Globalization Free Trade

Global Deregulation: Risks and Opportunities in the Area of Free Trade

• INTRODUCTION

Globalization has been one of the major driving forces for achieving the concept of a ‘borderless world and society’. This period only shows that the world is innovating and becoming smaller not in terms of its size but in means of transportation, communication, and exchange of ideas. As this aspect of modernization happens, every country in the whole world is compelled to adapt to changes just like what Great Britain did during the Industrial revolution. Changes include trade liberalization, floating exchange rates, market driven economies, and improve financial sector that can cope up with the fast pace of transactions between different countries regardless of their locations with each other.

The concept of deregulation has become known in the era of globalization. Deregulation, the opposite of regulation, aims to allow countries’ markets to move freely and make them very accessible from other states. This involves removing barriers or restrictions of trade which enables other countries with free access of goods and services of a certain state. Deregulation of trade can contribute either positively or negatively to developed countries and the developing states.

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This research paper discusses the different measures, policy reforms, and trade agreements the core countries and the peripheries have taken in response to the trends of globalization. This research paper also tries to identify the positive and negative impacts of the concept of deregulation on the era of globalization. To be more specific, the paper will focus on the notion of free trade system as well as other aspects that is affected by globalization like the banking industry. These aspects are needed for free trade security on both countries that are integrating with each other.

• GLOBAL DEREGULATION

Heinemann (2006) reports that deregulation in the past two decades has materialized as international mobility of goods, services and factors also increase. The impact of these things hit the regulatory structures of markets and prompted them to undergo changes. He also mentions that deregulation enhances globalization trends. However, Heinemann asks the question of “how and to which extent increasing cross-border factor mobility will impact on regulatory equilibrium in the fields of labor, financial market, and trade or product regulation?” (Heinemann, 2006)

Heinemann (2006) argues deregulation based from economic evidences is driven by trade openness and capital mobility in a limited fashion. Based from evidences gathered, he concludes that labor market regulation results in to trade openness. He adds that national divergence from deregulations as influenced by globalization is not related clearly to the economic integration on global capital, goods and services markets. (Heinemann, 2006)

Banking Industry

In the U.S. Banking Industry the regulatory structure of existing banks started to decline in the 1980’s. This was due to improvements in technology, increased incidences of holding companies and competition from emerging firms that also provide banking services. To be able to cope up with these challenges, the US Banking Industry submitted itself to deregulation measures. (Becher, Campbell Ii, and Frye, 2003)

Deregulation, together with changing technology and fast consolidation, flourished in the 1990’s. To start with, the Federal Deposit Insurance Corporation Act was enacted in 1991 which adopted a “least-cost resolution method and prompt resolution approach” for failing banks. (Becher et al., 2003) It also directed the creation of a “risk-based deposit insurance assessment scheme.” In the year 1994, another act was ratified as law in the name of Riege-Neal Interstate Banking and Branching Efficiency Act. This law removed the restrictions on interstate banking and branching which was in effect for 70 years, and also took out the regulatory burden and paperwork requirements of banks. This was followed by the Economic Growth and Regulatory Paperwork Reduction Act of 1996 which edited the regulations concerning the flow of credit from lending institutions to various businesses and consumers. It also introduced the mortgage lending process. (Becher, Campbell Ii, and Frye, 2003)

Free Trade

For the European Union, deregulation of markets plays an important role for the growth of its large corporations. In order to achieve that, the Union initiates Free Trade Agreements (FTA) with other countries and regions of the world. In their FTA with Mexico, which was enforced in 2000, the Union got 95 percent deregulation for goods and services, together with North American Free Trade Agreement (NAFTA) parity’s inclusion of provisions in investment, procurement, trade facilities and competition rules. After their Global Agreement with Mexico, EU promoted free trade agreements the Investment Promotion and Protection Agreements (IPPA) with Latin American countries. Two years later, the Union had also made Chile to sign to another Global Agreement. (Reveles and Rocha, 2007)

In 2006, the Union underwent major reforms in its trade policies. On October 2006, EU issued a strategy paper entitled: Global Europe: Competing in the World. This new trade policy reform encourages complete deregulation of markets. Reveles and Rocha (2007) mention other measures presented in the paper by the European Union:

(1)” reducing non-tariff barriers for EU exports and investments,

(2) increasing access to raw materials,

(3) guaranteeing energy supplies by expanding trade in third countries’ energy sectors, (4) reinforcing the presence of EU corporations in emerging markets,

(5) opening up public procurement markets,

(6) improving implementation of anti-dumping mechanisms, and

(7) implementing intellectual property rights.” (p. 6)

The European Union has also started negotiating Free Trade Agreements with Andean Community of Nations and Central America in the Latin America, South Korea, India, and Association of South East Asian Nations (ASEAN).

