The Challenges of Trade Liberalisation for Late Industrialisers Written by Siyaduma Biniza 1

The issue of the impact of trade to economic growth and development is highly

contested. Although there is some agreement that under very specific conditions,

trade liberalisation can lead to growth there is little consensus regarding those

conditions and the empirical evidence is inconclusive. Therefore the relation is still

an empirical issue and some argue that the inconclusiveness of empirical evidence

results from ineffective liberalisation or the methodological and theoretical

problems of the comparative advantage theory that underpins trade liberalisation.

However, besides the concerns about the viability of growth from free trade, I am

concerned with the impact of trade liberalisation on the industrialisation of late

industrialising countries. Here the main debates are whether trade liberalisation

on itself will lead to industrial growth; or the extent to which trade liberalisation

leads to competitiveness pressures that result in increased industrial productivity

and growth; or whether trade liberalisation and specialisation would allow for

industrialisation.

In this essay, I argue that the global movement towards trade liberalisation can

make it more difficult for late industrialising countries to develop their industrial

sector because there are export-commodity-specific and structural socioeconomic

constraints that undermine their industrialisation and that these constraints are

overlooked by the global movement towards trade liberalisation; and because

trade policy is insufficient as industrial policy, as illustrated through a case study

of South Africa, late industrialising countries need a strong industrial policy that is

coherently supported by trade policy. Lastly, and most importantly the question of

trade liberalisation should be approached as a question of the degree of

liberalisation and within which sectors, instead of the blind pursuit of free trade.

1 Siyaduma Biniza is currently an M.Com. in Development Theory and Policy student at the University

of the Witwatersrand, holding a B.Com (Hon.) in Development Theory and Policy with Cum Laude

and B.Soc.Sci in Politics, Philosophy and Economics from the University of Cape Town.

Firstly I consider the theoretical justifications for the global movement towards

trade liberalisation. Then I consider the empirical evidence in relation to the

theory before discussing the export-commodity-specific and structural

socioeconomic challenges to the theoretical mechanisms. Lastly I conclude the

analysis with a case study of South Africa before making final remarks regarding

the question about the impact of trade liberalisation on industrialisation.

Theoretical Justifications

The view that free trade is the most efficient way for international trade to

proceed is justified by the theory of comparative advantage. In my analysis of

theoretical justification for trade liberalisation I use comparative advantage theory

interchangeably with factor endowment theory even though these are distinct

theories. This is because, despite their unique theoretical content, both the

classical and new comparative advantage theories use the same logical

mechanisms and arrive at the same conclusion which is to promote trade

liberalisation. Both theories assert that all countries stand to gain from free trade

if they specialise according to their comparative advantage because all countries

have comparative advantage due to the opportunity costs and unique relative

factor-intensity of producing various commodities traded amongst countries

(Leamer, 1995; Schumacher, 2013; Deardorff, 1998). The comparative advantage

principle and mechanisms of the gains from specialisation and free trade are

illustrated in the example below.

For simplicity, assume that the relevant factors to producing cars and maize are

capital and labour, and that South Africa and a foreign country have the following

endowments of these factors:

Table 1: Factor Endowments

South Africa Foreign Country

Capital 10 10

Labour 4 25

Capital / Labour 3/4 2/5

South Africa has a higher ratio of capital relative to labour than the foreign. This

means that South Africa has a comparative advantage in the production of

commodities that are more capital-intensive because it has a higher capital-labour

ratio. Therefore the principle is that countries have a comparative advantage in

the production of commodities that use their relatively more abundant factor

(Leamer, 1995). The comparative advantage in capital-intensive production implies

that South Africa should import commodities that are labour-intensive. Practically,

assuming that car production is more capital-intensive than maize production,

South Africa should specialise in producing car and import maize from the foreign

country. Conversely the foreign county should specialise in maize production and

import cars from South Africa. Furthermore, this analysis means that even if a

country is at an absolute disadvantage in its endowments it can have a

comparative advantage due to the unique relative factor-intensity and the

opportunity costs of producing cars and maize.

