FREE TRADE OR PROTECTION? The assumption of static equilibrium is crucial to the analysis underlying the argument for free trade. Given some innate capacity for change, the free-trade doctrine can be extended to conditions of slow evolutionary change. Given that the degree of dislocation and the social costs of adjustment are positively related to a disturbance, this book considers the efficiency of commerical policy as a means of slowing the rate of adjustment (reallocation). The analysis requires a model using heterogeneous factors of production with industry-specific attributes. The use of commercial policy to suppress change is counterproductive. Three types of disturbance are examined: reversible changes when major industries temporarily lose their international competitiveness; dislocation when a large shock induces change too rapid for the economy's capacity to adjust; and possible chronic unemployment of low-skilled workers caused by market failure in a fully integrated, free-trade world. The policy implications are considered in both a North-South and a North-North context.
H. Peter Gray is Professor of Economics and Finance, School of Business, Rutgers University, New Jersey. Born in Cheltenham, England, in 1924, he was educated at Queens' College, Cambridge, and then went into business with Dexion Ltd. in London. In 1953 he emigrated to Canada to open the firm's Canadian manufacturing subsidiary; ~, later e enrolled in the PhD program in economics at the University of California, Berkeley, where he was awarded his doctorate in 1963. In addition to a year's fellowship at the Brookings Institution, he has taught at Wayne State University, Detroit, and at Thammasat University, Bangkok. In 1968 he became chairman of the Department of Economics at Douglass College, Rutgers University, and from 1982 to 1984 was Director of the undergraduate program of the newly formed School of Business at Rutgers, of which he is now a member. Professor Gray is the author of International Travel: International Trade, The Economics of Business Investment Abroad, An Aggregate Theory of International Payments Adjustment, A Generalized Theory of International Trade and International Trade, Investment and Payments.
FREE TRADE OR PROTECTION? A Pragmatic Analysis H. Peter Gray Professor of Economics and Finance Rutgers University Palgrave Macmillan
ISBN 978-0-333-36201-3 ISBN 978-1-349-06983-5 (ebook) DOI 10.1007/978-1-349-06983-5 H. Peter Gray 1985 Softcover reprint of the hardcover 1st edition 1985 All rights reserved. For information, write: St. Martin's Press, Inc., 175 Fifth Avenue, New York, NY 10010 Printed in Hong Kong Published in the United Kingdom by The Macmillan Press Ltd. First published in the United States of America in 1985 ISBN 978-0-312-30374-7 Library of Congress Cataloging in Publication Data Gray, H. Peter. Free trade or protection? Bibliography: p. Includes index. 1. Free trade and protection. I. Title. HF1713.G585 1985 382.7 85-11930 ISBN 978-0-312-30374-7
To those economists who recognise the need for and do not shun the difficulty of analyses of reactions to evolution, institutional change and substantial changes in underlying conditions
Contents Preface ix 1 THE PRESENT NEED TO RECONSIDER THE FREE-TRADE DOCTRINE 1 2 THE ARGUMENT FOR FREE TRADE AND ITS UNDERL YING ASSUMPTIONS 8 Conclusion 19 3 'DOMESTIC INEFFICIENCY' AND CONDITIONAL PROTECTION 22 I Domestic efficiency 23 II The dynamics of domestic inefficiency and conditional protection 31 III Summary 44 4 THE PROBLEM OF THE RA TE OF ADJUSTMENT 46 I Canterbery's vita theory 50 II Labour market congestion 54 III Senile industry protection 63 IV Reinforcing disturbances 66 5 THE POSSIBILITY OF PERMANENT UNEMPLOYMENT 70 I Permanent unemployment with homogeneous labour 72 II Permanent unemployment with heterogeneous labour 77 III Inequalities in subsistence income 83 IV Summary 87 6 IMPASSE IN NORTH-SOUTH POLICY FORMULATON 90 I The evolution of social costs and political pressures 91 II Neglecting to confront the clash of interests 95 III The division of adjustment strains 102 IV Policy options 109 V Conclusion 112 vii
viii Contents 7 SOUTHERN DEMANDS AND A CONSTRUCTIVE ALTERNATIVE 114 I A new international economic order? 116 II A constructive alternative 121 III Political considerations 125 IV Conclusion 127 8 FREE TRADE AMONG THE INDUSTRIALISED NATIONS? 129 I Transitory losses of international competitiveness 130 II Unequal sharing of the burden of chronic adjustment costs 134 III Long-run growth considerations 135 IV A variant on binding free trade 140 V Conclusion 141 9 SUMMARY AND CONCLUSIONS 143 Appendix A: Canterbery's Vita Theory of Income Distribution 150 Appendix B: The Legal Institutional Environment for Protection in the US 154 Notes and References 161 Bibliography 166 Index 172
