Liberalization due to WTO participation in Asia

Two stories on WTO-induced liberalization:

Vietnam: “Accession to the World Trade Organization would throw up jobs in hi-tech fields in Vietnam but also present challenges, a top labor expert said.”

Malaysia: “Come 2008, Malaysia has to bear the full brunt of the liberalisation rules under the World Trade Organisation (WTO) for ‘non agricultural access’ and this covers products like automobiles. Known as the ‘big bang liberalisation’, the picture is rather grim ahead unless Malaysian national car companies become more competitive.”

Will emerging markets produce globallly competitive firms?

Donald Sull of the London Business School has a column in tomorrow’s Financial Express on the viability of firms from developing or newly industrialized countries that pursue international expansion to compete with developed nation companies:

Recent Chinese bids reveal a much broader phenomenon: the rise of fiercely competitive companies from the crucible of emerging markets, including India, Brazil and Mexico as well as China. These emerging market champions pose a much greater threat than most western managers recognise…

The harsh environment overwhelms the majority of emerging market companies. The few that survive the brutal process of Darwinian selection, however, emerge as fierce competitors that excel at efficiency, innovation and risk management. Having conquered local markets, they have strong incentives to expand abroad. Global expansion allows them to tap new markets, spread risk geographically, build economies of scale and compete in many places with multinationals…

The most critical element of these emerging market champions is their diversity. Here the facile analogy with Japan is at its most misleading. Japan’s push towards globalisation was co-ordinated by the government’s trade ministry, targeted at a handful of industries, and pursued by similar companies coming out of the same cosy home market. Emerging market champions, in contrast, vary in headquarter country and industry as well as their strategies to go global…

Executives who lull themselves to sleep with reassuring bedtime stories about Japan may sleep well for now. But they risk waking up to a very unpleasant reality.

Read the full piece for examples of innovative firms and more myth-busting.

WTO & Trade Liberalization: Don’t read blog posts when research papers are available

Posting an answer to a question you posed only four hours earlier is a sure sign of unfamiliarity with the literature in that area. Luckily, Ben Muse has pointed me to Andrew K. Rose’s web page, which contains a plethora of links to his papers and various responses on the topic of the GATT/WTO’s effectiveness in liberalizing trade. I’m going to bury my nose in these papers for a day or two.

Yes, the WTO does liberalize trade

Perhaps I have found an answer to the question posed in my previous post‘s title.

Check out this Economist article for more discussion of the WTO’s effectiveness in liberalizing trade. The paper by Tomz, Goldstein and Rivers that it mentions exhaustively investigates the criterion Rose used to determine GATT participation. By using formal membership as the measure of GATT participation, Rose’s paper neglects the substantial participation by informal member nations:

The solution to this mystery lies in understanding who actually participated in GATT. We show that Rose has overlooked a large proportion of countries to which the agreement applied. By mistakenly classifying many countries as nonparticipants, when in fact they had both rights and obligations under the agreement, he systematically underestimates the effect of GATT on international trade. The purpose of this paper is to identify the full set of GATT participants and, once this institutional detail is understood, to show that GATT did indeed contribute to the substantial growth in postwar trade.

They find that “trade is approximately 72 percent higher when both sides of the dyad participate in GATT and nearly 31 percent higher when only one side participates.”

GATT created rights and obligations not only for contracting parties but also for countries and territories that did not appear on the formal membership roster. By treating colonies, de facto members and provisional members as if they were outside the organization, previous research has understated the institutional research and economic effects of GATT.

Once we account for all participants, our analyses show that participation in GATT— either as a formal member or as a nonmember participant–substantially increased trade. Grouping nonmember participants with nonparticipants causes a substantial downward bias in the estimated effect of GATT membership. When this misclassification is corrected, we find that the agreement proved beneficial for both formal members and nonmember participants, which traded at higher levels than countries outside GATT. These findings withstand a variety of sensitivity tests involving changes in sample definitions and estimation techniques. Overall, GATT exerted a positive effect on trade in nearly all time periods and for most groups of countries.

It would be hasty to dismiss the WTO.

Does the WTO liberalize trade?

In reply to my pessimistic evaluation of trade liberalization’s momentum, Alex Singleton says that I shouldn’t let the best be the enemy of the good, noting that CAFTA, while unpopular, was more politically feasible than unilateral liberalization.

I would normally reply that the realistic alternative to regionalism is multilateralism, not unilateralism, but I just read a paper (PDF) from Andrew K. Rose of Berkeley that argues that the conventional faith in the WTO is misplaced. Using a very traditional gravity model, Rose finds WTO membership to be both economically and statistically insignificant in affecting trade flows, with point estimates occasionally turning out negative. After demonstrating the robustness of this (non-)finding, he ponders:

Of course the most interesting issue that remains is why the GATT/WTO doesn’t seem to have had much of an impact on trade. It is natural to ask whether GATT/WTO members have systematically lower trade barriers. The answer seems to be negative; see Rose (2002). There are at least two possible reasons. The first is that the GATT/WTO has not typically forced most countries to lower trade barriers, especially developing countries that have received “special and differential treatment.” The second reason is that members of the WTO seem to extend most favored nation status unilaterally to countries outside the system, even though they are under no WTO formal obligation to do so. Ongoing research (Rose, 2002) indicates that the negative effect of GATT/WTO membership on trade may appear because membership simply has little effect on trade policy. [Berkeley (PDF)]

In discussing the negative effects of preferential trade agreements, I have sometimes described discriminatory trade policy as damaging the WTO. Dr. Rose’s paper is a good reminder that MFN and low barriers, not membership in the WTO, are the hallmarks of good trade policy. As is often noted, unilateral liberalization, whether spurred by the desire for improved economic performance or forced upon policymakers by a crisis, has occurred frequently during the last half century, but rarely received the attention that is showered upon reciprocal liberalization.

