Friday, November 6, 2009

Re: Trade Rigged Rules [Gues Post by Yaya Jallow]

Last week I posted on Facebook a link I had seen with animations by oxfam on trade and how it is rigged to work against poor countries. My friend Yaya Jallow, an economics student in Ghana, wrote this essay in response. It is quite insightful and I though it should be presented to a larger audience. Enjoy.

Response to ‘Trade Rigged Rules’: For the average Non Economist

By Yaya Saidou Jallow

Before going on to the arguments for trade, it would be best to start off by defining trade and to ask, what is the purpose of trade? We need to understand these two points in order to fully appreciate the arguments below. The main problem with the Oxfam argument is that the author either does not know or ignores the true purpose of trading and thus ends up making arguments that, though on the surface look valid, looked at more closely will reveals its flaws.

I won’t bother you with the textbook definition of trade; trade is just the exchange of goods (or goods for money) between two parties. Now the question to ask is, why do we trade? Can’t we just produce everything we want? No we can’t, but even if we could, it wouldn’t make sense to do so. This is because there will always be goods which others can produce at a lower cost than we could. Thus it would make sense that we produce goods that we can produce relatively cheaper than others, sell it to them and use the proceeds to buy the goods we do not produce from the others at a cheaper price. An example, assume Gambia and Senegal are the only two countries In the world (unrealistic I know and they’d probably even try to invade us). Also assume that there are only two goods the citizens of these countries need, food and clothing. Gambians and Senegalese could try and produce both goods for themselves or Gambia could produce one of the two and Senegal could produce the other. By specializing and producing only one good, Gambia and Senegal could produce more of the two goods than they could separately.

Food Clothing
Gambia 3 6
Senegal 5 5

The table above is a hypothetical illustration of how much Gambia and Senegal can produce from a labor hour. In The Gambia for example one labor hour will produce either 3 units of food and 6 units of clothing. In Senegal one hour of labor will give you 5 units of food and clothing respectively. Notice that in this situation, the total amount of food produced between the two countries is 8 and that for clothing 11. Now if Gambia decided to focus solely on clothing and let Senegal focus on food, then Gambia can produce 12 units of clothing per hour and Senegal can produce 10 units of food. The sum of these will be greater than each country trying to produce everything.

Though the assumption seems simplistic, it is a very good representation of what goes on in the real world. The model shouldn’t be taken too literarily, countries should not depend on only one product but rather produce the good they have a comparative advantage in (I haven’t defined comparative advantage, didn’t want to get too technical). The basic idea holds though. Now that we know why we trade, we have to ask ourselves what the aim of trading is? The aim of trading is simple, get as much as possible from your trading partner and give him as little as possible (I know sounds grim). I think the previous sentence seems a bit too harsh but an example would clarify this point. When you go to the shop to buy let’s say bread, you don’t tell yourself “I’ll give the shopkeeper as much money as possible and get from him as little as possible”. That’s just crazy but this is what people mean when they say that importing is bad and exporting good. Though they do not know, but that’s what their statement implies. Countries produce goods to meet a demand, that is people want a product and suppliers produce it. The aim of production is not to create jobs, job creation is a by=product of production and trade. When you produce a good and export it, you are creating jobs (something the author of the Oxfam argument supports) but then you are denying your citizens from consuming these goods. The aim is to use the money from the trade to buy goods from the other country at a cheaper price than you would have had you produced it at home. Therein lies the gains from trading. Specialization allows a country to get more goods that was previously possible and at a lower price. This is a win for both producers and consumers. Producers will sell more goods and consumers will be able to get these goods at a lower cost.

Now to the whole reason I even bothered writing:


The argument here is that the Western countries subsidize their firms (and farmers) and therefore Western firms have an unfair advantage over African firms. This advantage means that they can produce at a lower cost and sell their products in African markets at cheaper prices than African firms. Western firms go as far as even dumping their products in African countries thereby putting many African firms out of business.

