God's Diplomacy: International Trade and the Macedonian Economy

By: Sam Vaknin, Ph.D.


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A British politician, Richard Cobden once (1857) wrote:

"Free Trade is God's diplomacy and there is no other certain way of uniting people in the bonds of peace."

International, free trade is particularly important to developing, poor, countries (among them the "economies in transition").

Without international trade, the local economy is limited. It does not manufacture and produce more than it can consume. If it produces excess products, commodities, or services - no one buys them, they accumulate as inventory, and they bring about losses to the producers and, often, a recession. So, in the best of cases - even assuming optimal management and unlimited availability of capital - a firm in a closed economy can expect to grow by no more than the rate of growth of the local population.

This is where exports mitigate population growth as a constraint.

An export market is equivalent to a sudden growth in the local population. Suddenly, the firm has more people to sell to, additional places to market its products in, an increasing demand which really is unlimited. No firm in the world is big enough not to be negligible in the global marketplace. With 6.2 billion people and 170 million new ones added every year - it is much cleverer to export than to limit oneself to a market with 2, 20, or even 200 million inhabitants. In sum: local firms - and, as a result, the economy as a whole, can increase their production above the level of local consumption and export the surplus.

This, obviously, has the beneficial effect of increased employment. Export oriented industries in economies in transition are labour intensive. The more the country exports - the more its industries employ. This equation led some economists to say that a country exports its unemployment when it exports products. Every product contains a component of labour. When someone buys an imported product - he really buys the labour invested in this product, among other inputs. See the Technical Appendix for more.

But free trade cuts both ways. Some products are so expensive to manufacture locally, that it is more cost effective to import them cheaply. In aggregate, the local economy benefits from this more efficient use of its (ever limited) resources.

It has been proved in numerous studies that countries benefit from certain kinds of imports no less than they benefit from exports or the resulting enhancement of local manufacturing. This is called the theory of "comparative relative advantage".

Cheap imports (only as a replacement for expensive locally produced goods) have two additional effects: they reduce the costs of operating enterprises (and thus encourage the formation of businesses) - and, naturally, they reduce inflation. Where cheap products are available - inflation, by its very definition, is subdued.

So, instead of wasting money on purchasing expensive products, which are manufactured locally - instead of paying high interest payments on liabilities due to high inflation - the economy can optimally allocate its resources where they are at their productive best.

Free trade assists the economies of all players. It allows them to optimize the allocation of their (scarce) economic resources and, thus, maximize national incomes.

Optimal allocation frees up sizeable resources which were previously engaged in inefficient production, or dedicated to defraying financing expenses, or locked into the consumption of expensive local products. A consumer allowed to buy a cheap, imported car instead of an expensive locally manufactured one, saves the difference and invests it in a savings account in a bank. The bank, in turn, lends the money to firms - and this is the relation between free trade and high savings and, hence, high investment rates. Free trade reduces the overall price level in the economy, more money can be saved, and the savings can be lent to more businesses on better terms. Plants can, thus, be modernized, technological skills can be acquired, more comprehensive education provided, infrastructure can be improved.

Above all, those who trade do not fight. Free trade pacifies countries. It leads to the peaceful and prosperous coexistence of neighbouring nations. It yields mutual collaboration on trade, investments and infrastructure.

But free trade cannot exist in a legal and infrastructural vacuum. To achieve all these good outcomes a country must rationalize its trading activities.

First and, above all, it must gradually dismantle regulatory and tariff barriers to allow the unobstructed flows of goods, services, products, commodities, and information.

I used the word "gradually" judiciously. A poor country must make the transition from a protectionist environment, heavily isolated by regulations, customs, duties, quotas, tariffs and discriminating standards - to completely free trade in minute, well measured steps. The influence on local industries, the level of employment, the national foreign exchange reserves, interest rates, and many other parameters - economic as well as social - should be gauged regularly to prevent unnecessary shocks. But these monitoring and fine tuning should not serve as fig leaf, they should not be an excuse to prevent or delay the freeing of trade. The country must, unequivocally, announce its plans and intentions, replete with timetables and steps to be adopted. And the country must stick by its plans - and not succumb to the inevitable and forceful demands of special interest groups.