For instance, if we continue with the example of trading in cars and maize, South

Africa would have a comparative advantage over a foreign country even if South

Africa has an absolute cost disadvantage in producing either of these commodities.

This is because the countries have different opportunity cost of producing these

commodities which allows for comparative advantage (Schumacher, 2013). For

example, assume South African and the foreign country’s costs of producing cars

and maize are given by:

Table 2: Cost of Production

South Africa Foreign Country

Cost of Producing 3 Cars 5 3

Cost of Producing 100 kg of Maize 10 1

From this we can see that it is absolutely more costly to produce either of the

goods in South Africa, but the opportunity cost of producing 3 cars in South Africa

is 50 kg of maize since that is the amount of maize that could have been produced

using the same resources otherwise. Similarly the opportunity cost of 3 cars is 300

kg of maize in the foreign country. Therefore South Africa has a comparative

advantage in producing cars because it has lower opportunity costs related to

specialising in the production of cars as opposed to maize; conversely the foreign

country has a comparative advantage in producing maize because the opportunity

cost of producing 100kg of maize is one car in the foreign country in comparison to

6 cars in South Africa. The lesson to be learned from this illustrative example is

that even if countries are at an absolute disadvantage they can still gain from

specialisation and free trade because of their comparative advantage.

Consequently, comparative advantage theory asserts that it would be

advantageous for all countries to specialise according to their comparative

advantage and trade freely (Schumacher, 2013). Therefore the relative factor

intensity and opportunity costs of production leads to comparative advantage

incentivising specialisation and trade liberalisation because all countries stands to

gain if that occurs.

If there is free trade between the countries in the example above, and each

specialised according to their comparative advantage, the overall output would be

higher than the in autarkic state. The autarkic state is when countries are isolated

and do not trade with any other countries, i.e. the very opposite of free trade. In

the example above, there can only be a total 200 kg of maize and 6 cars produced

under autarky if each country produces both commodities. But if each country

specialised according to its comparative advantage South Africa would produce

cars and the foreign country would produce maize; and there would be a total of 9

cars and 400 kg of maize. In addition to higher output, free trade and

specialisation would lead to higher consumption than the autarkic state because

under autarky each country would have 100kg and 3 cars. However, with free trade

and specialisation the countries would trade commodities and possible have a

higher share of each commodity for its consumers. So each country would gain in

that its consumer would have higher consumption and there would be a higher

total output than under autarky. These are the two main gains from free trade

according to the comparative advantage theory.

The analysis is that specialisation and free trade will lead to higher output and

consumption. Free trade is asserted as the best end that countries’ trade policies

should pursue. This is what justifies the global movement towards trade

liberalisation. However the theory of comparative advantage is underpinned by the

dubious assumption that there are constant returns to specialisation. The implicit

assumption of constant returns to specialisation is dubious because the assumption

of constant returns to scale is conflated with constant returns to free trade after

specialisation. Comparative theory also implies that free trade is beneficial

regardless of a country’s export commodities and the demand for the exports.

Thus trade liberalisation is asserted as being beneficial to all countries regardless

of their degree of industrialisation or development. This exposes some theoretical

challenges, which I will briefly discuss; in addition these assumptions and

implications I argue that the theory comparative advantage overlooks some key

export-commodity-specific and structural socioeconomic factors that influence the

possible gains from free trade.

Theoretical Challenges

The theoretical grounds for promoting trade liberalisation, or free trade, are not

empirically sound. But first it’s important to differentiate between free trade,

which is the ideal, and trade liberalisation which is the mechanism by which

countries pursue free trade. Free trade is not empirically observed due to even

miniscule transaction and transport costs related to international trade. Therefore

in many studies that seek to explain the relationship between trade and growth

there are various problems with testing the impact of free trade due to the

challenge of operationalising variables to measure ‘how free trade’ is in a country

(Rodriguez & Rodrik, 2000). Despite this, trade liberalisation consists of various

policy measures that promote the pre-eminence of market mechanisms such as

price, demand and supply in determining trade; examples include the reduction in

tariffs and quotas which are seen as distortionary to trade and inimical to market-

mechanistic determined trade (Rodriguez & Rodrik, 2000).

