Trade Agreements as a Basis for Sustainable International Trade
An Article in the Compendium of Market-Based Social-Ecological Economics
Key issues in view of the neoliberal crisis:
How can we guarantee employment and fair income?
How can we protect the environment effectively?
How should we shape the economic globalization?
What should the economic sciences contribute?
What must be the vital tasks of economic policy?
How can we legitimize economic policy democratically?
Table of Contents
Economic sustainability can only be expected, if international trade is governed by bilateral and multilateral agreements. Productivity and price differences between national economies in particular have to be neutralized by carefully calculated and agreed exchange rates. This is the only way to conduct international competition on the basis of relative price advantages, and to stimulate regional developments. No doubt, viable autonomous regions are the foundation for a sustainable, future-proof economic globalization.
The euro zone is the current example of what kind of financial and economic difficulties countries may face by joining a heterogeneous supranational currency area and subsequently waiving their autonomous monetary and exchange rate policy. Details of the European development are summarized in the article EU: Federal Superstate or Confederation?.
In this article of the compendium I present the principles for a future-proof international trade as they are derived from the requirements of a sustainable, socially and ecologically oriented market economy. Please note that autonomous regional and national economic systems form the foundation for a sustainable international and global economic system, supplemented by normative guidelines and regulations reached by consensus at the global level. Conversely, of course, economic globalization is doomed to fail, if international trade and international competition are designed to destroy their own regional and national foundation – as is the case under the present neoliberal doctrine.
The proposed post-neoliberal foreign trade, which allows participating economies to mutually achieve gains from trade, is to a large extent based on David Ricardo’s theorem of »comparative advantage« (for details please see the article Comparative Advantage – Upgraded).
I have however adapted the theorem to modern-day requirements: Decisive in this respect are bilateral trade agreements on fixed exchange rates and mutually granted autonomy in setting import quotas and import tariffs. In this way, productivity and price differences between national economies can be neutralized, foreign trade and international competition can be based on relative prices, trading partners can beneficially limit their economic specialization and prevent cut-throat competition and hostile market penetration, and last not least, gains from trade can be maximized in today’s complex trade environments through multi-bilateral price competition, price comparison and appropriately adapted trade flows.
3. Starting Position
The underlying principles are built upon the conviction that mankind should share and exchange information and economic products, while respecting and benefitting from one another’s cultural and economic diversity. However, the success of international exchange essentially depends on the sustainability of agreed rules governing commercial trade. The present neoliberal reality is however far from conforming to this goal. In fact, the neoliberal economic globalization is serving selfish interests, and is in the process of dividing mankind more and more into few winners and many losers, and is therefore bearing responsibility for the globally spreading social and ecological crisis.
It is imperative for foreign trade to be built upon a foundation of intact domestic economies. This requires political and economic decisions to be taken democratically, applying a subsidiary, bottom-up approach. That is, lower levels of social and economic life should always have the right to decide what should be delegated to upper levels, not vice versa, as is common under today’s neoliberal economic doctrine. Since only a subsidiary approach can ensure economic diversity – in agriculture, crafts, trades, commerce and industrial production alike – and create social and environmental responsibility at the local level as a precondition for full employment and environmental protection. Economic subsidiarity implies that the diverse economic cycles at the local level are cross-linked with cycles at upper levels, and that technological requirements naturally increase from lower to upper levels.
4. The Significance of Bilateral Agreements
A clear distinction has to be maintained between the regulation of domestic economic activity and the agreements for foreign trade. The success of domestic activity depends on the quality of regulation and control exercised by autonomous economic policy. In contrast, foreign trade takes place between autonomous economies of different cultural, political and economic stamp and character, so that conflicts can only be avoided and sustainable gains from trade only be achieved, if differences are neutralized a priori by contractual clauses included in bilateral agreements. In other words, beneficial international interaction requires carefully designed bilateral interfaces. However, bilateral agreements can and should be supplemented by multilateral agreements, just as national value chains can be expanded across national boundaries, provided the structural subsidiarity is retained in doing so. In any case, bilateral agreements should include short periods of notice to prevent incentives for unilateral economic dependencies and extortions. The multilateralism of the World Trade Organisation (WTO) is the present bad example that enforces irredeemable agreements and unresolvable dependencies and extortions (for more details see the article World Trade Organization (WTO)).
