ANALYSIS

Whether Free or Fair Trade, Corporate Mercantilism Rules the Day

The world has gone free trade mad. There appears to be almost universal public agreement these days that the world must reduce the barriers to trade in order to return to economic growth and prosperity. It is hard to pick up the business section of a newspaper or to scan the covers of news magazines without seeing mention of ongoing or proposed inter national trade negotiations, either am ong Canada, M exico and the United States, in the European Com munity or at the General Agreement on Tariffs and Trade (GATT). Despite apparent unanimity about the goal of free trade, managed trade is the rule. Indeed, mercantilism thrives and has adapted to the eco nomic world of the 1990s. Corpora tions have replaced nations as the driving force behind efforts to manage the in te rn atio n a l trad e system . Corporate mercantilism propelled by the multinational enterprise is the prevailing model. S laves o f d e fu n c t eco n o m ists Mercantilism is a term that historically was applied to the trading practices of European countries during the sixteenth, seventeenth, and eigh teenth centuries. Trade surpluses w ere sought through the use of tariffs and nontariff barriers (NTBs) to d isc o u ra g e im p o rts, and by subsidies to encourage exports. The popularity of mercantilism has ebbed and flowed over the centuries and appeared to be in total retreat with the multilateral negotiation of the GATT following the Second World War. Although mercantilist practices multiplied in the 1980s as co untries used N TB s and state subsidies, the start of the GATT round in 1986 appeared to signal that the days of these practices were numbered. But neither the logic nor evidence conclusively supports this view. Free trade negotiations are always based on the assertion that we are not rich enough to ignore free trade. Economic theory suggests that the free flow of goods across international boundaries leads to the maximum well-being of all nations. This, however, is only true in a perfect world. In reality, the organization and operation of a world economy leads to perverse results. The theory assu m es th at trad e is b etw een countries and companies; in practice, international trade is increasingly between subsidiaries and affiliates of multinational corporations. Further more, history does not support the hypothesis that trade-opening efforts will be conducted for the public good. In fact, trade negotiations are based on national interests of countries, which are the private interests that are m ade effective by dom estic bargains between the government and industry. Free trade is there fore a poor basis for negotiating international trade rules. John Maynard Keynes, the British econom ist who pioneered a new approach to manage the macroeco nomy, wrote in 1936 that practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist. In this case, the free traders (academics, and business and government leaders) are the slaves of eighteenth century classical economists and their aca demic scribblings on the theory of gains from trade. C o n v e n tio n a l th in k in g and strategizing around international trade negotiations flows directly from the seminal work prepared in the eighteenth century by David Ricardo, one of Englands first economic theo rists. His theory of the gains from trade, elaborated in chapter seven of The Principles o f Political Economy and Taxation published in 1817, hypothesizes that e ach co u n try could benefit if it specializes in the production of those products for which it has comparative advantage. He argued that national comparative advantage depends on the endow ments of the factors of production land, labour, and capital. In short, countries endowed relatively highly with fertile land could better their standard of living by producing field-based crops and trading those crops for manufactures, while those endowed with ample labour should concentrate in the production of labor-intensive goods (such as tex tiles). Countries could then better their standard of living by trading. Ricardo went on to show in his now-famous example of Portugal and E ngland that in that period P ortugal should concentrate on producing wine and England cloth, even though Portugal had a clear absolute advantage in both products. By specializing and trading for the products they did not produce, both Portugal and England could increase their well-being.

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C la ssica l p a ra d ig m n o w invalid This classical paradigm assumes perfect competition. Perfect competi tion assumes a homogeneous product, free entry to and exit from the sector, constant (or at least largely equal) returns to scale, full information, rational actors, and a large number of firms. Furtherm ore, the theory assumes trade is largely between different firms in different countries. Provided these conditions hold, it would be irrational for countries to erect trade barriers in the form of tariffs or nontariff measures. The logical consequence of the theory is that states should unilater ally rem ove their trade barriers because they would be unquestion ably better off than otherwise. In reality, governments are extremely slow to negotiate changes to their trade and tariff rules. And it is com panies w hich now lead the charge to reduce barriers to trade in services and flows of intellectual and financial capital. Concerns with free trade are valid; the problem with the theory of gains from trade lies in its assumptions. In short, the classical economic paradigm is no longer valid, if it ever was. During the 1970s and 1980s, the world economy was transformed by the expansion of trade and the operation of large transnational corporations. The traded share of national GDP co n tin u e d to rise in alm o st all national econom ies w hile many tra n sn a tio n al co rp o ra tio n s now often produce components of single products in different countries and only assemble them in the destina tion market in so-called screw driver plants. This production system depends critically on the continua tion of trade and financial flows. By 1972, much intraindustry trade was within single firms automo tiv e firm s, co m m o d ity trad in g houses (see International Regimes, S. Krasner, editor, Cornell Univer sity Press, 1983, p. 261). Since that

