Free Trade

Free trade policy refers to a trade policy without any tariffs, quantitative restriction and other devices obstructing the movement of goods between the countries. Free trade, also called laissez-faire, a policy by which a government does not discriminate against imports or interfere with exports by applying tariffs (to imports) or subsidies (to exports). A free-trade policy does not necessarily imply, however, that a country abandons all control and taxation of imports and exports. Free trade is a policy followed by some international markets in which countries' governments do not restrict imports from, or exports to, other countries. Prof. Bhagwati defines free trade policy as “absence of tariffs, quotas, exchange restrictions, taxes and subsidies on production, factor use and consumption.” The policy of free trade means simply complete freedom of international trade without any restriction on the movements of goods between the countries. However, there is an exception. Import duties can be levied for revenue and not for protection even under free trade. Thus a country following the free trade policy levies duties which are lower than the cost advantage enjoyed by the lowest cost foreign good. The theoretical case for free trade is based on Adam Smith’s argument that the division of labour among countries leads to specialization, greater efficiency, and higher aggregate production. From the point of view of a single country there may be practical advantages in trade restriction, particularly if the country is the main buyer or seller of a commodity. In practice, however, the protection of local industries may prove advantageous only to a small minority of the population, and it could be disadvantageous to the rest. Since the mid-20th century, nations have increasingly reduced tariff barriers and currency restrictions on international trade. Other barriers, however, that may be equally effective in hindering trade include import quotas, taxes, and diverse means of subsidizing domestic industries. Most nations are today members of the World Trade Organization (WTO) multilateral trade agreements. However, most governments still impose some protectionist policies that are intended to support local employment, such as applying tariffs to imports or subsidies to exports. Governments may also restrict free trade to limit exports of natural resources. Other barriers that may hinder trade include import quotas, taxes, and non-tariff barriers, such as regulatory legislation. There is a broad consensus among economists that protectionism has a negative effect on economic growth and economic welfare, while free trade and the reduction of trade barriers to trade has a positive effect on economic growth. However, liberalization of trade can cause significant and unequally distributed losses, and the economic dislocation of workers in import-competing sectors. Features of free trade Free trade policies generally promote the following features. Trade of goods without taxes (including tariffs) or other trade barriers (e.g., quotas on imports or subsidies for producers) 2. Trade in services without taxes or other trade barriers 3. The absence of "trade-distorting" policies (such as taxes, subsidies, regulations, or laws) that give some firms, households, or factors of production an advantage over others 4. Unregulated access to markets 5. Unregulated access to market information 6. Inability of firms to distort markets through government-imposed monopoly or oligopoly power 7. Trade agreements which encourage free trade.

ECONOMICS OF FREE TRADE: Economic models Two simple ways to understand the proposed benefits of free trade are through David Ricardo's theory of comparative advantage and by analyzing the impact of a tariff or import quota. An economic analysis using the law of supply and demand and the economic effects of a tax can be used to show the theoretical benefits and disadvantages of free trade.

Most economists would recommend that even developing nations should set their tariff rates quite low, but the economist Ha-Joon Chang, a proponent of industrial policy, believes higher levels may be justified in developing nations because the productivity gap between them and developed nations today is much higher than what developed nations faced when they were at a similar level of technological development. Underdeveloped nations today, Chang believes, are weak players in a much more competitive system. Counterarguments to Chang's point of view are that the developing countries are able to adopt technologies from abroad, whereas developed nations had to create new technologies themselves, and that developing countries can sell to export markets far richer than any that existed in the 19th century.

If the chief justification for a tariff is to stimulate infant industries, it must be high enough to allow domestic manufactured goods to compete with imported goods in order to be successful. This theory, known as import substitution industrialization, is largely considered ineffective for currently developing nations.

