02.03.2008
Is Free Trade Heading for Eclipse?
№1 2008 January/March
Jean-Pierre Lehmann

Jean-Pierre Lehmann is Emeritus Professor, IMD, and Founder of the Evian Group, Lausanne, Switzerland.

The answer to the
question posed in the title, seen from the perspectives and trends
of how things stand in the last quarter of 2007, would seem to be
“yes.” The great dream of the early 1990s, when President George
Bush Senior proclaimed that a “new world order” was about to dawn,
has now become a nightmare. It is true that the global economy is
booming, like never before, with growth occurring in all
continents, coupled with low inflation. And yet, the geopolitical
picture – which obviously influences trade – is bleak. While the
Middle East has long been a cauldron, it has reached an
unprecedented state of frenetic ebullition.

Much of global
instability and tensions can be ascribed to the disastrous policies
of the current American administration since 2001. In the 1990s,
the U.S. appeared as a benign hegemon, combining seemingly
formidable ‘hard power’ – military, geopolitical and economic might
– with unparalleled ‘soft power’ – the arts, academe, the media,
lifestyle, etc. Today, with the humiliating failure in Iraq, the
U.S.’ hard power appears inept and impotent; the economy is in a
state of uncontrolled disarray, while on soft power, the U.S.’
prestige in the world has plummeted to depths not seen for
decades.

The weakness of
the U.S. results in the aggravation of problems and indeed turning
what should be opportunities into threats. The most evident example
is China. Thus, while China’s massive entry into the global
economic arena since the 1980s should be heralded on all counts as
a tremendous positive boost, America’s economic disarray and
weakness of leadership are in grave danger of transforming this
great opportunity into a conflict.

Generally
speaking, while much of the responsibility must, per force, lie
with the global hegemon, the U.S., the global “mood” is generally
unhealthy. Between the great powers, the U.S., Russia, the EU,
China, India, Brazil and Japan, there is an acute absence of trust.
American weakness, geopolitical volatilities, the spirit of
mistrust, and lack of political will also explain why the global
trade agenda is at a paralytic standstill. In fact, the current
round of the WTO, the so-called Doha Development Agenda, is
effectively dead – certainly brain dead – though trade negotiators,
for reasons of their own, like to pretend otherwise. This in turn
both causes and reflects the growing obsolescence and irrelevance
of the international economic institutions.

Without a solid
global governance framework and the collective commitment of the
major trading powers to solidify the framework and adhere to its
rules and principles, and with the global economy bound to dip,
free trade will undoubtedly erode and protectionism, in various
guises, reappear. The outlook is not good.

FREE TRADE AND
POLITICAL POWER

There is no
serious economic theory that questions the basic premise that free
trade is the preferred form of cross-border economic relations and
that the benefits on balance accrue to most stakeholders. Both
material and welfare gains are considerable, including not only
standards of living but also the quality of life. Contrast North
Korea with South Korea or Myanmar with Thailand – or indeed Vietnam
– to get a sense of the costs of autarky in contrast to the great
gains, at all levels, of an open economy.

All great
civilizations have been great traders. Nayan Chanda’s excellent new
book (Bound Together: How Traders, Preachers, Adventurers and
Warriors Shaped Globalization, 2007), demonstrates how over the
millenniums trade has enhanced not only the consumption of goods
and the movement of capital, but also the flourishing of the arts
and sciences. Trade ultimately brought the Chinese invention of the
printing press to Europe, which in turn allowed Gutenberg to
publish his eponymous bible and thereby herald a cultural
revolution, bringing the written words to the masses, hence
breaking the monopolistic power on reading of the ecclesiastic and
civil autocracies. Trade with China also enabled the rich and
powerful of the West to decorate their palaces with Chinese
porcelains and scrolls, collectively known as chinoiseries. Today,
trade with China benefits millions, indeed billions, thanks to the
tremendous reduction of costs that Chinese production has brought
about. The price of a T-shirt in the U.S. is estimated to have
fallen by close to 40 percent this decade, clearly a great boost to
the poor, notably single mothers on social security.

