International Trade and Comparative Advantage Because Trade

International Trade and Comparative Advantage

Because trade between nations is as ancient as mankind itself, there have been a number of theories advanced over the years to help account for why some countries seem to benefit more than others in the process. To this end, this paper provides an overview of trade theories according to Adam Smith and Ricardo to determine how free trade has adversely affected developing countries in general and Egypt and the Middle East in particular. An examination of different trade policies in developing countries and how these policies assisted some countries but not others is followed by a summary of the research in the conclusion.

Background and Overview of Trade Theories. Early on, David Ricardo examined the laws that seemed to control the distribution of everything that could be produced by the "three classes of the community" (e.g., the landlords, the workers, and the owners of capital) (Spengler 1). As part of his theory of distribution, Ricardo maintained that profits tended to shift inversely with wages, which increase or decrease according to the cost of necessities. Ricardo also suggested that rent tends to increase as population increases because of the higher costs associated with the agricultural requirements of a larger population (Spengler 2). In this regard, Ricardo believed that unemployment was not as much of a threat to a nation's economy uncontrolled population growth, a trend that could constrain wages to the subsistence level, thereby restricting both profits and the creation of new capital through the extension of the margin of cultivation; further, he also believed that trade between nations was affected by the relative costs of production and by differences in internal price structures that could maximize the comparative advantages of the nations involved (Spengler 3). For example, Ricardo maintained that the real wage would tend to the "natural price of labor," in other words, the wages that are required to allow labor to reproduce itself; the concept of reproduction included social as well as subsistence considerations. In the Principles of Political Economy, Ricardo makes the point that:

It is not to be understood that the natural price of labor, estimated even in food and necessaries, is absolutely fixed and constant. It varies at different times in the same country, and very materially differs in different countries. It essentially depends upon the habits and customs of the people. Many of the conveniences now enjoyed in an English laborer's cottage, would have been thought luxuries at an earlier period of our history. (1951, pp. 96-7)

In Jarsulic's analysis of Ricardo's the example is made that an economy of an agricultural-based capitalist country that produces, for instance, only corn by using land, labor and seed corn in the process of production can achieve successful yields if everything in the marketplace is just right: "If there is plenty of land of uniform quality," Jarsulic says, "those who possess a sufficient stock of corn to pay the wages of workers through the agricultural production cycle will be able to hire workers and organize production in the way they wish" (12). This type of simple economy, though, also requires labor for the production of corn; because it has been assumed that corn must be provided to a country's workers during its production, some of the output must be subtracted from this physical surplus when determining the amount of economic surplus that is actually going to the capitalist farmers who advance these wages (Jarsulic 12). Any surplus represents the profit for these farmers, which is the very reason they were willing to pay wages from the outset; therefore, Jarsulic points out that if the total amount required for wages is too much, there will be no profit and no reason for those with stocks of corn, the only 'capital' in this economy, to engage workers. "Both the labor requirement and the real wage," he says, "are crucial for determining the division of surplus and the level of profits" (13).

In his work, The Wealth of Nations, Adam Smith stated that the first goal of any political economy was "to provide a plentiful revenue or subsistence for the people, or more properly to enable them to provide such a revenue or subsistence for themselves" (449). In the market economy described by Smith as a "subsistence for the people" would depend on their wages or what he called the natural price of labor. "The natural wage of labor meant to Smith, as the just wage had to medieval thinkers, that society should be concerned when labor markets did not provide a subsistence that was 'plentiful.' Smith's study of wages was a significant advance over his predecessors, who emphasized prices" (Stabile 1997:293).

Today, the structure of international trade is considered to have both behavioral and institutional attributes; for example, the extent of openness to international commerce from one nation's perspective can be described both by the flow of goods and by the policies that are followed by states with regard to trade barriers and international payments (Frieden & Lake 2000:24). "Openness," they advise, "is associated with those historical periods in which tariffs were substantially lowered: the third quarter of the nineteenth century and the period since the Second World War" (Frieden & Lake 24). These various economic and political considerations are discussed further below as they apply to the economies of Middle Eastern countries in general and Egypt in particular.

