The Economic Effects of Global Trade Liberalization
Clarke Ricks School of Business,
Liberty University
BUSI 690: Policy and Strategy in Global Competition
Dr. Hicks
May 7, 2022
The Economic Effects of Global Trade Liberalization
The objective of reducing barriers to trade, of course, is to increase the level of trade,
which is expected to improve economic well-being. Economists often measure economic well-
being in terms of the share of total output of goods and services (i.e., gross domestic product,
GDP) that the country produces per person on average. GDP is the best measurement of
economic well-being available, but it has significant conceptual difficulties. As Joseph Stiglitz
notes, the measurement of GDP fails “to capture some of the factors that make a difference in
people’s lives and contribute to their happiness, such as security, leisure, income distribution
and a clean environment—including the kinds of factors which growth itself needs to be
sustainable.”[10] Moreover, GDP does not distinguish between “good growth” and “bad
growth”; for example, if a company dumps waste in a river as a by-product of its
manufacturing, both the manufacturing and the subsequent cleaning up of the river contribute
to the measurement of GDP.
As the result of a multilateral round of trade negotiations under the GATT/WTO, tariffs are
reduced during a transition period but are not completely eliminated. In the United States’
bilateral or regional free trade agreements (FTAs), however, parties to the agreement
completely eliminate almost all tariffs on trade with each other, generally over a transition
period, which may be five to ten years.
Although reducing barriers to trade generally represents a move toward free trade, there
are situations when reducing a tariff can actually increase the effective rate of protection for a
domestic industry. Jacob Viner gives an example: “Let us suppose that there are import duties
both on wool and on woolen cloth, but that no wool is produced at home despite the duty.
Removing the duty on wool while leaving the duty unchanged on the woolen cloth results in
increased protection for the cloth industry while having no significance for wool-raising.”[11]
This happens for some products as a result of multilateral trade negotiations. For
example, a country often reduces tariffs on products that are not import sensitive—often
because they are not produced in that country—to a greater extent than it reduces tariffs on
import sensitive products. In an FTA, where the end result is zero tariffs, this would not be an
effect when the agreement is fully implemented. However, during the transition period it could
well be relevant for some products. Other than this exception, however, reducing tariffs or
other barriers to trade increases trade in the product, and this is the intent of the trade
agreement.
The benefits to an economy from expanded exports as a trade partner improves market
access are clear and indisputable. If the United States’ trade partner reduces barriers as a result
of a trade agreement, U.S. exports will likely increase, which expands U.S. production and GDP.
And suppliers to a firm that gains additional sales through exports will likely also increase their
sales to that firm, thereby increasing GDP further.
The firms gaining sales through this may well hire more workers and possibly increase
dividends to stockholders. This money is distributed through the economy a number of times as
a result of what economists call the money multiplier effect, which states that for every $1 an
individual receives as income, a portion of it will be spent (i.e., consumption) and a portion will
be saved. If individuals save 10 percent of their income, for every $1 earned as income, 90 cents
will be spent and 10 cents will be saved. The 90 cents that is spent then becomes income for
another individual, and once again 90 percent of this will be spent on consumption. This
continues until there is nothing left from the original $1 amount.
In fact, expanded exports increase a nation’s GDP by definition. One equation economists
use for determining GDP is GDP = Domestic Consumption (C) + Domestic gross investment (In) +
Government spending (G) + [Exports (E)—Imports (I )], or GDP = C + In + G + (E—I)
The impact of trade on GDP, therefore, is the net amount that exports exceed or are less
than imports. However, this is a static measure. As noted above, expanded exports also have a
dynamic effect as companies become more efficient as sales increase.
The economic impact of increased imports is different. By the economists’ definition of
GDP, of course, increased imports reduce GDP. A way of looking at this is that if a U.S. firm
produces a product that suddenly loses out to increased imports, it will reduce its production
and employment, and consequently its suppliers will also reduce production and employment,
thereby reducing economic output.
This would suggest that the mercantilists were right, that a nation would be well advised
to restrict imports. However, almost all economists today would reject that conclusion, and in
fact many economists believe that reducing its trade barriers benefits a country whether or not
the country’s trade partners also reduce their barriers. Adam Smith and many economists after
him argue that the objective of production is to produce goods for consumption. Stephen
Cohen and his colleagues express this argument as follows: “The theories of comparative
advantage (both classical and neoclassical) imply that liberalizing trade is always beneficial to
consumers in any country, regardless of whether the country’s trading partners reciprocate by
reducing their own trade barriers. From this perspective, the emphasis on the reciprocal
lowering of trade barriers in most actual trade liberalization efforts . . . is misplaced.”[12]
The benefits of unilateral elimination of trade barriers are particularly obvious in those
cases where the country does not produce the product; in these cases, eliminating trade
barriers expands consumer choice. (As noted above, however, an exception to this occurs in
situations where reducing a trade barrier on a raw material or component that is not produced
by the country increases the effective rate of protection for the finished product.)