That said, dramatic unilateral liberalization would certainly capture public attention, and Mr. Singleton is likely right that it will not be politically feasible in the near future. As such, free traders ought to devote attention to making the WTO an effective force for liberalization.

Optimism and Pessimism: Global Free Trade

Alex Singleton, president of the Globalization Institute and a man whom I admire, has a thoroughly optimistic article on the state of trade liberalization in The Business. It opens:

It has been a great few days for supporters of global free trade, despite the best efforts of reactionary forces in the United States, Britain and Brussels. The Central American Free Trade Agreement, which extends open markets to six nations plus the US, passed in the House of Representatives, defeating the sugar producers and trade unions that fought desperately against it.

In the crucial House vote, only 15 out of 202 Democrats voted for the trade agreement, and it was carried by a wafer-thin majority of two votes, but the end result was nevertheless a big victory for free trade. The agreement was also passed in the Senate and has now been signed into law; its main beneficiaries will be ordinary people in Costa Rica, the Dominican Republic, El Salvador, Guatemala, Honduras, Nicaragua, and the US, who will enjoy faster economic growth in the long term, more jobs and better living standards.

This is either unfounded optimism or desperate spin. These were not “a great few days” marked by “a big victory for free trade.”

CAFTA is not a meaningful trade agreement. It grants preferential access to some US exporters, but otherwise does not significantly lower trade barriers. As Dan Griswold and Dan Ikenson of Cato lamented in a pro-CAFTA briefing paper, “the agreement is less ambitious than it could and should have been. But despite those shortcomings,” they argue, “CAFTA is an affirmative step toward the policy goal of free trade.”

In the wake of CAFTA’s diminutive stature, most free trade advocates argued that passing the agreement was a critical symbolic gesture. These proponents said that the Bush administration needed a win on trade to keep up liberalizing momentum.

If the fight over CAFTA was merely a symbolic flexing of the Bush administration’s liberalization muscles, then free traders ought to be very worried. The Bush administration didn’t build a compelling case for free trade that captured public opinion; it squeaked out the deal’s passage by only two votes. Moreover, the passage required plenty of horse-trading on non-trade issues. Overcoming resistance with pork-barrel bribes isn’t exactly building momentum.

The Bush administration has no meaningful leverage on trade issues. CAFTA carved out large exceptions for textiles and sugar, yet protectionist forces still mounted significant opposition to the deal. The administration also allowed opponents to use outsourcing as a smear against the deal. There’s little reason at this point to have confidence in the Bush administration’s ability to win the next trade fight.

Nevertheless, Singleton writes that “despite the protests of opposition parties, free trade is on the rise again.”

As another piece of evidence for his thesis, Singleton notes:

Asian countries are pushing ahead with their own trade deals. India and China want a bilateral trade agreement…

This is far from desirable. Throughout the 1990s, the Asian economies steadfastly adhered to the doctrine of “open regionalism,” whereby they cooperatively lowered their trade barriers on a Most Favored Nation basis, preserving the hallmark of good trade policy – nondiscrimination. (For an excellent discussion of this approach, see Europe, East Asia and APEC by Peter Drysdale and David Vines.) The region’s new fondness for bilateral, preferential trade deals should be taken as the most serious signal that the global trading system is in danger. MFN has already been abandoned by the EU, and now Asia is following suit.

Singleton continues:

Nations wanting more liberal trade will increasingly turn to agreements outside the WTO to make progress. Supporters of the multilateral agreements made at the WTO point complain that bilateral agreements are often messy and discriminate against countries not party to the agreements. This is a fair criticism, but countries have to make the choice between a perfect agreement that is not on the table and a bilateral one which, though impure, does at least make some progress.

I’ve covered the regionalism vs multilateralism debate many times before. The arguments for why bilateral deals will usually do more damage than good are too numerous to reprint here; I merely want to note that Singleton ought not to so easily conclude that bilateral deals “at least make some progress” toward global free trade.

It is likely that I am being overly pessimistic about trade liberalization’s prospects. Even so, Singleton’s take on the issue is overly optimistic. In his concluding paragraph, he writes:

The Central American Free Trade Association is just at the beginning of a century of trade liberalisation, more significant and powerful than any previous wave of liberalisation.

The Asian abandonment of non-discriminatory trade policy, the increasing popularity of bilateral agreements, and the Bush administration’s inability to pass a largely meaningless CAFTA deal without eleventh hour pork promises are signs that free trade faces an uphill battle at the start of the twenty-first century, not indicators that it is on the rise.

Trade Diversion & CAFTA’s Passage: Cause & Effect?

Although CAFTA’s passage certainly depended upon last-minute horse-trading in Congress, it received plenty of support because the agreement will benefit US exporters. And as the US Trade Representative’s office proudly trumpeted, many of those benefits will be due to trade diversion: “Eliminating these tariffs will create in many cases preferences for U.S. exporters over third country suppliers, including those in Canada, Europe, and South America, helping to restore lost U.S. market share and expand overall U.S. exports.”

Celebrate CAFTA’s passage by reading Pravin Krishna’s classic paper on this topic:

Preferential trading arrangements are analyzed from the viewpoint of the “new political economy” that views trade policy as being determined by lobbying of concentrated interest groups. Two conclusions are reached: first, that trade-diverting preferential arrangements are more likely to be supported politically; and second, that such preferential arrangements could critically change domestic incentives so multilateral liberalization that is initially politically feasible could be rendered infeasible by a preferential arrangement. The larger the trade diversion resulting from the preferential arrangement, the more likely this will be the case.