How “Cultural Distance” Acts as a Barrier to Trade

By: Lipton Matthews

Economists frequently tout trade as a mechanism to boost growth and living standards. Yet some continue to extol the virtues of protectionism. However, the internecine debate between free traders and protectionists is less interesting than interrogating why countries erect barriers to international trade. A basic explanation is that opposition to trade is a consequence of nationalism and this assumption is partially true.

During the early twentieth-century trade policies in several European countries were cultivated by national sentiments, and more recently Donald Trump advocated imposing tariffs on China, so undoubtedly nationalism can stimulate demand for protectionist policies. Likewise, protectionism also gains traction when leaders perceive trade as a zero-sum game by not recognizing that the savings derived from trade are incomparable to the deficit.

Like most transactions, we engage in international trade because it increases utility. For example, when we purchase consumer goods, clearly, we lose money, but in exchange, we are provided with commodities that enrich the quality of life. Hence in this regard, international trade is no different, since it is essentially about maximizing utility. A fundamental misunderstanding in the perception of international trade is that it should privilege the national good, when, in reality, trade serves to elevate the preferences of individuals.

States have political agendas that are usually incompatible with the interests of individuals. As such, advocating the national good is a rhetorical trick employed by politicians to guilt citizens into embracing their policies. Ideally, the state and the individual are separate entities, and the former should refrain from encroaching on the rights of the latter. When the state limits the choices of consumers by instituting protectionist measures this violates one’s right to choose and by extension property rights.

Although we have exposed the fallacies inherent in political and economic critiques, the puzzle remains unsolved. Such arguments articulate why countries renounce international trade under certain circumstances, but they do not demonstrate why trade is more likely to be parochial than global. In brief, direct opposition to trade is not the only barrier to international distance, cultural distance also explains obstacles to international trade.

Though libertarians would prefer a stateless society, the truth is that governments are primarily responsible for economic policy, and like people, they select trading partners based on commonalities. Although trading occurs to ensure that both parties obtain products that cannot be sourced locally, states must respect each, before trading is initiated. Of course, culturally similar states do compete, but due to commonalities, they are more likely to be appreciative of individual differences.

On an anecdotal level, it is evident that regional trade blocs are more popular than global ones. A perfect example is that despite the glorification of global trade, bureaucrats in Europe and Asia are passionately promoting regional trade, supranational trade blocs encompassing several regions are failing to gain steam. Unsurprisingly, research has captured the impact of cultural distance on trade. Tadessa and White in a 2007 paper tracking the effect of cultural distance on U.S. state-level exports during the year 2000, submit that greater cultural distance reduces aggregate exports, alongside the exports of cultural and non-cultural products.

Furthermore, after employing bilateral trade data that cover the period 1996-2001 for nine OECD countries and 58 other countries for which cultural distances can be calculated researchers conclude that cultural dissimilarity has a statistically positive and negative influence on the volume of trade flows. According to the results, a 1 % increase in the cultural distance between OECD countries and their trading associates would reduce aggregate imports of the typical OECD country by 0.7758%.

In addition, according to a 2017 meta-analysis exploring the nexus between cultural distance and firm internationalization, companies are unlikely to establish operations in culturally distant locations. The researchers further report that cultural distance has a negative effect on subsidiary performance, but no effect on the performance of the whole MNC. A possible reason for this is that MNCs can use the experiences of the subsidiary as a guide to improving performance in other markets, thus compensating for the negative performance of the subsidiary.

Undeniably, cultural distance inhibits trade, but luckily economic analysis suggests that immigration might play a role in countering the trade inhibiting effects of cultural distance. Immigrants through their diverse preferences can generate demand for foreign products thereby accentuating partnerships with non-traditional trading neighbors. Moreover, by possessing intimate details relating to their country of origin, immigrants can enhance the quality of information available to local businesses; therefore, lowering information costs for producers.

For example, in a groundbreaking paper, Burchardi et al (2018) assert a relationship between the number of residents with ancestry from a foreign country and the propensity of firms to engage economically with that country. Further, they also contend that immigration achieves these results by reducing the cost of information transmission.

In sum, cultural distance is not a prominent topic in economic debates, but it deprives people of major opportunities, by acting as a barrier to trade. Therefore, policymakers must consider this hurdle when crafting trade policy. We cannot afford to lose the benefits of trade due to an inability to transcend cultural differences.

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