Free trade and global dynamics

By Dr Callie Lau

INTERNATIONAL trade involves the exchange of goods and services between firms across national boundaries. The current account in the balance of payments reflects an economy’s overall trade performance.

The trading of goods constitutes the largest component in the current account, while trading of services and net income from abroad, which includes factors of production, such as capital income, contribute relatively less to the economy’s trade performance.

It’s important to note that while technological changes have significant effects on global dynamics, they are not directly reflected in the current account. For instance, factors of production, including labour, have become more integrated and complex, with labour potentially remaining in the domestic economy but working remotely for foreign firms.

Trade policies are government-implemented measures aimed at addressing trade deficits (when imports exceed exports) and protecting jobs, particularly in industries in their early stages.

While measures promoting exports can increase exports, the income levels of importing economies have a greater impact on domestic exports.

Therefore, it is often easier to reduce imports than to increase exports in an attempt to reverse a trade deficit and stimulate domestic product demand.

Import taxes and import licences are common protectionist measures that affect the prices and quantity of imports. For example, Malaysia utilises both taxes and import licences to limit car imports and protect jobs in its domestic car manufacturing industry, which is still developing.

Trade policies can enable the creation of comparative advantage if the protected industry commits to acquiring technology, with the government committed to eventually lifting protectionist measures.

However, an optimum duration for protectionism has not been proposed by Professor Melitz of Harvard University, who emphasises the temporary nature of trade policies.

The success story of South Korea’s car industry exemplifies prudent trade policies that have had a significant impact on the global car market.

The industry was protected in its infancy and gained knowledge from Ford, an American carmaker, for approximately two decades.

Today, South Korea is one of the world’s top ten largest car manufacturers. The success of the Korean government’s trade policies can be attributed to a favourable environment for the growth of the infant industry and technology diffusion within the industry.

By restricting the imports of foreign cars, South Korea created a profitable domestic car market that allowed the carmaker to benefit from economies of scale. The government’s commitment to liberalise the car market also encouraged carmakers to acquire technology, improve their products, and eventually expand exports.

Free trade is often praised for providing a wide variety of choices, lower product prices and improved efficiency for firms due to competition.

At the aggregate level, free trade leads to increased total world output and greater international trade. However, as economies become more highly integrated due to technology and free trade, the implementation of trade policies requires in-depth studies of the targeted industry’s forward and backward linkages and a thorough analysis of the policies’ benefits and costs.

While short-term costs and benefits are easier to trace and measure, the identification and measurement of long-term costs and benefits, especially in the presence of disruptive innovations, can be challenging.

The speed and levels of technology diffusion within the domestic industry relative to the pace of technology change in the external environment must be considered, particularly as income levels rise and consumers become more willing to pay for higher-quality imported products.

Technology plays a crucial role in reducing production costs and transaction costs, enabling greater volumes of international trade. On the other hand, trade policies can harm the domestic economy by leading to higher product prices, limited choices, lower domestic product quality, and inefficiency of domestic firms.

These policies may prove ineffective if the speed and levels of technology diffusion are insignificant compared to technological advancements in the external environment as domestic incomes increase.

For small and open economies like Malaysia, trade policies often have more negative than positive effects on the domestic economy and have limited impact on global economic dynamics. Conversely, larger economies may experience short-term benefits from similar policies.

In the long run, such policies can have negative effects on both the domestic economy and global economic dynamics if there is insufficient technological advancement in the larger economy.

The views expressed here are those of the writer and do not necessarily represent the views of the New Sarawak Tribune.