The handmaiden of growth

Free trade, Ricardo showed, ensures that an economy makes best use of its resources, deploying labour to its best advantage. But open markets might also unleash the forces of accumulation and innovation, adding to and augmenting those resources. Trade, in other words, may raise an economy’s rate of growth as well as boosting its level of income.

According to Ricardo’s intellectual predecessor, Adam Smith, foreign trade liberates an economy from the “narrowness” of the domestic market, opening it up to the broader opportunities of world commerce. This encourages any branch of art or manufacture to “improve its productive powers, and to augment its annual produce to the utmost”.

Latter-day economists have elaborated on this argument, and many have sought to demonstrate it empirically, with mixed success. Mr Anderson draws on such studies to make an educated guess about the impact of trade liberalisation on growth. Cutting trade barriers by half could raise the rate of growth by a third in developing countries and one-sixth in richer countries, he reckons.

Such bold assumptions raise the benefits of trade liberalisation by several orders of magnitude. They could scarcely do otherwise: even small increases in the rate of growth, compounded over many years, make a huge difference to the size of the economy. This quicker growth, compounded over 50 years, combined with the static efficiency gains from trade, adds more than $23 trillion to the present value of the world economy. Of this total, poor countries would reap $11.5 trillion. These totals do not translate directly into gains in welfare: not all of the added output will be consumed if some is devoted to higher rates of investment inspired by open markets. And adjusting to a more liberal trade regime will not go as smoothly as many models, with their perfectly flexible labour markets, assume. But even if the transition period is protracted and painful, lasting five years and costing $243 billion per year, the ratio of global benefits to costs would exceed 20.

For policymakers keen to make the most of the world’s scarce resources, an investment in the ideas of Ricardo and Smith yields rich returns.

(Source: http://economist.com)