The Myth of Free Trade

The reasons for the current turmoil in International money markets such as panic selling go back to August 2007 when the Sub-prime market in the US collapsed which resulted in huge loses for the worlds investment banks, hedge funds and finance houses as all of them had placed large sums of money in the US real estate market.

The collapse of the sub-prime market had such a large ripple effect it led to a run on Northern rock (Britain's 5th largest bank) and has brought to an end a decade of economic growth with the possibility of a world-wide recession. As the threat of a US-driven recession looms ever larger, it is state intervention that is keeping the market economy afloat. In December 2007, central banks across the world coordinated to pump billions into the global financial system in an effort to loosen the effects of the credit squeeze (because banks refuse to lend to each other in case such money is defaulted on). In January the much dreaded spectacle of state investment funds from South Korea, Singapore and Kuwait taking stakes in US corporate giants such as Citigroup, the world's largest bank, to offset the impact of the sub-prime mortgage crisis and the biggest loss in the bank's history took place.

What follows is a selection of myths about free trade and free markets:

Free trade and markets are the most efficient way of allocating resources that in turn will eradicate poverty

Since the 1960s, the prevailing theory of economic development, known as modernisation theory, maintained that industrialisation and the diffusion of liberal economic ideas would transform traditional economies and societies. These influences would place poor countries on a path of development similar to that experienced by Western industrialised nations during the industrial revolution.

However consider the following: Poverty is the state for the majority of the world's people. 3 billion people in the world live on fewer than two dollars a day, the third world owes over $1.2 trillion in debt, another 1.3 billion people live on less than one dollar a day; 1.3 billion have no access to clean water; 3 billion have no access to sanitation and 2 billion have no access to electricity. The developing world now spends $13 on debt repayment for every $1 it receives.
Although Free trade has created some of the richest people in the world it has also created a vast disparity between the rich and poor and this remains its major failure. A number of surveys have highlighted that free trade has created even more poverty stricken people in the world. The 7th December 2006 saw the culmination of a global study - from the World Institute for Development Economics Research of the United Nations. Some of its findings are staggering; by gathering research from countries all over the world the studies findings concluded that the richest 1% of the world owns 40% of the planet's wealth and that only 10% of the world's population owned 85% of the world's assets.[1]

Capitalism views the distribution of wealth of secondary importance and because of this although western economies are growing the generated wealth remains with just a handful of the population. The UK for example generated wealth (GDP) of £2.2 trillion in 2005, this was an increase from the previous year which for liberal economists means people have more wealth, have more to spend thus they must be happy. However if we look at how much the 60 million population of the UK received of this generated wealth, 2005 statistics from HM Revenue and Customs show that the richest 10% have more then 50% of the nation's wealth and that 40% of the British population shared in only 5% of this wealth. This has resulted in the majority of the population resorting to borrowing to fund their lifestyles and this is why UK consumer debt is more the £1.3 trillion, it is more than the actual economy. The US situation is even worse, the US may generate $13 trillion a year in wealth but National debt is $8.5 trillion. This means US citizens are funding their lifestyles by borrowed money rather then the $13 trillion the economy generated. In a 2005 Harvard report it was calculated that 10% of the population owned 71% of the wealth, and the top 1% controlled 38%. On the other hand, the bottom 40% owned less than 1% of the nation's wealth.

This is the case in the developed world who have lived under free markets for over a century. In perhaps the most comprehensive study of poverty to date, Scorecard on Globalization 1980-2000, Mark Weisbrot, Dean Baker and other researchers at the Centre for Economic and Policy Research documented that economic growth and rates of improvement in life expectancy, child mortality, education levels and literacy all have declined in the era of globalization (1980-2000) compared to the years 1960-1980. From 1960-1980 many countries maintained protectionist policies to insulate their economies from the international market to nurture their domestic industries and allow them to become competitive. Those policies are the same ones on which US economic prosperity was built. Hence free trade was the direct cause of poverty for the third world.

The Industrialised nations developed due to the adoption of free trade and markets


Britain is regarded as the fountain of laissez-faire doctrine and the only country to have practised free trade. Britain is regarded as the only nation to have developed with little or no state intervention; however this cannot be further from the truth - Britain was the first country to establish infant industry protection.
The 1721 reform of the mercantile law was summed up in 1907 as: "manufactures had to be protected at home from foreign finished products; free exportation of finished articles had to be secured; and where possible, encouragement had to be given by bounty and allowance.[2] This meant import duties on raw materials were lowered, duties on foreign manufactures goods were significantly raised. Specifically Britain banned the imports of superior goods from some of its colonies if they happened to threaten British industries.