The Economics of tariffs The pink regions are the net loss to society caused by the existence of the tariff. The chart at the right analyzes the effect of the imposition of an import tariff on some imaginary good. Prior to the tariff, the price of the good in the world market (and hence in the domestic market) is Pworld. The tariff increases the domestic price to Ptariff. The higher price causes domestic production to increase from QS1 to QS2 and causes domestic consumption to decline from QC1 to QC2. This has three main effects on societal welfare. Consumers are made worse off because the consumer surplus (green region) becomes smaller. Producers are better off because the producer surplus (yellow region) is made larger. The government also has additional tax revenue (blue region). However, the loss to consumers is greater than the gains by producers and the government. The magnitude of this societal loss is shown by the two pink triangles. Removing the tariff and having free trade would be a net gain for society. An almost identical analysis of this tariff from the perspective of a net producing country yields parallel results. From that country's perspective, the tariff leaves producers worse off and consumers better off, but the net loss to producers is larger than the benefit to consumers (there is no tax revenue in this case because the country being analyzed is not collecting the tariff). Under similar analysis, export tariffs, import quotas, and export quotas all yield nearly identical results. Sometimes consumers are better off and producers worse off, and sometimes consumers are worse off and producers are better off, but the imposition of trade restrictions causes a net loss to society because the losses from trade restrictions are larger than the gains from trade restrictions. Free trade creates winners and losers, but theory and empirical evidence show that the sizes of the winnings from free trade are larger than the losses.

Trade diversion According to mainstream economic theory, the selective application of free trade agreements to some countries and tariffs on others can lead to economic inefficiency through the process of trade diversion. It is economically efficient for a good to be produced by the country which is the lowest cost producer, but this does not always take place if a high cost producer has a free trade agreement while the low cost producer faces a high tariff. Applying free trade to the high cost producer (and not the low cost producer as well) can lead to trade diversion and a net economic loss. This is why many economists place such high importance on negotiations for global tariff reductions, such as the Doha Round.

Opinion of economists

The literature analyzing the economics of free trade is extremely rich with extensive work having been done on the theoretical and empirical effects. Though it creates winners and losers, the broad consensus among economists is that free trade is a large and unambiguous net gain for society. In a 2006 survey of American economists (83 responders), "87.5% agree that the U.S. should eliminate remaining tariffs and other barriers to trade" and "90.1% disagree with the suggestion that the U.S. should restrict employers from outsourcing work to foreign countries." ….{DATA SOURCE WIKIPEDIA} Quoting Harvard economics professor N. Gregory Mankiw, "Few propositions command as much consensus among professional economists as that open world trade increases economic growth and raises living standards."In a survey of leading economists, none disagreed with the notion that "freer trade improves productive efficiency and offers consumers better choices, and in the long run these gains are much larger than any effects on employment." Most economists would agree that although increasing returns to scale might mean that certain industry could settle in a geographical area without any strong economic reason derived from comparative advantage, this is not a reason to argue against free trade because the absolute level of output enjoyed by both "winner" and "loser" will increase with the "winner" gaining more than the "loser" but both gaining more than before in an absolute level. Post-World War II:

Since the end of World War II, in part due to industrial size and the onset of the Cold War, the United States has often been a proponent of reduced tariff-barriers and free trade. The U.S. helped establish the General Agreement on Tariffs and Trade (GATT) and later the World Trade Organization (WTO); although it had rejected an earlier version in the 1950s (International Trade Organization or ITO). Since the 1970s, U.S. governments have negotiated managed-trade agreements, such as the North American Free Trade Agreement (NAFTA) in the 1990s, the Dominican Republic-Central America Free Trade Agreement (CAFTA) in 2006, and a number of bilateral agreements (such as with Jordan).

In Europe, six countries formed the European Coal and Steel Community (ECSC) in 1951 which became the European Economic Community (EEC) in 1958. Two core objectives of the EEC were the development of a common market, subsequently renamed the single market, and establishing a customs union between its member states. After expanding its membership, the EEC became the European Union (EU) in 1993. The European Union, now the world's largest single market, has concluded free trade agreements with many countries around the world.

CURRENT STATUS:

Most countries in the world are members of the World Trade Organization,[which limits in certain ways but does not eliminate tariffs and other trade barriers. Most countries are also members of regional free trade areas that lower trade barriers among participating countries. The EU and the US are negotiating a Transatlantic Trade and Investment Partnership. Initially led by the U.S., twelve countries that have borders on the Pacific Ocean are currently in private negotiations around the Trans-Pacific Partnership, which is being touted by the negotiating countries as a free trade policy. In January 2017, the United States pulled out of negotiations for the Trans-Pacific Partnership. THE CASE FOR FREE TRADE There are many benefits of free trade, such as:

Giving corporations comparative advantage Generating currency Opening up markets

Adam Smith wrote in his 1776 book The Wealth of Nations that free trade was beneficial to trading partners. Smith noted that when the countries in a free trade agreement made products and provided that product for the other country at a cheaper rate than the receiving country could produce it, both countries benefited. We, as consumers, often apply that concept to our daily lives. We purchase goods or services that we cannot cost-effectively produce ourselves, benefiting both parties.