On the other hand, the country must encourage foreign investment. (Foreign Direct Investment (FDI) and even portfolio investments are a critical part of free trade. Investors build manufacturing plants, which export their products, or sell them locally, substituting for imports. Direct investors are usually connected - directly or indirectly - to trading networks. Financial (portfolio) investors usually come only much later, when the local capital markets have matured and have become much safer. A country can encourage the inflow of foreign investment by providing investors with tax incentives (tax holidays, tax breaks, even outright grants and subsidized loans). It can provide other incentives - there are too many to enumerate here. Above all, though, it must protect the property rights of investors of all kinds - domestic, as well as foreign. Investors flock to secure places and no incentive in the world can convince them to put their money, where they do not feel certain that they can always - and unconditionally - recover it. Property rights is the countries in transition's weak point in this respect: the appropriate legislation is lacking, courts are slow, ignorant, and indecisive, law enforcement agencies are immature and uncertain of their authorities and how to exercise them. Some countries are outright xenophobic. This is not conducive to foreign investment.

But all this is not enough. A skilled, well educated workforce is a prerequisite for the development of export industries. Even low-tech industries (textiles, shoes) require the workers to be literate and to know basic arithmetic. As industries mature, the workers are required to train, retrain and re-qualify ceaselessly.

The nation must make education as a top priority. education is as much an infrastructure as roads and electricity. To think differently is to be left behind and to be left behind in today's competitive world is to die a slow economic death.

All this will be to no avail if a country does not make an intentional, conscientious effort to identify those things that it is good at, its "relative, competitive advantages".

But should a nation leave the forces of the marketplace to take their course, unhindered? Alternatively, should a government determine the priorities of the nation within a very long term plan?

Personally, I do not support fanatic views. The market has its flaws. It is never perfect. Governments should intervene (marginally) to fix market imperfections and failures. Otherwise, who will supply public goods like defence or education?

The same is true for trading. Japan and Israel are two prime examples of extremely successful government involvement in determining national priorities and in pursuing them (the current slump in Japan notwithstanding). The all powerful Ministry of Industry and Trade (MITI) in Japan virtually dictated what should be done, where, with whom and how for decades. Israel actively encourages the formation of hi-tech, labour-poor, high value added industries. But both governments recognized the limits of their intervention, and the difference between advice, incentives and coercion.

The government of a country should identify its relative competitive advantages and re-orient itself to materialize them.

This realization phase can be successful only if the country is an active and complying member of and participant in the international community of nations. It must peacefully and willingly adhere to international agreements on trade and investments and it must agree to resolve its conflicts within the international judicial and arbitration frameworks.

Macedonia is in a difficult economic spot - but it is by no means unique. Almost all the newly-formed countries lost almost all their previous export markets simultaneously. COMECON and the USSR disintegrated almost at the same time as Yugoslavia did. Some countries have not adapted to the new situation:

Their GDP was halved, their industrial infrastructure was demolished and they ran ever-widening trade deficits. They preferred to mourn their situation and blame the whole world for it. Others have oriented themselves to become a (geographical and mental) bridge between East (Europe) and West (Europe). They adopted the Western mentality, Western institutions and Western legislation regarding investments, banking and finance. They emphasized their roles as transit countries in the best sense of the word: having a lot to contribute within the process of transit.

What is common to all the more successful countries is that they encouraged joint ventures with foreign investors, suppressed xenophobia and ethnic discrimination, shared economic benefits with their neighbours by collaborating with them, imported mainly capital goods (instead of consumption goods), adopted sound fiscal policies and really privatized. In most of them, lively capital and money markets have developed.

This is the future that Macedonia should aspire to. It can become the Switzerland of the Balkans. It has all that it takes. Ask the financial markets: they are paying for Macedonian government securities (almost) the same price they pay for Slovenian national debt. That means that they think that Macedonia is the Slovenia of tomorrow.

And that, in my view- is not such a bad future, at all.



International Trade, Inflation and Stagflation

Situation I

The exporting country has:

  1. An overvalued currency;
  2. Low inflation or deflation as prices and wages decrease to restore competitiveness.

The exporting country thus exports its deflation (through the low and competitive prices of its goods and services) and its unemployment (through the labour component in its exports).

The importing country's inflation rate is affected by the deflation embedded in imported goods and services. Cheap imports thus exert downward pressure on prices and wages in the importing country.

This, in turn, tends to increase the purchasing power of the local currency and to cause its appreciation.

In other words:

The macro-economic parameters of the importing country tend to REFLECT the macro-economic parameters of the exporting country.

