Trade Forum Features

The State of World Trade - Many Grounds for Optimism

28 June 2011
ITC News

Things seem subdued, if not pessimistic, in the world of trade. While the heated talk of global currency wars has cooled to some extent, major imbalances remain. The success of the Doha Round is still not assured. And although protectionist pressures have generally been resisted, stubbornly high unemployment rates in many Western countries in particular could yet render them politically irresistible – no matter how economically undesirable.

I want to focus on what tends to get overlooked – the many grounds for regarding the real possibilities around trade with optimism. I use the traditional set-up of trade theory: two countries, two goods, a single production stage for each, characterized by a perfectly competitive structure and zero transportation costs as the foil for this discussion. By examining departures from this mental model and exploring the possibilities around trade, one might weaken the model’s hold on us and spur the pursuit of those possibilities. Achievable gains from trade liberalization may provide an increment of up to several percentage points of global gross domestic product (GDP).

Consider half-a-dozen aspects of reality that go beyond the traditional set-up and how they affect the estimated gains from trade or levers for unlocking them.

1. Many goods

Restricting the world to two goods is more than just a simple quantitative restriction. It obviously limits the (static) opportunities for specialization. And as has been stressed before, the restriction to a small number of goods – or countries – also understates the dynamic gains, particularly for small countries, from specializing their learning and specialization in a small number of sectors. After all, it should be much easier to advance on the world productivity frontier in one or a few sectors than in many. Furthermore, disaggregation also greatly amplifies the estimated gains from trade liberalization. Thus, according to one study, it raises the real income gains from liberalization from 0.5% of global GDP to 0.88% (although, as I will argue below, I think that even the latter number is too low).1

2. Many stages of production

Assuming a one-stage production process that converts factor inputs into final consumption goods represents another mental restriction on the real space of possibilities. In a world characterized by large amounts of intra-industry trade and, particularly, the slicing-up and cross-country dispersion of value chains, choices about where to compete are more than choices about which goods to focus on. As the Director-General of the World Trade Organization, Pascal Lamy, stresses, decisions also need to be made about which vertical stage to compete in. While the need to think through the vertical dimension has long been with us, recent developments seem to amplify it. Until recently, the division of tasks across countries became ever finer and more complex; the manufacture of some garments, for instance, might have involved as many as 40 processing steps in a dozen countries. Increased concerns about the environment and sensitivity to energy prices, not to mention the possibility of protectionism, appear to be reversing that trend. A 2009 survey of logistics providers revealed that nearly one-quarter of North American and European clients had taken steps to shorten their supply chains during the previous year. The fluidity of the vertical division of labour increases the need to distinguish among vertical stages in value chains and to identify a focus or trajectory over time.

3. Many non-merchandise categories

The traditional focus on trade in goods misses out on trade in services. The latter is actually already higher than reported because of a tendency to lump many service activities into the manufacturing sector (e.g. the internal provision of accounting services in a firm that manufactures for export). But the big recent and prospective increases in potential are related to developments in information technology (IT), which have decoupled where certain kinds of services are performed from where they are delivered, i.e. increased the tradeability of services. The most obvious and well-developed example of service offshoring of this sort has to do with IT services and business process outsourcing. While cheap, high-bandwidth connectivity has led many firms to offshore IT and related services to India and elsewhere, the volume still accounts for less than 20% of the addressable market – which might itself triple in size by 2020.2 And the extent of offshoring in other categories of IT-enabled services is significantly lower. There are also many service sectors unrelated (or not necessarily related) to IT where gains are possible e.g. education, health care, tourism and transportation.