Therefore, although the empirical evidence cannot say anything about free trade

per se since free trade is unobserved, the empirical evidence does not conclusively

justify supporting trade liberalisation either. Because the evidence is in itself

questionable due to the operationalisation of variables and even when we accept

the validity of evidence there is contradictory evidence that either supports or

undermines the theoretical mechanisms described above (Rodriguez & Rodrik,

2000). Nevertheless, I argue that even if we accept the theory of comparative

advantage there are still deficiencies in the global movement towards trade

liberalisation because it cannot account for export-commodity-specific and

structural socioeconomic factors that determine the gains from trade. So, contrary

to what the theory implies, trade liberalisation and specialisation does not always

just lead to high output and consumption that benefits all; and free trade can be

inimical to growth and industrial development.

Export-commodity-specific and Structural Socioeconomic Factors of Trade

The global movement towards trade liberalisation overlooks export-commodity-

specific and structural socioeconomic factors such as deteriorating terms of trade,

which can be intuitively understood by comparing the price of cars and maize to

reasonably justify the idea that one country needs to trade a lot of maize order to

import cars; and the fact that when people’s incomes change they do not continue

demanding goods the same way. Therefore cars and maize are very different

commodities and they are demanded differently which is unaccounted for by the

assumptions of constant returns to scale and specialisation.

Structural theory and dependency theory approaches to development emphasise

the importance of structural conditions and processes which undermine

development of late industrialising countries and perpetuate unequal development

(Ake, 1981; Hunt, 1989). Some of the structural conditions that lead to

underdevelopment can be the deteriorating terms of trade for underdeveloped

countries’ exports, preferential trade agreements or even characteristics of the

domestic economy (Todaro, 1996). This is to say that there are export-commodity-

specific and structural socioeconomic factors that are not accounted for by the

global movement towards trade liberalisation, which impact on the prospects of

industrialisation, growth and development from trade.

From this perspective late industrialising countries who export predominantly low

value-add primary commodities to industrialised countries; whilst industrialised

countries produce higher value-add manufactured goods and export these to the

late industrialisers. This causes developmental problems for late industrialising

countries because their exports are goods with deteriorating terms of trade,

volatile prices and low income elasticity of demand which negatively affects their

prospects at industrialisation (Ake, 1981).

Deteriorating terms of trade is the situation where the price of late industrialisers’

exports is decreasing relative to the price of its imports which means that the late

industrialisers need to increase the volume of exports in order to balance trade

(Todaro, 1996). In addition late industrialising countries export commodities with

volatile prices which means that a country could face uncertain foreign exchange

earnings from its exports which can affect its balance of trade (Todaro, 1996). This

could possibly also lead to sovereign debt or currency crisis if the country

persistently cannot balance its trade and payments; or if a country has to

repeatedly revalue its currency in order to realise its exports. Lastly, there is

sufficient empirical evidence showing that there is a lower income elasticity of

demand for primary commodities, which predominantly late industrialising

countries have a comparative advantage in (Todaro, 1996). That is to say, as

incomes rise in a foreign country, there is diminishingly increased demand for the

export commodities from late industrialising countries which has the same

negative impact as the other structural conditions due to diminishing export

earnings. In other words, late industrialisers may experience diminishing returns to

scale and specialisation if they export commodities with deteriorating terms of

trade and lower income elasticity of demand; and they will realise diminishing

returns to scale and specialisation.

Given these key export-commodity-specific and structural socioeconomics factors,

late industrialising countries would not experience constant returns to

specialisation. Therefore, although specialised free trade can be mutually

beneficial in terms of high output and consumption, it is neither equally beneficial

nor is it maximally efficient if we consider export-commodity-specific and

structural socioeconomic factors which determine the nature of gains from free

trade. Thus free trade is not necessarily the best end for poor countries’ trade

policies, as the theories imply.