This argument makes a number of contentious assumptions:

    1. All (or most) poor people in Africa are farmers
    2. In Africa, the welfare of producers is more important than the welfare of consumers

It is true that most of Africa’s population is engaged in farming and most of these farmers produce cash crops, which means they can be severely affected by dumping, but anyone who lives in Africa knows that farmers are not the only segment of the population that are poor. People in a number of occupations are or can be termed as poor, dock workers, market women, laborers are just a few occupations in there Gambia where you can find people who can be termed as poor or almost poor. If the idea is to fight poverty, then don’t these people deserve the same consideration? Or is it that farmers are more important in the society due to some yet to be explained reason?

In economics we are taught that one cannot compare the utilities of two people, it must never be done. Actually it’s a cardinal sin for one to do so. For example, taking one dalasi from a rich person and giving it to a poor person and claiming that the improvement in welfare of the poor person is greater that the decrease in welfare of the rich person and thus society is better off is wrong. We cannot tell how much the rich person and the poor person value money and thus cannot compare their welfare gains and losses. The dumping argument assumes (implicitly) that the loss of farmers (and other African firms) is greater than the gain in welfare of consumers or that farmers lose and consumers do not gain. Both of these assumptions are wrong. On the surface, the dumping argument seems to hold merit but upon closer inspection. It fails to hold up. An example on the dumping process will shed more light.

Going back to our example about Gambia and Senegal, if the Senegalese government decides to subsidize their clothing industry in order to boost their exports of clothing whilst still producing food, the net effect of this is that it would be clothing would be cheaper in Senegal than Gambia and thus Senegalese clothing producers would be able to price Gambian cloth producers out of the market. This has effects in both Gambia and Senegal. First in order to subsidize they will have to raise taxes to pay for the subsidies, the best way to do this would be to tax food producers more or tax consumers. Both of these have effects, the first would raise food prices and the latter would decrease the welfare of consumers. In The Gambia, the subsidies would affect producers of clothing negatively but all consumers of clothing positively. Cheaper imports of clothing would put Gambia clothiers out of business but the cheaper clothes for consumers means that they can use the money saved from cheaper clothing to buy more food (and maybe even more clothing). From this it can be seen that producers’ welfare has decreased whilst the welfare of consumers has increased. As mentioned earlier we cannot compare welfare gains and losses of different people, but from the above example it is clear that dumping is not totally bad for a country, as in most things there are gainers and losers.

Market Access

This argument is seriously flawed, in that tariffs are lower now than they were in the 50s, 60s and 70s yet Asian countries like Japan, China, Singapore and South Korea were able to move from exporting agricultural products to exporting consumer electronics and cars (they had a better educated population than African countries). The Asians succeeded in moving up the ladder with the decks also stacked against them. The issue of exporting primary produce permanently goes beyond just having market access. As I’ll explain in more detail on the next point, the reason for the success of the Asian tigers and the failure of other developing countries was due to the policies that these countries set up in their pursuit of development immediately after gaining independence.

Countries like The Gambia have been given increased market access for their products into the US market with lower tariffs than most countries, yet since then little improvement has occurred in Gambia’s groundnut industry. The problems in developing countries with regards trade is more complicated and the reasons for the problem more domestic than Western.

Forced Liberalization

The Oxfam piece argues that farmers (producers in developing countries) are forced to lift tariffs and other forms of trade barriers and liberalize their markets. Their argument is that developing countries are forced to liberalize whilst Western nations do not. This, the piece states will lead to domestic firms in developing countries being overrun by big multinational corporations, and the most vulnerable of these firms are the infant industries in these developing countries. Infant industries are industries that are fairly recently established. These industries usually requirement some form of protection until the firms in that industry can compete internationally. The argument says that these firms will not grow without protection and thus protecting these industries will create jobs now and in the future and improve exports and/ reduce imports.