5. The Anarchy Induced by Neoliberalism
Before embarking on the principles of a post-neoliberal foreign trade, it is helpful to evaluate the neoliberal reality: The starting point is the neoliberal free-trade doctrine, which has its origin in the »natural« entrepreneurial striving for expansion and growth. When the Bretton Woods Agreement failed in the early 1970’s, global players seized the opportunity to free themselves from political reins. Ever since, and for the first time in economic history, economic freedom is conceived by economic players as being free from any kind of regulation and restriction, and in particular as being free to operate globally across national borders and use global resources at ones sole discretion.
By disintegrating the political framework in the way described, the free market economy has been gradually converted into an anarchic market economy (this development is described in the article Bretton Woods System (English)).
6. The Neoliberal Indoctrination
Figure 1: Neoliberalism spreads its doctrinaire message with wrongly occupied terms: Firstly, with the euphemisms »liberalization« and »free trade«, secondly, by disparaging the useful measures of domestic market protection with the terms »protectionism« and »foreclosure«. This indoctrination is promoted by the World Trade Organisation despite the fact that the term »protectionism« originally refers to economically nonsensical foreclosure. For example, foreclosure for cultural or ethnic reasons, as practiced in Japan up to the 19th century, or for ideological reasons as practiced in the former Eastern Bloc up to the 1980’s. In contrast, the term »protection« refers to meaningful measures such as fixed exchange rates, import tariffs and import quotas, which countries should employ to consensually control and domestically integrate their foreign trade transactions and subsequently to benefit from international competition. The contradictions of neoliberalism become obvious, when countries take measures of meaningful protection to escape domestic devastations and, at the same time, accuse one another of protectionism.
7. The Implications of National Deregulation
Unregulated financial markets facilitate capital flight, speculative transactions which affect the real economy, shareholder-value strategies, exchange dumping, distorting key currencies (the dollar and recently the euro), uncontrolled foreign direct investments and »freedom« of establishment, cross-border locational competition and capital concentration.
Unregulated commodity and goods markets facilitate hegemonic pricing, cost pressure, predatory competition and hostile market penetration, curtailed depreciation of production capital, growing transport volumes causing cost externalization, altogether: dumping of social and environmental standards.
Unregulated service markets additionally facilitate privatization of general interest public services.
Unregulated labor markets facilitate unrestricted immigration into high-wage countries resulting in dumping of social standards and wages.
Altogether, deregulation causes destruction of domestic economic cycles, regional de-industrialization, diminishing balance between the development of productivity against wages and purchasing power, unemployment , poverty and environmental deterioration.
8. Neoliberal Trade: Based on Absolute Price Advantages
Figure 2: When markets are »liberalized« and trade agreements abandoned, uncontrolled competition emerges between participating economies. This neoliberal competition is inherently determined and decided by absolute price advantages in key currency (dollar or euro). The bilateral currency parities lose their relevance, because they change in an uncontrolled manner due to global currency speculation and national currency manipulation (exchange dumping), and because the neoliberal global competition requires instant price comparisons – that is only feasible if prices can be compared on the basis of an accepted key currency. In the initial stage of »liberalized« (open) markets, highly productive countries (like England in the illustration) usually have absolute price advantages at first, so that the trade flows are directed from highly to lowly productive countries (as indicated by the red arrows). At the same time, and caused by the absence of agreed trade quotas and tariffs, a tendency arises for squeezing competitors out of the market, for concentration of capital and for territorial specialization.
Figure 3: Since open markets allow to combine advanced production capital with low wages in order to increase productivity, capital is transferred from countries with high productivity and high wages to those with low productivity and low wages. Initially high productivity is accompanied with high wages. But immediately, incentives evolve for low-productivity countries (like Bulgaria in the illustration) to lower their social and environmental standards (standards dumping) and to devalue their currency against the key currency (exchange dumping) to achieve competitive, absolute price advantages. Hence redirecting the trade flows for their own benefit (as indicated by the red arrows). Due to the shifting of economic costs to society and environment, the advantages are associated with an apparent and destructive productivity. As relocation of productions and dumping propagate amongst countries and enterprises, price advantages and trade flows change continuously, and severely intensify global competition. Unscrupulous behavior is rewarded and leads the global economy into a neoliberal vicious circle (for a description of this circle see the article Neoliberal Vicious Circle, and in addition Neoliberal Economic Doctrine).
