## Narcís Serra and Joseph E. Stiglitz

Print publication date: 2008

Print ISBN-13: 9780199534081

Published to Oxford Scholarship Online: May 2008

DOI: 10.1093/acprof:oso/9780199534081.001.0001

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# The World Trading System and Implications of External Opening 1

Chapter:
(p.180) 10 The World Trading System and Implications of External Opening1
Source:
The Washington Consensus Reconsidered
Publisher:
Oxford University Press
DOI:10.1093/acprof:oso/9780199534081.003.0010

# Abstract and Keywords

Countries can still reap substantial economic benefits from external opening — an estimated 0.3% increase in income over twenty years for each 0.01 increase in the ratio of trade to GDP. Non-economic effects of trade are more complicated. Taking the case of SO2 pollution, trade can be on net beneficial, while for CO2 the outlook is worse, absent effective global governance, due to the international free rider problem. This chapter considers what should be priorities for the form and content of trade negotiations. The conclusion is to favour multilateral negotiations, as in the WTO. The chapter's back-of-the-envelope attempt to take into account dynamic gains says that the increase in welfare from comprehensive multilateral liberalization, such as the Doha Round if it had been successful, might have been 2% of global income. Environmental issues increasingly need to be addressed through multilateral institutions as well; they cannot be addressed through the assertion of national sovereignty.

# Introduction

The idea that it is more efficient for countries to engage in international trade than to produce everything they want domestically is virtually as old as the field of economics itself. During the first half of the 20th century, governments turned back the hands on the historical clock of international integration. The resulting decline in trade was implicated in world depression, political upheaval, and war. During the second half of the 20th century, the leadership of the Western alliance, in general, and at one time the United States, in particular, turned forward the hands of international integration. The resulting increase in trade has been accompanied by overall world prosperity and the spread of Western economic and political values to virtually all parts of the globe.

Nonetheless, critics are questioning the gains from further efforts to liberalize trade. Many are not convinced that historical correlation implies causation. Others might agree that the increase in trade has contributed to economic growth, but argue that concerns other than GDP—such as equality or the environment—point to a different judgment regarding the desirability of trade. Still others might agree with the characterization of the last half‐century, but say that little more now remains to be done. After all, most tariffs are now close to zero, and international integration seems to be complete.

The chapter begins by pointing out that external opening, which here means reductions in barriers to international trade, still has a long way to (p.181) go. It reviews the evidence on the economic benefits from integration. It reports an econometric attempt to address a major concern regarding simultaneous causality between growth and trade: does openness lead to growth, or does growth lead to openness? We remove the complication of simultaneous causality by isolating variation in trade patterns that could be clearly attributed to geographical influences. The result indicates that the observed effect of trade on growth—an estimated 0.3 percent increase in income over 20 years for each 0.01 increase in the ratio of trade to GDP—is not attributable to simultaneity.

Next the chapter considers non‐economic effects, taking the case of the environment. The evidence suggests that for some pollutants (such as SO2) trade can be on net beneficial, while for other environmental criteria (such as CO2) the reverse is true. A ready explanation is that when externalities arise primarily at the national level as with local air and water pollution, an adequate level of income and effective national governance are sufficient to enact regulation to protect the environment, but that in the increasingly important case of global externalities such as emissions of greenhouse gases, the free‐rider problem prevents individual countries from acting on their own in the absence of an effective international agreement.

