Decades Have Witnessed an Acceleration of Economic Globalisation

‘Recent decades have witnessed an acceleration of economic globalisation, in particular international trade. Is trade openness the key strategy to achieve economic development? What lessons could you draw for policymaking? Support your arguments with economic theory and empirical evidence from developing countries’. Introduction In this essay, I shall critically examine the statement put forward – and test whether trade openness is the key strategy to achieving economic development, and from this consider whether we can conduct further analysis upon whether there are any lessons that can be obtained from this in regards to policy making.To focus our discussion; using relevant empirical evidence, I will relate this essay primarily towards developing countries, enabling us to gain a clear understanding of the task at hand. It is of importance that we first briefly explore how the literature define and pursue globalisation; this is done in the next section. The remai nder of the essay will be dedicated on segments on economic theory of international trade, the relationship between trade openness and economic growth, we will then draw upon empirical evidence, the negatives of trade openness, and lessons for policy making.Finally I will offer my concluding remarks. Before delving into the core aspect of the essay, it’s essential to consider the underlying reason towards trade liberalisation in international trade; globalisation and also provide a definition of trade openness. Globalisation can be considered as an important rhetoric of contemporary international relations. The term globalisation is often invoked to describe the process of increasing interdependence and global enmeshment through a variety of economic, cultural, social and, political changes that have shaped the world over the past five decades. Hurrell & Woods, 1995; Guttal, 2007) Globalisation is considered a form of capitalist expansion that entails the integration of local and national economies into a global, unregulated market economy through an increase in international trade by increases in exports and imports of nations which has been widely regarded as being facilitated by international trade agreements post world-war II. The extent of integration is outlined in table 1 where we can see that there has been increase in the ratio of trade to gross domestic product (GDP) when integration had been apparent from 1870 up until 1914 the eve of World-War I.Integration was halted during the periods of the two world wars and the era of the Great Depression. During this period protectionism was rife, which saw the integration of trade and foreign asset ownership revert back close to their levels in 1870. (Dollar, 2005) Table 1: Measures of Global integration Adapted from Dollar (2005) Table 1: Measures of Global integration Adapted from Dollar (2005) In recent decades there have been various literatures invoking continuous debate discussing whether there is positive correlation between economic growth and trade openness.Advocates thoroughly support that trade liberalisation induces an increase in economic growth; whilst critics hold that protectionism is the essence to increased economic growth. The WTO (World Trade Organisation) and GATT (General Agreement on Tariffs and Trade) have shaped and influenced the integration of global markets through much debate, discussion and reciprocation, agreements have been established, aiming to promote the vision and objective of trade openness by lowering barriers to trade.Developing countries have been primarily on the agenda throughout the history of the GATT and WTO in order to promote development in these countries as WTO’s Mike Moore as cited in Rodrik (2001) puts it, â€Å"the surest way to do more to help the poor is to continue to open markets. † Trade Liberalisation Paradigm Vs. Protectionism Paradigm â€Å"More open and outward- oriented economies consistently outperfor m countries with restrictive trade and [foreign] investment regimes. † OECD (1998, pp. 6, cited in Rodriguez & Rodrik,1999) â€Å"Policies toward foreign trade are among the more important factors promoting economic growth and convergence in developing countries. † IMF (1997, pp. 84, cited in Rodriguez & Rodrik, 1999) Despite such claims, historically during the 1960s, and 1970s although the GATT aided the reduction of trade barriers, it was apparent that many developing nations continued to venture in the protectionist perspective to facilitate in driving economic growth.Nations in Latin America and in some African and Asian nations embraced the idea of f Import Substitution Industrialization (ISI). ISI refers to a trade and economic policy based on the premise that a developing country should attempt to substitute products which it imports (mostly finished goods) with locally produced substitutes. This often times involves government subsidies, high tariff barriers an d/or artificially maintained domestic currencies to protect local industries. (Kulkarni and Meister, 2009)Economic authors such as Trebilcock and Howse (1999) hold that their reasoning for adopting such an approach to international trade is that with trade liberalisation protectionist tariffs would have to be reduced, which would in turn hurt domestic production as imports would be considered more attractive than domestic; therefore affecting the long run economic growth of their nation. â€Å"tariffs on industrial products have fallen steeply and now average less than 5% in industrial countries. During the first 25 years after the war, world economic growth averaged about 5% per year, a high rate that was partly the result of lower trade barriers.World trade grew even faster, averaging about 28% during the period. † (Rivera and Olivia, 2004, p. 78) It’s apparent by data presented by Rivera and Oliva (2004) and linked with data available in table 1 that since after the world war policies adopted to ensure unrestricted flow of products and services consequently lead to global competition and innovation which benefits all involved. Krugman (1986) further elaborates that with such trade liberalisation that there are a number of key benefits. Firstly, due to economies of scale enjoyed by