Free trade cannot
be disassociated from the broader phenomenon of globalization.
Globalization in essence means the growing integration of markets
through the cross-border movements of goods, capital, information,
technology and people. Free trade is the engine of globalization. A
car may look beautiful, but unless it has an engine it will not
move. The same applies to the relationship between globalization
and free trade.

While there are
certain absolute fundamental realities about free trade, there are
also a number of myths. Thus there is the quite powerful myth,
propounded by some of the more enthusiastic advocates of free
trade, that there is a close correlation between trade and peace.
Tell that, as they say, to the Chinese. In the course of the Qing
Dynasty (1644-1911), China opted for an isolationist unilateralist
policy. By the late 18th and early 19th centuries, Britain,
followed by other Western powers, engaged in aggressive imperialist
trade policies. Dissatisfied with the meager results of its trade
with China, the gaping trade deficit and outflow of specie that
ensued, Britain sought, successfully, to force by war the Chinese
government to open its market to the one product that at the time
Britain knew was in great popular Chinese demand – Bengali opium.
Thus the Opium Wars (1838-1841, 1858-1860) stand in condemnation of
the view that free trade is peaceful and moral. Indeed, throughout
most of the 19th and early 20th centuries, China and other
non-Western countries (by the late 19th century joined by Japan)
were the victims of the West’s rapacious trade policies.

The modern
historical narrative of trade demonstrates that there is in fact a
very close correlation between economic trade and political power,
which at times has been transformed into military might. Gunboat
diplomacy during the era of Western imperialism more often than not
consisted of utilizing national military means for commercial
interests. This was the case with the Opium Wars. The Royal Navy
bombarded and invaded China to serve the interests of the great
Scottish opium traders of the period, notably Jardine, Matheson
& Co. Free trade, therefore, can be said to be the lance of the
powerful and protectionism the shield of the weak.

TRADE POLICIES
AFTER WORLD WAR TWO

After World War
II, when the power of the West seemed to have eroded, when
decolonization occurred and developing countries found new sources
of self-confidence and identity, and the prestige of the Soviet
Union soared, there was in the Second and Third Worlds a rejection
of the principles and practice of free trade and indeed of trade in
general, which was perceived, at best, as a necessary evil. The
adoption of protectionist policies ranged right across the
political spectrum, from democratic to dictatorial, from right to
left. Import substitution industrialization (ISI) policies were
premised on the theory that nations must build up strong domestic
industries before considering opening their markets; otherwise
their colonial conditions would remain. Thus India engaged in a
state-sponsored policy of quite extensive industrialization across
multiple sectors. As a senior Indian government official told the
author on a visit to New Delhi in 1981, “We [India] can make
everything from nuclear power stations to hairpins.”

One of the most
influential proponents of protectionism and import substitution was
the Argentine economist Raъl Prebisch who developed the theory of
dependencia. Whenever a developing country engages in trade with a
developed country, the theory goes, inevitably the developing
country will be caught in a trap of dependence whereby it is doomed
to remain forever a supplier of low value added commodities to the
industrialized country, in exchange for which it imports
manufactured goods, hence postponing irredeemably its own process
of industrialization. This perspective, indeed doctrine, prevailed
in most of the developing world until the late 1980s and the early
1990s.

The post-war
developments in the West, however, were quite different. Three
forces propelled the West to a greater degree of market integration
and trade liberalization. First, it was quite widely recognized
that the aggressive protectionist and trade war policies engaged in
by Western countries in the wake of the Great Depression of 1929
had not only caused great economic devastation, but also
contributed powerfully to the ultimate outbreak of war itself.
Second, the emergence of what Winston Churchill dubbed the “Iron
Curtain” and the ensuing Cold War acted as a major lever in
bringing about greater Western cooperation on all fronts, including
on trade. Third, the U.S. led forcefully in setting global economic
policy. Through both capital transfers, notably the Marshall Plan,
and opening up its own booming post-war market, it acted as a
formidable economic locomotive, allowing both its allies and its
erstwhile enemies (the Federal Republic of Germany, Italy and
Japan), to engage in economic reconstruction, ultimately leading to
a series of “economic miracles.”

