Free Trade and Global dynamics

By Dr Callie LauFree trade offers variety, lower prices, and improved efficiency.International trade involves exports and imports of goods and services by firms across boundaries.  An economy’s overall trade performance is reflected by the current account in the balance of …

Free Trade and Global dynamics

By Dr Callie Lau

Free trade offers variety, lower prices, and improved efficiency.
SWINSays financial literacy

International trade involves exports and imports of goods and services by firms across boundaries. 

An economy’s overall trade performance is reflected by the current account in the balance of payment.  Trading of goods is the largest component in the current account while trading of services and net income from abroad which reflects the income of factors of production such as capital income, remain smaller contributors to the economy’s trade performance. 

Although technological changes have significant effects on global dynamics, the current account, however, does not reflect such changes directly.  For example, factor mobility including labour has become highly integrated and complicated. 

While labour may move from one region to another region, labour may remain in the domestic economy but, working remotely for firms in foreign economies.  

Trade policies are policies implemented by the government often to reverse trade deficits. Trade deficit is when imports are greater than exports and used to protect jobs particularly when the industries are in their infancy stage.

Although exports may increase if measures are taken to promote exports, the income levels of importing economies have greater effects on domestic exports.  Hence, it is easier to decrease imports than to increase exports in an attempt to reverse a trade deficit and stimulate the demand for domestic products.  

The most commonly used protectionist measures are import taxes and import licenses which affect the prices and quantity of imports respectively. 

In Malaysia for example, both taxes and import licenses are used to reduce imports of cars and to protect jobs as the domestic car manufacturing industry is an infant industry.

Trade policies and protectionism

Trade policies enable the creation of a comparative advantage if the protected industry is committed to acquiring technology and the government is committed to lifting the protectionist measures in the future. 

Professor M Melitz of Harvard University says that trade policies have to be temporary However, he has not proposed an optimum duration of protectionism. 

The South Korean car industry’s success story is an example of prudent trade policies that affect the global car market significantly. The car industry was protected at its infancy stage and acquired its knowledge from Ford, the American carmaker for about two decades

Today, the Korean carmaker is one of the world’s top ten largest car manufacturers.  The success of the Korean government’s trade policies is due to a conducive environment for the infant industry to grow and, technology diffusion in the industry.

The protectionist measures restricted the imports of foreign cars in South Korea and made the domestic car market profitable and sufficiently large for the carmaker to reap economies of scale. The Korean government’s commitment to liberalize the car market encourages carmakers to acquire the technology and continue to improve and eventually, export their cars.

Benefits of free trade

The benefits of free trade often cited are a variety of choices, lower product prices and improvement of firms’ efficiency due to competition.  At the aggregate level, free trade leads to more total world output hence, increases in international trade.

As technology and free trade have made economies more highly integrated than before, implementation of trade policies requires thorough studies of the targeted industry’s forward and backward linkages, and analysis of the benefits and costs of the policies. 

While the short-term costs and benefits are more easily traced and measured, the long-term costs and benefits are not easily identified and measured especially when there are disruptive innovations. 

When technology is advancing fast, the speed and levels of technology diffusion in the domestic industry relative to the speed of technology change in the external environment must be considered.  This is because as the levels of income increase, the willingness to pay for better-quality imported products increases.

Technology reduces production costs and transaction costs, hence enabling international trade to a greater volume than ever before.  Trade policies, on the other hand, hurt the domestic economy because of the higher product prices, lack of choices, low domestic product quality, and inefficiency of domestic firms. 

The policies can be rendered futile if the speed and levels of technology diffusion are insignificant relative to the technology advancement in the external environment while the levels of domestic income increase. 

For a small and open economy like Malaysia, trade policies do more harm to the domestic economy than good and, have insignificant effects on global economic dynamics.  However, a large economy may see short-term benefits if similar policies are implemented. 

In the long run, such policies have negative effects on the domestic economy as well as the global economic dynamics if there is insufficient technological advancement in the large economy.