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While the text has shown why, in general, free trade is a good policy, this chapter considers two controversies in trade policy that challenge free trade. The first regards strategic trade policy. Proponents of such activist government trade intervention argue that certain industries are desirable and may be under funded by markets or dominated by imperfect competition and warrant some government intervention. The second controversy regards the recent debate over the effects of globalization on workers, the environment, and sovereignty. While the anti-globalization arguments often lack sound structure, their visceral nature demonstrates that the spread of trade is extremely troubling to some groups.
As seen in the previous chapters, activist trade policy may be justified if there are market failures. One important type of market failure involves externalities present in high-technology industries due to their knowledge creation. Existence of externalities associated with research and development and high technology make the private return to investing in these activities less than their social return. This means that the private sector will tend to invest less in high technology sectors than is socially optimal. While there may be some case for intervention, the difficulties in targeting the correct industry and understanding the quantitative size of the externality make effective intervention complicated. To address this market failure of insufficient knowledge creation, the first best policy may be to directly support research and development in all industries. Still, while it is a judgment call, the technology spillover case for industrial policy probably has better footing in solid economics than any other argument.
Another set of market failures arises when imperfect competition exists. Strategic trade policy by a government can work to deter investment and production by foreign firms and raise the profits of domestic firms. An example is provided in the text which illustrates the case where the increase in profits following the imposition of a subsidy can actually exceed the cost of a subsidy to an imperfectly competitive industry. While this is a valid theoretical argument for strategic policy, it is nonetheless open to criticism in choosing the industries which should be subsidized and the levels of subsidies to these industries. These criticisms are associated with the practical aspects of insufficient information and the threat of foreign retaliation. The case study on the attempts to promote the semiconductor chips industry shows that neither excess returns nor knowledge spillovers necessarily materialize even in industries that seem perfect for activist trade policy.
The next section of the chapter examines the anti-globalization movement. In particular, it examines the concerns over low wages in poor countries. Standard analysis suggests trade should help poor countries, and, in particular, help the abundant factor (labor) in those countries. Protests in Seattle, which shut down WTO negotiations, and subsequent demonstrations at other meetings showed, though, that protestors either did not understand or did not agree with this analysis.
The concern over low wages in poor countries is a revision of arguments in Chapter 2. Analysis in the current chapter shows again that trade should help the purchasing power of all workers and that if anyone is hurt, it is the workers in labor-scarce countries. The low wages in export sectors of poor countries are higher than they would be without the export-oriented manufacturing, and while the situation of these workers may be more visible than before, that does not make it worse. Practically, the policy issue is whether or not labor standards should be part of trade pacts. While such standards may act in ways similar to a domestic minimum wage, developing countries fear they would be used as a protectionist tool.
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Anti-globalization protestors were by no means united in their cause. There were also strong concerns that export manufacturing in developing countries was bad for the environment. Again, the issue is whether these concerns should be addressed by tying environmental standards into trade negotiations, and the open question is whether this can be done without destroying the export industries in developing countries.
Finally, globalization raises questions of cultural independence and national sovereignty. Specifically, many are disturbed by the WTO’s ability to overturn laws which do not seem to be trade restrictions, but which nonetheless have trade impacts. This point highlights the difficulty of advancing trade liberalization when the clear impediments to trade-tariffs or quotas-have been removed, yet national policies regarding industry promotion or labor and environmental standards still need to be reformed.
The final section of the chapter examines the link between trade and the environment. In general, production and consumption can cause environmental damage. Yet, as a country’s GDP per capita grows, the environmental damage done first grows and then eventually declines as the country gets rich enough to begin to protect the environment. As trade has lifted incomes of some countries, it may have been bad for the environment-but largely by making poor countries richer, an otherwise good thing. In theory, there could be a concern of “pollution havens” where countries with low environmental standards attract “dirty” industries. There is relatively little evidence of this phenomenon thus far.
Answers to Textbook Problems
The main disadvantage is that it can lead to both “rent seeking” and beggar-thy-neighbor policies, which can increase one country’s welfare at the other country’s expense. Such policies can lead to a trade war in which every country is worse off, even though one country could become better off in the absence of retaliation. This is the danger in enacting strategic trade policy: it often provokes retaliation, which in the long run, can make everyone worse off.
If everyone knows that an industry will grow rapidly, private markets will funnel resources into the industry even without government support. There is need for special government action only if there is some market failure; the prospect of growth by itself isn’t enough.
The results of basic research may be appropriated by a wider range of firms and industries than the results of research applied to specific industrial applications. The benefits to the United States of Japanese basic research would exceed the benefits from Japanese research targeted to specific problems in Japanese industries. A specific application may benefit just one firm in Japan, perhaps simply subsidizing an activity that the market is capable of funding. General research will provide benefits that spill across borders to many firms and may be countering a market failure, externalities present in the advancement of general knowledge.
