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Trade liberalization has been forcefully advocated by institutions such as the International Monetary Fund (IMF) and the World Bank as part of the so-called Washington Consensus . which it can instead import from country B.The discussion about the benefits and harms of free trade is one that has divided economists and politicians ever since its theoretical inception in the 19th century. Because of specialization. If the costs of cars are higher than those of computers. By examining the historical development of different countries with varying degrees of trade liberalization and in particular contrasting the paths of presently developed countries with the measures they now advocate. The costs for country A to produce cars are the resources it takes to produce computers and vice versa. The principle of comparative advantage as set out by Ricardo (Mankiw and Taylor 2006. it will attempt to establish whether there is a link between free trade and growth and discuss the effects of present trade regimes on the developmental capabilities of developing countries. However. then it is better for A to produce more computers at the expense of allocating resources to produce cars. This is because the two countries have limited resources that have to be allocated in order to produce differing combinations of the two goods. through comparative advantage it can be shown that countries ought to trade. two economies A and B that each produces cars and computers. It is normally assumed that these countries ought only to trade goods if each country is better than the other at producing a certain good. Free trade plays an especially important role in the debate over the most suitable and effective policies for developing countries to implement in order to facilitate growth and eliminate poverty. By focusing on producing cars. for example. B can gain an advantage through specialization and import computers in exchange for cars.3) lays the theoretical foundation for the espousal of free trade and can be explained by assuming. both countries will be able to 1 . ch. even if one country is better at producing both goods than the other. with often mixed results for developing countries. before briefly discussing further arguments that have been developed in support of this theory. This essay will explain the origin of the concept of free trade in the work of economist David Ricardo.
As in reality this is clearly not the case. it will benefit other industries as well: If an corporation decides to set up a manufacturing plant in a country with cheap labour. other arguments have been brought forward (McCulloch 1993): Even if government intervention in markets could raise welfare levels. Many studies have been conducted in the aim of analyzing the effects of free trade and have shown no conclusive relationship between free trade and growth. free trade is said to enlarge markets by including many countries.e. this would in practise be difficult to implement and highly susceptible to being abused by special interest groups. On the other hand. Some economists conclude therefore that trade liberalization is an essential strategy to be adopted by developing countries on their quest for growth. this simple model cannot readily be applied to reality. In the course of history and also recently. countries have lowered trade barriers and liberalized their 2 . the skills and knowledge of the technological process will be passed on to the workers. thereby benefiting consumers through a more efficient allocation of resources and greater division of labour through economies of scale and the increased competition amongst producers. because markets have to be perfect for it to hold. Furthermore. However. who will through their increased technical proficiency be able to set up their own businesses and be more attractive to other potential investors. countries have achieved growth despite employing protectionist instruments and intervening in the operation of markets. technical knowledge within one industry is said to possess spillover effects.32). Similarly. This example demonstrates the classic economic argument in support of free trade.produce an overall greater amount of cars and computers than would have been the case without trade amongst the two. meaning that producers as well as consumers are to have perfect information about all aspects of the market. International institutions such as the IMF and the World Bank have used these arguments in order to force developing countries to liberalize their markets and open up their economies to foreign investors (Stiglitz pp. thereby leading to an actual reduction of welfare. i. as thereby it can be shown how it is of mutual benefit to all countries participating. Therefore free trade is to be preferred as the safer choice.
Many Latin American and African countries that have eased trade restrictions in order to better supply their natural resources to the world market and exploit their comparative advantage in agriculture have not experienced any gains in technology or knowledge. as real wage rates decreased and low-income earners were made poorer through subsidized American products flooding the markets and driving down the price of Mexican agricultural products. Whilst Mexico has experienced a growth in exports and Foreign Direct Investment (FDI). 22) describe the case of Mexico.markets without reaping any of the promised benefits. After undertaking extensive reforms in 1994-1995. many Asian states chose to play a more interventionist role in the development of their economies (Stiglitz and Charlton 2005). p. The rapid liberalization of Latin America and various Carribean countries did not increase growth rates. but rather reduced them in comparison to pre liberalization years (Gallagher 2008). Japan for example protected industries that were not deemed ready to compete internationally and promoted those that were. which joined the North American Free Trade Agreement (NAFTA) in 1994 and embarked on a substantial liberalization of markets together with the United States and Canada. leaving them stuck in the role of commodity supplier to the rich countries of the world. its growth rate in the decade following the agreement to NAFTA has been lower than in previous decades. Stiglitz and Charlton (2005. it experienced no increase in growth rates or improvements in social injustices. The cases of China and India (Rodrik and Subramanian 2005) further demonstrate that growth can be achieved without resorting to trade liberalizing measures. 28) further dents the claim that market liberalization leads to growth. curtailed foreign imports and restricted international as well as domestic competition. On the other hand. Inequality grew. p. These countries achieved high growth rates a decade before 3 . Japan and many other Asian countries experienced some of the highest growth rates in history and challenged the consensus-view that anything short of a total committal to free trade would have negative effects on a countries economy. The example of Haiti (Malhotra et al 2003. The government issued easier credit to such companies via banks.