4. Many possible gains

Another significant source of optimism arises from the fact that, as Pascal Lamy has observed, trade economists and professionals still tend to focus on volumes when they should be thinking more broadly about all the ways in which cross-border exchange can create value. Here, a business perspective is particularly informative, because businesses figured out the importance of this trend decades ago. Looking at how businesses evaluate international moves calls attention to cost drivers that extend beyond the usual focus on absolute cost differences to include scale economies, investments in cost reduction, utilization effects, etc. Business experience also suggests paying much more attention to the effects of cross-border exchange on differentiation, as well as costs, on industry structure and on risk factors and learning opportunities. The figure above lists some of the recent strands in the literature that emphasize additional gains from trade, beyond the conventional. My own reckoning is that taking all these gains into account pushes the gains from trade liberalization up to several percentage points of global GDP.3

5. Many best places

The thrust of trade theory, particularly in the absence of transport costs, has been on identifying the ‘one best place’ in the world to make a particular product (or perform a particular activity). This focus has also been promoted by applied work on industrial clusters, which has tended to dichotomize the effects of distance by assuming that on the production side, geographic distance is prohibitive in the sense that all ‘interesting’ interactions are localized, but that in going to market (as well as in ‘uninteresting’ interactions), distance is no deterrent. Getting beyond this dichotomy to take a more stretched-out look at distance and its effects, i.e. moving beyond the binary contrast of home versus abroad towards an understanding of degrees of cross-border difference, suggests, in many cases, ‘many best places’ to compete. This logical conclusion is backstopped by data indicating greater geographic dispersion, rather than concentration of production, in most categories of manufactured products since 1970, as well as (less directly) continued evidence of distance sensitivity and, in many regions, decreases in average distance shipped.

6. Many addressable barriers

When one looks at why cross-border integration is as limited as it is, a range of barriers stands out. However, only a subset of the administrative barriers tends to be considered in analysing the gains from further liberalization; thus regulatory harmonization, trade facilitation and other measures to reduce red tape are still generally glossed over. So are the opportunities for cultural facilitation to deal with barriers rooted in insularity, hubris and a basic lack of information. While geography sometimes seems immutable, progress is possible even there, such as via the improvement of ports and internal roads and railways that ultimately link up to international borders. A shift from focusing on a limited set of administrative levers for increasing integration to expanding the policy space is likely to suggest more ways to tap the gains identified above. And many of these other barriers can and should be tackled unilaterally.


Summarizing: the half-a-dozen complexities of the real world pointed to above remind us of both the large potential gains from trade and the degrees of strategic freedom that individual countries can avail of in pursuing them. But full pursuit of this potential requires multilateral and unilateral efforts. In this regard, it is worth noting that the Doha Round essentially focuses on the first two issues raised above, but does not address services, many administrative barriers and a variety of drivers in value addition in any depth. Therefore, unlocking the potential gains from trade will be predicated on bringing some of the issues removed from the agenda at Cancun in 2003, back onto to post-Doha agenda.

Pankaj Ghemawat is the author of numerous business publications including ‘Redefining Global Strategy’ and ‘Strategy and the Business Landscape’. For more information visit

 This article is based in part on Pankaj Ghemawat, World 3.0: Global Prosperity andHow to Achieve It. Boston: Harvard Business Review Press, May 2011.
1 David Laborde, Will Martin andDominique van der Mensbrugghe, Measuring the Benefits of Global Trade Reform with Optimal Aggregators of Distortions. IFPRI and World Bank, September 2010.
2 Pankaj Ghemawat and Steven A. Altman, The Indian IT Services Industry in 2009, Exhibits 6–9, unpublished draft, August 2009, available from
3 SeeGhemawat, op cit., chapter 4.


Value component Additions
Adding volume  
Decreasing costs
  • Scale economies
  •  Investments in cost reduction
  •  Other cost drivers (e.g. utilization)
(increasing willingness to pay)
  • Economics of missing products
  • The moving quality window
Intensifying competition
  • Productivity studies (decomposition, turnover)
  • Rent-seeking/directly unproductive profit-seeking(DUP) activities
  •  Entrenchment effects
Normalizing risk
  • Case studies (e.g. food)
Generating and deploying knowledge/other resources
  • Technological progress/capabilities literature
  • Imitation as well as innovation
  •  Complementarities with investment