CHAPTER 11

Trade Policies and International Political Perspectives

Introduction

This chapter examines two international topics with political macroeconomic ramifications. The first subject is the political economy of free trade versus trade protectionism. This subject partially overlaps with the second topic. The second topic is a comparison of the three ideological perspectives of economic liberalism, neomercantilism, and economic structuralism. These three international perspectives provide insights on the political and economic implications of international trade policy and globalism.

Relation between Net Exports, GDP, Unemployment, and the Exchange Rate

A commonly used measure of international trade is net exports or the trade balance. Net exports is equal to exports minus imports (NX = X – M). Exports are domestically produced goods that are transported and sold to buyers in foreign nations. Imports are foreign-produced goods that are transported and sold to buyers in the receiving country. A trade surplus occurs if exports exceed imports. A trade deficit occurs if imports are greater than exports.

One of the four main components of GDP is net exports. GDP and net exports are mathematically related based on the GDP accounting identity. GDP = C + I + G + NX, where C is consumption, I is gross investment, and G is government spending. From an accounting point of view, a trade surplus causes GDP to increase by the amount of the surplus. A trade deficit causes GDP to decline by the amount of the deficit. Suppose GDP is initially equal to $20 trillion with a trade balance of zero (X = M or NX = 0). Now, assume a trade deficit of $0.5 trillion ($500 billion) occurs. GDP declines from $20 trillion to $19.5 trillion. Suppose a trade surplus of $0.5 trillion occurs. GDP rises from $20 trillion to $20.5 trillion.

Historically, the United States ran trade surpluses during most years after WWII until the early 1970s. This occurred partly because the United States emerged as the dominant economic power following the World War II. The economic infrastructure of the United States including export industries was unharmed from the devastation of WWII that occurred overseas. Most of the military conflicts of WWII took place in Europe, Asia, and North Africa.

After WWII, many of the countries in Europe, Asia, and elsewhere required several years to rebuild their war-torn economies. By the 1970s, however, they had largely reestablished their economies. The United States consequently began experiencing trade deficits as the economies of Europe and Japan became more trade competitive. Since the 1970s, the U.S. trade deficit has gradually worsened as the global economy has become even more economically competitive.

Figure 11.1 shows the pattern of U.S. net exports as a percentage of GDP in the post-WWII era. The solid line in the graph is net exports as a percentage of GDP. The dashed line is the unemployment rate. The shaded areas denote time periods of economic recession.

images

Figure 11.1 Relation between net exports and unemployment

The accounting relation between net exports and GDP may be somewhat misleading in understanding the interconnection between the trade deficit and GDP. A smaller trade deficit causes higher GDP based on the accounting measurement. This effect is important but often not the dominant influence. The impact of GDP on the trade deficit is frequently greater than the impact of the trade deficit on GDP.

Higher GDP is often associated with a larger trade deficit, not a smaller trade deficit as the accounting suggests. National income is closely linked to GDP. National income equals GDP minus depreciation of capital in the economy. Higher national income generally occurs alongside higher GDP. Higher national income enables households and businesses to increase their purchases. This is the consumption function effect.

Higher income enables greater spending. A portion of higher spending is on more imports. This reduces or worsens net exports. Consequently, the trade deficit often becomes worse during periods of high economic growth and declining unemployment. On the other hand, the trade deficit frequently improves or becomes smaller during periods of declining GDP, recession, and rising unemployment.

Lower GDP and rising unemployment are associated with lower national income. Lower income leads to lower business and consumer spending. This includes less spending on imports. As imports decrease, the trade deficit improves or becomes smaller.

Figure 11.1 shows these results. The trade deficit as a percentage of GDP improved during many (but not all) of the economic recessions. The trade deficit, for example, was large at about 5.5 percent of GDP in 2005 when the U.S. economy was strong prior to the Great Recession of 2007–2009. At the same time, unemployment was low at about 5 percent in 2005 prior to the Great Recession.

Unemployment worsened during the Great Recession to around 10 percent. The trade deficit consequently became smaller at around 2.5 percent of GDP during this period. The trade deficit improved during the Great Recession because income fell alongside higher unemployment. Fewer jobs led to less income and less spending, including less spending on imports. As imports fell, the trade deficit became smaller. The smaller trade deficit occurred alongside lower GDP and worsening unemployment during the Great Recession.

