Free trade is a largely theoretical policy under which governments impose absolutely no tariffs, taxes, or duties on imports, or quotas on exports. In this sense, free trade is the opposite of protectionism, a defensive trade policy intended to eliminate the possibility of foreign competition.
In reality, however, governments with generally free-trade policies still impose some measures to control imports and exports. Like the United States, most industrialized nations negotiate “free trade agreements,” or FTAs with other nations which determine the tariffs, duties, and subsidies the countries can impose on their imports and exports. For example, the North American Free Trade Agreement (NAFTA), between the United States, Canada, and Mexico is one of the best-known FTAs. Now common in international trade, FTA’s rarely result in pure, unrestricted free trade.
In 1948, the United States along with more than 100 other countries agreed to the General Agreement on Tariffs and Trade (GATT), a pact that reduced tariffs and other barriers to trade between the signatory countries. In 1995, GATT was replaced by the World Trade Organization (WTO). Today, 164 countries, accounting for 98% of all world trade belong to the WTO.
Despite their participation in FTAs and global trade organizations like the WTO, most governments still impose some protectionist-like trade restrictions such as tariffs and subsidies to protect local employment. For example, the so-called “Chicken Tax,” a 25% tariff on certain imported cars, light trucks, and vans imposed by President Lyndon Johnson in 1963 to protect U.S. automakers remains in effect today.
Arguments for Free Trade
(i) Advantages of specialisation
Firstly, free trade secures all the advantages of international division of labour. Each country will specialise in the production of those goods in which it has a comparative advantage over its trading partners. This will lead to the optimum and efficient utilisation of resources and, hence, economy in production.
(ii) All-round prosperity
Secondly, because of unrestricted trade, global output increases since specialisation, efficiency, etc. make production large scale. Free trade enables countries to obtain goods at a cheaper price. This leads to a rise in the standard of living of people of the world. Thus, free trade leads to higher production, higher consumption and higher all-round international prosperity.
(iii) Competitive spirit prevails
Thirdly, free trade keeps the spirit of competition of the economy. As there exists the possibility of intense foreign competition under free trade, domestic producers do not want to lose their grounds. Competition enhances efficiency. Moreover, it tends to prevent domestic monopolies and free the consumers from exploitation.
(iv) Accessibility of domestically unavailable goods and raw materials
Fourthly, free trade enables each country to get commodities which it cannot produce at all or can only produce inefficiently. Commodities and raw materials unavailable domestically can be procured through free movement even at a low price.
(v) Greater international cooperation
Fifthly, free trade safeguards against discrimination. Under free trade, there is no scope for cornering raw materials or commodities by any country. Free trade can, thus, promote international peace and stability through economic and political cooperation.
(vi) Free from interference
Finally, free trade is free from bureaucratic interferences. Bureaucracy and corruption are very much associated with unrestricted trade.
In brief, restricted trade prevents a nation from reaping the benefits of specialisation, forces it to adopt less efficient production techniques and forces consumers to pay higher prices for the products of protected industries.
Arguments against Free Trade
Despite these virtues, several people justify trade restrictions.
Following arguments are often cited against free trade
(i) Advantageous not for LDCs
Firstly, free trade may be advantageous to advanced countries and not to backward economies. Free trade has brought enough misery to the poor, less developed countries, if past experience is any guide. India was a classic example of colonial dependence of UK’s imperialistic power prior to 1947. Free trade principles have brought colonial imperialism in its wake.
(ii) Destruction of home industries/products
Secondly, it may ruin domestic industries. Because of free trade, imported goods become available at a cheaper price. Thus, an unfair and cut-throat competition develops between domestic and foreign industries. In the process, domestic industries are wiped out. Indian handicrafts industries suffered tremendously during the British regime.
(iii) Inefficient industries remain perpetually inefficient
Thirdly, free trade cannot bring all-round development of industries. Comparative cost principle states that a country specialises in the production of a few commodities. On the other hand, inefficient industries remain neglected. Thus, under free trade, an all-round development is ruled out.
(iv) Danger of overdependence
Fourthly, free trade brings in the danger of dependence. A country may face economic depression if its international trading partner suffers from it. The Great Depression that sparked off in 1929-30 in the US economy swept all over the world and all countries suffered badly even if their economies were not caught in the grip of depression. Such overdependence following free trade becomes also catastrophic during war.
(v) Penetration of harmful foreign commodities
Finally, a country may have to change its consumption habits. Because of free trade, even harmful commodities (like drugs, etc.) enter the domestic market. To prevent such, restrictions on trade are required to be imposed.
