The Flow of Goods and Services between Countries - Essay Example

?Introduction The flow of goods and services between countries has been a very important economic activity in the history of mankind. International trade has a huge potential for the economic development of a country. But it can also have adverse consequences on the economy of any country. For this purpose every country needs to follow a definite trade policy in tune with the economy of the country.(1) While some country had adopted an open economy policy with regard to foreign trade others have taken a more protectionist approach. The advocators of trade points out that trade help the countries to export goods and services in which they have a comparative advantage. It helps the countries to utilize the economies of scale and optimize their resources. Transfer of technology also helps the countries to achieve higher levels of production with the given resources. All these lead to lower global prices which ultimately benefits the consumer. Increase in competition wipes out domestic monopolies and monopsony. It also helps the countries to use their surplus goods to get other things. For example the Middle East countries have a lot of oil but they lack in primary and secondary sectors. In absence of trade they would not have very little agricultural and manufactured goods. Similarly Japan which has very limited raw material gains from trade. The protectionist approach is the restriction of free trade in the country through various policies including the creation of trade barriers like tariffs and quota. Economists and policy makers have engaged in a lot of debate for centuries on the role and impact of free trade and protections of the development of a country. Free trade has certain advantages. For the exporting country it helps the economy of a country to produce goods that utilizes its resources more efficiently. Therefore the income of the people should rise. At the same time for a country exporting a good the standard of living improves as import from a country having efficiency in production of good will be necessarily cheaper. It also offers more choices to the people. Trade enables a government to divert the national resources of capital, labour and technology towards better utilization. The World Trade Organization argues that trade has a positive impact on the growth and hence the income of the nation. The extra income can then be redistributed by the government to achieve better facilities for the citizen. Estimates suggest that reduction of protection on trade by one third would expand the world economy by $613 billion. It can be argued that free trade will have a beneficial effect on the entire world economy. It allows for a division of labour and employment of resources at production it is best suited for. However the effect of free trade on employment may or may not be beneficial. According to EU estimate creation of single market would create 300,000 to 900,000 new jobs. But the domestic industry faces stiff competition from the imports which enjoy the benefit of economies of scale. That may also lead to a loss of jobs. Also without any restriction on the mobility of labour and capital, a flight of capital from a country becomes easy. This can accelerate the contraction of any economy. (2) Benefit From Free trade and the Theory of Comparative Advantage In the 18th and the 19th century a number of renowned economists propagated the idea of trade as the engine of growth for a nation. Among them Adam Smith gave the concept of Absolute Advantage. Advantage here means the ability of country to produce goods and services at a lower cost and thus better management of resources. His successor David Ricardo gave the theory of Comparative Advantage. To demonstrate the benefits of trade among two countries he gave the classic example of England and Portugal. Suppose England has a comparative advantage in production of cloth and Portugal in wine. Then England should utilize all their resources in the production of cloth and Portugal in wine. In this way the total cloth and wine in the two economies after trade will be more than that before trade. In this way Ricardo highlighted the advantages of trade. This theory has found acceptance in many of developed countries like UK in the 19th century and USA in 20th century. Several agreements have been reached between various countries which seek to develop the countries by promoting free trade to reap the benefits of comparative advantage. Followers of the Theory of Comparative Advantage had advised that the Britain should open up their grain market during the Great Irish Famine. But even this failed to bring the cost of food within the affordability of the Irish. Adam Smith, the first proponent of free trade had mentioned that some sectors like defense and navigation should be kept under protection for the benefit of the people. Furthermore, the developing industries of country can hardly survive if faced with stiff external competition. Therefore it is always necessary to shield and encourage the domestic nascent industries till they reach a mature stage of production. This policy had been followed by USA, Germany and the newly developed industrial countries of Asia. They had wisely protected and subsidized their domestic industries and reached a high level of industrialization. According to Mark Weisbrot the Comparative Advantage theory assumes that there is perfect competition and resources of a country are fully