David Ricardo expanded on Smith's ideas, arguing that countries should do what they do better and cheaper than other countries. This is called comparative advantage. Ricardo further noted that concentrating on core competencies gave nations a comparative advantage.

Free trade also helps countries generate foreign currency that they can use to purchase the things that they need. Japan, for instance, exports cars and computers to China and the United States, generating foreign currency. Japan takes the revenue it earned from exporting and uses it to import needed products, such as food or mineral fuels.

Free trade opens foreign markets and lowers barriers for corporations that otherwise might not be able to compete against local competitors. As previously mentioned, without free trade agreements, foreign corporations must pay tariffs that increase their cost and decrease competitiveness. The classical economists were in favour of the free trade policy. Of the modern economist, Haberler advanced the following argument in favour of free trade

Maximization of output : The case for free trade arises from the theory of comparative advantages which states that a country specializes in the production of those commodities in which it possesses greater comparative advantage are least comparative disadvantage. Therefore, trade a country specializes in the production of those commodities which it is relatively best suited to produce and export them in exchange for those imports which it can obtain more cheaply. This maximizes the output of all the participating countries because all gains from trade which, in turn, increases the real national income of the world economy. Thus free trade leads to the maximization of output.

Optimum utilization of resources: Free trade leads to international specialization and division of labour. As a result, the existing resources in which trading country unemployed more productively and a resource allocation become more efficient. There is more efficient utilization of factors within a firm or industry. Thus international trade and division of labour lead to optimum utilization of resources.

Optimization of consumption: Free trade secures the optimization of consumption. In other words, it benefits the consumer when they are able to buy a variety of commodities from abroad at the minimum possible prices. This, in turn, has the effect of raising their standard of living.

Educative value: according to Haberler: Free trade has an educative value. International competition encourages home producer to sacrifice leisure in order to increase productivity. For this, innovate and bring improvement in organization and method of production.

Wide Markets: free trade leads to wide extent of markets for goods:

As the demand for goods is not confined to one country but to a number of countries, the entire world becomes the market for all type of goods. This leads to the production of quality goods at low prices because of the world competition.

Prevent Monopolies: Free trade prevents the establishment of monopolies. Under free trade each country specializes in the production of free commodities and the firms or industries are of the optimum size so that the cost of production of each commodity is the minimum. Thus free trade ensures a lower price for export as well as imports and the price mechanism under perfect competition prevent the formation of monopolies. Best policy for economic development: Haberler points out that "substantial free trade with marginal, insubstantial correction and deviation is the best policy from the point of view of economic development". Besides, the direct gains of a free trade noted above, free trade leads to the importation of capital goods, raw materials, and foreign capital, instills new ideas, and brings technical know-how, skills, managerial talents and entrepreneurship to the developing countries.

Lastly, it fosters healthy competition and checks inefficient and exploitative monopolies.

THE CASE AGAINST FREE TRADE

The policy of free trade, with all its advantages noted above, was abandoned after The Great Depression by the countries of the world. There are certain theoretical and practical difficulties in the following the free trade policy.

1. Free trade presupposes the existence of laissez-faire and the working of price mechanism under perfect competition. But these conditions do not exist in present world. Monopoly, monopsony, cartels, imperfect labour markets and tariffs led to the abandonment of free trade. 2. Under the policy of free trade, some industries expand in which the country possesses comparative advantage but other industries are not developed. An agricultural country may develop only agriculture and neglect the industrial sector. Or, one type of industries may be developed while others may remain undeveloped. This naturally led to one side and development of the economy. Hence free trade had to be abandoned. 3. There be no restriction on the movement of goods under free trade, substandard and harmful commodities are likely to be produced and traded. This leads to diminution of social welfare. Trade restrictions on the import of such commodities become necessary. This was another cause of abandonment of free trade. 4. Countries with better factor endowments are able to produce certain commodities cheaper than others. This led to cut-throat competition in the world markets under free trade. So certain countries like Japan restarted to the policy of dumping whereby they would sell huge quantity of their products at Rock bottom prices in the foreign markets. Naturally, this policy led to imposition of trade restrictions. 5. Free trade may lead to the emergence of International monopolies and local monopolies, according to Haberler. Such monopolies developed under free trade which proved harmful to the other countries and the domestic interests. This factor also lead to the adoption of the policy of protection. 6. Economist does not agree with the Haberler that free trade policy helps in the development of underdeveloped countries. Rather, this policy leads to the exploitation and colonization of the countries during the 19th and early 20th centuries. It is now recognize that underdeveloped countries can develop under a policy of protection and not of free trade.

