Wednesday, March 14, 2007

Trade and Reciprocity

Last week, i exchanged views with fellow commenter Justice League on mlq3's blog regarding the pro's and cons of allowing foreign doctors (from Cuba, India and Pakistan) in the country. Along the way, the discussion touched upon the pro's and cons of free trade in general, specifically, the issue of reciprocity. The take off point was this provision in the Constitution:

"The State shall pursue a trade policy that serves the general welfare and utilizes all forms and arrangements of exchange on the basis of equality and RECIPROCITY" [Justice League's emphasis]

Justice League favored a strict bilateral interpretation while i was for a less restrictive multilateral approach (via the WTO). The practical implication of my position is that we should not put up trade barriers against another country solely because it has in turn imposed trade barriers of their own against our products and/or services.

Why am i against strictly bilateral reciprocity? My reasons have to do with the cost of enforcement and the corruption arising from attempts to circumvent such rules. Under the current quality of governance, rules just present profit opportunities for would-be smuggling lords and other such enablers. Aside from this, the trade barriers themselves would penalize our own consumers who would be either be facing shortages or getting inferior products or services at higher prices. Both of these consequences lead us further from the intended goal of the Constitution to [serve] the general welfare.

The question remains though, when does it make sense to enforce reciprocity i.e. retaliation by imposing trade barriers? Helpman's account on the impact of tariff barriers to economic growth provides some insight into this:

Bairoch(1) argued that the European experience in the late nineteenth century does not support the view that protection is bad for growth...In response to an inflow of cheap grain from Russia and the New World, some countries raised their impediments to trade. France went protectionist in 1892. The growth rate of its GNP increased from an annual average of 1.2% in the decade preceding the policy shift to 1.3% in the decade following the policy shift. Germany changed its policy in 1885, experiencing a rise in the growth rate of its GNP from 1.3% in the decade preceding the rise of protection to 3.1% in the subsequent decade. Sweden also experienced an acceleration of GNP growth around its policy shift toward more protection in 1888, while Italy experienced a slowdown in GNP growth around 1887, the year in which it went protectionist. In view of this evidence Bairoch noted that 'it remains generally true that in all countries (except Italy) the introduction of protectionist measures resulted in a distinct acceleration in economic growth during the first ten years following a change in policy, and that this took place regardless of when the measures where introduced'

O'Rourke(2) examined more carefully the relationship between average tariffs and growth in the late nineteenth century. Estimating a growth equation with data for ten countries between 1875 and 1914, he found a positive effect of tariffs on the rate of growth of real income per capita, thereby confirming Bairoch's argument...

Clements and Williamson(3) confirmed O'Rourke's findings for a sample of more than thirty countries between 1870 and 1913. But they also found that the relationship was reversed in the post-World War II period [emphasis mine] That is, in the postwar period high-tariff countries grew more slowly than low-tariff countries.

Clemens and Williamson suggested that the reversal might be related to the average level of protection in the world economy. [emphasis mine] When a country's trade partners have high tariffs, it can speed up its own growth by adopting a higher rate of protection. When a country's trade partners have low tariffs, however, higher protection harms growth.

....Tariffs were higher before World War I than after World War II, and they hit record levels between the wars. This intertemporal pattern of tariffs is at the heart of Clemens and Williamson's explanation of the reversal of the relationship between protection and growth. - from The Mystery of Economic Growth, Elhanan Helpman, 2004

(1) Bairoch, Paul. 1993. Economics and World History.
(2) O'Rourke, Kevin. 2000. Tariffs and Growth in the Late 19th Century.
(3) Clemens, Michael and Jeffrey G. Williamson. 2002. "Why did the Tariff-Growth Correlation Reverse after 1950?" NBER Working Paper no. 9181

I don't consider the above the last word on the matter as even Helpman further discusses other possible explanations for the reversal of correlation of trade and economic growth in his book (e.g. structure of countries). However, the heuristic of raising and/or lowering trade barriers based on the average level of protection in the world economy (which ties back to my recommended multilateral approach to reciprocity) seems to have basis in the historic data.

Update (03-15-2007): From Blurry Brain's blog, a recent real world case of a local industry (i.e. the soap and detergent industry) rejecting reciprocity for sound business reasons.

Update (03-16-2007): Minor revisions in wording for clarity.

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