What Is Free Trade - Report Example

What is Free Trade? 2008 I. Introduction Free trade is a market model in which goods and services can be traded across national barriers without the hindrance from the government in the form of subsidies, tariffs and non-tariff barriers. While neo-liberal economists who advocate free markets also propose free trade between countries, which ostensibly increases efficiency of production and lowers product prices globally. The opponents of free trade, however, point out to market imperfections that put some parties of the international trading order at a disadvantage. In this paper, I will discuss the arguments for and against free trade through a historical analysis of international trade and show that welfare of all countries is not necessarily met through free trade. II. Theoretical Premise for and against free trade The proponents of free trade base their arguments on the absolute advantage theory of Adam Smith and comparative advantage theory propounded by David Ricardo. While Adam Smith, in the seminal treatise Wealth of Nations, proposed that a country should produce what is cheaper to produce at home and import other products (Buchan 2006, pp 145-146), Ricardo, in Principles of Political Economy and Taxation developed a model by which a country might gain through importing a commodity even if its cost of production is lower in the home country if the opportunity cost of producing it is higher (Findlay, 1987, pp 514-517). On the other hand, the opponents of free trade, mostly in the Marxian school of thought, argue that free trade in the classical liberal sense, which essentially is based on free markets, is contingent to restrictive assumptions of homogenous labor across industries and to no movement of labor and capital across countries, does not necessarily lead to increased welfare of all countries. The latter stream of thought is also critical of the neo-liberal theories that advocate free trade even in open economies on the premise of imperfections in markets. The post-World War II global economic order has seen major changes in the balance of power between economic agents. While the 1950s and 1960s were mainly the period of post-war reconstruction in major developed countries in the western world, it was also the period of growth of transnational countries originating in this part of the world and increase in international trade, mostly through exporting manufactured goods to developing countries in Asia, Africa and Latin America and importing primary goods from this group of countries. At the same time, many of these developing nations were then grappling with issues of post-colonialism and revival of domestic industries. This resulted in the development of various alternative theories regarding international trade, many of which refuted the argument that free trade is beneficial for all countries. The ‘unequal exchange’ theory developed separately by Singer and Prebisch maintained that gains of trade have in generally been towards the rich countries. In the 1950s, Raul Prebisch (cited in Thomas, 1994, pp 156-165) and Hans Singer (cited in Toye, 2003 pp 388) both arrived at the same conclusion through empirical research that terms of trade between primary and manufacturing goods have been adverse over time. That is, the exporters of manufactured good were at an advantage in terms of prices than the exporters of primary goods. Hence, the developed countries, which exported manufactured goods, gained more from international trade than the developing countries, which exported primary goods like food, did. Besides, income elasticity of demand of manufactured goods is higher than that of primary goods, particularly food. Hence, the countries that produce primary goods can import less manufactured goods, thereby increasing the difference in the levels of income in the two sets of countries. The Singer-Prebisch thesis has lost much of its relevance over the 50 years since, with manufacturing processes developing in less developing countries as well, yet researchers find that the growth differentials between the rich and poor countries have continued. Toye (2003, p 465) maintains that structural changes in the products and factor markets and inequalities in technological progress have ensured that unequal exchange in trade persists. Samir Amin argues that in the 1970s international trading systems operated as if in a center-periphery relationship in which the developed countries of Europe and America formed the center and the neo-colonial underdeveloped countries of Latin America, Asia and Africa formed the periphery (Amin, 1997, pp 156). The center-periphery had existed even earlier but then, according to Amin, the divide was based on being industrialized and non-industrialized. In the post-war period, industrialized peripheries also emerged and the world capitalist system reorganized on the basis of control over technology, financial flows, natural resources, media and communication, and weapons. However, the center-periphery relationship remained intact, primarily on the basis of international trade flows. Emmanuel (cited in Kenneth, 1999, p 64), too, found western imperialism as a bottleneck to the development process of poor countries, discarding the Ricardian theory of homogenous labor, uniform wages across countries and immobile capital. This results in a situation in which a low-wage country pays more for a good that it imports than it earns through the export of another good. Despite the various arguments posed