Besides national income and GDP, another major factor that affects the trade deficit is the exchange rate. The exchange rate affects the prices of traded goods and the amounts of traded goods.

An increase in the exchange rate is the same thing as a currency appreciation or a stronger currency. An appreciation of the currency means the domestic currency can buy more units of a foreign currency. A stronger currency causes import prices to fall and export prices to rise. Based on the law of demand, imports increase as import prices go down. Additionally, exports decline as export prices go up. The trade deficit worsens when the currency appreciates.

A decrease in the exchange rate denotes a currency devaluation or a weaker currency. A decrease in the value of the currency means the domestic currency can buy less units of a foreign currency. A weaker currency causes import prices to become more expensive while export prices become cheaper. Based on the law of demand, imports fall as import prices go up. Additionally, exports rise as export prices fall. The trade deficit tends to become smaller because of a stronger currency.

In summary, two main determinants that affect the trade deficit are national income or GDP and exchange rates. A stronger dollar and higher economic growth tend to make the trade deficit worse. A weaker dollar and lower economic growth, especially a recession, tend to make the trade deficit smaller.

Comparative Advantage, Free Trade, and Economic Liberalism

According to the theory of comparative advantage, the most efficient approach to international trade is through competitive market forces. Comparative advantage asserts that international trade should be relatively unimpeded by government intervention such as import tariffs and quotas. An import tariff is a tax on imports, while an import quota is a quantity restriction on imports. The theory of comparative advantage recommends free trade policy. Free trade occurs through competitive market forces unhindered by government intervention. With free trade, businesses and households are free to buy and sell exports and imports through supply and demand forces.

The theory of comparative advantage maintains that countries should specialize in producing and exporting economic goods that they can supply relatively cheaper than other nations. Countries should import products that other nations can provide relatively cheaper. According to comparative advantage, free trade through competitive market forces generally creates win-win economic outcomes among nations. Free trade enables countries to increase consumption of products beyond what would occur without trade. Free trade enables more exports and more imports to occur across nations, which generates greater spending and higher world economic growth.

The economic theory of comparative advantage should not be confused with the similar-sounding strategic business management concept of competitive advantage. The idea of competitive advantage was developed by Michael Porter in his book entitled Competitive Advantage of Nations (1985). The concept of competitive advantage refers to the strategies and abilities of businesses and industries to compete with domestic and international business rivals. Competitive advantage strategies emphasize providing customers with increased product value through approaches such as low production costs and low prices, product differentiation, and target markets.

The trade theory of comparative advantage, on the other hand, is associated with the ideological perspective of economic liberalism. The root word of liberalism is liberty. The perspective of economic liberalism considers the concepts of economic liberty and economic freedom as basically synonymous with the idea of competitive market forces. Economic liberalism emphasizes the positive outcomes of economic freedom or competitive market forces such as innovation, productivity, business competition, and efficiency.

Economic liberalism emphasizes that through free trade consumers benefit from lower product prices, increased consumption of goods, as well as increased variety and quality of products. These beneficial results are called the consumption gains from free trade. Even with a trade deficit, the economic benefits to consumers generally outweigh the potential negative effects on jobs and businesses in import-competing industries, according to economic liberalism.

Trade Protectionism and Neomercantilism

Protectionism is government intervention in international market forces to boost trade outcomes based on national economic interests. This contrasts with comparative advantage and free trade that emphasizes private economic interests among buyers and sellers through unimpeded supply and demand forces. Protectionist policies seek to reduce imports or increase exports, thereby raising net exports. An increase in net exports is associated with either a larger trade surplus or a smaller trade deficit. In either case, higher net exports cause higher GDP.

Trade protectionism seeks to boost the national economy through higher net exports, which causes higher GDP and by extension lower unemployment. The political left is more likely to embrace trade protectionism than the political right. This is because the political left is more inclined toward government intervention in the economy to remedy perceptions of market failure.