The World Bank (2002) reports that the average tariff rates of developing countries have been reduced in half from 30 percent in the early 1980’s to 15 percent in the late 1990’s. Martin (1997) notes that the reduction of tariff rates from developing countries is higher than the industrial countries and “decreases from a higher level are likely to have much greater welfare benefit than corresponding decreases from a lower base.” World Bank (see Figure 1) adds that the reductions have been great in South Asia, Latin America, and East Asia. While in areas of Sub-Saharan Africa, Middle East, and North America, free trade was in a limited extent. Aside from the reduction in tariffs, quota coverage and foreign exchange restrictions declined which enables trade liberalization to develop widely. (World Bank, 2002)

John Audley (2003) reports the initial challenges faced by the Latin American and Caribbean countries. These challenges include: (1) growing national economies, (2) creating good jobs, and (3) generating necessary revenues in order to afford basic public goods like human health and environmental protection. Their expected annual growth of workforce of 1.9 percent from 2001 – 2010 will be a burden since the last two decades; there were insufficient jobs to provide the growing population. The weak economic performance also resulted to 150 million people of Latin American and Caribbean according to the Inter-American Development Bank earning less than $2 per day. Mexico, the major trading partner of EU and United States, faced the challenges also encountered by the Latin American countries. Facing a major economic crisis in 1982, President Miguel de la Madrid Hurtado of Mexico decided to make the country export oriented. To further enhance their international trade, Mexico joined the General Agreement on Tariffs and Trade (GATT). The next president, President Carlos Salinas de Gortari, continued the measures of his predecessor by “reducing the size of the public sector, promoting land ownership reform, and securing a commitment from the United States and Canada in 1991 to negotiate a free-trade agreement.” (Audley, 2003, p. 6)

In order to provide measure to solve these problems in the Latin America and Caribbean, thirty-four (34) governments located at the Western Hemisphere met in 1994 to address the following: advancing prosperity, democratic values and institutions, and security. So they formed the Free Trade Area of Americas (FTAA) because many government officials who attended the meeting believed that free trade will help the failing economies to recuperate. (Audley, 2003)

The governments of Latin American countries have been involved in 17 free trade agreements with members of the Organization for Economic Cooperation and Development (OECD). Last January 2003, Costa Rica, El Salvador, Guatemala, Honduras, Nicaragua, and the United States announced the start of the comprehensive trade negotiations. (Audley, 2003)

Razeen Sally (1999) describes how the “less-than-rich countries (developing countries) have been gaining positive breaks in the international trade and investment since the 1980’s. She reports that the share of developing countries in the world manufactured exports doubled from 10 percent to 20 percent. This assessment is similar on the observations of the World Bank. One-third of the world’s foreign direct investment (FDI) is from them, which increased from 14 percent in the 1980’s. The World Bank estimates that their shares in world trade and output could reach around 50 percent and 30 percent respectively in the year 2020. The developing countries also show their presence in the international scene through the World Trade Organization (WTO) wherein they account to over three-fourths of the total membership. (Sally, 1999)

S.M. Shafaedin (2005) identifies two (3) main reasons of upgrading the export structure as well as production capacity: (1) for essential sustainability of exports, (2) for assistance in “technological development and spillover effects” to the economy by the export sectors, and (3) for reduction of economic vulnerability to “external factors, balance of payments crisis, fallacy of composition, and terms of losses. (Shafaedin, 2005, p. 11)

Wacziarg and Welch (2003) report the increasing number of open countries from 1960 to 2000. As were countries having open trade policies. In the year 2000, the number rose to 73 percent (47% of world population) of the countries in the world are considering international trade. (Wacziarg and Welch, 2003)