Alternatives The following alternatives for free trade have been proposed: Balanced trade Fair trade Protectionism Industrial Policies

In literature:

The value of free trade was first observed and documented by Adam Smith in The Wealth of Nations, in 1776. He wrote, “It is the maxim of every prudent master of a family, never to attempt to make at home what it will cost him more to make than to buy.... If a foreign country can supply us with a commodity cheaper than we ourselves can make it, better buy it of them with some part of the produce of our own industry, employed in a way in which we have some advantage” This statement uses the concept of absolute advantage to present an argument in opposition to mercantilism, the dominant view surrounding trade at the time, which held that a country should aim to export more than it imports, and thus a mass wealth. Instead, Smith argues, countries could gain from each producing exclusively the good(s) in which they are most suited to, trading between each other as required for the purposes of consumption. In this vein, it is not the value of exports relative to that of imports that is important, but the value of the goods produced by a nation. The concept of absolute advantage however does not address a situation where a country has no advantage in the production of a particular good or type of good.

This theoretical shortcoming was addressed by the theory of comparative advantage. Generally attributed to David Ricardo who expanded on it in his 1817 book On the Principles of Political Economy and Taxation, it makes a case for free trade based not on absolute advantage in production of a good, but on the relative opportunity costs of production. A country should specialize in whatever good it can produce at the lowest cost, trading this good to buy other goods it requires for consumption. This allows for countries to benefit from trade even when they do not have an absolute advantage in any area of production. While their gains from trade might not be equal to those of a country more productive in all goods, they will still be better off economically from trade than they would be under a state of autarky. Degree of free trade policies The Enabling Trade Index measures the factors, policies and services that facilitate the trade in goods across borders and to destination. It is made up of four sub-indexes: market access; border administration; transport and communications infrastructure; and business environment. The top 30 countries and areas in 2016 are: [EMPERICAL DATA]

Singapore 6.0 Netherlands 5.7 Hong Kong 5.7 Luxembourg 5.6 Sweden 5.6 Finland 5.6 Austria 5.5 United Kingdom 5.5 Germany 5.5 Belgium 5.5 Switzerland 5.4 Denmark 5.4 France 5.4 Estonia 5.3 Spain 5.3 Japan 5.3 Norway 5.3 New Zealand 5.3 Iceland 5.3 Ireland 5.3 Chile 5.3 United States 5.2 United Arab Emirates 5.2 Canada 5.2 Australia 5.1 South Korea 5.0 Czech Republic 5.1 Portugal 5.0 Lithuania 5.0 Israel 5.0 Note: Singapore is the top country in the Enabling Trade Index. CONCLUSION:

It can be concluded that free trade has been a reality to developing countries since it contributed greatly to development of current developed countries such as china, South Korea, and other European countries such as Germany and Britain. For example, China is one of the developed countries that have achieved its developments through taking advantage of free trade to attract investors to its country and it investing in small countries such as those in Latin America thus boosting its developments. Although free trade has been attributed by negative impacts on small developing countries, positive impact surpasses the negative one and thus contributing to most of developments in the small countries. Therefore, based on my opinion, I think that free trade has positively impacted to developing countries as it has stimulated their economic development goals such as millennium development goals. Hence free trade has been a realistic aspect to developing countries.

RECOMMENDATIONS:

Since the opportunities are there and favorable for the growing business to enter a foreign market, I recommend that a growing business such as manufacturing business should explore these opportunities and learn from larger manufacturers especially technologically. This will help to increase efficiency, profitability and manufacturing better goods to its customers and succeed in the industry competition as well as gaining a competitive advantage which will help the growing business becoming a larger business worldwide.