Get on Track with Trade

• Author: Maurice Obstfeld

Get on Track with Trade Finance & Development, December 2016, Vol. 53, No. 4

Maurice Obstfeld

Trade raises productivity but may hurt some unless policies redistribute the benefits

As the global economy struggles with slow growth, political support for freer international trade has weakened, most notably in advanced economies and especially in the United States. While some resistance to freer trade is nothing new, it never stopped the postwar trade liberalization process, which delivered growth in advanced economies and promoted convergence of per capita incomes throughout a significant portion of the developing world.

Opposition to trade remains a minority view—most people gain from trade, but it seems to have many more vocal enemies these days.

Trade enables a country to use its resources more efficiently. But the gains from that greater efficiency may be divided unevenly among a country’s citizens, so that some of them lose out. The result can be greater income inequality and disrupted lives.

Over the past quarter century, the global economy has seen a seismic transformation thanks to increased trade and technological and political changes. While there is much progress to cheer at the global level, most governments have not ensured that gains from economic growth—including those due to trade—are broadly shared. In some places, tepid and declining overall income growth has brought frustrations to a boil.

Trade’s benefits have always been unequally shared, and maybe more so in recent years. But its gains are all the more important in today’s low-growth environment. Countries must protect and expand these gains through policies that redistribute them more equitably. That will also make economies more resilient to a range of market forces, beyond those connected with globalization.

Trade and technologySince World War II, progressive reduction in trade barriers such as tariffs and quotas has supported growth and welfare everywhere it was undertaken—in part by getting a greater variety of goods to households at lower prices. Even more important, trade also has powerful positive effects on productivity—that is, the efficiency with which global resources are used to produce economic goods. These gains are especially important to reap in a world where economic growth seems to be slowing.

The main reason trade enhances productivity is comparative advantage, as the British economist David Ricardo explained two centuries ago. For example, he said, if England and Portugal both can produce cloth and wine, output of the two goods is maximized when the country with the lower domestic opportunity cost of wine making specializes in producing it, while the other country specializes in cloth. Both trade partners gain from this specialization. Moreover, that specialization remains efficient even if one of the countries can produce both goods more efficiently than the other—that is, has an absolute productivity advantage in making both goods. Trade always raises the productivity of every country that allows it—a point often missed in public discourse today.

Empirical research supports Ricardo’s fundamental insight that trade fosters productivity. But the productivity and growth benefits of trade go far beyond Ricardo’s insight. With trade, competition from abroad forces domestic producers to raise their game. Trade also offers a wider variety of intermediate production inputs firms can use to produce at lower cost. Finally, exporters can learn better techniques through their engagement in foreign markets, and are forced to compete for customers by raising efficiency and upgrading product quality (for example, Dabla-Norris and Duval, 2016).

In Ricardo’s world, trade is like a new, better technology that simultaneously becomes available to all countries that open their borders and from which everyone benefits equally.

Trade sometimes works this way. But such positive accounts of trade throw no light on why some people bitterly oppose it.

There are two main aspects of trade that help explain the opposition. First, there are short-run costs of redeploying an economy’s resources out of the sector that shrinks under free trade. Some workers are stranded in a contracting cloth sector, perhaps unable to move to a wine-producing region or to learn wine-making skills quickly. In the real world, costs and inefficiencies can be protracted and fall harshly on some, making long-run gains to the economy feel abstract and irrelevant to them.

Second, even without adjustment problems, trade can worsen the domestic income distribution, even making some people worse off in absolute terms. In this case, although the country as a whole experiences increased...