The Failure of the OECD's Brand of Trade Liberalization

The Failure of OECD's Brand of Trade Liberalization: A Need to

Reexamine the Paradigm

Moriah Lee

Dr. Wedig

Economic Development Fall 2014

The Josef Korbel School of International Studies

University of Denver

Lee, Moriah Failure of Trade Liberalization

Table of ContentsIntroduction...................................................3Failure of Rapid Trade Liberalization to Generate the Expected Gains..........................................................3Structural Biases Within the Current International Economic System.........................................................7Measures for Achieving an Internationally Competitive Level of Economic Development..........................................10Conclusion....................................................13Appendices....................................................15References....................................................17

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Introduction

To conceive of economic phenomena as embedded is not to renounce theory, certainlynot; it is to start theorizing differently. Caille 1994

I would add to Mr. Caille's statement that, in light of the

colossal failure of rapid trade liberalization fostered by mainly

OECD-run development aid agencies, it is in fact imperative that

these agencies in tandem with least developed countries (LDC's)

"theorize differently", if their economic viability is to be had

in the 21st century. The policies pursued by these aid agencies

have come to be known as "The Washington Consensus", and are

rooted firmly in the Neoclassical approach to economic thinking.

Extensive global trade liberalization had definite expected

gains; it is these that led to its entrenched promotion globally

to the point where it has become part of the institutions

themselves. Criticisms of these policies are based firstly on the

failure of expected gains due to structural biases within the

current fragile international economic system, and second,

distorted capabilities on behalf of developing countries to

handle the liberalization of their markets. These criticisms

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provide a generalized view of specific phenomena, often lacking

empirical evidence. The best measures for achieving an

internationally competitive level of economic development,

therefore, should be incumbent upon the specific LDC to, rather

than allow for the propagation of external policies, critically

examine the specifics of their own context. Indeed, the best

external action on behalf of the OECD-run development aid

agencies would be to respect these internal decisions, as well as

structure trade policies around individual country contexts

rather than the inverse.

Failure of Rapid Trade Liberalization to Generate the Expected GainsThe expected gains from trade liberalization perpetuated the

idea, but each has resulted in significant shortcomings in the

case of most LDC's. Two exceptions or success stories are India

and China- at least in strict terms of GDP growth. The suggested

OECD policy path didn't take into consideration the complexity of

the challenges in achieving economic development (Figure 1).

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One expected gain was that market liberalization would optimize

global resource allocation, increase commodities and maximize

consumer welfare. Because of asymmetric gains, however, this has

not happened (Smith and Toye 1979). Because of the diversity of

natural resources, institutional capabilities, and existing

infrastructure, it makes sense to assume that there is room for

comparative advantage to play out which is purported to promote

consumer welfare as a result of increased utilization of

resources via trade avenues. But this phenomenon, comparative

advantage, is not a natural, self-regulating process. That is;

the idea of mutually beneficial trade is based on the policies

that guide resource mobility (Smith and Toye 1979). Policies must

include regulation enforced from within in the form of

protections until the country can understand its capabilities and

its appropriate role in the international trade and finance

arena. Or, in other words, competition does increase as a result

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of trade liberalization, but increased competition without

innovation leads to disaster in the form of inequality.1,2

Nor did trade liberalization's removal of distortionary effects

of trade reduce rent-seeking behavior, another purported

advantage. Rather, liberalization policies, again, induced much

higher wage and resource access inequalities (Stiglitz 2014).

High inequality diminishes a shared sense of purpose and may

facilitate rent-seeking behavior in governments or economic

groups (UNDP 2014).

Trade liberalization was also supposed to generate gains by

expanding the country's markets and realizing economies of

1 Latin America, Sub-Saharan Africa, the Middle East, North Africa, and South Asia have fallen behind the West relative to average income since the ‘80's, and their manufacturing sectors are stagnating in the face of East Asian competition (Wade 2011).2 The UN Development Program's Human Development Report 1999 states: "The top fifth of the world's people in the richest countries enjoy 82 percent of the expanding export trade and 68 percent of foreign direct investment --- the bottom fifth, barely more than 1 percent. These trends reinforce economic stagnation and low human development. Only 33 countries managed to sustain 3 percent annual growth during 1980-96. For 59 countries (mainly in Sub-Saharan Africa and Eastern Europe and the CIS) GNP per capita declined. Economic integration is thus dividing developing and transition economies into those that are benefiting from global opportunities and those that are not" (pg. 31).