Sally (1999) also reports that in the last 15 years, trade policies concerning overseas have changed and they were followed by trade reforms. Over thirty-three (33) developing countries shifted from closed economies to open markets from 1985 to 1995. Also in the same period of time, the number of liberal countries in terms of “cross-border capital movements” increased dramatically from 9 to 30. (Sally, 1999, p. 2) Not only those, since the year 1990 almost 75 percent of the transition regimes have undergone liberalization in trade and payments which resulted into the “most dramatic episode of trade liberalization the world has ever seen.” (Sally, 1999, p. 2)

However, Sally (1999) addresses the depth of adjustment and reforms the different countries did in trade policy. The author sees the liberalization of trade policy as “very patchy and uneven”. (Sally, 1999, p. 2) She mentions the East Asia, Latin America and Eastern Europe have liberalized expansively. Their deregulation of trade is accompanied by “macroeconomic stabilization, internal price liberalization, privatization, and industrial reforms.” (Sally, 1999, p. 2) While Africa, Middle East, South Asia, Southeastern Europe and the former Soviet Union have done liberalization measures in a limited manner.

Wacziarg and Welch (2003) provide reason to the differences in the depth of adjustment in trade policies. In their study of 13 developing countries, Wacziarg and Welch (2003) find out countries that experienced positive outcomes in economic growth pursued and deepened trade policies. On the other hand, countries that experience negative impacts or neutral effects on economic growth encoutered “political instability, [contracting] macroeconomic policies in the aftermath of reforms or to actively counteract trade reform by shielding domestic sectors from necessary adjustments.” (Wacziarg and Welch, 2003, p. 29)

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Dennis Arnold (2004) reports on the efforts of the Association of Southeast Asian Nations to liberalize and deregulate in trade. The economic policymakers of these countries are finding possibilities in expanding the bilateral, regional and multilateral trade relations and investment. It includes: (1) ASEAN-US dialogue in the Enterprise for ASEAN Initiative (EAI), (2) ASEAN-Japan and ASEAN-China free trade initiatives, (3) ASEAN Plus Three (APT) plan which will include China, Japan, and Korea, (4) ASEAN-Australia-New Zealand Closer Economic Relations Trade Agreement (ANZCERTA) free trade agreement, and the Trans-Regional EU-ASEAN Trade Initiative (TREATI) in 2003. (Arnold, 2004)

After the post war years, Urata (2002) reports that globalization was on a fast pace during those years because of “multilateral trade negotiations of the General Agreement on Tariffs and Trade (GATT), trade liberalization and investment, deregulation and privatization of national industries; and increasingly cheaper cost of foreign trade from technological developments in telecommunications and transportation.” (Urata, 2002, p. 20)

Urata also highlights the trend of regionalism that was developed along with globalization. The European Economic Community (EEC) which was formed in 1958 is the earliest region bloc brought by the development of regionalism in Western Europe. The trend continued in the 1990’s when Free Trade Agreements (FTA) emerged as the driving force towards regional integration. By September 2001, there were 239 regional trade agreements (RTA’s) wherein 162 of them remained in force. (Urata, 2002)

Urata (2002) believes that deregulation can help in revitalizing the economy. However for other countries like Japan, domestic politics has been an obstruction for future regulation reforms. So the Free Trade Agreement (FTA) has become the driving force in pressuring these governments to institute regulation reforms. The”gaiatsu” or external pressure was first done by the United States in bringing domestic regulation in Japan. (Urata, 2002)

• IMPACTS OF DEREGULATION

Opportunities for Free Trade

Trade deregulation among the developing countries contributed to huge increases in exports and imports. This is manifested by the increase in the export of manufactured goods from 40 percent in 1980 to 80 percent in 1998. This effect led to the increase in shares of the developing countries in the world economy as well as liberalization of country trade for the developing states. (World Bank, 2002) Sally (1999) reports countries that have undergone extensive trade deregulations resulted to higher economic growths while countries that have partially liberalized ended in lower growths or even negative economic growths.

