Free Trade, Protectionism, and Economic Shifts: 1800s

Posted on Feb 15, 2025 in Business Administration and Management (BAM)

Free Trade and Protectionism

1. Protectionism: The Repeal of the Corn Laws

In 1846, Britain abolished the Corn Laws (tariffs on the trade of cereals). It is a 2×2 model = 2 commodities and 2 sectors; however, Labor (L) can only be in 1 sector.

Consequences of the Repeal:

  • Point C: If the price (P) of food changes, which in this case falls because of the abolition of the law, there is a new equilibrium point. There will be a fall in the demand for labor in the food sector (DLF) since there are more workers in the industrial sector, and there will also be a fall in wages (W) in both sectors. The industrial sector is better off because it has more labor force and lower wages.
  • Points A-C: Decrease in DLF as a result of the repeal; the fall in the price of food leads to a fall in demand that generates a fall in wages in both sectors.
  • Points A-B: Loss in price of agrarian goods. Due to this, landowners are going to be in worse condition, and this is why they are against the laws; however, the industry was in favor.

Winners = industry; Losers = agriculture.

Free Trade (1860s-80s)

In the 1850s, the British started campaigns to convince the rest of Europe to enter a free trade commerce, as they were the only ones, and the rest of the countries still had tariffs. The first country to convert was France, which signed the Cobden-Chevalier Treaty with Great Britain in 1860, in which they agreed to lower tariffs between economies. The most relevant aspect of the treaty was the Most Favored Nation (MFN) clause, which requires a country to provide any concessions, privileges, or immunities to one nation in a trade agreement.

Return to Protectionism

It means a general rise in tariffs, not a complete reversal. It was a short-lived era because of:

  1. The Grain Invasion: The invasion of European economies by products produced outside Europe, caused by the transport revolution.
  2. Transport Costs: Transport itself (fall in prices because of technology) and trade barriers (lower tariffs initially, but governments acted by raising tariffs, leading to the return to protectionism due to the competition of prices of wheat with other countries outside Europe).

Spain: Technological Change and Structural Transformation

Characteristics of the Spanish economy in the late 19th century:

  • Lower demographic pressure than in the rest of Europe.
  • Low level of domestic investment in school enrollment.
  • Less open economy to international trade than advanced countries of similar population size.
  • Higher share of employment in agriculture (wider productivity gap).
  • High tariff protection.
  • Relative backwardness (a gap in income per capita that widens as income per person increases).

Loss of the Colonial Empire – Short Run:

  • Trade in goods and services fell sharply, and investment levels declined.
  • Domestic industry lost a protected market.
  • Loss of financial revenues.

Loss of the Colonial Empire – Long Run:

  • Flexible sectors able to adapt.
  • Improvement in terms of trade.
  • Impact milder.
  • Macroeconomic instability (brought forward the fall of the peseta).
  • Cuban revolt and war (repatriation from Cuba and boom in the international market).

Gerschenkron: Construction of the railways in the mid-19th century and its impact on industrial sector growth, which was an opportunity for relatively backward economies.

Railways and foreign capital (topic 1).

The Gold Standard

Rules:

  • Fixed gold content of the domestic monetary unit (official exchange rate), which is determined by supply and demand. Fixed in terms of gold between countries.
  • Central Banks (CBs) had to back money issuing with reserves of precious metals, meaning Money Supply (MS) is related to gold reserves.
  • Central Bank notes are directly convertible into gold.
  • Freedom to import and export gold.

Rules of the Game:

Deficit Country (Imports > Exports): If you have a debt, you have to pay in gold:

  1. If you pay with gold, you have a gold outflow, and you should contract the Money Supply (MS).
  2. To contract MS = raise the discount rate (make money more expensive).
  3. Rise in discount rates = commercial banks increase interest rates.
  4. These two increases = decrease in investment.
  5. Decrease in investment = increase in unemployment and decrease in wages (less economic activity).
  6. Because of this, MS is contracted, and we will have an economy with deflation (price declines).

On the other hand, all of this is temporary, and we will have an increase in exports and a decrease in imports, which will cause a correction of the trade balance, resulting in a trade balance surplus. For rising interest rates, there will be an increase in net capital inflows since they are convertible into gold.

Theory:

  • CBs have to respect the rules.
  • A deficit country must allow gold outflows.
  • MS must be adjusted to gold reserves.

Reality:

  • Not respected.
  • Few countries corrected the deficit.
  • Some countries never adjusted MS.

Real Life:

Commitment to convertibility = the system worked because of one country (Great Britain), one institution (Bank of England), and because of the trust in pounds, plus cooperation (France).

Ideology Behind:

  • Authorities (commitment to an anti-inflation, balanced-budget, stable-money policy).
  • Prices and wages (more flexible).
  • The core countries (Great Britain and France) had no capital controls.

Convergence and World Market Integration

(Heckscher-Ohlin)

Convergence is the tendency toward factor price equalization. Therefore, when we focus on trade, we have to say that the decline in transport costs, especially railways and navigation, was the main factor of the price convergence of exports and imports. In some cases, due to this, the price of a certain good was cheaper in the importer country than in the exporter country where it was produced. Related to wage convergence, as Europe had a large supply of labor but with low wages, and the New World had scarce labor with high wages, there was a great amount of international migration flows. This migration was the main cause of the convergence in wages. In the counterfactual, without migration, there wouldn’t have been a price convergence as there was. Finally, related to land rent, we can strongly say that there was also land convergence, as the increases and decreases in land rent in the New World were parallel to the ones in Europe.

The Heckscher-Ohlin model convincingly explains the trade patterns and changes in factor prices in the world market between 1870 and 1914. It has to make several assumptions, like 2 sectors: agriculture and industry; 2 commodities: food and manufactured goods; and 2 factors: land and labor (technology is fixed).

The First Globalization (1870-1914)

The basic variable of market behavior is price. Therefore, the key evidence of globalization. During the Globalization, we find integration; this means, the lower the price gap, the higher integrated the market is; in other words, there is convergence. This first globalization was promoted due to the fall in transport costs. Convergence is the tendency toward factor price equalization. In trade, we find a commodity price convergence in agricultural goods like cereals and wheat. Mass migration caused a wage convergence, capital inflows caused convergence in the interest rate between countries (importers and exporters of capital), and finally, there was land convergence in the price of land and rent.

Advantages and Disadvantages of Late Comers

Modern economic growth is characterized by a process of continuous technological innovation, industrial upgrading, and improvement in hard and soft infrastructure. Gerschenkron is right to postulate that in the process, a developing country has an advantage of backwardness. If a developing country uses that advantage right, they will have faster economic growth than the advanced countries and achieve convergence to an advanced country in one or two generations. The precondition for a country to use that advantage right is to follow the comparative advantage determined by its own factor endowment in the industrial upgrading and technological innovation. Two countries had special benefits from these two advantages: Germany and the USA.