In order to remedy these failures. deprive developing countries of domestic instruments in order to regulate foreign competition more stringently. These policy tools are important for managing the economies of developing countries in order to address so-called market failures . however. Many of the problems that developing countries face when they take the necessarysteps to liberalize their markets are connected with the trade policies of developed countries and the organization of institutions such as the World Trade Organization (WTO) (Wade 2003). This results in the service industries of developing countries being open to foreign firms. making it difficult for local companies to establish themselves. along with negative effects on the overall welfare of society. Because of the unequal market for knowledge. with developed countries registering a multiple of the amount of patents that developing countries do.lifting trade restrictions by adopting measures that were business-friendly without exposing them too much to aggressive foreign competition. a measure that many developed countries employed in the early stages of their development. this benefits the large corporations of developed countries through larger earnings from royalties and hampers the developing countries abilities to gain knowledge through imitation of advanced technology. As a result of the Uruguay round. The Agreement on Trade-related Investment Measures (TRIMS) bans performance requirements on foreign firms. Numerous agreements that have been reached. developing countries often resort to interventionist measures in order to correct these distortions. such as export requirements or the need to use local inputs in the manufacturing process. in which resources are not allocated efficiently and distort the functioning of the economy. a swathe of such policy-space restricting measures were passed. which are often the result of intense lobbying on the part of vested interests within developed countries. while the General Agreement on Trade in Services (GATS) liberalizes the markets for services by hindering developing countries from interfering in them. If a developing country chooses to violate any of these 4 . such as the Agreement on Trade-related Aspects of Intellectual Property Rights (TRIPS) which force developing countries to pass laws that set a minimum standard of patent protection and strips them of the ability to deny companies certain patents.
China and Taiwan. in which the order and pace of liberalization play a crucial part. Many of the measures that have been banned under the new agreements have been used previously by countries on their paths to development and have proved successful at fostering internationally competitive industries. that certain amounts of local suppliers be used or that technological innovation directly benefit the host country are measure that have been instrumental in the development of many countries today. He emphasizes the need to tailor the recommended measures to the needs of the economy. with no obvious relationship between free trade and growth distinctly visible (Rodriguez and Rodrik 2001). even their accusation of distortion on the part of developing countries is sufficient for them to win the case against the developing countries and thereby force open the markets for their own corporations (Stiglitz 2003). The evidence for the benefits of free trade is therefore inconclusive at best. but rather needs to be restrained appropriately. many of the developed countries that now argue in support of the benefits of free trade have themselves attained this developed stage through blatantly protectionist measures. it can be taken to the Dispute Settlement Mechanism within the WTO. Requiring foreign companies investments to be undertaken jointly with local companies. It therefore appears that trade is not an independent force for good in developing countries. The policy protection of agricultural sectors further damages developing countries by subsidizing farmer s wages and enabling them to compete on the world market at much lower prices than can be produced at in developing countries (Wade 2003). Stiglitz (2003) argues for a more cautious approach to trade liberalization than has been pushed by international institutions in the past. As Chang (2002) points out. Because of the power of developed countries. such asin South Korea. state support and protection of new manufacturing industries played a vital role in the development of these industries in Britain and the United States at the end of the 19th and beginning of the 20th centuries. As has been noted by many economists. had until the middle of the 20th century the highest manufacturing tariffs in the world. Furthermore. Opening a developing economy to foreign corporations can 5 . for example.agreements. The United States. it appears that reaping the fruits of a successful fair trade policy is contingent on a host of other internal factors.
as the knowledge required on their part is quite low. and perhaps even necessary. In order for developing countries to experience higher growth rates. however.lead to them crowding out the underdeveloped local manufactures without there being any beneficial spillover effects for the local economy.. This limits their capacity to decide the course of development that they think most fitting to the local circumstances. otherwise public resources are squandered on useless projects. such as the domestic policies. Unfortunately it is now the case that the agreements that are made in the name of free trade at various trade rounds and the policies that are prescribed by international institutions strip developing countries of the ability to impose effective regulations on their domestic markets. As a result. It is clear. Large investments there do not go hand in hand with benefits to labourers. However. that a certain degree of protectionism and state intervention is beneficial. 6 . from the historical experience of developed countries. governmental intervention has to be undertaken with the utmost care that the right industries are chosen to be protected. it is necessary for developed countries to change their attitudes towards such issues as the appropriateness of market liberalization for less-developed countries trading with them and apply their own policies of liberalization to agricultural and textile markets. This particularly is a problem that besets developing countries if their largest sector is the agricultural one. Whether trade is good or bad depends on a number of other factors. a sound legal framework and macroeconomic stability. free trade cannot definitely be said to benefit or harm developing countries. for the development of effective industries that can successfully compete at an international level.
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