The next big change came in 1846 with the repeal of the Corn Laws, which were import tariffs ostensibly designed to protect British farmers and landowners against competition from cheap foreign grain imports. But this was intended to halt the move to industrialization on the continent by enlarging the export market for British agriculture. British technological lead that enabled the shift to a free trade regime had been achieved behind high and long lasting tariff barriers. The overall liberalisation of the British economy was a highly controlled affair overseen by the state and not achieved through a laissez-faire approach.

With the use of industrial promotion strategies, Britain when it reached its pinnacle in 1800 was navigating the seas in search of riches around the globe. This programme of aggressive colonisation entrenched Britain's position in the world and changed battles from being fought for territories to offshore markets. It was this colonial war machine that drove a large chunk of Britain's scientific research, innovation, new ways of organising labour and military strategy. The liberal values which are trumpeted as the source of Britain's development arrived after achieving global domination. It was only after Britain achieved global supremacy that it championed free trade and this was to gain access to foreign markets. Free markets most certainly came after development rather than being the trajectory that launched the British Empire.

US development also occurred in similar fashion, It wasn't until after WW2 that the US began to liberalise trade and the reasons for this was outlined by Dr Joon Change expert in economic history at Cambridge 'it was only after WW2 that the USA - with its industrial supremacy unchallenged - finally liberalized its trade and started championing the cause of free trade.'[3]

Once western countries establish industrial dominance behind protectionist walls, they tend to advocate free trade in order to kick away the ladder from the followers and consolidate their dominance; this was certainly the case for Britain in the mid 19th century which led the liberalisation drive in Europe. The United States followed a similar path a hundred years later.


Free Trade leads to development

This most certainly was not the case for Britain or the US, rather both nations progressed behind protectionist policies. China today represents a nation that has developed completely opposite to the formula the West continues to sell to the developing world.

China has evolved from its decades long narrow and reactive approach to global affairs in the past. China is abandoning its long-held victim mentality of 150 years of shame and humiliation and adopting instead a great power mentality (daguo xintai). The natural extension of this is the increasing role of China in global issues. With the abandoning of the victim mentality and the adoption of a great power mentality China is increasingly seeing itself more akin to the world's major powers. This represents a shift from the 1990's, China is now openly speaking about the need to share global responsibilities and this is the lens through which China's strategists view the world.

China represents an interesting conundrum for orthodox economics experts and for all those who believe the adoption of liberal values equals economic success. China firstly undermines the belief that progress is exclusive to the western formula of free markets, democracy and liberal values and demonstrates how much of the wider world remains unconvinced of such a formula.

China has managed to achieve phenomenal economic growth and industrialisation by not adopting democracy but by remaining deeply authoritarian, where liberal values have not featured remotely in China's economic rise. China's President Hu Jintao said in 2004 'We will never blindly copy the mode of other countries political system. History indicates that indiscriminately copying western political systems is a blind alley for China.'[4] This shows there is very little likelihood that China will adopt liberal values in the near future secure in the knowledge that it has achieved success without the Western model of development.

Economically China has utilised and retained its centrally driven and interventionist approach similar to Japan and Germany. China has extensive levels of government involvement across all market sectors. By being centrally driven China has been able to direct its resources in one direction which has propelled it into a regional power and the largest economy in the world after the US. China has received little assistance from the Western world mainly due to its historic communist credentials and has shown that an independent, nation first policy driven centrally can attain economic success.


Free trade ensures economic stability
Capitalism has been praised for the amount of wealth it has created and for the development it has brought to many parts of the world. However aside from the mass inequality in wealth distribution and poverty it has created across the world capitalism has a track record of the regular busts, recessions, depressions and economic collapse. Richard Robbins in his award winning book 'Global Problems and the Culture of Capitalism said, 'The emergence of capitalism represents a culture that is in many ways the most successful that has ever been deployed in terms of accommodating large numbers of individuals in relative and absolute comfort and luxury. It has not been as successful, however, in integrating all in equal measure, and its failure here remains on of its major problems.'[5]

The great depression if 1929 still bewilders economists. Economists continued to hold, against mounting evidence to the contrary, that time and nature would restore prosperity if government refrained from manipulating the economy. Unfortunately, approved remedies simply did not work. The economy did not behave in the way assumed by the "classical" economists, which was the dominant school for over a century, but times had changed and what were required were different government policies. New explanations and fresh policies were urgently required and this ushered in the era of government intervention in the economy until the Thatcher and Reagan period.