An absolutely key
and indeed momentous lesson that the architects and leaders of the
post World War II economic system took away from the 1930s was that
trade between states needs an overarching framework and a set of
rules. It was the lawlessness indeed anarchy of the 1930s that had
caused, or certainly exacerbated, the economic conflicts that
occurred. Hence, the establishment of the General Agreement on
Tariffs and Trade (GATT) based on certain fundamental principles,
notably that of non-discrimination, and the compilation of rules
that would seek to ensure “fair” trade.

The consequences
were remarkable. The Western nations and Japan engaged in binding
multilateral trade agreements based on the principle of
non-discrimination. Their economies boomed, the specialization
emerging from trade allowed the Japanese, for example, to excel in
transport equipment (cars and motorcycles) and in electronics,
providing Western consumers with high quality low-cost goods.
Furthermore, while the countries of Western Europe, Japan, the
U.S., Canada, Australia and New Zealand had spent most of the first
half of the 20th century in various alliances at war with each
other, the new order brought both peace and prosperity.

However, the
West’s prosperity brought by the free trade came to stand in stark
contrast with the stagnation of the autarkic East increasingly in
the course of the latter decades of the 20th century. As popular
dissatisfaction mounted in the former Socialist states, the
developing countries that had been practicing import substitution
policies were facing financial crises. A group of developing
countries, which were initially referred to as the NIEs (newly
industrialized economies) of Hong Kong, Korea, Singapore and
Taiwan, were seen as models. These Four Dragons, as they were
subsequently called, had come to spurn import substitution
industrialization strategies in favor of remarkably successful
export oriented strategies (EOS).

As it became
increasingly seen that while central control and command economies
had failed, in contrast to the thriving market economies, the world
was also approaching what was about to become the information and
communication technology (ICT) revolution, the most profound
technological change since the industrial revolution or indeed, as
some have argued, since the publication half-a-millennium ago of
the Gutenberg bible.

Thus in the early
1990s, there occurred a dual global market and information
technology revolution that had great seismic force and indeed shook
the world. The outcome has not been a “new world order,” as
President Bush Snr argued, but a chaotic transition to a very
different, uncertain and still undecipherable paradigm. It was in
the midst of the early stages of this transition that the WTO was
established in 1995. In fact, the last GATT Round, the Uruguay
Round (UR), launched in Punta del Este in 1986 and concluded in
Marrakech in 1994, can be said to mark the transition from the
familiar paradigm of the world market economy that emerged from the
ashes of World War Two to the new globalization era.

THE CONSEQUENCES
OF THE OPEN MARKET SYSTEM

The trade system
that prevailed from 1945 to 1995 (or thereabouts) cannot be termed
global. It was international in the sense that it engaged multiple
nations and it was multilateral in that the trading nations adhered
to a set of principles – though often violating them in practice –
that derived from the GATT. However, it excluded all of the
Socialist nations, and most of the Third World countries were
either not members or simply passive. The GATT was effectively
controlled by four players who called the shots, in fact mainly the
first two: the U.S., the EU, Canada and Japan, collectively known
as the “Quad.”

This system could
be characterized as an oligopolistic cartel. It should be also
stated that these four accounted for 80 percent or more of world
trade. The result was that negotiations were conducted, compromises
were made and conclusions were reached in a manner and on terms
that benefited the Quad. The interests of other actors, notably the
developing countries, were not taken into consideration and indeed
they were disadvantaged in many ways. The advantages possessed by
the Quad – and also some of its peripheral members, such as
Switzerland, Norway and Australia – included the “savoir-faire” of
trade negotiation.

However, the
institutional “culture” that emerged during the GATT era has been
one of bureaucratic complexity and obfuscation. Trade documents
tend to be hellishly and totally unnecessarily complicated. The
GATT/WTO is also possibly unique in that its rhetoric, which is
unashamedly mercantilist, is in contradiction to its principles,
which are founded in liberalism. Thus the GATT/WTO has, rightly,
been derided by a number of its critics as a bastion of hypocrisy.
The most egregious example is agriculture, in which European
negotiators posture and pant that cutting subsidies and reducing
tariffs will impose great sacrifices, pain and, indeed suffering,
whereas in fact the great beneficiaries of European agricultural
reform and liberalization would be the European consumers,
especially poorer ones. The visceral inclination to bare-faced lies
on the part of negotiators has inevitably resulted in what can only
be termed a very warped institutional ethos, which undoubtedly has
contributed markedly to the deterioration of trust in global
governance.

