December 9, 2005

Chavista Trade Policy: Something for nothing...

I can't say I really get it. Not two months ago Chavez was denouncing Mercosur as a "failed neoliberal experiment" and now we're about to join it. Though I know most of you don't believe it, I really am working on a PhD dissertation on trade policy in between breaks from blogging, so this is one issue I can claim expertise on.

Conventional economic theory tells us two basic things about what happens when you liberalize imports. First: the economy as a whole is made better off. Second, the gains are not evenly distributed. While everyone is made a little bit better off, some are made much worse off.

To see why, take a simple example. Say our farmers can produce corn for 100 per kilo. Foreign farmers can produce it for 95. When you liberalize imports, the price of corn to our consumers drops, so everyone is made a little bit better off. At the same time, our corn farmers suddenly find they can't compete, so they're wiped out of the market.

In the lingo, gains from import liberalization are diffuse, but costs are concentrated.

This explains why countries rarely liberalize unilaterally even if economic theory shows that the diffuse gains are bigger than the concentrated losses. Governments, in general, pay more attention to organized groups that mobilize to lobby for a given policy than they do to calculations of overall welfare or economics textbooks. Since each consumer is made only a little bit better off by import liberalization, consumers as a group find it difficult to organize themselves to petition the government for liberalization. But since producers stand to lose a lot, they have a much easier time banding together to lobby for protection.

Of course, that tells only half the story, because countries also have sectors that stand to gain from trade. If, say, our producers can make neckties for 95 a kilo, but it costs their producers 100 to produce that many neckties, our necktie producers obviously stand to gain a lot from access to their market. Liberalization would make neckties slightly more expensive in our country, but the costs to our necktie consumers are diffuse, while the gains to our necktie producers are concentrated. The equation is exactly reversed.

In that case, our necktie producers have every incentive to lobby our government for better access to their market. But when our government sits down to ask their government to open up their necktie market, it has to offer something in return. Since their corn producers are interested in better access to our corn market, there's a fairly obvious bargain to be struck: we'll liberalize our corn market if you'll liberalize your tie market. This, in extreme shorthand, is the reason trade negotiations happen.

The whole point of trade negotiations, then, is to overcome a problem of collective action by making sure someone in our country has a strong interest in seeing our own markets liberalized. If our government tries to liberalize corn unilaterally, corn farmers will work hard to block it, and there'll be no other group similarly organized to argue in favor of liberalization. By bargaining off access to our corn market against access to their tie market, trade negotiations set up a situation where our tie producers have a strong incentive to push our government to liberalize our corn market - as an indirect way of gaining access to their tie market. It's a pretty nifty trick.

This little framework is enough to explain why Chavez's decision to join Mercosur is puzzling to say the least. In effect, Venezuela will be opening up its market to Argentina and Brazil's world-beating agricultural producers. Not surprisingly, Venezuela's agricultural producers are none too happy about this. Venezuelan manufacturers are similarly freaked out. In exchange for their sacrifice, though, we'll get access precisely? Venezuela's major export commodity is oil, but we already have free access to their energy markets! If there is some Venezuelan export sector chomping at the bit for better access to Southern Cone markets, I haven't heard about it. So, in effect, Chavez proposes to give them access to our farm market in exchange for...nothing!

It's true that there are a number of sectors where Venezuela has a potential comparative advantage, and joining mercosur provides new opportunities for those sectors. However, a pile of economic research - most of it from left-leaning academics - argues convincingly that better access to foreign markets is very rarely enough to turn potential comparative into actual export success. To do that, you need a whole raft of government measures - from R&D tax credits and export credit to specialized training institutes and improved property rights - to help boost domestic producers' competitiveness to the point where they actually can crack foreign markets. Needless to say, those supply-side policies are not in place in the Bolivarian revolution.

In practical terms from Venezuela's point of view, joining Mercosur is a lot like liberalizing our imports unilaterally. Now, there's an old and venerable economic argument in favor of unilateral liberalization. I'm not going to get into that debate here, but I will point out that it's an argument one associates more with Adam Smith, Milton Friedman and Jagdish Baghwati than with Ezequiel Zamora, Jorge Giordani, or Martha Harnecker. How, exactly, the decision to enter Mercosur fits in with Chavez's whole verbal diarrhea about food security, endogenous development, land reform, etc. etc. I haven't the slightest clue. It's more like neoliberalismo del siglo 21, really...