Trade barriers such as import tariffs and quotas are used to reduce imports and protect import-competing industries. Free trade can harm business performance and employment in import-competing industries. For example, manufacturing industries in the United States and other developed countries face international trade competition from lesser-developed countries such as China, India, and Mexico. These countries have a comparative advantage in basic manufacturing because of lower wages, lower production costs, and lower product prices. Trade protectionism reduces the inflow of imports that are less expensive than domestically produced goods. From a comparative advantage and economic liberalism perspective, an adverse effect of trade protectionism such as import quotas and tariffs is economic harm to consumers. Tariffs and quotas typically cause higher import prices for consumers.

Political Pressures on Trade Policy

Public sentiment, special interests, the media, opinion leaders, and political parties exert pressure on elected officials to influence international trade policies. Political pressure for trade protectionism occurs in response to economic harm to import-competing industries. This includes lost jobs and weak business performance in import-competing industries. In contrast, political pressure in support of free trade occurs in response to economic gains such as jobs and business performance in export industries, as well as the economic benefits of imports to consumers.

Trade sanctions are another type of government intervention in international trade based on political criteria rather than economic considerations. Trade sanctions are used as an economic penalty against a country for political actions considered harmful or hostile. Trade sanctions reduce or eliminate trade with a foreign country through trade barriers such as tariffs and quotas. In a complete trade embargo, all exports and imports with a foreign country are blocked. Trade sanctions apply economic pressure on a foreign nation to induce the foreign government to alter its policies.

Trade sanctions have been used against countries for acts relating to international terrorism, human rights violations including crimes against humanity and genocide, wars, and illegally developing weapons of mass destruction (WMD). Trade sanctions are less destructive than military action against a foreign nation. Sanctions, however, often have a limited impact on causing a foreign state to modify or change its policies and actions.

Trade sanctions can harm consumers in the affected country. Sanctions may limit important consumer imports such as food and medicine. Sanctions also hurt business activity and employment in industries in the foreign country that rely on trade. The elites in a country may be able to maintain a wealthy lifestyle while low-income households and small businesses are economically hurt by trade sanctions.

For example, a dictator in a rogue state may refuse to alter policies, such as development of WMD. Consequently, trade sanctions may be imposed. This could end up harming those who are poor in the country rather than the dictator. The trade sanctions could backfire. Imports of food and medicine could be cut because of the sanctions. The economic hardship caused by trade sanctions could create public animosity against the government issuing the sanctions.

Trade sanctions are often effective in economically penalizing a country. The affected country, however, may be able to partially negate the negative impact of sanctions by increasing trade with other nations. Consequently, multiple countries may need to simultaneously adopt trade sanctions for the policy to work.

Sanctions often harm those who are economically vulnerable while frequently being ineffective in causing a regime to modify its actions. To increase effectiveness, a punitive trade sanction could be combined with a positive offer. For example, foreign aid could be offered in exchange for compliance with the terms of the country issuing the trade sanction. A carrot-and-stick approach may have greater success than trade sanctions alone.

Mercantilism and Neomercantilism

Mercantilism was a nationalistic trade approach adopted by some European countries such as England and France from the 16th to the 19th centuries during the gold standard era. Mercantilist policies were adopted to increase exports, reduce imports, and, if possible, attain trade surpluses. A primary goal of mercantilism was gold and silver accumulation through exportation of goods. Countries were typically required to pay gold and silver to their trade partners to cover a trade deficit.

In the mercantilist system, international trade affected the national accumulation of precious metals, the money supply, and product prices through the price–specie flow mechanism. A country with a trade surplus increased its accumulation of gold and silver. The trade-surplus country was paid gold and silver in exchange for its exports to its trade partners. This caused the nation’s money supply to rise because of the gold standard. The amount of money in circulation was tied to the amount of gold held by the government. Higher money supply typically caused higher inflation. Exports consequently became more expensive because of inflation. This ultimately led to less exports and a declining trade surplus.

In contrast, a country with a trade deficit experienced declining stockpiles of gold and silver. The trade-deficit country paid gold and silver in exchange for imports received from its trade partners. This caused the country’s money supply to decline and price deflation. Exports therefore became cheaper. This led to more exports and a shrinking trade deficit.