As most of the arguments in the piece it seems on the surface to be convincing, what the article fails to mention is that developing countries have already tried to protect their industries at a great cost. Let me just digress a bit for it is necessary to go back in order to have a more complete understanding of this point. After independence (round the 1950s) developing countries were faced with the task of trying to develop their respective countries. This was around the time that Development Economics rose to prominence (some would argue over this but it’s beside the point), and development economists had theories as to the most efficient way a developing country could be developed. There were two main schools of thought, the first believed the import substitution and the second export promotion. These two schools can be termed as a nation looking inwards and looking outwards respectively. The first school believed that for developing countries to develop, they needed to protect their domestic infant industries, from international competition. These countries need to create industries that dealt in the production of capital intensive goods (goods whose production requires machinery, a good example would be Sankung Sillah type businesses), shield them from competition until they were matured then lift the shield. One doesn’t need to be a rocket scientist (or a programmer) to see that this method raises a lot of questions, for example who will determine what industries are worth protecting since not all industries will be protected? What will be the determinant of ‘maturity’ of an industry? Shielding industries from competition has consequences, as in the dumping case, protecting industries means that goods will be produced at a higher cost and consumers have to bare that cost. Is it right for a few business men in society, who are neither farmers nor poor, to benefit from protection at the expense of the rest of society? This was tried by countries like India, Brazil, Nigeria and Ghana and needless to say it failed. The problem with this theory was that it failed to take into account the tendency of producers to take advantage of protection by government. In most of the countries above, businessmen, knowing that they were being protected used their surplus profits to lobby for continued protection (both internationally and domestically) instead of innovating and cutting costs. By the 80s, these firms were seriously inefficient, using technologies that were decades old and producing at costs there way above their international competitors. Removal of protections meant that these companies eventually went out of business.

The second theory says that the fastest way to develop is to promote exports. Countries should start by exporting primary products and as time goes on they can use the excess money from trade to move into exporting new products that require more capital intensive methods of production. This was the route taken by the Southeast Asian countries (Singapore, Malaysia and South Korea) China also followed this method. More than fifty years later, history has shown us that the second theory was more accurate.

Back to the Oxfam piece, forcing countries to liberalize can be very destabilizing, this is because countries that are forced to liberalize are in so much trouble. The trouble is brought about mostly by anti market policies and liberalization when it occurs causes a shock that has effects that last for decades. The Gambia had a Structural Adjustment Program (SAP) in the mid eighties the result was a steep decline in output and income for the country. Incomes did not return to their pre SAP level for another 7 years. The reasons why countries have to (or are forced to) liberalize are numerous and complicated and going into them would just end up making this paper too long.

Well to sum things up, protecting domestic industries does not help developing countries, it’s been tried before and it has failed. Arguing that developing countries should be allowed to protect their domestic industries because Western countries are doing the same is equivalent to arguing that one should fall off a cliff because all of one’s friends are doing so. The reason they might be doing so is because they have parachutes.

Labor Rights

There is a book by a well known Economist called Jeffery Sachs called ‘The end of poverty’, his argument against NGOs like Oxfam that lobby for companies like Nike to raise their wage rates in developing countries is perhaps the best I have seen. His argument is that the women working in the sweat shops work there because they have no other better place to work, if they had they would move jobs. Multinational companies open factories in developing countries because labor is cheap (high unemployment and low education levels) and the workers require minimum training to be able to do the work. Most of the sweat shop workers are women and children, the women use the money from their work to pay for their kids’ schooling, health matters and to take care of the family. Working gives these women independence that they would not have had had the multinational not offered them work.

Arguing that multinationals should raise wage rates would reduce the incentive of these firms to operate in these countries by increasing their labor costs. The result would be less employment opportunities for women in developing countries. The aim of these NGOs to help these women leads to these women being losing their live hoods and dropping further down the social ladder.

Another argument related to the point above, deals with working conditions. The women in these sweat shops are mistreated because they are poor. As cruel as it may sound, this occurs everywhere, businesses have been known to take advantage of people, a good example is in Florida where orchards that grow orange take illegal immigrants from Mexico and pay them below minimum wage and deny them any other benefits that the average American worker gets. This is because the orchard owners know that these people have no choice. The problem can only be solved by the governments of the countries where these sweat shops are located, only they can enforce these policies to make workers environments safer. Workers being taken advantage of is not something new, it has always been the case. This has mostly been solved with legislature from the domestic government demanding better treatment of workers, and not by some foreign government passing some law against it.

Regional Trade Agreements

To some extent this point is true, but given that the WTO negotiations are not yet done and that developing countries are taking it upon themselves to devise agreements between themselves that would benefit them, I think I’ll leave this point until the matter has been fully resolved.

Didn’t think this piece would be so long; hope you’ll find it a bit more enlightening. When it comes to trade, issues are a bit blurred and emotions tend to dominate. It’s a pity because countries could gain so much from trade only if people could realize this.

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