Under President Trump administration, the U.S. takes a deliberate offensive trade tariffs on China's USD 250 billion of imports, and it has brewed into an ongoing trade-war with the world's largest developing nation. The move has been seen as a blunt protectionism that is unfavourable to citizens not just in both affected countries but in many parts of the world.
The Sino-U.S. trade war seems to have taken a pause for a moment, with the U.S temporarily pausing from issuing new tariffs.
The U.S.' actions came at a time when Beijing was entering into another phase of its opening up its market to the world. At the same time China is being blamed for currency manipulation, by President Trump. U.S. move, was discouraging for China and, may carry a lesson for other nations that if they tried to open up their markets, on the pattern of China, they may face similar consequences. In a similar move, the U.S. has threatened to pull out of the Universal Postal Union Treaty, which would affect rates for foreign postal deliveries in to the U.S. This shows that the U.S. is aware of the fact that globalisation and open markets can challenge its position as world’s number one economy.
Hence, the predicament which China faces, and the Washington’s protectionist policies to undo globalisation, raises the questions such as, should the developing nations open up their markets to the outside world and participate in global trade? If yes, then how should they do it? Similarly, if a nation decides to open up its economy, should it allow international market to decide its currency exchange rate or should it decide the valuation of its currency keeping in view the state of its economy? These are some of the question which are addressed in this article. Also, it is important to understand how countries open up and what steps are involved in the process.
A, simple answer is “yes!”, a developing country should open up to the outside world. Many developing countries have benefitted from multilateral trade negotiations, materializing into trade agreements since the Second World War. By further opening up, a country will integrate better into the world economy. However, it is important to see what challenges lie in a nation's path to integration with the global economy.
According to renowned economist Peter Henry, professor of International Economics at Stanford GSB, when developing countries open their markets to foreign capital, manufacturing wages and productivity increases exponentially. A study of 18 nations showed that typical manufacturing workers' real wages went up seven times faster, after the inflow of foreign capital; than they could have otherwise, during the first three years. At the same time, productivity grew faster than real wages.
That is because as unit-labour costs falls, firms begin to earn more profit. Hence, more new markets become available for international companies to explore, resultantly spurring foreign direct investment (FDI) into a country.
The opening of new financial markets benefits the capital markets rather than wages at the initial stage. As manufacturers may often find it easier to get financing and might have a wider range of potential investors and stakeholders. Subsequently, consumers are able to secure funding for a lower cost. The opening of the stock market effectively reduces the cost of capital, so some things that were not profitable as before will become profitable.
Nonetheless, every country is different from the other one and has its own economic situation as well as priorities. Therefore, each country has a right to decide on what aspects of economy to liberalise, when should it be liberalised and in what of order to liberalise.
In order to open up their markets to the external world, most countries start with trade reforms as it is an easier move. Trade is about allocating resources across countries, there will be movement of information, commodities, services, and factors of production including capital, labour and resources. The modern day opening up of trade involves signing memorandum of understandings for two countries at the very least. It does require some careful considerations but it would not be as complex as the opening up of financial systems which would require more expertise and trials.
The International Monetary Fund (IMF) and the World Trade Organisation (WTO) provide advises pertaining to liberalisation of a country’s economy. It sets good practices and promotes a framework for countries. When a country opens up, it seeks opinion from IMF when it comes to economic policies and WTO when it comes to international trade. Additionally, the World Bank provides developing countries loans for capital projects so that these countries can build infrastructure.
Bilateral trade among nations is as simple as signing a memorandum of understandings (MoU) as it does not involve many complexities, it is an agreement between two countries to carry out trade. However, opening up a country’s financial system to the external world is a complex initiative and requires expertise.
After the gradual opening up of trade, the next step is to attract foreign direct investments, a case in point is China. By attracting FDIs, the country has managed to sustain long term capital into it. The need for FDIs is beneficial for both the country and the investor companies. It is because companies’ source for greater markets and cheaper means of production.
The latter part is for financial system to open up to the world and it is usually advised by IMF, to gradually open up, that is, the adoption of a fixed currency before the managed floating currency. For operational needs businesses need to forecast some degree of certainty. Since there is always foreign exchange risk, a fixed exchange rate is a good way to remove uncertainty.
The notion of letting exchange rate being determined by the international market is brought in after the collapse of the Bretton Woods agreement which fixed the USD to gold. Since then, it is not always a good idea to adopt a floating exchange rate, as it could involve having a freely tradeable currency subject to the impossible trinity triangle.
After the Argentinean Peso and the Mexican Tequila crisis, it is believed that it is not always ideal to have a floating exchange rate as it could induce capital flights and emerging markets sell-off easily when there are uncertainties. IMF used to advocate for free floating currency until those crises.
Capital flights and emerging markets sell-offs are perpetually bad for any economy as the developing currency takes a hit and builds uncertainties into the whole financial system. Businesses will find it incredibly hard to forecast and thus would not invest into a country.
If China is a case in point, throughout years it has carried out a slow reforms process towards the exchange rate, starting with a fixed-exchange rate system to a managed-float system. Its currency is on its way to become a more market-driven currency. Coupled with good fundamentals and other reforms, China was able to sustain approximately two-decade of rapid growth and FDI’s inflows and became the second largest economy of the world.
Hence, the opening up of the market and later the financial system of a country should be decided by any nations keeping in view its national priorities and state of economy. The ideal way to have a sustainable opening up involves trade reforms, international bilateral trade agreements, attracting FDI and having a control over currency. The gradual adoption of this approach will wave off several dangers posed by not so certain global economy.
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