A Memo on Liberalized Global Trade Order

Steven Donaldson

All analysis conclude that free trade is economically beneficial for the globalized world; however, there has been increasing resistance towards the liberalization of trade. Trade talks aimed at breaking down these trade barriers have fallen apart due to a sharp difference in opinion between rich and developing countries. To make matters worse, hegemonic powers that have to support the liberalized trade orders, like the World Trade Organization (WTO), have sought protectionist policies as of late. This memo will address the need for a liberalized world trade order by first explaining the origins of globalization. More specifically, what the first and second unbundling is in relation to the current state of globalized trade. Next, the memo will explain how comparative advantage and economic analysis has made free trade beneficial to the globalized world. It will then transition to explore why resistance, in the form of trade barriers, is met despite the benefits of free trade. Lastly, this memo will explain the need for improving hegemonic powers through the use of pareto improvement; by bolstering a hegemonic power, an enforcer of trade rules and regulations is created, which is necessary to achieve a liberalized global trade order.

THE ORIGINS AND BENEFITS

To fully comprehend the historical origins of globalization, the reader must understand the two stages or unbundlings of globalization. The steam revolution is what caused the first unbundling of globalization; similar to the Agricultural Revolution before it, the steam revolution triggered a “phase transition” that eventually launched modern globalization (or more precisely, what we have been calling Old Globalization, or the first unbundling)” (Baldwin, p.77).As the 19th century progressed, steam displaced wind and animal power before being displaced by internal combustion and electric engines. Despite this, the development of steam power is what started the domino effect of progression (Baldwin, p. 77). It is important to note that the falling cost increased global trade; however, the benefits were primarily concentrated in a few countries. In fact, “by the late twentieth century, two-thirds of economic activity was clustered in just seven nations—the G7” (Baldwin, p. 78). The steam revolution lowered the costs of transportation which subsequently interconnected the world through global trade. Using Ricardian logic, the clustering or agglomeration of industry in a nation facilitates new inventions. These innovations then have the ability to strengthen a nation’s competitiveness within a sector. The next step, according to the principle of comparative advantage, is that the heightened comparative advantage leads to more exports and more production. “The crank comes around full circle when this extra production generates additional industrial clustering” (Baldwin, p. 128).

The second unbundling is known as the revolution in information and communication technology (ICT). The ICT revolution “lowered the cost of coordinating complex processes across great distances” (Baldwin, p. 102). The newness of the New Globalization stems from two aspects of the second unbundling which are “fragmentation and offshoring in manufacturing and service sectors, and the technology flows that follow the jobs sent offshore” (Baldwin, p. 142). This ironically had the opposite effect on the countries from the first unbundling. Once it was possible to separate manufacturing processes internationally, firms pursued the option to have their plants to more economical locations. They started moving labor-intensive stages of production from high-wage nations to low-wage nations. The Old Globalization produced an industrialization of the North and a deindustrialization of the South. The

New Globalization has turned this situation on its head. “The North—the group of countries called “industrialized nations” twenty years ago—has seen a rapid fall in the number of jobs and value-added shares in the manufacturing sector” (Baldwin, p. 108). Manufacturing output has increased in six developing nations, which are China, Korea, India, Indonesia, Thailand, and Poland. The key difference between the unbundling is transportation cost in the first unbundling and communication in the second unbundling.

Baldwin argues that the ICT revolution lowered the cost of moving ideas inside the boundaries of international production chains. Due to this, G7 firms started “to arbitrage the gigantic imbalance in the planetary distribution of know-how by moving Northern knowledge to the South” (Baldwin, p. 215). Subsequently there was rapid industrialization of the nations involved in these global value chains and a rapid deindustrialization of the G7 firms’home nations. Furthermore, since industrialization can happen stage by stage in global value chains as opposed to sector by sector in Old Globalization, industrialization policy is now easier and less risky. A prime example of the changing development policy is what happened in Thailand. “Like most ambitious developing nations in the 1960s, Thailand’s auto industry relied on imported kits that were assembled for local sales” (Baldwin, p. 250). The country moved beyond this business model by pursuing a subtle industrial policy. Specifically, “Thailand raised local content requirements. In reaction, U.S. and European makers exited, but Japanese companies decided that Thailand would be a good export platform for SoutheastAsia and beyond” (Baldwin, p. 250).