Government involvement in the economy led to the rise of protectionist polices which ensured recessions generally were restricted to nations rather being world wide. As each segment of the capitalist economy relies on the proceeding segment the system is built upon creating artificial needs to keep consumers purchasing more and more goods to keep the main segment (catalyst) going. This is why the developed world witnesses regular recessions when enough people have spent beyond their means there would inevitably be a reduction in aggregate spending by consumers as a large chunk of disposable income is now used to service debt, this cycle of spending - increase in production - more jobs - purchasing more goods is never sustainable and has to end somewhere.

The current threat of recession is due to the fact that the US has been experiencing economic growth that has been fuelled by the expansion of personal debt, which in turn is being fuelled by the high price of housing or real estate. As the cost of housing rises, house owners have increasingly been taking out personal debt, offering equity in their homes as collateral. This process of effectively re-mortgaging homes in order to fund an extravagant lifestyle has been a nation wide phenomenon for the US and the UK. As long as house prices continue to rise, consumers will be able to take out more debt against the value of their homes. This practice has been evolving since the 1990's, and we now have a situation where house prices are so high that they have outstripped salaries by several times. This means that the situation has reached a dangerous level where this debt is now struggling to be serviced and houses are increasingly too expensive to be bought by people. This came to its peak last summer when the sub-prime market collapsed. US household debt is $8.5 trillion and 20% of households have more debt then assets.

The fact the global investment banks and hedge funds can easily move capital around the world has only compounded the situation. The current crisis and those which occurred before clearly prove that capitalism does not cause stability but in fact is the cause of speculative wealth driving up prices and the bubble reaches a point where it will inevitably burst.

Japan and the Asian tiger economies developed due to free markets

The 'tiger' economy was a term coined to describe South Korea, Singapore, Hong Kong, and Taiwan who underwent rapid growth and industrialisation in the 1960's and 1970's. The four 'Tigers' share a range of characteristics with other Asian economies, such as China and Japan, and pioneered what has come to be seen as a particularly "Asian" approach to economic development, that of an export driven economy. These countries and territories focused on developing goods for export to the industrialised West and domestic consumption was discouraged through government policies such as high tariffs.

A closer look at the development of such nations shows there development was a largely centrally driven affair with huge government subsidies and protectionist policies to achieve development.

Japan developed from policies which are the complete opposite to free markets and globalisation. The Japanese government wanted key sectors to develop and protected them from foreign competition. The government retained the right to allocate foreign exchange, and by this it was able to restrict inward investment, to manage the acquisition of foreign technology by Japanese firms and to influence the composition of foreign trade. The export bank of Japan and Japan development bank were setup to become the main vehicles for expanding the flow of finance to government targeted industries.

Central to the development of Japan has been the role of Ministry of International Trade and Industry (MITI) which was a ministerial department. This central government department regulated production and the distribution of goods and services. It developed plans concerning the structure of Japanese industry, controlling Japan's foreign trade; ensuring the smooth flow of goods in the national economy; promoting the development of manufacturing, mining, and distribution industries; and supervising the procurement of a reliable supply of raw materials and energy resources. Hence Japanese development was centrally driven and not left to the free market to allocate resources.


South Korea pursued a similar strategy of central government intervention. In 1961 the first of many 5 year plans were initiated by central government, as only it rather then the free market had the capacity or resources to direct such drastic change in a short time. The economy was dominated by a group of large private conglomerates, known as chaebol, and was also supported by a significant number of public corporations in such areas as iron and steel, utilities, communications, fertilisers, chemicals, and other heavy industries. The government guided private industry through a series of export and production targets utilising the control of credit, informal means of pressure and persuasion, and traditional monetary and fiscal policies.

Central government by 1965 extended government control over business by nationalising banks and merging the agricultural cooperative movement with the agricultural bank. The governments direct control over all institutional credit further extended central governments command over the business community. The Economic Planning Board created in 1961, headed by a deputy prime minister allocated resources, directed the flow of credit, and formulated all of South Korea's economic plans.


In the case of South Korea and Japan government intervention played an important role in their development and is seen as the backbone to progress. Taiwan, Singapore and Hong Kong followed similar strategies and this clearly shows orthodox capitalism has not been followed but rather government intervention has steered the Asian tigers into the positions they are in today. The tiger economies are fundamentally consumer led where exports are the driving engine for the economy.