Trade mercantilism during the gold standard era evolved into modern neomercantilism of the 20th and 21st centuries in the post-gold standard era. Neomercantilism means new mercantilism. Trade barriers were used to increase net exports to acquire gold and silver in the mercantilist period. In modern neomercantilism, protectionist trade barriers are used to increase net exports, GDP, national income, employment, and international reserves (foreign currencies) in the banking system. Some examples of neomercantilist or protectionist policies besides import quotas and tariffs include production subsidies, export subsidies, trade dumping, and exchange rate devaluation.

Neomercantilist trade policies seek to boost the economy through increasing exports or reducing imports. An export-led growth strategy consists of neomercantilist policies designed to raise exports such as export subsidies and trade dumping. Export subsidies consist of government financial assistance to businesses to promote exports. Some examples of export subsidies are monetary grants, special tax concessions, or low-interest loans.

An import-substitution strategy is trade protectionism designed to reduce imports. A production subsidy is an example of an import-substitution policy. A production subsidy is government financial assistance to businesses to increase their production at lower after-subsidy costs and prices. This enables business firms to be more price-competitive against imports. Production subsidies are typically in the form of financial grants, tax breaks, and low-interest loans.

Exchange rate manipulation is another kind of protectionist or neomercantilist policy to influence international trade. An exchange rate devaluation affects the prices of traded goods so that exports increase while imports decrease, thereby causing net exports to rise. Imports become more expensive and exports become cheaper through a currency devaluation. Based on the law of demand, imports decline as import prices rise, while exports increase as export prices go down. Net exports consequently increase from a protectionist currency devaluation.

Two types of exchange rate regimes may occur. They are fixed or pegged exchange rates and flexible or floating exchange rates. The government directly determines the level for a fixed exchange rate. A protectionist currency devaluation occurs by government action in a fixed exchange rate regime. The government sets the exchange rate at a weaker level, which improves net exports through the effect on the prices of exports and imports.

In contrast, market forces determine the level of a flexible exchange rate. Attaining the intended result of a protectionist currency depreciation is more difficult in a flexible exchange rate regime than for a fixed exchange rate. The government or central bank must sell a large amount of domestic currency in the foreign exchange market to cause a noticeable depreciation of a flexible exchange rate. If the currency is a major hard currency with substantial international usage, such as the U.S. dollar, then the government action of selling dollars in the foreign exchange market would likely have a minimal impact. A vast amount of U.S. dollars already exists in the foreign exchange market throughout the world. A government attempt to flood the foreign exchange market with more dollars would probably have a small effect on the total supply of dollars and therefore a small depreciating effect on the currency.

Trade neomercantilism may be offensive or defensive in nature. Offensive neomercantilism may be referred to as beggar-thy-neighbor policies, unfair trade, or exporting unemployment. Unfair trade or offensive neomercantilism occurs if exports and imports violate international laws and norms. Offensive neomercantilism uses trade barriers to aggressively boost net exports, jobs, and GDP. This comes at an economic cost to the trade partner. The trade partner experiences reduced net exports, GDP, and employment. This is sometimes called exporting unemployment. An increase in net exports for one country causes a decline in net exports for the trade partner. The neomercantilist perspective suggests that international trade is often a zero-sum game with win-lose results. Countries with trade surpluses gain economically, while countries with trade deficits are harmed economically.

Defensive neomercantilism is the punitive use of trade barriers against unfair trade. Defensive neomercantilism is protectionist trade retaliation against unfair trade practices. The goal of defensive neomercantilism is to induce an unfair trade partner to discontinue aggressive protectionism and adopt a more conciliatory or mutually beneficial trade policy. Defensive neomercantilism attempts to induce an unfair trade partner through punitive protectionism to adopt a fairer trade policy.

The danger of protectionist retaliation against unfair trade is that international tensions could worsen between the countries. The trade partner could retaliate further with additional trade barriers. A trade war could arise. A trade war is the escalation of trade protectionism between nations that reduces the volume of trade and economically harms both trade partners. A trade war creates a negative-sum or lose-lose economic outcome. The risk of neomercantilist policies, whether offensive or defensive, is that a trade war occurs. Diminished trade from escalating trade barriers consequently takes place, and slower economic growth occurs for both trade partners.

