Vietnam. Contrary to some WTO members’ worries, however, the total number of people in poverty in the region would be reduced by moderate amounts.
Even more significantly, Gilbert found that if countries supported dramatic, comprehensive agricultural trade reform—more than the modest amounts requested in Doha—even more countries would benefit, and there could be even larger broad-based declines in poverty in the region.
Despite the gains to be made, even the small proposals of Doha are uncertain to ever become reality.
“Doha is still in stasis at the moment,” said Gilbert. “With the world economy in major recession, there is concern, and that could lead to a revival of protectionism or a focus on regional negotiations. If that happens, Doha may never go through.”