Globalization and free trade among nations have provided numerous benefits to this interdependent world. The concept of comparative advantage explicitly proves the advantages of free trade. Comparative advantage, in an international sense, is “the ability of a country or firm to produce a particular good or service more efficiently than the other goods or services that it can produce, such that its resources are most efficiently employed in this activity” (FLS, p. 348). The comparison is to the efficiency of other economic activities that the actor might undertake; given all the products, it can produce not to the efficiency of other countries or firms just as personal specialization implies that each individual should do what he does best, and not what he does better than all others. For example, Albert Einstein is very good at astrophysics as well as typing. Despite being a good typist, he decided to hire an assistant to do his typing for him. Even though he is better at typing than his assistant, the opportunity cost of spending his time is much higher for him because of his qualified skills in physics. Relating this back to an international realm, the specialization involved in comparative advantage implies that countries should produce what they produce most cost-effectively.

WHYTHERE IS RESISTANCE

While international trade is beneficial to the globalized world as a whole, this is not necessarily true on an individual country basis. International trade is only beneficial in terms of aggregation. Inherently, there will be winners and losers on each side. The loser’s losses lead to trade barriers among industries and sectors. These barriers usually reflect domestic concerns, despite the fact that they implicate foreign relations. William McKinley, a leading protectionist member of the U.S. Congress before he became president, “once said of a tariff he was shepherding through the House of Representatives: ‘This is a domestic bill; it is not a foreign bill’” (FLS, p. 306). This is the general sentiment for many citizens in their home countries. Trade policy typically reaches the public consciousness, and the media, when some national producers complain that there is too much or too little trade in the goods they produce. Often, producers are concerned because imported goods cut into their profits or cost them their jobs. Other producers may complain that foreign barriers to their goods keep them out of markets abroad and similarly cut into

profits and cost jobs at home. The theorem that protection benefits the scarce factor of production is known as the Stolper-Samuelson theorem. This view flows from the Heckscher-Ohlin theory, which explains that “if a country imports goods that make intensive use of its scarce factor, then limiting imports will help that factor” (FLS, p. 310). To simplify, in a labor-scarce country, labor benefits from protection and loses from trade liberalization. On the other hand, there is the Ricardo-Viner theory which explains trade relations that emphasizes the sector in which factors of production are employed rather than the nature of the factor itself. This “differentiates it from the Heckscher-Ohlin theory, for which the nature of the factor labor, land, capital is the principal consideration” (FLS, p. 311).

Furthermore, countries with a relatively low level of economic output generally want to develop; however, it is sometimes hard to achieve this goal. Development can hinder the interests of those domestically or abroad. There are three general elements for reaching economic development. An international relations analyst must “consider geography, domestic factors such as a nation’s political economy, and domestic institutions” (FLS, p. 427).An example of how geography hinders economic development is landlocked countries. Landlocked countries, regions with diseases that are difficult to control or cure, and areas that are very far from major markets for their goods are all at a developmental disadvantage. These disadvantages were more than likely exacerbated before the first unbundling when communication and transportation costs were much higher. In regard to the domestic factors, governments can willingly control the pace of how fast a country grows. This power, of course, is not absolute and only works within certain bounds. Governments can provide things like infrastructure that help facilitate the transaction of goods across the country. Examples include roads, railroads, airports, utilities, and ports. Additionally, a crucial function of the “government is to ensure the security of property.After all, economic growth requires everyone from farmers to factory owners to invest in improving their ability to produce, and such improvements are unlikely to be made if property rights are not safe” (FLS, p. 429). These policies can sometimes work and fail, depending on lobbying efforts.As domestic industrial interests grew in size and strength, they were able to push for a complex of policies known as import substitution industrialization (ISI). These policies had the goal of replacing imports with domestically produced goods. It was in this context that “Raúl Prebisch and his followers argued that such enforced self-sufficiency was actually desirable and should be deepened” (FLS, p. 489). These policies were pursued by most developing countries from the 1930s through the 1980s to reduce imports and encourage domestic manufacturing, often through trade barriers, subsidies to manufacturing, and state ownership of basic industries. Sugar subsidies are an example. In contrast to ISI, there is export-oriented industrialization (EOI). This is “a set of policies, originally pursued in the late 1960s by several East Asian countries, to spur manufacturing for export, often through subsidies and incentives for export production” (FLS, p. 489). Some actors have a large collective interest in one policy resolution. In these cases, the individual citizen would lose more fighting the policy than going with the status quo. In terms of domestic institutions, the interests that characterize a society, the interactions among them, and the institutions that develop within the society are all interrelated. Rich countries are rich because they exploit LDCs (Least Developed Countries). For example, “a multinational mining company and an LDC government have a common interest in getting minerals out of the ground and to market, but they are likely to disagree about the division of the profits. Similarly, LDC companies and governments may appreciate being able to borrow from international development banks, but there is likely to be political controversy about making the sacrifices necessary to pay back their debts—especially in hard times” (FLS, p. 439). Rich countries can profit from low wages in the LDCs, which means that they may have little interest in encouraging development that will raise wages. Ultimately, this makes rich companies richer while poor countries remain stagnant. Raúl Prebisch, an

