The Economic Effects of Trade Liberalization
The objective of reducing barriers to trade, of course, is to increase the level of trade, which is expected to improve economic well-being. Economists often measure economic well-being in terms of the share of total output of goods and services (i.e., gross domestic product, GDP) that the country produces per person on average. GDP is the best measurement of economic well-being available, but it has significant conceptual difficulties. As Joseph Stiglitz notes, the measurement of GDP fails “to capture some of the factors that make a difference in people’s lives and contribute to their happiness, such as security, leisure, income distribution and a clean environment—including the kinds of factors which growth itself needs to be sustainable.”[10] Moreover, GDP does not distinguish between “good growth” and “bad growth”; for example, if a company dumps waste in a river as a by-product of its manufacturing, both the manufacturing and the subsequent cleaning up of the river contribute to the measurement of GDP.
As the result of a multilateral round of trade negotiations under the GATT/WTO, tariffs are reduced during a transition period but are not completely eliminated. In the United States’ bilateral or regional free trade agreements (FTAs), however, parties to the agreement completely eliminate almost all tariffs on trade with each other, generally over a transition period, which may be five to ten years.
Although reducing barriers to trade generally represents a move toward free trade, there are situations when reducing a tariff can actually increase the effective rate of protection for a domestic industry. Jacob Viner gives an example: “Let us suppose that there are import duties both on wool and on woolen cloth, but that no wool is produced at home despite the duty. Removing the duty on wool while leaving the duty unchanged on the woolen cloth results in increased protection for the cloth industry while having no significance for wool-raising.”[11]
This happens for some products as a result of multilateral trade negotiations. For example, a country often reduces tariffs on products that are not import sensitive—often because they are not produced in that country—to a greater extent than it reduces tariffs on import sensitive products. In an FTA, where the end result is zero tariffs, this would not be an effect when the agreement is fully implemented. However, during the transition period it could well be relevant for some products. Other than this exception, however, reducing tariffs or other barriers to trade increases trade in the product, and this is the intent of the trade agreement.
The benefits to an economy from expanded exports as a trade partner improves market access are clear and indisputable. If the United States’ trade partner reduces barriers as a result of a trade agreement, U.S. exports will likely increase, which expands U.S. production and GDP. And suppliers to a firm that gains additional sales through exports will likely also increase their sales to that firm, thereby increasing GDP further.
The firms gaining sales through this may well hire more workers and possibly increase dividends to stockholders. This money is distributed through the economy a number of times as a result of what economists call the money multiplier effect, which states that for every $1 an individual receives as income, a portion of it will be spent (i.e., consumption) and a portion will be saved. If individuals save 10 percent of their income, for every $1 earned as income, 90 cents will be spent and 10 cents will be saved. The 90 cents that is spent then becomes income for another individual, and once again 90 percent of this will be spent on consumption. This continues until there is nothing left from the original $1 amount.
In fact, expanded exports increase a nation’s GDP by definition. One equation economists use for determining GDP is GDP = Domestic Consumption (C) + Domestic gross investment (In) + Government spending (G) + [Exports (E)—Imports (I )], or GDP = C + In + G + (E—I)
The impact of trade on GDP, therefore, is the net amount that exports exceed or are less than imports. However, this is a static measure. As noted above, expanded exports also have a dynamic effect as companies become more efficient as sales increase.
The economic impact of increased imports is different. By the economists’ definition of GDP, of course, increased imports reduce GDP. A way of looking at this is that if a U.S. firm produces a product that suddenly loses out to increased imports, it will reduce its production and employment, and consequently its suppliers will also reduce production and employment, thereby reducing economic output.
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