Liberalization: The “Deregulation” of International Trade
Liberalization: The “Deregulation” of International Trade

 Trade liberalization has become a ‘hot button’ issue in world affairs. Many countries have seen great prosperity thanks to the disintegration of trade regulations that had otherwise been considered a harbinger of free trade in the recent past. The controversy surrounding the issue, however, stems from enormous inequality and social injustices that sometimes comes with reducing trade regulations in the name of a bustling global economy.

Given the dislocations and controversies, some people question the importance of efforts to liberalize trade and wonder whether the economic benefits are outweighed by other unquantifiable negative factors such as labor exploitation. It is important to remember, however, that the original impetus for the process of trade liberalization was undertaken for reasons that went far beyond economic concerns, as we will see in this section.

The Origin of Recent Trade Liberalization Efforts

Following World War II, the leaders of the world’s largest industrial economies set about to create institutions such as the General Agreement on Tariffs and Trade (GATT), which would later become the World Trade Organization in 1995 (WTO), to promote trade liberalization, and the World Bank and the International Monetary Fund, to better coordinate global economic policy. The world leaders who established these Intergovernmental Organizations (IGOs) did so out of what they believed to be a bitterly learned lesson about the costs of not coordinating economic policy and of not safeguarding free trade.

The generation that developed these organizations witnessed World War I and the Great Depression, two unprecedented catastrophes in the opening twentieth century and an increasingly linked global community. In the late 1920’s, the world economy faltered, causing widespread unemployment and slashing economic production. The U.S. government, like many others, saw its revenues falling and domestic production increasingly endangered by now-cheap foreign imports. In response, the U.S. Congress passed the Smoot-Hawley Tariff Act in 1930, which raised tariffs on imports by nearly 60 percent (US Department of State, 2012).   This was done as a means of both raising revenue and curbing imports. As a result, 60 other countries retaliated against the United States’ actions, raising their own tariff barriers. Nations also began to devalue the exchange rate of their currencies, making their exports cheaper to their trade partners.

As a result of these “beggar-thy-neighbor” policies, the volume of world trade dropped dramatically, both deepening the severity of and lengthening the duration of the Great Depression.

President Franklin D. Roosevelt’s Undersecretary of State Sumner Welles later concluded, ”The high tariff [of Smoot-Hawley] rolled up unemployment in Great Britain and in Western Europe…. [It] encouraged the German government to adopt its autarchic economic policy, which in turn was a contributing factor in bringing about the Second World War.”

 The disastrous results of Smoot-Hawley were flagrant and swift.  The Reciprocal Trade Agreement Act of 1934 was passed to counteract the measures of the Tariff put into place just four years earlier. For the first time, Congress gave the president the authority—albeit for three years only then subject to renewal—to negotiate tariff cuts on a bilateral, reciprocal basis with other countries. These cuts could be implemented by Executive Order, i.e., without the need for Congress’s permission. This authority was renewed repeatedly in the ensuing years and by 1945, 25 reciprocal agreements had been negotiated. Most importantly, this meant that the ability to implement protective trade policy was now constrained by international agreements committing the United States to lower trade tariffs.  The United States became a forerunner of liberalization of trade as opposed to protectionism that characterized the Smoot-Hawley tariff. Protectionism is economic policy that serves the internal interests of a singular country, as opposed to acting for the benefit of the global economy (Bhagwati, 2008).  

After World War II, global leaders sought to put permanent agreements and institutions into place to ensure that economic chain reactions, like the one triggered by Smoot-Hawley, never took place again. One of their goals was the creation of the International Trade Organization (ITO). The ITO had an ambitious agenda that not only covered trade but was also extended to include rules on employment, commodity agreements, restrictive business practices, international investment, and services.

Despite being a cornerstone to the inception of the ITO, the United States Congress did not ratify the proposed agreement—ultimately leading to the organization’s demise. Instead, the leading nations of the International Trade Organization, including the United States, settled upon the GATT, which was not a permanent organization and had a narrower focus limited to the reduction of industrial tariffs (the United States insisted on the exclusion of agricultural goods as well).

At any given time, no matter how prosperous the world economy may be, there are usually a few countries undergoing some kind of economic shock. Every time a country suffers an economic downturn, it is very tempting for political leaders to try to “export” their problems onto their trading partners by raising tariffs or devaluing their currencies.

Many economists make the analogy that the pursuit of free trade is a bit like riding a bicycle: If you don’t continue to make forward progress, you are in danger of falling off. Governments around the world are under almost constant pressure to protect domestic industries—either because of an economic downturn, changes in technology, or any of the myriad forces behind the “creative destruction” of the free market.

Trade agreements that are vigorously enforced are the most powerful ways to prevent governments from succumbing to these pressures. Although many valid criticisms can be levied against the current world trading system, it is the view of the author that critics should remember the precedent that led to its creation, and the global turmoil that was caused by the absence of international rules.

Time Line of Events

1929 Great Depression begins
1930 Smoot Hawley Tariff Act: Raises tariff of imports by 60 percent
1934 Reciprocal Trade Agreements. President (executive) authorized to eliminate tariffs with bilateral agreements
1939-1945 World War II
1947 GATT created to reduce industrial tariffs worldwide

Questions for Discussion:

  1. Why do you think the U.S. Congress opposed the International Trade Organization?
  2. Do you think the international regulation of trade benefits countries overall? Does it help particular countries more than others?
  3. How do governments balance the need to respond to domestic demands for protection of particular sectors (agriculture, manufacturing, etc.) and international demands for open markets?

 

 

Next: The Liberalization of International Trade