A neomercantilist reaction against globalism arose in the United Kingdom and the United States in 2016. This anti-globalism sentiment could be interpreted as a populist reaction to the debt crises and economic hardship caused by the Great Recession a few years earlier. Anti-globalism appeared to intensify during and following the Great Recession. In June of 2016, the majority of U.K. citizens voted in favor of the Brexit referendum to withdraw from the European Union. Then, in November of 2016, Donald Trump was elected as U.S. president. Subsequently, American foreign policy shifted to a more protectionist stance on trade and other international issues such as immigration, environmental treaties, and NATO.

The following year, in 2017, France elected Emmanuel Macron as president. His political rival in that election was Marine Le Pen. An important element of Le Pen’s campaign was for France to withdraw from the European Union. The political stability of the European Union could have been jeopardized if Le Pen had won the presidential election and France had left the European Union. Instead, Macron was elected by a wide margin. France consequently remained in the European Union. An important ongoing issue, however, is whether the neomercantilist pressures in the United States and parts of Western Europe will persist or subside over time.

Economic Structuralism

In addition to economic liberalism and neomercantilism, economic structuralism is a third perspective on international trade and globalism. Economic structuralism emphasizes the harmful effects that may arise from global capitalism. According to structuralism, a major structural issue of the market system is the adverse results that may occur from the business profit incentive. If unconstrained by effective business laws and regulations, the profit drive can lead to harmful exploitation of economic resources, workers, consumers, and the environment.

Economic structuralism focuses on potential inherent problems of capitalism such as labor exploitation, consumer exploitation, environmental damage from globalism, and disparities in income and wealth within and among countries. The market system simultaneously creates wealth and poverty among and within nations according to structuralism.

Developed countries and multinational corporations tend to economically benefit from international trade and globalism. Developing countries, in contrast, may become worse off or may not economically gain from globalism to the extent of developed countries. The economic gap between rich and poor states could persist or become worse. Rich countries maintain structural advantages such as more economic resources, greater productivity of resources, a more developed economic infrastructure, a stronger educational system, more income and wealth, military and commercial technological superiority, and harder currencies. These advantages allow developed nations to maintain international economic, political, and military dominance. Poorer countries face structural obstacles to economic advancement. Poor countries often find it difficult to economically compete with richer states.

Modern World Systems View and Dependency Theory

Modern economic structuralism may be further explained in terms of modern world systems theory and dependency theory. Countries may be grouped into one of three politico-economic classifications according to world systems theory. They are the industrial core, the agricultural periphery, and the economic semi-periphery. The industrial core consists mainly of developed countries. The agricultural periphery refers to many of the developing countries. The semi-periphery is composed of newly industrialized nations.

The industrial core is made up of nations and geographic regions that have a relatively high degree of economic development. This includes the United States., Canada, Western Europe, Japan, Australia, New Zealand, and Israel. The industrial core of developed nations largely determines the political, military, economic, and legal frameworks and characteristics of the global political-economic system. Countries with stronger economic and military power have greater influence on the structure of the global order. Richer countries mainly determine the rules and mechanisms of the international system, which may adversely impact the periphery and semi-periphery.

The agricultural periphery consists of economically underdeveloped nations. Geographic regions in the agricultural periphery include Central America, much of South America, most of Africa, parts of Central and Eastern Europe, and Southeast Asia. The dominant industries of underdeveloped nations in the periphery are agriculture and natural resource extraction.

A key dynamic of the world systems theory is that industrial core exploits resources in the agricultural periphery. Through international commerce, MNCs from richer states obtain economic resources and commodities, such as raw materials, labor, and food from poor states at relatively low prices. MNCs use the commodities and resources obtained from lesser-developed countries to produce higher value-added goods at higher prices. This generates greater profitability for MNCs and higher GDP among richer nation-states.

