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The political economy of trade and development

Nicolas Delmas

How does global free trade affect development, and what role can the state play?

Dr James Scott, Lecturer in International Politics at King’s College London, examines the issues

Two years ago trade seemed to be losing its lustre. The World Trade Organization (WTO) appeared to have become unmoored by the ongoing failure of its members to bring the current round of trade negotiations – known as the Doha Development Agenda (DDA) – to a close and there were suggestions that the WTO might even be finished as a forum for creating trade rules. The Obama administration was widely perceived to be unwilling to expend the political capital needed to push a strong trade agenda, and continued fall-out from the global financial collapse rendered the creation of new trade agreements a secondary concern.

Today, things are very different. The WTO is out of the doldrums, reinvigorated by having secured in December 2013 its first multilateral deal since it was created in 1995. Building on this, in July 2015 a group of 54 WTO members, including the biggest trading nations, overcame the final hurdles to completing the Information Technology Agreement, eliminating tariffs on over 200 products. Meanwhile, in the United States Obama overcame initial Congressional opposition to secure trade negotiation authority, giving impetus to the so-called ‘megaregional’ deals the US is negotiating (namely the Trans-Pacific Partnership and the Trans- Atlantic Trade and Investment Partnership). The wind has firmly returned to the sails of trade liberalisation and the WTO has started to get the stalled DDA back on track.

For many, this turn of events is of unquestionable benefit to the world, and to the developing world in particular. It is not hard to see the importance of trade as a central component of successful development stories. The industrial revolution in Britain in the latter part of the eighteenth century could not have taken place without the trade patterns put in place in the preceding centuries and the opening up of foreign markets. The age of discovery unlocked the world to trade across the oceans, and ships continue to account for over 90 per cent of all commerce.

The export-led growth model

The role played by trade in the more recent industrialising countries post-WWII was even more striking. Trade was so central to the development models of Japan, South Korea, Malaysia, Singapore and Taiwan (the original East Asian miracle economies) that the strategy was termed export-led development. Trade generated the foreign exchange required to fund development programmes and provided the markets necessary for economies of scale in industrial production, while investment from Western countries created jobs and learning opportunities. More recently still, China has famously followed this path to spectacular effect, achieving some of the most rapid economic growth ever witnessed. Again, this was based on a model of export-led growth, driven by massive exports of consumer goods to the largest consumer markets in the world (particularly that of the United States) as a means of generating employment and revenue. Such narratives appear at first glance to tie in strongly with traditional ideas around the benefits of free trade as set out by Adam Smith and David Ricardo during the Enlightenment, and have certainly been used in support of that principle (for example by the most unswerving contemporary proponent of free trade, Jagdish Bhagwati). In recent years this has been given a new spin through the rise of Global Value Chain (GVC) analysis. Though an old idea, GVCs have received great attention in recent years, pushed notably by the WTO. GVC analysis highlights the division of the manufacturing process across multiple countries, each performing different stages of production most suited to their particular level of technological development. Fifty years ago a product stamped ‘Made in the UK’, for instance, would have likely signified that almost all the manufacturing process took place within the UK’s borders with only the input of raw materials coming from elsewhere. Today, such labels are increasingly misleading, as almost nothing is made within the confines of one state anymore. In some regards, stamping things ‘Made in China’ (as is most prevalent nowadays) is almost meaningless, referring only to where the product was finally assembled and packaged, using components imported into China from many countries. For this reason the WTO claims that many goods should more accurately be labelled ‘Made in the World’. For poor countries wanting to improve their lot, the policy prescription flowing from this is often taken to be one of pursuing greater liberalisation to try to become more attractive as a site for entering these global production networks.

The ‘developmental state’

And yet, controversies remain. Perhaps the greatest revolves around the vexed question concerning the appropriate role of the state in the process of economic development, something that has been a feature of political economy debates for centuries. Though, as noted above, for some the history of those countries that have achieved sustained, rapid growth points to the importance of market mechanisms driving trade, while for others the lesson to be learnt is almost the opposite. In detailed historical examinations of these examples, what stands out in each case is the crucial role of a ‘developmental state’, playing a much more active part in driving the development process than liberal, free trade theory would allow. Though Adam Smith’s ‘invisible hand’ of the market was important, it would appear that the much more ‘visible hand’ of the state was also a necessary element, with the two working in tandem.

The developmental state was crucial in actively working to change the areas of comparative advantage that the country enjoyed, pushing economic activity away from traditional areas (generally agriculture and raw material production) toward initially basic industry (primarily textiles and clothing) and subsequently into other more technologically advanced areas. A range of policies were used to do this, all of which contravened core tenets of orthodox economics and its emphasis on allowing the market to direct economic activity. Policies used included targeted tariffs to protect nascent industries, conditions placed on inward investment aimed at encouraging spill-over benefits, and preferential interest rates for key sectors of the economy.

The restriction of ‘policy space’

Such policies have been increasingly outlawed by the rules of the global trade system. The strategies used by the current industrialised countries – both those of the West and the more recent industrialised states of East Asia – during their own periods of rapid development are no longer permitted, shrinking the ability of other countries to reapply those lessons. WTO rules, which are backed up by its dispute settlement system and the threat of sanctions for non-compliance, restrict what has come to be known as developing countries’ ‘policy space’ – that is, the freedom that they have to experiment with a set of policies tailored to their particular circumstances, aimed at fostering economic development. There is a fear that new trade agreements made within the WTO or on a regional basis will further restrict this policy space, entrenching the concentration of developing countries in producing raw materials and agricultural goods. If that happens, the possibility of large-scale poverty reduction through trade is diminished, as industrialisation appears to be a necessary condition for achieving sustained, rapid economic development.

Arguably, a similar argument holds true even for advanced, developed countries, in which there is still an important role for the state in sustaining a balanced, successful economy. Though the market mechanism has become something of a shrine to which all politicians bend the knee, the most successful high-technology, exporting nations – Germany and the United States are good examples – rely on a complex interplay between public and private sectors, with the public sector often playing a crucial but widely overlooked role in mitigating the risk of entrepreneurial activity and pursuing major technological advances. The current pursuit by governments of deeper, more stringent trade agreements that place ever greater restrictions on what policies the state can employ may prove to be far from optimal.

In sum, trade has always been one of the central arenas in which the big questions of political economy are played out. Perhaps no such question is more perennial or more pertinent than that related to the appropriate role of the state in the economy. Trade undoubtedly has, in the right circumstances, the capacity to raise people out of poverty and to alter fundamentally the future prospects of poor countries. The opportunities opened up by increasing commerce are of immense benefit to a wide range of people across the globe, suggesting a need to continue the liberalisation agenda with renewed vigour. And yet, balanced against this, the lessons of those countries that have been most successful in harnessing the benefits that trade can bring demonstrate that the state plays a crucial role in this process, working alongside the private sector. Liberalisation, if pursued too far or too fast, prevents this happening – something that is forgotten all too often in the rush to pursue market efficiency. If the potential of trade for achieving development is to be realised, we must give greater recognition to this tension and re-open for debate the appropriate part that the state plays in enabling that process.

James Scott is co-editor of the recent books, Trade, Poverty, Development: Getting beyond the WTO’s Doha Deadlock (with Rorden Wilkinson, 2013) and Expert Knowledge in Global Trade (with Erin Hannah and Silke Trommer, forthcoming 2015)