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scale. Inherently in the definition of "economies of scale" is

the reality that for small to medium companies, increasing

production may raise costs. In the case of China's manufacturing

industry, this has proven to be good news because of low-labor

costs, large manufacturing base and high-level of supply-chain

logistical integration. In the case of India, however, the

government did not access technology from abroad or take

advantage of economies of scale, therefore, lags behind China in

terms of growth. Additionally, China induced productivity growth

through improved innovation (diffusion of technologies, lower

costs) driven by competition, which was an expected gain of

liberalization, while India, again, lagged behind in rapid

economic growth because of its internal focus on small-scale

industry (Dahlman 2009). It is obvious in the case of both China

and India that growth is a result of accessing outside knowledge

and expanding on it within their contexts (Dahlman 2009).

Additionally, both the enormous size of China's economy and the

fact that it significantly protected infant industry allowed it

to take successfully on liberalization policies (Dahlman 2009).

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Another expected gain was increased agricultural production

through price incentives. In India, this has been the case where

syndicated research efforts increased varieties of wheat, thus

improving grain exports (Dahlman 2009). A final expected gain was

the reduction of poverty by the relocation of resources to low-

skilled, labor-intensive industries, or comparative advantage

specialization, as previously mentioned. In India's case, the

export sector is largely knowledge-based, or service-based. Urban

migration has increased concordantly with population and GDP

growth in India, but this action has not increased access to the

global economy for most of these workers (Figure 2, Davies and

Vadlamannati 2013). It has increased inequality in what has been

called "race to the bottom in labor standards," (Davies and

Vadlamannati 2013).

Trade liberalization, as a component of pecuniary transformation,

worked within India and China for the above-mentioned reasons, as

it has worked for some low and middle-income regions as well.

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However, success again was limited to those countries whose

changes took place within highly industrialized economies (Sachs

1996). Unfortunately, these growth patterns later declined in the

cases of two regions encompassing several countries that we will

look at- the case of Eastern Europe and the former Soviet Union

(EEFSU) countries, and the East Asian countries once touted as a

miracle. In these regions, liberalization led to a severe crisis.

In the case of EEFSU countries, rapid trade liberalization in the

context of highly industrialized economies allowed no room for

interests to form around barriers to trade, which is a positive

thing (Sachs 1996). As Sachs demonstrates with a regression

between economic growth (defined through GDP increase) and reform

progress, "…liberalization of the economy surely proved to be the

quickest and most effective area of change." This progress

quickly reversed, however. According to the European Bank for

Reconstruction and Development, in 2002, twelve years after the

start of economic transition, most post-Communist countries had

not returned to their 1989 levels of economic output; in fact,

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liberalization in these countries has a strong correlation with

an increase in mortality rates in the region (Fidrmuc 2003,

Stuckler et. al. 2009).

The East Asian Economic crisis mirrors the experience of the

EEFSU transition, without the dramatic mortality rate increase.

That is; inappropriately performed financial liberalization was a

primary cause of the crisis. East Asia had been lauded by the

international agencies, as a "Miracle," a phrase coined, in fact,

by the World Bank to stand as a testament to its successful

policies (Sachs 1996). Like the EEFSU, these policies were

enacted in what was assumed to be an environment that was

institutionally sound enough to handle the changes. The weak

financial sectors proved, in fact, linked to the shocks of

capital flows. This volatility was reflected in the cases of many

Latin American countries in the 1980s, to Mexico in 1994, to

Sweden and Norway in the early 1990s (Kaminsky 2000). These

countries all faced, among other disadvantages, sudden currency

depreciation due to speculative attacks or large outflows of

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funds, the deregulation of which is a requirement of

liberalization (Kaminsky 2000).

