Wednesday, January 14, 2004
What Europe has to gain from free trade
Posted by David Smith at 08:52 PM
Category: David Smith's other articles

A few months ago I did a talk for the Stockholm Network on this theme. It has just been republished in a Montenegro economic journal - Montenegro Economic Trends - so a good excuse for posting it here. This is the talk:

What do you say to an audience that is, I imagine, fully committed to free trade, expert in the details of the Doha development agenda, and does not need convincing of the need to make progress?

Well sometimes, I think we all need to remind ourselves of the benefits of trade liberalisation.

The other weekend I was watching the film A Beautiful Mind where, even through the Hollywood treatment, you could see that John Nash had given us the Nash equilibrium, the win-win situation. Trade is not a zero-sum game, even though some in the development lobby argue that it is, with all the benefits accruing to the rich.

Long before Nash, Ricardo demonstrated how the gains from trade accrue to all those who take part in it. Often I think, however, that it is not just the developing countries that need reminding of this.

Thus, there is an argument you come across in Europe. It goes like this. We’ve already liberalised a huge amount, it is said, so why is worth going further for marginal gains that may involve significant political costs, most notably by upsetting the farm lobby.

Or, it is said, why bother with external trade liberalisation when there is a huge amount still to be achieved in terms of internal liberalisation within the EU. Let’s focus on the challenging task of completing the single market and turning the EU into a genuine free trade bloc. Or let’s concentrate on the job of integrating the accession countries of eastern Europe into the EU.

Now, I have no problem with completing the single market. Indeed I wish the process well. But I hope very much that it is not at the expense of external trade liberalisation. As Jagdish Bhagwati has warned, one of the greatest dangers to free trade is preferential trading agreements that exclude some countries.

So let me look at some of the benefits of free trade to the EU.
1. The first is that the benefits of free trade generally are incontrovertible. World trade has increased 20-fold, in real terms, during the GATT-WTO liberalisation period that began in 1947. As average tariffs in the industrial countries have come down, from 40% to under 5%, so trade has gone up. This a proven economic relationship. Roughly speaking, world trade grows about as twice as fast as world output – during the 1990s world trade growth averaged 7% a year. The liberalisation of world trade gave us the unprecedented prosperity of the past half a century. Last year world trade grew by 2.5%, following a 1% decline in 2001, while world output rose by 1.5%. I’m always proud of Britain’s role in trade liberalisation – and not just the fact that UK governments have tended to push for free trade. As you will know, one of the earliest GATT rounds was in dear old Torquay, not usually thought of these days as a location for big international conferences, and quite a lot of progress was made there. The EU has quite a high proportion of the world’s big exporters and it is currently suffering from the weakness of world trade. Last year EU exports rose by a mere 0.6% while imports fell by 0.5%. It has everything to gain from stronger world trade growth. Before we pass on, the other notable thing about this league table of exporters is that China overtook the UK last year.

2. Secondly, I am a strong believer in two related propositions. The first is that trade, through increased competition, puts pressure on countries to sharpen their economic act. The second is that EU economies badly need that competitive spur to become more flexible and less regulated. I could write a book on this, in fact I have done. But let me just give one or two statistics. GDP per capita in America is roughly 40% above the EU average, while US GDP growth exceeded that of the EU throughout the 1990s – the longest period in modern times it had done so. EU R & D spending is under 2% of GDP and steady, while in the US it is nearly 3% and rising. The EU employment rate is 65%, compared with nearly 80% in America. Long-term unemployment is nearly 4% of the active population, compared with under 1% in the US. Organisations like the World Economic Forum, scoring the Lisbon reform agenda, have consistently found that major EU economies – France, Germany, Italy and Spain – but not in general countries like the UK and Finland, have poor enterprise environments. I do not believe the spur of internal competition, within the single market, will be sufficient to bring the changes the EU needs. Greater external pressure is needed too.

3. Thirdly, I think there is a great prize to be had from the liberalisation of services. Trade in services accounts for only a fifth of all world trade. There appears to be a significant disconnect between the situation in most advanced economies, where two-thirds of GDP is accounted for by services, and the 20% share it has of world trade. Even allowing for the fact that some services cannot easily be traded internationally, services are lagging well behind. Growth in trade in services is picking up, but from a very low base, and needs new momentum, which it is to be hoped will be provided by Doha. It is also the case that whereas goods prices are subject to deflation, services are generally not. For the EU, there is enormous potential from the liberalisation of services. EU economies have a significant share of global exports of services. The benefits of liberalisation in this area would not be purely for the advanced economy providers of services. The World Bank has estimated that trade liberalisation in services would benefit developing poor countries to the tune of $900 billion.

So the potential benefits to the EU from trade liberalisation are enormous. I’ve mentioned just three areas – the general benefits of stronger world trade growth, the spur to economic reform and the potentially enormous gains from liberalisation of services. But there are many others. I don’t need to dwell on the gains to EU consumers, and taxpayers, that would flow from genuine reform of the Common Agricultural Policy, the existence of which in its present form is something like a source of shame in Europe. If the CAP is responsible for derailing the Doha round, which is a danger, that would add hugely to the damage it has already done.

The EU also has more interest in pushing trade liberalisation than usual. I don’t know how seriously one should take the idea of a post-Iraq trade backlash, and a breakdown in EU-US relations. What is clearly the case, however, is that even before the war the EU was dealing with a US government fully-prepared to abandon aspects of free trade, is steel and farm support, often using EU protectionism as an excuse. The EU should make it is mission not to provide any such excuse. Whether or not protectionism is increasing, and I fear it is a danger, the risk is that the momentum behind world trade is slowing. Foreign investment has been weaker, as has trade in recent years.

Indeed, if we look at trend growth in world trade growth, a slowing from the heady days of the 1950s and 1960s is clear. What is crucial is that we do not go back to the grimness of the 1970s.

Are there any meaningful estimates of the benefits of trade liberalisation? You’ll remember the great debate about the creation of a transatlantic free trade area, which was supported by the European Commission. Updated estimates from the UK Treasury – based on the liberalisation of transatlantic trade – show a boost equivalent to 1.3m EU jobs, an annual GDP boost of 1.1%. I’m sure this only scratches the surface.

The EU has an enormous amount gain from trade liberalisation, and everything to lose if the process started to go backwards.

Geneva, May 2003

Comments

Well said David

Posted by: Gary Bezowsky at January 14, 2004 10:04 PM
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