Role of World Trade Organization in Reducing Barriers of Free Trade - Assignment Example

In an ideal world, there should be no trade barriers’ Table of Content Need for international trade 3 Theories of international trade 4 Comparative Advantage 4 The Absolute Advantage Fallacy 4 Endogenous Advantage 5 Bilateral Trade Patterns 5 Division of the Gains 6 Concept of quota, tariff & subsidy 7 Role of World Trade Organization in reducing barriers of free trade 10 Reference 12 Need for international trade The term “international trade” indicates exchange of goods and services between two countries. Such inert-country trade started years back to stabilize the demand and supply between two countries and it helped in reallocation of resources through out the world. This had benefited the producers as they where able to reach large numbers of consumers and in the same way consumers got benefited because they had more variety to choose. As the time passed by, countries realized importance of trading on international platform because it allowed them to use their resources (labor, technology or capital) efficiently and produce them at comparatively law cost. On the other hand the countries which can not produce goods and services efficiently at law cost started importing from other countries and thus international trade began. Thus international trade created opportunities for foreign direct investment (FDI). Through FDI many countries received inflow of capital which helped in their economic development through development of industries and infrastructure and creation of employment opportunities. Such investments were beneficial not only for the companies who receive FDI, but the investing countries also made good return on their investment. But free trade is viewed differently by different nations; as some developed nations supported free trade on the other hand many developing nations protested it. To protect their domestic industries countries applied many trade barriers like tariffs, subsidies and quotas (Heakal, R, 2009). Theories of international trade There are many theories proposed by different economist at different point of time which focuses on liberal trade. The term liberal trade refers to international trade without any barrier. Theses theories are as follows Comparative Advantage This theory was proposed by Ricardo which takes into account the difference in labor productivity between two nations. The country will prefer to produce that very product for which competitive advantage is high in terms of wages paid to the workers. So the countries who have lower wages rates will be able to produce goods at much lower cost compared to others and the price of these product will be comparatively low. Thus demand for their goods will be high among other countries and they will start exporting. Thus as per this theory, trade between two countries occurs due to difference in relative prices. Thus each country can use their resources effectively as if there was a completely integrated world (Anderson, James E., n.d.). The Absolute Advantage Fallacy This theory simply says that a country will export its goods to other countries if these goods are cheap in the domestic market but the price of these products is high in the foreign market. Thus the only cause behind such trade is the price difference in two markets (Anderson, James E., n.d.). Endogenous Advantage As per this theory, a country will import those items those are unavailable in the domestic market. Examples of such products are oil and diamond which are found only in certain regions but get exported to vast part of the world. Thus such exporting countries have endogenous advantage over other and this provides them the opportunity to carry out international trade. Due to high volume of international trade, the exporting countries enjoy economics of scale which help them to increase their profit margin further more and to expand their product lines (Anderson, James E., n.d.). Bilateral Trade Patterns This theory explains the cross commodity trade pattern between two trading countries. This model is based on three main assumptions which are as follows- Expenditure on goods from all sources is equal to income from sale to all sources. All countries have same taste for all goods. Product differentiation due to the place of origin is strictly restricted. Thus trade should be frictionless and any restriction on free trade will create hindrance on international trade and thus the cost of trade will increase (Anderson, James E., n.d.). Division of the Gains As per the bilateral trade, both the countries who are in trade will gain advantage, but this advantage may not get equally distributed among both the countries. A nationalistic trade policy makes the country to gain more from trade and resulting to destructive trade war. Due to such trade policy the poor nation suffers more as compared to the well developed dominating nation (Anderson, James E., n.d.). Thus all these theories specify the cause and impacts of free international trade on developed and developing nations. It has been seen that the developing nations take many precautionary measures to protect their indigenous industries from threat of foreign competition which are in the form of Tariffs, Quotas and subsidies. Concept of quota, tariff & subsidy Effect of tariffs and quotas on producers, consumers & economy as whole Fig-1 Quotas are the non monitory measures of protectionist policy that creates barrier in free trade. It puts limitation on the physical quantity that should be imported or exported from abroad. This simply benefits the domestic producers as because they get protected from international competition, but quotas leads to high prices of foreign goods for the consumers. Thus it reduces the amount of foreign goods which can be imported from aboard. The economic impact of quota is as follows- In a perfect competitive market, equilibrium price is determined by demand and supply curve. Initially when free import was available, the quantity of goods consumed by domestic consumer increases but this reduces the domestic producers’ profit. In this state the domestic producers make less contribution where as rest of the portion is be supplied through import. The consumers have to pay less due to reduction in price and they are able to purchase more. So along with the consumers, the whole economy gets benefited. To protect the