Moreover, trade liberalisation ensures that the structural and industrial inequality

in the global economy is maintained in favour of industrialised countries. Trade

liberalisation ensures that late industrialising countries continue needing to

increase the volume of their exports and face uncertain foreign exchange earnings

whilst facing lower income elasticity of demand and depending on imports with

higher income elasticity of demand. Besides, most industrialised economies

actually followed a route to industrialisation that was followed by heavy

protectionism and in fact some of the causes of great wars were the protection or

monopolising of specific trade-related inputs (Chang, 2004). As a result it is very

suspicious that most industrialised countries, which are often in control of

multilateral financial institutions, which require policies that they themselves did

not follow in their route to development. If history is laden with examples of what

to do, and what to avoid, late industrialising countries ought not to embark of

trade liberalisation with the end goal of free trade. Even if we can accept the

theory due to its theoretical validity despite its empirical indeterminacy, the move

towards trade liberalisation fails to take commodity-specific and structural

contexts that undermine the sufficiency of trade policy as industrial policy.

In addition, if we consider the unique factor endowments between countries, each

country has a comparative advantage due to its relative factor endowments and

the unique factor intensity of producing the traded commodities. That means that

global inequalities in factor endowments are a source of comparative advantage

which incentivises trade. This is the strongest thrust of the global movement

towards trade liberalisation. The argument is that inequalities in factors of

production can be compensated through international trade (Leamer, 1995). This is

because free trade leads to factor price convergence through price and demand

mechanisms according to the theory (Leamer, 1995). As demand for the abundant

factor increases due to specialisation, the price of that factor increases and

demand for the scarce drops which reduces its price allowing countries to

overcome absolute disadvantages of their factor endowments. Therefore free

trade will lead to mutual benefit for trading partners with unequal factor

endowments because their comparative advantage will lead to high output and

consumption under free trade; and there would be a global convergence in factor

prices which allows for income convergence in the world (Leamer, 1995). But there

is significant global divergence and growing income inequality even though there is

a strong political and ideological push towards trade liberalisation (Deraniyagala &

Fine, 2001; Pritchett, 1997). Therefore beyond the theoretical and empirical

problems above, trade liberalisation faces problems that undermine it even

ideologically. The foregone objections point to the dubious separate treatment of

trade and industrial policy in the trade liberalisation discourse (Deraniyagala &

Fine, 2001).

The discourse of trade and development are dominated by two paradigms, one

which views trade policy as sufficient substitute for industrial policy, and another

which views trade policy as an instrument of industrial policy. As already

mentioned the global movement towards trade liberalisation consists of various

policy measures that promote the pre-eminence of market mechanisms such as

price, demand and supply in determining trade; examples of which include the

reduction in tariffs and quotas which are seen as distortionary to trade and

inimical to market-mechanistic determined trade. Often this paradigm is described

as promoting export-led growth models by advocating free trade which is meant to

expose domestic economies to foreign competition from substitutable imports that

are seen as an impetus for domestic firms to improve efficiency and promote

industrial growth and development (Rangasamy & Harmse, 2005). In this view

trade policy is sufficient as industrial policy and proponents of this view would

advocate for minimal state intervention excepting when the state promotes trade

and economic liberalisation, i.e. the neoliberal or neoclassical economics type of

propositions.

However this paradigm is diametrically opposed to the view that trade policy is an

instrument of industrial policy. Here trade policy is seen as important in aiding the

promotion of certain economic sectors through various coherent tariff regimes that

protect infant industries. This approach often advocates for coherence between

trade and industrial policy to promote import-substitution industrialisation as a

mean of structural economic transformation which is seen is a requirement for

development and industrialisation in late industrialising countries (Hunt, 1989).

Therefore in this paradigm trade policy on its own is not sufficient and the

industrialisation of late industrialising countries requires industrial policy that is

aided by coherent trade policy. In light of this, South African case is a relevant

example that shows the insufficiency of trade policy as industrial policy.

The Case of South Africa

South Africa’s liberalisation began in the 1970’s but really culminated in the strong

liberalisation direction in the 1990’s. South Africa’s trade liberalisation was based

on the premise that increased competition from imports would be an impetus for

improved efficiency which would result in higher exports from domestic producers

of competing goods. Therefore the main thrust behind trade liberalisation was the

pursuit of greater manufacturing competitiveness as a means of creating growth

and employment (Rangasamy & Harmse, 2005). But this was not achieved.