For most of the
GATT era, this did not matter, as the key players, the Quad &
Co, knew the nature and “rules” of the game. But with a radically
changed environment, there is now a growing dissonance between the
game and reality and also between the defendants of the status quo
and the aspirations of new entrants.

The victory, if
that is the word, of the open market economic system has been truly
overwhelming and its consequences very wide-ranging and profound.
As the global market revolution occurred and more and more and more
nations came to embrace trade liberalization, the reflex in the
West was to salivate and leer over what were termed as “emerging
markets.” The fact that the “emerging markets” might also become
“emerging competitors” had not been thought through. The figures,
however, are revealing: in the period from 1994 to 2004, trade
increased among various countries as follows: India – 333 percent,
China – 487 percent, Chile – 550 percent, and Vietnam – 575
percent.

All of this has
resulted in a number of concurrent and intertwined
trends:

A number of
developing countries have dramatically increased their share of
world trade.
This is leading not only to much increased penetration of Western
(above all, the U.S.) markets, but also to ever-increasing flows of
what is termed ‘South-South’ trade and investments.
The accumulation of huge piles of foreign exchange reserves and the
windfalls generated in oil rich countries by the huge increases in
energy prices have brought about a change in the balance of global
prosperity, illustrated by the emergence of Sovereign Wealth Funds
(SWF).

In the meantime,
developing countries continue to feel discriminated against by the
system that the Quad club concocted over the decades.
While the new aspiring nations that are enjoying the fruits of
globalization – even though they may not be distributed equally –
have become enthusiasts of an open market economy, in the West
there is a rising backlash against open trade and increasingly
strident protectionist calls.

Consequently,
there is in fact a systemic failure in the global trading
system.
While free trade has become the lance of the strong, protectionism
has become the shield of the weak. Firms in the West that are
innovative and competitive remain committed to free trade, but
their political clout is decreasing.  At the same time, the
power of uncompetitive firms and the lobbies of those vested
interests that wish to maintain their privileges has been rising.
An ever increasing number of the workforce feel insecure. While
traditionally open markets only “threatened” blue collar workers,
with the rise of outsourcing – as a consequence of the ICT
revolution – white collar workers are also affected.

This rising
insecurity, the uncharted and seemingly turbulent waters in which
the global economic ship is heading, is occurring amidst
frightening environmental degradation and climate change,
apprehensions related to “identification” and immigration, the
steep decline of the U.S. and the quagmire of the Middle East, the
seemingly daunting industrial and financial muscle of China, rising
inequality and high levels of poverty, and the fear of possible
devastating pandemics.

The omens are not
good. And this is happening precisely at a time when the system
should be strengthened, not weakened, both in order to accommodate
the new players, China especially, and to ensure that the benefits
of trade are more evenly spread in order to enhance global
prosperity and hence reduce poverty.

There is a need,
indeed an imperative, for a new 21st century global contract,
something along the lines of the Atlantic Charter of 1941 that
heralded both the spirit and the structure of the post-war
settlement. There is the need, indeed the imperative, for the
refurbishing and possible restructuring of the existing
institutions.

Russia, apart
from its membership of the G8, has been on the global economic
architectural sidelines. It is still outside the WTO and there is
growing doubt whether membership would actually benefit Russia.
Given Russia’s heavy reliance on oil and gas, it is difficult to
make a purely economic case for Russian adhesion to the WTO. But it
is vital for all nations to look beyond narrow short-term economic
calculations, even though none of them are doing so at present.
These are times that demand statesmanship.

When reading the
history of the 1930s, one quite striking thread was how the League
of Nations in Geneva became increasingly impotent and irrelevant.
When the WTO ministerial meeting in Seattle in 1999 failed
spectacularly, the then WTO Director General Mike Moore expressed
the fear that the WTO might become “the League of Nations” of the
21st-century world economy. Eight years later, that fear would seem
to be materializing.