Urata (2002) reports that since the 1970 deregulation accompanied by the removal of domestic regulations made easy for developing countries in East Asia like China and Taiwan, and industrialized countries like United States and United Kingdom to have high economic growth. The reason for the economic growth is the strong competition which drives incompetent and inefficient firms out of the market and gives opportunities for competitive companies to flourish in the world market. (Urata, 2002)

Perry and Olarreaga (2006) concluded that trade reforms in Latin America contributed positively in the fight against poverty. Trade reforms reduce poverty by measures of reducing the consumption bundle of the poor people. The reforms also helped in limiting the cases of unemployment. The authors see trade reforms as significant because “as the income of the poor increases with trade reform, poverty traps become easier to avoid and the poor may be more able to undertake the necessary investments to adjust in the presence of market failures” like the absence of credit or insurance. (Perry and Olarreaga, 2006, p. 37)

Ganesh Seshan (2005) studies that the impact of the distribution of trade policies on households in low-income, agricultural countries, where imperfect labor markets exist. In the author’s study on Vietnam, results show that trade liberalization did not worsen the income inequality but did improve the incomes of the rural households, at the expense of the urban households. Rural households experience more growth in their income distributions compared to the better-off rural households and urban households. (Seshan, 2005)

The North American Free Trade Agreement has produced positive impacts on Mexico in terms of exports and imports, and the foreign direct investments (FDI). The exports of Mexico increased three times from $67.5 billion to $187.4 billion from 1993 – 2002. Mexico’s FDI in the same period totaled more than $124 billion, with the investments from the US leaping by 204 percent. Its labor productivity has also risen by 45 percent since 1995. For the imports and exports, the United States has been Mexico’s major trading partner with 65 percent of imports from the US and 89 percent of its exports going to US. (Arnold, 2004)

US legislations concerning the deregulatory measures of the banking industry gained improvements in monetary value. Brook, Hendershott, and Lee (1998) report the passage of the Riege-Neal Interstate Banking and Branching Efficiency Act of 1994 increased the value of the banking industry by $85 million. Not only that, deregulatory measures together with technological advancements removed the regulatory barriers and increased the investment opportunities of banks. Becher, Campbell Ii, and Frye (2003) also argue that deregulation in the banking industry has also led to increase in the use of “executive incentive-based compensation” however; there was no existing study that will describe deregulation’s effects on director compensation. (Becher, Campbell Ii, and Frye, 2003)

Risks for Free Trade

Weller and Hersh (2002) perceive deregulation as a negative force for trade markets as well as for capital markets. They argue that deregulated trade flows would result to into having more inequality in terms of income distribution, and more unregulated capital flows. Macro economically, these incidents would lead into economic stabilities and will affect the poor negatively. Based from their data gathered from the World Bank, the International Monetary Fund (IMF), and the United Nations, they find out that the “income share of the poor is generally lower in deregulated and macro economically less stable environments … trade flows in more regulated environments may be good for growth and, by extension, for the poor in the long run”. (Weller and Hersh, 2002, p. 1) The reason for the unequal income share for the poor is the capital flows’ faster mobility in deregulated environments. “Faster capital mobility in a more deregulated environment can lead to rising inequality in the short and medium term, both within countries and between countries, and to less poverty reduction or even increasing poverty.” (Weller and Hersh, 2002, p. 4) They conclude based from the results of their study that trade, as well as capital flows, can be significant for economic growth and have no negative effects on the income shares of the poor in the long-run as long as the environment is regulated. (Weller and Hersh, 2002)

Trade liberalization or what Weller and Hersh describe as the “complement to deregulated capital markets” has been criticized by a number of authors (Bannister and Thugge 2001; Mishel, et. al. 2001; Ocampo and Taylor 1998; Taylor 1996) in relation to the rising inequality. They argue that: “by inducing rapid structural change and shifting employment within industrializing countries that liberalize, trade leads to falling real wages and declining working conditions and living standards.” On the other hand some authors blame the ‘skill-biased technological change” as the main cause of inequality. (Weller and Hersh, 2002, p.5) Feenstra and Hanson (2001) support the argument by saying that skill-biased change is a possible effect of trade liberalization.