The various economic crisis in the last 50 years were primarily a result of nations not being liberalised (having free markets)


In reality all the crises in last 50 years were a direct result of economies being liberalised (left open) due to the pressure to modernise (free markets) and in the last two decades globalisation. The problems many nations faced were compounded due to the economies of the nations concerned being unable to control the flow of wealth due to free trade, a few examples prove this: -


- By 1997, Asia attracted almost half of total capital inflow to developing countries. The economies of Southeast Asia maintained high interest rates attractive to foreign investors looking for a high rate of return. As a result the region's economies received a large inflow of hot money and experienced a dramatic run-up in asset prices. At the same time, the regional economies of Thailand, Malaysia, Indonesia, the Philippines, Singapore, and South Korea experienced high growth rates, 8-12% GDP, in the late 1980s and early 1990s. This achievement was broadly acclaimed by economic institutions including the IMF and World Bank, as the Asian economic miracle. But then the story turned sour.


From 1985 to 1995, Thailand's economy grew at an average of 9% per year. In May 1997, the Thai baht was hit by massive speculative attacks as investors tried to cash in on their money. By withdrawing their cash in large sums the currency collapsed, this set off a domino affect where financers lost confidence in the region and began moving their money out in large sums leading to the infamous Asian financial crisis. The only country in the region to survive the fall out was Malaysia as it was not under the control of the IMF's structural adjustment program and had placed restrictions on capital withdrawal from its country which meant speculators could not affect the country. The rest of the region left their economies open hence they were unable to do anything when speculators withdrew their capital, thus proving free trade was the problem. This problem was aptly encapsulated by Economic expert Paul Krugman of Princeton University "As long as capital flows freely, nations will be vulnerable to self-fulfilling speculative attacks, and policymakers will be forced to play the confidence game. And so we come to the question of whether capital should really be allowed to flow so freely."[6]


- Turkey in 2001 faced the brunt of the IMF's globalisation policies as US investors withdrew large amounts of their capital. Turkey was ordered to peg its currency to the US dollar, a peg works on the basis that a currency is linked to another currency by ensuring the exchange rate remains within agreed bands on the open market. If the currency moves out of the bands then the government would literally sell or buy currency to bring it within the bands. As investors scrambled to buy foreign currency, the Turkish central bank reached the point where it could no longer support the exchange rate, hence it abandoned it and was about to default on its loans. The peg to the dollar was realistically never sustainable and by liberalising the economy it was only a matter of time before foreign investors cashed in and moved out. The currency peg, which controlled the movements of the lira, was the centrepiece of the IMF-backed financial reform package designed for Turkey. By removing restrictions on capital flight Turkey was unable to defend itself. Akyüz and Boratav, well-known economists from Turkey (Akyüz is Director of the UNCTAD Division on Globalisation and Development Strategies and Boratav is Professor of Economics at the University of Ankara) at the time commented, "In many respects the Turkish economy today is in a worse shape than it was on the eve of the December 1999 stabilization programme." They went on "the policies advocated were based on a poor diagnosis of economic conditions in the country and the Fund was experimenting with programmes that lacked sound theoretical underpinnings."


- Latin America for decades has been a laboratory for free market treatment which began in 1973 when Augusto Pinochet came to power through a military coup widely considered US backed. The military junta received the document 'the brick' from the University of Chicargo's Economics Department which was considered the epicentre of the laissez-faire doctrine. The Chile project involved the wide scale sale of state owned banks, introduction of cutting edge new forms of speculative finance, removal of all restrictions to imports and the cutting of government spending on education and health. Pinochet was confidently advised that government withdrawal from the economy would allow the 'natural laws of economics to rediscover their equilibrium.' Chile's experiment with free markets led to the economy being swamped with imports leading to most local businesses closing. In 1974 inflation reached 375% the highest in the world at the time, the cost of basics such as bread went through the roof. 45% of the population fell below the poverty line whilst the rich who incidentally supported the coup saw their incomes rise to over 85%. In the case of Chile free markets quite clearly created the problem.


In March 2003, the IMF admitted in a paper that globalisation may actually increase the risk of financial crisis in the developing world. "Globalisation has heightened these risks since cross-country financial linkages amplify the effects of various shocks and transmit them more quickly across national borders" the IMF notes and adds that, "The evidence presented in this paper suggests that financial integration should be approached cautiously, with good institutions and macroeconomic frameworks viewed as important."[7] In addition, they admit that it is hard to provide a clear road-map on how this should be achieved, and instead it should be done on a case by case basis. This is a shift from the "one size fits all" style of prescription that the IMF has long advocated.