9. The Original Function of Exchange Rates
Figure 4: Exchange rates have one single original function: namely to neutralize natural productivity-related price differences between countries. Trading countries can mutually achieve sustainable gains from trade regardless of their stage of technological development and their productivity levels, if they bilaterally implement price-neutralizing exchange rates amongst them. If, in the simplest case, a single product is traded between two countries (as shown in the illustration between England and Poland) the exchange rate results directly from the two domestic prices of that product. In the example shown, the 6 pounds paid for English hops are equivalent to the 8 Zlotys paid for Polish hops. Meaning that 6 pounds can be exchanged into 8 Zlotys and vice versa, or 1 pound into 1,33 Zlotys and 1 Zloty into 0,75 pounds.
Such a price-neutralizing exchange rate guarantees
Figure 5: If two trading partners trade more than one product, the exchange rate results from the two average prices of a jointly compiled virtual basket of goods. The basket should initially contain only traded and prospectively traded products, and only those produced in both countries, regardless of whether the products are traded in one or both directions. Subsequently, the resulting exchange rate is also valid for common products being produced in only one of the countries and therefore traded in only one direction. But if rare national specialties are supposed to be traded, their prices should be included into the calculation of the average price of the exporting country, and conversely, estimated prices should be included into the calculation of the importing country.
Average prices and bilateral exchange rates are to be recalculated, whenever price changes of individual products in one country significantly effect that country’s average price with respect to the products contained in the joint basket of goods. Normally these changes occur because productivity growth differs considerably from industry to industry within each country.
As a warning example see also the article Currency War and Exchange Rate.
10. Conditions for Bilateral Trade Agreements
Trading partners must be prepared to
11. Bilateral Trade Agreements
Calculation of Bilateral Exchange Rates via a Basket of Goods
Figure 6: The illustration shows a multi-bilateral trade relation between three countries. In the first step, bilateral baskets of mutually traded goods are compiled and the average domestic prices between the three countries calculated to determine the exchange rates.
England and Poland: the specific basket for these two countries contains four products. The English average price is 8 pounds, the Polish average price is 13 zlotys. Therefore, 8 pounds equal 13 zlotys, which is the directly resulting exchange rate between England and Poland.
England and Bulgaria: their basket contains only three products, because steel and cotton are unidirectionally tradable products. Therefore, 5 pounds equal 12 levs, which is the directly resulting exchange rate between England and Bulgaria.
Poland and Bulgaria: their basket also contains only three products, so that 9 zlotys equal 12 levs, which is the directly resulting exchange rate between Poland and Bulgaria.
Calculation of Relative Prices, Import Prices and Gains
Figure 7: In the second step, the relative prices of all products within each existing bilateral trade relation are determined. The term »relative« refers to the ratio of product price to average price. A product becomes a declared candidate for export, if its relative price is lower than the relative price of the same product offered by a trading partner. Hence, trade is conducted and trade flows are determined by comparing relative prices – this being the fundamental difference to the present neoliberal practice.
To demonstrate the calculation of prices and gains from trade, we can take a closer look at the trading of potatoes within the triangular trade relation between England, Poland and Bulgaria:
England and Poland: The relative price for English potatoes is 0,5 (the price of 4 pounds divided by the average price of 8 pounds). Whereas the relative price for Polish potatoes is 0,53 (the price of 7 zlotys divided by the average price of 13 zlotys). Therefore, English potatoes have a relative price advantage, because their relative price is lower than the relative price of Polish potatoes.
If Poland imports English potatoes, the import price is only 6,52 zlotys by applying the calculated exchange rate (4 pounds equal 6,52 zlotys). Since the Polish domestic price for potatoes is 7 zlotys, Poland draws a profit of 0,48 zlotys for each and every unit of imported English potatoes.
England and Bulgaria: Because the basket of goods contains only three products (steel and cotton are only unidirectionally tradable), the relative price for English potatoes is now 0,8. The relative price for Bulgarian potatoes is 0,92. Therefore, England has again a relative price advantage for potatoes.