Structural Biases Within the Current International Economic System

Structural biases within the current international economic

system have limited poor countries in making their policies

(Dahlman 2009, Stiglitz 2014). Since the debt crisis of the

70's, when many developing countries came under World Bank, WTO,

and IMF policies which included trade-liberalization, the fear of

default on loans from these agencies imposes policy constraints

not only relating to trade. These constraints make it difficult

for countries to change their policies toward healthy economic

growth. The paradigm is set, so what we need is to reexamine this

paradigm and change the framework, or extend it so that countries

may make policies of their own that allow for contextual

considerations (Smith and Toye 1979).

Many countries fell into debt because of commodity price

fluctuation. China's success in manufacturing has increased

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commodity prices worldwide, but just like coffee and natural gas

commodity prices fluctuated dramatically due to weather changes,

the international business cycle demands that the commodity

prices worldwide must drop in the future (Dahlman 2009). Since

most of the raw commodities-exporting countries currently are not

using the income to boost their long-term capacities through say,

education or infrastructure improvement, they will be facing

tougher competition in the wake of the inevitable fall of prices

(Dahlman 2009). Also, the final products from China are being

exported to developed countries that can afford luxury items.

This phenomenon of resources being extracted from poor countries

(periphery) to promote the wealth of developed countries (core)

is reflected in the Dependency Theory.

The Dependency school theorizes that the current paradigm has

made it to where resources flow from poor countries into

developed ones or the standard of living in developed countries

is dependent upon the output of developing ones. Essentially, the

idea is that the nature of how developing countries are

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integrated to the global economic system perpetuates poverty in

these developing countries based on an inability to escape what

has been the status quo for the last 30 some-odd years. Developed

countries have been accused of propagating this inability out of

their presumed necessity to keep underdeveloped countries

underdeveloped (Smith and Toye 1979, Stiglitz 2014). This seems a

reasonable indictment and may even be apparent in the case of

growth of China's manufacturing industry into the largest in the

world based on cheap labor and heightened exports (Dahlman 2009).

African countries undersell themselves as well in this regard.

Dependency theory also argues that there will never be a right

time for LDC's to trade with developed countries and that self-

reliance should be maintained indefinitely. Unfortunately, the

permanent aid agency policies deny LDC's access to many of the

technological advances that developing countries have made. A

good example of this happening is in Argentina, where "the 1964

Ford Falcon is still being produced with the U.S. machinery of

that time, without model change, as if the clock has stopped,"

(Dornbusch 1992). Additionally, low elasticity of demand, or

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sensitivity of consumers to price change, is affecting people's

well being at the family level. Just like governments are not

able to rapidly switch to more productive modes of trade via

manufacturing or service of goods and services that are in higher

demand, consumers cannot rapidly change their buying habits if

they are stranded in an economy fueled by low-paying jobs.

Also, The IMF and WB continue to grant new loans and impose new

"belt-tightening" restrictions (structural adjustment policies,

or SAP's) dictating what a country can spend, and how they can

spend it; these SAP's may include requiring countries to cut

spending on education and health, eliminate basic food and

transportation subsidies, devalue national currencies to make

exports cheaper, privatize national assets, freeze wages, and

finally, liberalize their trade policies (Chattopadhyay 2000).

OECD-run debt relief agencies justification of these impositions

is that they ensure debt repayment. The consequences of these

imposed policies now seem clear. That is; the cycle of poverty

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has been, on an international scale, perpetuated, rather than

eliminated (Chang 2003).

Short-term liberalization has demonstrated far-reaching effects

for long-term macroeconomic stability. The interconnected nature

of the global economic system means a change in these policies

falls to both LDC's and OECD agencies. Poor countries would be

better off to protect their economies until they have achieved an

internationally competitive level of economic development (Wade

2011).

Measures for Achieving an Internationally Competitive Level of Economic Development

The reexamination of the global economic liberalization paradigm

would ideally involve the acknowledgment of behalf of OECD

development agencies of their responsibility in creating this

vicious cycle. Even if they completely change their policies,

which they have failed to do so far, the responsibility falls to

the countries themselves, who have demonstrated varying levels of

success in economic reforms. The common thread is that

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institutional capabilities are a vital prerequisite to handle

economic liberalization, and those capabilities and institutions

almost by definition, are linked to distinct cultural realities,

existing economic conditions, thus government ability to regulate

and protect markets and infant industry (Wade 2011, Stiglitz

2014, Smith and Toye 1979). Therefore, countries must come at

their pace to the liberalization table if they are to liberalize

successfully (Dahlman 2009). This is in accordance with

Structuralist theory.