Globalisation is the pinnacle of free trade and essential for economic development in the 21st century


The first time the word globalisation was used was in describing the activities of the large American companies in the mid-1990s. The end of the cold war put the US in a conundrum; the arms race with the USSR resulted in financial circles pouring money into the US resulting in an expensive dollar which in turn made the climate for US multi-nationals to export their goods virtually impossible. US companies found it too expensive to maintain a competitive position overseas when it was costing them so much to make the products at home. Hence cheaper foreign markets had to be found.


The setting up of production facilities in a foreign country making use of the cheap labour, with very little labour laws and outright abuse was termed globalisation. The first nation to be given the globalisation treatment was Russia. The fall of communism in 1990 and the break-up of the Soviet Union represented a wonderful opportunity for capitalist institutes to transform a huge centralist economy to a market orientated one. A total of $129 billion poured into Russia with the IMF and the World Bank implementing a number of its development schemes. The Russian economy was opened to foreign investment and industry was sold to foreigners leaving the country vulnerable to swings in world prices. In 1997 due to a loss on confidence in Russia speculators begun to withdraw their money and Russia couldn't even defend itself as liberalisation required there to be no restrictions on capital flow. The crisis raised poverty from 2 million to 60 million, a 3000% increase. UNICEF noted that this resulted in 500,000 'extra' deaths per year. Russia is a clear example that globalisation directly allowed the crisis to reach the peak it did.


Globalisation today in reality is the superpower pushing for various policies that imply free trade which is in reality a continual repeat of mercantilist processes seen throughout history. The US broke away from British colonial rule in 1776, recognising the unfairness and harshness in Imperial Britain's policies. However, the US has now taken on that role and is doing the same things that the British once did to others. Shortly after the War of 1812 was fought to defeat British mercantilist trade practices, US statesman Henry Clay pointed to the necessity of the United States developing a defensive capability by quoting a British leader, "Nations knew, as well as [ourselves], what we meant by "free trade" was nothing more nor less than, by means of the great advantage we enjoyed, to get a monopoly of all their markets for our manufactures, and to prevent them, one and all, from ever becoming manufacturing nations."[8]


The Reagan and Thatcher era in particular, saw free trade pushed to most parts of the globe under the guise of globalisation. Almost demonising anything that was public, and encouraging the privatisation of anything that was owned by the public, using military interventions if needed. Structural Adjustment policies were used to open up economies of poorer countries so that big businesses from the rich countries could own or access many resources cheaply.


Conclusions


The credit crunch reverberating around the world has once again highlighted the real nature of what's called the free markets in modern capitalist economies - neither free nor transparent, and utterly dependent on state support. As the fallout from what shows every sign of becoming a wider economic crisis becomes clearer, demands for alternatives are certain to grow.


It was the British Empire in the 17th century that championed free markets when it was at the height of it power and today the US champions Globalisation when it is at the height of its power. Both nations developed by central government involvement and both advocated free trade once this was achieved. Free trade today has no success stories rather as some of the myths have shown free trade has a successful track record of destroying economies, producing wealth inequality and creating booms and busts.


The Muslim world should take lessons from the track record of Capitalism and look at its history which clearly proves an alternative system exists which can bring stability, growth and equality for all citizens.







[1] www.iariw.org/papers/2006/davies.pdf


[2] Brisco N, 1907, 'The economic policy of Robert Walpole,' New York, The Colombia university press


[3] Joon Chang H, (2003) 'Kicking away the ladder; development strategy in historical perspective,' Anthem Press


[4] Mary Hennock 'China's graft: Tough talk, old message,' 27th Sep 2004,

http://news.bbc.co.uk/1/hi/world/asia-pacific/3693714.stm


[5] Richard H. Robbins, 'Global Problems and the Culture of Capitalism,' (Allyn and Bacon, 1999), pp. 11-12


[6] Paul Krugman, MIT Professor of Economics, Princeton University, 'How Washington Worsened Asia's Crash; The

Confidence Game,' http://thenewrepublic.com/archive/1098/100598/krugman100598.html and

http://web.mit.edu/krugman/www/myth.html


[7] Eswar Prasad, Kenneth Rogoff, Shang-Jin Wei and M. Ayhan Kose, 'Effects of Financial Globalisation on Developing Countries,' International Monetary Fund, March 17, 2003, retrieved 23rd Jan 2008, http://www.imf.org/external/np/res/docs/2003/031703.pdf


[8] J.W. Smith, 'The World's Wasted Wealth 2,' (Institute for Economic Democracy, 1994), p. 123.