employed. Under such a situation, shifting the resources of a country to the sector having comparative advantage will boost the national production. This extra production can be redistributed to account for any loss of income and employment in sector having comparative disadvantage. But in real life, rarely are resources of a country fully employed. In such a situation free trade may lead to further unemployment. Benefits of free trade are likely to benefit only the richer section for the poor section it can lead to stagnation or depression of wages as the markets become more competitive. Greece having a rigid nominal wage rate failed to gain from the single market of Euro zone. A major disadvantage of the theory, Weisbrot points out, is that it assumes that a country will continue have the same state of production efficiency and capacity forever. However in reality, the specialization of a country’s resources tends to change with economic growth, technological innovation and various other factors. According to Richard Brinkman, a country currently having specialization in primary sector will continue to remain at a low level of income if it cannot develop the other productive sectors. According to some opponents of free trade, the most important benefactors are the transnational corporations. The multinationals in search economies of scale and the optimum resources spanned their existence in multiple nations and paved the way for globalization. In this way they help the nations direct their resources towards efficient utilization. But the gains of the MNCs does not always benefit the host countries. The TNCs mostly employ only some hundreds of employees. So they does not generate huge employment. Moreover international trade also occurs within the corporation or between corporations. Therefore the corporations earn more than the nations. The transnational corporations also become so powerful that they can mould the policies and strategies of the government to their advantage. Free trade can also lead to formation of cartels among the corporations which leads to a suppression of supply or rise in price. Free trade and agreements towards free trade has been surrounded by a lot of controversies. While some have pointed out that it would lead to growth of income and employment, others have argued that it is a too optimistic expectation. Empirical Results NAFTA or the North American Free Trade Agreement is an agreement between United States, Canada and Mexico to promote unrestricted trade between the three countries. It is a very important international trade agreement partly because it brought a huge region under free trade and also because the domain of issues it brought under consideration. There was a lot of debate about the possible impact of the agreement because the deal was between a developing country and developed countries. The deal was to dismiss all tariffs and reduce the other non tariff restrictions. It has had a lot of impact on the economies of the member countries. In the United States, the deal was supposed to create a large number of jobs through increased trade. The rationale was that increase in trade would lead to creation of more jobs. The argument was that Mexico has a large consumer market which will have a high demand for US consumer goods. Thus export of these goods will rise leading to income  and employment generation. However it was seen that after the agreement majority of the US export were parts and components for the Mexican manufacturing industries. The finished products from Mexico returned to the US markets at a higher price. These products are assembled at the duty free zones of Mexico where duties are paid only as VATs. United States in these circumstances have faced rising trade deficit with Canada and Mexico. This can be attributed to the fact that though exports from US to its NAFTA partners have increased considerably. Real export growth for Mexico is 95.2% and for Canada it stands at 195.3%. But the growth in import outweighs them. From mexico import growth is 195.3% and from Canada it is 61.1%. As a result balance of trade has suffered miserably. This has led to loss of employment in all the states of US. NAFTA had special provisions for encouraging foreign direct investment. There were several guidelines for performance that was required. Canada and Mexico benefitted from this provision. They managed to make proper use of these to develop their economies and attract a number of foreign direct investments. After the deal there was a huge increase in the amount of FDI in both the countries. This is because the countries showed adequate commitments to change their policies to reap the benefit of the provision. The deal not only encouraged the US investors to invest in Mexico but also cleared all doubts of the other global investors about the capital utilizing capacity of the country. The high labour force and the low wage rate made Mexico an attractive place for foreign investors to invest their money in the labour intensive secondary industries. A large number of factories came up in Mexico and Canada that produced goods for exporting to US. As a result the amount of import in USA increased considerably in the aftermath of NAFTA. Though the exporting industries of the countries performed well, but the import competing industries had to face competition and lose jobs. The loss of jobs in the import competing sector was more than export sector. So the net effect was a loss of jobs. Read More