If Bulgaria imports English potatoes, the import price is only 9,6 levs by applying the calculated exchange rate (4 pounds equal 9,6 levs). Since the Bulgarian domestic price for potatoes is 11 levs, Bulgaria draws a profit of 1,4 levs for each and every unit of imported English potatoes.
Poland and Bulgaria: Because the basket of goods again contains only three products (steel and cotton are again only unidirectionally tradable), the relative price for Polish potatoes is now 0,78. The relative price for Bulgarian potatoes is still 0,92. Therefore, Poland has a relative price advantage for potatoes.
If Bulgaria imports Polish potatoes, the import price is only 9,31 levs by applying the calculated exchange rate (7 zlotys equal 9,31 levs). Since the Bulgarian domestic price for potatoes is 11 levs, Bulgaria draws a profit of 1,69 levs for each and every unit of imported Polish potatoes.
Specification of Trade Flows, Trade Volumes and Tariffs
The trade flows derived from relative price advantages are initially only options. Whether products are actually traded and in what quantities, is up to importing countries to decide by virtue of their autonomy. Arbitrary exports are therefore excluded. In the above example, England has no option for imports, at least not, if only monetary gains are considered.
Poland needs to decide whether and in what quantity to import potatoes from England, and whether and in what amount to impose tariffs upon the English potatoes. To start with, Poland has to answer two specific questions: Is there a demand in domestic markets for additional quantities of potatoes, and if so, is the quality of the imported potatoes such that it can enrich the supply in domestic markets? If Poland decides to import potatoes, it then has to precisely calculate the amount of import tariffs so that Polish potato farmers become motivated to improve their quality and productivity in international and domestic comparison.
Contrary to Poland, Bulgaria needs to decide whether and in what quantity to import potatoes from England and/or Poland. Because the imports from Poland guarantee larger gains, Bulgaria has to make its decision on quantities dependent upon a quality comparison between English and Polish potatoes. Concerning the calculation of import tariffs, the same rules apply to Bulgaria as outlined for Poland.
The political decision on imports, import volumes, and import tariffs is crucial for the beneficial integration of foreign trade and international competition into domestic trade and competition.
As opposed to neoliberal foreign trade, producers can sustainably improve both their quality and productivity and gain international competitive advantages without endangering their very existence under the conditions presented here.
Illustration for the Calculation of all »Basket-based« Trade Flows
Figure 8: To deepen the understanding of the future-proof, beneficial foreign trade based on relative price advantages, the illustration shows all trade flows possible for products contained in the three bilateral baskets of goods. Calculations of relative prices, import prices and gains from trade can be easily reproduced applying the scheme presented in the above paragraphs.
It should be added that even products with a relative price disadvantage may be imported in exceptional cases, if the quantitative domestic demand cannot be met otherwise, or if foreign products have unique features. It would be conceivable, for example, that England and Poland import steel from each other, because each country produces a unique variety.
Illustration for the Calculation of all »Off-Basket« Trade Flows
Figure 9: The illustration shows all trade flows possible for common products not contained in at least one of the bilateral baskets of goods. If a product is not contained in a basket, it’s because only one of the trading partners disposes of it, and obviously, such a product can only be traded in one direction. As explained above, the exchange rates derived from the baskets are nevertheless valid for these common products.
Since common »off-basket« products are only unidirectionally tradable, it would be superfluous to determine their relative prices and the monetary gains from trade. However, it makes sense to reproduce their import prices applying the scheme presented in the above paragraphs, because importing countries may have to choose between export offers from more than one country (in the illustration Bulgaria may choose between the steel offers from England and Poland).
For »off-basket« products the gains from trade can only be measured indirectly (non-monetary), mainly with respect to trade balances and the overall benefits induced in importing countries.
12. The Benefits of Future-Proof Foreign Trade
The effective building of subsidiary economic structures under the conditions of the neoliberal globalization as a base for a post-neoliberal economic order is addressed in the article Building Subsidiary Economic Structures.
In addition, I recommend the articles Sustainable Social Welfare, Economic Competition, Re-Industrialization Not De-Industrialization, Principles of Global Economic Order and Ten Imperatives to Secure Our Future.
Click here for the German-language version: Zukunftsfähiger Außenhandel