A subsidy is effective when the firm in the other country does not produce when the domestic firm enters the market. As the text tables show, a subsidy may present a credible threat of entry and deter production by the other firm: a subsidy encourages Airbus to produce and Boeing not to produce. However, Boeing may still produce even if Airbus receives a subsidy. Airbus’ return is less than the subsidy if Boeing enters the market.
Key assumptions in the model are that economies of scale are large for each firm, while the market is of a limited size. Because of these assumptions, there is only room for one firm to profitably produce the new jet aircraft. In the absence of economies of scale, both firms can share the market and divide the profits. If the market were larger, both firms could enter into the market profitably even with economies of scale.
Because the economy has limited resources, a trade policy that conveys a strategic advantage on one industry necessarily puts other industries at some strategic disadvantage. It is not possible to achieve a strategic advantage in all industries. This point should be clear from the emphasis on movements along production possibility frontiers as illustrated in previous chapters. Korea’s across-the-board subsidy probably has little net effect on the strategic position of the industries because, while it provides each industry with a direct subsidy, it indirectly raises all industries’ costs.
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Advantages to such policies are that some workers are able to enjoy higher standards in the workplace. The disadvantages with such policies are that they may serve as a deterrent to employment creation in developing countries as costs increase to producers of locating manufacturing in these countries. Policymakers have to weigh the trade-off between insisting on decency in working conditions, with imposing standards of the already industrialized countries on the developing world, as these policies may cost large numbers of jobs in manufacturing in developing countries.
A primary argument must be made that there is some sort of market failure that voids the standard logic of free trade. One might argue that Microsoft’s monopoly position allows it to capture excessive profits, and that its market power dissuades entry. A state-sponsored firm might be able to overcome these entry costs. Furthermore, the software industry may have numerous knowledge spillovers with other industries and high-tech applications that make it desirable to have some local presence even if the local industry loses money. On the other hand, Microsoft may be a natural monopoly.
It is much easier for the world to have one computer standard. Furthermore, state direction of an industry where innovation is so important is unlikely to be successful. Finally, in software, physical location may be of minor importance as ancillary industries could develop anywhere and use modern telecommunications technology to interact with U.S. based software firms.
The main critique against the WTO with respect to environmental issues is that the WTO refuses to impose environmental standards on countries, but rather does not allow countries to discriminate against imported goods that are held to a different standard than domestically produced goods. In some respects those opposed to globalization would rather see the WTO have more power than it actually claims for itself, power to impose environmental laws as well as resolve trade disputes. However, the WTO does in one sense intervene in environmental issues of member countries by forcing member countries to apply the same standards to imported goods as to domestically produced goods.
The French may be following an active nationalist cultural policy as an economic or strategic trade policy to the extent that cultural activities, such as art, music, fashion, and cuisine, are linked to other French major industries. Indeed, the fashion industry is tied to the huge textile industry, as well as to the retail sector and advertising services. One could argue that the promotion of fashion, art, and music will benefit both tourism, and these large strategic trade sectors of the French economy. However, the existence of market failures is not clearly documented in the cultural sector except to the extent that there are other less tangible externalities. Furthermore, the cultural promotions are not, in economic terms, the first best approach to supporting larger industries.
The concern is seen clearly in the idea of the environmental Kuznets curve where environmental damage increases as a country moves from very poor to middle income and declines as the country gets subsequently richer. The problem comes if the fastest growing countries are the ones moving from poor to middle income, especially large countries such as India and China who are almost certainly on the up slope of the curve. Thus, the countries doing increasing environmental damage are relatively poor, making stopping growing environmental damage a challenge. On the other hand, as Figure 11-2 shows, the U.S. is still the world leader in carbon dioxide emissions, and as Figure 1 shows, rich countries moving from Points C to D could help balance poor countries move from A to B. Lastly, it is possible that rich countries could make side payments or share technologies to help the growth of poor countries be less environmentally damaging (effectively flattening the curve).
A pollution haven is a place where economic activity that is subject to strong environmental regulation in other countries may operate without such regulations. France’s concern is that its (and other EU countries’) regulation of carbon emissions may be pointless if economic activity that generates carbon dioxide emissions simply moves to other locations that do not have such regulations. Given the worldwide long run externalities of carbon dioxide emissions, the goal of the policy makes sense. On the other hand, the implementation will likely be judged discriminatory due to the fact that Frances’ domestic regulation comes in the form of tradable permits and its restrictions on imports is in the form of a tax.
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