Barcelona Graduate School of Economics


Señoras y señores

I am delighted to be here this evening on the occasion of the inauguration of the Academic Year at the Barcelona Graduate School of Economics. You will not be surprised if I say that the WTO follows with great interest a lot of what you do here.

Let me share a small secret with you. Our economists were largely inspired by your work on the relationship between trade and growth in preparing our 2008 World Trade Report on “Trade in a Globalizing World”. The Report looks into the role of trade in an interconnected world and the challenges facing governments to ensure it results in greater prosperity for its citizens. You may want to check the number of quotes of your faculty in this now famous publication!

It will come as no surprise to you, therefore, that I shall focus my remarks this evening on international trade, its economic underpinning and its political realities. Two sides of the same coin.

I have recently read that the financial crisis and the economic downturn have become such central preoccupations of policymakers and the public at large that there is no room to worry about trade any more. This kind of compartmentalization, I think, reflects a narrow view — one that disregards the inseparability of all aspects of international economic governance.

We already see how financial difficulties are squeezing trade opportunities as trade financing dries up in respect of far too many potential trade transactions. We can also see the lay-offs of thousands of workers in factories in China as demand in developed countries contracts.

Managing these linkages effectively and devising multi-faceted solutions is at the centre of today’s policy challenges, truly testing the capacity of governments to cooperate effectively with one another, as we saw at this weekend's leaders summit in Washington. And it is therefore no surprise that in addition to a stimulus package, and laying the foundations for better global financial governance, leaders also sent a powerful message on trade and the importance of rapidly concluding the WTO Doha Round.

Gains from trade: old and new theories

The case for open trade has a long and rich intellectual history. David Ricardo's intuition that the gains from international trade are rooted in the law of comparative advantage has provided the backbone for 200 years of trade theory and practice.

Traditional theories taught us that countries — like people — gain from trade because they are different, and that it is relative rather than absolute differences in production costs that make trade profitable. This last insight provides the vital intellectual underpinning for the argument that all countries can gain from trade — you only have to be more competitive in relative, and not absolute, terms across production activities to gain from trade. Understanding this reality has been indispensable to the efforts of many over the last six decades and more to build a more open and inclusive multilateral trading system.

David Ricardo linked the comparative advantage of countries to technological differences. Later theorists, such as Heckscher and Ohlin, emphasized differences in factor endowments — such as labour, land and capital — as the driving force of comparative advantage and gains from trade. These differences in emphasis embody no contradiction. They merely emphasize the rich opportunities offered by diversity.

Notwithstanding the robustness and continued relevance of traditional propositions that explain the advantages of trade, theory has continued to move on, and we have seen important innovations in quite recent times. For instance, from around the 1980s onwards trade analysts focused on exchanges of products within the same industries. Intra-industry trade is largely explained by economies of scale and associated market imperfections, and it accounts for a big part of increased prosperity and enriched choice, especially in high-income countries. I might also add that Paul Krugman’s contribution to this thinking, often referred to as the new trade theory, was part of what earned him this year’s Nobel Prize.

Even more recently, new data sets with information on production and trade revealed considerable differences among firms, challenging the standard assumption that we could treat producers as identical and think in terms of ‘the representative firm’. The theoretical formulations resulting from these new insights demonstrate that opening up to trade does not just offer new opportunities to specialize productively. It also raises the average level of productivity of domestic industries. These insights have been dubbed the “new new” trade theories — surely evidence that economists' ability to give names to their theories does not match their intellectual achievements!

Another challenge to traditional trade theories has arisen on account of the international fragmentation of production processes resulting from the break-up of supply chains — a phenomenon that has accelerated in recent times. Off-shoring, or trade in tasks, whether in goods or in services, is in reality a new application of the traditional comparative advantages. It has been made possible by a powerful combination of new technology in information, communication and transport, and increasingly open trade policies.

This rapid journey through the history of trade theory is a useful reminder of the diverse sources of gains from trade, including increased efficiency, the realization of economies of scale, greater product variety and higher productivity.

But trade theory, just like trade, is not much use as an end in itself. Theory is useful if it informs policy and trade is useful if it enhances the human condition. And on both these counts, realism and intellectual honesty require that we consider the costs and the politics associated with trade. If the beginning and end of the story was that trade was unconditionally beneficial to all and that the more we had of it the better, then governments would surely embrace it unilaterally and without question. And there would certainly be no need for the WTO Agreement to manage international trade relations!

The costs and politics of trade

As far back as Ricardo, we have understood that trade creates winners and losers. It affects the distribution of income within societies. For example, traditional theories predict that when industrialized countries import labour-intensive goods from emerging economies that are abundant in low-skill workers, the result is lower demand and therefore lower wages for low-skill workers in the industrialized world.