Argentine economist and head of the UN Economic Commission for Latin America, argued that “in principle, trade was good for both rich and poor countries. However, he noted that LDCs produced mostly raw materials and agricultural products, while rich countries produced mostly manufactured goods” (FLS, p. 442). Essentially, trade worked against the interests of the LDCs and in favor of the interests of the developed countries.

Ultimately trade and development complications arise due to a plethora of conflicting ethnic and national interests. However, the hegemonic stability theory may be a possible solution. This theory argues that the existence of a single very powerful nation facilitates the solution of problems of collective action and free riding; the hegemonic power is large and strong enough to be both willing and able to solve these problems for the world as a whole. In economic affairs, this approach argues that when there has been such a hegemonic power over the past two centuries (Great Britain after 1860 and the United States after 1945), trade liberalization was facilitated by the leadership of an overwhelmingly influential world economic power.

Hegemonic powers have used trade organizations to promote free trade in the past. For example, the GeneralAgreement on Tariffs and Trade (GATT) is an international institution created in 1947 in which member countries committed to reduce barriers to trade and to provide similar trading conditions to all other members. The “GATT’s design was heavily influenced by lessons drawn from historical trade liberalization efforts” (Baldwin, p. 3, as cited in Irwin, Mavroidis, and Sykes, 2009). In 1995, the GATT was replaced by the World Trade Organization (WTO). The WTO is an institution created in 1995 to succeed in the GATT and to govern international trade relations. This organization “encourages and polices the multilateral reduction of barriers to trade, and it oversees the resolution of trade disputes” (FLS, p. 325). The GATT was “created in 1947 as one of the original Bretton Woods institutions, and it oversaw a dramatic liberalization of trade relations, in particular among developed countries, for more than 40 years” (FLS, p. 325). The demand for trade liberalization was great “because tariffs were still high from the Smoot–Hawley tariff and retaliation in the 1930s. The supply of trade liberalization was, in general terms, also great as leaders of the largest trading nations wanted to avoid the protectionist mistakes of the 1920s and 1930s” (Baldwin, p. 3). Both the GATT and the WTO have been enormously successful in their stated purpose of reducing barriers to trade among member nations, with world trade growing faster than world output for virtually all the postwar period. The principal achievement of both organizations has been to arrange a series of “rounds” during which member states negotiate multilateral reductions in trade barriers. The negotiations take place under a loose rule of reciprocity that balances the dollar value of concessions, which are then automatically extended to all other member states under the most-favored-nation (MFN) rule. There are also rules about when and how countries can use safeguards to protect domestic industries temporarily.

WHAT SHOULD BE DONE

EdwardAlden and Laura Taylor-Kale in The WorkAhead: Machines, Skills, and U.S. Leadership in the Twenty-First Century argue that “the most important challenge facing the United States—given the seismic forces of innovation, automation, and globalization that are changing the nature of work—is to create better pathways for allAmericans to adapt and thrive” (Alden & Taylor-Kale, p. 6). If this is not achieved, the United States will fall to political pressure for a retrenchment strategy. This could include things like “trade protection, immigration restrictions, and possibly even restraints on technology and automation” (Alden & Taylor-Kale, p. 7). Unfortunately, with the current administration, we already see some retrenchment policies underway. While the Trump administration points to countries like China for the loss of unskilled jobs in the United States, automation

and technological advancement seems to be the largest disrupter in blue-collar jobs. Alden and Taylor-Kale point out that “advances in computing and robotics have made it increasingly possible for companies to replace human labor with machines” (Alden & Taylor-Kale, p. 6). While these unskilled jobs will be lost, new jobs will be created to help service, program, and maintain these machines. Transitioning a labor force to do such tasks is easier said than done.Acquiring the education and skills needed to prosper in a more automated work environment is a big obstacle, given the current structure of education in the United States. The lack of accessible educational opportunities that are clearly and transparently linked to the changing demands of the job market is the reason behind this challenge (Alden & Taylor-Kale, p. 14). If the labor force is not replenished, then automation and artificial intelligence (AI) is likely to exacerbate inequality and leave moreAmericans behind. It is evident that for manyAmericans, the link between work, opportunity, and economic security is in jeopardy. The United States should rebuild these links for all Americans through three actionable steps. First, “the United States should set and meet a goal of bringing postsecondary education within reach of all Americans and linking education more closely to employment outcomes” (Alden & Taylor-Kale, p. 76).

