Free Trade and Its Misconceptions

Analysis    | 23 Mar 2015 | Read 2484 times  
Free Trade and Its Misconceptions

Over recent years, free trade has become a new trend in Asia. Asian countries have been focusing on ways to expand intra-regional trade that include: the establishment of Regional Trade Agreements (RTAs) in the form of Free Trade Agreements (FTAs) and Economic Partnership Agreements (EPAs). As from the basis of comparative advantage, every country in the world cannot fulfill all of its needs. Trade then emerges as a means of fulfilling the needs of a country.

Each country has specific resources, but even though it may have abundant resources it cannot meet all of its internal needs and demands, therefore it needs to rely on other countries. But along the way, several obstacles depress the trend toward an integrated market. These obstacles are fueled by strong opposition challenges that lead public opinion toward misconceptions about free trade.

According to Krugman and Obstfeld (2000), there are at least three mythical values that are used to argue against free trade. The first myth is about resiliency to cope with foreign competition.

For a less competitive country like Indonesia, the opposition argues that our country may not be able to produce more efficiently than anyone else, given competitive pricing. But as we learn from the traditional trade theory, the differences in resource and factor endowments, production structures and productivity lead to a complementary relationship.

Data from the rapidly growing intra-industry trade in electronic products and components, in the case of ASEAN China FTA (ACFTA), shows that at high levels of disaggregation, product differentiation creates complementarity in production and trade. Even in non-manufacturing, such complementarity can be found: Fruit and vegetables produced in China’s temperate region are complementary to those produced in ASEAN’s tropical region. My own research in 2009 revealed that there was relatively little evidence that showed a huge Chinese product inflow to Tanjung Priok, as one of Indonesia’s main ports after the ACFTA was in force.

When tracing the data, I found that there was a statistical discrepancy between the CEIC database in Hong Kong with trade data that we had in Indonesia. The discrepancy was quite huge and revealed that illegal Chinese products had overwhelmed the Indonesian market. However, since the ACFTA in 2010, the discrepancy has become smaller over time. This implies that the ACFTA eliminates the black market, which eventually diminishes illegal income for the black traders.

The second myth is about free trade hurting low income countries. The opposition argues that trade liberalization will continue oppressing the already low wage country. This is followed by the third myth that says free trade exploits a country and makes it worse off if its workers receive lower wages than workers in other nations.

These arguments are often expressed in emotional terms with very little data backing the evidence. My research in 2011 showed that free trade equalizes the wage rates between the trading countries in the long term. We see that free trade improves welfare in two ways.

First, it increases the wage rate in Indonesia where labor is a relatively abundant production factor. Second, the development of fragmentation raises productivity through a realization of the scale economy. Even if we assume that free trade is induced by FDI, and that a part of the benefit from FDI is refluxed to the investing country as a reward of capital, the fragmentation still contributes to a rise of income through the increase in wage rates and job opportunities. Or to put it in a colloquial manner, as the production networks expand in the region, the income gap is expected to diminish in the future.

Unfortunately for Indonesia, the wage for labor is increasing in a very deviant manner since it is now becoming a function of labor strikes. This will eventually lead to a decreasing level of inward FDI, causing massive unemployment. To conclude, in a world polluted with voluntary export restraints, administered protection and a strong tendency toward the formation of trading blocs, the difference between discriminatory and nondiscriminatory liberalization may be blurred. Thus, free trade agreement may be the key to achieving regional trade liberalization. This trade liberalization would be deemed to promote international specialization and to increase regional output.

Moreover, it is also seen to promote efficient use and allocation of regional resources, thus facilitates the working of the international market system and the working of price signals to ensure efficient allocation of resources, international competition and the associated benefits to all.

In ASEAN, intra-regional labor mobility, foreign direct investment, and financial-capital flows will play an increasingly important role in the coming years. To the extent that harmonization of policies across countries can help facilitate such movements, regional integration can offer unique gains. Thus, regional trade integration can help reduce political tension and promote political harmony among former enemies.


*) The article first published by Jakarta Post Monday, April 08 2013

Fithra Faisal Hastiadi

Fithra Faisal Hastiadi mendapatkan gelar sarjana Ilmu Ekonomi di Universitas Indonesia. Setelah lulus, Fithra bekerja sebagai asisten dosen di fakultasnya, sebelum melanjutkan studi master dan doktor di Keio University dan Waseda University, Jepang. Telah mempublikasikan sejumlah publikasi di beberapa jurnal ternama.

Fithra juga menyumbang kontribusi signifikan tentang studi ASEAN 2030 ketika menjadi peneliti di Asian Development Bank Institute (ADBI) Tokyo. Fithra juga terlibat dalam Komite Ekonomi Nasional (KEN) yang memberikan masukan ekonomi kepada Presiden RI 2012-2013.

Kini aktivitasnya adalah peneliti dan mengurusi aktivitas masyarakat di Fakultas Ekonomi Universitas Indonesia. Bisa dihubungi melalui akun twitter: @hastiadi