Wednesday, 9 October 2013 00:00
From time to time, there is a surge in the urge to go for Free Trade Agreements (FTAs). There is now a whiff in the air about new Free Trade Agreements. I think it is timely to revisit the subject.
The concept of free trade goes back a long time. It was the classical economists who propounded the theory that the whole world would be better off if every country focussed on what they were best at and then exported the surplus and imported everything else from those who were best at making them. Like a lot of these cute economic theories, they give great excitement to economists who are detached from the real world.
Now some modern day pundits who suffer from the same infirmity of being detached from the real world also get excited about Free Trade Agreements. A move away from the macro approach and a micro examination of the consequences helps to get it all into a sensible perspective.
Free trade with China
We all know about the industrial giant called China. It produces goods of high quality at unbelievable prices. It then romps around the world and those who are foolish to let it in will find that the Chinese goods demolish all local industry. It has happened to the best of yesteryear. Great Britain is certainly one nation that you can describe as one of the very best of yesteryear. Two recent examples in GB help to illustrate the dangers of the pervasive intrusion of Chinese goods into a market. They can destroy even the relative niche market segments.
There was a firm called Pace which had a reputation for outstanding quality TV set top boxes. Everyone subscribing to SKY TV had a Pace set top box. Sadly no longer. I peered at my new set top box, and what did I see? “Made in China”. I bought a greeting card from Marks and Spencer. It is a very old and highly respected chain that started in clothing and has now become more of a general store. As I now have a little phobia about China taking over the world, I looked at the back and it said (guess what?): “Made in China”.
Great Britain and free trade
So I moved around a Marks and Spencer shop looking at labels and at the back of boxes. Almost everything came from China or Bangladesh or Indonesia, etc. Of course Sri Lanka was represented in clothing. Any very pro-Brit who likes to support the mother country and buy only British-made will be hard pressed to find anything with a “Made in Great Britain” label in the Marks and Spencer clothing section. So the Great is falling off from Great Britain. China is the relatively new kid on the block as a major global exporter. Already Great Britain has a huge trade deficit with China.
But it is not China alone that has driven GB into the current recession. Even a cursory review reveals that a large number of GDP producing activities in GB have been steadily ceasing to exist! Locally manufactured products have been replaced by imports. That is the reason why the current macro approach pursued by the Government is not moving GB out of the recession.
Interest rates have been sharply reduced and held down. Liquidity has been increased. An individual cannot get anything more than 2% on a one-year fixed deposit. But, cheap money does not generate investment if there are no investment opportunities. The scarcity of opportunities is because the market segments in a whole raft of categories are dominated by imported goods and it by no means easy to dislodge them.
Globalisation then and now
For many years this was touted as the essential strategy for all countries. This mantra was so strong that even those who did not grasp its full ramifications felt it would be somewhat sacrilegious to oppose it. However, there were some economists in developing countries who argued with emotion and eloquence that this was all a diabolical scheme dreamt up by some economists in the developed countries to achieve growth at the expense of crippling economic growth in the poorer developing countries.
So the mantra ‘open your economies and banish tariffs’ resulted in imported goods flooding in and destroying local industry. The balance part of the hymn was that the developed countries in return would remove their tariffs and create tariff free entry for goods from the developing countries. This it claimed opened the vast potential of developed countries to the poorer developing countries.
What was not pointed out was that there was zero possibility for goods from the developing countries dislodging in the market place the products of the developed countries.
The globalisation theme is waning!
We now hear less about the merits of globalisation. This is because the concept is biting those who propounded it. Tariff free entry has taken a lot of economic activity out of the old developed countries. With the new power houses like Brazil, Russia, India and China threatening the trade of the old power houses, there is unease about keeping a country tariff free.
But still none of the former power houses have said they will protect their home industries with tariffs. Bit difficult to do so after all the noise about the merits of globalisation. So the route they are pursuing are non tariff barriers. The easiest is subsidies to make the home industries competitive to the point of keeping out imports. This has been widely used to protect domestic agriculture.
Is it sensible to play David and Goliath?
The answer is no. We cannot have Free Trade Agreements and believe that we can somehow compete successfully with the stronger economies. The chances of David getting the better of Goliath in Free Trade Agreements is pretty slim. The big countries with their economies of scale will have better cost structures and home industry will perish sooner or later. At the same time the products from the developing countries will make no headway in the developed country markets.
The price to pay
There is a price to pay for keeping out imports with tariffs. It cannot be disputed that in a tariff free country you will find everything at the best globally competitive price. So this game of keeping tariffs or removing them has to be carefully structured. In the segments where there is no local activity there is no disadvantage in removing tariffs. In fact there is the benefit of getting the best global prices.
Where we need to protect our agriculture and industry we must use tariffs. If we do not do this, we will demolish our GDP and employment creating economic activity. This is the trade off .To eliminate poverty, to have full employment and sustained growth; we must protect all that cannot compete in a tariff free world. To pay somewhat higher prices for some goods is indeed a small price to pay to save our economic future.
Bilateral and multilateral arrangements
The challenge is to structure bilateral and multilateral arrangements that will enable us to protect what we must and at the same time get us the best prices for what we will have to import (as we do not produce such goods). In such arrangements tariffs must not give protection to the point of protecting inefficient industries. There has to be pressure to create efficient economic activities. Therefore tariff protection must be used judiciously.
The real challenge in trading arrangements is to also look for tradeoffs that benefit us. So one will barter low tariff entry for specified goods in return for tariff free entry for our exports which have some competitive edge. Giving tariff free entry and getting tariff free access is a complex game. Played well it can undoubtedly help our economic growth. Omnibus Free Trade Agreements will never achieve this.
(The writer has a Master of Arts Degree from Cambridge University, UK, and the AMP of Harvard Business School USA. He counts over 40 years of board experience having served as a Director of several companies in Sri Lanka and abroad. He was a Director on the main Board at Reckitt Benckiser PLC, UK, where he worked most of his career and at the time of his retirement was Global Director – Pharmaceuticals. He has served as the Chairman of the Board of Investment and Sri Lanka Telecom Limited and was a Senior Advisor to the Ministry of Finance. Currently, he serves as Chairman of Hemas Holdings PLC and First Capital PLC.)