Free Trade - Research Paper Example

 Free Trade Introduction and Background The expression “free trade” implies to commercial activities, which are, comparatively unimpeded and not supported by the set of laws and policies of government, for instance subsidies, quotas and tariffs. The idea of free trade was first perceived in 18th century, in response to mercantilism by a famous group of French economists called “physiocrats” and afterwards by Adam Smith and David Ricardo, who have been famous classic economists. (Sudo, p. 27) Comparative Advantage As stated by Maidment (p. 43) continuing the “laissez-faire” philosophy headed for worldwide trade, they emphasized the nations to focus production and export of goods which they could manufacture most efficiently and similarly to import those products which could not be efficiently produced. Thus, there will be a global advantage for all economies to privilege by this economic law of proportional benefit, in the condition, no obstacles for this type of trade. The practice of free trade received its initial impetus in Great Britain with the repeal (1846) of the Corn Laws and the subsequent sweeping tariff reductions under William Gladstone. In order to promote free trade among the fragmented German states, the Zollverein, a customs union, had already been formed (1834). The Anglo-French Treaty of 1860 and later free-trade treaties introduced the concept of most-favored-nation status, which greatly expanded international trade. Emergent nations, though, for instance the United States and numerous European countries, inclined in favor of high-tariff policies to protect young industries from foreign competition. The United States remained protectionist, until the 1930s, when the Reciprocal Trade Agreements Act of 1934 and other initiatives by Secretary of State Cordell Hull revived interest in free trade. An increased desire for free trade was reflected in the Bretton Woods Conference (1944); the General Agreement on Tariffs and Trade (GATT), after World War II; and such organizations as the European Free Trade Association and the European Economic Community. The European Community's effort to create a single European economy in the European Union, ratification of the North American Free Trade Agreement (NAFTA), and the inauguration of the World Trade Organization (WTO), succeeding GATT, in 1995, as well as the existence of such Latin American common markets as the Caribbean Community (CARICOM), the Central American Common Market (MCC), and the Southern Common Market (Mercosur) all illustrate the continuing shift toward universal free trade. Some economies, however, such as Japan's, remain highly protectionist. Nonetheless, through the Asia-Pacific Economic Cooperation (APEC), Asian countries including Japan, as well as other Pacific Rim nations are moving toward greater free trade in the 21st century. Western Hemisphere countries are also working toward a greater free-trade area in the early 21st century, and in 1998 they agreed to begin formal negotiations on creating the Free Trade Area of the Americas (FTAA). In 2003, Chile and Singapore became the fifth and sixth countries to sign free-trade agreements with the United States, after Canada, Mexico, Israel, and Jordan. (Maidment, 44) Protectionism versus Free Trade There are strong arguments against the restriction of international trade. Tariffs, for example, distort true cost relationships and reduce the differences in comparative costs. The extent of international specialization is reduced and so is the potential level of world output. Consumers in the home country are obliged to pay higher prices for the protected home-produced goods and services for imports. The erection of trade barriers also invites retaliations and increases the probability of a general reduction in world trade. Industries operating behind a tariff wall are protected from foreign competition and this could lead to a lower level of efficiency. On the other hand, there are arguments which can be advanced for the protection of particular industries or for a general system of protection in particular circumstances. Some of these may apply particularly in the case of developing countries which are trying to build up infant industries and industries producing substitutes for imports. (Dent, p. 47) Supply and Demand Side in Free Trade Although a number of supply-side measures have been taken in many countries during the last twenty years, many of the supply-side effects have been the result of changes in demand. During the recession of the early 1980s, much of UK industrial capacity was lost forever. Many of the redundant became deskilled and demoralized as they became long-term unemployed. On the other hand, many of those companies that survived were only able to do so by considerable increases in efficiency. Resistance from unions to the introduction of new labor saving technology was weakened by high unemployment and the fear that without the new technology firms might be forced to close. When demand was expanded in the late 1980s and unemployment began to fall, inflation rose and the balance of trade went into record deficit even during the depth of the succeeding recession in 191 and 1992. These events cast serious doubts on the ability of the economy to maintain sustained high economic growth and on whether the supply-side measures were as successful as the government maintained. The rate of increase in productivity has been higher in the 1980s and 1990s than in the 1960s and 1970s. But, to what extent his is attributable to the government’s supply-side measures rather than to other factors, such as international competition and a more rapid rate of technological advance, is not clear. (Grant & Stanlake, p. 467) Public Goods As is the case with other government intervention in the economic systems, the trade regime is usually characterized by non-excludability i.e. no one can be excluded of the use of such goods by policy and is also non-rival. With more use of such goods the value of the rules is increased that constitute such government controls. Such government control is manifested between economies that wish to enter into mutually beneficial trade practices on non-rival public goods. Whereas as far as the non-excludability is concerned, it is undesirable to exclude such goods from governments scope as the gains enjoyed by the society are enormous due to high rate of users, although this also might lead to the problem of the creation of “free riders” . Eventually, the execution of the worldwide market system is improved by the more and more producers and consumers, as more traders lead to increased but positive network external benefits. (Mendoza & Bahadur, p.1) Consumer & Producer Surplus The following diagram explains consumer and producer surplus in free trade situation: The domestic supply and demand curves on the left side of the diagram are represented by the SH and DH curves. The world supply curve is denoted by the line SW so that at OP the world price is kept constant. When free trade is observed the importing country imports QC, consumes OC and produces OQ. When the domestic price is raised to op’ by tariff, the consumption reduces to OC’ and production falls to OQ’, whereas the imports are reduced to Q’C’. The reduction in the consumer surplus overweighs the amplification in producer surplus by S’SHH’, whereas the tariff revenue is dispatched to consumers i.e. F’FHH’, thus the welfare loss is reduced to S’F’H’ +SFH. A similar effect is represented on the right side of the diagram where demand curve for imports is represented by DM, which is obtained by calculating the difference between domestic supply and demand at each and every price. At price OP, there are no imports as the demand is fully catered by the supply. On the other hand demand exceeds the supply on price OP. when due to tariff the domestic price increases to OP’; this causes imports to reduce to Q’C’. The welfare loss id RVR’ and the revenue from tariff is PRR’P’, the losses are combined into these two combined effects of consumption and production. (Kenen, p. 178-9) Pros and Cons of Free Trade Relatively free trade is beneficial in at least five ways: 1. In a broad sense, free trade permits and encourages persons and nations to produce for export those items to which their skills and resources are best suited. It also permits and encourages imports of items that other countries are well suited to produce. For example, the United States efficiently produces soybeans, soybean meal, and soybean oil. Soil and climate in the Midwest are well suited to soybean production; in addition, technical knowledge and mechanization have resulted in relatively low-cost output. Consequently, the United States exports soybeans and soybean products in large quantities. In somewhat the same manner, tea is produced relatively efficiently outside the United States. Even though tea might be produced in the United States under controlled conditions, it is advantageous for the United States to import tea and export soybeans. One or more countries to which the United States exports soybeans or soybean products probably could produce them at a lower absolute cost domestically. But they have rightly discerned that they can obtain even more soybeans (and other products) by producing tea (and other products), and trading the latter group for the former. This special capability is known as comparative advantage. All nations participating in foreign trade enjoy a higher level of living than they would if they tried to be self-sufficient. 2. Freedom to trade enables nations and individuals to specialize to some degree and achieve economies of scale that contribute to low-cost output. The ability to export successfully has encouraged the development of chemical, drug, farm equipment, and electrical machinery industries in the United States and the transistor radio industry in Japan. In each case, of course, there existed a degree of efficiency that of it encouraged exports. 3. Free trade enables nations to enjoy a wider variety of products. Furniture designed in Scandinavian countries and works of art from Asia and Africa enrich the lives of people in the United States even though similar items perhaps could be produced at home. Other items, such as coffee, might not be enjoyed at all, or might be enjoyed by only a few at very high prices, if trade restrictions prohibited imports. 4. Political and social progress within countries has been stimulated by relative freedom to trade. 5. Mutual benefits derived from freedom to trade strengthen international political cooperation and increase the chances for peace. Through the years the concept of complete freedom to trade has been subject to various limitations, some perhaps desirable, some not. At least five impediments exist. 1. The assumption that there will be international military or political conflict has motivated countries to protect industries they deem essential for self-sufficiency and defense. Also, industries or corporations that have been built up during a war tend to receive strong trade protection after the war ends. 2. Economic fluctuations within countries have tended to perpetuate or increase trade barriers. Thus the Great Depression of the 1930s created in the United States and other countries a strong inclination to support and maintain domestic industries as world demand declined. In part, however, this policy proved self-defeating because barriers to imports reduced the foreign exchange needed to support exports. 3. Some nations have desired to achieve greater exports than imports in order to increase foreign trade balances or international financial reserves. As a consequence, their foreign exchange goals may, from time to time, lead to the creation of trade barriers. A continued trade conflict of at least a moderate sort appears likely, since a trade surplus by every nation is impossibility. 4. Trade barriers tend to bring retaliation: comparable or more severe trade barriers arise in other countries. The imposition of each new trade barrier, no matter how well justified, tends to set in motion a chain reaction of trade barriers. 5. Determined efforts to reduce trade barriers tend to be frustrated by changes within countries and even in individual corporations. In negotiations on the General Agreement on Tariffs and Trade the general and apparently necessary conclusion has been that the achievement of free trade must be gradual. Works Cited Dent, John H. Protectionism versus Free Trade, Vital Speeches of the Day, 2007, Vol. 37 Issue 2, p47, Database: Academic Search Premier Grant, Susan & Stanlake, George. Introductory Economics, 7th Edition, Pearson Education Limited, 2000. P. 467 Kenen, Peter B. The International Economy, 4th Edition, Cambridge University Press, 2000, ISBN0521644356, 9780521644358, p. 178-9 Maidment, Fred. International Off-Shoring: The Changes in the World Economy, Journal of American Academy of Business, Cambridge. Hollywood: Sep 2009. Vol. 15, Issue 1; p. 43 -5 Mendoza, Ronald. & Bahadur, Chandrika. Toward Free and Fair Trade: A Global Public Good Perspective - Reforming Globalization - Statistical Data Included, Sep-Oct, 2002, July 11, 2009 at http://findarticles.com/p/articles/mi_m1093/is_5_45/ai_91659835/pg_2/ Sudo, Phil. Is Free Trade Fair Trade, Scholastic Update, 1996, Vol. 126 Issue 14, p27, Database: Academic Search Premier. Read More