against free trade and the unequal benefits arising from it, the neo-liberal arguments for free trade have remained dominant in international policies, particularly those that are advocated by multilateral organizations like the World Bank, International Monetary Fund and the World Trade Organizations. These organizations have proposed and put in place in many countries structural adjustment programs that essentially remove restrictions to free trade by removing tariff and non-tariff barriers. III. Globalization and Free Trade Although post-war international order has given rise to two alternative economic models – the capitalist system and the socialist system, the capitalist system, based on the neo-liberal theory of free trade is dominant in the international trade sphere. Proponents of free markets and free trade have argued that these enable increased efficiency and thus faster growth in both developed and developing countries (Bhagwati, 2004, pp 256). By the 1970s, however, an alternative doctrine of trade arose, by which market imperfections were thought to result in a bias against developing countries, which became more assertive in demanding for an economic order that would shift power from rich countries to a more equitable system (Looney, 1999, pp 345). The New International Economic Order (NIEO), framed by member governments of the developing world, was approved by the United Nations in 1974. The main elements of the NIEO included providing stable commodity prices in the export market, governments’ rights to regulate transnational companies and a balance of power among nations in international trade. It was aimed at providing a more equitable trading system, even at the cost of some assumptions of free trade being relaxed. This, however, did not mitigate the growth of a parallel economic order – the transnational companies (TNCs) - which had by then grown to be independent of local politics and governments. Despite the political movement by countries towards an international order through the 1970s and 1980s, TNCs have continued to remain on their growth trajectory and since the 1990s, the global economic order has moved from being international to transnational. The New International Economic Order (NIEO) of the 1970s and 1980s was instituted during the backdrop of stagnating domestic economies, growing inequalities with the developing world and diminishing competitive powers in global trade, particularly for commodity exports, and success of the oil cartel by OPEC. The North-South confrontation, in essence, had its theoretical roots in the Marxist literature on past exploitation during colonialism and present exploitation by transnational companies, termed neo-colonialism (Looney, 1999, pp 346). Through the 1970s and 1980s, the South pushed for a set of documents in the NIEO in the UN General Assembly, but these remained only political rhetoric rather than legally binding agreements. Through the decades, the international trading system continued to be biased against the developing nations and ruled by multinational companies. By the 1990s, globalization reached a new height such that companies, rather than countries, became the prime movers. Multinational companies expanded through globalization of production, that is movement of capital and labor. According to Human Development Report (1999, cited in Serrano, 2005, pp 2), globalization refers to shrinking space, time and disappearing borders. Globalization also means increased trade and investments. While this is generally beneficial to businesses, it may not necessarily be so for the everyday person. Globalization is most typically based on free trade between countries and removal of tariff and non-tariff barriers, which had earlier protected local industries in many countries, particularly the poorer ones. According to Stiglitz (2002, pp 167), the discontent over globalization has been due to unfair practices and mismanagement, which has not enabled all countries and stakeholders to reap the potential benefits of globalization to the same extent. IV. Free Trade and Labor Typically, while the developed nations have insisted on a liberal environment in the developing countries, with Structural Adjustment programs requiring reduction of tariffs and non-tariff barriers, the former group of countries imposes many non-tariff barriers on imports from the latter. World Trade Organization (WTO) laws prohibit discrimination against imports of products from particular countries unless these are deemed “necessary to protect public morals….human, animal and plant life or health” and are not “arbitrary or unjustifiable discrimination” (quoted in Shaffer, 2000, pp 147). However, there are increasing demands on the WTO to take a stand on whether to allow trade discriminations based on labor standards. Essentially what Shaffer (2000, pp 149) calls a “western approach”, such restrictions are based on standards laid out by the International Labor Organization (ILO) on forced labor, minimum wages and maximum work hours, non-discriminatory work environment, workplace safety and child labor (OECD, 1996 cited in Stern & Terrell, 2003). Taking advantage of these labor standards, developed countries often impose non-tariff barriers to imports from developing countries on the basis of these conditions. Advocates of labor standards argue that imposing the above conditions for trading particularly with the developing ones would force the latter to implement better conditions of work while at the same time protect jobs in developed