Thursday, May 10, 2007

Rodrik on Trade Liberalization and Favorable Economic Outcomes

Dan Rodrik offers sound advice to free trade boosters (which includes me). Specifically, he answers the question "under what conditions will trade liberalization enhance economic performance?" and offers the following list:
  • The liberalization must be complete or else the reduction in import restrictions must take into account the potentially quite complicated structure of substitutability and complementarity across restricted commodities.
  • There must be no externalities or microeconomic market imperfections other than the trade restrictions in question, or if there are some, the second-best interactions that are entailed must not be adverse.
  • There must not be any increasing returns to scale, or else activities with scale economies must expand "on average."
  • The home economy must be “small” in world markets, or else the liberalization must not put the economy on the wrong side of the “optimum tariff.”
  • The economy must be in reasonably full employment, or if not, the monetary and fiscal authorities must have effective tools of demand management at their disposal.
  • The income-redistributive effects of the liberalization should not be judged undesirable by society at large, or if they are, there must be compensatory tax-transfer schemes with low enough excess burden.
  • There must be no adverse effects on the fiscal balance, or if there are, there must be alternative and expedient ways of making up for the lost fiscal revenues.
  • The economy must not have a trade deficit that is already "too large," or else nominal wages or the exchange rate must adjust to compensate.
  • The liberalization must be politically sustainable and hence credible so that economic agents do not fear or anticipate a reversal.
[Source: Dan Rodrik's weblog, May 04 2007]

I have highlighted the items and phrases i do not yet understand for future study.

Update (05-10-2007 8:05pm): Thanks to commenter Gabby D. for his explanation on optimum tariffs. (I will be highlighting in green the items that i begin to understand.) I also got some further explanation on how a large country benefits from such a policy.

"Large countries are defined as those with the ability to significantly affect world prices. In other words, a large country faces upward sloping foreign supply curves for the agricultural commodities it imports. Thus, changes in domestic policies and other variables in the country would, by definition under a large country scenario, alter international prices and trade flows, implying the exercise of market power...For example, Chinese restriction of imports following the 1995 world grain price increases may be justified within an optimal tariff framework. Chinese limitations on imports may have helped to keep world prices lower than they would have otherwise been since 1996, reducing Chinese import costs. Hence, self-sufficiency may be defended not only on political economy grounds, but also for reasons of trade policy efficacy."
[Source: Zhuang Renan, 2005, China's agricultural trade: An optimal tariff framework perspective, Purdue University]


Gabby D said...

hi! the optimum tariff argument says, that a country that can influence prices on the world market ('large' countries as they are often called) will be better off imposing a positive tariff because it can improve its terms of trade. This is one of those static arguments that comes from departures from perfect competition. (i.e. in perfect competition, all countries are considered small)

Jego said...

From the parts of it I do understand, it seems quite clear that the Philippines isnt ready yet.

And this: The income-redistributive effects of the liberalization should not be judged undesirable by society at large, or if they are, there must be compensatory tax-transfer schemes with low enough excess burden.

Brrr-r-rr. Taxes. Gives me the creeps. We working stiffs always carry the heaviest tax burden.

cvj said...

Hi Gabby, thanks for the explanation!

Hi Jego, i don't think it necessarily follows that trade liberalization will benefit the rich. For example, with retail trade liberalization, maybe the sales ladies working in SM may get a better deal if WalMart enters the local market. To me, the key is whether trade liberalization leads to more business activity. Protection, on the other hand, often leads to more paperwork and opportunities for smuggling.

Jego said...

How about protection for our farm products, cvj? Would you favor it? I mean liberalize everything else but protect our farmers. That means helping the agri sector by strictly implementing the CARP, then following that up with encouraging them with loans and help in building cooperatives. Our farmers just can't compete with foreign agribusiness.

cvj said...

Jego, that's a good question which i have not completely worked out my position on. We need to consider things like: (1)how stopping agricultural imports would impact the level of hunger, (2) how our trading partners will retaliate, specially with our agricultural exports (including the ones by our locally based agribusiness), and whether we can live with the trade-offs, (3) it's effect on the increase in agricultural productivity. For the medium to long term, i think that too many of our people are in agriculture. We need to encourage them to get jobs in industry and services.

Nonetheless, i agree with you regarding CARP and cooperatives which i think are separate policy issues.

Jego said...

Too many workers in agriculture and not enough land to till. That's because a lot of the agricultural land have been turned over to industry and housing for the affluent.

Personally, I think we shouldve gone for food security first, self-sufficiency in food, before we tried to industrialize. But it might be too late now. We've been caught up in the globalization/industrialization whirlwind, hence those problems you enumerated. We're importing rice! That is a travesty, imo. Taiwan can feed itself, export food, and industrialize. They had their priorities straight. We might have to abandon primary production and industrialize just to keep up. Our farmers will be left out in the cold if they dont adjust to the new realities.

cvj said...

Hi Jego, i don't necessarily think it's wrong to convert agricultural land to industry or housing provided that the benefits don't disproportionately go to the landlords with little or nothing left for those who otherwise would have been beneficiaries of land reform. IMHO, urbanization and industrialization is a good thing. BTW, i guess some of that converted land is being used for this program to attract four million retirees from other countries. (via Japundit)

For the rest of your comment, i have posted my reactions in a separate blog entry.