If the exporting country's currency is overvalued - the importing country's currency will tend to appreciate as a result of the export/import transaction.

If the exporting country's inflation is low - it will exert a downward pressure on wages and prices (on inflation) in the importing country.

Unemployment will tend to decrease in the exporting country and increase in the importing country.

Following the export transaction, the importing country will have:

  1. An appreciating currency;
  2. Deflation or low inflation;
  3. Higher unemployment.

Why would anyone import from a country with an OVERvalued currency?

Because it has a monopoly or a duopoly on knowledge, intellectual property, technology, or other endowments.

Situation II

The exporting country has:

  1. An undervalued currency;
  2. High inflation as prices and wages increase (to restore equitable distribution of income).

The exporting country thus exports its inflation (through the higher though competitive prices of its goods and services) and its unemployment (through the labour component in its exports).

The importing country's inflation rate is affected by the inflation embedded in imported goods and services. Expensive imports thus exert upward pressure on prices and wages in the importing country.

This, in turn, tends to decrease the purchasing power of the local currency and to cause its devaluation.

In other words:

The macro-economic parameters of the importing country tend to REFLECT the macro-economic parameters of the exporting country.

If the exporting country's currency is undervalued - the importing country's currency will tend to depreciate as a result of the export/import transaction.

If the exporting country's inflation is high - it will exert an upward pressure on wages and prices (on inflation) in the importing country.

Unemployment will tend to decrease in the exporting country and increase in the importing country.

Following the export transaction, the importing country will have:

  1. A depreciating currency (devaluation);
  2. Higher inflation;
  3. Higher unemployment.

The state of higher inflation with higher unemployment is called "stagflation". So, in this scenario, the importing country imports stagflation as part of the goods and services it imports.

The TPP (Trans-Pacific Partnership) and Europe

Written October 2015

The Trans-Pacific Partnership (TPP) is by far the biggest Free Trade Agreement (FTA) in history. It incorporates 12 countries with a combined Gross Domestic Product (GDP) equal to roughly 40% of the global economy and exports and imports which amount to about 35% of the world’s total, or $28 trillion. In the vast territories the TPP brought together there are 800 million, mostly young, inhabitants. The USA, Canada, Japan, Australia, Mexico, Malaysia, and Singapore are among its signatories.

The TPP will lower or abolish more than 18,000 bilateral tariffs, especially on agricultural goods. It establishes a common framework to tackle intellectual property rights, including industrial patents and drug licenses. It opens up this vast territory to professionals and providers of services. It puts in place labour and environmental standards. It also creates a dispute settlement mechanism accessible to individual and corporate foreign investors.

In its current form, the TPP undermines the rules and regulations of the World Trade Organization (WTO) as promulgated in the Uruguay round of talks in 1995. It is, therefore, a direct challenge to the current multilateral regime of international trade. It is likely to lead to the fragmentation of global trade into competing, insular blocs, each with its own protectionist policies.

The TPP is also a major step backward, mainly because it excludes China and the European Union (EU). The EU has a free trade agreement with the USA (called TTIP – Transatlantic Trade and Investment Partnership), but it is nowhere near as comprehensive as the TPP. China is likely to gravitate towards Russia, Turkey, Central Asia, and Africa. Latin America is already effectively integrated with the economy of the USA. Only the EU is left out in the cold.

The EU will face unfair competition in critical Asian export markets: lower tariffs for TPP members, higher tariffs for EU products, commodities, and goods. Some European agricultural goods will be banned altogether!

Europe’s economies rely on exports. Exports equal between 40-70% of the GDP of many key members of the EU (Germany, Italy, Spain, France, UK) - compared to 13% of GDP for the USA. The figures are even higher for non-EU members such as Macedonia. Any decline in exports to Asia will inexorably lead to long-term economic stagnation, deflation, and massive social unrest in the EU. It may even prove to be a coup de grace to this ill-fated experiment at European integration, in the wake of the migrant crisis, the euro crisis, the looming pension crisis, and the surging anti-EU sentiment within its member states, old and new alike.

Macedonia must immediately start to diversify its export markets. Currently, about three fifths of its exports and imports are to and from European destinations. It must urgently begin to look elsewhere: Asia, the Middle East, Africa, even the Pacific and North America. It must move away from tangible, physical goods to digital products and intellectual property which can be sold anywhere instantaneously and to tourism. Macedonia cannot rely on Europe anymore. It is no longer the important global player that it used to be.

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