countries by reducing the wage differentials between the developed and the developing countries. Economists, however, point out that linking labor standards with trade does not result in optimum use of labor and capital since it is essentially biased against the productive use of resources. They argue that imposing labor standards on developing countries actually reduces their productive opportunities, thereby making them poorer and hence reduces wage levels even further, instead of protecting their bargaining power in the labor market (Stern & Terrell, 2003). V. Free Trade Agreements The effect of trade on labor and consumers is evident in the North American Free Trade Agreement (NAFTA) signed between the United States, Mexico and Canada in January 1994 to create the largest free trade area in the world. The agreement, modeled on the European Union, was supposed to reap the maximum potential from trade among the three North American economies by eliminating tariffs between them. The final tariff reduction was done in 2003 and since then nearly all trade between the three countries is free. Besides tariff reduction, the trading partners agreed to reduce trade restrictions on a wide range of products, including automobiles and parts, computers, textiles and agriculture. The agreement also protected intellectual property rights and removed restrictions on investments between the three countries. Although exports from Mexico and Canada to the United States have increased since the signing of the NAFTA, US exports to these countries have resulted in controversies. The issue has particularly been contentious in the case of agricultural exports from the United States as Mexican and Canadian farmers have claimed that US exporters of agricultural commodities have an undue advantage over them because of the huge amounts of subsidies paid to them by the US government. Corn imports from US have been severely criticized in Mexico and critics claim that corn imported from the US is sold at a 15 to 20% lower price in Mexico. While free trade through NAFTA has in general reduced the costs of production since production has shifted to locations were costs are lower, it has nevertheless resulted in a lowering of product prices. It has given consumers more choice regarding products as well as lower prices. The pattern of trade has not only had an effect on the structure of agriculture and industries in the trading partners, but has also spurred changes in consumption patterns. For example, US corn exports have changed in composition, while yellow corn was used to make animal feed, it is increasingly exported from the US to Mexico and Mexican farmers have increased the production of white corn, which is used to make tortillas. As a result, Mexican flour companies are increasing their sales of white flour not only in Mexico, but also in the United States. This has resulted in a shift of consumption preferences even in the United States (Zahniser & Koyle, 2004). VI. Conclusion Thus, many of the assumptions of classical free trade theory do not exist anymore. With globalization, there is movement of labor and capital across countries which further complicates the comparative advantage positions. However, neo-liberal theorists have continued to insist upon free trade, claiming that this increases efficiencies in production in all countries. However, historical and present evidence shows that free trade leads to inequalities across countries, gains from trade being unequal, differences in welfare and distortions in labor and product markets particularly in the developing nations. Reference list Amin, S 1997, Capitalism in the Age of Globalization, Zed, London. Bhagwati, JN 2004, In Defense of Globalization, Oxford University Press, Oxford. Buchan, J 2006, The Authentic Adam Smith: His Life and Ideas, W W Norton, New York. Fieldhouse, D 1999, The West and the Third World, Blackwell Publishing, New York. Findlay, R 1987, “Comparative Advantage”, The New Palgrave: A Dictionary of Economics, volume 1, Macmillan and Stockton, London and New York. Frank, AG 1979, Dependent Accumulation and Underdevelopment, Macmillan, New York. Looney, R 1999, “New International Economic Order” in R.J.B. Jones ed., Routledge Encyclopedia of International Political Economy, Routledge, London. Serrano, I, 2005, Community Development and Globalization, Paper presented at the International Conference, Civil Society, Religion and Local Governance: Paradigms of Power and Persuasion, 1-2 September, Australia, Canberra. Shaffer, G 2000, WTO Blue-Green Blues: The Impact of US Domestic Policies on Trade-Laor, Trade-Environment Linkages for the WTO’s Future, Fordham Internation Law Journal, Nov – Dec, pp 144-152 Stern, RM & Terrell, K 2003, Labor Standards and the World Trade Organization, Position Paper, World Trade Organization, August. http://www.wto.org/English/forums_e/ngo_e/labor_standards_e.doc Stiglitz, J 2002, Globalization and its Discontents, W W Norton and Co, USA. Thomas, LJ 1994, Neoclassical Development Theory and the Prebisch Doctrine: A Synthesis. American Economist, Vol. 38, pp 156-165. Toye, J FJ 2003 "The Origins and Interpretation of the Prebisch-Singer Thesis" History of Political Economy, Volume 35, Number 3, Fall, pp. 437-467. Zahniser, S & Coyle, W 2004, US-Mexico Corn Trade During the NAFTA Era: New Twists to an Old Story, United States Department of Agriculture, May, retrieved from http://www.ers.usda.gov/publications/FDS/may04/fds04D01/fds04D01.pdf#search=%22NAFTA%20US%20MExico%22 Read More