More recent estimates of the comparative static gains in economic welfare from a hypothetical full global liberalization of goods and services trade, surveyed by Anderson (2004), are similar. The more conservative estimates are: US$254 billion (1995 dollar, taking 2005 as the baseline year) according to ADFHHM (2002), US$355 billion (1997 dollar, on 2005 baseline year) according to WBGEP (2003), and US$367 billion (1997 dollar, on 1997 baseline year) according to FMT (2003).45 In round numbers, again 1 percent of gross world product. Approximately half the gains accrue to OECD countries and half to poor countries. More specifically, according to the Anderson (2004) estimates of welfare gains to be had from removing all post‐Uruguay Round barriers to goods trade, 57 percent of the gains accrue to developed countries and 43 percent to developing. The more relevant policy question is what sorts of liberalization are most important. Liberalization by high‐income countries is credited with 55 percent of world gains. The most important sector for liberalization is agriculture and food (responsible for 65 percent of global gains). Here the view that the emphasis should be on barriers in rich countries is true in that three times as much of the benefits of agricultural liberalization come from rich‐country liberalization as poor; on the other hand three times as much of the benefits go to rich countries as well. Liberalization in manufactures also matters, and here it is the removal of the barriers kept by developing countries that is most important, responsible for three‐quarters of the total. If one is choosing among priorities for liberalization by developing countries, in their own interests, the estimated returns to the agriculture and food sector are exactly the same as the return to manufactures (including textiles and clothing): each is equal to 12.3 percent of the aggregate global gains from removal of all remaining barriers to goods trade. As estimates from the potential gains from the Doha Round, these CGE estimates are very optimistic in that trade negotiations usually in fact fall far short of goals such as cutting barriers in half, let alone eliminating them completely, as the authors know. On the other hand, they are conservative in two respects. 1. 1. They build into the baseline full liberalization with respect to China, Taiwan, and textiles and apparel because it has already been agreed, though it might not be realistic to think it will be fully implemented. 2. (p.209) 3. 2. More importantly, they only attempt to capture static gains. The estimates of the CGE models are not generally designed to take into account the possible long‐term effects on the growth rate, as opposed to a one‐shot effect on the level of real income—the dynamic benefits mentioned earlier in this chapter. As already noted, these potential dynamic gains include the benefits of technological improvements through increased contact with foreigners and their alternative production styles. Such interactions can come, for example, from direct investment by foreign firms with proprietary knowledge, or by the exposure to imported goods that embody technologies developed abroad. For a back of the envelope calculation that includes all growth effects, one approach is to return to the macro estimates of the effect of openness on growth. One of the CGE estimates entails a 20 percent increase in global trade volumes,46 raising the global levels of merchandise exports plus imports as a share of income from a ratio of about 37 percent to 45 percent. Combining it with the 0.3 Frankel‐Romer coefficient implies that global liberalization might raise global income per capita by 2 percent over a two decade period (and four times that in the truly long run). In other words, the dynamic gains over 20 years are roughly double the static estimates. Needless to say, such a calculation merits many qualifications. And some will say these effects are small. But to me they seem large. If trade can have long‐term effects of this nature, it makes the case for further integration even more compelling. References Bibliography references: Acemoglu, D., Johnson, S., and Robinson, J. (2001). ‘Colonial Origins of Comparative Development: An Empirical Investigation’. American Economic Review, 91: 1369–401. —— (2002a). ‘Reversal of Fortune: Geography and Institutions in the Making of the Modern World Income Distribution’, Quarterly Journal of Economics. —— and Thaicharoen, Y. 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CEPR Policy Paper, No. 4. ## Notes: (1) The paper this chapter comes from was written for the forum ‘From the Washington Consensus Towards a New Global Governance,’ Fundacio CIDOB, Barcelona, Spain, held September 24–25, 2004. The author would like to thank Maral Shamloo for research assistance and the Kuwait Fund at Harvard University for research support. (2) For example, in the case of the US, even though the trade/output ratio has already tripled over the post‐war period, it would have to rise from its current 12 percent to 70 or 75 percent before it fully reflected the share of non‐US producers and consumers in the world economy. (Because of its size, the US appears off the chart, in the lower right corner.) Even this statistic of a six‐fold