Debating free trade with Korea

The prospect of a free trade deal with South Korea has set off a mini-debate at Stephen Gordon’s Worthwhile Canadian Initiative. Jim Stanford’s column in the Globe prompted this post from Stephen:

Mercantilism at the Globe and Mail

Courtesy of Jim Stanford:

Why the rush to ink more deals? Where free trade is concerned, Canada is getting worse with practice: Now Ottawa is racing to seal a deal with South Korea. If trade with Korea then follows the same pattern as under our first five free-trade agreements, our imports will grow by 250 per cent in 10 years, our exports by 100 per cent, and our deficit with Korea will widen from $3-billion to $13-billion. That will destroy more than 33,000 jobs across a swath of Canadian industries — including 4,000 in the auto industry.

This is eerily reminiscent of our actual free-trade experience with Mexico. Our exports are up, but our imports are up much more. Our deficit with Mexico ballooned from $3-billion to $11-billion. In fact, we’d be lucky to do that well with Korea. Unlike Korea, at least with Mexico we have (weak) supply-chain links that benefit from Mexican growth. And Korea’s sophisticated technology and continuing interventionist policies will make it much harder to crack its markets. The trade officials have one thing right: We are badly missing out on Asia’s economic miracle, and must do something dramatic to offset existing trade imbalances. But the historical evidence is overwhelming that free-trade agreements make matters worse, not better. We need a much more complex, sophisticated, and far-reaching industrial strategy to address Asia’s competitive challenge — applying some of the same policy tools the Asians themselves have so successfully used.

The reason for advocating trade liberalisation is not that it makes it easier to export things to other countries; the gains from trade are due to the fact that consumers can now buy things more cheaply than they could before. Although net exports are necessarily zero-sum – the gains from trade most definitely are not.

I’d be more sympathetic to this sort of argument if we were facing a US-type trade balance; there might be some merit to deferring a trade deal that might exacerbate a pesky current account deficit. But that’s not the case.

Jim Stanford, it should be noted, based his PhD dissertation on CGE modelling of Canada-US free trade using “real world” assumptions, so he’s not a knee-jerk protectionist. After a couple obnoxious comments, Jim then hits back:

1. The gains from trade are not that “stuff becomes cheaper to buy.” That could be attained simply by boosting the domestic exchange rate, if that’s all you wanted. The gains from trade are supposed to come from an increase in overall productive efficiency resulting from a trade-induced reallocation of productive factors. This is fine in a full-employment world (especially if we assume comparative advantages are static and determined by natural endowments). CGE modelers and others have found that these static reallocation gains tend to be small.

2. In a more dynamic world, in which full-employment is not assured (ie. the demand constraint can bind), then there is no guarantee that the relatively small reallocation gains will be achieved. Small welfare gains from producing something that can be traded for desired goods with a more appealing opportunity cost trade-off than along a domestic production possibility frontier, can be easily overwhelmed if the displaced factor resources end up not being employed at all. In the lexicon, “Okun gaps outweigh Haberger triangles.”

3. In addition to demand-side issues, there are also dynamic/technology issues. In the real world, a country’s successful exports are not solely those which reflect its “natural” endowments. Industries and countries (especially in non-resource sectors) create competitive advantage in fluid industries through innovation, technology, and investment. A FTA which tends to reinforce one country’s orientation in rapidly-growing, more dynamic industries, will allow it to catch more of that dynamic upside; vice versa for a country which is pigeon-holed into less dynamic sectors. Look at Canada’s existing trade with Korea: We sell them coal, wood pulp, and base minerals. We buy back motor vehicles, large-screen TVs, and other sophisticated, technology-intensive products. We will thus experience structural difficulties by intensifying that relationship, in addition to demand difficulties.

3. In a demand-constrained world, the trade balance, not just the volume of trade, matters. In a demand-constrained globalized economy, total output depends on global competitiveness (and trade reflects absolute competitiveness, not comparative advantage). Then a deterioration in competitiveness (resulting, for example, from FTAs which enhance one side’s competitiveness more than the other’s) will tighten the demand constraint and increase unemployment. (Alternatively, it may also produce a shift in employment toward non-tradeable sectors which are relatively insulated from the deterioration in competitiveness; this is what has happened in Canada since 1999, with consequent damage to average productivity.) The deterioraton in competitiveness will be reflected initially in a trade deficit. Eventually (once the residents of the less competitive jurisdiction stop borrowing to finance former levels of consumption) it will be reflected in balanced trade but at a lower level of output and employment (Thirlwall called this “balance of payments constrained growth”.)

4. I argue that the pattern of our past FTAs shows they have stimulated imports to Canada more than exports from Canada, and the experience with Korea is likely to be even more unbalanced (precisely because of … effective industrial policies … which are not in any meaningful way separable from trade policies, given the ambitious export-led orientation of the Korean growth strategy).

If anyone is interested in more detail on the CAW argument, there are 2 studies posted here:
http://www.caw.ca/campaigns&issues/ongoingcampaigns/korea/index.asp
One reviews the nature and success of East Asian export-led industrial policies, the other develops our empirical estimates of the likely job losses from a FTA with Korea.