Another issue that Weller and Hersh see on the removal of the barriers of trade is that it contributes to lower tariff revenues for developing countries. They used India as an example where in 40 percent of its tax revenues come from tariffs in the 1980’s. Removing the barriers for trade will lower or remove the tariffs and thus, there would be changes in the structure of tax in order to fill up the shoes left by the tariff fees. “Restructuring tax regimes to offset lost tariff revenues takes time and introduces administrative costs. Even if trade liberalization were growth

enhancing in the long-run, in the short-run revenue shortfalls may seriously constrain a government’s ability to maintain spending on social services that benefit low-income households.” (Weller and Hersh, 2002, p. 5)

Bronfenbrenner (1997, 2000) sees free trade as advantageous for employers in response for the workers’ pleads for their rights like higher wages and improved working conditions. The author argues that companies and factories are encouraged to either shut down their own workplaces and/or locate to other states wherein they will benefit the most. These benefits may be in the form of less strict labor regulations or lower taxes and wages. The negative implications will be felt by the workers because they cannot pressure strongly these companies for an increase in wages. As Weller and Hersh concludes in their article: “this trend fuels a race to the bottom in which national governments vie for needed investment by bidding down the cost to employers (and livings standards) of working people.” (Weller and Hersh, 2002, p. 5) Examples of these companies are the multinational companies which have Business Process Outsourcing (BPO) Industries that are located in many developing countries. The United Nations Conference on Trade Development (UNCTAD) (1997) reports that the liberalization of trade in many parts of Latin America has resulted to widening wage gap, falling real wages for unskilled workers and rising unemployment.

Perry and Olarreaga (2006) identify four (4) main reasons why in Latin America and in several countries, trade liberalization resulted to increases in skill premiums and wage inequality:

(1)” Relative factor endowments, as most Latin American countries are rich in natural resources (which, are in general complementary with capital and skills) and were more capital abundant than other developing countries with large pools of unskilled labor, such as China and India, that were already integrating into the world economy by the time of Latin American trade liberalization.

(2) Dynamic effects of trade that led to an acceleration of skill-biased technical change and Schumpeterian creative destruction, which led to an increase in demand for skills in most industries.

(3) Initial conditions and contemporary events that make predictions based on a simple factor abundance model difficult to generalize; for example the pre-reform structure of protection was biased towards unskilled intensive sectors in most LAC countries and tariff reductions naturally led to a relative increase in demand for skills, but differences in consumption bundles across income groups and exchange rate policies also complicate predictions.

(4) The impact that trade reform had on imperfectly functioning labor markets, such as potential transitions in and out of unemployment, informality, as well as income volatility are likely to affect and sometimes change the direction of the impact of trade reforms on income inequality and poverty.” (Perry and Olarreaga, 2006, p. 1)

Reveles and Rocha (2007) see the other dimension of the EU-Mexico Free Trade Agreement and the IPPA which made negative impacts on Mexico. The agreements not only brought severe effect on the social and economic conditions of Mexico but also left the Mexican state incapable of encouraging local and small businesses and enterprises. These medium to scale businesses were the ones hit hard by the agreements because the large companies of the European Union has dominated them. Mexico’s industry which is the essential part for economic development has been increasingly controlled by the European Union. The financial sector of Mexico was also affected that it cannot provide credit for production and seeks assistance from the United States and EU. (Reveles and Rocha, 2007) Shafaedin (2005) mentions other setbacks of Mexico after the free trade agreements in relation to base industry:

“In the important case of Mexico where exports grew extremely fast, acceleration of manufactured exports was not accompanied by an acceleration of MVA. Much upgrading of the industrial base did not take place and the non-maquila [factory] industries which performed better than others were those which had enjoyed high investment during import substitution era.” (Shafaedin, 2005, p. 20)

Dennis Arnold (2004) identifies the drawbacks of Mexico during the North American Free Trade Agreement (NAFTA) which badly affects its workers particularly the rural poor. The NAFTA has removed several agricultural sectors and pushed the wages and working conditions at the bottom on factories and non-factories. Audley (2003) notes five (5) points that will conclude the impacts of NAFTA to the Mexican economy as a whole:

• “NAFTA has not helped the Mexican economy keep pace with the growing demand for jobs. Unprecedented growths in trade, increasing productivity, and a surge in both portfolio and foreign direct investment have led to an increase of 500,000 jobs in manufacturing from 1994 to 2002. [However, employment reduced in the manufacturing sector because of import competition and substitution of foreign input in assembly operations. (Arnold, 2004)] The agricultural sector, where almost a fifth of Mexicans still work, has lost 1.3 million jobs since 1994.