Preface For many years I have had the growing impression that the discipline of economics has sought to solve problems which were capable of solution in an elegant way: the art-form lay in restricting the number of assumptions needed for a mathematically-precise solution. This set of problems is to be contrasted with those which provide untidy solutions at best but do reflect the complexities of the world around us. Very little attention is paid in economics to consideration of the different types of disturbances or shocks which can impinge on an economy and of how the appropriate policy response (including passivity) might vary according to the kind of disturbance. Some of this failure to concern itself with different types of disturbances can be traced to the infatuation of the discipline with cyclical problems following the Great Depression and with the refinement of Keynes's General Theory. The success of so-called Keynesian policies in the 20 years after the Second World War could have produced a tranquil state of mind among economists: in the language of this book, problems of resource reallocation which arose were 'benign' because the changes came so slowly that they were well within the capacity of the system to adjust without serious dislocation. If one ignores disturbances, one works in a domain of steady-state equilibrium and this is the arena in which the debate of free trade or protection has traditionally been conducted. In such an arena, free trade always wins. But the reality of our world is one in which disturbances come in different shapes and sizes and at different frequencies. A tranquil world of minor disturbances can quickly change to a state of turbulence in which major reallocations of resources are forced on national economies: recent events have shifted a world of virtual tranquillity or suppressed changes to one in which changes must be accommodated. This is a very different arena and in this arena the relative merits of free trade or protection take on new perspectives: indeed, the perspective changes according to the kind of disturbance with which the system is afflicted. At the risk of taking liberties with the concepts of Jan Tinbergen ix
x Preface (1970), it is possible to present the issues considered in this book as a consideration of the policies which can best accommodate qualitative change. Tinbergen distinguishes between quantitative and qualitative policies: qualitative policies involve the changing of some aspect of economic structure, while quantitative policies involve changes in certain parameters within the same economic structure. Tinbergen's analysis seems to limit his consideration of qualitative policies to those required to bring about a change which follows from the emergence of a new general interest function for the economy (1970, pp. 68-73). This book is concerned with a more difficult problem: what policies should be used to best adapt an economy with an unchanging general interest function to a new set of economic conditions in world markets? To quote Tinbergen: 'the scientific treatment of qualitative policy meets with great difficulties' (1970, p. 72). My interest in commercial policy and in the process of adjustment began many years ago with a thought about the possibility of the need for phase-out protection. (I learned while writing this book that Ricardo had broached the same issue about 150 years earlier!) Phaseout protection only becomes a matter of concern when some factors are industry- or product-specific. This was an outgrowth of a concern with the limitations of a body of trade theory based on generic factors of production. From this standpoint came my concern with the creation of a theory of international trade which would be broad enough to allow for the existence of industry-specific factors, intraindustry trade and multinational corporations. Any theory of international trade which does not encompass the existence of multinational corporations is misleading and the dynamic features of multinationals require that international trade theory not be confined to a domain of steady-state, long-run general equilibrium. The other seed from which this book sprang is Canterbery's vita theory of income distribution which addresses itself to the problems of skill-levels and skill acquisition. The vita theory proved to be the Rosetta Stone which enabled me to formulate all my misgivings about the interaction of rapid changes in trade patterns and the rate of employment in industrialised nations. I am greatly indebted to E. Ray Canterbery for his endless patience in explaining the subtleties of his theory. I am also particularly indebted to Ingo Walter with whom I have had ongoing discussions about international trade and commercial policy spread over many years. Detlef Lorenz and Thomas A. Pugel have both contributed to my understanding of this arcane area of economics.
Preface xi I wish to acknowledge the courtesy of the Eastern Economic Association and the Indian Institute of Foreign Trade in New Delhi for allowing me to reproduce material first published in the Eastern Economic Journal and the Foreign Trade Review. I am obliged to the Trade Policy Research Centre for permission to quote extensively from one of its International Issues series entitled 'MFA Forever?' This book seeks to reconsider the possibility that protective measures might be useful features of international economic policy in a turbulent world. Nothing in the book suggests that, within the confines of their assumptions, the models of advocates of free trade are incorrect: the argument is merely that reality and the assumptions of free traders part company when the world is undergoing rapid evolution. Some proponents of free trade cleave to their doctrine with what amounts to a religious fervour. I hope that they will do my book the courtesy of considering the arguments dispassionately. If they disagree with the arguments put forward here, I would ask only that they set down exactly what assumptions they have to make (or refuse to grant me) in order to render my arguments invalid. The most probable candidate is the assertion that, once protection is instituted on behalf of an industry, that protection is locked in for eternity: if such be the case then free trade may be the best rule of economic policy formulation even in turbulent times, but it will be a poor reflection on the stuff of which economists and politicians are made. Belle Mead, New Jersey, USA H. PETER GRAY