How does global trade work?

Author(s): Dr Eamonn Butler

March 16, 2021

The growth and extent of world trade is staggering. In 1950, trade accounted for just 8.6% of world output (GDP). By 2008 it accounted for an astonishing 60% of world GDP, involving $20 trillion in goods and over $5 trillion in services. Despite setbacks — financial crises, wars (including Trump-style trade wars) and even pandemics — trade seems set to expand, bringing yet greater interaction between the world’s peoples, ideas and cultures.

Trade has always existed. That is because, as Adam Smith noted in The Wealth of Nations, both sides benefit from it: they wouldn’t bother if they didn’t. David Ricardo went on to observe that by specialising on their ‘comparative advantage’, countries can overcome the bounds of geography and climate. It’s why we can enjoy bananas in December.

Like all progress, the long-term impact of trade is positive; but in the short term all change produces winners and losers. Thus, people in rich countries complain that cheaper foreign workers are taking their jobs, while developing countries complain that their fledgling industries cannot compete against transnational giants. But consumers everywhere benefit from greater choice, and from the competition that bids down prices and bids up quality.

And the boom in trade since 1990 — brought on by reforms that brought China and South East Asia, India, Eastern Europe and South America into the world trade network — has produced history’s biggest and fastest rise in prosperity, particularly for the world’s poorest. It has taken roughly a billion people out of $2-a-day poverty. And it has made the world culturally richer than ever before.

Yet governments still face fierce lobbying from producers who see foreign competitors eating into their markets. Tariffs, quotas and other trade barriers are the result. But while these might give temporary comfort to a few producers, there is a cost. The imported goods that their consumers want, and the inputs their manufacturers need, become more expensive or even unavailable. That is why almost all economists agree — uniquely — that protectionism is a mistake.

Realising how two world wars had stifled trade and prosperity, the major trading countries sought, through the General Agreement on Tariffs and Trade (GATT) and its successor the World Trade Organization (WTO) to limit protectionism and promote, easier, freer trade. And indeed, though high tariffs do remain (the EU, for example, imposes taxes up to 30% on imports of agricultural products), average world tariffs have been brought right down.

As a result, value chains today have become truly global. The iPhone, for example, is assembled in Taiwan and includes parts from South Korea, India, Brazil, the UK, China, Singapore, the US, Switzerland, Indonesia, India, France, Japan — and others.

The gains are not just economic. There is good evidence that trade promotes international trust, cooperation and understanding. It is also associated with political freedom, the rule of law, honesty, free speech and other liberal values. It helps defuse nationalism and ethnic conflict, and promotes peace, fairness and equality. After all, if people are to reap the many benefits of trading with each other, they have to cooperate.

Of course, the expansion of trade has thrown up new issues. One is a rising focus on security. For example, the US and UK ban mobile providers from importing new Huawei 5G equipment, fearing it could be used to spy on their networks. Another issue is the export of counterfeit and pirated goods, including clothes and shoes, electronics, perfumes, toys and medicines, which the Organisation for Economic Cooperation and Development (OECD) estimates at a chunky 3% of world trade. Services (such as banking, accountancy, legal services, healthcare and education) have become a much bigger part of world trade, leading to questions about whether the qualifications of one country’s lawyers, bankers, doctors and other professionals should be accepted by others. Another big concern is the environment, with countries resisting imports with high carbon footprints or banning the importation of certain fertilisers and pesticides. And more generally, the growth of ‘emerging’ economies (such as Brazil, China, India, Indonesia, Mexico, Morocco, the Philippines, South Africa and Turkey) is tilting the traditional economic balances between regions across the globe and bringing new challenges of its own.

However, most policy on trade is driven by domestic politics rather than economic logic. To work well, therefore, trade needs an international framework, and a global rule of law. This is no easy task, given the many pressures on countries to protect their own industries and raise barriers against others. But we have no way of knowing where trade will take us, or the new benefits it will bring in quite unexpected areas.