Tuesday, March 07, 2006

Looking at US-ROK Free Trade - Part 1

Considering I have been away for a while, I deiced to take up a request made by a friend. He wanted a better breakdown of the upcoming US/ROK free trade agreement talks. Specifically he wonders why the timing, and why rush. Most papers talk about why it needs to get done before the Spring of 2007, yet really fails to bring out why. They also do not really mention reasons on why the process was not started long before this. Finally the big question is unanswered, will the rush make things easier or harder. Now while I do not know all the answers, I will bring up some of the answers I have come up with.
 
Before the big questions, I think a primer is needed. In the ideal world of textbook economics Free Trade is sold as a sort of nirvana. The idea reaches back all the way to the observations of Adam Smith, a man considered the father of economics. He noted two theories relating to free trade the division of labor and the subsequent competitive advantage.
 
To put this concept simply, first consider village of cave people. By themselves they would have a very short life, say 30 years. You would also occasionally have the birth of a caveman who is no good for hunting (bad eyesight, slow, crippled, etc.). Now if all these cavemen kept to themselves, most would live well and die at 30, while the weak would have a hard life until 30 or even die well before that.
 
The division of labor now comes to the rescue. What if the weak one does not hunt, but becomes the village witch doctor. He will treat cavemen for a portion of the hunt. As a result of this specialization, cavemen now live 40 years, and the weaker man now makes a comfortable living. See the nirvana? Longer lives, and some of the less fortunate in caveman society live a better life.
 
Now the further leap Mr. Smith made was, what if countries were to do the same thing? Every country specializes in either what it does best, or simply avoids doing they do the worst. The conclusion is like the caveman example, a better life for everyone. When applied to countries this is specialization called comparative advantage (I am simplifying this somewhat here).
 
“Not so fast”, you may say “We are not cavemen”. This is true. Countries are complex economic entities that serve up a wide variety of goods. It would be impossible, not to mention impractical, to have only one country be all doctors. Smith therefore adroitly relied on “the invisible hand” of market forces that would make countries adapt there production accordingly.
 
For example the US is much more efficient in producing corn than Korea. However, US corn take awhile to come here, which would spoil fresh corn. The answer is the US would produce dried corn, while a smaller set of Korean farmers then exists now would make corn for corn on the cob consumption.
 
We are now faced with the main dilemma of free trade, what if your one of the Korean corn farmers? As a country specializes a small segment of the economy is forced to give up his current role, and in some cases this can be devastating to that segment. This creates one of the main hurdles to free trade agreements. The problem is further magnified in democratic governments where by not only does this segment (rightly so I hasten to add) protests to ask for relief, but the general uncertainty of the plans for the “invisible hand” of the market makes many others express there worries about this risk.
 
Despite this groundwork done over 300 years ago there was little action on the subject. Unfortunately what it took for the idea to be seriously considered was a global financial crisis and a world war. The protective tariffs enacted worlds wide after World War I are seen as one of the causes, or exacerbations, of the Great Depression (note, this link is a bit US-centric, internationally as well there were high tariffs and barriers). From that depression sprang World War II. If anybody wants to do more reading on this I highly recommend Keynes’s The Economic Consequences of the Peace, a treatise published shortly after WWI.
 
One of the little known efforts at the end of World War II was the effort to globalize the world’s economy. Many thinkers, including the aforementioned Keynes himself, thought one of the best ways to avoid wars was to tie everyone together into a stable economic system. This somewhat mirrored the political ties that made the United Nations. While there were many aspects to these economic agreements and understandings, one of the key features was the need to generally liberalize international trade.
 
From this came the General Agreement on Trade and Tariffs, or GATT. These were a series of agreements starting in 1947 regarding trade. However as time passed the global economy got more complicated, and GATT was revised in the early 1990’s to the now famed World Trade Organization (WTO) that most critically provided a trade dispute resolution body.
 
In addition to such global efforts, there were multiple free trade agreements between nations. Perhaps the most successful has been the BENELUX economic agreements, which eventually became the kernel of the European Union. Other success stories are the customs unions and other agreements made in the wake of decolonization after the war (the British CommonwealthCFA monetary union, etc.) However in the fight of free trade, everyone looks to the actions of the USA, the largest single economy in the world.
 
Objectively speaking, considering the cards delt the US after WWII they have played their hand with respect to free trade to the fullest. A major handicap was the aforementioned economic agreements after the war. For example the US spent an enormous amount of resources to keep gold a certain price which arguably played havoc on its monetary supply planning (Nixon, for better or worse, pulled out of this agreement in 1972). Most notably in my mind however was the US from the outset lowered its tariffs substantial from pre-WWII levels, this made negotiations difficult since there was nothing to take off the table (no carrot if you will), this made sticks of tariffs and quotas the only tactic available (more on this later). However the US did maintain certain tariffs and quotas then and now and these became the few bargaining chips the US had for negotiations.

2 Comments:

At March 13, 2006 10:55 AM, Blogger Sperwer said...

Nice work. One quibble though. While the Benelux pacts were undoubtedly significant, it really was the ECSC - becuase it involved serious compromises among France, Germany and Italy, the big economic players, over the biggest inductrial issues, coal and steel -- that was dispositive in the history of the formation of the EEC/EU. A question of relative importancre and emphasis.

 
At March 22, 2006 4:07 PM, Blogger Dram Man said...

Sorry for not catching this too late. I hope you get to this.

As I recall the BENELUX agreements provided the framework for the ECSC, and that is why I mentioned them first. No doubt however economic intergration in earnst did begin with the ECSC. Correct me if I am wrong.

 

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