03 August 2018 15:22:56 IST

A long-time ‘deskie’, Baskar has spent much of his journalism career on the editorial desk. A keen follower of economic and political matters, he likes to view economic issues from a political economy lens as he believes the economic structure of a society is deeply embedded in its political and social ethos. Apart from writing the PolitEco column for BLoC, Baskar writes book reviews and articles on politics, economics and sports for the BL web edition. Reading and watching films are his other interests, though the choice of books and films are rather eclectic.  A keen follower of sports, especially his beloved Tottenham Hotspur FC, Baskar is an avid long-distance runner.  He hopes to learn music some day!

Trade wars and Ricardo’s theory of comparative advantage

The US, once a proponent of free trade, come a full circle on its policies

A full-fledged global trade war broke out a few months ago when US President Donald Trump slapped tariffs on a slew of goods, which included steel, aluminium and electronic goods. The tariffs were imposed against China, South Korea, Japan, Canada and the EU but were primarily aimed against China. Of course, the US’ humongous trade deficit against China was a hot electoral issue during the last US elections and Trump won the election on the promise of imposing tariffs and reducing the US’ trade deficit with China. In that sense, when Trump imposed the tariff he was merely keeping his electoral promise.

China too retaliated and imposed tariffs on goods ranging from aircraft to pork and soyabeans, hitting at Trump’s core constituency in the US.

US vs. China

Though China has been the primary target of the US administration, it has not spared its allies including the EU, Canada, and even India. India enjoys a trade surplus against the US, much to Trump’s chagrin. The US tariffs on steel extends to India too. India, on its part, threatened to retaliate by imposing tariffs on 29 US goods; but it may defer its plan to impose these tariffs, and perhaps give negotiations one last shot.

But how did things come to such a pass? After all, for more than three decades both the US governments and multilateral agencies, like the IMF and World Bank, have been extolling the virtues of free trade and exhorting the developing world to open up its markets and adopt more export-oriented policies.

When the WTO trade talks in Cancun, Mexico, collapsed in 2003, the then US Trade Representative, Robert Zoellick, who went on to become World Bank President, made a chilling comment that the US would continue to “prise open” markets around the world and redouble its efforts to reach bilateral trade deals. Fifteen years on, the US stance on global trade has indeed come a full circle.

Trade theory

It is interesting to see how traditional economic theory treated the issue of trade. Oxford economist Linda Yueh, who has also worked with the BBC and Bloomberg , in her recent book The Great Economists – How Their Ideas can Help Us Today devotes a chapter on David Ricardo, who was the first, and foremost, trade theorist in the history of economics.

Ricardo was born into a wealthy Jewish family in late 18th century in Britain, though his family disinherited him when he married a Quaker. But he went on to become a successful stock broker and ended up becoming the wealthiest man in Britain then. According to Yueh, after amassing wealth in stock market investments, Ricardo retired to the countryside and devoted himself to writing on economics.

Ricardo’s theory of comparative advantage in trade states that countries must focus on producing goods in which they have a ‘comparative advantage’ over others and import goods in which they have a relative disadvantage. He constructs a two-goods, two-nations model, where Portugal and Britain both produce cloth and wine. Now, even if Portugal is more efficient than Britain in producing both goods it must still focus only on producing the good in which it is relatively more efficient, and import the other. So according to Yueh, in Ricardo’s theory, “… countries gain from trade even if they are less efficient in all production than their trading partners”. So Ricardo’s theory was tied to economic efficiency.

Yueh goes on to argue that if the services sector is included then perhaps both the US and the UK would, if not run a trade surplus, at the very least have a much reduced trade deficit. So she argues for the opening up of the services sector for global trade, as both the US and the US have a comparative advantage in these sectors today.

The US’ hypocrisy

This is precisely the reason why the US, the UK and the EU have been pushing emerging economies such as India and China to open up their services sector and even trying to get this issue on the WTO agenda for negotiations.

India and other emerging economies have been vehemently opposing this as they want other important issues, such as food subsidies and food security, to be sorted out. Besides, the emerging economies want the Western nations to cut their mammoth agriculture subsidies before reciprocating on services.

Given how the US has been tightening the rules for the H1-B visas for Indians over the last few years — and this began during the Obama regime — it is rich on its part to ask India to open up its services sector to foreign competition.

Though Ricardo’s theory is an elegant construct, Yueh rightly asks what happens to workers who work in the “less efficient” industries. That the traditional industrial areas of the US turned into the “rust belt”, thanks to NAFTA and Chinese imports, is proof of their neglect by past US administrations.

So how would Ricardo view the current trade scenario? Yueh argues that Ricardo wouldn’t have been much concerned about the trade deficits of western nations but would have called for a more level playing field in international trade. She argues that Ricardo would have wanted more opening up of the services sector given the US and the UK’s relative advantage in those areas. But Ricardo would have also urged the scrapping of the West’s huge and unfair subsidies to farmers.

So, in a nutshell, global trade has winners and losers, just as the process of globalisation has. The challenge for governments and policy-makers is to take care of those who lose out. This issue holds as much a moral significance as economic.