Tuesday, May 09, 2006

Free Trade 1: Estonia's Free Market, Globalization

While Hong Kong and Singapore remain the world's good examples of a generally free economy, there are other new-comers who trail these 2 small-population but dynamic Asian economies. Among those new-comers are Estonia. In a span of just 10 years (1995-2004), per capita GDP (adjusted for cost of living through PPP) has almost doubled!

An article from Cato website written by Marian Tupy featured Mart Laar and what he did to Estonia as that country's former PM. Again, for brevity purposes, I cut several paragraphs of Ms. Tupy's article. To see the whole paper, visit

Among the achievements of Mart Laar for Estonia, according to Ms. Tupy, are the following:

* According to the Economic Freedom of the World: 2005 Annual Report, which is published by the Fraser Institute in Canada, Estonia is the ninth economically freest country in the world. Today, many people find it difficult to remember the days of the Soviet Union, when the Estonian economy was completely dominated by the state and marked by endless lines and shortages. Mart Laar replaced the "dead hand" of the government with Adam Smith's "invisible hand."

* His government eliminated import tariffs (a decision that was partly reversed by Estonia's membership of the European Union) and established a flat income tax. Corporate taxes on reinvested profits fell to zero and a currency board was established to combat inflation. The government also undertook extensive privatization of state companies.

* Though Estonia experienced a sharp but short recession that was shared by all transitional economies, by 1995 the economy was roaring again. According to the World Bank, between 1995 and 2004, Estonia's per capita gross domestic product (GDP) grew at a compounded average annual rate of 6.6 percent. During that decade, Estonia's GDP per capita adjusted for purchasing power parity rose from $6,847 to $12,773 in constant 2000 dollars, an increase of 86.5 percent. Estonia's sustained, high growth rate was among the region's highest and set the country on course to join the rest of the developed world....

* Mart Laar's impact was felt beyond the influence he had on the lives of his fellow countrymen. Other post-communist countries learned from Estonia's reforms and imitated them. Estonia's successful adoption of the flat tax led the way for Russia, Slovakia, Ukraine, and others. Estonia's unilateral trade liberalization is a continued inspiration for other countries; including, most recently, Georgia. There are also those who feel that the presence of a market-liberal Estonia in the European Union will lead the EU away from her socialist policies....

A related note I wrote last April 19, 2006:

Globalization = Lower Inflation

The IMF has recently released its World Economic Outlook (WEO) 2006 (www.imf.org). Chapter 3 is entitled, "How has globalization affected inflation?" and among the major findings and analysis of the chapter are:

* Over the past decade, globalization has pared or reduced inflation rate; by 1/4 of a percentage point in developed economies, by 1/2 of a percentage point in the US in particular.
* Globalization is no guarantee of low inflation in the next year or two, due to forecast robust global growth and diminishing economic slack.
* For globalization to have substantial lasting impact on inflation, it must change the overarching objectives of monetary policy (like inflation-targeting near zero).
* Globalization has restrained price and wage growth in sectors more exposed to international competition like textiles and electronics.

In economic theory, globalization and free trade results in "factor price equalization"; or if certain factors of production are less or non-mobile, free trade results in "commodity price equalization". This means that countries that have surplus output (say, surplus rice in Thailand and Vietnam) will experience declining rice prices domestically, while rice prices in countries that have low rice output relative to their population's needs (like the Philippines) will be high -- if international trade in rice is restricted. Globalization and free trade reallocates resources and production from countries and places where they are abundant, to places and countries where they are scarce and needed. Such resource reallocation is reflected in commodity price (in this example, rice price) that is generally the same across many countries, adjusted for cost of living in those countries.

Graphically, the global supply curve tends to move more flat in a regime of free trade and unhampered globalization. A flatter supply curve means a flatter price range (ie, small difference from the most expensive to the cheapest price of a commodity) across a wider and bigger supply of that commodity around the world.

Thus, even in years and periods of robust global economic growth, globalization and free trade should result in modest price rise and stable single-digit inflation rate on average across the world. This is because for countries and places to further expand output, they will have to hire more workers and technology from other countries, import more production inputs (from agricultural raw materials to high-tech farm machineries) from other countries. The fast movement of inputs, intermediate goods and services, and final products around the globe will provide the momentum for such robust global growth to be sustained for several years. This is on the assumption of course that there are no adverse external interruptions like wars, large-scale terrorist attacks, and natural catastrophies.

I do not know how far the IMF will recommend in further pushing for more free trade, in further removing and ultimately abolishing various forms of export subsidies, production subsdies, and by extension, slashing taxes that help finance those trade-distorting subsidies.

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