Free trade has had its time

Come on. Does anyone really believe that the world will be okay if nations simply adhere to a belief that a nation should produce goods and exports in accordance to one's comparative advantage?

Or is international relations a bit more complex, thus requiring a bit more honesty about the limitations of recent policy trends?

In truth, there has never been a period where all nations adhered to free trade. Some did to a greater extent, others did not. In most recent times, one can note the protectionist barriers that have accompanied the rise of China to develop its manufacturing sector (and exports).

Even though most economists generally concur that true free trade erases inefficiencies and inequalities, the evidence indicates just how unfree international trade remains. While about 400 free trade agreements have emerged since the early 1990s, covering about a third of global trade, most had been 'nation-to-nation and, invariably, carry exemptions that protect domestic industries that politicians decided were vital'. For instance, as of 2008, all Canadian pacts protect Canada's milk, poultry and egg industries. Even the 15-year-old North American Free Trade Agreement had protectionist provisions given that 62.5 per cent of an automobile's total parts must be made within the three member states (Canada, the US and Mexico) before a car could cross a border. Further, agricultural subsidies by the US and European nations have 'paralyzed global trade talks since 2001'.

In Australia, where most tariffs are five per cent or less, considerable protectionist barriers remain. This includes bounties on the outputs of select industries; tax concessions on R&D; investment incentives/subsidies; and export assistance. There are also limitations placed on foreign acquisitions, and some regulation in key industries. For example, only a limited number of airlines are allowed on domestic routes and foreign banks in Australia must operate as a wholesale bank through an Australian branch or conduct business through an Australian-incorporated subsidiary.

Of course, there are good reasons why freer trade should be supported. For example, international food aid groups rightly blame agricultural subsidies - along with a conversion of farmland from food to bio-fuel - for increasing hunger across the developing world as local food producers give up growing crops that cannot compete against subsidised imports. Further, depriving poor nations their economic opportunities can lead to many more illegal immigrants or refugees, as suggested by Mexico's President Felipe Calderon of Mexico in 2008 when Obama vowed to renegotiate NAFTA to protect US workers.

But national policies never operate fully in accordance with an ideal. Each nation must make up its mind just what kind of policy mix is needed. There is no such thing as a magical policy solution in a world of competing nations still struggling for resources and the influence of certain ideas.

Truth is that Western leadership never had the complete answers. The US especially since the Second World War simply promoted freer trade as the best policy option to serve its national interest while promoting the growth of the international trade to encourage economic prosperity between nations.

The need to take account of national economic imperatives remains. Take the US decision in August 1971 to abandon ties between the value of its dollar to gold, and to abolish its capital controls in 1974. With a declining trade deficit and inflation reaching an unheard post-war high of 4.5 per cent in 1971, the US currency came under increased pressure because of declining international confidence that its value could be sustained. US financial dominance was also challenged by the expansion of private international finance, notably through the establishment of Eurocurrency and Eurobonds, where investors were able to avoid many of the national regulations governing the operation of domestic banks, especially in relation to national capital controls. With the US abolishing its capital controls, it was assumed that private market actors were more likely to hold their assets in American dollars in an open international financial environment because of its position as the world's largest economy.

In time, after the turmoil of the 1970s of high oil prices, unemployment and inflation, many Western governments gave policy support to floating exchange rates and the discipline of the market.

However, and despite many Western governments seeking to make their economies more competitive by lowering tariffs and promoting user-pay principles, although the degree varies between nations, Western nations became increasingly reliant upon debt (see Table 1). This includes Australia which, despite maintaining a relatively low level of government debt amongst developed nations, has experienced one of the greatest increases in household debt since 1990.

Table 1: Gross government and household debt as percentage of GDP