How politics distorts trade

By Shahid Javed Burki

Economists used to talking in terms of "on the one hand this, on the other hand that," have almost total agreement on one thing that trade is good for economic development and growth.

The theory behind this broad consensus is a simple one and is based on a system of production according to which people and the nations to which they belong produce goods and services for which they have comparative advantage.

Those who have some advantage to manufacturing a good or providing a service should produce beyond their own needs and export the rest. A country may have advantage over others because it has a certain kind of soil and weather pattern to grow, for instance, cotton.

This is why north Sindh and south and central Punjab do well in producing this crop. The amount of land, labour and water committed to the production of cotton results in output that is much larger than needed by the country's textile industry.

Which is the reason why in most years Pakistan is the second largest exporter of cotton in the world, after the United States. To produce beyond domestic needs helps Pakistan since it earns foreign exchange from exporting its surplus.

It also helps those countries that have large textile and garment industries but don't have the soil and the weather conditions to grow cotton. Some of the cotton Pakistan exports finds its way to Bangladesh after stopping en route in places like Hong Kong and South Korea.

These countries buy raw cotton from Pakistan, spin and weave it into fibre and fabrics and then export those to Bangladesh to turn them into garments. The reverse of this relationship also holds. Take tea as an example.

Pakistan is a tea drinking nation and the people drink so much of this beverage that the country is by far the largest tea importing country in Asia. Tea production needs a certain kind of soil, some elevation, a lot of rain and a lot of sunshine.

These conditions exist in India's Assam state, in Hangzhou province in China, in the highlands around Kandy in Sri Lanka, and in the uplands of Kenya. That is the reason why all these places do well in growing tea and why they are amongst the largest exporters of this commodity.

There was once a mistaken attempt made to grow tea in the hills around Abbotabad under the theory that self-sufficiency was better than dependence in almost all cases.

Trade based on the strict application of the concept of comparative advantage increases global welfare. It adds to global productivity since goods are manufactured, commodities are produced and services are provided by those who have the resources and the skills to do all of those things.

If trade was free - if, that is to say, goods, commodities and services moved from place to place without restriction - the world today would be a much richer place. But economic theory does not always translate easily and without resistance into practice.

It makes little sense for the states of North and South Carolina to continue to produce textiles. But these two states have large political clout which can be converted into public policy.

Even though the United States provided generous assistance to Pakistan after 9/11 it did not give it better access in textiles. The case against doing that had little economic logic but made some political sense.

The legislators representing these states were not prepared to have their constituents suffer job losses in order to help the low paid workers in Pakistan's textile towns. This was one example of politics distorting economics.

There are many areas in which politics does that to economics; three of the most egregious ones are arrangements that govern trade in garments and textiles, subsidies provided by the governments in America, Europe and Japan to their farmers and restrictions against the movements of workers, in particular from the developing to the developed world.

The Multi-Fibre Agreement, or MFA, that regulates global trade in textiles is set to expire on January 1, 2005. The MFA is a good example of the severe distortions that restrictions in global flow of goods can make to the world production systems.

The MFA allowed textile importing countries in the developed world to lay down quotas beyond which textile exporting countries could not export their products. The allocation of quotas was based on history; developing countries who were in the business were allowed to export their products at a pre-determined rate of growth.

When Bangladesh gained independence from Pakistan, it was allowed access to Pakistan's quota. It made little economic sense to partition the quota since Bangladesh did not have a textile industry of any significance to make use of this largesse.

The real reason for taking that step was to punish Pakistan for the way it had handled East Pakistan's demand for autonomy and independence. However, once Bangladesh was awarded a quota, countries such as Korea, Hong Kong and Singapore, that were now high wage economies, stepped in.

It made a great deal of sense for them to establish a new production capacity in Bangladesh which had great amounts of unutilized quotas. The East Asians, the South Koreans in particular, provided Bengali entrepreneurs with management and production training so that they could meet the standards demanded by importers in Europe and America.

The Bangladesh garment industry flourished and provided handsome dividends to the domestic economy. Tens of thousands of new jobs were created, a large number of them for young women.

With women now gainfully employed, and with the opportunity cost of their time increasing, in terms of real money, to a significant amount of earnings, it is not surprising that the country's fertility rate began to decline rapidly.

It was from a family's perspective a better choice to have women doing factory labour than spending bearing children and looking after them at home. The arrival of the garment industry, although the outcome of a deliberately introduced distortion in the global trading system produced by the MFA, had a number of beneficial consequences for Bangladesh.