The semi-periphery consists of nations with a level of economic development between the industrial core and the agricultural periphery. Countries in the semi-periphery exhibit some industrialization, especially in labor-intensive semiskilled manufacturing. Some examples of countries in the semi-periphery are Mexico, Argentina, Brazil, China, India, and South Korea. Countries in the semi-periphery have developed economically beyond the agricultural periphery. Countries in the semi-periphery, however, face structural difficulty advancing economically into the industrial core because of various obstacles in the global capitalist system such as gaps in technology, wealth, education, innovation, energy, and natural resources.

Structural obstacles inhibit upward economic mobility of poorer nation-states partly because of the technological advantages of the industrial core. These advantages initially arose because of the industrial revolution. The industrial revolution began in Great Britain in the late 18th century. Over the subsequent decades, the industrial revolution spread to other nations in Europe, such as Belgium, Germany, and France, as well as to North America and Japan.

According to world systems theory, this group of countries developed into the industrial core. They gained a commercial technological advantage in manufacturing at the time of the industrial revolution. The industrial core achieved a technological head start because they were the first countries to take advantage of manufacturing technology. The industrial core has been able to maintain a commercial and military technological advantage since the time of the industrial revolution. The technological advantages of the industrial core have been sustained through continual innovation and development of new commercial and military advancements. Most technological breakthroughs take place in the industrial core and are later transferred to the periphery and semi-periphery through international business activity.

Dependency theory is a further extension of modern economic structuralism. Lesser-developed countries in the agricultural periphery are vulnerable to the policies and actions of richer nations. The lopsided international power structure adversely impacts poorer countries. The agricultural periphery and the semi-periphery may be coerced to conform with the political and economic agenda of the industrial core.

Rich states possess the economic and military power to reward or punish poorer countries based on whether poor states support or oppose the agenda of rich states. If poor countries support the policies of the industrial core, they may be rewarded with increased foreign aid, favorable trade relations, international investment, technology transfer, and military protection. These actions lead to increased jobs and economic growth among poorer states. In contrast, if poorer countries resist the economic and political agenda of the industrial core, then poor nations could be penalized with reduced trade and investment, declining foreign aid, reduced technology transfer, and reduced military protection. These policies adversely affect the jobs, the economic growth, and the political stability of poorer states.

Summary

The political economy of free trade versus protectionism examines the various political and economic effects of the two opposing policy approaches. The concept of free trade emphasizes the beneficial results of competitive market forces on international trade, especially for consumers. Comparative advantage theory prescribes free trade with minimal government intervention. Comparative advantage theory asserts that countries should specialize in producing and exporting goods in which they are relatively more productive. Nations should import goods from other countries in which the latter are relatively more productive.

Comparative advantage and free trade are aspects of the economic liberalism perspective. Economic liberalism maintains that free trade through competitive international market forces generally creates win-win economic outcomes among nations. In general, free trade is mutually beneficial across countries. The ideal approach to global economic growth for both rich and poor countries alike is through free trade. The political right tends to be a stronger advocate than the political left for free trade. The political right tends to have greater confidence in market forces.

The neomercantilist perspective asserts that trade protectionism is often necessary to protect national economic interest. Neomercantilism sees international economic relations, including trade, as often generating win-lose economic outcomes. Countries with trade surpluses gain, while countries with trade deficits are harmed. Trade barriers are often needed to increase net exports, jobs, and GDP. The political left is generally more likely than the political right to embrace trade protectionism. The political left is more inclined to support government intervention in the economy, including trade barriers, because of perceptions of market failure.

Economic structuralism views international trade and global capitalism as often detrimental to poor countries while enriching developed countries. Globalism simultaneously creates prosperity and poverty. In a worse-case scenario, rich countries become wealthier while the poor states remain impoverished. More realistically, rich countries become wealthier while many poor countries also become richer but often not enough to reduce income disparities between rich and poor nations. Economic structuralism views globalism as often generating win-lose outcomes. Developed countries attain greater economic growth than many poor states because of structural problems inherent in the capitalist system.

To alleviate the wealth and income gaps among rich and poor states, economic structuralism recommends that richer countries should economically assist poor countries in various ways such as greater foreign aid to poor countries, increased exports from poor countries to rich countries, greater technological transfer to poor states, and greater foreign direct investment in lesser-developed nations.

..................Content has been hidden....................

You can't read the all page of ebook, please click here login for view all page.
Reset
34.200.248.66