When Open Markets Lead to Sustainable Growth... And When They Don't

Last week at the start of the G20 Summit, the International Chamber of Commerce (ICC) released this year's Open Markets Index, an annual assessment of economies based on how open they are to trade. The OMI was created as a guide for governments looking to implement policies that will help them use international trade to encourage job creation and support sustainable growth.

There is little debate about the strong links between trade and growth: the past half century shows that economies that trade tend to record higher GDP growth; it is also well known that the quickest way to boost trade is to open up an economy and build the infrastructure to move goods and services. Thus, the OMI measures an economy's observed openness to trade (e.g. are there many tariffs or trade restrictions in place), trade policy, openness to foreign direct investment, and the quality of trade-enabling infrastructure.

As the ICC notes in its introduction, the release of this year's OMI occurs as the world faces rising anti-globalization sentiment coupled with escalated protectionist rhetoric from the world's largest economy, the United States. It calls on the G20 to reject protectionism and to make the case, once again, for open markets as the best route to prosperity for all.

While Trump may be short-sighted in thinking that protectionism is the best way to put "America first", he is right in one observation: that trade and globalization might have expanded the overall economic pie, but some have clearly benefited more than others. Specifically, over the past thirty years, incomes at the very top have grown at over 10 times the rate of the middle class and over 17 times the rate of the lower class (bottom quintile). As a result, overall inequality has increased alongside globalization. Of course, globalization - and free trade as one of its most prominent manifestations - are not the only factors at work, but the correlation does raise questions. How can open markets result in increasing inequality if its goal is sustainable growth?

This is where the OMI data becomes very useful, because one can clearly see that positive performance on the OMI (indicating a greater openness to trade) does not always correlate to positive performance on income inequality, as measured, for instance, by the Gini coefficient or similar measures of economic inclusivity. Indeed, the top two performers on the OMI - Singapore followed by Hong Kong - have both experienced rising inequality, and in fact Hong Kong has the dubious honor of being the advanced economy with the highest level of inequality in the world, with a Gini coefficient of 0.53.

Those countries in the second quartile - which include many western and northern European economies - are only "above average" in openness but perform significantly better in terms of inclusivity. Netherlands, Ireland, Switzerland, Belgium, Norway and others, for instance, all record Gini coefficients around or below 0.30. How do they achieve this?

It has nothing to do with the openness of the economy, at least not directly. In the world of Gini coefficients, calculations can go two ways: one is before taxes and transfers (aka social spending) and the other is after such measures. Almost all the European countries which score so well on Gini coefficient actually started in the mid to high 0.40s, and instead of leaving the population like that, used fiscal and social measures to bring down inequality to a socially acceptable level.

The chart below shows that within the OECD, as countries spend more on social measures, relative to the levels of household income, the greater the impact on lowering levels of inequality.

Indeed, these countries have achieved the best of both worlds: open markets to drive greater trade, and fiscal measures to mitigate its perverse effects, to ensure inclusivity and sustainability. In other words, trade cannot be viewed in a vacuum: open markets, like closed ones, are not ends in themselves, but rather a means to greater prosperity throughout all levels of society.

In Asia, free trade is often (wrongly) taken to mean that government should adopt a hands-off approach. It may be that government needs to step back in some areas, but step forward in others where open markets are less able to produce beneficial outcomes for all members of society.

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