gap is an understatement, because exports and imports are gross transactions, not net value‐added. Singapore and Hong Kong, for example, export and import well over 100 percent of their GDPs (because of their extreme openness, they too appear off the chart, in the upper left corner). (3) These estimates of the gravity model of bilateral trade are from Frankel (1997); Rose (2000); and Frankel and Rose (2002). (4) For example, Helliwell (2000). (5) Engel and Rogers (1996). (6) The most important reference is probably Helpman and Krugman (1985). (7) Important citations include Grossman and Helpman (1991a, b); Rivera‐Batiz and Romer (1991); and Romer (1994). (8) Examples include Michaely (1977); Krueger (1978); Feder (1982); Kohli and Singh (1989); Quah and Rauch (1990); de Melo and Robinson (1991); DeLong and Summers (1991); Dollar (1992); Edwards (1993a); Romer (1994); Sachs and Warner (1995); Harrison (1995); and Eusufzai (1996). Edwards (1993b), Rodrik (1993), and USITC (1997) survey the literature. (9) Four examples for Asia are Helliwell (1995); Page (1994); Pack and Page (1994); and Fukuda and Toya (1995). Bradford (1994) surveys the literature. (10) Empirical studies that emphasize imports include Lee (1995) and Wacziarg (2001). (11) Levine and Renelt (1992) reach similar conclusions. (12) For example, Rodriguez and Rodrik (2001) argue that the Sachs‐Warner measure is driven overwhelmingly, not by tariffs or quotas, but by the black market premium for foreign exchange, and a measure of state export monopoly. They argue that these largely reflect policies not related to trade. (13) Jung and Marshall (1985), Hutchison and Singh (1987, 1992), and Bradford and Chakwin (1993) apply Granger‐causality tests to the problem. Esfahani (1991) attempts a simultaneous equation approach. (14) Perhaps the best theoretical rationale for the idea that bilateral trade depends on the product of GDPs comes from the model of trade in imperfect substitutes, e.g., Helpman and Krugman (1985). Frankel (1997) elaborates, applying the gravity model to issues of trade blocs, tests for trade blocs, and gives further references. (15) For a study that seeks to explain growth for a cross‐section of countries, one does not wish to treat GDPs of trading partners as exogenous, even if the domestic country is small. But if the standard factor accumulation terms in a growth regression (labor force growth, investment, and education) can be treated as exogenous in the domestic country, then they can also be considered exogenous in trading partners, as discussed below. An alternative is to omit income from the exogenous variables, and use population alone to represent country size. (16) Estimates in Frankel and Rose (2002) contain updated data and a sample of 200 diverse countries, and added as variables in explaining bilateral trade: common languages, common borders, common colonizers, and FTA membership. Perhaps for this reason, the t-ratio on openness in the growth equation rose, from 2–3 in Frankel‐Romer, to 3–5 in Frankel‐Rose (and the correlation of the gravity‐based instrument with actual trade/GDP rose from 0.62 to 0.72). (17) Taken from the working paper version of Frankel and Rose (2005). (18) Frankel and Romer (1999) and Irwin and Terviö (2002) adopted a more stripped down specification by omitting these controls, following Hall and Jones (1999). They regress output per capita against distance from the equator and measures of country size, reasoning that the factor accumulation variables might be endogenous. Including the controls in the output equation might result in a downward biased estimate of a, if some of the effect of openness arrives via factor accumulation. But inappropriately excluding these variables would also produce biased results and could be expected improperly to attribute too large an effect to trade. My own preference is for the specification that includes the controls, in part because it is likely to avoid a possible upward bias in the openness coefficient. (19) Diamond (1997); Gallup et al. (1998); Hall and Jones (1999); and Sachs (2001). (20) Bosworth and Collins (2003) use a composite of tropical area and frost days. (21) Easterly and Levine just group openness together with other policies. Hall and Jones consider latitude a proxy for European institutions, and thus don't distinguish the independent effect of tropical conditions. (22) There were exceptions to the rule: the failure of Argentina during the 20th century and the success of Japan, the failure of Eastern Europe during the last third of the century and the success of the East Asian Newly Industrialized Countries (NICs). But there is little agreement over what lessons to draw from these cases. (23) Two references in this rapidly growing field are: Jagdish Bhagwati and Robert Hudec (1996) and Dani Rodrik (1997). Maskus (2002) argues that labor issues lack the international externalities of competition policy or cross‐border environmental problems. (24) Frankel (2004) surveys the effects of international trade and the WTO on the environment. (25) An earlier reference is International Bank of Reconstruction and Development (IBRD) (1992). Frankel and Rose (2005) put the peak in concentrations at an income of about US$6,800 per capita, for the case of SO2.