Structuralists make their position in the middle and acknowledge

that while there are gains from free trade to be made for LDC's

and developed countries alike, free trade might be harmful to

LDC's if not managed appropriately. Structuralist policies favor

government support to protect infant industry and promote

industrial development, thus strengthen institutions through

regulation (Lin and Chang 2009, Wade 2012). Yet, the Washington

Consensus has prescribed a removed economic role for the state,

relying instead and foolishly on the purported self-regulating

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nature of the "free market". The lack of development in LDC's

globally has undermined this belief to the extent that the OECD

aid agencies and the US have begun to question what it before

considered conventional wisdom. The subtle nature of the global

economic system requires an equally nuanced approach to policy.

Thankfully, an increase in the belief in a more Structuralist

approach, that is, the importance of governments' roles, has

evidence of having taken hold.

All countries internally face the adoption of a framework to

promote long-term economic growth. Inherently trade, thus

international economic relations, is spurred externally. While

forgiveness of loans is an example of a policy that would

potentially spur growth, the dependency theory demonstrates that

a break from the world economic system by LDC's is indeed called

for. The need for countries to have the freedom to make their own

policies lay in what Smith and Toye call in reference to Samir

Amin's Marxist analysis "freedom of maneuver in relation to world

capitalism" (1979). This broad theory kind of ignores contextual

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realities, but nonetheless has value based on the fact that

neoliberal policies, or those promoted by the Washington

Consensus, have resulted in the many negative economic outcomes

in LDC's in the form of commodity fluctuation and low GDP growth

which is linked to internal access to resources at the family

level. However, theories at high level of abstraction may have

landed many world economies in crisis, so it's important to look

at individual circumstances in any case. In the case of India and

China, both have grown, one faster than the other, under

protectionism and strict internal and external market controls on

behalf of the government (Dahlman 2009).

Industrial Policy has made all the difference in the context of

China and India's growth, both at over double the percentage of

world GDP growth (Dahlman 2009). Yet, their examples provide

little in the way of models for other LDC's to follow because,

firstly, their contexts are larger economically and in terms of

population, and secondly, the world has, "become more restrictive

towards traditional industrial policy" (Dahlman 2009). Industrial

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policy can mean any of the following, and usually does encompass

some form of, "direct state ownership, selective credit

allocation, favorable tax treatment to specific industries,

tariff and non‐tariff barriers to imports, and restrictions on

foreign direct investment, local content requirements, special

intellectual property rights policies, government procurement,

and promotion of large domestic firms" (Dahlman 2009). The

different approaches to each of these within the two countries

have partly contributed to their respective rates of growth.

China's industrial policy has been focused on manufacturing,

while India's has uniquely been focused on information and

communications technology (ICT), which was and is driven by

entrepreneurs. India, in fact, focused more on education of

engineers, which propped up their now booming service sector

(Dahlman 2009). In other developing countries, the answer to

continual economic growth isn't merely a strong industrial

policy, but the private sector that goes along with it, and

government policies to prop up that private sector growth (Lin

and Chang 2009).

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Indeed, for states to even be qualified to intervene with

policies, there are major prerequisites so that LDC's don't end

up worse off due to corruption, failed policies, additional debt

and a soiled reputation. Once institutional capability to handle

trade relations within the government is established, LDC's

should focus both on short-term goals via the generation of low-

skilled jobs, and gradually move towards medium to long-term

strategies by utilizing their comparative advantage. That is;

comparative advantage is not the end game. Focusing on the

utilization of abundant labor and available resources will allow

LDC's to gradually increase their economic development through

the strengthening of domestic firms, if, and only if, they

recognize the importance of using comparative advantage as a

short-term launch pad for other economic opportunities (Lin and

Chang 2009). The gradual nature of this process does not sound

appealing because it is tedious. However, tedium is how Korea and

Japan moved away and even ignored external policy suggestions and

established strong economies (Lin and Chang 2009). China is not

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following this path, as well as India via protectionism and

subsidies for infant industries (Dahlman 2009).