Table 3: Manufacturing exports: 1990-2000 (% contributions)

Source: (Rangasamy & Harmse, 2005)

Figure 1: Sectoral Growth (real GDP 1990=100)

Source: (Rangasamy & Harmse, 2005)

The table above shows that between the liberalised and moderately protected

sectors there was stagnant contribution from technology-intensive production

meanwhile technology-intensive production increased for protected sectors. The

figure above also show that there has been growth in liberalised sectors (L) which

exceeds growth in moderately liberalised (M) and protected (P) sectors. This shows

that growth in manufacturing has been closely correlated to liberalisation

(Rangasamy & Harmse, 2005).

However, although there was higher output, trade liberalisation was unable to

increase production of technology-intensive goods which suggests that technology

transfer did not result as expected from trade liberalisation (Rangasamy & Harmse,

2005). In addition, although there was an increase in exports during the 1990’s,

there is no mechanism to prove that these exports were due to trade

liberalisation. And although there wasn’t significant de-industrialisation in

manufacturing sector, output in this sector was specialised in technologically

stagnant goods (Rangasamy & Harmse, 2005). Therefore, trade liberalisation did

not deliver gains as expected. Therefore trade liberalisation was not a source of

competitiveness and industrialisation.

Furthermore, trade liberalisation had the impact of restructuring the composition

of labour and production in the economy (Edwards & Behar, 2006). The South

African government’s commitment to trade liberalisation and global

competitiveness pressures meant that many domestic firms had to restructure

through “right-sizing” and “downsizing” which led to large-scale job losses (Satgar,

2012, p. 47). More importantly labour-intensive import-substitution industries

suffered the most whilst export-led industries failed to create job due to a shift

towards capital-intensity in order to retain competitiveness (Satgar, 2012).

This has had dire impacts on South Africa in terms of its employment because the

country has an abundance of unskilled labour which would mean its

competitiveness is in labour-intensive production. However, trade liberalisation

has had a negative impact since South Africa could not maintain its

competitiveness in labour-intensive production and instead had to succumb to

international pressure and shift towards capital-intensive production to retain

competitiveness (Rangasamy & Harmse, 2005). The ability to resist international

competition and promote competitiveness of labour-intensive production requires

industrial policy in order to promote the development of sectors involved in

labour-intensive production. This case shows the clear insufficiency of trade policy

as industrial policy which shows the gap that requires industrial policy and

coherent trade policy. Therefore South Africa needed a clear industrial policy

which ought to have support by trade policy that could promote labour-intensive

production in order to grow its industry.

Moreover, even if one does not accept the forgoing import-substitution line of

argument, the South African case is a classic example that shows that the issue of

trade liberalisation is more about the degree of trade liberalisation than complete

free trade. Thus, the South African case like many other late industrialising

countries, shows that regardless of the paradigm trade liberalisation should be a

case of blind pursuit of free trade. This case shows that there are problems with

trade liberalisation that treats trade and industrial policy as separate because in

fact the two are intimately connected, and trade policy is insufficient as industrial

policy.

In conclusion, the global move towards trade liberalisation therefore makes it

difficult for late industrialising countries because: firstly it is underpinned by shaky

theoretical grounds, secondly the paradigm ignores the impact of commodity-

specific and structural socioeconomic factors that are related to what a country

exports which also determine the gains from trade, and lastly the movement

towards trade liberalisation overlooks the importance of industrial policy in

determining the impact of trade for growth and development. Therefore, having

analysed the situation there are export-commodity-specific and socioeconomic

factors that make it difficult for late industrialising countries to industrialise

through trade liberalisation.

Regardless of whether one advocates the export-orientated or import-substitution

industrialisation approach to growth, countries need to be sensitive of the link

between industrial and trade policy and understand that growth from trade

liberalisation does not necessitate completely free trade; instead the question

might be the degree of liberalisation or protection and within which sectors.

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