There are, of course, risks associated with basing developments on distortion. If the MFA is phased out starting on January 2005, it would have a grim impact on Bangladesh.

With quotas gone, the country will no longer be able to compete with countries such as China, Egypt, India and Pakistan that are naturally competitive in this industry. Other cotton growing countries such as the former constituent republics of the Soviet Union in Central Asia - Uzbekistan in particular - will also, no doubt, enter this crowded field.

What should a country such as Bangladesh do in such circumstances? There are basically two options. It could plead for some special treatment even after the MFA regime expires.

The World Trade Organization, under whose auspices such a dispensation would have to be awarded, has a general provision that goes under the title of special and differential treatment (SDT).

Applied to the developing countries, these provisions are to be used to provide some relief to the pain that necessarily comes with any far-reaching programme of adjustment.

The elimination of the MFA is a major change in the trading regime of many parts of the developing and developed world. It is not inconceivable that once negotiations begin within the postponed Doha round, countries such as Bangladesh will seek protection against a rapid and painful process of adjustment through which they will have to proceed if the MFA is eliminated as promised.

The other approach, and from Bangladesh's perspective in the long-run a much better one, would be to obtain better access from its trading partners, in particular from those in the developed world, for the exports of the goods, commodities and services in which the country does have comparative advantage. The most obvious of these is services, the production of which requires abundant and skilled labour.

Like other South Asian countries, Bangladesh has a large and young population. It is, therefore, well positioned to do the type of "outsourcing" work for which India now has gained considerable reputation.

It is in this sector and in that of agriculture where the next great trade war will be fought. It will come in the form of a series of battles where developing countries such as Bangladesh, India and Pakistan will have to gain new ground inch-by-inch.

Are developing countries ready for this series of encounters? My reading is that so far they have not fully understood what issues are involved, where developed countries may yield some ground, and where they will fight long and bloody pitched battles.

Let us start with agriculture. The issue that received the most attention in this area is that of farm subsidies which have created serious distortions in agriculture across the globe.

This issue has two components. One concerns the trade in agriculture among developed countries, not just between America and Europe but also within Europe, among the expanded European Union's rich and not-so-rich states.

This is where the heavy guns have gone into action, firing across the Atlantic and across the plains of central Europe. Looking at where this particular battle stands, I would guess that the European and American trade ministers will reach an accommodation but outside the Doha round.

This they will do by making changes in their farm subsidy programmes. Rather than reward farmers for producing more they will give them subsidies to keep land out of production.

That way the famous butter and grain mountains of Europe will gradually diminish in size as will the ocean of milk that lies undrunk in America's mid-western states.

Grain, milk and butter are not the products in which the American and European farmers have comparative advantage. They can produce their vast output for the simple reason that they can throw a lot of capital into the production processes.

Heavy mechanization, almost indiscriminate use of chemicals as fertilizers and pesticides, use of expensive science to produce new varieties of grain and animals, and expensive processes to convert all this output into products that eventually reach the shelves of grocery stores require a great deal of money.

A fair amount of this money comes in the form of subsidies provided by the American, European and Japanese states. With the subsidy programmes changed to build a consensus of sorts across the Atlantic, the farmers in America and Europe will be moving into another part of agriculture where the farmers in South Asia, parts of China, and parts of Latin America have real comparative advantage.

The reference here, of course, is to such high value added agricultural products as fruits, flowers and vegetables and processed items based on them. It is the trade in these that could grow at rates considerably greater than the increase in the combined domestic product of the entire developing product.

The developing countries' combined GDP could increase by 4.5 per cent a year between 2005 and 2025 without a major structural change in trade in agriculture, particularly in that part of agriculture in which high value added crops begin to play a significant role.

If a level playing field is created in this aspect of trade, it could grow at a rate three times the rate of increase in GDP, or 13.5 per cent a year. This could lift the overall increase in GDP growth by a percentage and a half to 6.0 per cent a year.

Since this output will come from agriculture, where most of the world's poor are employed or are looking for work, concentrating increasing world trade in high value added agriculture would have enormous consequences for reducing the incidence of poverty.

It will take a great deal of serious analytical work on the part of the developing world to stake out a claim for itself in this area. Watching what is going on in and around the WTO, it doesn't seem that developing countries have really prepared themselves for these forthcoming series of battles.

[taken from http://www.dawn.com/2004/07/27/op.htm]

Date/Time Page Created: 12/01/2004

Date/Time Last Modified: 12/1/2004 8:30:15 AM

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