Almost as an aside, but an important point nonetheless, apart

from government action, actions taken on behalf of citizens can

provide the necessary spark for economic development. Collective

citizen action in the form of labor unions has successfully

challenged the corporate sector to improve the governance of

supply chains, in the apparel industry for example; over 150

retailers signed the legally enforceable Accord on Fire and

Building Safety in Bangladesh, which was issued in 2013 (UNDP

2014). Collective action as a means to spur growth is not common

but is worth mentioning because it is possible, thus a

consideration for policy makers and students of the field.

Conclusion

Today, greater vulnerability because of the nature of the current

economic system requires global and regional collective action of

governments in all cases and citizens in some where they are

able. The Washington Consensus has proven unable to promote

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symmetrical development in LDC's, and in fact in most cases has

stimulated inequality. The OECD aid agencies that propagated this

policy path are gradually recognizing the error of their ways,

but 30 years of entrenched policy, especially in the

international arena with its hegemonic and uncooperative nature,

is hard to break away from. Global integration in the economic

arena has shrank national policy space and constrain national

capacities to address their specific vulnerabilities. Even though

a subtle transition to policies that support Structuralist views,

or government involvement via regulation, is underway on behalf

of the OECD aid agencies due to their inefficiency to date, the

examples of India and China, among others demonstrate that it is

incumbent upon the internal workings of the LDC's to avoid rent-

seeking behavior, take advantage of the sectors at which they are

least bad via comparative advantage, and enforce regulation and

protectionism from within. These behaviors will ultimately result

in a gradual, but successful development campaign if administered

from within LDC governments.

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Appendices

Figure 1

There is a mismatch between global challenges and global governance mechanisms.

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Figure 2

Internal Migration Flows of India 2001

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Source: R.B. Bhagat and S. Mohanty, "Emerging Pattern of Urbanization and the Contribution ofMigration in Urban Growth in India,” Asian Population Studies, vol. 5 no. 1 (2009): 5-20

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References

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Chattopadhyay, R. (2000). Zimbabwe: Structural adjustment, distribution & food insecurity. Review of African political economy, 27(84), 307-316.

Dahlmann, Carl. "Growth and Development in China and India: The Role of Industrial and Innovation Policy in Rapid Catch‐Up. “Industrial Policy and Development: The Political Economy of Capabilities Accumulation (2009). Print.

Davies, R.B., and K.C. Vadlamannati. 2013. “A Race to the Bottom in Labor Standards? An Empirical Investigation.” Journal of Development Economics 103: 1–14

Dornbusch, R. (1992) The case for trade liberalization in developing countries. Journal of Economic Perspectives, 6 (1), pp.69-85.

Fidrmuc, J. "Economic Reform, Democracy And Growth During Post-communist Transition." European Journal of Political Economy 19 (2003): 583-604. European Journal of Political Economy. Web.

"Human Development Report 2014." (2014). UNDP. Web.

Kaminsky, Graciela L. "Currency and Banking Crises: The Early Warnings of Distress." Gwu.edu. 1 Jan. 2000.

Lin, Justin, and Ha-Joon Chang. "Should Industrial Policy in Developing Countries Conform to Comparative Advantage or Defy It?A Debate Between Justin Lin and Ha-Joon Chang." Development Policy Review 27.5 (2009): 483-502. Print.

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Sachs, Jeffrey. "The Transition at Mid Decade." The American Economic Review86.2 (1996): 128-33. American Economic Association. Web.

Smith, Sheila, and John Toye. "Introduction: Three Stories about Trade and Poor Economies." Journal of Development Studies 15.3 (1979): 1-18. Print.

Stiglitz, J. "Structural Change and Inequality." Azim Premji University Public Lecture Series. 9 Jan. 2014. Lecture.

Stuckler, D., L. King, and M. Mckee. "Mass Privatization And The Post-communist Mortality Crisis: A Cross-national Analysis. “The Lancet (2009): 399-407. The Lancet. Web. 8 Nov. 2014.

Wade, Robert H. "Return of Industrial Policy?" International Review of Applied Economics 26.2 (2011): 223-39. Print.

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The Failure of the OECD's Brand of Trade Liberalization

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