Programs like apprenticeships, work-study programs, and internships need to be a priority for educational institutions. These programs bridge the gap between what is learned in classrooms and the actual skills that are required on the job.Additionally, these programs inevitably lead to the curriculum to become tailored towards applied learning. In addition to the prioritization of these programs, there needs to be “a society-wide effort to increase public respect for and acceptance of work-based training programs” (Alden & Taylor-Kale, p. 76). Many parents believe that a four-year college education is the only path to a sustainable career when, in reality, this is false. Many so-called “middle-skilled” jobs ironically pay better than “high-skilled” jobs that are only attained by acquiring a bachelor’s degree. Baldwin, in addition toAlden and Taylor-Kale, argues that “promoting investment in human capital with policies linked to education, training, and retraining” is the first step to rebuilding these links (Baldwin, p. 227).

Beyond the prioritization of postsecondary school, governments should adopt an explicit goal of creating better jobs and career paths for Americans. Initiatives should aim at attracting investment and revitalizing entrepreneurship (Alden & Taylor-Kale, p. 57). The United States is currently competing with many other nations to host multinational corporations (MNCs). In order to remain competitive, the U.S. government needs to make policies conducive to their business practices. Companies will follow the best investment climates and create jobs within those countries. On the federal level, the government should reassure MNCs of their commitment to maintaining open trade and investment policies (Alden & Taylor-Kale, p. 62). Additionally, a low corporate tax rate is needed to keep companies in the United States and attract others to creating headquarters inAmerica. Lastly, the federal government needs to revamp the national infrastructure. High-speed transportation and broadband coverage are some specific areas where the government should focus on. Baldwin emphasizes the need for reliable connections between factories, which “often involves time-sensitive shipping, world-class telecoms, and short-term movement of managers and technicians” (Baldwin, p. 239).Assurances on infrastructure services and visas will attract foreign direct investment. On the local government level, “states and cities continue to offer tax and other incentives to encourage companies to site their job-creating activities in those locations” (Alden & Taylor-Kale, p. 60). To ensure the best outcomes for their local community, these municipalities should subsidize training programs instead of offering direct tax cuts. Retraining programs will enable the locals to gain valuable skills that will pay dividends for a lifetime.

Lastly, “governments and employers should work to reduce barriers to labor mobility for Americans, including high housing costs, occupational licensing restrictions, and inflexible hiring practices” (Alden & TaylorKale, p. 92). These actions are quintessential in order to rebuild the link between work, opportunity, and economic security. The mobility of the labor force is directly correlated to how well balanced the country is in terms of skilled workers. In many areas of America, there is a shortage of skills, while in others, there is a shortage of work. By improving mobility, the economy is better able to find an equilibrium between these two ends of the spectrum. In order to do so, states should reduce licensing requirements for certain occupations, or, at the very least, “improve the portability and reciprocity of occupational licensing across state borders” (Alden & Taylor-Kale, p. 93). Additionally, fast-growing cities should pay close attention to the labor market barriers posed by high housing costs. Options for addressing this issue include affordable housing subsidies, lessening of zoning restrictions that discourage high-density development, and improvements in public transit to speed up longer commutes (Alden & Taylor-Kale, p. 93). Mobility can also be improved by the implementation of unemployment insurance. This type of insurance policy will be a stop-gap program that enables citizens to sustain their livelihood while developing new skills for their future employers.

This memo has addressed the needs for a liberalized world trade order by first explaining the origins of globalization and how free trade is beneficial to the globalized world. It then explored why resistance is met despite the benefits of free trade, and lastly has explained what must be done to achieve a liberalized global trade order.All analysis have concluded that free trade is economically beneficial for the globalized world. Despite this being the case, many nations have adopted protectionist policies. In order to rebuild the confidence in trade talks and restore the powers of free trade organizations, the above suggestions must be heard and considered.