nations, economies are able to gain from their comparative advantage.Secondly, there is a rise in intra-industry trade, increasing product differentiation enabling consumer satisfaction to be increased. Finally as Porter (1990) establishes, trade liberalisation ensures nations adopt sound economic policies to increase competitive advantage to ensure foreign investment occurs in their economy. Theoretical Considerations To elaborate on the points made above it’s essential to consider the theories of international trade, as comparative advantage is an important concept for explaining pattern of trade.David Ricardo firstly introduces the concept of comparative ad vantage. It is then well recognized as the Ricardian model. In the neoclassical theory of international trade, Heckscher and Ohlin examine the effect of different factor endowments on international trade. – Theory of Competitive Advantage The basic idea of premise of Ricardo’s model boasts that comparative advantage postulates that a nation will export the goods or services in which it has its greatest comparative advantage and import those in which it has the least comparative advantage. (Ricardo, 1817 cited in Widodo, 2009)For example, it takes less productive inputs to produce clothes in China than in Great Britain. However it takes less productive inputs to produce bread in Great Britain than in China. Given this comparative advantage these China and Great Britain can increase their welfare of consumption by specialising in clothing and bread respectively and trade them. The overall gain from this is that greater economic growth can be attained through the utilisat ion of other economies comparative advantage. – Factor Endowment theory Coque et al. (2003) furthers the comparative advantage model outlined byRicardo criticising one area by stating that comparative advantages arise only because international differences in labour productivity. Coque et al. continues by expressing that in the real world, trade also reflects differences in countries’ resources: not only labour, but also other factors of production such as land, capital and mineral resources. The basic premise of this theory is centred that a country will tend to produce relatively more of goods that use its abundant resources intensively. For example, consider two goods and two factors of production (land and labour).The two goods have different factor intensities, that is production of one of the goods use a higher ratio of land to labour than the production of the other. The nation in question has an abundance of land, therefore would specialise in the production of this good which uses land intensively. Husain (2007) identifies that from these free-trade models, countries gain from trade and world output is increased; that the countries will tend to specialise in products that use their resources abundantly; and given identical technologies and production throughout the world, factor prices will equalize across trading countries.By enabling countries to move beyond their production possibility frontiers trade is assumed to stimulate growth by securing capital as well as consumption goods from other parts of the world. Trade thus stimulates economic growth, promotes and rewards those activities in which the country has relative abundance of factors of production. As developing countries poses labour in abundant supply their wages will rise and the majority of the population will be better off compared to no trade scenario. Empirical EvidenceTrade liberalisation and growth In regards to the protectionism and trade liberalisation paradigms discu ssed, a key case study is that of Pakistan. Pakistan’s international trading policy consisted of ensuring a highly protective trade regime until the late 1980s. Tariff rates were excessively high and non-tariff barriers kept competing imports away from the domestic markets. It was only in the 1990s that trade liberalization policies were initiated. During the period of protection the manufacturing and tax revenues grew by less than 5% annually.Once the tariff reforms were adopted manufacturing, revenues and exports have all grown in double digits. This correlation shows that despite the perceived views that protectionism protected the domestic, once policies that promoted trade openness were in place, exports within Pakistan actually increased, due to the comparative advantages they would have held in certain industries. Per Capita GDP Growth Rates, by Country Type, 1990s (%), based on GDP in purchasing power parity terms)Per Capita GDP Growth Rates, by Country Type, 1990s (% ), based on GDP in purchasing power parity terms) Figure 1: Per capita GDP Growth Rates by country type in the 1990s Adapted from Dollar (2005) Figure 1: Per capita GDP Growth Rates by country type in the 1990s Adapted from Dollar (2005) Dollar (2005) furthers this argument by presenting evidence from figure 1, which shows three categories; Rich countries (developed industrialised nations), other developing nations (Lack of trade openness) and developing country globalizers (those who have adopted trade openness policy).From the evidence provided it is clear that developing nations that have reformed their trading policies to enable them to become more open have grew substantially than their other developing counterparts who did not. Prabirjit (2007) further adds credence to this discussion by providing empirical evidence on cross-country study of averages and panel regression analysis for a sample of 51 less-developed countries over a uniform time period 1981-2002. Like many other works in this field, the results from this study shows that a country with a higher trade share based on openness tends to experience a higher real growth.Trade liberalisation and inequality Although we’ve been able to provide empirical evidence upon the growth benefits of trade openness, many analysts are legitimately concerned about the effects of trade liberalisation on the distribution of income. Research shows that there’s no evidence of a systematic tendency for inequality to increase when international trade increases. If we consider figure 2, this figure reflects the experiences of more than 100 countries, with changes in trade and changes in inequality measured over periods of at least five years in order to capture long-run relationship between trade and inequality.From the figure 1 we can see that there is no real correlation between changes in trade and changes in inequality. Figure 2: Changes in trade and income inequality Adapted from Dollar and Kraay (20 01a) Figure 2: Changes in trade and income inequality Adapted from Dollar and Kraay (2001a) Trade liberalisation and Poverty Reduction One of the most common criticisms of trade liberalization and globalization, particularly in developed countries, is that it drives down wages and exports jobs to low wage economies.As we’ve analysed the combination of increases in growth has little systematic change in inequality, now with such results can we expect to see a reduction in poverty for developing countries. In Malaysia, for example, the average income of the poorest fifth of the population grew at a robust 5. 