time, corporate concentration has in cre ase d , p a rtic u la rly vertical integration in production of specific p ro d u c ts such as au to m o b iles, electronics equipm ent, and food from the extraction of the primary products up through the processing and marketing of the final product. DeAnne Julius, Chief Economist at Shell International Petroleum in London, England, recalculating trade balances for the United States and Japan for 1986 on an ownership basis and comparing them with conven tional estimates, shows how mislead ing conventional measures can be (The Economist, December 22, 1990, p. 45). Whereas national accounts show that the United States appears to have gross trade of only about $600 billion, in reality the global trade by U.S.-owned companies totaled $2.7 trillion. In contrast, Japanese owned companies accounted for $450 billion international trade, rather than the $260 billion indicated by the national accounts. C om panies are m ore dependent on international trade than countries and, as such, now are the driving force for freer trade. The assumption of perfect compe tition that underlies the theory of gains from trade is no longer valid. As such, the search for free trade between states is not a sound basis for international trade negotiations. Most trade is not between unrelated firms but now is more the result of an adm inistrative decision by a corporate m anager based on the maximization of after-tax profits in its subsidiaries (regardless of the costs or benefits to any single subsidiary in one country). Therefore, there is no reason to suspect that trade liber alization will yield greater gains from trade. The more likely outcome of reduced tariffs and elimination of trade barriers will be further expan sion of multinational corporations (MNCs) and greater concentration of economic wealth and power. B ecau se trad e now is w ithin com panies rath er than betw een

countries, comparative advantage is no longer based on the initial factor en d o w m en t o f land, labor and capital. Instead, W illiam C line, economist at the Institute of Interna tional Econom ics in W ashington, argues that for many industrial sectors comparative advantage is made, not given. (See Managing Trade R e la tio n s in the 19 8 0 s: Issu e s Involved in the G ATT Ministerial Meeting o f 1982, S. Rubin and T. Graham, editors, Rowman & Allen, 1984, p. 26.) As production and trade become further captive of the multinational companies, the opera tion of the financial markets and the underlying econom ic clim ate in separate countries will determine the balance sheet of those countries. Iftheclimate becomes less welcoming, MNCs simply shift their production and profits to more accommodating regions and countries, leaving the former host countries in a financial and economic bind. N ew , m u ta ted m ercantilism Business and governm ent united efforts under the free trade banner during the 1980s. Now in the 1990s there is a surfeit of exercises designed to lower trade barriers and increase the flow of goods and services between countries. If one looks care fully at the past and current rounds of the GATT, it is apparent that mer c an tilism has m utated : national mercantilism has been replaced by corporate m ercantilism . As they expanded operations globally, MNCs have sought to strengthen their c o rp o ra te s u p p ly c o n n e c tio n s abroad bankers, insurers, trans porters and input suppliers. For evidence, one need look no further than the United States nego tiating stance at the current round of the GATT. The United States has announced that, in addition to lower tariffs and NTBs and a better disputes settlement system, it also seeks free trade in services, rigorous rules on

Challenge!'January-February 1992

intellectual property rights, and re duction in barriers to capital flows. The theory of the gains from trade is based on the production and trade of goods, with trade flows determined by factor endowments. If the United States were able to secure liberalized trade in services, intellectual property, and capital, it w ould m aterially undercut the econom ic basis for international trade. The theory of gains holds that as the endowment of factors of production is equalized across all countries, the com parative advantages would diminish. Theo retically, then, as this process contin ued, there would be progressively less to gain from international trade. But in practice, an examination of U.S. objectives from the corporate perspective demonstrates these make perfect sense in the context of the emerging corporate mercantilism. Corporations worldwide have been cooperating to develop vertically integrated enterprises, where one family of related or friendly companies controls the entire production, distri bution, marketing and financing system for products. In other words, these e n te rp ris e s w h e th e r Ja p an e se keiretsu, the now legally tolerated corporate alliances in the United States, or consortia of European busi nesses supported by the European Communityseek to control products from the ground to the consumer, and beyond to financing and servicing. Some Canadian commentators estimate that foreign-owned companies oper ating in Canada already purchase about 80 percent of their business services from their parent companies or affiliates. These corporate enterprises have taken strategic decisions to become involved in influencing trade nego tiations in order to level the barriers that inhibit corporate alliances. This involvement ranges from lobbying g o v e rn m e n t e ith e r d ire c tly or through business associations to the provision of managers or consultants to assist governments with the trade

negotiations or public encourage ment of support for trade goals. This support is widespread throughout the business community. In short, that is corporate mercan tilism. Corporate agenda m ay dominate From an economic perspective, to search for intellectual property rights, free the flow of investment and open trade in services are not justified. If the GATT is forced to encompass these issues, the efforts to realize the gains from trade by resolving the agricultural trade wars, lowering tariffs, and controlling NTBs might be jeopardized. Furthermore, the citizens of many nation states would lose as national economic progress gets overwhelmed by the corporate mercantilist agenda. Many economists agree that in the fastmoving economic world, the most mobile factors of production gain the most (or lose the least) from economic change. In other words, highly skilled labor (mostly first-world business m anagers and professionals) and capital are the big winners of change. Currently, companies are partly restricted from shuffling their operations between countries by restrictions on the movement of labor, capital, and services. This effectively spreads the gains (and losses) between all factors of production. If companies are allowed to operate freely in all markets, then they will be able to play off one country against another. In this situation, if countries were to attempt to imple ment progressive (or regressive) social or economic development programs, companies would be able to move quickly. In short order, the corporate agenda would rule, GATT should stick to what it was designed to do, namely work toward realizing the gains from trade.

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