More generally, Paul Samuelson reminded us in an important article written in 2004 — using a standard Ricardian framework — that productivity growth in one country can undermine the export success of another country, thus reducing income in the latter. This argument, and certain variants of it, have spurred renewed interest in the evolution of inequalities in industrialized countries and the role of trade in this evolution.

While the recent literature appears to have converged to the view that other forces — most prominently technological change — have been rather important in changing income distribution, there is no doubt that trade can contribute to rising wage inequality. This does not, however, offer an argument for protection, or for turning our backs on openness. Rather, it makes a powerful case for attending to the social tensions arising from inequality, be this through public provision of basic services, better education and training opportunities or fiscal reform.

A second source of costs is the inevitable structural adjustment associated with trade opening. Some sectors, firms or individuals gain from trade, while others have to adjust into alternative activities, if they can, in the face of new competitive realities. Moreover, trade — especially that associated with off-shoring — can increase uncertainty. This has no doubt further raised concerns about the virtues of globalization in general and trade in particular.

On the other hand, countries that miss out on international production opportunities risk being marginalized from globalization. Firms' decisions to off-shore are strongly influenced by the quality of the institutional framework, the costs of setting up a business and the quality of infrastructure. Not addressing these issues is likely to limit the participation of low-income countries in production networks despite their advantage in terms of factor prices. Being left out is surely much worse than trying to manage change and localized losses against a background of generalized gains.

It is clear that the politics of trade have to be properly managed if societal gains are to be realized. Anthony Downs, in his theory of democracy, shows that political competition will lead politicians to propose and enact the policy preferred by the voter with median policy preferences. The application of this theory to trade policy suggests that increasing inequality will be associated with an increase in opposition to trade and, ultimately, with more restrictive trade policies. Greater inequality will lead to increased calls for protectionism.

A second political issue concerns a ‘collective action’ problem. The gains from trade opening tend to be distributed widely within societies and individual gains from trade opening may be relatively small. But the losses from trade reform tend to hit relatively small groups, and are often heavily concentrated. The losers from greater trade opening have a higher incentive to lobby against trade reforms than the winners. This may slow down or reverse the process, even though overall gains exceed overall losses.

A third issue relates to uncertainty. Voters tend to prefer the status quo — that is, they will vote against trade reform — as they may not know in advance whether they will be among the winners or losers from reform. The fragmentation of production implied by off-shoring intensifies uncertainty and public reticence to embrace change that is beneficial overall.

My final point touches upon domestic policies in an economically integrating world. Today the economy is more and more global, but politics is still local. This discrepancy may lead national governments to choose domestic-oriented policies, which reduce the likelihood of further economic integration at a global level. But globalization is moving international interdependence to a level never seen before. And this process creates new and stronger forms of policy considerations that cross national borders, be it in the area of social choice, environmental standards, financial market regulation, or elsewhere. There is, therefore, a need for more and better global rules. But there is also need for domestic policies which are coherent and complementary to the global ones.

As I mentioned during my recent visit to Berkeley University, I am convinced that restoring the confidence of Americans in trade requires ensuring that the right health and pension systems are in place through domestic tax and spending policies. Equally, boosting domestic consumption in China, which today is limited by its high saving rate, will also necessitate greater spending in social policies in areas such as health or education.


The policy challenge I have outlined this evening is that of balancing the significant economic — not to mention socio-political — advantages of international engagement through trade with social justice and a perceived sense of legitimacy. This is not a new challenge, it is just a more intense and pressing one.

After 60 years of multilateral trade cooperation in a dramatically changing world, the case for an open trading system is as strong as ever. But as technology improves and intensifies global interdependence, national policymakers and the global community are confronted with an increasingly pressing need to demonstrate imagination, leadership and a willingness to face up to new demands.

For national policymakers in the industrialized world, disregard for rising public concern about some aspects of globalization would threaten to undermine the legitimacy of governments and imperil social support, as would neglect of the gains from trade. The answer to this tension lies in a balance between open markets and complementary domestic policies, along with international initiatives that manage the risks arising from globalization.

As for the global community, integrated economic markets need good legal and political institutions. Without these institutions, markets lack the basic regulatory framework to function properly. Our changing global realities, punctuated dramatically by the current economic crisis, call for a re-think of many aspects of international governance.

I have dwelled somewhat on the nexus between theory and the practical policy challenges facing governments precisely because I believe that institutions such as Barcelona Graduate School of Economics have a vital role to play in maintaining strong links between conceptually disciplined thought and the challenges of every-day decision-making. I look forward to developing these exchanges with the Barcelona GSE in the future.

Thank you very much for your attention.

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