domestic producers from adverse effect of high import, government introduces quota which put limits on the quantity of goods that can be imported from abroad. As the effect of quota, production of domestic producer increases and producers surplus expands. This causes the price of goods to increase and finally the quantity of goods consumed in domestic market declines. All this leads to loss in world economy which is called “deadweight loss”. Government sometime imposes export quotas to reduce the level of export from their own countries to aboard. Hence this is a tool through which government can suppress export of necessary goods like rice, wheat, sugar or any other commodity and can keep a tag on their prices. Tariff is the monitory barrier that is imposed by government to reduce import from abroad. It is in the form “duty” which is imposed on goods that moves across the countries but may be imposed on export goods to reduce the level of export. Actually tariff is the extra price which consumers have to pay for imported goods or the extra charges which the importer pays on importing goods. As a result the amount of goods imported into the country and of the exported goods both reduces. There are different types of tariffs which government imposes like: Ad-valorem tariff which is equal to certain percentage of the value of goods that is to be imported. But the main problem is that they continuously fluctuate as the price of the goods changes in domestic or international market and as a result alter the amount of import or export taking place from the home country. Specific tariff is non fluctuating tariff which does not change with change in the price of goods or change in the market situation. They only changes when they get updated by government. Revenue tariff is the tool used by the government mainly to raise money. Example of this tariff is the one which is imposed on export of coffee by non coffee growing countries. Prohibitory tariff is an extreme high tariff, so that no one can import that particular item from aboard. Protective tariff is imposed typically to prohibit the export of particular product and to safeguard domestic industry from foreign competition. Environment tariff which is also known as “green tariff” or “eco tariff” is imposed on those exported or imported item which are related to environment pollution controls The theory of tariff is based on the assumption that the demand of item is perfectly elastic and the supply of good from abroad is unlimited. To protect the domestic producer, government increases price of goods by imposing tariff on them and as a result of increases in price, consumption of that very item goes down. The impact of tariff can be negative as well because it increases the price and reduces the level of international competition on domestic industry. Thus the domestic industry pay less attention toward quality control and the product quality goes on reducing. But this cause huge loss to the economy as because a major section get lost without causing any benefit to anybody. Thus tariffs causes more lose to economy compared to quotas (The Theory of Trade Policy, 2009). To protect the domestic industry form foreign competition many government provide subsidy to different sectors. Subsidy is a financial assistance which government pays to support business or to encourage activity which otherwise doesn’t have survived. These are the form of trade barriers which government provided to distort market condition and it impose larges economic cost. There are many kinds of subsidies like Direct subsidy- these are direct cash provided as financial assistance. Indirect subsidy- these are non-monitory assistance which are provided for development of the domestic industry. Labor subsidy- this subsidy is paid for labor cost or deduction in tax against wages paid to workers by the companies. Production subsidy- it is provided to encourage a particular industry. Infrastructure subsidy- this is special form of subsidy which is directly provided for infrastructure development. Export subsidy- this is provided to different industries for promoting export which are in form of tax reduction, or reduction in the price of raw materials and other consumables. Consumption subsidy- government provides such subsidy by reducing the price of goods and services, or by providing economic incentives like in education, public health care, or goods of public consumptions. Role of World Trade Organization in reducing barriers of free trade World Trade Organization (WTO) was founded in 1995 with an aim to promote not only free trade but also encourage the sector like services, agriculture and intellectual property. The main principle of WTO was to promote non discrimination between nations in term of trade, to bring transparency among negotiations and to provide special and differential treatment for the developing nations till they attain strong economic state. But the main aim was to develop free trade across the world as this will lead to true globalization (Shah, A. 2006). For this WTO has asked different nations to remove all trade barriers like subsidies, quotas and tariffs. As per WTO this will be highly beneficial for the consumers because they will have more choice and that also at much reasonable prices. Increase in bilateral trade will lead to higher exports and thus the GDP of nation will increase which will have a synergic effect on the whole economy. As the domestic industries will be exposed to international competition, so to sustain in the market these have to improve the product quality and have to keep prices comparatively low. Thus it can be concluded that “In an ideal world, there should be no trade barriers”. Reference Anderson, James E., no date. International Trade Theory. Boston College. [online]. Available at: http://www2.bc.edu/~anderson/PalgraveTrade.pdf [Accessed 30th June 2009] Heakal, Reem, 2009. What Is International Trade?. Investopedia. [online]. Available at: http://www.investopedia.com/articles/03/112503.asp?viewed=1 [Accessed 29th June 2009] Shah, Anup, July 28, 2006. The WTO and Free Trade. Global Issues. [online]. Available at: http://www.globalissues.org/article/42/the-wto-and-free-trade [Accessed 30th June 2009] The Theory of Trade Policy, 2009. World Scientific Publishing. [online]. Available at: http://www.worldscibooks.com/etextbook/6849/6849_chap11.pdf [Accessed 30th June 2009] Read More