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Economics August 24, 2017

What is the future of free trade?

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In the run-up to the G20 summit in Hamburg, hardly anything preoccupies politics, business, and science more than the question of how the free exchange of goods, services, and capital can be further improved.

The clear and unanimous commitment on the part of the last G20 summit in Hangzhou to create an open world economy — i.e., the rejection of protectionism and the promotion of trade and investment on a global scale — will be subjected to a real test. Some observers even argue that free trade is experiencing the greatest crisis of many decades. Consequently, in Hamburg, one could be satisfied with stabilizing the current level, rather than falling back into a state of more protectionism and restrictions.

In order to assess the great advantages of free trade, a look back is worthwhile. Paul Samuelson, the American economist and Nobel laureate, was confronted by a mathematician with the following question: What knowledge of social sciences is simultaneously true and not trivial? A good dose of skepticism against the findings of economics evidently lied in the mathematician's question.

Paul Samuelson allegedly had to think long about it until he could give the right answer. He referred to the paper that celebrates its 200th birthday this year: On April 19, 1817, David Ricardo published his work "On the Principles of Political Economy and Taxation," thus shaping Samuelson’s thought on the concept of comparative advantages. In this work, Ricardo noted that it is advantageous for sovereign  states to enter into mutual trade. His findings continue to reinforce today the idea that open markets for goods, services, and capital support the growth and prosperity of all participating countries. This realization is particularly deeply rooted in European consciousness, since these fundamental freedoms play a central role in the European integration process. Especially for Germany, open markets have been an essential precondition for the successful economic development of recent years and the creation of many new jobs. Free and fair world trade is a cornerstone of the social market economy as well as prosperity for Germany. This finding is equally true for the exchange between China and Germany. Both countries are important economic and trade partners. Their economic relations have developed more dynamically in recent years, even decades, than economic relations with other countries and world trade as a whole.

It may be therefore surprising that criticism of free trade in Germany has increased significantly in recent years. Even more surprising is that this criticism also comes from the US, which traditionally belonged to the greatest proponents of open markets. The call for "America first" misunderstands that the US is a major beneficiary of open markets. For example, a recent study by the Peterson Institute for International Economics shows that the country has achieved significant gains through free trade in recent decades. The study also predicts that in the coming years American GDP could rise significantly again due to the reduction of further barriers. The critique of free trade is therefore not justified and is partly based on misunderstandings and false perceptions.

However, in order for states to be able to continue to enjoy the great advantages of free trade, some of the criticisms must be seriously examined. Firstly, it has been too long since an examination of how a state, on average, can benefit from free trade. However, the political discussion is sometimes as decisive as it is in the cross-section. Even if a nation benefits from free trade, this does not mean that all of its citizens or all regions also benefit therefrom. This is one of the findings that has regained importance, especially after the partly surprising election exits of 2016—consider the Brexit referendum and the American presidential election. An important question is therefore how many citizens can participate in the fruits of free trade. Inclusive growth is one of the commandments of the hour. Equally relevant is the question of how citizens can sustainably benefit from free trade. The resilience aspect is therefore equally important.

Secondly, the advantages of open markets as described by David Ricardo can only be achieved if they are based on reciprocity. The markets in the European Union, and thus also in Germany, are open to foreign trade partners and investors. Europe also expects the same from other countries. Existing investment restrictions on foreigners, for example through the compulsion to establish joint ventures or the disadvantage of public tenders, must be dismantled. The openness of the markets—the "level playing field"—is a gauge of the seriousness and credibility with which governments want to implement free trade. They should be a good example to those who are (still) hesitant.

Thirdly, trade partners and investors are in urgent need of legal certainty in the international exchange of goods, services, and capital. In this respect, freedom of contract is a central component of competitively organized economies. We see this above all in the protection of intellectual property, which is a premise of sustainable innovation. Academic literature has repeatedly pointed to the great role that a functioning legal system plays in the economic development of a nation. The expansion of the legal dialogue and the strengthening of international corporate governance are indispensable prerequisites for the further development of free trade.

The G20 summit in Hamburg is crucial, especially in the context of changing global political conditions. Therefore, a clear commitment from heads of state and government to free trade and the highlighting of the benefits would be an essential sign that could go from Hamburg to the world. In the next step, the necessary actions would be decisive in order to benefit the countries described by David Ricardo 200 years ago. China and Germany have a particular responsibility, perhaps with greater responsibility than ever before in the G20 process—and not just for themselves, but for free trade as a whole.

Originally published in People’s Daily (Chinese; link) on July 11, 2017.

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