Analysis of Impact of Free Trade on Developing Countries. According to Frieden and Lake, the concentration of trade within regions comprised of states at different levels of development represents an indicator of the openness of the international political economy. "The degree of such regional encapsulation is determined not so much by comparative advantage (because relative factor endowments would allow almost any backward area to trade with almost any developed one)," they say, "but by political choices or dictates" (24). Countries that have larger economies will likely try to protect themselves from the exigencies of a global marketplace by exploiting their interests through regional trading blocs; in reality, though, the increased openness in the global marketplace has meant primarily increased trade among the leading industrial states only (Frieden & Lake 25). When international trade is less open, the developing nations of the world have fewer opportunities to engage with the larger industrial states, thereby constraining their ability to effectively compete. "A description of the international trading system involves, then, an exercise that is comparative rather than absolute" (Frieden & Lake 25). Notwithstanding the emergence of regional trading blocs among the leading nations of the world, many emerging countries of the Middle East have been excluded from these economic partnerships.

In their essay, "Dividends of Fear: America's $94 Billion Arab Market Export Loss," the editors of Washington Report on Middle East Affairs point out that the share of world merchandise exports to the Arab Middle East from the United States decreased from 18% in 1997 to just 13% in 2001. This decline took place at a time when there was strong import demand that had been averaging one percent per year together with high demand for value-added capital goods among Arab economies ("Dividends of Fear" IM1). "The hardest hit U.S. export sectors include civilian aircraft, agriculture, heavy transportation," they report, "as well as telecommunications and industrial equipment. On the demand side, the broad U.S. export downturn is driven by growing Arab boycotts against U.S. consumer and industrial goods" ("Dividends of Fear" IM1). These declines in American exports occurred largely as a response to the perceived loss of U.S. regional foreign policy legitimacy from the perspective of Arab buyers:

On the supply side, the increasing restrictions on Arab business travel to the United States, and surging U.S. fear, xenophobia and legal campaigns leveled against Arab business are positioned to accelerate the toll on future trade. The IRMEP estimates that America has already lost U.S. $31 billion in exports between 1998 and 2002. If the trend continues, the U.S. stands to lose an additional U.S. $63 billion through 2007 for a ten-year export loss of U.S. $94 billion. ("Dividends of Fear" IM2).

The Middle Eastern nations are at a crossroads both in terms of their political as well as their economic futures. To the extent that the economic theory of Smith's "invisible hand" at least play out in the real world will be the extent to which these emerging nations become part of the rapidly growing globalized marketplace; however, there remains much to be done in many of these countries in terms of how their policymakers decide to approach their strategic economic positioning as well as come to terms with the growing political strife that is increasingly characterizing this region of the world.

The World Bank provides a Knowledge Economy Index (KEI) assessment of selected countries of the world; the KEI is the average of the performance scores of a country or region in all four KE pillars: 1) Economic Incentive Regime, 2) Education, 3) Innovation, and 4) Information Communications & Technology); each pillar score is the average of the normalized scores of each pillar's defining variables for which data is available (KAM 3). The KEI, Innovation, Education, and Information Infrastructure for Egypt, the Middle East and the world are provided in Table 1 below.

Table 1. KEI, Innovation, Education, and Information Infrastructure for Egypt vs. The Middle East and the World.

Country

KEI

Econ. Incentive Regime

Innovation

Education

Information Infrastructure

Egypt

4.24

3.34

6.25

4.59

2.78

Middle East and North Africa

3.95

3.90

3.62

3.72

4.54

World

4.81

4.55

4.84

4.90

4.96

Source: KAM 2005:2-3.

Figure 1 below shows that Egypt enjoys a slight advantage over its Middle Eastern and North African neighbors in terms of its Knowledge Economy Index and Education, and vast superiority in terms of its Innovation qualities, but lags behind the region and the rest of the world in terms of its Information Infrastructure.

Figure 1. KEI, Innovation and Information Infrastructure for Egypt vs. The Middle East and the World.

Source: KAM: Egypt 4.

In his essay, "Globalization: Trade and Investment in Egypt, Jordan and Syria since 1980," Sullivan (1999) reports that the gross domestic product (GDP) per capita in Egypt increased from $560 in 1980 to $750 in 1985 and 1986; in 1987, though, the country experienced a decline in GDP per capita to $600 (Sullivan 35). For the next five years, the country's GDP per capital fluctuated between $600 and $700, thereafter though, Egypt enjoyed a steady increase (possibly as a result, at least in part, of Egypt's economic reform, the structural adjustment program as well as the benefits from Egypt's decision to become part of the Gulf war multinational coalition against Iraq that cut their debt almost in half, increased remittances [especially in 1992], and increased aid from the EU, the U.S. And Japan) (Sullivan 35).

