Will International Trade Liberalization Enhance Economic Development? (original) (raw)

Almost a decade has passed since developing countries' delegates walked from the negotiating tables and protesters took to the streets in Seattle 1999, as they saw their interests and concerns at best neglected and at worst undermined. Since then, the industrialized countries have pledged to put development first, explicitly making it the aim of the following round started in Doha, Qatar, in late 2001, dubbed the "Doha Development Agenda." The ongoing Doha of multilateral trade-negotiations at the World Trade Organization (WTO) ground to a halt in Cancun in 2003, experienced further hiccups in Hong Kong in 2005, and appears destined to stall for a while longer. We briefly discuss its theoretical foundations to highlight the inappropriateness of pure trade theory for policy making and the often dubious empirical evidence of development gains from free trade, especially the efforts of the trade modeling community to advance the free trade agenda. The case for trade liberalization rests on David Ricardo's theory of comparative advantage. Put forward in the early 19th century, he argued that England and Portugal could engage in mutually beneficial exchange of cloth and wine-whatever the respective industries' prices and productivities were. However, this argument requires a world of flexible exchange rates responsive to changes in goods markets, instantaneous full employment, and no factor mobility, meaning neither labor nor capital crosses borders. Quite obviously, especially in developing countries with chronic underemployment and volatile, pro-cyclical, capital flows, the latter two assumptions are generally not satisfied. Exchange rates, on the other hand, often are flexible, but believed to be determined primarily by asset markets, where they respond to changes in expectations about future growth and interest rates. Even if these conditions are satisfied, Ricardo's theory and its 20th century "Heckscher-Ohlin-Samuelson" (H-O-S) version, after the three economists who popularized it, would run into problems, mainly because a large share of trade flows are not driven by factor endowments. 1 In Ricardo's original story, England focuses on producing cloth, and Portugal specializes in wine, where they both have relatively higher productivity. The modern version of H-O-S, in turn, relies on the idea that countries specialize in the industry that requires relatively more of its abundant factor of production-hills the sun shines upon for Portugal's port wine, and textile mills for England's tweed manufacturers. More recently, with the outsourcing boom, attention has turned to the fragmentation of the value chain-thus, vineyards in Portugal, but packaging in Morocco. 2 Unfortunately, trade patterns do not conform to this theory. The overwhelming majority of trade occurs between countries that are very similar both in terms of 1 See Fontagne et al. (2006) for a discussion of horizontal as well as vertical intra-and inter-industry trade flows. Horizontal two-way trade within an industry is most important between developed, neighboring countries. Recently, with the rise of China, vertical differentiation between developing and developed countries has become more important. 2 See Arndt (2001) for a representative exposition. 11 See Stiglitz and Charlton (2004). 12 See Ackerman (2005).