Even where the country does produce the product, increased competition from trade
liberalization will likely lead to lower prices by the domestic firms. In this event, some of the
consumer’s savings will then be spent consuming other products. The amount spent consuming
other products will have positive production effects, which will somewhat mitigate the loss in
production by the firm competing with the imports.
Increased import competition also has dynamic benefits by forcing domestic producers to
become more efficient in order to compete in the lower price environment. Lower prices also
may have a positive impact on monetary policy; because import competition reduces the threat
of inflation, central banks can pursue a more liberal monetary policy of lower interest rates
than otherwise would be the case. These lower rates benefit investment, housing, and other
productive sectors.
Economic Models
Economists have developed a number of sophisticated models designed to simulate the
changes in economic conditions that could be expected from a trade agreement. These models,
which are based on modern economic theories of trade, are helpful where the barriers to trade
are quantifiable, although the results are highly sensitive to the assumptions used in
establishing the parameters of the model.
One type of model used extensively by economists to estimate the economy-wide effects
of trade policy changes, such as the results of a multilateral trade round, is the Applied General
Equilibrium Model, also called the Computable General Equilibrium (CGE) Model.[13] James
Jackson of the Congressional Research Service notes: “These models incorporate
assumptions about consumer behavior, market structure and organization, production
technology, investment, and capital flows in the form of foreign direct investment.”[14]
CGE models may be used to estimate the impact of a trade agreement on trade flows,
labor, production, economic welfare, or even the environment. They may consider the effects
of the agreement on all countries involved, and are ex ante; that is, they attempt to forecast
changes that would result from a trade agreement. General equilibrium models are based on
input-output models, which track how the output of one industry is an input to other
industries. General equilibrium models use enormous data inputs that reflect all the elements
to be considered.[15]
One of the great strengths of these models is that they can show how the effects on
industries flow through the entire economy. One of their disadvantages is that because of their
complexity, the assumptions behind their projections are not always transparent. Economic
models are useful to give a sense of what might happen as a result of a trade agreement. They
give the appearance of being authoritative, but users need to be aware that economic models
are not predictive of what will actually happen and that they have significant weaknesses.
First, the results of any model depend on the assumptions underlying it, such as the
degree to which imported products and domestically produced products can be substituted for
one another, or whether or not there is perfect or imperfect competition. Differing assumptions
can produce a wide range of results, not only in magnitude but also sometimes even in the
direction of projected changes.
Second, the economic data needed are often weak, not only for developing countries but
even for the United States and other developed nations. For example, trade and economic data
between countries, and even within countries, are not readily compatible. In the United States,
the North American Industry Classification System (NAICS), which is used to collect statistical
data describing the U.S. economy, is based on industries with similar processes to produce
goods or services. In contrast, data on international trade in goods are collected on a
commodity basis.[16] The United States’ NAFTA partners, Canada and Mexico, also use NAICS,
but the European Union uses a system called Nomenclature of Economic Activities. Although
there are concordances between these differing systems, these are far from exact.
Nontariff barriers—such as import quotas, subsidies, standards, and regulations—must be
converted to their tariff equivalents, and this is often difficult and unreliable. For new areas
covered in trade negotiations —such as services, investment, and intellectual property—efforts
to measure the impact of barriers is even more difficult.
Although measuring the impact of tariffs is more accurate than measuring nontariff
barriers or services, it is not as straightforward as it would seem. For example, often economists
use a weighted tariff by considering the proportion of imports entering under that tariff line. A
problem with this approach is that a very high duty will completely block imports, resulting in
the false conclusion that that tariff line is given no weight.
In view of the problems with trade models, some economists dismiss their usefulness. For
example, Bhagwati says: “I consider many of the estimates of trade expansion and of gains from
trade—produced at great expense by number-crunching at institutions such as the World Bank
with the aid of huge computable models…as little more than flights of fancy in contrived flying
machines.”[17] Many economists would consider this criticism extreme, but nonetheless trade
models do need to be viewed with a large degree of caution.
