'Free trade' is a tricky banner to unfurl

Nikkei Weekly July 22, 1996


One understands why Indonesia's national-car program has run into criticism from Tokyo and Canberra. Control has been handed over to the son of President Suharto, a man not known for shyness in encouraging relatives to control key areas of the economy. Its partner will be a carmaker from South Korea, a nation not known for reticence in seizing easy ways to dislodge Japanese firms from hard-won positions in overseas markets.

But that said, do Japan and Australia really have the right to cry foul? Both countries set up their own car industries by excluding foreign competition. Korea is an even better example of what a nation can do for itself by keeping the foreigners at bay.

But what probably influences the Indonesian mind most is the example of Malaysia. With its small domestic market, weak technology and few ancillary industries, Malaysia seemed an unlikely candidate for a car industry. Yet through heavy protectionism and intelligent planning it was able to persuade Mitsubishi Motors Corp. into a localproduction deal to build the Proton, now being sold and even exported in volume.

If Malaysia could do so well, then Indonesia, with a much larger domestic market and several already well-established ancillary industries, would seem to have every right to try to do the same.

Divisive rhetoric

Tokyo and Canberra warn darkly that the Indonesian plan runs counter to the Asia-Pacific Economic Cooperation (APEC) forum's free-trade principles. But is this really a smart thing to be saying? The Southeast Asians, influenced largely by Malaysia's car success, have already been hinting strongly that APEC needs to tone down its free-trade rhetoric, to allow them to create national industries. Efforts to use APEC as a blunt instrument against Indonesia would simply hasten the disintegration of what is already turning out to be an unwieldy attempt to ape other economic-integration efforts, such as the North American Free Trade Agreement (NAFTA).

Almost all the advanced economies developed their manufacturing behind large protectionist walls. Their attempts to use free-trade principles to prevent the developing economies from doing the same smack of ugly hypocrisy.

Besides, in today's world of floating exchange rates there can be no such thing as free trade. If speculators sense a nation is less than competitive, its currency can depreciate tens of percent in a matter of days. In the process, that nation's import-competing industries gain the equivalent of very large tariff protection and all its export industries gain the equivalent of a very large subsidy.

NAFTA boasts "free trade" in its name. Yet within months of its establishment in a flurry of free-trade rhetoric, the Mexican peso collapsed to a level where every producer of tradable goods there was getting protection in the hundreds of percent. Free traders say they oppose protectionism. What they should really be saying is that they prefer exchange-rate protection to tariff/subsidy protection - a very different thing.

Ironically, the ultimate losers in a genuinely free-trade world could well be the advanced economies, not the developing economies. Japan is safe for some time. But Australia is already in deep trouble.

Free-trade theory developed back in the 19th century when it was easy to imagine a world divided into a superior West and a backward Rest. The West had a comparative advantage in work ethic and skills. The Rest had cheap labor. Free trade would encourage the advanced West to upgrade its skillintensive industries, and to graciously hand over its labor-intensive industries to the developing Rest. Today things are very different. The Rest, or at least the Asian part of it, has shown convincingly that it has work ethics and skills equal to if not better than those of the West. And it has had the further advantage of much lower wages. In this situation, and since the currencies of developing

countries tend to appreciate very slowly if at all, strict adherence to the laws of comparative advantage would mean disaster for the West, because most manufacturing of tradable goods would concentrate in Asia rather than the West. And to some extent this has already begun to happen.

Fortunately, the continental Western Europeans have begun to realize this danger. Their attempt to debate problems to economic globalization at the recent G-7 summit was one response. Japan also realizes the danger. But it does not waste time debating theory; it simply slaps quotas and tariffs on Asian competitors that threaten its high-laborcost industries. The innocents are the people who gave the world free trade and comparative-advantage theory - the Anglo-Saxons, and us Australians in particular.

Pure fantasy

Canberra embraced free trade and APEC back in the 1980s, genuinely convinced that if it opened its markets to Asian imports its inefficient industries would be forced to upgrade, and resources would flow into skill-intensive industries. Clever, inventive Australian firms would flood Asia with enough high-tech manufacturing wonders to keep trade in balance.

It was pure fantasy. The high-tech wonders never emerged. The trade balance collapsed under the flood of cheap, high-quality imports from Asia. Eventually the collapse of the Australian dollar provided the exchange-rate protection needed for some industry to survive.

Even so, Australia has still not been able to match Asian manufacturing competitiveness. Too much damage was done both to its manufacturing base and its social base during the early stages of Canberra's anti-protectionist fervor - before the Australian dollar collapsed and exchange-rate protectionism came into play. Instead of high-tech wonders, the trade balance depends heavily on primary and processed goods selling into booming Asian markets. The economy is now propped up largely by an inflow of Asian money snapping up devalued Australian assets.

But even depreciation has not rescued the Australian car industry, now seriously threatened as rising resource exports force the Australian dollar marginally upwards. Meanwhile, the same Australia tries to lecture Indonesia about the protectionist evils of trying to develop a national-car industry.