By 1997, GDP per capita in Egypt was about $950 (Sullivan 35). There were a few years, during the precipitous decline in the price of oil in the 1980s when the GDP per capita was declining precipitously. After the Gulf War, there was an upturn that, in real per capita terms, only managed to make up for the losses experienced during the late 1980s (Sullivan 35). From 1930 to 1985, GNP per capita grew from $570 to $630 and then dropped again below $600 for the period 1988-1991; after 1991, the GDP per capita increased to more than $1,000 by 1996 (Sullivan 35) and stands at about $4,200 today (2004 est.) (Egypt 5).

It was this lack of any significant economic reforms since the mid-1990s that constrained foreign direct investment in Egypt and kept annual GDP growth in the range of 2%-3% through the period 2001-2003; however, in 2004, Egypt implemented a number of initiatives designed to encourage foreign direct investment (Egypt 6). For example, in September 2004, Egypt adopted custom reforms, proposed income and corporate tax reforms, reduced energy subsidies, and privatized several industries; the country's budget deficit increased to approximately 8% of GDP in 2004 compared to 6.1% of GDP in 2003, due in part to these economic initiatives (Egypt 3). Increased monetary pressures in January 2003 resulted in an overvalued Egyptian pound; in response, the Egyptian government decided to float the currency, causing a sharp decline in the pound's value and associated inflation (Egypt 4). Table 2 below provides current estimates (2004) for Egypt's gross domestic products.

Table 2. GDP Permutations for Egypt.

GDP:

Purchasing power parity - $316.3 billion (2004 est.)

GDP - real growth rate:

4.5% (2004 est.)

GDP - per capita:

Purchasing power parity - $4,200 (2004 est.)

GDP - composition by sector:

agriculture: 17.2%

industry: 33%

services: 49.8% (2004 est.)

Source: Egypt 5.

As late as 2004, the Egyptian Central Bank launched a number of initiatives designed to improve the liquidity of the nation's currency liquidity that have appeared to have some positive results; for example, in spite of the Taba and Nuweiba bombings in September 2004, Egypt enjoyed precedent-setting tourism levels. Furthermore, the development of an export market for natural gas represents an opportunity for future growth; however, improvement in the capital-intensive hydrocarbons sector will not help offset the nation's lingering unemployment rates (Egypt 4).

Examination of Trade Polices and Their Implications for Developing Countries. The international analysts at the CIA report that, "India's diverse economy encompasses traditional village farming, modern agriculture, handicrafts, a wide range of modern industries, and a multitude of services. Services are the major source of economic growth, though two-thirds of the workforce is in agriculture" (India 2). Today, India is also one of the most ethnically diverse countries in the world; besides the country's numerous religions and sects, India is also home to thousands of castes and tribes, as well as more than a dozen major and hundreds of minor linguistic groups from several totally different language families (Schwartzenberg 4). Economic development in India, though, continues to be constrained by quality control issues as well as an inordinately service-based economy that restricts real growth otherwise; however, when a strong processing industry eventually develops in the near-term, access to consumers should be easier because there is already a nationwide retailing infrastructure in place (Turcq 4). The current estimates (2004) for India's gross domestic products are shown in Table 3 below.

Table 3. GDP Permutations for India.

GDP:

Purchasing power parity - $3.319 trillion (2004 est.)

GDP - real growth rate:

6.2% (2004 est.)

GDP - per capita:

Purchasing power parity - $3,100 (2004 est.)

GDP - composition by sector:

agriculture: 23.6%

industry: 28.4%

services: 48% (2002 est.)

Source: India 5.

The current Knowledge Economy Index for India is provided in Table 4 below.

Table 4. KEI, Innovation, Education, and Information Infrastructure for India vs. East Asia and the World.

Country

KEI

Econ. Incentive Regime

Innovation

Education

Information Infrastructure

India

3.85

2.78

8.54

2.13

1.95

East Asia

5.67

5.41

6.31

5.13

5.83

World

4.81

4.55

4.84

4.90

4.96

Source: KAM: India 4.

Figure 2. KEI, Innovation and Information Infrastructure for India vs. East Asia and the World.

As can be seen in Figure 2 above, India lags behind its East Asian neighbors in terms of its Knowledge Economy Index, Economic Incentive Regime, Education and Information Infrastructure (in some instances, seriously so), but far outdistances its neighbors in general and the rest of the world in particular in terms of its focus on Innovation. This concentration on one sector of the economy to the exclusion of others has caused some profound effects on how the Indian economy has developed in recent years. From India's perspective, the global marketplace has clearly changed in profound ways as the country now has the reputation as being the best place in the world to employ cheap, highly skilled labor, in what Smith (2003) calls "a back office of the business world" (8).