In view of all these arguments against free trade, governments of less developed countries in the post-Second World War period were encouraged to resort to some kind of trade restrictions to safeguard national interest.
Free Trade Theories
Since the days of the Ancient Greeks, economists have studied and debated the theories and effects of international trade policy. Do trade restrictions help or hurt the countries that impose them? And which trade policy, from strict protectionism to totally free trade is best for a given country? Through the years of debates over the benefits versus the costs of free trade policies to domestic industries, two predominant theories of free trade have emerged: mercantilism and comparative advantage.
Mercantilism is the theory of maximizing revenue through exporting goods and services. The goal of mercantilism is a favorable balance of trade, in which the value of the goods a country exports exceeds the value of goods it imports. High tariffs on imported manufactured goods are a common characteristic of mercantilist policy. Advocates argue that mercantilist policy helps governments avoid trade deficits, in which expenditures for imports exceeds revenue from exports. For example, the United States, due to its elimination of mercantilist policies over time, has suffered a trade deficit since 1975.
Dominant in Europe from the 16th to the 18th centuries, mercantilism often led to colonial expansion and wars. As a result, it quickly declined in popularity. Today, as multinational organizations such as the WTO work to reduce tariffs globally, free trade agreements and non-tariff trade restrictions are supplanting mercantilist theory.
Comparative advantage holds that all countries will always benefit from cooperation and participation in free trade. Popularly attributed to English economist David Ricardo and his 1817 book “Principles of Political Economy and Taxation,” the law of comparative advantage refers to a country’s ability to produce goods and provide services at a lower cost than other countries. Comparative advantage shares many of the characteristics of globalization, the theory that worldwide openness in trade will improve the standard of living in all countries.
Comparative advantage is the opposite of absolute advantage—a country’s ability to produce more goods at a lower unit cost than other countries. Countries that can charge less for its goods than other countries and still make a profit are said to have an absolute advantage.
Pros and Cons of Free Trade
Would pure global free trade help or hurt the world? Here are a few issues to consider.
Advantages of Free Trade
- It stimulates economic growth
Even when limited restrictions like tariffs are applied, all countries involved tend to realize greater economic growth. For example, the Office of the US Trade Representative estimates that being a signatory of NAFTA (the North American Free Trade Agreement) increased the United States’ economic growth by 5% annually.
- It helps consumers
Trade restrictions like tariffs and quotas are implemented to protect local businesses and industries. When trade restrictions are removed, consumers tend to see lower prices because more products imported from countries with lower labor costs become available at the local level.
- It increases foreign investment
When not faced with trade restrictions, foreign investors tend to pour money into local businesses helping them expand and compete. In addition, many developing and isolated countries benefit from an influx of money from U.S. investors.
- It reduces government spending
Governments often subsidize local industries, like agriculture, for their loss of income due to export quotas. Once the quotas are lifted, the government’s tax revenues can be used for other purposes.
- It encourages technology transfer
In addition to human expertise, domestic businesses gain access to the latest technologies developed by their multinational partners.
Disadvantages of Free Trade
- It causes job loss through outsourcing
Tariffs tend to prevent job outsourcing by keeping product pricing at competitive levels. Free of tariffs, products imported from foreign countries with lower wages cost less. While this may be seemingly good for consumers, it makes it hard for local companies to compete, forcing them to reduce their workforce. Indeed, one of the main objections to NAFTA was that it outsourced American jobs to Mexico.
- It encourages theft of intellectual property
Many foreign governments, especially those in developing countries, often fail to take intellectual property rights seriously. Without the protection of patent laws, companies often have their innovations and new technologies stolen, forcing them to compete with lower-priced domestically-made fake products.
- It allows for poor working conditions
Similarly, governments in developing countries rarely have laws to regulate and ensure safe and fair working conditions. Because free trade is partially dependent on a lack of government restrictions, women and children are often forced to work in factories doing heavy labor under slave-like working conditions.
- It can harm the environment
Emerging countries have few, if any environmental protection laws. Since many free trade opportunities involve the exporting of natural resources like lumber or iron ore, clear-cutting of forests and un-reclaimed strip mining often decimate local environments.
- It reduces revenues
Due to the high level of competition spurred by unrestricted free trade, the businesses involved ultimately suffer reduced revenues. Smaller businesses in smaller countries are the most vulnerable to this effect.
In the final analysis, the goal of business is to realize a higher profit, while the goal of government is to protect its people. Neither unrestricted free trade nor total protectionism will accomplish both. A mixture of the two, as implemented by multinational free trade agreements, has evolved as the best solution.