Is Open Trade Viable ?

Nearly a month ago, Narendra Modi gave his plenary address at the World Economic Forum in Davos, Switzerland. He expressed what his audience wanted to hear: a strong defence of globalisation. In fact, he went as far as equating economic protectionism with terrorism. Supposedly a dig at the anti-free trade stance of President Donald Trump of the United States, Modi said,

“Many countries are becoming inward focused and globalisation is shrinking, and such tendencies can’t be considered lesser risk than terrorism or climate change.”

However, as Modi was fulminating against protectionism in Davos, his finance minister in Delhi was devising a plan to do exactly that. The Union Budget for 2018-19 put up a customs duty wall to exports in order to incentivize domestic value addition and boost the government’s ‘Make in India’ programme. These actions, guaranteed to hurt either some or most Indians in order to protect a few, were legally justified by proving that these domestic industries are being harmed by unfair foreign competition.

So, the question to be asked now is whether these decisions would ultimately help or hinder India’s economic growth in the long run.

Let’s start this discussion with Adam Smith’s book ‘An Inquiry Into the Nature and Causes of the Wealth of Nations’. The argument for free trade is one of its major themes. Smith argued that trade among nations is just like trade among people. No one feels compelled to grow his own food, sew his own clothes or manufacture his own mobile phone simply to keep busy. Instead, we find employment doing what we do best and rely on other people for most other goods and services. Similarly, nations are likely to prosper most if they specialized in producing what they do best and freely traded with other nations to fulfil other consumption needs.

This case was further expanded by David Ricardo, who addressed the question: What if one nation does everything better than another? His answer holds that trade depends on comparative advantage — how good a nation is at producing one good relative to another.

More recently, economists have attempted to review how trade affects productivity. In a model pioneered by a professor at Harvard, when a nation opens up to international trade, the most productive firms expand their markets to outside the nation, while the least productive ones are forced out by the increased foreign competition. As resources move from the least to the most productive firms, overall productivity of the nation rises.

A sceptic might say that all this is merely theory, where’s the evidence for it?

Well, here are your evidences:

• In a 1995 paper, the economists Jeffrey D. Sachs and Andrew Warner studied a large sample of nations and discovered that open economies grew significantly faster than closed ones.
  

• In fact, we observe that throughout history, whenever nations have opened themselves up to the world market, the typical result has been an increase in their growth rates. We witnessed this in Japan in the 1850s, South Korea in the 1960s and Vietnam in the 1990s.
  

• A third answer to the same is a research by economists Jeffrey A. Frankel of Harvard and David C. Romer of the University of California, Berkeley who tried to observe the impact of trade on national income. Analysis of data revealed that

“A rise of one percentage point in the ratio of trade to G.D.P. increases income per person by at least one-half percent.”

All this simply proves that these theories of Smith and Ricardo need to be taken seriously. Expanding trade might hurt some people in the short run, especially those in the import-competing sectors who will have to find new jobs. This situation may even call for a robust safety net in the form of import tariffs. But such instances of market interference end up leaving all impacted countries worse off by reducing specialization as well as the average living standards of the people.

After all, the whole point of free trade is that it’s not fair.

- Shreeya Jain