Deepak Lal: Foreign trade - The US turning inwards?- I

US trade policy will remain incoherent because of its continuing adherence to the principle of reciprocity.

There are disturbing signs that, with the victory of the Democrats in the mid-term Congressional elections, the US might turn inwards. In this and the next column I want to discuss whether this is likely, and if so, what it bodes for India.

The signs of weariness in the US with the outside world are related to both foreign trade and foreign policy. I begin with trade as this is the most imminent threat and would be of serious concern for India. These are still straws in the wind, but influential Democrats have recently suggested that even if a Doha agreement is reached, they might vote it down because it will not incorporate the labour and environmental standards they want. There is also growing concern that the new fast track authority the US administration is seeking to complete the Round will not be granted without adding the requirements for these standards to be incorporated in any multilateral trade agreement.

Against these trends there seems to be growing bipartisan support for the acceptance of the various bilateral trade agreements the US has already negotiated, primarily with a number of Latin American countries. But taken together these are still worrying developments. As trade analysts have pointed out, bilateral trade agreements are inferior to multilateral agreements. By fragmenting rather than integrating world trade through their complex systems of rules of origin""which are required to keep their promised gains of tariff-free access to the partners""they have led to a "spaghetti bowl" which can destroy the multilateral trading system. Moreover, these bilateral agreements allow the strong to coerce the weak. The multilateral WTO system, with its dispute settlement mechanism, by contrast, offers protection against this coercion.

These demands for incorporating labour and environmental standards arise whenever the Democrats (attempting to assuage their trade union supporters) are in the ascendancy. It happened with both Presidents Carter and Clinton, and will become shrill if a Democrat succeeds President Bush to the presidency. Underlying the popular appeal of these protectionist demands (whose aim is to hamper labour-intensive exports from developing countries) are developments in the US labour market. From the late 1970s till about 1992 there was a fall in US real wages. Thereafter, they have stagnated. Hence there has been increased inequality (in family income) since 1973. There is growing agreement that these trends are due as much to technology as trade.

For, the world is undergoing another industrial revolution, associated with advances in communications. It is leading to a substitution of human for fixed capital in industrial countries. Their comparative advantage now lies in producing skill-intensive services, with labour- and capital-intensive production moving to China and India. Both trade and technology will thus put a premium on skills in the West. A signal for the acquisition of these skills is a widening of skill differentials and the stagnation of the wages of the unskilled, or in the inflexible labour markets of Europe to unemployment. But, once the existing incentives to acquire skills lead to the necessary accumulation of human capital, the levels of living of even those on the lowest rung of the current income distribution should rise. This process will, however, take time, as happened in Britain in the 19th century, when the first industrial revolution was taking place. From the still unsettled debate it appears that living standards of the poorest took a long time to rise as, for instance, the handloom weavers of the old "putting out" system were converted into the factory workers of the modern age.

To ensure a rapid adjustment to today's industrial revolution, the spread of quality education to acquire the needed skills is required. But the poorest find it difficult because they are dependent on the low-quality and dysfunctional public education system. Milton Friedman's last crusade was for the introduction of vouchers for the poor to purchase private education. This needs to succeed, as it does in India, if educational opportunities are to be equalised and the poor are to benefit from globalisation.

Meanwhile, the relatively unskilled in the growing service economies of the West will be protected by the distance which shelters domestic products from foreign competition and makes them "non-traded". A hairdresser in South Central L.A. is not going to see his or her rates cut by competition from barbers in Meerut. However, these personal services require both acquired skills and personal attributes like tidiness, punctuality, politeness and trustworthiness. Mothers in Los Angeles are hardly likely to employ a member of the so-called "underclass" as a baby sitter or housekeeper even she is willing to accept the wages of a maid in India. The reform of Western welfare states, which have undermined the Victorian personal virtues, is required to help these potential "losers" from the current processes of globalisation.

These required policy changes are slowly taking place and, if the current populist pressures can be fended off, should ease the domestic pressures which are leading to the growing inward stance of US trade policy. But, US trade policy will remain incoherent because of its continuing adherence to the principle of reciprocity (which looks upon foreign trade as a zero sum gain). It has always refused (even in the 19th century era of free trade) to accept the indubitable cast iron case made by classical economists for a unilateral reduction in trade barriers as being in a country's own interests. China has, surprisingly, followed this advice, and carried out one of the largest unilateral trade liberalisations since the British upheld this correct principle by the repeal of their Corn Laws in the 19th century. India, sadly, has not followed suit.

So, in the face of this likely inward turn in US trade policy, there are two actions that India needs to take. First, it should walk away from any agreement in the Doha Round which trades off access to US and EU markets for labour and environmental standards. Second, if the US and the EU remain and even become more protectionist, instead of seeking bilateral trade agreements, it should undertake unilateral trade liberalisation""as this is in its own interests, no matter what others are doing.