• Real wages for most Mexicans today are lower than they were when NAFTA took effect. However, this setback in wages was caused by the peso crisis of 1994-1995—not by NAFTA. That said, the productivity growth that has occurred over the last decade has not translated into growth in wages. Despite predictions to the contrary, Mexican wages have not converged with U.S. wages.

• NAFTA has not stemmed the flow of poor Mexicans into the United States in search of jobs; in fact, there has been a dramatic rise in the number of migrants to the United States, despite an unprecedented increase in border control measures. Historical migration patterns, the peso crisis, and the pull of employment opportunities in the United States provide better explanations for the increase in migration than NAFTA itself.

• The fear of a “race to the bottom” in environmental regulation has proved unfounded. At this point some elements of Mexico’s economy are dirtier and some are cleaner. The Mexican government estimates that annual pollution damages over the past decade exceeded US $36 billion per year. This damage to the environment is greater than the economic gains from the growth of trade and of the economy as a whole. More specifically, enactment of NAFTA accelerated changes in commercial farming practices that have put Mexico’s diverse ecosystem at great risk of contamination from concentrations of nitrogen and other chemicals commonly used in modern farming.

• Mexico’s evolution toward a modern, export oriented agricultural sector has also failed to deliver the anticipated environmental benefits of reduced deforestation and tillage. Rural farmers have replaced lost income caused by the collapse in commodity prices by farming more marginal land, a practice that has resulted in an average deforestation rate of more than 630,000 hectares per year since 1993 in the biologically rich regions of southern Mexico.” (Audley, 2003, p. 6-7)

• ASSESSMENT OF THE IMPACTS OF DEREGULATION IN TRADE

The period of globalization has brought the emergence of free trade agreements between countries, trading blocs and world organizations. Deregulation of trade by countries open up their markets for free access from other countries. As the risks and opportunities of global deregulation of trade are mentioned, several issues, problems, concerns are raised to address and assess the effects of deregulation in the overall conditions of the economies.

• Regionalism. The issue of regionalism has emerged in the era of globalization. With the creation of the European Union, Association of Southeast Asian Nations (ASEAN) and other regional blocs, free trade began to materialize starting from within these regional blocs. Sooner these regional organizations started multilateralism in terms of international trade with other regional blocs or with other nations. Regionalism did not only open the markets of most countries but also enhanced regional integration between the member states. This regional integration also assisted developing countries to increase their potentials and develop. The deregulation of trade was imminent and become a factor for the current success of regionalism.

• Multinational Corporations. The emergence of multinational corporations created positive and negative effects on the deregulation of trade and investment in the world. The deregulation of developing countries enabled these large companies to establish business outsourcing companies in their territories which gave additional employment, and boosted the economies of the peripheral states. However, their dominance in the industry discouraged medium to small businesses and enterprises to invest and pursue in their own native lands. This was seen in the case of Mexico after the NAFTA and the EU-Mexico Free Trade Agreement.

• Rising Inequalities. This is an emerging concern based from the studies of Weller and Hersh (2002). Free trade can contribute to higher incomes and higher economic growth but the problem is on how these incomes are being distributed from the top, down to the bottom. The expansion of large corporations from abroad also contributed to the rising inequality between the poor and the rich since the growth most of the growth in income came from these big companies. Government subsidies for the poor could prevent the situation to worsen but long-term measures must be applied. However, Seshan (2005) showed that not all developing countries experience inequalities. In her study of Vietnam, liberalization raised the income distribution of the poor relative to the rich. To further address the differences, more focus in this area is significant for future studies.

• Poverty. Studies in trade deregulation of different countries especially in the Latin American countries showed that even though deregulation increases inequalities, the incidence of poverty is reduced. It is because the income of the poor has also increased and unemployment was lessened. Opportunities for income generation not only inside but also overseas were widened because of regional integration.

• Nationalism. This concept tells about the identity of every nation in the world. Nationalism is what keeps every nation unique and united. The trends of globalization brought by deregulation and free trade serve as challenges for keeping the sense of nationality in every citiz