4% annually. Even in China, where inequality did increase sharply and the income growth rate of the poorest fifth lagged behind average income growth, incomes of the poorest fifth still grew at 3. 8%annually. (Clift and Diehl, 2007)The fraction of the population of these countries living below the $1 a day poverty threshold fell sharply between the 1980s and the 1990s: from 43%to 36% in Bangladesh, from 20% to 15% in China, and from 13% to 10% in Costa Rica. Dollar and Kraay (2002) and Ravallion (2001) support the hypothesis that mean incomes of the poor rise and poverty rates decline with the rise in overall mean incomes. But state reliance on cross – country evidence to make inferences about specific instance is not helpful. Apparent factors which impair the effects of trade liberalisationNugent (2002) identifies factors which affect the effects of trade openness for example a trade liberalization program may have been well-designed but initiated at the wrong time. Arguments about comparative advantage and gains from trade are more plausible when real world conditions approximate those of the theoretical models used to justify them, namely, equilibrium at full employment. Yet, it was during the extremely turbulent and depression-like conditions of the mid-to-late 1980s and early 1990s that most of the Latin American countries and transition e conomies of Central and Eastern Europe initiated their trade liberalization programs.Nugent states that one problem is that in such turbulent circumstances, often before stabilisation has been achieved and when both inflation rates and relative prices are very volatile, the price signals exerted by the trade liberalization measures may be either misleading or too noisy to have the â€Å"right† effects on resource allocation. This can be an argument for delaying trade liberalization until after stabilization can be achieved. But, if trade liberalization is delayed, it may mean that the stabilization programs that help raise the prospects for future growth and stimulate investments will do so in the â€Å"wrong sectors†.Yet, the currency depreciation required to offset reductions in tariff equivalents may also trigger inflation. Clearly, there are tradeoffs and problems inherent in these inevitable interdependencies. But, whether, stabilisation occurs before, after or si multaneously with trade liberalization (if at all), it suggests that the need for a well-articulated, coherent and credible program is even greater than would be the case if trade liberalization was to start from a stable, full employment economy.A second problem in which Nugent (2002) identifies is that trade liberalization, and capital market liberalization, is likely to increase the vulnerability of the economy to new kinds of shocks. These shocks can easily be very challenging to policy makers and make it even harder to stick with reforms. Both Chile of the 1970s and Mexico of the mid-1990s were heavily indebted and then buffeted by unexpected shocks in the form of higher interest rates in the US. Indeed, some analysts blame the setbacks of Mexico and Chile in their trade liberalization programs simply to bad luck.Even if this is not entirely true, it is quite true that even if the trade liberalization programs had been well-designed for normal condition over time, they may not have been sufficiently well designed to also withstand the severe external shocks that may be more likely to come in a liberalized economy. Lessons for Policy Makers The weight of evidence suggests that openness to trade is good for growth and that growth benefits the poor. But to enjoy the full benefits of trade liberalization, McCulloch et. al. 2011) state it should be accompanied by sound policies in areas such as transport and communications infrastructure, market facilitation, competition, education and governance. In order to boost the competitive advantage qualities of the environment – subsequently increasing investment within the nation. McCulloch et al (2011) further state that trade liberalization can change the nature of the risk and uncertainty that poor households face although not always for the worse. It can also affect their ability to cope with risk and uncertainty.Policies such as improving access to credit markets can help a great deal here along with impr ovements in asset distribution and in the flexibility of local labour markets. Conclusion In essence to conclude, in comparison to protectionist international trade policies, from empirical evidence presented trade openness as a whole can be considered as a key strategy to achieve economic development, as we have been able to witness an increase of imports for developing nations which in turn increases efficiency and reduces costs, which can be considered more effective than import substitution policies.However as established in this paper, there are various factors in which can affect the effectiveness of trade liberalisation policies, which policy makers must take into consideration. References Clift, J. and Diehl, E. (2007) Financial Globalization: A compilation of articles from Finance & Development Washington, D. C. : International Monetary Fund Dollar, D. , 2005, Globalization, Poverty, and Inequality since 1980, World Bank Research Observer, 20 (2): 145-175 Dollar, D. & Kraay , A. 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