(26) Adam Jaffe et al. (1995).

(27) In any case, indoor air pollution (particulate matter from cooking and heating fires) and lack of clean drinking water are larger environmental threats in poor countries, each claiming millions of premature deaths per year. Economic development is the best way to address them.

(29) Frankel (1997) offers an analytical framework that evaluates whether regional trading arrangements are natural—more likely to be trade‐creating than trade‐diverting—and an extensive review of the literature, including the political economy of regional arrangements.

(30) Progress is unlikely to accelerate after the 2004 US presidential election, because the president will need to pass a farm bill and new fast‐track authorization in 2006.

(31) Bhagwati (1998). The requirement that WTO members must adhere to all negotiated obligations as a ‘single undertaking’ still has exceptions for the poorest developing countries. Also, two areas, government procurement and civil aviation, remain under ‘plurilateral accords’ of the WTO (see Schott 1998).

(32) In the past, the immediate legal obstacle to including most environmental and labor issues, beyond the more fundamental political obstacles, has been the key distinction between internationally traded goods, which are the proper subject of internationally agreed rules, and the processes by which the goods are produced within each country, which have not been considered an appropriate subject for the WTO. It might be argued that the inclusion of intellectual property rights in the Uruguay Round and the shrimp‐turtle case in which the WTO panel and appellate body affirmed the right of the United States to seek to influence the methods used by shrimp fishermen in the Indian Ocean, have now shattered the distinction regarding processes. But environmentalists have failed to notice this trend or to capitalize on the precedent.

(33) Wang and Winters (2000), Arvind Subramanian (1999).

(34) Less developed countries tend to tax agriculture rather than subsidizing it. In OECD countries, agricultural protection, measured as the rate of assistance, has risen to about 60 percent in 1998, from about 30 percent 30 years earlier, a period during which tariffs on industrial goods have fallen sharply (Hertel 1999; and Roberts et al. 1999).

(35) Anderson et al. (1999).

(36) Hoekman (1995, 1999).

(37) The enactment of anti‐dumping duties means import quantities on average fall by almost 70 percent and import prices rise by more than 30 percent (Prusa 2000).

(38) e.g., China initiated 22 AD investigations in 2003, compared to six in 2000 (FT, June 7, 2004).

(39) Bhagwati (1998) and Graham (1998).

(40) Richardson (1998).

(41) Cooper (1986).

(42) Francois et al. (1996).

(43) Jackson (2000).

(44) Nagarajan (1999) includes in his experiment a modest reduction in trade costs from a WTO agreement on trade facilitation, coupled together with a 50 percent across‐the‐board cut in worldwide protection in all agricultural, industrial, and services sectors. He estimates resulting annual welfare gains of around US$400 billion for the world economy, or about 1.4 percent of global income. In addition, a WTO agreement on competition is said to generate an annual welfare gain of approximately US$85 billion. Dee and Hanslow (2000) use a version of the model that has been modified to include the effects of foreign direct investment, so as to be able better to get at liberalization in services. They project an increase in world real income of more than US$260 billion in current dollars as a result of eliminating all post‐Uruguay trade barriers (pp. 17–18). About US$50 billion of this would come from agricultural liberalization, US$80 billion from liberalization of manufactures, and US$130 billion from liberalizing services trade.

(45) Anderson et al. (2002); Brown et al. (2003); Francois et al. (2003).